When Canada increased social security taxes, Canadian households reduced savings by 90 cents on the dollar.
One concern with raising taxes to fix Social Security’s growing funding shortfalls is that people will react by saving less on their own. They’ll have less money with which to save and, because higher Social Security taxes mean higher payable Social Security benefits, they’ll have less reason to save. If so, fixing Social Security by raising taxes – or, going further, expanding Social Security as many progressives favor – won’t increase retirement income so much as shift it from households to government.
But this is a tough dynamic to test with the U.S. Social Security plan, for a variety of reasons. We don’t have great data. We haven’t changed Social Security since the early 1980s, and since this was the same time that 401(k)s were expanding the trends may be confused. And, because Social Security’s benefit formula is progressive, it’s not clear how much someone should change their personal saving even if the intended to do so. And finally, some people are planners who take all of these issues into account, while others will save, or not save, regardless. (This 1999 report from the Congressional Budget Office, for instance, finds widely varying results.)
A new report from Canada’s Fraser Institute looks at how Canadian households’ personal saving habits responded to increases in the tax rates used to finance the Canada Pension Plan (CPP). These tax increases, which took place from 1996 to 2004, enhanced the CPP’s solvency so it can pay greater benefits in the future. Unlike Social Security, which is progressive, the CPP replaces a constant 25 percent of the individual's pre-retirement salary, which simplifies the calculations both for households and for researchers. Canada also pays a universal flat dollar benefit, called Old Age Security (OAS), to help protect against poverty. Together, the CPP and OAP provide benefits that are roughly comparable to the U.S. Social Security program in terms of generosity and progressivity.
The Fraser study, authored by Charles Lammam, François Vaillancourt, Ian Herzog and Pouya Ebrahimi, found that for each dollar of additional CPP contributions, Canadian households reduced their personal saving by around 90 cents. As a result, total saving – and thus total future retirement income – would increase by a lot less than you’d think. Households would receive more income from the CPP but less from their own saving. Which may or may not be a good outcome, depending on your philosophy.
While these questions are highly uncertain, I found a similar result across OECD countries: when a country’s government provided an additional dollar of retirement benefits, retirees provided for themselves about 93 cents less in income from savings and work in retirement.
The Fraser result also agrees with a 2003 analysis by Suzanne Rohwedder and Orazio Attanasio which found that, for the United Kingdom’s earnings-related pension system, individuals reduced personal saving by 65 to 75 cents for each dollar of benefits they expected to receive from the government.
These results are one reason why I’ve favored fixing Social Security through a combination of lower benefits for future middle and high earners coupled with truly solid protections against poverty for low earners. Low earners don't save much and need better income protection, but middle and high earners will likely react to lower promised benefits by saving more and working longer.
Our next installment will feature a second lesson on retirement saving from North of the Border. Stay tuned, eh?
