This article was originally published in Maclean's Magazine on September 29, 1997
Ottawa's Pension Reform Plans
Barely five feet tall, firmly "over 65," Lillian Morgenthau can throw a political punch that would bring most politicians to their knees. So when the president of the 315,000-member Canadian Association of Retired Persons complained that the proposed federal Seniors Benefit would penalize higher-income Canadians who are saving for retirement, Finance Minister Paul Martin hastened to placate her. Earlier this month, the minister, two aides, his special adviser on PENSIONS, his parliamentary secretary and three very senior bureaucrats trooped into CARP's headquarters on the 13th floor of a Toronto office tower, brandishing packets of charts and factlets, listening intently and scribbling notes. The foray was one of at least 20 visits that Martin has made to seniors' organizations across Canada over the past two months in an attempt to quell objections to the proposed benefit before it is debated in Parliament. Morgenthau appreciated the gesture but remains dubious. "Mr. Martin told us that he was not going to do things to seniors, he was going to do things for seniors," she says. "But we want a transition stage to the new benefit of at least 15 years."
Scant kilometres to the north, in an uptown office tower, 33-year-old David Crichton is pondering just how much more he can stand before he applies for a U.S. work permit. As a high-income advertising creative director, he knows he will likely never receive the new Seniors Benefit because it is intended for less prosperous Canadians. He also knows his Canada Pension Plan premiums will rise in stages to a whopping 9.9 per cent of pensionable earnings by 2003. And he knows that Ottawa has even clamped a limit - $13,500 per year until 2003 - on what he can save for himself in tax-free registered retirement plans.
Perhaps worst of all, Crichton knows that few younger Canadians are paying attention to such matters, so the finance minister will never try to placate him. "My mother thinks that the country should take care of her, that she's worked all of these years and it's her turn to get back," he says. "As romantic as that notion is, I don't feel that it's reality anymore. I am torn: I know we have to take care of them. But I am paying so much tax that I resent my country. The government just uses our generation."
The gulf between Morgenthau and Crichton offers a glimpse of the divisive debate ahead when Ottawa introduces two bills this fall: one to revise the CPP and the other to transform its old age pension into the Seniors Benefit for anyone who has not turned 65 before Jan. 1, 2001. Despite Martin's best efforts to downplay the impact of those changes - Maclean's has learned that he will likely phase in key benefit provisions - the changes are destined to provoke a wrenching and furious debate. The issues of fairness are profound. To what extent should the young be taxed to fund the retirement of the old? How much should middle-income Canadians transfer to lower-income Canadians? Should today's seniors remain almost totally insulated from the sweeping revisions that Ottawa says are necessary to save public pension benefits?
Granted, actuarial reports are rarely the stuff of parliamentary dramas. But buried within Martin's plan are several highly incendiary notions. For starters, the CPP overhaul requires younger workers to pour more money into a plan that will provide lower returns than they could get from any private retirement savings plan - a miserly two per cent per year after inflation. As Mike Maguire, a 27-year-old account manager at a branch of the CIBC in St. John's, Nfld., forlornly remarks: "Given the uncertainty that's there, I'd rather have that money to invest myself. It would be great if there was that option."
In an even more contentious move, Ottawa is quietly preparing to gut the existing old age pension. The Seniors Benefit would convert that hallowed program into an income support system paying a maximum benefit of $11,420 per individual and $18,440 per couple. It would be tax-free for seniors with no other income. The poorest recipients would receive an extra $120 per year. Seventy-five per cent of all seniors in 2001 would be the same or better off; nine out of 10 single women would be better off. But the flip side is that Ottawa would tax back the Seniors Benefit from many better-off recipients, with a complicated formula that takes into account all household income.
The Old Age Security and the Guaranteed Income Supplement - the two main components of the existing old age pension - constitute more than one-fifth of all federal program spending, or about $22 billion this year. That tab has nowhere to go but up, because the number of Canadians over age 65 will soar to almost nine million in 2030 from 3.7 million now. To curb expenses, the proposed Seniors Benefit would impose a special levy that, combined with regular income taxes, would claw back benefits at rates ranging from about 45 per cent to more than 70 per cent, for each dollar of household income over $25,921. As a result, projected pension costs will be 10.7 per cent lower in 2030 that would have been the case under the old system. "They want to give the same or more money to 75 per cent of seniors, but they want to save 10 per cent of the cost, so you can see that the winners hardly win at all and the losers have to lose big," says Malcolm Hamilton, a pension expert with William M. Mercer Ltd. in Toronto. "In effect, they are converting the old age pension into a type of welfare program. But the benefits are so high that they have to start clawing them back fast, gouging right into the heart of the middle class."
Already, the proposals have provoked intense debate in corporate and labor circles over the amount of money that middle- and upper-middle-income taxpayers should expect from government when they retire. In 2016, when the first baby boomers turn 65, there will be almost six million seniors, or 16 per cent of the population, up from 12 per cent in 1995. In 2030, when the pressure on the public pension system peaks, there will be only three workers for every senior compared with the current five.
The proposals also raise questions about the amount of money that Ottawa can extract from middle-class taxpayers when, at the same time, it is cutting their future retirement benefits. No doubt fearing a political backlash, federal officials are reluctant to discuss those ramifications. But at the request of Maclean's, David Slater, a retired former chairman of the Economic Council of Canada, made some rough calculations. They show that in 2010, well before the boomers start to turn 65, at least 700,000 seniors - about one-quarter of those who will be eligible for the Seniors Benefit - will receive no net benefit because of the clawback. Another 400,000 will be worse off than they would have been under the current system. "Politically, federal politicians bought the idea that if they took care of the lowest end of the spectrum, they could hammer the middle- and upper-middle class," says Slater. "To which my response is: who do you think is paying the taxes?"
To be sure, the changes are welcome news for those who cannot save for their own retirement and who may have feared that Ottawa would slash everyone's pension, across the board, to save money. That group includes considerably more women than men, and those women are more likely to be living alone. Reason: females live longer, earn lower average wages and are less likely to remarry as they grow older. "I'm going to be a bag lady," frets 54-year-old Jane Sacchetti, executive secretary for an Italian-Canadian charitable group in Toronto. With an annual salary under $40,000 and only 12 years of contributions to RRSPs, the divorced Sacchetti fears she will spend her old age "penny-pinching" because her employer has no private pension plan. "I have to eat. I have to put a roof over my head," she says. "I'll never be able to put away enough to continue living the way I am now."
In fact, Ottawa's decision to preserve lower-income benefits means that her worst fears will probably not be realized. She will have some income from RRSPs. As things stand, she would also receive the Seniors Benefit of $11,420 plus the CPP of $8,841.72 - both of which are indexed to inflation.
But such security comes at a price. The implications of Ottawa's proposed changes, coupled with its freeze on contribution limits to RRSPs and company pension plans, are so enormous that no actuary even pretends to understand the full effect. But some trends, at least, are clear. Because household income of more than $25,921 would be taxed back at steep rates, critics argue that it would no longer be worthwhile for low- and middle-income families to save for their retirement. Slater calculates that working couples with retirement income of more than $40,000, including old age benefits, will be worse off under the new system. He cites the hypothetical example of a retired couple receiving $28,000 a year plus the Seniors Benefit. They would pay about 25 per cent in federal and provincial taxes and 20 per cent for the clawback, for a marginal rate of at least 45 per cent on each dollar of income. The problem? That tax bite is far greater than the tax break they would have received for contributions to their RRSPs before retirement. And unless the money was in the RRSP for a lengthy period, the taxes would also likely exceed the amount that would have accumulated tax-free. "To put it mildly," Slater says, "the incentives for saving by such people would be weak."
Among those who defend Ottawa's approach is Ken Battle, president of the Ottawa-based Caledon Institute of Social Policy. He argues that the clawback will only discourage savers in their early 60s - because the money they put into RRSPs may not earn enough tax-free interest to counter the clawback's effects. Battle himself suggested the basic outline of the Seniors Benefit in a 1993 policy paper, although his proposed clawback rate was 12.5 instead of 20 per cent. He has urged the government to lower the rate, but insists that "the notion that this will unbalance the pension system is cuckoo."
Few analysts share that view, however. Most predict that when middle-income Canadians realize what is happening, they will abandon efforts to save for their old age and use the money instead to reduce their mortgages or pay now for things they will use once they stop work, such as retirement accommodation. "It's getting pretty questionable if people with below-average income should do very much saving," says Hamilton. "The government may be able to frighten and trick a generation of moderate-income people into saving, but in the long run I'd rather see a system where people who did right were financially rewarded."
The changes may also have profound implications for future labor negotiations. Company pension plans typically assume that recipients will receive Old Age Security. The Seniors Benefit throws that assumption out the window. In fact, because the benefit is based on household income on retirement, it becomes almost impossible to even do the calculations. "Maybe we should just pretend that the Seniors Benefit does not exist and try to get more money out of the workplace pension," says researcher Bob Baldwin of the Canadian Labour Congress. For employers, already facing steep increases in CPP premiums, such talk evokes shudders. "It will become increasingly difficult for Canadian-based companies to hire and retain highly skilled employees," says Timothy Reid, president of the Canadian Chamber of Commerce. "The Seniors Benefit breaks values that this nation has always held dear. It spells out disincentives to work and to save."
Given those objections, Martin is unlikely to be able to stickhandle pension reform through Parliament with his customary finesse. Despite his rush to reassure seniors' groups, many remain unconvinced - if only because they have members who will be less than 65 in 2001 and who could suffer sizable reductions in benefits. Maclean's has learned that the minister is considering a phase-in of the clawback over three to five years to mollify those groups. But that, in turn, may provoke charges of opportunism. A coalition of 20 diverse, high-powered groups, ranging from the Canadian Federation of Independent Business to the Canadian Bar Association, is demanding that Ottawa clarify the impact of its proposals before it proceeds. The opposition Reform party, meanwhile, has declared war. "We will fight this tooth and nail," says Reform pension critic Diane Ablonczy. "It has negative effects on economic growth, on investment and on capital formation."
If Canadians have so far heard little about those measures, it is partly because the proposed amendments to old age pensions, the CPP and private pension plans were introduced separately, buried under other announcements and crafted according to the recommendations of taxpayer-funded polls and focus groups conducted by Earnscliffe Strategy Group Inc., an Ottawa-based consulting firm. In those reports, the political message is clear: Ottawa should exempt current seniors and near-seniors because they firmly believe that they have fully paid for their pensions. Earnscliffe also urged the Liberals to fix the CPP as fast as possible because a "massive majority" wants to keep it. The reports added that small increases in old age pensions for low-income seniors bring big political rewards, and that pension changes should be sold as measures to preserve the system for future generations and not to cut costs.
In retrospect, Martin has followed that advice to the letter. (In March, 1996, he even paid a visit to Solange Denis, the elderly woman who angrily confronted former prime minister Brian Mulroney in 1985 over a planned change to old age security benefits. Denis gave her blessing to the plan.) The resulting lack of public outcry to date, Maclean's has learned, prompted British Prime Minister Tony Blair to ask Martin for advice on how to sell pension reform when the two men met at the annual Group of Seven economic summit in Denver in June. Ultimately, though, even Martin's political skills may not be enough to counter his critics' forceful and anguished concerns. "My political antenna says that this is going to be difficult for him," says John Wright, senior vice-president of Angus Reid Group Inc. "At the end of the day, he must explain what the future will look like so people can put their own plans in place. If he is confusing, somebody else who disagrees may define the issue."
To Ottawa, the beauty of its pension proposals is that they promise to reduce the burden of retirement payouts gradually and stealthily. Over time, the number of Canadians who collect the richer Old Age Security benefits will diminish. And because the new system takes account of household income and imposes a much larger clawback, the new Seniors Benefit will cost far less than the programs it replaces. By 2016, 70 per cent of 70-year-old female seniors will have held a job - about double the proportion today - and will therefore qualify for CPP and perhaps company-sponsored pensions. As well, many of today's workers are stashing money in RRSPs, an estimated $6.5 billion this year alone. Taken together, those trends mean that more and more households will receive nothing from Ottawa.
Perhaps that is as it should be. To date, however, no federal politician has come out and said publicly what the Seniors Benefit implicitly states: that middle-income Canadians should no longer count on old age pensions to help them through their golden years. What's more, largely for reasons of political expediency, the government has chosen to spare today's seniors from the brunt of its reforms. The unspoken reality is that seniors have fared far better than the rest of the population throughout the 1980s and 1990s. Adjusted for inflation, the average income of people aged 65 and over was 16 per cent higher in 1994 than in 1981 - while those aged 15 to 64 received almost no increase. And although one in five seniors was technically below the low-income threshold in 1994, even Statistics Canada notes that such numbers are probably misleading because they ignore seniors' after-tax position: they generally pay less income tax, many own their own homes and receive assistance with everything from drugs to property taxes.
Whatever happens, the coming debate almost certainly will not be pleasant. Pension issues always pit generations and income groups against one another. In this round, the Liberals will face charges that changes depicted as preservative reforms are in fact middle-income tax grabs. They will also be called upon to explain the combined effects of the Seniors Benefit, the CPP overhaul and freezes to retirement plan contributions. And they must somehow convince taxpayers that this is all for their own good.
Maclean's September 29, 1997