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© Copyright 2000 Rogers Media. The following article first appeared in the July 2001 edition of
BENEFITS CANADA magazine.
Pensions under Attack
The creation of the Canada Pension Plan Investment Board was terrific news for the money management
industry. Less so for those in favour of a public retirement income system.
By Monica Townson
The creation of a Canada Pension Plan (CPP) investment fund was essentially a compromise on privatization.
While it did not go as far as the neoliberal advocates of privatization through individual accounts would
have liked, it will channel a significant portion of the CPP contribution revenue through the private
market.
Partial funding of the CPP was agreed to by federal and provincial finance ministers on the assumption that
this would allow contributions to be maintained at a combined rate of below 10% indefinitely. Many
progressive commentators questioned this assumption. They point out that, while the government has said the
two objectives of the new CPP financing are to maintain a stable contribution rate and a stable
fund-to-expenditure ratio, it is impossible to do both.
Bob Baldwin, national director, social and economic policy of the Canadian Labour Congress pointed out
that, in money purchase pension plans and registered retirement savings plans, the short-term instability
of investment returns translates directly and immediately into changes in the level of benefits provided to
retirees. Indeed, he says the uncertainty of investment returns "is one of the many factors that make it
impossible for these plans to make a reasonably certain promise of the benefit that will be provided to
retirees."
If the key objective of partial funding for the CPP is to keep the combined contribution rate steady at
9.9% indefinitely, then the size of the investment fund will inevitably vary from time to time, because
rates of return will fluctuate. There will inevitably be periods when the size of the fund is declining.
This also raises the possibility that such periods--when the rate of return on the fund may be below
expectations--may lead to pressure to increase contribution rates again, or even to cut benefits further.
Advocates for full privatization by way of individual accounts kept up the pressure, even as the investment
fund was being put in place. The C.D. Howe Institute, for instance, published a study in early 1999 that
claimed the 9.9% steady state contribution rate would not be enough to sustain the plan indefinitely. But
even if the 9.9% contribution rate could not be maintained indefinitely, other options could be pursued.
ALTERNATIVES TO PRIVATIZATION
B.C. had suggested expanding the base on which CPP contributions are applied by raising the ceiling on
contributory earnings, currently set at roughly the level of the average wage. Contributions for U.S.
Social Security, currently at a combined rate of 12.4% of contributory earnings, are applied to earnings up
to the equivalent of $113,000 in Canadian dollars, or about three times the average Canadian wage.
As well, in the U.S. there is no basic exemption from contributions for the first few thousand dollars of
earnings. Abolition of the year's basic exemption in the CPP--now frozen at $3,500--was also proposed
during the 1996 CPP reform discussions. This would have represented a significant increase in contributions
for lower-income earners, and it was suggested they might be compensated with an enhanced tax credit. In
fact, the government itself proposed this option in its February 1996 discussion paper, saying it would
"improve employer compliance and decrease the contribution rate."
There are certainly many ways to moderate the increasing inter-generational transfers involved in
pay-as-you-go pension plans to accommodate an aging population. John Myles and Paul Pierson, in their paper
The Comparative Political Economy of Pension Reform, note that, unlike programs financed from general
revenues, transfers financed exclusively from payroll taxes impose all of the cost of an aging society on
wage income. Since covered earnings are often limited to the bottom half or two-thirds of the earnings
distribution, rising pension costs fall disproportionately on lower--and especially younger--wage-earners.
While all the consumption of the inactive population must ultimately come from wealth created by the
working age population, these authors point out that financing population aging primarily through payroll
taxes places most of the burden on wage income.
But they also suggest that, where pension systems result in a large volume of interpersonal transfers among
beneficiaries, the division between so-called earned and unearned benefits is being made more transparent.
This means that the financial responsibility for redistributive transfers can be shifted from payroll taxes
to general revenues.
There is no reason why countries with aging populations and pay-as-you-go public pension plans must abandon
and replace them with private individual savings accounts. Canada's choice--at least for the moment--has
been to move to a system of partial funding for the CPP, where investment earnings will be used to
supplement contribution revenue, while retaining the essential character of the CPP as a social insurance
program. Other countries have also chosen approaches that will retain their public pension programs in the
face of the aging population.
LOOKING TO THE NETHERLANDS
The Netherlands has capped social security taxes and will make up any funding shortfall in its public
pension program through a special fund financed by an allocation from general tax revenues. In other words,
the program is funded partly by seniors through their taxes.
There is broad support in the Netherlands for the public pension, and recognition that switching to an
individualized system would involve high transaction costs and people would lose money.
Those who are concerned about the possibility of future benefit reductions from the public pension system
accumulate private retirement savings through the third pillar of the retirement income system. But there
has not really been any public discussion of the possibility of allowing opting-out of the public pension
system or replacing it with a system of mandatory private savings accounts.
ROLE OF PUBLIC PLAN
Public pensions play a key role in the Dutch retirement income system, combining with workplace pensions to
provide retirees with a pension of 70% of final earnings (before taxes) after a 40-year career.
All income earners under 65, whether self-employed or employed, are required to contribute to the
Netherlands public pension plan known as the Algemeine Ouderdoms Wet (AOW or General Old Age Act). There is
no matching employer contribution.
Contributions are levied as a percentage of income in the two bottom tax brackets of the income tax system.
No contributions are required on the first roughly 8,000 guilders of income and, as in Canada, this basic
amount of income is also exempt from income tax. Everyone is entitled to benefits at age 65, regardless of
whether they have contributed to the scheme or are retired. The AOW benefit is taxable.
Contribution rates are currently running at 17.9% of covered earnings. As part of a restructuring of
funding arrangements for the public pension program, the Dutch government has capped contribution rates at
18.25%. In addition, the government has moved to strengthen the pay-as-you-go public system by setting up a
separate fund in 1997 with an initial contribution from general tax revenues of NLG$750 million (equivalent
to about $526 million Canadian). A booming economy and higher-than-expected tax revenues enabled a further
contribution of NLG$1.5 billion to the fund in 1998.
For the next 20 years, the government is required by law to contribute a minimum of NLG$250 million each
year to the fund. The money will remain within the government sector and, in return, the government will
pay interest to the fund, increasing available capital. At this point, there is no intention of investing
the fund in the market.
Legislation does not allow the government to withdraw amounts from the AOW Savings Fund until 2020 when the
baby boom generation will be retiring. At that point, the fund can be used as needed to supplement
contribution revenue to pay for public pensions. Until then, any shortfall in public pension contribution
revenue will be made up from the government's general tax revenues--even if that means increasing taxes.
TWO-TIER SYSTEM
Virtually all Dutch workers have an occupational pension plan through their work, and there is heavy
emphasis on this second pillar of the retirement income system. Unlike Canada's extensive system of
registered retirement savings plans, individual retirement savings play a much more limited role in the
Netherlands. Workers are covered through a sectoral system of industry-wide occupational pension plans,
negotiated through collective bargaining between employer organizations and trade unions.
Occupational pensions are designed to build onto the state pension, and the AOW benefits an employee will
receive are taken into account in structuring the occupational pension so that the person's total
retirement income will reach the target replacement rate.
There are lessons to be learned from the Neatherlands. For example, the allocation of funds from general
tax revenues to establish an investment fund that will supplement future contribution revenues is a way of
tapping into revenues from future seniors to fund their own pensions. In addition, contribution rates to
the public plan will be capped at 18.25%, while finance ministers in Canada have felt compelled to keep CPP
contribution rates below 10%.
It is also important to note that the replacement rate for public pensions in Canada is relatively low
compared to many other European countries. For a worker whose final salary is about US$20,000, the
Netherlands public pension replaces about 66% of final salary. At the same income level, Canada's public
pension system--including the CPP and the OAS--replaces roughly 34%.
RESISTING THE ATTACK
Those who want to replace the CPP with a system of individual savings accounts are clearly following their
own political and ideological agenda, using warlike imagery of demographic time bombs. These threats are an
attempt to justify reducing the role of government and eliminating collective responsibility for our aging
population under the guise of preventing generational conflict.
Many of those who advocate privatization through individual accounts have a thinly-disguised self-interest
in the outcome of this debate. They would like to see the mandatory contributions of workers and their
employers directed to private financial markets where fees, commissions and other charges can be levied.
Canada has already taken action to address the concerns raised by a pay-as-you-go pension plan in the face
of population aging. A wide range of further acceptable options is available to policy-makers, if
necessary, without resorting to privatization and individual accounts.
Canada's retirement income system already has a reasonable balance of public and private arrangements. If
we are really concerned about protecting the financial security of future seniors and ensuring them an
adequate income in retirement, we must resist the attack on public pensions. Our retirement income system
is worth fighting for.
Monica Townson is an economist and the author of Pensions Under Attack, co-published by the Canadian Centre
for Policy Alternatives and James Lorimer & Co. Ltd. www.policyalternatives.ca.
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