What would you think if someone told you that pensions encourage people to live too long? It sounds like a line from the popular British comedy series, “Yes, Prime Minister.” In fact it comes from a long forgotten paper by two very good Canadian economists.
Here is their story. To finance our public pension plan we carefully figure out how long people live on average and we collect just enough money to pay the pension bill. But having a pension affects people. They start to think more about retirement.
They start to take better care of themselves. This sounds good, but it is actually bad, according to economists Peter Kuhn and Jim Davies. People who take care of themselves will live a longer and cost the pension fund more.
There is evidence that Kuhn and Davies were right. With our Canadian pensions and healthcare benefits, we have one of the longest life expectancy in the Organization of Economic Co-operation and Development (OECD). The USA, with its weaker healthcare and pension schemes, is 14 places behind us. Ahead of us are countries like Sweden and Iceland with stronger pension and health care systems.
Kuhn and Davies apply a strange term to this temptation to live too long. They call it “moral hazard.“ Back in the 1600s, insurance companies realized that insurance might encourage customers to take more risks. They might be less likely to clean their chimneys if they have fire insurance. Today, people with car insurance might drive a little faster and people with accident insurance might take up skiing. From the company’s point of view, insurance policies encourage irresponsible behaviour. This irresponsible risk-taking is immoral, hence the term ‘moral hazard.”
The pension example might seem like the exact opposite of moral hazard – people with pensions take more care, and that should be good. But from the point of view of the pension plan manager, their behaviour increases costs for the plan. That is definitely an incentive problem.
Moral hazard is actually a very common problem. The meltdown in the U.S. housing market was a result of mortgage companies encouraging homebuyers to sign mortgages they would have to default on. The companies created a moral hazard for their customers. They also created a more hazard for their own employees, encouraging them to push paper that was rapidly becoming worthless.
The real point is that any incentives that lead to increased social cost are a problem. They lead people to do things they should not do.To reduce the level of moral hazard, insurance companies introduced deductables. If you have an accident you have to pay some of the cost. Perhaps the people who sold risky mortgages should have had to pay a fraction of any mortgage that has defaulted.
Kuhn and Davies proposed a provocative solution: the government should subsidize cigarettes and tax vitamins. It should encourage risky sports like skydiving. To protect the pension plan it should encourage people to die.
Our property tax system is a swamp of moral hazard. It encourages building in the suburbs, driving a lot, and emitting tons of carbon. It makes communities more expensive to service and maintain, and in Northern Ontario it makes communities much less sustainable.
How does it encourage so many sins? By continuing the outdated practice of taxing buildings instead of just land. Taxing building encourages smaller houses and discourages improvement to buildings. Reducing the tax on land and by taxing buildings encourages bigger lots. Using lots of space is what increases community costs. The current property tax system produces communities that are more spread out than they should be, with a cost of living that is higher than it needs to be, and with an environmental impact that is much larger than necessary.
The system is inherited from the medieval period, when buildings were much easier to tax than land. The result is that today we now have a system that makes using land cheaper and buildings more expensive. The medieval tax system encourages us all to make decisions that are bad for the community and bad for the environment.
It is time for our provincial politicians to change our medieval municipal act. Please, Mr. Tax Man, help us sin no more.
