Spin Cycle: Is there any tax revenue in NDP plan to close stock option 'loophole'?

Most Canadians don't spend a lot of time worrying about how much tax they'll be paying on their stock options.

Unless you're a senior executive at a large publicly traded company, or you're working for a tech startup, chances are you get paid the old-fashioned way: your employer pays you a salary, and you pay tax on that salary at a rate determined by your income.

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But thousands of Canadians, many of them quite wealthy, receive at least part of their compensation in the form of stock options in which a company provides an employee with an option to purchase company shares at a specified price at some future date. When that date arrives, that person is free to sell those shares on the open market.

If the share price has risen by that point, an employee stands to make a tidy profit. And because that stock option was part of someone's compensation package, you would expect the employee would have to pay tax on the full amount.

But a provision included in the 1984 federal budget allows the employee to deduct 50 per cent of the benefit received, a deduction that the Department of Finance estimates costs the treasury about $750 million a year.

The spin

The employee stock option deduction has been flying under the radar for a long time. But not anymore.

In this campaign, the Conservatives appear to favour the status quo, while both the Liberals and the NDP have called for changes.

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The NDP was first out of the gate. The party has made closing the stock option "loophole" a key weapon in its fight against child poverty.

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It expects to realize $500 million a year over the next four years by making options 100 per cent taxable, and all that money would go to meeting a commitment made by all parties in the House of Commons in 1989 to eliminate child poverty by 2000.

"This will be a dollar-for-dollar transfer in benefits from those who need it the least, to those who need it the most," declared NDP Leader Tom Mulcair when he announced the policy last spring.

The Liberals also have the stock option deduction in their sights. In their platform, released earlier this week, the party proposed placing a cap on how much can be claimed through the deduction.

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By capping the amount, the Liberals estimate they can realize $560 million a year, although unlike the NDP, they haven't specifically targeted where that money will go.

The counter-spin

At first glance, eliminating or capping the stock option deduction is low-hanging fruit for any party looking for a reliable source of revenue to pay for campaign promises. After all, why should rich CEOs get a tax break on their compensation package that none of the rest of us get on our paycheques?

But it turns out that it is not just bank presidents and industrial tycoons who take advantage of this deduction.

Stock options are also a popular form of compensation for high tech startups that don't have much cash on hand to compensate senior managers and engineers. Those people are in high demand, and stock options are one important way of attracting and retaining them.

Not surprisingly, the tech industry did not respond well to the NDP's plan to eliminate the stock option deduction.

Tobi Lutke, the CEO of Shopify Inc., an Ottawa-based retail merchant software firm that went public last spring, warned "there will be a lot less technology startups" if stock options are made fully taxable.

Canada's burgeoning tech industry is a big source of well-paying, non-polluting jobs, many of them in electorally sensitive areas like southwestern Ontario and B.C.'s lower mainland.

No politician wants to be seen doing anything that might get in its way. So when the tech guys scream during an election campaign, their voices tend to get heard.

Which is why Mulcair, in a letter written on Sept. 25, declared that contrary to his announcement last spring, his plan to fully tax stock option deductions "excludes options granted by early stage companies."

And it's why the Liberal platform calls stock options "a useful compensation tool for startup companies," and promised that employees with up to $100,000 in annual stock option gains would be unaffected by any new cap.

The rinse

There is widespread agreement among people who study this issue that eliminating stock option deductions is wise public policy.

Lindsay Tedds, a professor in the School of Public Administration at the University of Victoria, calls employee stock options "a poor, indeed perverse, form of executive compensation," and their preferential tax treatment "only exacerbates the problem."

A report issued earlier this month by Jack Mintz and V. Balaji Venkatachalam of the School of Public Policy at the University of Calgary declared that "the NDP and the Liberals are onto a good idea in proposing a more efficient way to tax stock options. Regardless of who wins the election, it is the right approach."

But having the right approach doesn't necessarily mean it will achieve the desired result, Mintz and Venkatachalam point out. And there are several reasons to believe that all that new revenue the opposition parties hope to generate by fully taxing stock options will never materialize.

The NDP says its plan will yield $500 million in each of the next four years, but that assumes companies will continue to issue as many stock options after the tax advantage has been removed as they did before.

But in fact, the popularity of stock options as a form of compensation has been in decline for several years, even with the tax break.

Employees have increasingly been opting for other forms of compensation, like receiving actual shares of companies rather than options because there is less risk involved.

In 2014, grants of stock options to the CEOs of Canada's 100 largest companies fell an average of 40 per cent, while grants of share units rose by 37 per cent. Removing the tax deduction on stock options will likely only accelerate that trend, making less money available every year for the NDP's fight against child poverty.

Another problem, as Mintz and Venkatachalam point out in their report, is that while employees currently benefit from the stock option deduction, the companies issuing them are actually penalized because they don't get to deduct their value from their corporate income tax as they would if they paid that compensation as salary.

The authors argue that if the personal deduction were removed, employers would have to be allowed to take the same deduction as they do with any other form of compensation. And once you do that, there is no net gain to be realized from fully taxing stock options.

In fact, they calculate that there would be a net loss to provincial and federal governments of about $12 million.

"Moving to full taxation of stock option compensation is appropriate with respect to efficiency and equity," they conclude, "but there is little money to be gained."

And that means the opposition parties will have to find money somewhere else to fund their war on child poverty and other election promises.