Tax-free saving schemes fail to prepare many for retirement: Don Pittis

With the RRSP deadline only days away, the inventorof one of Canada's tax sheltered saving plans says there is evidence such schemes have failed to encourage people to save properly, and he warnsthere are changes afoot.

"A lot of it is tax reduction without necessarily significant in the aggregate additional saving," says RhysKesselman, one of the inventors of Canada's tax-free savings account.

When he and a colleague first proposed the idea in 2001,Kesselmancalled it the tax prepaid savings account, and his intention was to create a savings scheme better suited to low-income savers thanthe existingregistered retirement savings planthat had been going since 1957.

Tax relief for the rich?

But since the late Conservative finance ministerJim Flahertyadopted Kesselman'sidea and introduced the tax-free savings accountin 2009, researchshows that neither it nor RRSPsaredoing what economists had hoped and expected.

• Canadians contributed less to their TFSAs last year, BMO survey finds
• RRSPs less popular since creation of TFSA, StatsCan data finds

"Is the effect more saving or less saving?"Kesselman asks. Once all the studies are done, the results are "pretty mixed," he says.

Kesselman, who now holds the Canada Research Chair in Public Finance at Simon Fraser University, says the tax-free accounts aren't having their intended effect, with the danger they will once again be perceived, as the RRSPonce was, as"tax relief for high earners."

"A lot of it is simply diversion of savings from taxable forms by upper-middle and high-income individuals to less-tax forms," says Kesselman.

That's not the way it was supposed to work.

To economists, giving people a tax break on savings wasintended to remove what they saw as a strong motivation not to save.

Imagine two people with identical incomes,one of whom spends every penny and the other who saves some income. The one who spends it all gets the full current value of that income.

According to economic theory, money spent now is worth more to us than money spenttomorrow or next year. That's why weare willing to borrowfor the immediate benefitsof having a new car, despite the additional cost. It is why people are willing to pay interest on loans of all kinds.

A penalty for saving

By the same logic, that is why savings are rewarded with interest.People who savesome of their income instead of spending it all defersome of that immediate benefit in exchange for the future benefit of investment income.

But if the investment income is taxed, economists say that means spendthrifts who blow their entire paycheque get full benefit of their money while the savers only get part of the benefit.

"Income-based tax penalizes the saver," says Kesselman.

Even people who think all taxes are bad and government should be small know we need some way of collecting revenue. The battle over the fairest wayto collect that tax, whether taxing income or consumption, has been grinding on since the 1920s.

And while people with lots of money are more able to save than poor people, the tax breaks just aren't enough to motivate many with more modest incomes who should be able to save.

"A lot of middle-earners do, but the second car, the speed boat or the additional vacation seem more pressing," says Kesselman.

Inability to save

High property prices mean that even people with good incomes and the best of intentions have nothing left over after buying a house.

The latest data from Statistics Canada shows that in 2013 RRSP contributions were falling. While more people contributed to tax-free accounts,withdrawals were up too. More than half of all people with the accounts removed money in that year.

According to surveys by Canada's big banks in 2016 and 2017, there is evidenceCanadians still aren't saving. Those who are saving, aren't saving enough.

The numbers vary according to each bank's statistical methods, but Scotiabankestimates thatnearly half of eligibleCanadians don't have a tax-freeaccount and nearly 40 per cent aren't saving for retirement at all.

Despite championingtax-free savings accounts more than a decade ago, Kesselmanhas changed his tune.

Since tax breaks have failed to motivate people to save for retirement, he hasnow reluctantly begun advocating a compulsory savings plan, under which savers areforced to contribute to a pension big enough to support themselves through their retirement.

Such schemes will require changes to existing savings plans. But any changes must not be seen as discouraging those who do make the effort to save.

Onechange that is almost certainly coming, he says, is the provisionthat allows people to accumulate huge tax-free savingsaccounts, but still be eligible forbenefits intended for lower-income seniors.

With assets and income sheltered in a tax-free account, some relatively well-off peoplewill be able to get Old Age Security benefits without paying any tax on those benefits and evencollect the guaranteed income supplement intended for low-incomeseniors.

"That, of course, is stupid, silly, short-sighted," says Kesselman.

"I'm sure the day of reckoning will come when governments do start to somehow factorit in, when more peoplehave TFSAs in the hundreds of thousands and the millions."

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