Is the Piggybank Broken?
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The politics of pensions in Canada are heating up once again, as a December meeting of Canada’s finance ministers looms to discuss pension reform. Large public-sector unions such as CUPE, PSAC and NUPGE have launched propaganda campaigns to convince Canadians and their political leaders that CPP expansion, in the form of increasing benefits by perhaps a factor of two, is the solution to all of Canada’s pension woes.
There is no doubt in my mind that Canadians in general support some meaningful pension reforms, a mood established by a succession of factors. These include high-profile corporate bankruptcies, such as that of Nortel Networks, leading to significant pension losses for retirees and workers; the recent work of various independent expert pension panels commissioned by the governments of Alberta, B.C., Ontario and Nova Scotia; and the deliberations and supporting work of Canada’s federal and provincial finance ministers on the topic of pension reform.
Expanding CPP benefits is a very complex undertaking that would likely have widespread repercussions for Canada’s pension system overall. The CPP expansion propaganda and rhetoric conveniently omits any discussion of repercussions, and instead relies on a number of unfounded myths concerning CPP’s place in Canada’s pension system.
Myth 1 Canada’s pension system is insufficient for the delivery of adequate pension income.
Of the 14 major pension systems in the world examined in the 2010 Mercer Melbourne global pension index, Canada ranks as number two in the Adequacy subindex (the others are Australia, Brazil, Chile, China, France, Germany, Japan, Netherlands, Singapore, Sweden, Switzerland, the U.K. and the U.S.).
However, the Canadian pension system has adequacy concerns, particularly around lack of utilization in the private workplace pension and individual retirement savings components. Fewer than 25% of private-sector workers in Canada participate in workplace pensions, with a declining trend in coverage. Moreover, contribution rates to individual registered retirement savings plans are low, particularly among private-sector workers, and subject to pre-retirement withdrawal.
By contrast, Canada’s public-sector workers are particularly well served by the world-leading adequacy of Canada’s pension system, with more than 85% of such workers covered by a workplace pension, many with full or partial indexing to cost-of-living increases. Canadians employed in the private sector, who are left in envy of such programs, must support them through their income taxes.
Myth 2 The CPP operates as a stand-alone program.
Although the CPP is structurally stand-alone, the rest of Canada’s pension system is integrated around the CPP. Any expansion of CPP benefits and contributions must affect the rest of the system. For example, CPP contributions are tax deductible, and like registered pension plan (RPP), deferred profit sharing plan (DPSP) and RRSP contributions, represent a tax expenditure. An increase in tax expenditure resulting from CPP expansion will require either a scaling back of other tax expenditures (perhaps contribution limits for other registered plans), an accompanying increase in personal or corporate taxation rates, or a reduction in government-provided services and programs (such as OAS/GIS), all of which will have further economic repercussions.
As well, an increase in employer CPP contribution rates will further marginalize maintenance and establishment of other workplace pension programs. Where such programs already exist, sponsors will likely wish to restructure them to offset the cost and benefit impacts of CPP expansion. Where such programs do not exist, there will likely be impacts on wage growth to offset the additional CPP costs, along with a disincentive to establish new workplace pension programs.
Myth 3 Canadian state pension programs (collectively CPP, Old Age Security and the Guaranteed Income Supplement) are risk-free and sustainable for at least the next 75 years.
In the opinion of Canada’s Chief Actuary in 2006, and subject to explicit caveats concerning several areas of uncertainty, including demographics, economic cycles and financial-market volatility, CPP funding and benefits were determined to be sustainable over a 75-year period. However, OAS and GIS are provided out of general government revenues and are not subject to independent review relative to their sustainability.
Demographic risks to the Canadian pension system are very significant and broader economic risks are also at play. General government revenues will be increasingly taxed by both the pension and medical benefit requirements of an aging population, as well as being subject to global economic events. In the 2010 global pension index, Canada scores a mediocre ranking of seventh in the sustainability subindex. A particular recommendation made in the index report is that Canada should “introduce a mechanism to increase the state pension age as life expectancy continues to increase.” In fact, Canada’s sustainability subindex score fell by almost 12% between 2009 and 2010, due in part “to the decline in asset values in 2008 expressed as a percentage of GDP and the increase in government debt, both which were caused by the global financial crisis.”
Myth 4 All Canadians get the same value for money on their CPP contributions.
This statement is simply false. Younger generations of Canadians get far less value from the CPP than older Canadians, particularly those already retired. The CPP is funded on a “modified pay as you go” system, with current benefits funded by current contributions. A contribution surcharge is allocated to the CPP Investment Fund for purposes of smoothing out the coming payments bulge of the aging Baby Boomers and to serve as a cushion for future potential economic risks to CPP funding requirements. Workers who most recently began contributing to the CPP pay far more than those who have retired, and even those who are mid-career. In short, the CPP is funded by an intergenerational transfer of wealth from younger Canadians to older Canadians.
Myth 5 CPP administration is low-cost.
CPP is very expensive to administer and does not reflect reasonable expectations for lower costs from a very large (in the Canadian context) economy of scale. Even medium-sized pension plans in Canada’s private sector easily achieve similar or lower cost structures.
The consolidated financial statements of the Canada Pension Plan for 2008-09 show operating expenses of $694-million, investment management fees of $383-million and investment transaction costs of $93-million for a total of $1.17-billion. Average assets of the CPP Investment Fund for the period were $118-billion. Thus investment-related expenses amount to approximately 0.40% a year, with administrative expenses of approximately $41 per year per CPP contributor/beneficiary (based on 17 million contributors/beneficiaries).
Myth 6 CPP is self-funded and does not impose a tax burden.
Ignoring that CPP contributions are widely regarded as a “payroll tax” by corporate and individual taxpayers in Canada, even though CPP is wholly funded by employer and employee contributions, other aspects translate into an additional tax burden for Canadians. For one, public-sector employers are funded by taxpayers, and thus so are CPP contributions made by such employers. And, as already mentioned, CPP contributions are considered a tax expenditure and the “steady-state” funding of the CPP includes a surcharge contribution relative to the costs of currently accruing benefits.
Canadians should take pride in their pension system; it is truly among the best in the world. Pension reform is required, however, particularly in the underutilized areas of employer-sponsored workplace pension plans and individual retirement savings. CPP expansion is not the answer to these needs — other more targeted solutions can be deployed in a manner that preserves the stability and improves the integrity of the current system.
I agree that Canadians should take pride in their pension system, but things are far from perfect. I also question some of the assertions made in this op-ed piece. In fact, as Linda McQuaig reports in the Toronto Star, Public better than private on pensions:
Mayor-elect Rob Ford famously painted the city’s garbage collectors as a pampered elite enjoying a “gravy train.” Appealing as it must be to pick up Toronto’s garbage, that’s one gravy train I don’t mind missing out on.
Similarly misleading attempts to portray public-sector workers as overindulged have come from business spokesperson Catherine Swift, who implies that relatively generous public-sector pensions — for workers cleaning schools and emptying hospital bedpans — are imposing a huge burden on Canadian taxpayers. (Swift omits to mention that public-sector workers pay into their pensions, both as workers and taxpayers.)
Such claims seem aimed at creating divisions among hard-pressed working Canadians, so that those in the private sector will angrily demand cuts to public programs.
The notion that we can’t afford strong public programs — that we’re better off buying services or benefits on our own — is one of the central falsehoods blocking meaningful progress toward improving Canadian well-being.
An excellent example is the looming battle over public pensions, an issue that will be the focus of a meeting of Canada’s finance ministers in December.
While reducing poverty among the elderly has been one of the success stories of Canada’s social welfare system, the situation threatens to deteriorate significantly, largely because of the recent failure of employers to expand private-sector pensions.
All Canadians over 65 receive the federal government’s Old Age Pension and those with very low incomes receive the Guaranteed Income Supplement. But even together, these provide an annual maximum of just $14,034 per person. The other key public program is the Canada Pension Plan (CPP).
The Canadian Labour Congress is pushing to expand the CPP, to double the average benefit, currently only about $500 a month. This expansion, which would involve mandatory increases in premiums paid by workers and employers, would be phased in over time and benefit younger workers most.
Support for an expanded CPP has come from former CPP chief actuary Bernard Dussault, but business and the financial sector would prefer Canadians rely more heavily on private investments in mutual funds and RRSPs.
This is a costly alternative, however, since the financial sector siphons off a significant amount through management fees.
According to Jonathan Kesselman, professor of public finance at Simon Fraser University, management costs at Canadian mutual funds eat up nearly 2 per cent of assets — the highest rate in 20 countries surveyed. By comparison, CPP management costs were just 0.17 per cent last year.
This enables the CPP to pay out more in pension benefits. Kesselman argues that significantly extending the CPP would be “by far the best of all savings vehicles.” In fact, expanding the CPP would ultimately save governments money, by making future retirees less financially dependent.
But this eminently sensible, cost-effective public solution has been resisted by some on the right, who argue that the mandatory CPP deprives Canadians of the choice not to invest in their retirement.
This is reminiscent of arguments by the American right against public health care, on the grounds that some risk-lovers prefer to be without health insurance.
Of course, those making such arguments are usually well-off financially, with little risk in their own lives. Still, they fiercely defend the right of the poor to experience the risky pleasures of life without a safety net.
It's time to significantly extend the CPP. We can improve on our pension system and reduce pension poverty. To sit back and say everything is fine is just ignoring the pending pension disaster that looms ahead. It's time for Canada to take the lead on pensions and show everyone why we truly are one of the best countries in the world.