CPP reforms need a complete rethink
News broke recently that the provincial and federal finance ministers will re-examine certain aspects of the Canada Pension Plan (CPP) reforms agreed to in late 2016, yet avoid a larger re-evaluation of the efficacy of an expanded CPP. Clearly, however, a genuine review of the reforms would result in their undoing.
For example, one of the principle arguments for an expanded CPP was its rate of return. Unfortunately this argument conflates the rates of return from the investment arm of the CPP—the Canada Pension Plan Investment Board or CPPIB—and the actual returns received by CPP contributors.
The CPPIB, which invests the surplus funds of the CPP, has performed well. Over the last five years ending in 2016, it earned an annualized rate of return of 11.8 per cent, which is impressive.
However, the returns of the CPPIB do not directly affect CPP benefits received by retirees, which are based on one’s earnings over time—between the ages of 18 and 64—relative to the average industrial wage and when the person retires.
Recent studies (see here and here) calculated the actual rate of return for CPP beneficiaries, based on what was actually paid into the plan compared to the benefits received in retirement. While the returns for retirees in the early years of the CPP were very high, they have since plummeted. For instance, for retirees born after 1993, the rate of return will be a meagre 2.5 per cent.
There are two reasons for the marked decline in the returns. First, retirees in the early years of the CPP paid into it for a shorter time period compared to younger Canadians. Second, the contribution rate (i.e. tax) has increased from 3.6 per cent when the CPP was launched (1966) to its current 9.9 per cent. It will increase further to 11.9 per cent beginning in 2019.
First, most analyses of retirement savings that conclude insufficient savings ignore the value of savings outside formal pensions. In 2014, the value of assets Canadians held in real estate, savings in stocks and bonds, and other investments were nearly triple the value of pension assets (i.e. CPP, QPP, RRSPs and RPPs). And many of these analyses failed to account for some of the decline in savings due to Canada’s aging population. That is, we should expect some decline in savings as Canada’s population grows older and begins drawing down their savings.
But when properly measured, as calculated by noted Canadian actuary Malcolm Hamilton in a 2015 analysis, private contributions to RRSPs and pensions actually increased substantially as a share of employment income: 7.7 per cent in 1990 to 14.1 per cent in 2012.
This error in measuring savings is compounded by the faulty assumption that an expanded CPP increases savings. At any particular point, individuals have a preference between their current consumption and saving for the future. Simply mandating more savings in the CPP does not change this preference. Their response, given both theory and evidence, indicates they will simply reduce their private savings (e.g. RRSPs and TFSAs) to offset the CPP increase.
Indeed, in response to the increase in the CPP tax from 5.6 per cent to 9.9 per cent between 1996 and 2004, average Canadian households decreased their private savings by roughly $1 for every $1 increase in the CPP. In other words, there was no net increase in the savings rate, simply a shift from private savings to the CPP. This shift is made all the more questionable by the meagre CPP returns outlined above.
And crucially, as the finance ministers themselves have apparently recognized, the reforms do nothing for low-income vulnerable seniors.
A broad assessment of the agreed-to 2016 CPP reforms would conclude that they were solutions in search of a problem—and in fact, don’t even solve the imagined problem. The actual evidence on retirement savings supports reversing course on the CPP reforms before the CPP tax hikes start in 2019.