My recent Globe and Mail commentary sought to address and dispel a common misconception about the financing side of proposals to expand the Canada Pension Plan: That higher CPP premiums would be a job-killing payroll tax. Apparently, the benefits side of such proposals is equally subject to misconceptions, as evidenced by William Robson’s subsequent Globe commentary.
Contrary to Mr. Robson’s contention that young workers will be most at risk from CPP expansion, such workers will, in fact, be the largest beneficiaries. Current retirees would gain nothing, since they would not be paying any additional premiums, and older workers would gain only limited benefit increases based on their few years of higher contributions.
Young workers would be paying higher CPP premiums over their entire working lives, and thus would stand to get the full increase in CPP benefits. Some proposals would go as far as doubling benefits, but the schemes being considered by provincial finance ministers would entail a more moderate 40- to 50-per-cent increase.
This tight linkage between an individual worker’s increased premium payments and future benefit entitlements is a key feature of proposals to enlarge the CPP. This linkage is unlike the situation for the program’s first 30 years since its launch in 1965, under which early beneficiaries gained benefits disproportionate to their contributions.
Perhaps that earlier episode has led to misconceptions about the nature of current proposals. All of the proposed CPP expansion schemes specify that the enhancement be structured to avoid intergenerational transfers. Indeed, the CPP legislation mandates that any benefit enhancements must be fully funded.
Skeptics also question whether the CPP Investment Board can achieve the 4-per-cent annual real rate of return needed for even the existing level of benefits to be sustainable. If any investing entity can achieve this rate of return over the long run, it is more likely the CPPIB than a private pension plan, mutual fund, or private investment manager.
Unlike private entities, the CPPIB does not need to charge fees and generate profits, and its massive scale and professional staff operate at lower administrative cost than its private counterparts. The CPPIB can also access a wide range of alternative investments around the world, such as real estate, infrastructure and private equity, so it is not constrained by financial returns in the slower-growing Canadian economy.
The CPPIB can take a much longer-term perspective on investment portfolios than any individual investor, on account of pooling the CPP contributions of the entire labour force across all ages. This factor also allows the CPP to be more heavily invested in equities versus lower-return fixed-income assets than a typical worker would be prudently advised in the last 15 years before retirement.
In fact, the CPPIB has earned an annualized 5-per-cent return over the past 10 years, even after adjusting for inflation. Despite being one of the most challenging periods for investors, this performance lies comfortably above the targeted 4-per-cent real rate of return.
Skeptics further fear that if the CPPIB fails to achieve its targeted rate of return, the costs will be downloaded on some future cohort of workers through increased CPP premiums. That outcome would lead to the kinds of intergenerational transfers that both the skeptics and the supporters of these reforms wish to avoid.
The remedy for the risk of investment shortfalls is simply to share it between future CPP contributors and future CPP beneficiaries. This feature is already embodied in the CPP Act: If long-run returns fall short, the burden is to be borne by both contributors (with higher premiums) and beneficiaries (with suspended indexing).
Critics of CPP expansion proposals have not offered any viable alternative to increase the retirement savings of workers. Voluntary saving schemes – including workplace pensions and RRSPs – have shown their growing inability to address the problem. Nascent pooled registered pension plans, also voluntary, will do little better.
All the empirical evidence suggests that only a mandatory increase in workers’ savings will address the problem. Enlarging the mandatory public CPP would be the best solution and offers many features superior to what a mandatory private scheme could deliver, but the skeptics and critics are not suggesting even the latter.
Rhys Kesselman is Canada Research Chair in Public Finance with the School of Public Policy, Simon Fraser University, and author of a study assessing “Big CPP” proposals.