Introduction
The proportion of retired Canadians in Canada's population has been increasing steadily. More critically, the proportion of retired Canadians has been increasing relative to the proportion of workers. This "greying" of the population has had, and will continue to have, a profound impact on the ability of the government to provide state-funded social security programs. The limitations placed on the public social security system will inevitably affect the ability of retirees to maintain a reasonable standard of living1 over the long term.
Given Canada's changing demographics and the limitations on the public pension system, it is incumbent upon the federal government to provide mechanisms by which Canadians can save. It is equally important for Canadians to earn a reasonable rate of return on their investments to augment their public social security benefits.
The importance of Registered Retirement Savings Plans (RRSP) and Registered Pension Plans (RPP) cannot be underestimated, as almost 8 million Canadians use one or both of these instruments to accumulate private savings for retirement. In addition, according to the Association of Canadian Pension Management, 77 percent of eligible Canadians use private pension savings to augment their public social-security benefits.
The Foreign Property Rule (FPR) limits the amount held as foreign assets in Registered Retirement Savings Plans (RRSP) and Registered Pension Plans (RPP). It has, therefore, significant ramifications for the ability of both future and current generations to save for their retirement. By its very nature, the FPR inhibits the ability of Canadians to diversify their portfolios and maximize the possible rates of return for a particular level of risk.
Grave questions have been raised by a number of authors and scholars regarding the effects of the FPR on investment returns and performance. A number of reports examining the impact of the FPR have concluded that Canadian tax-sheltered investments are under-performing and that risks for savers are higher than they would be in the absence of the FPR (Ambachtsheer 1995; Ernst & Young 1997; Conference Board of Canada 1997; Turner 1999). For instance, Garth Turner estimates that Canadians investing in the Canadian market over the last ten years garnered a nominal cumulative return of 75 percent while investment in global markets achieved a nominal cumulative rate of 500 percent or more (Turner 1999). Similarly, in a recent National Post editorial, Terry Corcoran quoted a private study from the Bank of Nova Scotia that concluded that markets in the United States, Japan, France, Germany, and the United Kingdom out-performed the Canadian market, on average since 1970, by 248.7 percent (Corcoran 1999).
This study will assess, on the basis of the empirical evidence, the efficacy of maintaining the FPR given the limitations of the public social-security system and the importance of ensuring the ability of Canadians to maintain an adequate level of income in retirement.
Objectives of the study
Although the empirical focus and intent of this study is to examine the limitations and difficulties associated with the Foreign Property Rule, the study will also examine a number of other related areas.
The first section presents a summary of Canada's public social-security system with a discussion of the inherent limitations and difficulties currently facing it. This section also provides a brief overview of Canada's relative tax position in order to illustrate the tax constraints inhibiting reform in the public system. Appendix A presents supporting theoretical and empirical research relating to the effect of taxes on productivity and economic growth.
The second section explains Registered Retirement Savings Plans (RRSP) (and, summarily, Registered Pension Plans). Longitudinal data (i.e., data over time), as well as statistics taken from the 1995 tax year highlight the tremendous growth in RRSP-based savings.
The third section of the study provides a theoretical overview of investing and the importance of portfolio diversification. A summary of the relationship between risk and return that underlies investment decisions is presented along with the general principles of portfolio management and diversification.
The fourth section summarizes the Foreign Property Rule, which limits the amount of foreign assets an individual can hold in an RRSP or RPP account. The section also discusses the definitional problems associated with the FPR, namely defining what is "foreign" and what is "Canadian." In addition, two provisions that allow investors to increase their foreign exposure are discussed, with particular emphasis on the effect of the provisions.
The fifth section of the study presents specific examples of how the FPR inhibits diversification. A series of data are presented, including profiles of major exchanges, summary statistics on the Toronto Stock Exchange, and comparative Canadian and provincial data to illustrate the efficacy of diversification and the real limitations associated with the FPR.
The sixth section presents three case studies of the foregone capital accumulation of investors due to the FPR. Appendices D(1) through D(9) contain specific profiles that augment the data presented in this section.
The seventh section briefly presents the initial public policy rationale for the FPR and assesses its validity in the current environment. The final section presents a summary of the main findings of the study.
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