This blog is based on a talk prepared for the influential industry investment lobby, the Portfolio Management Association of Canada. It was delivered by Jack Mintz at the Fairmont Royal York, Tuesday, November 24, 2015, and reproduced with permission of the organizers.
By Jack M. Mintz, President’s Fellow
School of Public Policy, University of Calgary
Special to the Financial Independence Hub
These days many governments, including the newly elected federal Liberal party, espouse the need for public policy to be evidence-based. I am sure everyone in this room would agree that evidence-based policy is far better than policy dependent on conjecture and the whims of a politician.
When it comes to pension reform, many politicians pushing for a much bigger public pension plan in Canada have based their policy prescriptions on an argument that Canadians do not save enough for retirement. The issue has been charged for almost a decade with some suggesting that Canada faces a pension crisis.
Four in five have adequate retirement income
In 2009, I was asked by the federal-provincial-territorial ministers of finance to be a research director of a project to determine whether there was evidence as to whether Canadians did not have adequate income for retirement. The overwhelming conclusion based on expert studies was that most Canadians – almost four-fifths – had adequate retirement income although a pocket of Canadians with modest incomes should be of concern.
The evidence developed at that time had a remarkable impact on the pension income debate. The words pension crisis disappeared and many experts understood that Canadians had many types of investment to ensure sufficient retirement wealth. This not only included CPP, QPP, registered pension plans, tax-free saving accounts and RRSPs but also home equity, which on an after-tax basis was more valuable than all other tax-favoured retirement accounts. With other financial and business assets, it was clear that most Canadians were doing just fine without expanding the Canada Pension Plan. Even our new Minister of Finance, Bill Morneau, concluded in a 2013 book with Fred Vettesse that the pension crisis was overblown although some issues needed to be addressed.
Low interest rates making investors nervous again
Of course, since 2009, the long period of low interest rates and financial returns in the markets has made many Canadians nervous again.
For example, Minister Mitzie Hunter professed in her introduction of the Ontario Retirement Pension Plan [ORPP] that in casual conversations at a barbecue, she heard from so many that they were worried about having enough money for their retirement. Now, I don’t think barbecue interludes among friends are in the category of evidence-based policy. So today, I would like to review whether a major expansion in public pensions like the ORPP or CPP is needed.
Before elaborating on any policy, it is appropriate to ask what is the problem? Without knowing the problem, one cannot talk about solutions.
It’s not true that we don’t save enough
The argument that Canadians do not save enough is simply wrong. Using the OECD benchmark that middle income households need 60 per cent of their working incomes at retirement, Statistics Canada and McKinsey surveys have concluded that at least three-quarters of Canadians today have considerable financial assets to fund their retirement. Similar to the 2009 Minister’s research project, Canadians with roughly $25,000 to $60,000 in income may not have sufficient retirement income.
While some have invoked behavioural economics as an argument that myopic Canadians may not worry enough about the future, it is also well known from behaviour economics that misers may be too worried about the future and save too much, reducing income available for consumption during early years. In fact, one Statistics Canada study suggests that Canadians are too risk averse and have accumulated retirement wealth in excess of what they need for retirement.
Even for those Canadians who do not have enough adequate retirement income, studies have failed to provide a clear answer as to why this is the case. Is it due to undersaving? Poor investment returns? Family marriage breakups? Poor health and disability? Spells of unemployment? If the problem is more related to unemployment spells and personal distress, the solution is much different than just expanding public pension plans. Despite all the rhetoric, it is simply amazing how little is known as to why a minority of Canadians have too little retirement income.
Three other facts before I go on.
94% of seniors protected from poverty
First, it has become a foregone conclusion that Canada’s social safety net has protected about 94 per cent of seniors from poverty, one of the best records among OECD countries. However, in some recent work with Philip Bazel at Calgary’s School of Public Policy, we found that the poverty rate among single seniors was quite high – 20 per cent using the most conservative measure. This should not be surprising. Even though two working adults at retirement could have as much as almost $40,000 in OAS and CPP benefits at retirement, a single senior would face a significant drop of income of over $12,000 when a spouse passes away. If the partner, typically female, did not always work, income could dip below the poverty line even with the Guaranteed Income Supplement.
People living and working longer
Second, people are living and working longer. However, recent studies have suggested that the period of ill health is also longer that will put a significant strain on households’ resources in the last years. While Canada provides public health care for hospitals and physicians, Canadians must cover out of their pockets expenditures related to homecare, longterm care, drugs and dental work. Tax relief is provided through the caregiver credit, medical expense credit and exemption for the purchase of life and health plans, many Canadians with modest income face significant expense to cover health-related needs.
Tax treatment of CPP results in inferior after-tax returns
Third, it is typically claimed that the investment returns earned by CPP funds have been stellar. I won’t doubt that is the case. What is less appreciated is that personal income tax treatment of CPP/QPP contributions and benefits can result in inferior after-tax returns on public saving plans for many Canadians. The problem arises for two reasons. For one, Canadians are not able to deduct the CPP/QPP contributions from income. Instead, they are given a tax credit based on the lowest marginal tax rate. For another, CPP and QPP benefits are included in income to determine income-tested benefits like Old Age Security, Guaranteed Income Supplement and the GST credit. It does not take an Einstein to figure out that an actuarially fair investment in CPP once taking into account personal tax effects can be a raw deal for many investors including the poor.
Using the above information, let me turn to the ORPP, which I have termed as “hare-brained idea”, in a my Financial Post article entitled, “Kill Ontario’s pension plan” of August 12th.
ORPP is poor policy addressing wrong pension issues
The ORPP with premiums set at 1.9 per cent up to $90,000 in income, matched by employer contributions, will annually cost up to $3,286 per worker. As the plan will be fully funded, benefits at 15 percent of insurable earnings will be paid at a later time, up to $12,816 per year. Those workers with defined benefit and sufficiently large defined contribution plans will be exempt from the ORRP.
The ORPP is an intrusive plan predicated on the belief that Ontarians do not save enough. There is no evidence that is the general case. Instead, the plan will impose a significant tax on employees and employers with several flaws:
- As many young workers are raising families and buying homes, a new public pension plan is only a burden since most Ontarians will have adequate income in later years anyway.
- The plan unnecessarily extends to two working employees who have up to $180,000 in income. While it makes sense for governments to ensure adequate protection for those with modest incomes, it is not necessary to extend pension support to such high levels of family income.
- Given interactions with personal tax system, forcing Ontario residents to hold more public pension assets rather than other better tax-treated assets is a raw deal with poor after-tax rates of return.
- The ORPP is expensive to administer with people moving in and out of the province. Taxpayers will be on the hook for any pension deficits arising from poor financial returns and future liabilities, a problem that can be exacerbated if funds are directed by governments to be invested in pet programs.
- Given that Ontario is imposing new taxes on energy and incomes, a pension tax with benefits paid many years down the road will sap further an already weak economy.
- The ORPP will also disrupt labour markets in Canada, creating incentives for some employers and employees to move in or out of the province depending on circumstances.
In my view, the ORPP is a poor policy addressing the wrong pension issues and should be scrapped. It would be far better to push for other retirement income reforms that largely require federal leadership.
Moderate expansion of CPP could be considered for mid incomes
Obviously, consideration could be given to a moderate expansion of the CPP that would be targeted to address three critical areas: providing more support to those with income roughly between $20,000 to $60,000 in income, assist more single seniors and fix the personal income tax to make CPP a better investment. Thus, a targeted approach would have six features:
- Increase insurable earning up to $60,000 ($120,000 for two earners).
- Raise the replacement income ratio from 25 to 35 per cent so that maximum benefits would increase from roughly $13,000 to $19000 on top of an additional $7,200 in OAS.
- Increase spousal benefits from 60 to 100 per cent to provide greater support to those seniors who lose their loved ones.
- Treat CPP/QPP like other saving plans to make contributions deductible from personal income rather than creditable. CPP/QPP benefits would be exempt from determining income to determine clawbacks under the OAS and GIS, with modifications.
- Provide a targeted increase in GIS for single seniors, a promise made by the Liberals in the last election.
- To improve incentives for work and encourage later retirement as Canada faces increasing labour shortages with demographic changes, the eligibility age for CPP/QPP should be increased to 67, similar to many other countries and recently adopted for the OAS in Canada.
CPP reform needs seven provinces to approve
The difficulty with CPP/QPP reform like this proposal is that it requires seven provinces representing two-thirds of the population to approve it. My understanding is that there may not be sufficient provincial support for any expansion of the CPP in part due to its economic impact on working Canadians when the economy is weak. Ontario is committed to move ahead with its dysfunctional plan hoping a coalition of willing provinces would join it. This would obviously be a bad move for Canada as an economic union and therefore should not be facilitated by the federal government.
The federal government has other means to move unilaterally to provide more support to seniors if CPP is not reformed. This includes improving its own retirement policies such as increasing contribution limits for TFSAs, registered pension plans and RRSPs. It could even provide a grant to low and modest income Canadians to invest in special TFSA subject to a clawback if funds are taken out before the official age of retirement. The federal government could fix the personal tax treatment of the CPP/QPP without pension reform.
And it could top up guaranteed income for single seniors as well as improve tax credit for out-of-pocket health expenses as suggested by the recent Naylor report. Further, the federal government could redefine the eligibility for most of its programs and tax credits to make them begin at the age of 67.
Retirement income policies are indeed complicated and highly contentious. The ORRP is not the right way to go and should be disbanded. CPP reform is much more sensible but if there is not sufficient willingness to reform it in a modest way, the federal government has other policies that could benefit young Canadians today when they retire.