Heading into meetings with his provincial counterparts, the federal finance minister hasn’t succeeded in justifying the need for increased retirement savings, nor the need to expand the CPP.
By Sean Speer, June 9, 2016
Federal Finance Minister Bill Morneau is set to meet his provincial and territorial counterparts later this month to discuss an expansion of the Canada Pension Plan (CPP). The meeting is expected to be more than the usual photo-op and talking points that characterize most federal/provincial exchanges. The survival of the government’s pledge to enrich the CPP is at stake.
Ottawa requires sufficient support – the amending formula requires two-thirds of the provinces representing two-thirds of the population – to change CPP premiums and benefits. The Vancouver meetings will confirm whether Mr. Morneau has managed to achieve this threshold.
It’s a difficult to foretell the meeting’s outcome. Partisan changes in provincial capitals, the Ontario government’s growing attachment to its own provincial-based pension scheme, and a final lobbying push by labour unions render the meeting’s results anything but a foregone conclusion.
The survival of the government’s pledge to enrich the CPP is at stake.
But what we do know is that the determination ultimately rests with the provincial and territorial finance ministers. It’s up to them to judge whether a CPP expansion is justified or expedient. And the evidence should give them cause for reticence.
The case for CPP expansion starts with the presumption that a large number of Canadians aren’t saving sufficiently for retirement – indeed, that the country is facing a broad-based retirement income “crisis.” This assertion belies the evidence but also reflects a top-down, state-centric view about the role and purpose of public pensions.
The debate about the state of Canada’s retirement income system is bedeviled by competing definitions, measurements, and assumptions. It’s not uncommon for politicians, economists, and policy commentators to talk past one another using apple-to-orange comparisons. There are also differing views about the role of the state in helping people save for retirement. The present debate is driven at least in part by divergent opinions about the line between “public good” and personal preferences.
An evidence-based retirement income policy should seek to help as many Canadians as possible maintain a reasonable level of income/consumption in retirement while recognizing that “reasonable” is the subject of some debate and generally based on one’s own circumstances and preferences.
Canada’s current retirement income system is striking a good balance between providing a basic public pension and otherwise enabling individuals to prepare for retirement based on their own needs and preferences. Those in favour of CPP expansion have failed to provide compelling evidence that we ought to alter this balance.
Few would argue that it should be the goal of the public pension regime to fully replace an individual’s working-age income. It not only doesn’t make practical sense in light of shifting post-retirement consumption patterns, it precludes personal preferences or choices about savings and consumption and substitutes one-size-fits-all, top-down assumptions about how much income we ought to have in retirement.
Canada’s current retirement income system is striking a good balance between providing a basic public pension and otherwise enabling individuals to prepare for retirement based on their own needs and preferences.
An individual’s consumption patterns generally change in retirement and he or she needs less income to cover expenses. This just makes intuitive sense. Spending on child care or mortgage payments or payroll taxes, to name just a few examples, invariably falls. It makes little sense therefore for public policy to set a goal of maintaining a certain level of pre-retirement income. Instead the goal should be to help people to maintain a reasonable level of consumption in their retirement. Misperceptions about the difference between income replacement and consumption replacement and what constitutes a reasonable target have contributed to the view that Canadians are ill-prepared for retirement.
The optimal replacement rate to maintain consumption patterns is the subject of some debate. There are, however, some useful rules of thumb. Actuary Fred Vettese has produced analysis showing that most retirees only need to replace about 50 percent of their income to finance what he calls “regular” consumption such as food, clothing, and utilities. Another study by pension expert Malcolm Hamilton finds that the proper range is somewhere between 30 and 70 percent depending on one’s individual circumstances. These estimates accord with work by Vettese (co-authored by Finance Minister Morneau) that finds the so-called “neutral retirement income target” ranges from as low as 41 percent for high-income couples with children to as high as 56 percent for middle-income couples without kids. The consensus of these studies is that, for the vast majority of Canadians, the target range is probably between 40 and 60 percent.
It’s also true that evaluating retirement income adequacy is partly a matter of personal circumstances and preferences. While public policy should aim to help Canadians maintain reasonable levels of consumption in their retirement, there’s a point at which the role of the state reasonably ceases and individuals must make the right choices for them and their families. Some people may wish to travel extensively in retirement and will therefore require more retirement income in order to cover their inflated leisure costs. But is this really a matter for public policy? Should all Canadians be forced to save more so that some have the means to travel on cruises?
One of the virtues of Canada’s retirement income system is precisely that it accommodates personal preferences better than others that rely more heavily on state-funded or administered pensions. This isn’t a flaw or a shortcoming. It’s an achievement.
Canadians can now make trade-offs between savings and consumption during their working years and in retirement based on their needs and preferences. Some may wish to drive used vehicles and defer home renovations in order to save faster and retire earlier. Others may choose to keep working in order to pay for their child’s competitive sports or start a small business and thus delay building a retirement nest egg.
The current retirement income system provides a basic public pension in the form of the CPP and Old Age Security/Guaranteed Income Supplement (what are often referred to as the first and second pillars of the retirement income system) and then otherwise decentralizes retirement income savings to accommodate these different choices. Yet it doesn’t mean that people are on their own. There’s a key distinction between state-centric and state-enabled solutions.
The government presently plays a critical enabling role mostly through tax incentives to help Canadians save for retirement on their own terms (the preferential tax treatment of RRSPs, for instance, costs the government as much as $15 billion in foregone revenues per year). This enables a high degree of individual choice with regard to the size and timing of one’s savings while gently “nudging” people in the direction of preparing for the future. Shifting a greater share of retirement savings to the CPP would diminish this flexibility and conceivably force some Canadians to over-save irrespective of their needs or preferences.
Put differently: the principal measure of the retirement income system’s effectiveness should be the extent to which it is ensuring that most Canadians can maintain reasonable levels of consumption in their retirement rather than being concerned with the mix between public and private savings. That the relative share derived from government sources is low compared to other jurisdictions is hardly an indictment. Public expenditures on pensions is a seriously flawed measure. Just ask Greece.
The real question is: how are Canadians faring with respect to retirement income security after accounting for all sources of savings, including public pensions and private savings? The overall picture is positive. Basic public pensions have contributed a dramatic drop in seniors’ poverty and one of the lowest rates in the industrialized world. The median Canadian senior earns about 91 percent as much as the median Canadian – well above the OECD average of 84 percent. And Canadians achieve relatively high levels of income/consumption replacement and place third among OECD countries.
It’s far from a “crisis” that Canadian public policy is achieving such high levels of income/consumption replacement primarily through voluntary savings rather than a mandatory regime or costly entitlement programs. It’s a real policy accomplishment, a source of economic competitiveness, and the basis for an effective model that enables Canadians to make the right choices for themselves and their families with regard to the future.
Provincial and territorial finance ministers should therefore be careful to avoid disrupting the system given that it is working well for most Canadians. There is room for incremental improvements (such as expanding enrollment for Pooled Registered Pension Plans) but there’s little evidence that broad-based reform – particularly in the direction of more centralization and less choice – is justified or advisable.
This month’s meeting between Finance Minister Morneau and his provincial and territorial counterparts could have significant implications for our retirement income system. The minister is committed to trying to secure sufficient support for CPP expansion and intends to make progress in this direction in Vancouver.
Yet the evidence finds that Canada’s retirement income system is striking a good balance between providing a basic, foundational pension and then enabling individuals to prepare for retirement based on their own needs and preferences. Provincial and territorial finance ministers shouldn’t consent to altering this balance.
Sean Speer is a Senior Fellow at the Macdonald-Laurier Institute.