No surgery needed [CPP]

NationalPost.com – financialpost.com
Wednesday, Dec. 15, 2010.    Jack M. Mintz, Financial Post

Facts keep getting in the way of those who push for big changes to our retirement income system. Most Canadians have sufficient replacement income in retirement years and have generally paid down most of their debt by 65 years of age.

Canadian household net wealth per dollar of income has already surpassed the earlier 2000 peak and is approaching 2007 levels. Unlike the U.S., Canadians have experienced no decline in housing equity, which is now close to $1.9-trillion.

Housing wealth is as large as all the combined assets held in pension plans, RRSPs and CPP/QPP, although, as most Canadians know, downsizing or reverse mortgages have no tax consequences, unlike pension and RRSP withdrawals, which are fully taxed. On top of this, Canadians have more than $2-trillion in net financial and business assets that are not sheltered from tax. Modest and middle-income Canadians hold many of these assets, not just the rich.

As recent research confirms, almost 90% of Canadians have managed their affairs quite well, taking all the assets into account. On average, most middle-income Canadians have at least 60% replacement income at retirement. While some modest-income Canadians may not be saving enough, others save more than they need in their retirement years.

And, Canada has done a good job in protecting the elderly from poverty. Even with the recent uptick in poverty, with a loss in financial income — which is a concern — Canada’s poverty rate is one of the world’s lowest. With Old Age Security, the Guaranteed Income Supplement, CPP, medicare, provincial support programs and tax breaks for the elderly, most low-income Canadians maintain their consumption after retirement. Focus instead should be directed where poverty rates are highest, such as single-parent working families.

Some proponents of pension reform argue that Canadians will earn poorer returns in the future than in the past. Actually, returns on investment, once adjusted for inflation, were quite poor in the 1970s and in the past decade. Those with defined contribution plans or RRSPs would find a large variation in retirement incomes depending on their years of investment, which is why plans with at least minimum guarantees are less risky.

The average annual return on assets has been 5.5%, which is just as likely to be the case in the coming decades as in the past. The system is performing well — we certainly don’t need major surgery.

Some nips and tucks could help, though, to remove regulatory and tax barriers that undermine the efficiency of retirement income markets. For example, smaller and medium-size businesses have difficulty pooling resources in multi-employer pension funds, since only the employer or a union sponsor such plans. Broadening sponsorship to include financial institutions could make it easier to develop cost-efficient multi-employer plans.

Then there’s discrimination against the use of group RRSPs. At present, employer contributions to registered pension funds reduce the payroll tax base for calculating CPP, QPP, Employment Insurance and

workers’ compensation payments. But this is not the case for group RRSPs, which can be a cost-efficient mechanism to provide retirement income to workers (and a flexible plan for employees who change jobs frequently).

The decline in defined-benefit arrangements in the private sector is also a concern since these options enable individuals to pool risks optimally with employers or financial institutions. Unlike defined-contribution plans and RRSPs, defined-benefit plans and annuities allow Canadians to share longevity risk by pooling across the population. Defined-benefit arrangements also enable many workers to know better their income at time of retirement, since employers or financial institutions absorb a significant share of the risk.

In the past, both regulatory and legal obstacles have made it more difficult for employers to offer defined-benefit arrangements. Some employers prefer to keep defined-benefit plans for workers as a competitive edge in labour markets. Recently, federal and provincial governments have improved the treatment of defined-benefit plans, such as enabling greater surpluses to be generated in the good years to offset declines in bad years. However, more still needs to be done, such as dealing with an inappropriate sharing of risks and surpluses in face of partial windups.

And those on disability insurance need to be assured that employers facing bankruptcy cannot have access to trust funds that are meant to cover their benefit payments.

This leaves whether CPP should be expanded. The Canadian Labour Congress proposes the doubling of the current earnings limit of $47,200 in seven years’ time, resulting in an estimated sharp hike in payroll taxes from 4.95% to 7.95% each for employees and employers (almost a 60% increase).

The virtue of the CPP is that contributions are pooled to reduce both investment and longevity risks, which for some workers is the only defined-benefit arrangement available to them. CPP pools risks best since it is a mandatory savings plan, forcing all Canadian workers to save more or reduce holdings of other assets.

Nonetheless, a CPP expansion has consequences. Some young Canadians prefer to put their money in a home, business or other financial assets rather than the CPP. Small businesses will find it more costly to hire workers. As an anti-poverty measure, CPP is less effective than the Guaranteed Income Supplement, since the latter is available to all seniors, whether they have worked sufficient years in the past or not.

More important, a CPP expansion could result in a large transfer of wealth from workers to retirees. For this reason, governments are considering a fully funded CPP expansion to avoid inter-generational transfers — a hard sale since payroll taxes would rise before benefits would be received.

Some modest increase in CPP to provide more defined-benefit arrangements makes some sense. However, bringing in higher payroll taxes at a time when the Canadian economy is on the rocks is rather bad timing.

When federal, provincial and territorial ministers of finance meet just before the holidays, they should first focus on low-hanging fruit, such as regulatory changes, and put off CPP expansion until the economy is in better shape.

-Jack M. Mintz is the Palmer Chair of Public Policy at the School of Public Policy, University of Calgary.

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