A careful CPP expansion might help the few upper-income Canadians who need it. Expand it along current lines, however, and the most certain winner will be the tax collector.
The threat that the roll-out of the Ontario Retirement Pension Plan (ORPP) in 2018 may further fragment Canada’s retirement system has moved Canada Pension Plan (CPP) expansion up the agenda for the June 20 federal-provincial finance ministers’ meeting. Yes, a bigger CPP looks better than the ORPP – but that is not saying much. Perhaps some higher-income Canadians could save more, but lack the foresight or discipline to do it. Even so, they – like so many lower-income earners the ORPP will hurt – might do poorly under an expanded CPP.
Why is that? Recall the standard pitch for an RRSP, or any other retirement saving plan where money going in is not taxed as income, and money coming out is. The idea is that the saver’s tax rate will be lower – or at least no higher – while retired than while working. In principle, RRSPs and pension plans ensure that retirement saving gets taxed only once, and since the tax bite on withdrawals is smaller – or at least not larger – than the tax relief on contributions, participants enjoy higher living standards over their lifetimes than they would outside these arrangements.
In reality, though, means-tested benefits and other wrinkles make actual tax payable at various income levels quite different from what the standard pitch assumes. For one thing, the main income supports for seniors are clawed back: OAS starts disappearing when other income surpasses about $73,000 annually, and GIS and related programs shrink by 50 or even 75 cents per dollar of other income pretty much from scratch. For many people, the tax bite on withdrawals is larger than the tax relief on contributions.
Roll in provincial benefits seniors lose as their incomes rise and the tax bite in retirement is so large that most low-income earners are better off outside a tax-deferred plan – or indeed not saving at all. A critical flaw in the ORPP is that, like the CPP, its coverage starts at $3,500 of annual employment income. Most people earning so little will pay contributions they cannot easily forgo for the sake of benefits that taxes and clawbacks may reduce to zero.
A bigger CPP that charged higher contributions and promised higher benefits over the same income range it covers now would do similar damage. So many advocates favour extending the CPP’s income range above the current maximum of about $55,000 annually, perhaps to the $90,000 maximum the ORPP envisions. But here’s the second thing: As Jack Mintz commented last month, a flaw in the tax treatment of CPP contributions means the advantages of RRSPs and pension plans do not apply to higher earners.
The flaw is that, unlike contributions to other retirement plans, CPP contributions by individuals are not deductible from taxable income. A revenue-hungry revamp of personal income taxes in the late 1980s turned many tax deductions – the deduction for CPP contributions among them – into credits calculated at the lowest tax rate. Since then, Canadians with incomes above the threshold where the bottom rate stops – now about $45,000 – or who are subject to income-tested benefits such as the Canada Child Benefit, have paid tax on part of their CPP contributions. Some of their retirement saving is getting taxed twice – on the way in as well as on the way out. From a tax point of view, they would do better outside the CPP.
Extending the CPP to higher incomes would catch more contributions in the same trap. The employer-paid portion of contributions on the newly covered income would presumably still be deductible, as it should be, but the employee-paid portion would not. Perversely, if concerns about job losses led the finance ministers to levy less of the new premiums on employers and more – perhaps even all of them – on employees, their non-deductibility would siphon even more revenue from participants to governments.
The ORPP, for all its flaws, gets this detail right. Like the plans it will supplement and replace, its contributions will be deductible from taxable income. If the ministers feel forced to act, a better outcome than the ORPP alone or a CPP covering higher incomes along current lines would be a hybrid: an extended CPP promising ORPP-size benefits up to the ORPP’s proposed limit, with all CPP contributions getting tax deductions rather than credits.
Predicting the outcome of the finance ministers’ meeting is hard, not just because of complicated politics, but because of unclear motives. If ministers just wanted to improve middle-class Canadians’ retirement prospects – rather than, say, to deflect private-sector anger about rich, under-funded public-sector pensions – they could do some simple things. Raise Canada’s relatively low limits on tax-deferred saving in RRSPs and defined-contribution pension plans. Delay the age when people must stop saving. Reduce the mandatory withdrawals that trigger so many taxes and clawbacks for retirees.
If stakeholder pressure and heading off the ORPP lead the ministers toward a bigger CPP, they should move judiciously. Lower earners should not pay higher contributions while working just to endure bigger clawbacks while retired. Higher earners should not pay tax on contributions they would have avoided if they had been left to save on their own.
A careful CPP expansion might help the few upper-income Canadians who need it. Expand it along current lines, however, and the most certain winner will be the tax collector.
William Robson is the president of the C.D. Howe Institute.
Published in the Financial Post
