Frigid Whitehorse provided an apt setting for the opening skirmish in what is emerging as the next major battle over Canadian social policy. At this week's "pension summit," federal and provincial finance ministers began struggling over ways to repair Canada's patchwork system of retirement income security.
The spoils of this conflict are clear: whether the income security of future Canadian retirees will be ensured by private markets and individual choices, or by public programs and collective choices. The impending battle will be intense, because vested interests and entrenched ideologies are implicated. Already, the various forces can be seen taking their positions.
On the left bank are ragtag contingents from the Canadian Labour Congress, the Caledon Institute of Social Policy and the Canadian Association of Retired Persons. The left bank armies are fighting to expand the Canada Pension Plan, to make sure that all Canadians can eventually retire with an adequate income, no matter how much they save privately or how their investments turn out.
Assembling on the right bank are smartly uniformed troops from the financial, investment, pension and tax advisory legions. The right bank armies are waging a valiant effort to buttress workplace pension plans and private saving schemes, hoping to thwart the Big-CPP forces.
Lest anyone think that Big-CPP proponents are just dreamy revolutionaries, two veterans who are familiar with the landscape are now approaching the left bank. Bernard Dussault, the former chief actuary of the CPP, and David Denison, the head of the CPP Investment Board, are both mapping potential Big-CPP strategies.
The CPP currently covers all employees and self-employed persons on their earnings up to $46,300 a year, with retirement pensions paid at 25 per cent of the worker's average insured earnings. The maximum annual benefits are $10,900, and the average benefits are just $6,000, far below full-time earnings. To finance the scheme, workers and employers each pay premiums that are 4.95 per cent of insured earnings.
Big-CPP fighters have their sights set on at least doubling the benefit rate to 50 per cent, others would fight for 70 per cent, and some aim to raise covered earnings to $70,000 or higher. Their schemes would raise the maximum benefits from threefold to sevenfold. Even for moderate earnings, the benefit would be at least doubled. As in all wars, the expansion of CPP would be costly, carrying with it a large hike in premium rates.
Opponents of Big-CPP insist that the current system of workplace pensions and tax-assisted savings can be remedied. Their arsenal includes a managed voluntary "multi-employer" pension plan, an improvement of the financial security of workplace pensions and an enhancement of the income-tax treatment of individual savings.
While workplace pensions and individual savings incentives could unquestionably be improved, those reforms still fall short of making sure that Canadians have retirement-income security. Arguments favouring a significant expansion of CPP flow directly from an economic analysis of public versus private pensions and individual saving behaviour.
A public pension plan can overcome the crucial barriers to adequate private savings for retirement: myopia that leads to inadequate saving; the high costs and risks associated with individual investing; lack of investment expertise; impediments to individuals' insuring themselves against longevity and inflation risk; and incentives for employer pension plans to shrink and to shift more risk onto employees.
THOSE WHO FAIL TO SAVE
Despite the existing provisions, many people at all income levels fail to save adequately for their retirement needs. Current spending imperatives often cloud people's perception of their future income needs, although they later regret their choices. Workplace pension plans are very limited outside the public sector and have become scarcer and weaker. The "forced savings" aspect of a mandatory universal public pension scheme can address these gaps.
Even when people do save enough for retirement, they face significant difficulties in investing, which many cannot handle. Investing through mutual funds carries high management fees, often consuming one-third or more of the total real returns. Professional investment advice is costly and of varying quality. Even seasoned investors can make mistakes or suffer misfortunes from which they cannot recover before they retire.
Moreover, adverse financial markets at the time an individual retires can sharply affect the conversion of lifetime savings into an annuity that has to last the rest of his or her life. Many retirees do not annuitize their savings because of annuities' overhead costs, the "adverse selection" of annuity purchases by the longer-lived, and barriers to inflation indexing. Private annuities also discriminate against women, because they have longer life expectancies.
In contrast, a public pension plan can avoid the risks to individuals arising from the state of markets at the point of retirement. Because of its mandatory coverage of the entire working population and its immense fund, the public plan can also operate at far lower costs than individual savings and annuities, provide professional investment management at minimal cost, spread longevity risks over a large group, offer inflation protection and eschew gender discrimination.
By pooling funds on a huge scale, a public pension scheme faces none of the risks that can beset workplace pension plans: inadequate diversification, dissipation of surplus funds, deficient reserves and insolvency of the plan sponsor. By mandating universal coverage, a public scheme also protects the treasury and the taxpaying public against another kind of risk: people with the ability to save for their retirement who fail to do so and thus draw upon income-tested public benefits in old age.
WHY OPPONENTS OBJECT
All of these considerations support expanding public pension schemes rather than simply bolstering provisions for private retirement saving - whether through employers or by individuals. But opponents of Big-CPP proposals raise several objections.
A major concern about expanding CPP is the increase in contribution rates that would be necessary. Under one Big-CPP proposal, premiums would need to rise from the current 9.9 per cent combined employer-employee rate to about 16 per cent. Higher premiums have been characterized as a payroll tax increase that would reduce employment.
Contrary to these concerns, raising premium rates where the individual's payments are closely tied to future benefit entitlements does not have the disincentive and distorting effects of a tax increase. Even at a rate of 16 per cent or higher, Big-CPP premiums would be near the U.S. Social Security rate of 15.3 per cent - which applies up to earnings of $106,800 (U.S.) - and well below the rates of 30 to 60 per cent that are common in Europe.
As CPP benefits began rising, employers who are currently offering generous pension plans could gradually reduce their benefit levels. Those employers offering inadequate pensions or none at all would have to bear the incremental tax burden, just as they would under alternative proposals for mandating workplace pension coverage. A universal scheme would level the financial playing field across all employers.
The higher contribution and benefit rates of Big-CPP would, over time, result in reduced savings in RRSPs and workplace pension plans, thus lowering tax deductions and saving the federal treasury billions every year. One Big-CPP proposal raising the insured earnings level to $122,000 would even eliminate the tax deductions for private savings, since the higher CPP contributions would get tax-deferred treatment.
A Big-CPP scheme that replaced 60 per cent of insured earnings could also permit the eventual abolition of universal Old Age Security benefits, eliminating this burden on the taxpayers. Guaranteed Income Supplement benefits would then be expanded to make sure there is adequate retirement income for individuals with very low lifetime earnings.
Another objection to Big-CPP is that many people already save enough for their retirement needs through personal savings or workplace pensions, or both; Big-CPP might induce them to save excessively for their future needs. Given, however, the very slow phase-in of the higher CPP benefits, up to 45 years, individuals and pension sponsors would have plenty of time to adjust their saving rates.
Some critics object that Big-CPP would expose future workers to increased risk because of uncertain investment returns on the additional contributions. Currently, those risks are borne entirely by the individual worker in the case of private savings and defined-contribution pension plans; and they are borne entirely by the employer for defined-benefit pension plans.
A reasonable solution would be for Big-CPP to distinguish between current and increased benefits, with the former maintained at inflation-indexed levels. The individual could choose to have the increased benefit entitlement annuitized at fixed indexed levels (in a graduated way beginning at the age of 50) or paid as a variable annuity based on future investment returns. This approach would insulate future generations from bearing the investment risk for their elders.
Some observers object that a Big-CPP scheme would do nothing for current retirees or those close to retirement, since its increased benefits would be phased in very gradually. In fact, most Big-CPP advocates aim to fix the current system for future retirees, not to bail out those who have failed to save adequately up to now.
THE HEART OF THE PROBLEM
Similarly, proposals by Big-CPP opponents would do nothing for these groups; they are trying to improve workplace pensions only for future retirees. Their proposals, however, miss the heart of the policy problem, because they remain voluntary, patchwork systems. Few employers are likely to voluntarily institute new pension plans, enrich existing plans or shift their plans to defined benefits.
Moreover, few of the many workers who under-save are likely to change their habits under a "supplemental" CPP scheme, such as the Liberal Party proposes. Supplemental CPP would offer some of the benefits of Big-CPP - defined benefits, low-cost administration and protection against long life and inflation risks - but it would lack the mandatory coverage essential to overcoming savings myopia.
Like most conflicts, the battle between Big-CPP proponents and supporters of enhanced voluntary savings and workplace pensions may not yield a clear-cut victory for either side. But some expansion of the Canada Pension Plan or an alternative mandatory scheme for employers and workers who save inadequately will be an essential element in any lasting peace.
Jon Kesselman is the Canada Research Chair in Public Finance and a professor in the graduate public policy program at Simon Fraser University.