Ontario Pension Plan based on faulty assumptions

The Ontario government's proposal to supplement the Canada Pension Plan with its own compulsory pension plan is based on a series of faulty assumptions. A fundamental but unproven assumption is that people are not saving enough to support their retirement. Another faulty assumption is that workers can’t make the link between insufficient saving and retirement, and unwittingly retire without saving enough to secure their own retirement; they behave as if they’re richer than they really are, an amazing act of self-delusion.

A third assumption is that governments can mandate higher household saving, when the evidence is that other savings fall when government raises mandatory public pension taxes. The government assumes that large pension plans always generate higher returns and minimize risk, although Quebec’s public pension plan demonstrates just the opposite. It is also assumed that investment is currently constrained by a lack of saving, and any increase in saving will boost investment. Finally, there is an assumption that higher investment automatically boosts productivity. All of these assumptions suggesting the need for a new mandatory public pension in Ontario are questionable if not downright incorrect.

It is ironic that Ontario stresses that people are not saving enough when traditionally Ontarians have one of the highest personal saving rates in the country. From 1990 to 2008, Ontario’s personal saving rate was always higher than the rest of Canada. After the 2008 recession, Ontario more than doubled its saving rate to 6.8 per cent, much higher than the 4.4 per cent saving rate elsewhere in Canada.

The household saving rate in Ontario uncharacteristically has returned to the national average, reflecting the pressure on households to stretch every dollar to sustain their living standard. This squeeze on household finances exists despite lower interest rates, which saves about two per cent of income from servicing debt. However, income growth has been so weak in Ontario that people had to lower saving to maintain consumption.

Permeating the government’s thinking is the notion that Ontarians are prevented from saving more because they share the government’s lack of discipline in managing their finances, not that they simply lack sufficient income to save after making their everyday expenses. To demonstrate its case, the budget cites polls of people wishing they could save more. Of course, the vast majority of people, if asked, would also say they would like better homes and cars, more travel and entertainement and so on. Simply asking people if they’d like to save more does not, by itself, demonstrate insufficient savings.

The underlying problem in Ontario is that real per capita incomes fell over the last two years, their first such declines since the  early 1990s. The squeeze on household incomes means saving more would require cutting back on spending, a logic that households in Ontario seem to understand better than their government. In such an environment, raising mandatory saving will not boost household saving, as people will reduce other forms of saving (like RRSPs) to maintain their standard of living. This is what happened in the late 1990s, the last time mandatory pension taxes were increased.

The ideal scenario is stronger income and job growth, which would allow both spending and saving to increase. Instead, the higher taxes required for the Ontario pension plan will depress household income and spending. The Ontario Budget glosses over the implication of employees paying 3.8 percentage points more on nearly twice as much income as the current CPP. It will cost individuals up to $3,420 a year, or nearly $7,000 for a working couple. About three million Ontario workers will be affected.

Ontario endorses the argument that more saving would be good for the economy by increasing investment, despite no evidence that investment is currently limited by a lack of saving. In fact, firms have increased their saving substantially over the past two decades. Given the high internal saving of firms, how would more household saving increase business investment? A lack of profitable opportunities has discouraged business investment, not a lack of funds. It is noteworthy that investment has floundered the most in Ontario and Quebec, where the failure to create a positive business environment has clearly played a role. Large government deficits also inhibit investment, since they promise unknown but inevitable tax hikes and spending cuts in the future.

There are also several flaws in the design of the management of the Ontario pension plan’s assets. Because the fund will be very large, its investments necessarily will be concentrated in fewer areas than individual investors would make on their own. This exposes the fund to the  risk of a spectacularly poor investment decision, as happened to the Quebec Pension Plan in 2007, potentially offsetting whatever efficiences are gained from lower management costs.

The fundamental problem behind the Ontario government’s thinking about all economic problems—whether it is a perceived lack of saving, low business investment or changing the distribution of income by raising the minimum wage and taxes on upper incomes—is that it has forgotten how rapid economic growth addresses all these problems without pitting one group against another in a battle over the table scraps left from meagre economic growth. Higher growth would also reduce the government deficit, the largest contribution to higher saving the Ontario government can make. Rather than mandatory saving plans, Ontario needs policies that encourage growth.