Some Distributional Impacts of Marginal Changes to Public Pension Parameters

Canadian Public Policy

Some Distributional Impacts of Marginal Changes to Public Pension ParametersAuthor(s): Bruce KennedySource: Canadian Public Policy / Analyse de Politiques, Vol. 16, No. 1 (Mar., 1990), pp. 73-85Published by: University of Toronto Press on behalf of Canadian Public PolicyStable URL: http://www.jstor.org/stable/3551260 .

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Some Distributional Impacts of

Marginal Changes to Public Pension Parameters* BRUCE KENNEDY The Institute for Research on Public Policy

Ce texte examine la redistribution dans le revenu disponible la vie durant entraine par de petits changements dans d'importants parametres du systeme public de pension au Canada. Les changements correspondent a des reformes en douce qui sont mises en place de fagon routiniere a l'aide de diverses formules d'indexation ou de changement marginaux a des programmes specifiques. Une analyse de microsimulation utilisant un simulateur de Statistique Canada indique que les effets redistributifs de ces changements peuvent etre important et contre-intuitif. De fait, il apparait que meme les groupes de pressions oeuvrant dans le domaine des pensions peuvent, a l'occasion, mal saisir l'impact de ces propositions sur leur commettants. De telles erreurs peuvent etre suffisantes pour bloquer des reformes potentiellement benefique telles le partage automatique et obligatoire des credits du R6gime des rentes du Canada.

This paper examines the redistribution of lifetime disposable income generated by small changes to important paramaters in Canada's public pension system. These changes represent creeping reforms of the sort that are routinely implemented through using different indexation formula for different programs or through subtle changes to individual programs. A microsimulation analysis using Statistics Canada's Lifetime Income Pension Policy Simulator (LIPPS) indicates that the distributional consequences of such changes can be significant and counter-intuitive. Indeed, it appears that even pension policy advocacy groups may, on occasion, fail to perceive correctly the impact of such proposals on their constituents. Such misperceptions can be enough to block potentially beneficial reforms such as automatic mandatory credit splitting in the Canada Pension Plan (CPP).

Introduction

anadian social policy appears to have entered an era of incrementalism. In

pension policy specifically, sweeping and constitutionally complex initiatives now seem less likely than creeping changes implemented through indexation formula and modest ad hoc changes to existing program parameters. Changes of this nature to the public pension system are happening continuously.

It is instructive to note that most of the recent changes (such as the CPP child-rear- ing dropout provision, and the indexation to wages of the CPP's Year's Maximum Pensibnable Earnings) were derived from modest proposals that enjoyed the support of the business community, anti-poverty groups, labour organizations and women's advocacy groups. The perceptions and as- sessments of these key advocacy groups appear to be critical determinants of whether or not a proposal is eventually imple-

Canadian Public Policy - Analyse de Politiques, XVI:1:73-85 1990 Printed in Canada/Imprime au Canada



mented. What we can expect from the near future is movement on a few simple, broad- ly supported proposals.

Changes to existing program parameters are subtle and achievable, and they don't normally attract a lot of attention. It should not be assumed, however, that they are distributionally insignificant or analytically trivial. This paper analyses some potential marginal changes to the existing public pension system. It shows that the distributional consequences of such changes can be very significant. They can also be obscure to the point that even advocacy groups that are key players in the policy process may not be able to distinguish between proposals that transfer money toward their constituents and those that transfer money away from them.

The analysis outlined below seeks to translate specific program changes into transfers of funds between various policy relevant sub-populations. The underlying premise is that transfer programs, including public pensions, can be translated from descriptive prose to detailed regulations, to computer code, and finally into flows of money. It is the last of these steps that is the most contentious. It is achieved using a technique known as 'microsimulation' which simply applies coded regulations to a database of case histories which represent a hypothetical reference population.

This article is based upon the author's doctoral research conducted at the School of Public Administration, University of Vic- toria. The first substantive section gives an overview of the simulation approach employed and the conceptual framework for the analysis. This is followed by a section presenting some interesting simulation results and their policy implications. The paper winds up with conclusions, and then a final section which expresses some methodological concerns and reservations. Modelling experts interested in assessing the simulation techniques will not find enough detail in this paper to do so. They are referred to Kennedy (1989a) which is available through University libraries.

Methods and Conceptual Framework

The LIPPS model is used to perform two roles in this type of pension policy simulation.1 First, the DEMOGEN component generates a dataset representing a reference cohort. This reference group is a hypothetical cohort generated by project- ing (age variant but time constant) demographic and economic hazards and probabilities that were observed over the early 1980s. It represents a single birth cohort ex- tracted from a steady-state growth scenario within which various socio-economic pro- pensities are typical of a society at Canada's current stage of development. Since the experience of each cohort in a steady-state scenario is the same, the reference cohort can serve to represent an entire population. It is effectively a microdata scenario, or a steady-state growth scenario that has been deeply disaggregated into a consistent set of individual records.

The individual histories generated by DEMOGEN consist of year by year records of the various demographic and economic variables required to compute personal income taxes (PIT), CPP and Unemployment Insurance (UI) 'contributions,' and benefits from Family Allowance (FA), Old Age Security (OAS), GIS, CPP and GAINS (Ontario). The second role of the model is 'policy simulation,' or the computation of these benefits and taxes. LIPPS applies a specified set of regulations (a 'policy scenario') to the reference cohort and adds year by year computations of these pension policy related transfers to each record in the file.2

In this application LIPPS has been ap- plied to determining policy 'impacts' from a lifetime perspective. These 'impacts' are changes in the lifetime disposable income of individuals generated by specific policy changes. They are family based, lifetime focussed, and systemic. They take into account effects of the tax system, interactions with other programs, and the burden of tax increases required to finance the policy changes on a sustainable basis.

74 Bruce Kennedy



The fundamental unit of this analysis is the individual, but the income concept is family based. The income of an individual who is married in a given year is taken to be half of the combined income of the couple in that year. Each individual's lifetime disposable income history is aggregated (with discounting as described below) from age 18 to death to determine the individual's lifetime disposable income. The 'impact' of a policy change on each individual is deter- mined by taking the difference between his or her lifetime disposable income computed using a reference policy environment (status quo), and that computed using an appropriately modified policy scenario.

The real discount rate is constrained to equal the real growth rate of aggregate earnings. The reader may prefer to think of this as 2.5 per cent real aggregate earnings growth and a 2.5 per cent real discount rate, though operationally both of these rates are implemented as zero. In the reference run all programs are assumed to be indexed to earnings (all programs maintain a constant size relative to aggregate earnings). Any departures from this norm, such as reduction of a program through inadequate indexing, are treated as interventions.

Financial consistency is maintained fol- lowing the observation by Aaron (1986) that under steady-state growth conditions any cohort's rate of return through a public pension is limited by the rate of growth of aggregate earnings. Discounting at the aggregate earnings growth rate, the discounted taxes paid through the program should equal the discounted benefits. Ap- plied to the 'growth = discounting' environment, this implies the restriction TOTAL BENEFITS = TOTAL TAXES. Since the steady-state cohort is typical of any cohort in the population, it can not reap any (implicit or explicit) inter-cohort gains or losses from a public pension program. The rate of return restriction insures that this will be the case. The resulting impacts reflect pure intra-cohort redistribution free of any unsustainable inter-cohort transfers. It is these intra-cohort transfers that

constitute the long-term, non-transient distributional characteristics of a pension policy.3

The first task in the analysis is to determine the distribution of lifetime disposable incomes in a reference run. For this purpose 1987 tax rates and program parameter values were taken as 'status quo'. The CPP contribution rate was increased to the steady-state's pay-as-you-go rate for current benefits (14.8%).4 Personal income taxes in the reference run were also increased (by 2.8 per cent of total earnings distributed in proportion to PIT paid) to maintain status quo revenues in the face of increased deductions for CPP contributions. (No effort was made to balance benefits from general revenue and taxes to general revenue.)

Figure 1 depicts two distributions of lifetime disposable income from the reference run. Plotted vertically in figure 1 are mean values of lifetime disposable income measured in 1987 dollars (effectively discounted to age 18 as described above). The cohort is disaggregated twice along the horizontal axis. The cohort is sorted into ten deciles of lifetime earnings (from the family perspective, discounted as above) and into two groups by sex. There are 200 simulated individuals in each of the deciles and 1000 in each of the groups by sex. (Each earnings decile is associated with the per- centile that marks the upper boundary of the group, i.e. '10' indicates the lowest earnings decile.)

The relationship between lifetime earnings and lifetime disposable income is much as we might expect. The distribution by sex, however, requires an explanation. From the family perspective, the earnings of married individuals benefit each partner in the marriage equally. Therefore, for the majority of earners, who are married, the gap in earnings that exists between the sexes does not affect the distribution of disposable income by sex.5 Earnings differen- ces within the relatively small sub- population of earning singles do affect disposable income by sex, though the dif-

Distributional Impacts of Changes to Pensions 75



Reference run

10 20 30 40 50 60 70 80 90 100 M F

Lifetime earnings / sex group Figure 1 Distributions of lifetime disposable income in the reference run

ference in earnings is smaller within this group. It appears to be of greater significance that women tend to outlive men, and consequently to consume more of such benefits as OAS. All things considered it is not surprising that the family-based mean lifetime disposable incomes of the two sexes are approximately equal.

The 'impacts' reported below are changes in the distributions of lifetime disposable income depicted in figure 1 induced by changes to the policy environment. To perform a policy experiment, the simulator is first run using the reference parameters plus the desired program changes. This first run indicates what tax and contribution rate changes will be required to con- struct a financially consistent version of the scenario. The CPP contribution rate is then adjusted to restore the balance in CPP financing, and a change in personal income taxes (distributed in proportion to existing

PIT liabilities) is used to keep aggregate disposable income the same as in the reference run. Hence personal income taxes are not balanced with transfers from general revenue, but taxes are adjusted to offset changes in benefits paid from general revenue net of changes in tax revenue generated by the policy change.

It must be emphasized that the microsimulation technique employed computes 'static impacts'. The model does not generate any behavioral responses to changes in pension program parameters. There are three reasons for this omission. First, there is no consensus on the range of behavioral responses that should ideally be represented, nor on the magnitude and direction of those responses. Second, the changes contemplated are small and con- cern program details of which most Canadians are totally unaware. It seems reasonable to assume that the response-re-

76 Bruce Kennedy



GIS (singles), $1000 increment Lifetime impact (thousands $ 1987)

^I/A ITT,,_ , 1 . 2 177

^^// 11

VA 7:71 vz / I

-50 1 1 I I I 10 20 30 40 50 60 70

Lifetime earnings / sex group

Figure 2 Impacts of an increase in GIS for singles

lated macroeconomic effects of these chan- (from 21.4 ges would be small. Finally, even in the ings). presence of significant behavioral respon- Figure ses 'first order' or 'static' impacts, so long that increi as they are recognized as such, provide use- progressiv ful distributional information. deciles all

The lifetin Simulation Results and Implications decile groi

70th perc GIS and OAS increases earnings) i Figure 2 presents impacts generated by in- earnings d creasing the GIS benefits for single pen- the highesl sioners by $1000 (1987) per year. These nificant tr impacts are changes in the distributions of plied by tl lifetime disposable income presented in of the poo figure 1, but note that the vertical scale in transfer be figure 2, and in all of the impact figures that expectatio] follow, is in thousands rather than millions The real of dollars (1987). To finance this increase in 3 much mc benefits personal income taxes were in- impacts of creased by 1.4 per cent of total earnings $1000 (198

8T 9I 1 80 90 100 M F

to 22.8 per cent of total earn-

2 indicates, as we would suspect, asing GIS (to singles) is a very e proposal. The lower earnings receive substantial net benefits. ne disposable income of the 7th up (those from the 60th to the entile of family based lifetime is not affected. The three highest eciles are net losers, particularly t decile group. There is also a sig- ansfer from males to females im- lis benefit increase. Since many r single elderly are female, this etween the sexes also meets with ns. der may find the results in figure )re surprising. This figure depicts an increase in OAS benefits of

37) per year. (PIT was raised by


50

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10

0

-10

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10 20 30 40 50 60 70 80 90 100 M F Lifetime earnings / sex group

Figure 3 Impacts of an increase in OAS

2.4 per cent of earnings to balance this scenario.) What is surprising is that the impacts are so similar to those of the GIS increase depicted in figure 2. Once again the lower earnings deciles gain, the 7th decile breaks even, the higher earnings deciles (particularly the highest one) lose, and there is a transfer from males to females. From this lifetime perspective, increasing universal OAS benefits could only be described as very progressive. At the mar- gin of program expansion it is no less progresive than increasing income-tested GIS benefits by the same amount.

Notwithstanding the federal government's hasty retreat from its 1985 attempt to reduce OAS indexing, OAS is still very much under attack because it is seen to be too generous to the upper-income elderly.8 Figure 3, however, reinforces views held since before OAS was introduced that the

program would be progressive from a lifetime perspective:

The committee has carefully considered the argument that such a universal system for pensions ... is uneconomically wasteful in that it provides the same benefits to rich and poor alike regardless of their needs ... it must be remem- bered that to the extent that the universal pay- as-you-go system is based upon individual contributions, individuals in upper-income groups would, through their personal contributions, have ... paid for their own retirement security, as well as making a substantial contribution to the cost of retirement security for others. In view of these facts the Committee does not consider that it would be equitable to impose a 'means test in reverse' and wholly deny retirement benefits to those individuals who have actually made the largest direct contributions to the revenues from which the universal

78 Bruce Kennedy



benefits will be paid. (Joint Committee of the Senate and the House of Commons on Old Age Security, 1950)

It should be noted that the simulations assume that all programs are indexed to earnings. At present this is true of the CPP but not of OAS and GIS which are both less generously (one hopes) indexed to con- sumer prices. Within the simulation framework this practice of inferior indexation of OAS and GIS must be seen as a policy of marginally reducing these programs. It is a practice that is currently generating impacts acting in the opposite directions from those in figures 2 and 3.

Pension lobby groups have generally been pushing in the other direction. The Canadian Labour Congress (CLC) has advocated increasing both OAS and GIS to guarantee a minimum income for the elderly equal to the Statistics Canada low-income cut-off for cities. They also support indexing OAS to earnings. The Business Committee on Pension Policy has also supported using OAS and GIS to insure a minimum poverty-line income and advocated particularly increasing GIS for singles (Business Committee on Pension Policy, 1983). Increasing OAS/GIS to the low income cut-off has also been supported by the National Action Committee on the Status of Women (1983), the Canadian Advisory Council on the Status of Women (1983), the Canadian Council on Social Development (Collins, 1978) and the National Council of Welfare (1984).

Canada Pension Plan Reforms The Canada Pension Plan is a more complex public pension, with more parameters to investigate. Various proposals for expansion of the CPP have been advanced by the CLC, women's groups, and anti-poverty organizations. The business community generally opposes any expansion of the CPP.

We start examining the CPP with a simulation of increasing the Year's Maxi- mum Pensionable Earnings (YMPE) by 10 per cent.10 Increasing the YMPE increases

both CPP contributions and benefits. It is a self financing change that had very little effect on the tax and contribution rates required to balance the scenario. (A slight tax cut of .2 per cent of total earnings was required in this simulation to offset induced savings through the GIS program.) The simulation results indicate that increasing the CPP in this manner is also quite neutral with respect to redistribution by earnings level and by sex (from a family-based lifetime perspective).ll

The CPP was designed with 'insurance principles' and 'individual equity' in mind. The YMPE simulation experiment results suggest that, notwithstanding such fea- tures as dropout provisions,2 and survivor benefits,13 the CPP remains surprisingly true to these principles when redistribution is viewed by sex and by lifetime earnings level. The CPP does produce intra-cohort transfers (such as from never-married to married individuals) but the winners and losers within the cohort are apparently quite evenly distributed by level of earnings and by sex.

Figure 4 shows impacts generated by increasing the replacement rate in the CPP benefit formula from 25 to 30 per cent.14 To balance this policy scenario the CPP contribution rate had to be increased to 17.6 per cent (from the full-cost pay-as-you-go rate of 14.8 per cent) and taxes were reduced by 1 per cent of total earnings (due to interactions with GIS). As the figure indicates, the principal beneficiary of this change is the highest earnings decile.

Increasing the YMPE, and increasing the replacement rate while adjusting the contribution rate accordingly, both produce self-financed increases in CPP benefits. The major difference between these ap- proaches is that increasing the YMPE does not increase CPP benefits (or contributions) for lower income individuals whose earnings already fall below 'maximum pensionable earnings'. Increasing the replacement ratio does increase benefits (and contributions) for the lower income group, though much of the increased benefits will




Increase CPP replacement rate to .30 Lifetime impact (thousands $ 1987)

f I I 1 T I

10 20 30 40 50 60 70 80


Figure 4 Impacts of increasing the CPP replacement rate

9 1

90 100

be taxed back through income tested programs. In consequence, increasing the replacement ratio tends to shift the burden of support for the lower income elderly from the PIT to the CPP payroll tax, and this change is of greatest benefit to the highest income group.

This simulation experiment demon- strates clearly how counter-intuitive the results of a parameter change in a complex system can be. We see here that increasing the replacement rate is more regressive than increasing the YMPE precisely because it increases CPP benefits to the lower income elderly while increasing the YMPE does not. With such twisted interactions at work, it is not surprising to find apparent confusion in the positions of some advocacy group. For example, the National Council of Welfare, which presumably speaks on behalf of the poor, supports both increasing the CPP replacement rate, and increasing

the CPP general dropout provision (see note 12) which would have a similarly regressive impact (National Council of Wel- fare, 1984).

Figure 5 presents what is arguably the first credible investigation of the distributional implications of the CPP general dropout provision.15 In this experiment the general dropout provision was raised from 7 to 10 years (15 to 22 per cent of eligible years). To balance the scenario financially the CPP payroll tax was raised to 15.6 per cent and personal income taxes were reduced by .3 per cent of total earnings.

As figure 5 suggests, increasing the general dropout provision is much like increasing the replacement ratio. It is an increase in CPP benefits that applies to all CPP participants. Due to the nature of the distribution by earnings level of earnings variability, these benefits are distributed (by earnings level) similarly to those

80 Bruce Kennedy

50

40 -

30-

20 -

10 -

0

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M F M F

i r I 1r r e I

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Increase dropout provision to 10 years Lifetime impact (thousands $ 1987)

50

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-fiO . . r , r I I I r I

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Figure 5 Impacts of increasing the CPP general dropout provision

generated by increasing the replacement rate.16 Individuals with high earnings are the main beneficiaries, largely because support for individuals with low lifetime earnings tends to be shifted from the PIT to the CPP payroll tax.

The final simulation experiment presented here concerns credit splitting and survivor pensions in the CPP. Credit splitting divides the combined earnings of a couple equally between the spouses for the purpose of computing the CPP pension pay- able to each spouse. Mandatory credit splitting is in force in the event of divorce, but the Parliamentary Task Force on Pension Reform (1983) and the National Action Committee on the Status of Women (1983) have both proposed automatic mandatory credit splitting for all couples. One effect of this would be to change the level of support for widows and widowers of pensioners (the

'survivors'). Currently if a pensioner's spouse dies the pensioner continues to receive a full pension. If the pensioner dies, the survivor receives a survivor pension of 60 per cent of the original pension. This dis- crepancy contributes to the preponderance of females among the elderly poor. With credit splitting (and no simultaneous changes to current survivor rules) no matter which spouse dies first, the widow or widower would continue with 80 per cent of the original level of benefits for the couple (a half pension in their own name and 60 per cent of the deceased spouse's half pension).17

Expert opinion to date has been that credit splitting would force the contribution rate up because it shifts credits from men who have higher earnings to women who have greater longevity (see for example Wolfson, 1988:225). The business


M F VV



community's opposition to CPP expansions extends explicitly to credit splitting (Busi- ness Committee on Pension Policy, 1983), though the CLC, women's organizations and anti-poverty groups all support the proposal.

The surprising thing about the credit splitting simulation experiment was that no increases in taxes (PIT or CPP payroll tax) were required to balance the scenario. Counter to expectations, automatic mandatory credit splitting is not an expansion of the CPP. The reason appears to be that credit splitting is a form of earnings averag- ing that reduces the variability of earnings, and hence reduces the cost to the CPP of the dropout provisions. This effect offsets the longevity effect noted above.18 The simulation results also indicate that the proposal is quite neutral with respect to lifetime (family-based) redistribution by earnings level and by sex. The extra support for widowed survivors is secured at the expense of widowed pensioners (who would receive an 80 per cent pension just as would widowed survivors) and of CPP participants who have erratic individual earnings but more stable family earnings (principally working wives in two earner families).

Automatic mandatory credit splitting would appear to present a rare political op- portunity. It could be introduced at no financial cost to government, to taxpayers, or to CPP contributors. It would increase the income of widowed homemakers and offer some recognition of the value of un- paid work in the home. It would be difficult to argue against on any equity grounds, and it would not offend the interests of any or- ganized constituency. It would appear that automatic mandatory credit splitting is a proposal that is thwarted only by misperceptions (primarily on the part of the business community) of the effects of the proposal.

Conclusions

All players in the pension policy arena

should consider proposals very carefully before announcing their support or opposition. There is a need to view the transfers generated by pension policies from different perspectives, and to assess these transfers within a disciplined framework that takes into account changes in program benefits paid, taxes paid on the benefits, changes in benefits from other programs induced through changes in incomes, the incidence of new taxes and 'contributions' required to finance the benefits, the effect of tax deductibility of any new 'contributions,' the changing social and economic status of individuals over time, and the effect of within family income sharing. Con- sidering all of these factors systematically is a very difficult task, and one that can be greatly assisted by simulation tools such as LIPPS.

Pension policy analysis is a very chal- lenging task for most advocacy groups, and some groups appear to have been better able to recognize the best interests of their constituents than have others. The Can- adian Council for Social Development de- serves recognition, in this regard, for ad- vocating partial funding of the CPP from income taxes (along with automatic mandatory credit splitting and increased survivor benefits), rather than general CPP expansions (Collins, 1978). Relief from the ever-increasing CPP payroll tax will be- come very important to the poor over the next two decades. American social security taxes started increasing annually about a decade before a similar schedule of 'contribution' rate increases was introduced in Canada in 1987. Half of all Americans now pay more in payroll taxes than they do in income taxes (The Economist, 311:7597:27).

This analysis has identified one policy option, CPP credit splitting, that is particularly deserving of further investigation. On the basis of the partial and preliminary examination presented in this paper, automatic mandatory credit splitting appears to be an almost painless way to increase the incomes of widows, and give some recognition of the value of homemak-

82 Bruce Kennedy



ing services.

Reservations The major limitation of LIPPS at present is that it doesn't have a savings/investment- income module. Since the simulated elderly have no income from private investment (including employer pensions) the role of GIS is exaggerated, as is the effect of GIS related tax-back of other benefits. This will tend to make the mean impact by earnings level distributions look more regressive than they should.

A second problem is that mortality generated by DEMOGEN is independent of earnings level. Since it has been observed that life expectancy increases with income in Canada (Wigle and Mao, 1980; Wilkins and Adams, 1983), wealthier Canadians can be expected to collect pension benefits over a longer period than poorer Canadians. DEMOGEN's omission of this relationship will tend to make the proposal impacts look more progressive than they should.

The practice of offsetting expenditures from general revenue in the simulation with increases in personal income taxes is not distributionally neutral. It would be preferable to build a special balancing tax into LIPPS to be used for bringing financial consistency to under-funded proposals. The incidence of this balancing tax would reflect some consensus as to the distribution of the total burden of financing government ac- tivity. For the time-being it is convenient to assume that new demands on general revenue imply increasing personal income taxes since these taxes are represented in the model and their incidence is clear. Since the PIT structure in the model reflects 1987 (prior to 'tax reform phase one') the impacts of proposals implying tax increases/ decreases will appear slightly too progressive/regressive. It is perhaps premature to speculate on the implications of phase two of tax reform, the Goods and Services Tax. Presuming that it will eventually decrease the progressivity of the tax system, then the biases noted above in association with phase one would increase. That is to say

that the impacts of an expansionary proposal, such as increasing OAS (figure 3), would not look so progressive if the expansion were being financed out of a less progressive tax system.

A sensitivity analysis performed on Wolfson (1988) and reported in Kennedy (1989a) suggests that this analysis is not likely to be very sensitive to details of the socio-economic microstructure of the simulated reference cohort. Analytic issues should prove more critical to the analysis than the fertility rates, participation rates and the like used within DEMOGEN. These more critical issues would include: what programs should be included in the policy environment; whether (and how) under-funded proposals should be modified to insure financial consistency; whether inter-cohort transfers should be permitted or prevented; whether impacts should be derived from individual-based or family- based incomes, how a family-based income should be computed, and whether impacts should be based on lifetime disposable income or annualized disposable income. The positions that have been taken on these issues are defended in Kennedy (1989a).

It is noted here, once again, that there are no behavioral responses to program changes represented in the simulations throughout this paper. This restriction is likely to remain a practical necessity for some time to come, and its significance is believed to be secondary to that of some of the other concerns raised above.

Notes

* This analysis would not have been possible without contributions to the LIPPS model made by Michael Wolfson, Gary Bagley, Dave Beavis, Dave Cogliati, F.P. Denton, Nagnur Dhruva, A.R. Dobell, Susan Leroux, R.C. McCrea, Garnett Picot, Goeff Rowe, and B.G. Spencer. Statistics Canada and the Institute for Research on Public Policy deserve special gratitude for supporting the modelling effort. The author takes full respon- sibility for this analysis.

1 A fetal version of the LIPPS model was developed by Michael Wolfson for the 1983 Parliamentary Task Force on Pension Reform. Since that time




the model has been evolving continuously thanks to the efforts of Wolfson and collaborators at Statistics Canada, Health and Welfare Canada, The Institute for Research on Public Policy, and Ivation Data Systems.

2 Detailed descriptions of the model and its perfor- mance can be found in Wolfson (1988) and Ken- nedy (1989a).

3 This study focuses consciously and normatively on intra-cohort transfers. Much earlier simulation work focussed on inter-cohort transfers, and it is consequently well understood that various public pension program expansions can generate 'wind- fall' benefits for the first generation of beneficiaries. For program design purposes it is more appropriate to focus on the long-term, full-cost implications of new proposals. This focus leads to a conceptual framework which is dominated by long-term growth scenarios, and within which there are no inter-cohort transfers, no 'wind-falls', and no sources of 'social security wealth'. Public pension programs are viewed within this framework as transfer programs, and pension reform is seen as a zero-sum game.

4 The Department of Insurance (DOI) estimates only period specific pay-as-you-go rates for current benefits, and for the early 21st century these range from 10 to 12% (Dept. of Insurance, 1986:19). The Department of Insurance modelling assumptions are almost universally more optimistic (with respect to CPP financing) than those of DEMOGEN. The DOI model assumes increases in fertility and in net immigration, and favourable changes in the age distributions of immigrants and emigrants. It assumes that female labour force participation will continue to increase, that the mean earnings of females will catch up to that of males by 2020, and that there will be a substantial decrease in unemployment and disabilities (Dept. of Insurance, 1986:63). The DOI model does anticipate a slight decline in mortality, but this is the only assumption that seems more optimistic than the DEMOGEN approach of strictly project- ing hazard rates observed in the 1980s. Fertility rates and earnings levels in DEMOGEN have been revised downward since the sustainable pay- as-you-go rate for current benefits was estimated by Wolfson (1988) to be 13.5%.

5 The earnings gap between the sexes is smaller in DEMOGEN projections than in current data. The difference is not exogenous, but arises because demographically aging a 1980s-like group of young females using 1980s-like probabilities of transi- tion into and out of the labour force (conditioned on age, sex, marital status, school leaving age, presence of infants at home, and current labour force status) generates a population of older women with higher labour force participation than today's older women and with more labour

force experience (see Picot, 1986). 6 The life expectancies at age 18 produced by

DEMOGEN are 73.1 years of age for males and 79.0 years of age for females.

7 Impacts generated using static microsimulation are closely related to the notion of Slutsky com- pensation. (See Kennedy, 1989a:169-75 for the complete argument.)

8 The 1989 federal budget includes a plan to 'claw back' OAS benefits (reduce net OAS benefits) for OAS recipients with individual incomes over $50,000. The 1985 proposal to reduce OAS indexing was an attempt to reduce all OAS benefits.

9 Summaries of CLC briefs can be found in Hamil- ton and Whalley (1984:112-3), the National Pen- sions Conference (1981), and Sayeed (1984).

10 The YMPE is a ceiling on the amount of earnings that are recognized for CPP calculations. Any earnings that an individual has in excess of the YMPE ceiling are 'non-pensionable'. No CPP 'contributions' are paid on them and they do not generate any future pension entitlements.

11 No figure is provided for this simulation experiment because there is not much to see in the figure produced. None of the earnings decile or sex groups used in the figures shows any significant impact. No figure is provided for the final 'credit splitting' experiment either, for the same reason.

12 The CPP benefits are proportional to an individual's 'average earnings ratio,' which is derived from a history of the indivisual's monthly earnings relative to the contemporary YMPE. The CPP dropout provisions permit individuals to ex- clude some of their low earnings ratio months from the calculation of their 'average earnings ratio'. The 'general dropout provision' permits the exclusion of any 15% (7 years) of the record. The 'child raising dropout' permits the exclusion of ad- ditional months in which the individual had at least one child less than seven years of age. At least 120 months must, however, be left on the earnings record for computing the 'average earnings ratio'.

13 When a CPP pensioner dies, their surviving spouse becomes eligible for a 'survivor pension' equal to 60% of the retirement pension previously paid the deceased contributor.

14 The individual's average earnings ratio is multi- plied by the average YMPE over the last three years, and then by the 'replacement rate' to determine the level of CPP retirement pension benefits. The replacement rate is effectively the proportion of pensionable earnings replaced on retirement by CPP benefits.

15 Transfers generated by the general dropout provision were examined in Rae (1981). However, individual earnings variation is critical to the operation of the dropout provision, and the model Rae employed (LIFESIM) produces no stochastic variation over time in individual earnings his-

84 Bruce Kennedy



tories. The analysis in this paper is based upon a study of individual earnings dynamics described in Kennedy (1989b), the results of which have been incorporated into DEMOGEN.

16 Absolute earnings variability tends to rise in proportion to earnings level as per Gibrat's 'law of proportionate effect' (Gibrat, 1931).

17 In the proposal of the Parliamentary Task Force on Pension Reform (1983), credit splitting was linked with a reduction in survivor benefits from 60 to 30% of the deceased contributor's pension. In this simulation experiment automatic mandatory credit splitting was introduced without changing survivor pension parameters. Credits were split when earned for all currently married couples.

18 There may be other factors, as well, that play a role in limiting the financial impact of credit splitting. There is, for example, a ceiling in the CPP limiting combined retirement and survivor benefits to the maximum retirement benefit. The effect of this ceiling on credit splitting proposals merits examination.

References

Aaron, Henry (1986) 'Comment.' Pp. 215-21 in David A. Wise, ed., Pensions, Labour and In- dividual Choice (Chicago: National Bureau of Economic Research.

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Collins, Kevin (1978) Women and Pensions (Ot- tawa: The Canadian Council on Social Development).

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-- (1989b) 'Mobility and Instability in Canadian Earnings,' Canadian Journal of Economics, 32(2): 383-94.

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Picot, Garnet (1986) 'Modelling the Lifetime Employment Patterns of Canadians,' Analytic Studies Branch Research Paper #4, Ottawa, Statistics Canada.

Rae, S.A., Jr. (1981) Redistributive Effects of Canada's Public Pension Programs (Ottawa: Economic Council of Canada).

Sayeed, Adil (1984) 'A Survey of Pension Reform Recommendations.' In Conklin, Bennett and Courchene (eds.), Pensions Today and Tomorrow: Background Studies (Toronto: Ontario Economic Council).

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Some Distributional Impacts of Marginal Changes to Public Pension Parameters

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