October, 1995 Vol 1, No. 3
October, 1995 Vol 1, No. 3
SAVING CANADA'S PUBLIC PENSIONS
Myth and Reality About the Aging Population
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Pension Funds and the "Paper Economy"
Finance Minister Paul Martin is sharpening his axe to go after Canada's system of public pensions. Having already slashed funding for UI, medicare, education, and welfare, Martin now thinks that Canada's seniors have gotten off too lightly. He has already warned that his February 1996 budget will contain huge cuts to public pensions--perhaps including an increase in the official retirement age, or the elimination of OAS benefits for middle-income earners.
To prepare the ground for these cutbacks, the federal government will release a discussion paper this fall on retirement income. The budget-cutters will tell Canadians that the current public system is not affordable. We will see staggering numbers on the cost of future pensions. The question will be posed: Why should today's young, who may never get a pension, pay for baby boomers' pensions? Over and over, Canadians will be scolded for relying on the government for their retirement income, while the merits of individual RRSP-style pension plans will be praised.
Unions fought for decades for a universal public pension system. Public pensions are essential to the well-being of millions of todays seniors. But how do we deal with the barrage of facts and figures which seem to sway the debate in favour of privatizing pensions? How do we counter the slick ads promising a golden retirement with million-dollar RRSPs?
A Shining Achievement
The Issue: Fair Retirement Income for All
- The right-wing agenda is to reduce public pensions and push Canadians toward a private system based on RRSPs.
- Public pensions have worked extremely well at reducing poverty among seniors. Cuts to the public system will mean a return to disgraceful levels of poverty for future retirees.
- The future costs of public pensions have been grossly exaggerated. Costs will increase, but not unduly; other countries have shown that affordable public pensions can be maintained even as society gets older.
- The key to paying for public pensions is to ensure job-creation and rising wages for Canada's working age population. This requires a full-employment growth strategy for our economy
Our public pension system, first introduced in the 1960s, is one of Canada's greatest social achievements. Thanks to public pensions, Canada has made tremendous gains in overcoming poverty among elderly citizens, and providing our seniors with much better prospects for a dignified and secure retirement.
The poverty rate among seniors dropped from 34% in 1980 to 21% in 1993. The drop in poverty rates among elderly women has been particularly impressive: from 71% in 1980 to 44% in 1993--still far too high, but a definite improvement. Studies have credited changes to the Old Age Security (OAS) system as "the single greatest factor" in reducing old-age poverty.
Public pensions have been especially important for lower and middle-income seniors. They are less likely to have been able to accumulate large stockpiles of private savings during their working lives, and less likely to have worked in jobs that provided decent private pension plans. For example, public pensions (OAS, GIS, and CPP or QPP) accounted for xx% of all income of the poorer two-thirds of seniors in 1992. Without these public pensions, poverty will once again become a fact of life for millions of seniors.
In contrast, the richest 5% of seniors enjoy ample private retirement income; they count on public pensions for only xx% of their total income. Indeed, were it not for public pensions, that elite 5% would actually take home more income than the bottom 65% of seniors put together (see Figure 1). No wonder the well-off are unconcerned about the fate of our public pension system.
Although the overall poverty rate for seniors has come down, the battle against poverty is far from over. Today, 1 of every 5 elderly Canadians still lives in poverty, and in 1993 (most recent data available), the seniors' poverty rate in almost every province increased over the previous year. Ontario reported a startling 70% increase in the poverty rate for elderly men. Clearly, saving and expanding public pensions will be an essential part of trying to minimize elderly poverty in Canada.
"I advise you to go on living solely to enrage those who are paying your annuities".
- Voltaire (French writer), 1850Defusing the "Time Bomb"
Frightening statistics are being publicized regarding Canada's aging population and the increased costs of retirement programs. The financial "burden" of pensions appears horrendous. But Canadians need a more rational picture of future trends in pension costs, without the hysteria of "ticking time bomb" stories.
Researchers take many factors into account when predicting future retirement costs: birth rates, immigration, life expectancy, economic growth, income, employment, and inflation. It is easy, if desired, to construct an incredibly pessimistic scenario, or an incredibly optimistic one.
The high-paid financial consultants who dominate the current debate are very pessimistic where public pensions are concerned (using forecasts to "prove" that public plans are unaffordable), but very optimistic regarding the benefits of RRSPs ("proving" that every Canadian will be a millionaire if only we follow their financial planning advice).
Future pension costs will indeed rise, due to the aging population, but not to the astronomical levels predicted by the pessimists. For example, a recent actuarial report suggests that CPP contributions need to rise from 5.4% at present to 9.9% in 2015, peaking a few years later once the baby boomers have retired (see box on p.5).PRIMER: CANADA'S PUBLIC PENSION SYSTEM
Old Age Security (OAS) and Guaranteed Income Supplement (GIS)
The OAS and GIS are funded through the government's general revenues. The OAS is a flat monthly benefit ($392 in July 1995) payable at age 65 and indexed to inflation. For years, the OAS was a model universal program with simple, low-cost administration. All Canadians with 10 years residency were entitled to the OAS. Thus the contributions of homemakers, bankers, and labourers were recognized equally.
Starting in 1977, benefits were reduced for immigrants with less than 40 years residency. Then in 1989, the federal government introduced the OAS "clawback", which taxes back OAS income at a special tax rate (often exceeding the income tax rate paid by millionaires). The clawback threshold is only partially indexed against inflation, so in future years many middle-class Canadians will lose much or all of their OAS benefit to the clawback.
The GIS is available to low-income OAS recipients. Unlike the OAS, the GIS is a "means-tested" benefit. Half of OAS recipients qualify for the GIS. The maximum GIS benefit is $466 for a single person; $304 for a married person.
This fall the federal government may propose merging the OAS with the GIS and means-testing the entire package. This would mean the end of universal public pensions in Canada.
Canada and Quebec Pension Plans (C/QPP)
The C/QPP is funded through employer and employee contributions. In 1995, the joint contribution rate was 5.4% of earnings to maximum earnings of $34,900. Any worker with a basic level of earnings ($3,400 in 1995) is a plan member. Pensions are set at 25% of final career earnings (the 1995 maximum monthly benefit is $713) and are fully indexed to inflation.
The C/QPP has many extra features to deal with the whole range of possible workforce experiences. In addition to normal retirement benefit at age 65, the plan also provides early retirement, disability pensions, death benefits, survivor benefits, and benefits for dependents and orphans. These features, together with full inflation indexing, would make an equivalent private pension system extremely expensive. Why Public Works Better
The public pension system has many advantages over the privatized alternatives being proposed by government and the financial industry:
- Coverage: Virtually all of the labour force is covered by public pensions (see Figure 2). They are thus much more effective at ensuring widespread income security for seniors. In contrast, only about one-third of workers are covered by private pensions (RPPs), and only about one-third of Canadians have contribute to personal RRSP plans.
- Portability: Public pension protection travels with you from one job to another, and from one part of Canada to another--unlike private plans which are job-specific.
- Quality: Public plans offer benefits such as inflation indexing, survivor's benefits, and disability pensions which are extremely expensive or even
This will still leave CPP premiums lower than in most other industrialized countries, including the U.S. Several European countries have already experienced demographic aging, yet they have preserved their public pension systems. An aging population does not mean we must adopt a privatized, "everyone for themselves" philosophy in our pension system.
Pensions and the Permanent Recession
Public pensions face a quite different financial threat that has nothing to do with the aging of our population. A bigger fiscal problem has resulted from very high levels of unemployment, and the resulting stagnation in wages, caused by Canada's disastrous fifteen-year experiment with high interest rates. It is this "permanent recession", more than the aging of the population, which poses the true risk to our public pensions.
Funds for the OAS and GIS programs come from the tax revenues paid by today's employed workforce. Similarly, the CPP (which is a "pay-as-you-go" plan) also depends each year on the premiums paid by the current working-age population. When 10% unemployment becomes the norm, and wages grow very slowly (if at all), then public pensions automatically face a funding crisis. Taxes and premiums are increased to offset the loss of revenue due to unemployment and low wages.
Therefore, it is not solely because more Canadians are retiring that the cost of pensions has become more expensive for today's workforce. More importantly, the ability of the rest of the economy to support our retirees has been severely undermined by high interest rates and chronic economic stagnation. In short, the fight for public pensions must go hand-in-hand with the fight for a new full-employment strategy, backed by lower interest rates.
The Latest from the Right: "Super-RRSPs"
As a replacement for public pensions, government and business argue that more emphasis must be placed on the "individual responsibility" of Canadians to save for their own retirement through RRSPs and other savings. Indeed, some important voices on the right (the Reform Party, the Globe and Mail, and even some top officials in the Finance department) are now calling for a "super-RRSP" program to replace public pensions altogether. The tax subsidy for RRSPs would be increased, and perhaps RRSP contributions would be made compulsory.
Each individual would be in charge of investing their own personal RRSP fund. Upon retirement, your pension would depend solely on the thriftiness of your investments--and on a lot of good luck in the stock market. Of course, those who support "private sector solutions"--banks and investment brokers--are the very institutions who profit handsomely from overseeing our current RRSP system. They do not make a penny from public pensions.
Even more hypocritical, while scolding Canadians for relying on government pensions, financial institutions and the well-off benefit from the huge government subsidies paid to the RRSP system. For example, in 1995 only someone earning over $80,000 could take full advantage of the tax subsidy offered for RRSPs. Moreover, since the RRSP subsidy is calculated as a deduction rather than as a tax credit, each dollar of RRSP contribution generates a bigger tax saving for the rich than for a lower or middle-income earner.
So for two reasons, the RRSP system strongly favours high income earners: they are allowed to contribute more to their RRSPs, and they receive a higher dollar-for-dollar tax saving for doing so. The average tax subsidy received by RRSP contributors earning over $80,000 in 1991 was almost $3600 per tax return--ten times as much as the average tax benefit received by the bottom 50% of Canadian tax filers (see Table 1).
So RRSPs are a very costly system, yet one which benefits only a small proportion of Canadians. RRSP tax shelters cost the federal and provincial governments almost $9 billion in 1991. In contrast, the entire OAS/GIS system cost $15 billion for the same year, yet covered virtually the entire labour force.
Privatizing our pension system--by cutting public pensions, while increasing support for RRSPs--will not save money, but will definitely produce greater poverty and inequality among retirees. The public costs of RRSPs need to be capped, by reducing the maximum contribution and by converting the tax deductions to a fairer tax credit system. The resulting savings would help to save our public pension.
Income Distribution and RRSP Benefits
|Income Category Share||Total RRSP Contributions||Average RRSP Contribution||Estimated Avg. RRSP Tax Break|
|SOURCE: Statistics Canada Catalogue 74-401, Canadian Tax Foundation. Data for 1991 (most recent available).|
Is the CPP Going Broke?
Alarming headlines appeared earlier this year when a federal report warned that the Canada Pension Plan's "reserve fund" could be exhausted within 20 years--just as baby boomers are retiring. The financial industry jumped on this news, reinforcing the popular but mistaken attitude that public pensions can't be relied on.
Of course the cost of public pensions will rise as more Canadians retire. But is the financial state of the CPP really that alarming? Definitely not:
Few Canadians know that almost all CPP pay-outs are covered by each year's incoming CPP premiums. Unlike other pension systems, the CPP does not require the creation of a large standing fund, since it is a "pay-as-you-go" plan. For an extra financial cushion, the CPP maintains a small "reserve fund", equal to about 2 years worth of benefits. This year the CPP will turn a $400 million profit, so it won't dip into the reserve fund at all.
The CPP reserve fund plays only a cushioning role, and is not a primary source of revenue. Therefore, a very small change in the contribution rate can make a huge difference to the size of the reserve. The federal report showed that by increasing the scheduled contribution rate by only 1 percentage point, the CPP would accumulate a reserve of $112 billion within twenty years (instead of being broke).
The long-range predictions and assumptions that go into forecasts of pension funding are notoriously unreliable. The accountants who perform these studies always use the most pessimistic assumptions. If the work history, income growth, and life expectancy of Canadians differ even slightly from the forecast's assumptions, then no change in the contributions schedule may be required.
The main problem in CPP financing has been the payment of disability pensions, not retirement pensions. The cost of CPP disability pensions has risen dramatically in recent years (and now accounts for over 20 percent of all CPP benefits). This is mostly due to offloading onto the CPP from provincial and private disability insurance programs. But disability applications and costs have already started to decline. Federal officials have since admitted that their initial report was far too pessimistic.
In short, reports of the CPP's demise have been greatly exaggerated. The federal Chief Actuary, Bernard Dussault, said this year that, "The concern people have is not valid. The CPP is expensive but is not going bankrupt." We need to maintain confidence in Canada's public pensions, so that Canadians will be willing to take action to defend them against federal cutbacks. 0
Pension Funds and the Paper Economy
The CAW has argued that the ultimate solution to Canada's debt spiral and our general economic difficulties must involve some fundamental restructuring of our financial system. The present system rewards those who own financial wealth by perpetuating high interest rates and zero inflation. Banks, bond-holders, and speculators have made billions from the resulting paper economy: they profit from the ever-faster recycling of loans, bonds, and foreign exchange through the financial system. But this has severely damaged Canada's real economy--the workers and businesses that produce the actual goods and services that people use--through perpetual stagnation, slow growth, high unemployment and the government deficits, thanks to super-high interest rates and chronic recession.
Pension funds (including both registered pension plans and individual RRSPs) now account for a large share of financial wealth in Canada. Unfortunately, the management of these huge sums of money (over $600 billion) has been turned over to exactly the same Bay Street speculators who have generally undermined our economy. Thus workers' pension money is being used for foreign exchange speculation, leveraged buy-outs, and other wheeling-and-dealing--exactly the same financial market behaviour that has hurt our real economy.
As a result, ironic conflicts of interest are created. The financial professionals hired to manage workers' pension funds start to lecture governments about the "need" for spending cuts and high interest rates--the same policies that are impoverishing workers every day. We cannot allow the financial power of our own pension funds to be used against us in this manner. There are various ways in which the pension system could be reformed so that our savings are used to build the real Canadian economy, instead of undermining it:
- Prohibit foreign investment of tax-assisted pension funds: At present, 20% of RPP and RRSP funds can be invested abroad--and the financial industry wants that limit raised to 30% and eventually abolished altogether. Largely thanks to the foreign investment of pension funds, over $50 billion in investment capital has left Canada in the past 2 years alone. If pension funds are to be subsidized by Canadian taxpayers, then their money should be invested here.
- Democratize control of pension funds: Many occupational pension funds (including most CAW plans) are managed unilaterally by the employer. Giving workers greater say in the management of those funds is the first step toward changing the way funds are invested.
- Limit the growth of RRSPs: When a pension system is built on the basis of millions of "individualized" RRSP funds, it becomes impossible to ever exercise democratic, social control over the investment of that capital.
- Start to consider alternative investment options: We cannot gamble workers' future income security on experimental investment schemes, and we cannot force pension funds to accept lower rates of return than are available to other categories of investor. Nevertheless, current "fiduciary responsibility" laws actually force pension funds to seek the highest return available--even if that means shipping capital out of Canada, and participating in financial speculation. We need to change the laws so that pension funds can eventually support alternative investments that will build our real economy: housing, community development, and strategic Canadian industries.
The experience of the Quebec Pension Plan provides a good example of the possible benefits of deliberately using pension funds to develop the local economy. All QPP funds must be invested in Quebec industries. As a result, a huge pool of socially-controlled industrial capital has been built up, with notable benefits for the Quebec economy.
When challenged on issues like interest rates and bank profits, Bay Street likes to claim that workers, too, benefit from the paper economy--thanks to our pension investments. But our retirement security would be enhanced far more by ending the "permanent recession" and putting Canadians back to work, than continuing the present policies of super-high real interest rates and financial market speculation. After all, no matter how high interest rates are, you can't save for retirement when you don't have a job.