Wednesday, February 1, 2012

Tax Fairness would Decimate Old Age Security

In a CBC interview about pension reform, Susan Eng of CARP was discussing the taxes baby boomers have paid to support old age security (OAS) payments:
“These are the same people who paid their taxes all through their working lives and have funded their retirement in this way.”
So, she is saying that it is an issue of tax fairness; boomers paid for their OAS benefits and would be cheated if these payments were reduced. Unfortunately, if we really introduced tax fairness it would decimate OAS. The reason for this is a combination of the way OAS is funded and demographics.

Unlike CPP, OAS is paid from current tax revenues. While the CPP amounts deducted from our pay are saved to cover future CPP benefits, OAS payments to retirees are paid for by current taxpayers. This means that boomers paid for their parents’ OAS and they will collect OAS payments from their children.

Boomers were in the middle of their careers around the year 2000. They will be in the middle of their retirements around the year 2030. Over that period of time, the ratio of the number of retirees to the number of working people will roughly double. This has happened because we’re having fewer children and we’re living longer.

As a group, boomers will collect roughly twice as much from OAS as they paid in. To achieve tax fairness, we’d have to cut their benefits in half. I’m quite certain that Ms. Eng would not support such a cut. I don’t support it either. But we do need to increase the age where OAS benefits start to reflect the fact that we’re living longer.


  1. CPP is pretty close to the same good deal for boomers, especially the older half. Boomers spent a big chunk of their working years paying lower than needed rates into an underfunded CPP. It is only in the last decade CPP rates have risen to bring the CPP back to fully funded, which isn't really fair for GenX and younger who get to pay the higher rates most/all of their working life.

  2. whether it is OAS or CPP, as a near-collecting time boomer, I would much rather be obliged to wait a couple of years than lose CPI-indexing. By far the most valuable (costly) promise of these plans is the inflation indexing as Keith Ambachtsheer explains in his book Pension Revolution.

    Of course, what turns out to be the case in fact with the benefit of hindsight - CPP and OAS inter-generational funding inequity not to mention DB plans like Ont Teachers, which is surprised to have a lot of centenarian pensioners to pay for (why do teachers so much longer than the average Joe anyway?) - cannot be known in advance. Did the designers of OAS and CPP in the 1950s and 1960s knowingly create impossible promises?

  3. @Greg: I haven't attempted to crunch the numbers on CPP, but my sense is that the boomers got a good deal, but not nearly as good as with OAS. I may be wrong about how good a deal they get on CPP, but I take your point that they seem to be getting a good deal on both.

    @Canadian Investor: I agree with you that indexing is very valuable. I don't see how it is much help if it will evaporate over the years.

    I don't know if the designers of CPP and OAS foresaw today's problems way back then, but the problems were foreseeable long before this year. We need to finally address the fact that people are living longer than they did in the 50s and 60s.

  4. I wrote a comment, then accidentally lost it before posting. I hope you'll excuse the fact that I direct you to my blog to read my comment:

    CPP is not a funded pension plan:

  5. @Robert: It is true that CPP is not fully funded. But the percentage of full funding continues to grow. The actuaries say that the current contribution rates are sustainable. This means that we are now having people pay the right amount to cover their (incremental) future benefits. The system is still unfair to the extent that people paid lower rates prior to the increase in CPP deductions. However, at least we are not continuing to deduct too little. For this reason I see CPP as closer to inter-generationally fair than OAS.

    My main point, though, is that appeals to fairness with OAS make no sense. Such appeals may or not make sense with CPP as well, but that is a separate issue.

  6. @CC: As I said to Robert, CPP has an inter-generationally unfair history, but that is improving with each passing year. OAS remains very unfair.

    I agree that CARP has little credibility, but they seem to have a following.

    1. The comment above is a reply to Canadian Capitalist's comment:

      As Greg points out CPP also works out to be a better deal for the baby boomers. That's because about 1/3 of CPP contributions of workers today goes towards covering the shortfall of contributions made by current CPP recipients.

      Anyway, CARP has very little credibility on this issue. All they ever do is carping that they need more benefits with no regards to whether we can actually afford it.

  7. "@Greg: I haven't attempted to crunch the numbers on CPP, but my sense is that the boomers got a good deal, but not nearly as good as with OAS. I may be wrong about how good a deal they get on CPP, but I take your point that they seem to be getting a good deal on both."

    I took a crack at crunching the numbers here. Under my assumptions a typical boomer who contributed the max to CPP from 1970 to 2010 would have a benefit worth $280k and would have had only accumulated $143.5k in value had their CPP contributions been invested as the CPP is now. According to my model, early Boomers can expect to get roughly double out of CPP compared to the value of what they put in after investment returns.

    Before 2000, I assumed the CPP had an average anual return of 7% (the long term average of a balance stock/bond portfolio), which is probably overly generous in spite of 1970s/80s inflation because the CPP was actually invested in provincial bonds at a 1% more than inflation. After 2000 I used the actual returns of the CPP investment board. To calculate the final value, I assumed the CPP payments were equivalent to withdrawals from the investment at 4% per year.

    Exercise for the reader: extend the spreadsheet to project into the future to see how a GenX'er does "investing" in the CPP from 1985 to 2025 or an unfortunate GenY'er from 2000 to 2040. It won't be pretty.

  8. @Greg: That's an interesting analysis. I would say that it applies only to the oldest baby boomers, though. The youngest boomers won't reach age 65 for another almost 18 years. It would be good to repeat your analysis for rolling 40 year periods and plot the benefits/contributions ratio for each period. Then we could average these figures across the baby boomer range and ranges for subsequent cohorts (not that I'm asking for you to do all this work). In the end we would find that boomers as a whole got a good deal, but not $2 for $1.

  9. When I wrote this post, I thought I would get some angry comments about how boomers deserved their OAS money no matter what analysis I did. Instead, most commenters have rightly pointed out that boomers got a good deal on CPP as well.

    So, I may follow up next week with a discussion of CPP if Greg is willing to keep the link to his speadsheet alive.

  10. @Michael sure, I'll keep the spreadsheet link alive.

  11. @Michael I think you will like this. Here is an even better CPP value/cost calculating spreadsheet that can extrapolate into the future. I've assumed 3% CPI in the future and 7% investment returns. If you sign into Google, you can make a copy of it and play around with it. It is all driven by entering the start and end years for CPP contributions in cells J3 and J4.

    Feel free to use this in a post, I think it will be a good one.

    I compiled results using this spreadsheet for people born every 5 years 1900-1995 in another here. Not surprisingly, the first folks to collect CPP got value up to 17 times their contributions. The first baby boomers get just about double their contributions, the last only get about 85% of their contributions in value. And it just keeps getting worse for GenX, stabilizing at value worth 66% of contributions. The break even point is boomers born in 1960, with those who are younger increasingly subsidizing those who are older.

  12. @Greg: Thanks very much for your effort. I'm planning a post on Wednesday about this that will mostly highlight your work.

  13. Just wondering if in @Greg calculations he included the employor's mandatory contribution to CPP as well?