Canada’s Finance ministers meet on Sunday and Monday, and discussions on the future of the CPP appear high on the agenda. Momentum for reform is driven by solid evidence on undersaving by middle income Canadians without workplace pensions. But, there is less clarity among the experts on what reform option might best address this challenge. Based on our study of different CPP proposals, we believe the kind of reform Canada needs is becoming clearer.
The Canada Pension Plan currently collects contributions on payroll income up to an earnings cap (set at $51,100 for 2013). CPP pensions are paid out on the basis of this same earnings cap, replacing a maximum of 25 per cent of these covered earnings, depending on how much you’ve earned over your career. Both the earnings cap and the 25 per cent replacement rate are central to most reform proposals.
Many Canadians care deeply about providing sufficient retirement income to those seniors who struggle with low income. However, most advocates of CPP reform understand that the right tools to redress low-income problems are Old Age Security and the Guaranteed Income Supplement, both funded out of general revenues. The current design of the CPP instead operates on a ‘user-pay’ principle, with benefits matching contributions. In this way, the CPP acts as a collective-savings mechanism more than a redistributive device.
One reform option is a ‘Big CPP’ that would retain the current earnings cap, but double the replacement rate to 50 per cent, funded by a boost to the payroll contributions. This is a bad idea. Currently, most lower-earning Canadians actually see an income boost when they hit age 65 because cheques for Old Age Security and the Guaranteed Income Supplement begin rolling in at 65. The last thing these struggling Canadians need is to take more money away from their consumable income during their worklife in order to fund an even bigger boost to their consumable income after retirement.
Fortunately, University of Ottawa economist Michael Wolfson found a way to expand the CPP without hurting lower earners. His plan focuses expansion on those with earnings from about $25,000 up to $100,000. These mid to higher earners would see earnings in this new range covered at a 40 per cent replacement rate instead of the current 25 per cent. A variant of this plan has been circulated by PEI Finance Minister Wes Sheridan. The PEI plan also exempts lower earners, but uses three different replacement rates, varying from 15 per cent to 40 per cent over different earnings ranges. Both of these plans focus attention on replacing the earnings of middle-earners while creatively shielding those with lower earnings from harm.
While delicately focused, these plans strike us as a bit complex. In our own research, we have shown that a simple expansion of the earnings cap up to about $100,000 would accomplish almost the same income replacement as the PEI plan for Canadians without workplace pensions. Under this extended earnings cap plan, the replacement rate would stay at 25 percent for everyone, meaning those earning under the current $51,100 cap would see no change. Only those with higher earnings would pay more, and in turn receive more from the newly expanded CPP. As a point of comparison, the 2013 earnings cap under the U.S. Social Security program is $113,700.
An expansion of the earnings cap is both feasible and simple to administer. Only employees with above average wages would be subject to the higher contribution rates, limiting the impact on small business. As long as the contributions are tied to the eventual CPP benefits, employees and employers can negotiate changes to wages or workplace pensions to incorporate the new CPP structure. In many cases, this kind of CPP reform could alleviate some of the financing pressures faced by workplace pension plans.
Some still ask the question whether any reform is needed at all. Both the PEI plan and our own expanded earnings cap proposal force middle and higher earners to save more through the CPP. Does government have responsibility to ensure everyone saves adequately, or should Canadians be left on their own?
Our answer is guided by the evidence. The fact is that many Canadians are not doing a good job of saving for their own retirement. An extended CPP earnings cap delivers a modest boost to retirement incomes to protect those with savings problems, but without completely stripping Canadians of control over their own economic welfare. We think this is the best balance between individual economic responsibility and a government that is responsible to the realities of Canadian’s savings habits and needs.
Tammy Schirle is associate professor in the Department of Economics at Wilfrid Laurier University. Kevin Milligan is associate professor at the UBC Vancouver School of Economics.