A version of this commentary appeared in the Charlottetown Guardian, the Guelph Mercury and the Miramichi Leader
This week, Finance Ministers across Canada met to consider an expansion to the Canada Pension Plan (CPP). One specific proposal for reform was that introduced by the PEI Finance Minister back in September. Wes Sheridan outlined the need for an expansion of the CPP and then described in some detail his idea for a “wedged” expansion. This is not entirely new as the idea arises from work done by Professor Michael Wolfson of the University of Ottawa (previously of Stats Canada). So the ideas have academic foundations and support.
Unfortunately, the proposals were deep-sixed by the Federal Finance Minister, Jim Flaherty who stated that the Canadian economy was too fragile at this time for anything that would raise payroll taxes.
Expanding the CPP is not an easy matter. First, it is counter-intuitive to mandate poor workers to contribute extra money to the CPP when any extra benefits would just be lost to claw backs in their Guaranteed Income Supplement (GIS) benefits. In fact, given that there are several provincial income supplement plans, the loss of benefits could be a full dollar for every extra dollar of CPP benefit earned. So they would be forced to pay in money they really don’t have to buy zero new net benefits.
The second important stumbling block is the fact that many research papers have found that the workers truly in need in the next generation of retirees are those who earn between 50% of the Average Wage and 200% of the Average Wage (i.e., between $25,000 and $100,000). Those below $25,000 do fairly well through combined Old Age Security (OAS), GIS and CPP benefits. Workers earning over $100,000 appear to be able to take care of themselves with the tax incented vehicles now available.
These two reasons are precisely why PEI was proposing a new wedge benefit. Here’s how — and why — it would work.
First, any new tier of benefits would be fully funded. That is, each generation of workers would pay in full for their own benefits. There would be no inter-generational transfers. This also means that the absolute full impact of any reforms would not be felt until 39 years from now. So starting soon is very important.
Today, the CPP provides an inflation-protected defined benefit that replaces 25% of earnings up to approximately $50,000. Contributions are 9.9% of earnings or a maximum of about $4600 (but split 50/50 with one’s employer). Currently the maximum annual CPP benefit is about $1000 a month or $12,000 a year. The average payment is about half of this or $500 per month.
The proposal would expand the CPP starting at earnings of $25,000. No new contributions or benefits would exist for those earning $25,000 a year or less. They would continue to depend on their OAS/GIS/CPP. Pensionable earnings would be expanded up to $100,000 and there would be a new tier of benefits, and would bring maximum benefits to a 33% replacement ratio versus today’s 25%.
This could be paid for with new contributions of about 3.1% (shared 50/50 with one’s employer — so 1.55% each) starting at $25,000.
Assuming a 40-year career, for workers earning $40,000, their contributions would increase by a total of $465 a year (split 50/50). This would bring an estimated increase in CPP benefits of $2250 per year.
Someone earning $75,000, would pay extra contributions of $1550 (split 50/50) and would see a $7500 rise in pension benefits annually. The maximum increase in benefits would be $11,250 — almost double the current maximum benefit under the existing plan.
The PEI proposal stated that these changes would be phased in over a relatively short period of time (two to three years). Further, Minister Sheridan argues that the new contributions are not taxes because they are buying real benefits.
It is not easy to amend the CPP. It requires the approval of 2/3rds of the provinces with 2/3rds of the population of Canada (including Québec). And, as we saw on Monday, it can be nixed by a single party: the Federal Minister of Finance.
The PEI proposal was carefully thought out and deserved serious consideration. The time for pension reform is now. PEI has a viable solution. It will be interesting to see if the announced Ontario “go-it-alone” proposals will use the PEI model. It wouldn’t be a bad place to start.
Robert Brown is an expert advisor with EvidenceNetwork.ca and a Fellow with the Canadian Institute of Actuaries. He was Professor of Actuarial Science at the University of Waterloo for 39 years and a past president of the Canadian Institute of Actuaries.