Why CPP hikes are a bad idea
CalgaryHerald.com – business
February 6, 2011. By Mark Milke, Calgary Herald
It’s an axiom of politics that the short-term often wins out over smart, long-term policy. Much as a politician might want to take generational issues and fairness into account, it’s tough to ignore immediate pressure and the cohort most likely to vote.
However, as of late, two examples are an exception to the rule. First, the creation of tax-free savings accounts (TFSAs), now in their third year. If, in this tax season, you must choose between a $5,000 contribution to a TFSA or a Registered Retirement Savings Plan (RRSP), choose the first option. You will permanently protect any investment gains from taxation.
That’s one example of farsighted political thinking. Here’s another. How just before Christmas, Ottawa and the provinces ignored a push by those who love all things taxpayer-financed and government-delivered, to double CPP taxes. Instead, they opted to create a Pooled Retirement Pension Plan, where employers must set it up and employees can choose to join or not.
The reason why a CPP hike would have been a bad idea requires some history. The earliest contributors to the CPP made out wonderfully. Those born in 1930 saw a real return of 9.4 per cent annually on their original contributions. In other words, had they invested such money, they would have needed a 9.4 per cent return each year to garner what they did from their CPP payments. Similarly, those born in 1940 obtained a real return of 6.3 per cent.
But the return on one’s CPP taxes become meagre the later one is born. It’s why it resembles a social program and not a true pension plan. Those born in 1950 and soon to retire will see a 4.2 per cent payback. Those who arrived in 1960 and 1970 will receive a three per cent and 2.4 per cent real return respectively. For those born in 1980, 1990 and 2000, a 2.3 per cent real rate of return on their CPP payments is their meagre payback. (All figures are derived from the 18th and 25th actuarial reports on the CPP.)
The early, high rates of return are not because CPP contributions were invested in a manner to make Warren Buffett look like a rank amateur. The low contribution rates for the pre-baby boom generation had everything to do with demographics. Over the decades, successive governments kept retirement contributions artificially low. That’s because a plethora of young workers existed to finance the pensions of relatively few seniors already (or soon to be) in retirement. That’s why the CPP is often referred to a partial Ponzi scheme. Those in first did great; those who came later, not so much.
The demographics explain why combined CPP employer-employee premiums were only 3.6 per cent until 1986. After that, premiums rose slowly, with a sharper increase after the 1997 reforms to hit 9.9 per cent by 2003. At some point, reality had to be accounted for and it was.
The 1997 reforms were meant to address both the unfunded liability in the CPP and partially address the generational imbalance. In that sense, the reforms succeeded. Before the reforms, those born in recent decades were on track to see negative real rates of return.
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