The government plan to tax income trusts has cost Canadian investors tens of billions of dollars. That's unfair and unnecessary. There is an alternative the Tories should consider.

It may not have been on the scale of the Crash of ’29 but I suspect that the Nov. 1 meltdown on the TSX will go down in the annals of Canadian financial history as Black Wednesday.

It wasn’t just that the Composite Index dropped almost 300 points, shedding $26 billion in capitalization in one day (and $36.3 billion in the trust sector in two days!). The real story was the people who took the biggest hit. They weren’t cigar-smoking Wall Street moguls, they were ordinary folks. Many retirees and 50+ baby boomers saw a big chunk of their life savings melt away before their eyes. As a result, some will have to scale back their lifestyle while others will have to put retirement on hold. Many pension plans were also battered, which may result in more problems down the road. This is not how a responsible government should behave!

Finance Minister Jim Flaherty attempted to placate the nation’s seniors by throwing them a couple of bones in the form of a $1,000 increase in the age credit amount and the introduction of pension splitting. Both of those initiatives are worthy but the bottom line is that they won’t come anywhere close to compensating older Canadians for the financial pain he inflicted on them.

Flaherty’s ironically named “Tax Fairness Plan” is the disastrous culmination of years of mismanagement of the income trust file by successive governments. The Conservatives will bear the brunt of public outrage, which may cost them the next election, but the fact is that preceding Liberal governments are equally culpable because of their failures to deal with the issue before things got out of hand. Twice they tried, and twice they pulled back from the brink.

However, that does not excuse the Conservatives for what amounts to a blatant betrayal of an election promise that undoubtedly encouraged many people to vote for them. In their election platform, the Tories stated categorically that they would not change the income trusts regime. In his first budget, delivered last April, Flaherty never once referred to the issue.

But based on his own words on Tuesday night, it appears work was underway within the Finance Department even before the April budget to devise a policy that would put the trusts out of business. “Our plan is the result of months of careful consideration and evaluation,” he said in his prepared statement. Months! The Conservatives have been in power for less than a year. That suggests Flaherty started the whole process (or, more likely, resurrected Ralph Goodale’s derailed program) shortly after he was sworn in. That suggests this was one election promise the Harper government never intended to keep. It was just a matter of timing.

Undoubtedly, the Conservatives would have preferred to wait until after the next election to drop the bomb. But the announcements by Telus and BCE Inc. that both would convert to trusts, combined with a similar planned move by EnCana, forced the government’s hand prematurely. They were the straws that broke the camel’s back. The Tories might have gritted their teeth and waited out more small-cap trust conversions but when the big telecoms made the move they felt they had no option – it was now or never.

After the BCE conversion announcement, I wrote in my newsletter, The Income Investor, in which I said that the move could force Ottawa to act on the trust file sooner rather than later. In that article, I said that if the government felt obliged to move, it should be guided by one overriding principle: shareholders who invested their money in good faith should not be the victims.

“Specifically, that means we oppose any action that would result in distribution cuts and, by extension, a resulting loss of capital as market valuations correct,” the article said. “If we must have legislation, don’t let it impose financial penalties on investors who played by the government’s own rules.”

Instead, I suggested focusing on the future rather than the past by grandfathering existing trusts while imposing restrictions on new conversions. Flaherty and the mandarins at Finance will undoubtedly argue that would give an unfair advantage to existing trusts and they all have to be treated in the same way. My response is that it is even more unfair to ravage the savings of seniors and compromise the ability of pension plans, many of which are already in deficit positions, to generate the returns that will be required to meet future obligations to retirees.

It’s not too late to fix this mess, although whether the government will have the will to do so is another matter. The Flaherty plan already contains a two-tier approach. Existing trusts will have until 2011 before they get hit by the new tax. But any newly-created trust will be on the hook starting next year.

There is still time for the Harper Tories to amend the plan before presenting it to Parliament. They could freeze the status quo indefinitely while at the same time proceeding with measures to discourage the creation of new trusts. The current tax drain is not serious enough to justify the destruction of personal wealth to the extent we saw last week. It is future conversions that are the big concern. Okay, so block them. But leave existing trusts alone. Just as happened a year ago, the market will almost instantly rebound, investors will recover most of their losses, and future cash flows will be protected. At the same time, the government will achieve its goal of preventing Canada from becoming a nation of trusts.

Would that give an unfair advantage to existing trusts? Sure. But is that worse that wiping out billions of dollars in retirement savings? I don’t think so.