Forcing Canadians to contribute more to CPP or Ontario pension plan will reduce voluntary private savings

In recent years, there has been a strong push to expand the Canada Pension Plan (CPP). Ontario has already set out a plan to create an additional mandatory provincial program mirroring the CPP called the Ontario Retirement Pension Plan (ORPP), which is slated for implementation on January 1, 2017. Yet the debate about expanding compulsory public pensions has largely overlooked important consequences for private savings, and thus may have overstated the benefits of such a policy move.

Increasing compulsory savings can have the unintended consequence of reducing the amount that households save privately. Households who are content with their balance between current consumption and saving for the future might respond to increased mandatory savings by reducing voluntary savings, maintaining their overall consumption-saving balance. This means that if governments mandate higher CPP or ORPP contributions, Canadians may simply reduce their private savings in vehicles such as RRSPs and TFSAs. In the end, there will be a reshuffling of retirement savings, with more money going to forced savings and less to voluntary savings.

This study empirically examines the extent to which historical increases to CPP contributions affected the private savings of Canadian households. The data used accounts for the saving patterns and demographics of Canadian households for select years from 1986 to 2008, spanning a substantial increase to the CPP contribution rate. The analysis focuses on important changes made to the CPP between 1996 and 2004, when the total contribution rate rose from 5.6 percent to 9.9 percent of insurable earnings as part of reforms to improve the program’s long term outlook.

The results show that past increases in the compulsory CPP contribution rate were followed by decreases in the private savings rate of Canadian households. This drop in private savings is not explained by changing interest rates or shifts in demographics such as age, income, or home ownership. Specifically, the results associate a 0.895 percentage point drop in the private savings rate of the average Canadian household with each percentage point increase in the total CPP contribution rate, holding other factors constant.

The benefits of increasing the CPP or enacting the ORPP must be weighed against the loss in flexibility and choice offered by private savings vehicles such as RRSPs and TFSAs. For instance, voluntary vehicles like RRSPs can be used for buying a home, obtaining skills training, withdrawing in case of a terminal illness, or fully transferring assets to a beneficiary upon death.