The Retirement Effects of Canada's Income Security Programs

"From the beginning of the 1960s through the end of the 1990s the labor force participation rate of 55-64 year old men fell from 87 percent to 61 percent."

Like many other developed nations, Canada has a large income security system for retirement. However, a variety of policy and demographic factors have created crises for both the Canadian and Quebec Pension Plans. As a result, Canada's Income Security (IS) programs for seniors face an uncertain future. In particular, the substantial reduction in the work participation of older Canadians is a trend that is creating fiscal concern.

From the beginning of the 1960s through the end of the 1990s the labor force participation rate of 55-64 year old men fell from 87 percent to 61 percent. For men over 65, it fell from 30 percent to under 10 percent. This creates a dual financial burden for the IS system: lower tax revenues and higher benefits.

In The Retirement Incentive Effects of Canada's Income Security Programs (NBER Working Paper No. 8658), authors Michael Baker, Jonathan Gruber, and Kevin Milligan find that the work disincentives inherent in the Canadian IS system have large and statistically significant effects on workers' retirement decisions. The Canadian IS system consists of a complicated web of programs that provide both incentives and disincentives to work at various ages. Overall, however, starting at the early retirement age of 60, there are large disincentives to continued work inherent in this system, the authors find. These disincentives largely arise from means-tested benefits programs that reduce retirement income as earnings and other income increase. By age 64, Canadian males face a net reduction in the present value of their retirement income of over $4400 if they work another year.

The authors study the impact of these program incentives and disincentives on retirement using a unique administrative dataset for Canada. Their data combines earnings records over a long time period with information on employment patterns and the characteristics of workplaces. Moreover, these data are linked across spouses, providing a full characterization of the earnings of both spouses. These rich data allow the authors to carefully compute both workers' retirement patterns and the financial incentives to retire that are inherent in the IS system.

The authors' analysis reveals that these IS programs have an important retirement effect: decreasing the incentive to work through IS programs significantly increases retirement among older Canadians. Moreover, this effect is strongest when the authors consider not only the incentive to work one more year, but also the entire path of future incentives to work Workers appear to understand, and respond to, incentives that might affect the value of work in several years, not simply in the current year.

These findings have important policy implications. They suggest that the disincentives to work put in place by income security programs can cause significant increases in retirement. And, they suggest that reforms that increase the incentive to work at older ages can reduce retirement. For example, policy changes to further increase benefits for those who stay in the workforce at older ages would significantly raise the share of older workers who stay in their jobs and do not retire.

-- Les Picker

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