The Coming Public Sector Pension Debate
The Economist has recently launched a major attack on public sector pensions, joining the likes of the CFIB and the Howe in Canada who similarly draw invidious contrasts between suuposedly gold-plated public sector pensions and those on offer in the private sector. http://www.economist.com/research/articlesBySubject/displaystory.cfm?subjectid=987105&story_id=13988606
It is true that in Canada, as elsewhere, defined benefit pension plans (which pay out a defined proportion of previous earnings) have become increasingly confined to the public sector.Â Only about one in five private sector workers now belong to an employer pension plan, meaning they basically don’t exist for non union private sector workers other than senior managers.
While many public sector plans are currently under-funded due to the recent fall in equities and ultra low interest rates (which increase the present cost of future liabilities),Â such plans are normally fully funded by employer and worker contributions negotiated as part of an overall wage and benefits package.Â Some public sector plans may look relatively “generous”, but that does not mean there is a significant subsidy to them by taxpayers as the right insinuates or alleges.Â In fact,Â research shows that a major effect of unionization in the private as well as the public sector is to shift the balance of the overall compensation package away from money wages and towards benefits. In short, the better the pension, the more likely it is that wages are lower compared to comparable workers who have no pension coverage.Â Nor are public plans anywhere near as “generous” as is often alleged – full indexing to inflation is actually not the norm and normally requires much higher contributions.
Critics ignore not only the total compensation aspect ofÂ public sector pension plans, but also the large scale and administrative efficiency of big pension plans compared to small plans and options available to individuals.Â Plans like OMERS and Ontario Teachers have typically obtained quite high rates of return at low cost, while defined contribution plans and RRSP returns are lowered by very high financial sector fees and charges.
The attack on public sector pensions directs attention from what should be the pressing policy issue – how do we improve retirement income security for all Canadians? It is true that the situation in the private sector is dismalÂ now that some 80% of workers now basically depend on suddenly depleted RRSPs to replace much of their previous earnings.Â Left to their own devices, individuals save far too little ( a median $60,000 or enough to fund a pension of about $250 per month for older workers nearing retirement) and returns from RRSPs are low and highly variable.
True, we have an important floor of public pensions in Canada. The OAS/GIS create a basic income floor which just about bringsÂ seniors above the poverty line (though the GIS – which is claimed by about one in three seniors – should be improved above this bare-bones level.)Â But the Canada Pension Plan (CPP) replaces only 25% of earnings up to about the average industrial wage, meaning it replaces much less than 25% for those paid above average.Â With the exception of very low paid workers, the maximum CPP and OAS in combination fall well short of replacing the 50-70% of previous earnings which is a desirable target income in retirement.
The crisis of the private part of our pension system is now widely recongized, including by several provincial governments and the likes of Don Drummond of the TD Bank. Many pension wonks are leaning to the creation of new, large pools of voluntary savings run by governments or not for profit bodies to replace RRSPs. This might be a small step forward, boosting returns to partcipants and lowering the costs of converting retirment savings into annuities as and even before retirement.
But the far better solution would be to do what should have been done back when we lauched the CPP – make it replace 50% of average earnings. The CPP is in good shape, is pretty well-run, has low administrative costs, and delivers a fully portable, inflation indexed final benefit to everybody.Â Â The vast majority of employer plans are integrated with the CPP – meaning that improvements to the latter would gradually take some of the burden off private pension arrangements.
Options for improving the CPP are being developed, by former Chief Actuary Bernard Dussault among others. An improved system could be phased-in, and would require a rather modest increase to worker and employer premiums. Lower wage workers could be spared from this premium increase by raising the floor of covered earnings or by increasing the CPP contribution tax credit.Â A bigger, better CPP will be strenuously opposed by employers who do not provide support to pensions (the vast majority of CFIB members!) and by a financial sector which fattens itself on all those hefty RRSP fees and charges.Â But it is the best way forwardÂ for workers, be they in private plans or not.