Wednesday, September 16, 2015
Mandatory savings are best for pension savings
A new Fraser Institute report raises serious questions about the accuracy of the Ontario government’s claim that a new provincial pension plan, intended as a supplement or alternative to restructuring and expanding the Canada Pension Plan, is needed because of a savings shortfall among retiring Ontarians.
Increasing government-run mandatory retirement savings programs could lead to less voluntary saving, with no overall impact on how much Canadians have to fund their elder years, according to a new study from the Fraser Institute.
The study looked at savings rates in the late 1990s as mandatory contributions to the Canada Pension Plan began to rise, and into the first four years of the following decade.
The study found that with each percentage point increase in the total CPP contribution rate, the private savings of the average Canadian household dropped by 0.895 percentage points.
With each new percentage point of earnings mandated for contribution, the report finds, there was a “substitution effect,” namely a 0.895 per cent drop in voluntary savings. In other words, an additional dollar contributed to the CPP led to a decrease of 89 cents in the average household’s private savings. Therefore, the argument is that we should not increase contributions to the CPP or have any new government run Pension Plans.
However, the employer would match an increase in CPP and the new Ontario plan would have the employer match the employees’ contribution. Therefore, in the end, the worker has more money for savings. The other argument against the increase of CPP and the Ontario Pension plan appears to be that the drop in savings by the consumer is coming at the expense of private pension plans, although no evidence is presented to support that view.
The income effect has also not been taken into account in the calculations done in the study. The income effect is the idea that as income for an individual rises they will spend and save more than they did when they had a lower income. Therefore, if income increases over time, the amount of money saved will increase over time.
I do not think it is correct to say that the amount of money saved by the individuals went down. The authors of the study appear to assume that money put into the Canada Pension plan is not savings. If we consider the money put into the Canada Pension as savings then the amount saved by the average worker went up .11% not down.
Behavioural Economics shows that voluntary savings programs do not work as effectively as mandatory savings programs. Studies show that when a voluntary program is put in place for retirement savings, most people do not sign up. In one study, enrolment of new employees reached 90 percent immediately when the program was mandated, whereas under the old opt-in approach it was only 20 percent after three months and only 65 percent after three years enrolled.
The Canada Pension Plan should be increased, as it is a mandated program, well run and well-funded.
As well, people should be educated on the fact that this program is a very important saving plan for them. Canadians are better prepared for retirement than we were in the past because of our existing programs of Old Age Security, the Canada Pension Plan, the Guaranteed Income Supplement as well as the Tax Free Savings Account program and the Registered Retirement Saving Program.
The study that shows that there was a decrease in overall savings because of increases in the Canada Pension Plan assumes that the money put into the Canada Pension Plan is not savings and that is not a realistic assumption.