public pensions - university of victoria -...
TRANSCRIPT
Why Pensions?
• Typically people work between the ages of about 20 and 65. – Younger people depend on parents to support
them – Older people depend on accumulated wealth, kids,
and/or society to support them • Pensions provide income support for people
in retirement – Can alternatively be thought of as savings or
insurance
Basics of Canadian Pension System
• 3 components – Old Age Security Program (financed out of general
revenues) • Old Age Security Pension (OAS) • Guaranteed Income Supplement (GIS) • Allowance program • These programs provide basic income support (most
people get the same amount, regardless of earnings during working years)
– Canada/Quebec Pension Plans (CPP/QPP) • Benefits tied to contributions; those who earn more and
pay in more, earn higher benefits (kind of like EI) • Provides disability insurance
Basics of Canadian Pension System
– CPP/QPP (continued) • Financed from employee contributions
• Private pensions make up third component of Canadian system – Registered Retirement Savings Plan (RRSPs),
Registered Pension Plan • Long-term viability of these programs is
cause of some concern – Public components (OAS, CPP/QPP) are “pay as
you go” systems – Contributions today don’t get put in a bank
account; they get paid out as benefits immediately
Why Public Pensions?
• Asymmetric information (adverse selection) – People don’t know how long they will live, though
they know better than an insurance company – People would like to purchase insurance against
“living too long” (running out of money) • Called an annuity. You pay a lump sum now, and the
insurance company pays you a stream of income until you die.
• If actuarily fair, then on average the stream of payments will be the capitalized value of the lump sum payment
– But companies will be reluctant to sell annuities to people who claim they won’t live for long
• Just like other insurance; those with greatest risk (of living long) are most likely to buy the annuity
Why Public Pensions?
• Paternalism – Maybe the government feels people are myopic.
Don’t plan well for future – Assumes people are not fully rational – Government holds peoples’ hands by forcing them
to save (by forced contributions to CPP, for example)
– Figures people will thank them someday – Also prevents people from failing to save and so
then going on welfare when they run out of money
Why Public Pensions?
• Missing information; costly planning – Maybe people lack the skills or knowledge to plan – Government could plan for them, hence saving
them the costs of figuring it out themselves – Why isn’t this a particularly good argument?
• Government could just provide people with needed information; put pension calculators online and offer financial advice to those who need it
• Arguably, with this information and assistance, people could best plan for themselves, rather than having government decide for them what their savings should be
Redistribution • The public pension system provides another
way to redistribute income – Wealthy get lower ratio of benefits/contributions
than poor – OAS gives everyone a basic amount (yet income
taxes are higher for wealthy which implies some redistribution)
– Public pensions don’t discriminate against people on basis of gender, for instance
• Private market would charge more to women for an annuity, because they live longer; so public pensions redistribute toward women (who tend to be poorer in retirement) from men
• Current debate in US over indexing benefits to life expectancy (i.e. pay less to people who will live longer)
Why Are Public Pensions Pay as-you-go?
• Pay-as-you-go financing pays current benefits out of current contributions – Your and your parents’ CPP contributions finance
your grandparents’ benefits – Your benefits will be paid out of your kids and
grandkids contributions • Under alternative financing arrangement,
government could manage a big bank account where everyone’s contributions go to earn interest until they retire – System of individual accounts (Bush tried to push
this in US)
Pay-as-you-go Finance
• Pay as you go financing is sometimes called Ponzi financing – Charles Ponzi was a con artist who went around
running pyramid investment schemes. – Sign on a few investors, then pay them high
returns by signing on more investors and handing the new investors’ money over to the old investors
– Scheme generates money for old investors until new people refuse to sign on
• Need a bigger crowd of new investors in each stage…hence the name pyramid scheme
• Eventually new round of potential investors worries they won’t get paid back and so refuse to contribute--pyramid collapses
Is CPP/QPP a Ponzi-Scheme?
• Under growing population and productivity growth, CPP/QPP flourished – Both sources of growth have declined – Now there is some concern that young generation
will pull out; system would certainly collapse if they did
• Why would young pull out? If they believe they won’t get benefits, why should they pay in?
• Many young people would rather take their chances with private accounts…put their own money where they’re (virtually) guaranteed to get it back.
• Now in both Canada and US there are calls for reform of the system
Why Choose Pay-as-you-go over Private Accounts?
• Politically it’s more viable to start – Voters alive today can shift costs to unborn
generations • If the economy is growing fast, then
contributions can grow more quickly than money in a bank account – This worked well for Canada and US in 1960s, not
so well after 1970s productivity slowdown • In some cases, exigent circumstances
required establishing benefit payments immediately (e.g. US in Great Depression)
Effects of Public Pensions on Behaviour
• Saving (could go up or down) – If government is forcing you to save, your private
saving is likely to decline in response – If your benefits are tied to choice of retirement
age, this may affect your decision to retire • If rules don’t allow you to work and collect benefits at the
same time, you may quit work earlier; in anticipation of this you may save more earlier in life
– Some people like to transfer wealth to their children in the form of an inheritance
• CPP/QPP reverses this transfer, by giving money from young to old
• Parents may try to undo this transfer by increasing bequests; will save more to do this.
Effect on Saving: Empirical Evidence
• Results generally suggest some negative impact on saving overall (most studies on US) – Feldstein (1974) found strongly negative effect of
US Social Security on saving • Famous paper, because the initial result was due to a
programming error • His RA’s fault (supposedly!) • Revised results found smaller effect
– Other studies have disputed his revised findings • Munnell finds much smaller effect when controlling for
unemployment (though effect on saving is still negative) • Burbidge suggests small negative effect in Canada
Effect of Public Pensions on Retirement Timing
• Certain program rules can create incentive for people to retire early – If government claws back benefits for people who
continue working, people will be more likely to retire early
– Retirement ages in Canada have decreased since the 1960s when public pensions were implemented
– But this decrease is part of a 100 year trend started long before the introduction of such programs.
Some Details on Canadian System
• Old Age Security Program – Started in 1927 with Old Age Pension Act
• Originally pensions were means tested (more you earn, the less you get)
– 1952 • Universal pension (no longer means tested) of $40/
month – Full indexation of benefits introduced in 1973;
attempts to back away from this were shouted down
– OAS benefits (around $500/month) are taxed
Details on Canadian System • Old Age Security Program (cont)
– GIS (guaranteed income supplement) is an add-on to Old Age Security Program
• Means tested program that operates like negative income tax
• Gives lump-sum benefit (also around $500/month) to poor retirees; taxes away that benefit according to level of other earnings
– Allowance • Means tested benefit to widows, widowers, spouses,
partners of OAS recipients
• Originally, OAS Program provided basic income for all retirees (universal program); regardless of earnings during working years
OAS Challenges
• In 1989, partial clawback of OAS benefits was introduced – Points to basic debate over whether programs
should be “universal” or “targetted” • Universal programs are viewed as easier to get political
support for • But it doesn’t make sense to “redistribute to everyone” • Further attempts at increasing clawback in ‘96 failed
• Population aging threatens viability of OAS. – Baby boom reaches age 65 in 2010 – If productivity growth remains strong enough, this
won’t be a problem
Some Details on Canadian System
• Canadian Pension Plan (CPP/QPP) – Differs from OAS Program in that people receive
benefits proportional to their contributions • High earners receive more benefits than low earners
• Basic components – Retirement benefits (regularly claimed starting at
age 65; options for early or late retirement exist) – Disability benefits (can collect these before regular
retirement age if you become disabled) – Survivor benefits (for spouse of primary income
earner) • CPP is more like insurance than OAS
Contribution Rates to CPP Have Grown Over Time
• Contribution rate in 1966 was 3.6%; more than funded current benefits – Founders expected contribution rates would
increase to 5.5% in 2030 – By 1996 contribution rates of 14.2% were
expected for 2030; why the increase? • Benefits expanded • Birth rates fell (so fewer paying in than expected) • Lifespans increased more than expected • Productivity slowed starting in mid-1970s • Disability claims have risen
1998 CPP Reforms
• Contribution changes – Contribution rate raised from 5.6% in 1996 to 9.9%
in 2003; set to hold there for rest of this century – Investment of reserve fund in securities
• Benefits changes (reductions) – Stricter eligibility rules for disability – Benefits based on Year’s Maximum Pensionable
Earnings of past 5 years (as opposed to past 3 years)--likely to reduce benefits paid out
– Limits on survivor and death benefits
Intergenerational Redistribution
• Different generations have fared differently under CPP – Those born in 1915 received $5.50 in benefits per
dollar contributed – Those born after 1975 are expected to receive
less than $0.50 per dollar contributed • Recent reforms make things worse for your generation
(at least on the contributions side) – Political opposition to intergenerational
redistribution may not be as strong as it could be, if young voters feel ties to older voters who benefit from such redistribution