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Elimination of the Foreign Property Rule on Tax Deferred Savings Plans

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    Abstract

    The Foreign Property Rule (FPR), limiting the holding of foreign property in pension plan assets, is scheduled to be eliminated this year. It has been rationalized on economic grounds by asserting that it improves the value of the dollar and decreases the cost of capital yet, at the time the FPR began, the government was trying to keep the dollar from rising and there were strong capital inflows. Further, evidence from the past changes in the FPR indicates it had little, if any, affect on the cost of capital and exchange rate, but cost middle income workers between one and three billion dollars per annum when set at 30%. I argue that the reason for its existence was the then common belief that governments could make better economic allocation decisions than markets. Removing the FPR provides pension plans with greater opportunity for risk adjusted returns as well as responsibilities. Relevant issues that arise include the degree of foreign currency exposure that is desirable and the degree of active management desired in foreign assets, and whether it makes sense to choose fund managers that are regionally focused rather than global. Pension boards will also have to rethink what a Canadian fund is and whether it should mimic Canadian production (as currently structured) or Canadian consumption patterns. An encouraging aspect of eliminating the FPR is the possibility that government ideology is changing to place greater emphasis on the positive benefits of using markets to allocate resources.

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    File URL: http://economics.uwo.ca/epri/workingpapers_docs/wp2005/Fried_05.pdf
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    Paper provided by University of Western Ontario, Economic Policy Research Institute in its series University of Western Ontario, Economic Policy Research Institute Working Papers with number 20055.

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    Date of creation: 2005
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    Handle: RePEc:uwo:epuwoc:20055

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    Postal: Economic Policy Research Institute, Social Science Centre, University of Western Ontario, London, Ontario, Canada N6A 5C2
    Phone: 519-661-2111 Ext.85244
    Web page: http://economics.uwo.ca/research/research_papers/epri_workingpapers.html

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    1. David Burgess & Joel Fried, 2004. "The Foreign Property Rule: A Cost-Benefit Analysis," University of Western Ontario, Economic Policy Research Institute Working Papers, University of Western Ontario, Economic Policy Research Institute 20049, University of Western Ontario, Economic Policy Research Institute.
    2. Bodie, Zvi & Merton, Robert C. & Samuelson, William F., 1992. "Labor supply flexibility and portfolio choice in a life cycle model," Journal of Economic Dynamics and Control, Elsevier, Elsevier, vol. 16(3-4), pages 427-449.
    3. Leonardo Bartolini & Allan Drazen, 1996. "Capital Account Liberalization as a Signal," NBER Working Papers 5725, National Bureau of Economic Research, Inc.
    4. Marianne Baxter & Urban J. Jermann, 1995. "The International Diversification Puzzle is Worse Than You Think," NBER Working Papers 5019, National Bureau of Economic Research, Inc.
    5. David Burgess & Joel Fried, 1999. "Canadian Retirement Savings Plans and the Foreign Property Rule," Canadian Public Policy, University of Toronto Press, vol. 25(3), pages 395-416, September.
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