There's a big push underway to reform Canada's public retirement fund to help those who aren't saving enough for their golden years. Two experts look at the pros and cons of expanding the plan.
'Big CPP' is at the expense of the young
Chronically low investment returns on inadequate saving are making more Canadians worry about retirement. Fair enough – but the bigger Canada Pension Plan many unions and provinces are pushing is a bad response. Durable pension improvements for people currently working must rest on more saving by those same people. Instead, “Big CPP” threatens another wealth grab at the expense of the young.
Advocates for a CPP that covers earnings up to a higher cap or replaces more of those earnings stress that the CPP is mandatory, has low investment costs and offers defined benefits. They typically play down how a bigger CPP would take more from people whose taxes before, and clawbacks after, retirement make them better off outside it, ignore hundreds of millions in federal administration costs and skip over past and potential future benefit cuts.
Critically, they usually also say higher Big CPP benefits will be “fully funded” – which sounds good, but could be the most misleading part of the pitch.
How could “fully funded” mean anything but “properly backed by real assets”? The answer lies in the CPP’s peculiar history. For its first three decades, it was unfunded: a Ponzi game that sent contributions straight out to recipients. By the late 1990s, the prospect of intolerable contribution increases inspired reforms. Governments cut future benefits and hiked contributions to create a modest investment fund.
Since then, the chief actuary’s projections have typically shown that the CPP can run for decades on its current contribution rate of 9.9 per cent – as the reforms intended. But that does not make it fully funded. The reforms aimed only to freeze the intergenerational unfairness, not undo it. About two-fifths of that 9.9 per cent cover not the contributors’ own benefits but past participants who paid too little. And the sustainability of the rate depends on the CPP’s investments earning 4 per cent above inflation indefinitely – no small challenge in an economy likely to grow barely half that fast.
The CPP’s intergenerational unfairness and dependence on as-yet-unearned robust investment returns resembles other defined-benefit pensions, most of which have too little saving, and some of which have already reneged on their promises. But if Big CPP advocates realize this, they’re keeping quiet. Some use models, including Statistics Canada’s LifePaths, in which payments from defined-benefit plans just happen – money from nowhere. Totally unrealistic. In other models, the defined-benefit payments happen because the demographic, economic and investment-return assumptions always work. Better – but still unrealistic.
It’s not just that forecasts will be wrong. Forecasts always are. It is that wrong forecasts affect different people when things go better, or worse, than expected. Optimistic assumptions – as in the CPP’s early days – trigger politically rewarding payouts to current voters. Disappointments hurt their successors.
Presumably, Big CPP means bigger benefits – that’s its main attraction. But what if our surprising longevity further increases the number of seniors per worker? What if age-driven health-care costs – not to mention Big CPP’s higher payroll levies – further depress earnings? And what if the plan’s investments earn not 4 per cent real, but the economy’s growth rate of 2 per cent, or the yield on the federal government’s real-return bond: barely above 1 per cent?
Do Big CPP advocates say that, should things go sour, the early recipients should repay some benefits, or suffer targeted cuts? No: the CPP is a defined-benefit plan. They doubtless assume that, as in the past, any cuts will come at the expense of the young – who will naturally pay the required higher contributions.
Not all who claim that Big CPP will deliver its richer benefits “fully funded” are deliberately misleading Canadians. But they are glossing over the risks and who bears them. Truly funding benefits means saving to back them – dollar for dollar. The CPP does not do that now. And no publicly available Big CPP plan does it either.
Without proper saving, Big CPP is a gamble – and an asymmetrical one. When things go well, as they sometimes will, the old win. When things go wrong, as will also happen, the young lose. Canada has already imposed large burdens on coming generations. Big CPP should not add to them.
William Robson is president and CEO of the C.D. Howe Institute.
It's time to expand CPP benefits
Finance Minister Jim Flaherty thinks that expanding Canada Pension Plan benefits might be a good idea, but just not now. The Canadian Federation of Independent Business thinks it might never be a good idea and has launched a national campaign against the reform.
Both have asserted that the requisite hikes in CPP premiums would act like any payroll tax by retarding economic recovery and killing jobs. The CFIB estimates that 700,000 “person years of employment” would be lost over the reform’s first 20 years.
In contrast, most knowledgeable pension experts have reached the conclusion that expanding CPP benefits would be an important advance in social policy. So should worries about the impact of higher CPP premiums be allowed to stand in the way of better income security for future generations of retirees?
These concerns are based on misconceptions about the nature and impact of CPP premiums. Fortunately, these misconceptions are easily addressed, as CPP premiums are unlike any other payroll tax.
To begin, the historical record is that the CPP premium rate hikes initiated in the 1990s to restore financial balance did not hamper an economic expansion. Between 1997 and 2003 CPP premiums were hiked 70 per cent while the country’s employment rate rose strongly and steadily except for a slight dip with the 2001 economic downturn.
In contrast, the premium rate hikes associated with most current proposals for CPP expansion would be only about 30 per cent. And unlike the earlier premium hikes, which were not associated with any improvements to CPP benefits, the proposed reforms would deliver large benefit increases.
Since the proposed CPP premium hikes would provide workers correspondingly higher benefits in retirement, they are not like an ordinary payroll tax increase. Rather, they are like an individual’s payment for improved insurance coverage. This premium-benefit linkage means that CPP premiums lack the disincentive effects of most taxes.
Because the CFIB’s study did not incorporate this premium-benefit linkage, it incorrectly modeled the CPP premium hike as a general payroll tax hike, yielding its large estimate of job losses. Examples of general payroll taxes are Ontario’s Employer Health Tax and Quebec’s Health Services Fund levy.
The CPP premium rate hike for most proposed reforms is about 3 percentage points on top of the current 9.9 per cent rate. Since the premium is paid half by employers and half by employees, the rate hike for employers would be just 1.5 per cent. Only the employer share of a CPP premium hike is alleged to hinder job creation.
Although the increased cost to employers at 1.5 per cent of payrolls is itself quite small, several factors further diminish any possible impact on hiring and employment.
Economic research on employer payroll taxes finds that their ultimate burden is shifted over several years to employees – via slower growth in wages and salaries. The CPP’s premium-benefit linkage is likely to accelerate this shifting of burden.
The long phase-in period for CPP premium hikes further dampens any adverse impact for employers’ hiring and facilitates the shift of burden to employees. If undertaken over five years, the 1.5 percentage point hike for employers would be just 0.3 per cent per year, which is less than ordinary year-to-year variations in wages.
Moreover, for employers offering generous workplace pensions, this slow phase-in would avoid any risk that enhanced CPP benefits will cause “over-saving” for their employees. Indeed, many workplace pension schemes have a CPP-offset provision that would reduce the employer’s pension costs as CPP premiums and benefits rise.
Based on the misconception that CPP premium hikes will be harmful, many observers suggest waiting for a more robust economic recovery. Yet even if federal and provincial finance ministers agree to enhance the CPP at their meeting this December, it would take at least until 2016 to implement the requisite legislation and begin phasing in the premium rate changes.
Canada has already awaited this reform for too long. In 1980 a federal task force assessed CPP benefit levels as inadequate and urged their increase. That reform was stymied by the Ontario government of the day along with business opposition.
For the last three years Canada has been on the verge of expanding CPP benefits. At one point even the Harper government was supportive. Yet each time the requisite agreement has been impeded by various parties expressing concerns over the potential adverse effects of companion hikes in CPP premiums.
For skeptics and outright opponents, no time is the right time to enhance CPP benefits and ensure the income security of millions of future Canadian retirees. Concern over the effects of CPP premium hikes is unwarranted and should not be allowed to block this important policy reform any longer.
Rhys Kesselman is Canada Research Chair in public finance with the School of Public Policy, Simon Fraser University, and author of an award-winning book on payroll taxes.
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