The best way to expand CPP? Let’s raise the earnings ceiling
The national debate on pension reform first kicked into high gear in 2007 with some high- profile commissions in key provinces and it has raged on ever since. At the heart of it is the contention that many Canadians are in danger of a bleak retirement because our three- pillar retirement income system has let them down.
There’s a widespread belief the average savings rate has declined precipitously in recent decades. This implies an urgent need to enhance government- sponsored pensions, which is why the idea of expanding the Canada Pension Plan ( CPP) refuses to go away. A CPP enhancement does make sense, but not the type that most proponents have in mind.
Given that any enhancement can affect both the economy and individual Canadians for decades to come, the basic premise that we’re not saving enough merits closer scrutiny.
The most frequently cited argument for improving government pensions is the dramatic decline in an official statistic known as the “household savings rate,” a figure that’s calculated by Statistics Canada as a byproduct of Canada’s National Accounts. Unfortunately, no one statistic is so widely misunderstood or misused.
Even prominent pension figures who should know better are asserting that Canada’s household savings rate has plunged to a “scant 5.5 per cent from 20 per cent in the early 1980s” without understanding that this is a meaningless figure. As Malcolm Hamilton points out in his C. D. Howe commentary, Do Canadians Save Too Little?, the retirement savings rate isn’t dropping at all. In fact, the commentary shows that the retirement savings rate has nearly doubled over the past quarter century, from 7.7 per cent of pay in 1990 to 14.1 per cent in 2012.
Canadians are saving more than ever.
It gets better, though. The 14.1 per cent figure doesn’t include CPP contributions, which for some reason are treated as taxes in the government’s National Accounts, rather than retirement savings. If CPP contributions were included with retirement savings, which seems more than reasonable, the commentary calculates that the amount contributed toward retirement has soared from 11 per cent of employment earnings in 1990 to 21 per cent in 2012.
So, why is the household savings rate dropping then? The C. D. Howe paper points out that the household savings rate is a rather curious number. It’s calculated for the population as a whole, including retirees and the unemployed, not just for those with employment income. The more retirees there are, the lower the savings rate, since retirees have little reason to save.
What’s worse, money withdrawn by retirees in the form of benefit payments is subtracted from aggregate savings when calculating the household savings rate. If the amount that was being saved by the working population was balanced out by retiree withdrawals, the household savings rate would be calculated as nil. This fact, combined with the fact that it excludes CPP contributions means “household savings” is a totally useless figure that’s best ignored.
The skeptics might be wondering: “If we’re saving more, then all that saving must be showing up somewhere in the government’s official statistics.”
Indeed it does. The same C. D. Howe paper indicates the net worth of the average household increased by 76 per cent between 1999 and 2012, and this is after inflation. The country’s aggregate pension assets, as measured by Statistics Canada, more than doubled between 1990 and 2012, from a level of 1.5 times employment earnings to 3.2 times employment earnings in 2012.
Clearly, Canadians are saving more than ever.
In fact, large swaths of the population are over- saving in the sense that they’ll have more disposable income after retirement than they ever had when they were working. In particular, the bottom 20 per cent of households ( by income level) will be better off in retirement, even if they never save at all ( other than making the requisite CPP contributions).
This isn’t to say that all Canadians are saving enough. Some people are definitely in for a rude awakening after retirement.
My own estimate is that about 15- 20 per cent of middle- income households are projected to have significantly less disposable income after retirement. This estimate is consistent with McKinsey & Company’s Retirement Readiness survey, which finds that 83 per cent of Canadian households are on track for retirement — implying that 17 per cent aren’t.
It’s for this low- saving, middleclass minority that an expansion of CPP makes sense, though not the type of expansion that big labour would like to see.
Given the above statistics, there is nothing wrong with the benefit accrual rate under the CPP, which is 25 per cent of pensionable earnings. What really needs changing is the CPP earnings ceiling, which currently sits at $ 53,600. It should be increased immediately to at least $ 100,000, and even then it would still be lower than the comparable ceiling under U. S. Social Security, which is $ 118,500.
This one change would go a long way to addressing the coverage gap that exists for the middle class, though it should be noted it would take a very long time to phase in. In the meantime, let’s stop bashing ourselves about our low savings habits.
Large swaths of the population are over- saving in the sense that they’ll have more disposable income after retirement than they ever had when they were working.