Public option best strategy to buttress pension system

TheStar.com – Opinion/Editorial Opinion
Published On Wed Dec 22 2010

There has been a wide-ranging discussion recently about the need to reform Canada’s pension system and it was a top topic at the recent finance ministers’ meetings.

This has included a lengthy paper published by the C.D. Howe Institute. Institute president William Robson also has expressed his views in a recent article, suggesting that the finance ministers should consider only “better private pensions and RRSPs” and not a general increase in, for example, the Canada Pension Plan (CPP). He refers to the Howe study as background to his recommendations. But the study itself does not make specific policy recommendations for pension reform. Indeed, some parts of it are counterintuitive to the suggestions Robson makes, and the Howe study’s numbers can be used to show the distinct advantage of the CPP over private pensions and RRSPs.

The Howe study does not, for example, compare the returns that might be expected from a private sector pension compared with public sector pension options, such as the Canada Pension Plan. The Howe study uses historical nominal rates of return of 6 per cent (4 per cent real plus 2 per cent inflation) on investments for pensions but reduces such returns to just 3 per cent (1 per cent real plus 2 per cent inflation) for RRSPs and 4.5 per cent (2.5 per cent plus 2 per cent inflation) for defined-contribution Registered Pension Plans (RPPs). The reduction for individuals is the result of “investment-management and other costs” plus the poorer performance levels of individual investments.

What kind of results would these numbers produce for a 30-year-old individual who saves $100 a month in an RRSP for 35 years at an annual return of 3 per cent? What pension would he or she would accumulate?

By contrast, what would the same $100 a month invested in the CPP at an annual return of 6 per cent less the cost of CPP management yield after 35 years?

The CPP investment would yield a pension approximately 80 per cent greater than an investment in RRSPs. This result is consistent with a British study by Mamta Murthi, Michael Orszag and Peter Orszag that in the U.K. individual pension accounts result in a 40 per cent reduction in pensions when compared to a public pension fund.

Would Canadians like those substantially greater pensions? They most certainly would.

Another consideration that Robson ignores is that the individual cannot know how much one needs to save for retirement. This is because the individual does not know how long he or she will live. And, in addition, the rate of interest on annuities may be based on government bond rates of say 16 per cent (as in the early 1980s) or just 3 per cent (as is the case now). But the large pension funds like the Canada Pension Fund can estimate quite accurately the life expectancies of the large numbers of its members. Thus the CPP is a far more efficient pension scheme than any individual RRSP or defined-contribution RPPs.

The CPP, then, both lowers the costs to the individual saver as well as reducing the individual’s risk. It should also be noted that the present level of CPP payments is considered inadequate by any serious analysis.

One other subject the Howe study does not report on is the effect of an increase in the retirement age. If the retirement age were to be gradually raised from 65 to 67 it would have a double effect; the years of saving would be increased by two years and the years of pension payments would be reduced by two years. The result would be a substantially positive increase in the adequacy of pensions looking out to the year 2050.

Robson also mentions that the Howe study shows that low-income individuals will be more effective in maintaining their income level in retirement than will the higher-income individuals. He, therefore, suggests that the higher-income individuals need “better private pensions and RRSPs” rather than an increase in the CPP.

Higher RRSP contributions would mean a tax-expenditure or a subsidy to savers. But such a subsidy would be paid for by the general taxpayer and the largest benefits would go to those in the highest income tax brackets. Thus Robson suggests as social policy that the poor should subsidize the rich so the rich can have larger pensions when they retire. That kind of social policy coming from the president of the C.D. Howe Institute must make the Liberal C.D. Howe spin in his grave.

It should also be remembered that an increase in savings, whether from increased CPP premiums or larger RRSP contributions or other savings, has exactly the same effect on the economy.

The exception is that increased RRSP contributions will make the financial institutions better off, while an increase in CPP contributions will make Canadian pensioners better off.

It is clear that increasing CPP contributions is by far the best way to improve pensions for Canadians. One would hope that all the finance ministers in Canada would heed this call for an improved Canada Pension Plan.

Douglas D. Peters is former chief economist of the Toronto-Dominion Bank and a former secretary of state (finance) in the Liberal government of Jean Chrétien.

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