Column

A RARE OTTAWA SUCCESS

The Canada Pension Plan is one of the best in the world—and will remain sound

DONALD COXE June 30 2003
Column

A RARE OTTAWA SUCCESS

The Canada Pension Plan is one of the best in the world—and will remain sound

DONALD COXE June 30 2003

A RARE OTTAWA SUCCESS

The Canada Pension Plan is one of the best in the world—and will remain sound

Column

DONALD COXE

THE NEXT TIME anyone tells you that all social programs Ottawa delivers are overpriced, badly designed and generally lousy deals for taxpayers, rebut the griper by citing the Canada Pension Plan. A case can be made that Canada has the second best social security program in the industrial world, not far behind Britain. “Best” means a program that delivers good benefits today and is based on a sound set of investment policies which, with occasional updating, will permit the program to function effectively for as far as the actuarial eye can see.

What occasions these personal reflections is reading the latest gloomy reports on U.S. Social Security and on similar programs in France, Italy and Germany. The CPP has been sounder than those programs for three decades and will widen its lead in the years ahead. Governments can make shaky pension programs seem sound for many years, but by the time they start to look dodgy, it is too late to fix them without harsh consequences for taxpayers and pensioners.

A 1989 hearing in New York City of the Social Security subcommittee of the U.S. Senate Finance Committee that never received Canadian media coverage is a good place to start this discussion. The CPP was the hot topic that day. Few Canadians know that U.S. Social Security was overhauled in 1983 to imitate the funding of the CPP, thanks to leadership from two prominent senators, Republican Bob Dole and Democrat Patrick Moynihan. Before 1983, it was a pay-asyou-go program that accumulated only an insignificant reserve fund. The Dole-Moynihan reforms created a long-term reserve trust fund, which became the largest holder of U.S. treasury bonds.

Moynihan, a fan of the CPP approach, chaired the hearing; it was the first full-scale review of the reformed U.S. trust fund. He asked Ottawa for an expert witness and CPP staff suggested a Canadian investment manager resident in the New York area with personal experience in the design of the CPP fund. The witness had spent five years on a

provincial royal commission on pensions studying tables that would make most people’s eyes glaze over. Explaining the CPP as social insurance—social benefits based on insurance principles—as opposed to a pay-asyou-go scheme, the witness described the concept of accumulating a sizable trust fund to pay benefits. Such a plan isn’t fully funded, unlike private pension plans. It divides the costs of each generation’s pensions between today’s and tomorrow’s workers. Based on the assumption that tomorrow’s workers will inherit a functioning economy that will permit them to earn more than today’s workers, those future workers should pay for that privilege by picking up part of the cost. But they shouldn’t pick up nearly the whole tab, as pure pay-go provides. The CPP’s approach is pragmatic. There was never a chance that

A FURIOUS Senator Patrick Moynihan apologized to the witness, welcomed his ‘powerful’ testimony and said Canada should be thanked

a universal government plan would be fully funded, because its investments would then take over the economy.

The CPP approach was elegant—and it has worked as envisaged (with a few tweaks along the way, that will be discussed in this space next issue). The original actuarial formula was created in the 1960s by Kenneth MacGregor when he was Ottawa’s superintendent of insurance. When the Royal Commission on the Status of Pensions in Ontario conducted its independent actuarial review of the CPP in 1978, it found that the mathematical relationship between the trust fund’s assets and the plan’s liabilities was almost exactly what MacGregor had projected. Runaway inflation had meant that the numbers on both sides of the equation were vastly bigger than he was allowed to forecast,

but the fund was as strong as he predicted. Those who think all government projections are self-serving balderdash, take note.

After a review of the CPP’s successful progress, the witness at the Senate hearing launched into a critique of the U.S. Social Security fund’s investment program. He contrasted it with the CPP’s approach and told the senators there was no chance their investment policies would perform as well. The U.S. fund was buying non-marketable treasury bonds twice a year whose maturity was set at the average term of the national debt—in the range of five years. The CPP was investing in 20-year provincial bonds. As just about everyone knows, year-in, yearout, long-term bonds have higher yields than mid-term bonds. So Social Security was systematically robbing pensioners by getting a poor rate of return. The winner was government, which dramatically reduced the cost of servicing its national debt by stiffing its major investor, the Social Security trust fund.

The Social Security staff expert at the hearing advised Moynihan that the Canadian’s testimony was in serious error, and the senator, believing him, dismissed the witness. But before standing down, the witness, in his defence, said, “Senator, I refer you to the following pages in the actuary’s notes appended to the last two evaluations.” Moynihan whispered to a personal staff member, who exited. The chairman asked the Canadian to remain in the room. Moynihan’s aide returned an hour later, and spoke privately to his boss. A furious Moynihan thereupon issued an apology on behalf of the entire subcommittee. The Senate had been misled by Social Security staff, he said, and the witness’s “powerful” testimony had been accurate—and Canada should be thanked.

Later the senator talked privately at length to the Canadian. “We senators have to deal with so many complicated subjects every day that we’re at the mercy of the Social Security experts. How is it that in Canada you were able to get politicians to do the right technical things on a program they couldn’t understand?” he asked.

When Moynihan asked me that question, it was the one thing I couldn’t answer then— but will next week. 1?]

Donald Coxe is chairman of Harris Investment Management in Chicago and of Toronto-based Jones Heward Investments. dcoxe@macleans.ca