The conservative government’s surprise move to tax income trust distributions isn’t likely to set a precedent. Economists and analysts believe only another dire emergency would force further tax changes outside of the normal budget process. And there aren’t any such situations on the horizon.

Finance Minister Jim Flaherty’s Halloween move was spurred by the urgent need to prevent large companies — such as BCE Inc. and EnCana Corp. — from forming trusts and robbing federal coffers of corporate tax revenue. But it has left many wondering if tax promises that were part of the Conservatives’ election platform — such as eliminating capital gains on reinvested assets — will be on the agenda when the government tables its next budget in either late winter or early spring (depending on when the Conservatives want to face another election).

No doubt, there will be changes to both personal and, possibly, corporate income taxes in the next federal budget. It will, after all, be an election budget. As well, says Dale Orr, managing director of economic consultants Global Insight (Canada) Ltd. in Toronto, the 2007 budget will need to be a “good news” budget to counteract the negative reaction to the income trust move.

Indeed, David Perry, senior research associate at the Canadian Tax Foun-dation in Toronto, looks to the pension income-splitting measures that accompanied the change in income trust taxation to suggest a possible direction for the 2007 budget.

Pension income-splitting can be seen as a step toward a tax system in which taxpayers have the choice to file tax returns as a family. Perry points out that this would be in line with the desire of the Conservatives — and particularly the branch of the party that used to be Reform — to encourage stay-at-home mothers.

Family taxation essentially means splitting the unequal income of the two partners so that the joint family income would be taxed at rates that are about half of what the higher earning partner would pay on that income. This would be a significant change in the tax system because it would mean that those still filing as individuals would probably see their rates rise to make up for the revenue lost from families filing joint returns.

Finn Poschmann, research director at the C.D. Howe Institute in Toronto, would like to see improvements in the tax rate for low-income families with children. This is tricky because, if the government increases the threshold for clawbacks, it just changes the income group hit the hardest. But, he says, it could be improved by adjusting clawback rates and thresholds so they don’t all hit at their maximum at the same income point.

Orr does expect the Conservatives to lower the amount of income taxes paid by those in the lowest tax bracket to 15% — the level to which the Liberals had taken it prior to the last election — or even lower. He also expects the Conservatives to increase the basic personal income exemption to more than $9,000, or at least as high as it was under the Liberals.

At the other end, Orr thinks the Conservatives should put a priority on lowering the top tax bracket, pointing out that that’s where the Canadian tax system is out of line with the U.S. system. Lowering that rate would both encourage new highly skilled immigrants to move here and keep our bright young people at home.

Perry expects there will also be targeted tax cuts in the 2007 budget. The 2006 budget had a number of these, including tax credits for employment, transit passes and physical fitness. He notes that this will further complicate the tax system and is contrary to the Conservatives general laissez-faire approach to the market place. But, again, this will be an election budget.

Delivering on the capital gains promise, however, is going to be tricky. The question is which asset sales and reinvestments would qualify and how much of the gains would be tax-free. It would not only be too expensive to eliminate the tax on all asset sales but that tack could also be abused by speculators moving in and out of assets every six months.

There is certainly no clear agreement among analysts. Orr, for example, thinks the Conservatives are unlikely to include capital gains from most equity investments but rather will focus on one-time sales of things such as cottages, family heirlooms and licences. The examples in the Conservatives platform were gains on equity investments donated to charities and fishing licences.

@page_break@The idea is to encourage people to sell assets when it’s economically appropriate rather than hanging on to the assets because they are afraid of how much taxes they will have to pay. Orr doesn’t expect reinvestment requirements; he instead envisions a lifetime limit on the capital gains exemption.

Poschmann thinks there are simpler approaches. One is the introduction of tax-prepaid savings plans into which taxpayers can put financial market investments on which they expect capital gains. They wouldn’t be taxed on those gains because money withdrawn from TPSPs would be tax-free. TPSPs weren’t in the Conservatives’ election platform but, Poschmann notes, the Conservatives have supported the concept in the past.

Poschmann favors TPSPs for much more than deferring capital gains. Because contributions are made from after-tax income and withdrawals aren’t taxed, they would provide an incentive for low-income individuals — for whom the RRSP deduction is not relevant — to save. TPSPs would also provide incentives to high-income earners to sock away more.

Another option is a capital gains deferral account, with a lifetime contribution limit of $150,000, into which investors could put financial assets without paying capital gains taxes until withdrawal. At withdrawal, taxes would be paid on a pro rata basis. For example, a withdrawal of 10% of the current assets would be treated as a withdrawal of 10% of the original tax base and 10% of the net accumulated capital gains. This was suggested in an April C.D. Howe joint paper by Jack Mintz, professor of business economics at the Rotman School of Management at the University of Toronto, and Tom Wilson, senior advisor for U of T’s Institute for Policy Analysis.

For hard assets and capital gains already accruing to financial investments, Poschmann says, another possibility would be a provision that allows individuals selling assets with capital gains to put the proceeds into their RRSP without paying the capital gains taxes on them. This was suggested in the 1998 report of the technical committee on business taxation, chaired by Mintz.

On the corporate taxation front, Orr would also like to see a commitment to a lower corporate tax rate than the 18.5% Flaherty announced with the income trust tax changes. The tax cut won’t take effect until 2011.

Poschmann agrees, calling the announcement of the 18.5% rate in 2011 “grudging.” He wants to see capital taxes on financial institutions eliminated. Both Ottawa and many provinces have moved toward eliminating the capital taxes on non-financial corporations but the tax remains on financial services companies.

One rumor is that the budget will introduce a provision allowing for flow-through shares for biotech companies. This doesn’t excite analysts, who would prefer to see broad measures aimed at lowering the cost of capital. Orr favours an increase in depreciation rates for assets that are depreciating faster than the current rates assume.

As for consumption taxes, no one is expecting the Con-servatives to deliver on their promise to shave another percentage point off the GST in the 2007 budget, even though Flaherty has been quoted as saying that it’s on the table. The fact is that there isn’t enough money to make the cut now — it would cost $5 billion — given other election promises, such as fixing the federal/provincial fiscal imbalance and eliminating capital gains on reinvested assets. Then there is the cost of the war in Afghanistan, on top of the slowing economy.

Ottawa should also be doing what it can, through co-ordination and/or a little bribery, to get Ontario, British Columbia, Manitoba, Saskatchewan and Prince Edward Island to change their provincial sales tax to a value-added tax, says Poschmann. IE