The Foreign Property Rule: A Cost-Benefit Analysis

The foreign property rule (FPR) requires that no more than 30% of the assets held in tax deferred retirement savings accounts be foreign property. The FPR is supposed to increase the value of the dollar and reduce its volatility and decrease the cost of capital and promote investment in Canada as well as decrease the extent of inequality inherent in these plans. On the basis of evidence from the easing of this regulation from 20% to 30% over the period 2001-2002 we find that it accomplishes none of these objectives. There was no measurable impact on the exchange rate predicted from the Bank of Canada's forecasting equation; the capital outflow from the change amounted to no more than 2 days trade in the forex market over the period 2000/01; Canada's equity markets did significantly better internationally while the FPR was eased than in the prior two-year period. Finally, closer inspection reveals that the rule exacerbates income inequality by imposing the largest costs on lower middle-income groups. We estimate that the increase in the FPR from 20% to 30% increased Canadians expected income by between 500 million and one billion dollars annually by permitting greater portfolio diversification. The complete removal of the FPR would increase income by an estimated additional 1.5 billion to 3 billion dollars annually.