Double Blind

There is a lot of misinformation going around about the HST. The government also has its own misinformation page on HST. This post attempts to clarify them, in no particular order:

1. The PST punishes the production of goods that depend on a long chain of companies to produce. If a product takes 10 companies to produce before it hits the consumer, the sale/purchase of the product will accumulate the cost of PST down the value chain. With HST/GST, only the value-added is taxed. For the end-consumer, however, all they will see is an increased tax.

This is best illustrated with an example. If you are a company that takes in a material to produce a gizmo, you will purchase the material from a company (paying GST and PST). If you pay $10,000 for material, you will pay $500 in GST, and $700 in PST. The $700 is non-refundable, while the $500 is refundable. With the HST, you will pay $1,200 in HST, but this will be fully refundable. In theory, this will affect the pricing of the gizmos that the company sells as you no longer have to cost in the $500 PST you paid to the BC government.

This will mean lower cost inputs for companies, but it will also be very difficult for the consumer to detect this at the retail pricing level. The academic studies that the government quotes is very indirect, and quotes a single university professor (Michael Smart) that has issued a series of papers from his research.

For this reason, the “tax competitiveness” reason for justifying the HST has a theoretical basis, but one could also use it to justify a more direct business subsidy, such as a decrease in the corporate income tax rate.

2. The BC government’s assertions that it was a “sudden proposal” after the May 12, 2009 election is pure hogwash. This is fairly self-evident, as the government has known about the open solicitation to harmonize its sales tax. For example, the March 11, 2008 Hansard stated:

J. Brar: We can continue this debate as long as we want, but I certainly see that the minister is not prepared to respond to that and throws away those kinds of questions to the Minister of Finance.

I will move on to another question. There has been a recommendation on the table of the minister about PST and GST harmonizing. I would like to ask the minister where the minister is. Is that on the table, or is there any action on that?

Hon. R. Thorpe: First of all, that is tax policy, which would fall under the Minister of Finance. But I have commented on that in the past, and I will comment on that here today, because on this particular issue, the Minister of Finance and I have worked extremely closely and have both said exactly the same thing to the public.

It sounds very attractive to talk about harmonization, but one of the things that people have to realize is…. I can’t remember if it was the competition board or the Progress Board that estimated that flow-throughs through harmonization to taxpayers could amount to $2 billion a year. I think that careful consideration has to take place when you contemplate those kinds of things.

In British Columbia we have an extensive exemption list. Under GST, there aren’t exemptions. Let me just give you a couple of examples. One is that restaurant meals in British Columbia are PST-exempt. They are not GST-exempt. That is a serious question. One that I think all members in this House would have concern about is that children’s clothing is PST-exempt, but it’s not GST-exempt.

Those types of decisions have far-reaching ramifications, and I can say that harmonization has not been on our agenda. We have been in phase 1 of a review to simplify and streamline and phase 2 to have streamlining and simplification continued.

We have focused on reducing small business taxes from 4½ percent to 2½ percent and increasing the threshold from $200,000 to $400,000. We’ve reduced personal income tax across the board. Most British Columbians see at least a 37 percent reduction in their British Columbia income taxes, and over some 250,000 British Columbians now pay no income tax, compared to paying income tax in the year 2000.

The government is not stupid, and they also know that with Ontario’s experience with tax harmonization that they would be in for a rough ride. So this is why they timed it right after the election – since there is really nothing the public can do except voice their displeasure for the May 2013 election cycle – presumably so far in the future that nobody remembers anymore.

3. The restaurant industry rightfully will scream bloody murder over the HST – the primary components of their costs (food and labour) are both HST-exempt, while they have to charge their customers a full 12% tax on top of whatever they charge. They will be hit badly by this change, as well as anybody patronizing these businesses. This also includes places like Tim Hortons and Starbucks. They, as well as the end-consumers, are going to be the big losers with this tax.

4. Providers of services will also be disproportionately hit by the HST, as the bulk of their cost inputs (typically labour) do not include HST.

5. Because the HST is regressive, it will disproportionately affect low income families. People making $20,000 or less will get $230 at tax time, which really translates into a senior citizens’ buy-off. If you live with somebody, the combined income is a maximum of $25,000 to receive a $230/person benefit, which is yet another tax penalty to live with another person.

6. The characterization of the HST in this government publication (“Benefits for Taxpayers“) is a true piece of propoganda. There are no benefits to the consumer taxpayer other than the $30 million a year of tax savings to get rid of the PST collection (as the sales tax collection will now be delegated to the federal government).

7. The $1.6 billion federal subsidy the province is receiving (about $370 per resident in BC) is being stated to “preserve health care and education”, but this is also a scare tactic. The $1.6 billion will be applied to lessen the amount of borrowing required for the 2010 fiscal year’s deficit.

8. I have done the appropriate costing on the HST, and have determined that it will cost me significantly more (approximately $400), given the rate of my expenditures in 2008. Even if half of these costs were presumably decreased due to the decreased cost burdens on businesses, it still represents a significant tax increase. This is my primary reason for opposing the HST. My business will also be forced to charge an extra 7%, but because I deal with other businesses, this will be neutral.

9. In terms of policy, instead of offering an income-tested $230 for people making less than $20,000, the government should have increased the basic personal amount exemption for income taxes by a nominal amount (currently $9,373 for 2009) to offset the increased personal burden for individuals that the HST will put on consumers’ budgets. I do not think they will be doing this.

In order to be “sold” on the HST, I would need to see one of the following:

a. Some other tax reduction to justify the extra revenues the BC government will be collecting post-harmonization that will be collectible to middle-class BCers; or
b. A reduction in the HST rate (11%); or
c. Exemptions to the HST consistent with that of the PST.

As currently implemented, with the available information on the proposed implementation, I oppose the HST.

Éric, the fellow that runs Three Hundred Eight (which tracks Canadian national polling for the purposes of election predictions) has done a great job in compiling the actual numbers obtained from polling. Wikipedia also does a good job of tracking summary results, but lately Wikipedia has been something less quick and accurate at getting the information. I will disagree with the way that he translates popular vote into seat projections, but for the most part, the site displays an excellent summary of the electoral situation in Canada.

One good way of testing whether an electoral model is correct or not is determining how many seats the Green party will win if there was an election this November. If the answer is anything higher than “zero”, then the model is obviously flawed. I say this half-jokingly since the polling probably suggests that the Greens will capture a seat in BC or Ontario, but everybody knows in a real election this has zero chance of occurring.

The next parliament opens on September 14th and it will be very interesting to see if the Liberals use their first opposition day (which, by the agreement that the Conservatives and Liberals cut on the last day of the June parliament, has to be by October 7th at the latest) to move a non-confidence motion. This would suggest an election date of November 16.

I had the pleasure of attending the grand opening of the Canada Line on August 17th – it was in the morning at YVR airport; there was about 45 minutes of meet-and-greet with the who’s who list of Richmond (e.g. most of City Council was there) and construction-related people. This was located in some part of the airport that was unfinished and overlooked part of the taxiway. The catered food that was available at this morning event was incredibly good, and ultimately wish that I could have taken some of it home (doing so would have been highly improper given the upper-class nature of the event).

All of the key players gave a speech at the podium, but in particular, the president of Canada Line Rapid Transit Inc., Jane Bird, gave a very passionate speech. It is not every day that you see a two billion dollar project go into service and this will be a very impressive bullet point on her resume. I have not seen her in the news at all during the project, and this is probably a testimony to the on-time and mostly on-budget nature of the project – it was very well executed and will provide a huge benefit to Richmond and Vancouver.

Everybody then went into the YVR Airport station, and more speeches were given. Finally, they cut the ribbon, the train came, and they went off to downtown Vancouver. The person I was accompanying had an 11:00am meeting that day, so could not join for the rest of the trip, but it was fun enough seeing the media circus at the station.

It was perfectly obvious to me well before the construction of the line that it will be a smashing success. Linking the airport with downtown Vancouver and Richmond with a high-speed train will be such a convenience for those coming and going (especially during the Olympics). Also, the people in Richmond finally have an option to getting to downtown Vancouver in less time than it takes with an automobile during daylight hours. This is one of the reasons why I dislike the cheaper light rail solution – it is too slow, and speed counts for everything when it comes to public transportation.

The two billion dollar price tag is steep. However, it is worth it when one considers the densification that will likely occur around the No. 3 Road and Cambie corridors in Richmond and Vancouver. Considering the one-time nature of the capital cost and also considering the low expense of operating the line, it highly suggests it will be a net benefit to the region – a much quicker payback than the Millennium Line.

About a week after the aforementioned event, I was in Richmond, and had to pick up some material in the middle of downtown Vancouver. So I took the Canada Line, and had the following thoughts:

1. The trains are nice and big. The seats are very spacious (they could easily accommodate two people that are 50 pounds overweight side-by-side) and there are poles everywhere to stick your hand on when the train gets moving. Skytrain seats are worse than economy class airline seating.

2. The trains are quiet compared to Skytrain. It doesn’t feel like they accelerate as quickly as Skytrain, but this could be my imagination. The top speed of the trains is also slower than Skytrain, but a high top speed is not really necessary when looking at the geometry of the line and relative distance between stations.

3. It is good that the Capstan Way station was scrapped – adding an extra station in Richmond would have likely added 90 seconds of time to the trip to downtown Vancouver, and this would have decreased the desirability of the Canada Line. I do not think adding in stations at 33rd or 57th street in Vancouver would be beneficial either; it would slow down travel times.

3. The tunnel portion (through Vancouver) is somewhat depressing compared to the overhead rail in Richmond. Having the bird’s eye view of Richmond at No. 3 Road does not make the city look pretty at all. However, it felt a lot more pleasant going through Richmond simply because there is stuff to see outside, compared to the dark tunnels in the Vancouver section.

4. The station platforms fit the trains entirely lengthwise. It will be very expensive to expand the platforms if this is required. Judging from the amount of people I suspect will be going from Richmond to Vancouver, this might be hit in a shorter time than expected.

5. The Lansdowne to Brighouse station section is a single track. This was a short-sighted design decision by Richmond City Council to reduce the visual impact of having two tracks overhead – if the Canada Line ever needs to expand southbound, there is no way they can do it without double tracking.

6. The stations themselves are very spartan, and more importantly, tell you exactly when the next train is coming. This is a huge design interface improvement.

7. The Vancouver City Centre station is located on Granville and Georgia, and is perfectly placed.

8. The River Rock Casino will literally cash in on this line. The proximity to the casino, plus the fact that people have to transfer at this station to get to the airport (or to Richmond) means that this area in Richmond will likely get a lot more use than it does currently over the next 10 years.

9. I am guessing somebody will make money if they put up another park-and-ride parkade somewhere near the Aberdeen or Lansdowne station.

The European Commission (the European Union government) has made some rulings with respect to whether European banks that have received bailout funding from national governments should defer hybrid capital instrument dividends under a “Burden Sharing” policy.

The rationale is that if banks have received government money to shore up their balance sheets that any subsequent dividends paid out to senior holders should take this into consideration; thus, despite the fact that such government bailouts were for junior securities, it would have implications with further senior securities, such as hybrid capital.

Not surprisingly, this government interference has caused a collapse in prices of various hybrid capital instruments. The one in particular that I have been looking at (and there are more examples of other institutions) is ING Group. Tickers include ISG, ISP, IND, INZ – they are all hybrid capital securities, perpetual maturity, but with varying coupons (ISG having the smallest coupon). I will use ISG as the prime example – it pays a 6.125% coupon, quarterly.

These instruments are effectively a promise by the lending institution (ING Bank) to pay you a quarterly 38.28125 cent interest payment for each unit of ISG you own. The bank has the right to defer payment indefinitely without any cost to them other than that they will be prevented from giving common stock dividends, or purchasing junior securities.

It is a typical term of agreement when companies refuse to pay interest payments on senior debt, the debt holders have the right to collect payment on the entire debt after 30 days of non-payment; with hybrid securities, there is no recourse for the debt holders to force the company into default. The only reason why the security holders have any power over the company is that the company’s board of directors is voted in by common shareholders, and common shareholders would like to see dividends at the end of the day – thus, if they wish to see dividends, they would have to pay off the hybrid security owners first.

The characteristic of hybrid securities is very similar to preferred shares, with the notable exception that hybrid securities give off interest payments, while preferred shares give off dividends.

The price of the hybrid security reflects the confidence of investors that the bank will continue to pay.

Before this European Commission fiasco, investors were paying about $18 for a 38.28 cent quarterly payment. This works out to about an 8.5% perpetual current yield on investment.

After this fiasco, investors are now paying about $11.20 for the same rights. This is about a 13.7% perpetual current yield on investment.

If ING is compelled to defer their hybrid debt dividends that the price of the hybrid securities would continue to fall further, well into the single digits. It would be an interesting speculative opportunity at that point, as ING would generally be able to dilute its common shareholders to raise enough capital to pay off its loan given to it by the Dutch government and eventually pay back the hybrid security owners. Just as a paper napkin-type calculation, if you are willing to settle for an implied 18% current yield (if they ever continue paying investors back), that would be an $8.50 entry on ISG.

During the peak of the March financial crisis, the same securities were trading as low as $2.83 a unit; this translates into a whopping 54.1% current yield if ISG continues paying off; not only that, but you would virtually be guaranteed of huge capital gains if the company stabilized. Timing the bottom like this is virtually impossible; I got my fill in at nearly double that price during that period of time since I thought that 28% was more than adequate compensation for risk taken. I don’t think we will see 54% compensation for risk again, but 20-25% certainly might be in the cards and I will evaluate it further when we start to see prices at that level.

Finally, to cash in on that 54% opportunity, you would have had to been there on March 9th to get your fill – on the trading day after, risk fell to 33.1% current yield; and a week later the risk was down to 24.3%.

Putting some money where my mouth is, I’ve once again opened a position on where short term interest rates are headed. I have used the May 2011 Federal Funds futures as my proxy – there are plenty of reasons for this, the two major ones being:

1. Quantitative easing will end in October – this is effectively an increase of interest rates from negative levels to zero.
2. Central banks are likely to raise rates to an above-zero level in the middle of 2010 to avoid potential inflation down the pipe.

This is a very small position, and the bet is at 2.2% – if rates are higher than 2.2% by May 2011, I will profit. If rates are lower than 2.2%, I will lose money.

Realistically, I expect this bet to materialize as either a small loss (exit at around 1.5%) or a larger profit (exit at around 4.5%) sometime in the first half of 2010.

I’m not buying into the “hyperinflation” scenario that we see, but I do want to protect myself against a macroeconomic shock, mainly the inability of the US government to finance its own debt. Although there still is plenty of appetite to swallow US debt like people at a Las Vegas buffet, the party will eventually end. The question is whether it ends with currency depreciation or inflation (which will lead to higher interest rates). These two options are generally mutually exclusive – in the inflationary scenario, interest rates will increase, which will put some stability on the currency value.

… or any other social engineering networking, tool (link):

The online message sent from Ann Cousins’s Facebook account said the Newfoundland woman had been robbed of all her money at gunpoint while vacationing in London, England, and was desperate for help from her friends.

In fact, Cousins was at work in Port Aux Basques, on Newfoundland’s southwest coast, at the time, unaware that her account had been hacked and someone was trying to con her friends and family.

Cousins spoke publicly Wednesday about last week’s incident in hopes of urging other people to protect themselves from possible identity theft.

This type of scam is perfect, mainly because it exploits the credibility that has been built up between relationships, and such credibility lines have been established with the explicit declaration of “friendship” on Facebook. It is therefore a very high-yield game if you can get into the accounts of people on Facebook and fake authentication to send messages requesting money, or something even more simplistic, such as “Click on this link” to infect unwary users to spyware, or even a few pennies for advertising revenues. All you need to do find a way to harvest accounts en-masse, and by having a botnet of keyloggers out there, you could queue up enough accounts in a relatively short period of time. You send out a message blast, and even if you get 1 out of 100 sending you something, it would likely have a very high return on investment.

Putting a lot of your social connectivity online for the public to see is a huge mistake, and will have unintended consequences in the future. This is why Facebook has offered “privacy” options to shield your information to those that care, but such privacy becomes useless when your actual account becomes compromised.

The root cause of the problem likely lies in the fact that most people have no idea whether there is spyware on their system which performs a very nefarious function of harvesting your logins and passwords to various services out there. This is why I feel a lot more confident using services that utilize other forms of authentication than username-password, such as a two-factor authentication such as RSA’s SecureID, or Interactive Brokers using tokens made from Secure Computing – although hackers have been able to exploit these with real-time keyloggers. Biometrics has been hailed as the solution to all of this, but even that can and will be hacked.

The yield curve refers to the differing interest rates that you would receive over a debt investment over certain periods of time. For example, Canadian government bonds have the following yield curve:

2 years – 1.35%
3 years – 1.86%
5 years – 2.62%
7 years – 2.84%
10 years – 3.48%

The reason why the rate of interest increases over a period of time is that you are taking more risk with a longer duration, hence you should be compensated more with a higher yield. The usual quoted figure is the 2 year to 10 year spread, which in this case is 3.48 minus 1.35 = 2.13%. The yield spread from short term duration to long term duration government debt is usually a good predictor of how well the economy will be doing in the future – a lower spread typically implies that stormy clouds are ahead. There are always exceptions to the rule.

The person that writes the Canadian Tax Resource articles is a knowledgeable writer; we are likely the type of person that get some sort of perverse entertainment analyzing tax rules and legislation.

His recent article is a very good point why working overtime is not necessarily the money-maker that it could be – due to the marginal rate of taxation. In BC, if you make anything more than (approximately) $40,700, approximately 30% of your overtime pay will be taxed away. If you earn approximately $82,000 then that goes up to approximately 38%.

Another good resource is taxtips.ca, where you can view the marginal rates for BC and other jurisdictions.

If you make “too much money”, it is likely more beneficial from a work-life balance perspective to take overtime off in time, rather than money. The government does not tax time taken off due to overtime work (not yet, at least).

The marginal tax structure is also a good reason why people with high amounts of income should start to look to restructuring their income stream into a corporation, to take full advantage of small business income taxes, which is considerably lower (13.5% in BC currently) and allows for tax deferral (which enables you to take income whenever you want to minimize taxes over a longer period of time).

I tend to give little credence to stock markets during the month of August; most of the critical decision makers are usually on holiday, until the end of labour day long weekend.

As such, I am finding the existing price action to be difficult to interpret other than idle cash looking for yield in an illiquid marketplace.

Corporate bond prices have risen so drastically over the past 6 months and are at levels where I will no longer consider buying them; I feel very tempted to chase yield, especially given the extremely low rates of borrowing that are available to me (roughly 1.75%), but I will not, at this time, be tempted to leverage by borrowing at 1.75% and taking what will likely be a yield of around 16% or so.

This might be financial insanity, but I am waiting for better prices before considering it. I am already very mildly leveraged (-3% cash position) and think going to -10% would be foolhardy – I do not want the markets to be able to force my hand with a sudden de-leveraging. Still, borrowing cash is nearly free and will likely be this way until at least the middle of 2010.

In the meantime, I am very happy to twiddle my thumbs and collect very high interest payments on a portfolio that is relatively risk-adverse by virtue of its position in the capital structures it has invested in. I am impatient, and I know when I make decisions when I feel impatient, I will lose money. The gameplan is to let the portfolio mature, or dump off the bonds at par value if they appreciate to that level – even then there are income tax considerations that strongly favour a deferral of sale until the calendar year that the bonds mature.

(Example: A bond, coupon 7%, matures December 2010; if the bond on January 1, 2010 is trading at 100, you can sell it and then only have to pay capital gains on April 2011; if you sold the same bond on December 2009, you would have to pay the tax on April 2010. If you held on January 1, 2010 and let the bond mature, the pre-tax return on capital in that event will be 7%. If you had a better candidate investment that would give beyond a 7% YTM, you would sell and move capital into that instrument.)

The implied short term interest rate for December 2010 is currently 1.72%; it was 1.55% yesterday. The implied short term interest rate for June 2011 is currently 2.48%. I have been watching these rates like a hawk, as there is a material possibility that the rates may go far, far higher in the future. This would have other economic repercussions, the least of which is crashing the resurgent real estate market (which has been, like in the past, fueled completely by credit).

I just wish that one could borrow $500,000 @ 2.65% without having to actually buy a house. I’m fairly confident that I could engineer a fairly low-risk spread over this.

If my math is correct, the capital plus accrued interest and cash in my TFSA account will show it has doubled over the past 6 months since I made my first TFSA investment.

All I have to do is repeat this trick 7 times, and I will have a million dollars tax-free. Beware of arguments peddled by less scrupulous people in finance that claim to make this “easy”!

I guarantee you that with the prices I see today, that such a feat (doubling in six months) will be very unlikely. I could structure a relatively low-risk double in 4-5 years (and this would also incorporate reinvestment risk), but certainly a double in six months is completely out of the question.