By Jason Clemens,
and Milagros Palacios
The Fraser Institute
Canadians likely noticed that their first paycheque of 2019 was slightly smaller than in 2018, even if they got a raise. The decline in after-tax income is because the first of several tax increases to finance an expanded Canada Pension Plan (CPP) took effect on Jan. 1.
Unfortunately for Canadian workers, much of the justification for expanding CPP is incorrect or debatable.
A principal justification for the expanded CPP was that Canadians don’t save enough for retirement.
This analysis, however, ignores savings in one’s home and businesses. In 2014, for instance, the value of savings outside of financial assets such as registered retirement savings plans (RRSP) and pensions was $7.7 trillion (after deducting debt). That’s almost 2.5 times the value of all pension and RRSP savings. (This finding confirms the conclusion of a working group convened in 2009 by then-finance minister Jim Flaherty.)
In addition, pension expert Malcolm Hamilton raised concerns in 2015 about how the household savings rate was being calculated since it ignored demographics. He concluded that contrary to popular opinion, the savings rate for pensions and RRSPs as a share of employment income almost doubled from 7.7 per cent in 1990 to 14.1 per cent in 2012.
Moreover, many proponents assume that an expanded CPP will result in a net increase in savings for retirement. Both theory and empirical evidence indicate this is not the case.
Instead, higher mandatory CPP contributions will likely result in less private savings in pensions and RRSPs.
A 2015 study found that between 1996 and 2004, CPP contributions were raised from 5.6 to 9.9 per cent. For every $1 increase in CPP premiums during that period, the average Canadian household reduced its private savings by almost $1.
People have preferences for how they split their income between saving and consuming. Mandating an expanded CPP doesn’t change those preferences. That means the overall rate of savings will likely remain unchanged, but the mix will change to favour more CPP and less private savings.
It’s also worth noting that CPP doesn’t provide inheritance to dependents that’s comparable to private savings. And unlike RRSPs, CPP doesn’t provide the flexibility to use money for a down-payment on a home or to finance a return to school.
A second pro-expansion argument is related to CPP’s rate of return and its comparatively low costs. Both lines of argument are incorrect.
A 2014 study calculated CPP’s total costs at $2.9 billion, more than three times what’s normally reported ($800 million). As a share of assets under management, that represents a cost of 1.06 per cent, which is comparable to a host of other pension and investment funds. So there’s no particular cost advantage for the CPP.
The typical rate-of-return argument conflates returns from the Canada Pension Plan Investment Board (CPPIB). The board invests the surplus funds of CPP. But unlike RRSP or tax free savings account (TFSA) returns, CPPIB returns don’t directly influence the benefits received by Canadian workers in retirement. Rather, CPP benefits are based on individual earnings and CPP contributions made between the ages of 18 and 64.
Also, some confuse the rates of return for Canadian workers in CPP’s early years with rates for current and future retirees.
When the working period was shorter and the CPP tax lower, workers enjoyed higher rates of return. For instance, a worker born in 1905 who retired in 1970, one of the first full years of the CPP, received a 39.1 per cent return (after inflation). However, Canadians born after 1971 will pay a higher CPP tax and work longer for eligibility. And they will receive a meagre 2.5 per cent return on their contributions (this is a post-expansion calculation).
CPP is not a low-cost, high-yield pension.
Some advocates argue that an expanded CPP would help Canada’s poorer seniors. Unfortunately, this too is largely incorrect.
The most vulnerable seniors are single with no CPP income, because they had insufficient or no employment income during their working years and don’t qualify for CPP benefits. And 48.9 per cent of this group were in low income in 2013. An expanded CPP won’t help them because they’re not eligible for CPP benefits.
As Canadian workers see their after-tax income reduced by the expanded CPP, they should consider the actual benefits in the future given the higher costs today.
Clearly, an expanded CPP is not a good deal for workers.
Jason Clemens, Jake Fuss and Milagros Palacios are economists with the Fraser Institute.