A Nickel Saved Through Opt-Out and Matching Grants is a Nickel the Government Won't Have to Give You

Having used Hal Varian's little blue book as one of my micro texts in graduate school, I have no doubt about his skills as a microeconomist. My complaint about this article examining policies to encourage low-income Americans to save more is that those skills are not used to identify the market failure the policies address.

To say, as in the opening line, that "Economists are in almost universal agreement that Americans save too little," and to follow with suggestions that the government intervene in the marketplace implies these markets do not produce the right incentives to save, that the market outcome is one of too little saving. The article does mention different savings rates as an explanation for differences in asset accumulation over time, but that is a behavioral statement, not a specific market failure. If we don't know what the problem is, how will we know what solution is best? My preference is to start by identifying the problem, then proceeding to find a solution. But whatever the problem is, the argument Varian makes is that these programs appear to work:

Looking for the Incentives That Will Prompt Americans to Save More, by Hal Varian, Economic Scene, NY Times: Economists are in almost universal agreement that Americans save too little, and several policies have been proposed with the goal of encouraging them to save more.

The Bush administration favors increasing contribution limits on tax-deferred savings accounts like I.R.A.'s. Critics argue that there would be little impact on total savings ... since wealthy households would simply transfer assets from taxable accounts to tax-sheltered accounts.

Leaving aside the behavior of high-income households, responsible members of both parties recognize that providing better incentives to low-income people is the most challenging problem. How can we get this group to save more?

It is possible for low- and middle-income groups to increase savings. After a detailed examination of the financial circumstances of people close to retirement, two economists, Stephen F. Venti ... and David A. Wise ..., concluded that the primary reason for differences in retirement assets was differences in propensities to save. ...

One promising proposal has been to set ... 401(k) plans so that employees are automatically enrolled in an appropriate plan unless they explicitly choose otherwise. ...[T]his simple policy increases participation rates dramatically.

Another suggestion is to provide matching grants to low-income individuals. ...("Saving Incentives for Low- and Middle-Income Families: Evidence From a Field Experiment With H&R Block"; ... nontechnical summary ...) In this experiment, ... low- and middle-income families ... were offered a 20 percent match on their contributions to an I.R.A., a 50 percent match or no match at all...

Only 3 percent of the individuals who had no match — the control group — contributed to an I.R.A. But 8 percent of those with a 20 percent match rate contributed, and 14 percent of those with a 50 percent match contributed. The amount contributed was four times as much as the control group for the 20 percent match rate and seven times as much for the 50 percent match rate. ... And most people stuck with their plans: four months after the initial contribution, over 90 percent of the individuals still kept the money in their I.R.A.'s.

These effects are far larger than those of the Saver's Credit, an existing program that provides a tax credit based on the amount of tax-deferred savings. The problem is that a tax credit is useful only if you pay taxes, and many low-income individuals have little or no tax liability after other deductions and credits are applied. Furthermore, the Saver's Credit is complicated and hard to understand. A matching contribution to a savings program is much easier to comprehend. ...

As the authors put it, "Taken together, our results suggest that the combination of a clear and understandable match for saving, easily accessible savings vehicles, the opportunity to use part of an income tax refund to save, and professional assistance could generate a significant increase in contributions to retirement accounts, including among middle- and low-income households."

Matching grants also have a long and venerable history as an American institution. They were invented by none other than Benjamin Franklin in conjunction with his fund-raising efforts for the Pennsylvania Hospital, the first public hospital in America, established in 1751.

Franklin persuaded the legislature to participate by indicating that it would receive "the credit of being charitable without the expense" and explained to the donors that "every man's contribution would be doubled." No doubt the sage of Philadelphia would heartily approve of his innovation being used to encourage the virtue of thrift.

Comments

[Stormy]

"How can we get this group to save more?"

Pay better wages.

If things continue as they are, the present generation of lower and middle class folk do not stand a chance.

[Bruce Webb]

There is an odd confusion going on here between overall national savings and savings by the working poor which like everything I touch goes back to our old friend Social Security. The implication that we should solve the national savings crisis on the backs of the working poor is strange to start with. Why not go where the actual money is, for example the people moving into 5 BR 6 1/2 bath McMansions with two SUVs parked outside?

No the claim that the working poor need to save more is embedded in the argument that they cannot simply rely on Social Security to meet their needs in retirement. Well why not? Under current Intermediate Cost projections benefits will be paid in full until 2039 and then dip to 75% of a benefit that is scheduled to be 160% of the benefit paid today. Which is by what I call the Rosser Equation works out to be 120% in real terms of what retirees get today. Millions of Americans get by on Social Security today, and a lot of the ones that struggle would have much of that struggle removed by taking Medicare drug coverage to Single-Payer. That combination alone would provide most of the working poor a dignified retirement.

If we add in the fact that the economy is likely to return better than Intermediate Cost, that the bias on the Rosser Equation is all to the upside, then the question becomes all the more acute. Why should the working poor be forgoing current consumption in favor of long-term savings? They are already investing an effective 12.4% of their income via FICA, why are we trying to squeeze blood from this particular stone? Or in Mark's terms what is the problem we are trying to solve?

Why do poor people need more money in savings? (As opposed to a emergency reserve). What is the first order problem that this second order proposed solution is designed to correct?

Because you really cannot separate these proposals for mandatory savings, from private accounts under Social Security, from Social Security solvency. Certain common assumptions are working at the foundations of each, and those assumptions need to be exposed to light and tested.

[ilsm]

Bruce,

According to a guy from Heritage in Wed WSJ letters if we 'leave SS and medicare on autopilot the deficit" (unified the discretionary deficit is already a mess)will skyrocket.

He implied this will adversely impact capital formation.

Notice he will leave the military industrial complex on autopilot which is a large cause of the deficit.

There are two answer to SS: fix the real deficit, that which is funded by the SS surplus and work on real productivity in the US, supply siders have not done a thing here.

The capital formation most in jeopardy is the formation of for profit arsenals.

Note Judd Gregg's plan unlike Graham Rudman does not effect reductions on the military industrial complex.

I guess a large capital stcok of the wrong things is more important than the cold war.

[piglet]

What do you make of today's figures: 5.6% growth rate in first quarter, increased number (313'000) of new unemployed? Is there any plausibility to those whopping growth figures? Does anybody actually believe they are real?

[LJM]

For years, after WWII, people lived in an environment where prices didn't rise for years. People could budget knowing what food, gas, etc... would cost them. They could budget to save and savings accounts and US savings bonds paid a good rate of return to make it easy to know how to save. Poor and middle class people weren't found putting their money in the stock market very often. They were still impacted from the crash of 29. People who had savings compounding at 5% actually did accumulate wealth. Matching money would be great, but it seems it doesn't even require such a costly incentive to get more people to save. Make savings vehicles safe. Pay a good rate of return, say 6% or so and have the ways to save through these instruments be as easy as the good old passbook savings account was in days of yore. Banking probably needs an overhaul to do this. Deregulation messed things up for savers and certainly made people targets for easy credit and high interest rates for credit card debt.

[spencer]

Before we can address the savings issue we need to know why the savings rate has fallen.

Research by the Fed implies that the bulk of the decline has been from the top quintile of the income distribution.

So if your issue is to rebuild savings you need to see
why this income segment has reduced savings and the type of suggestions targeted at the low income may not be the best solution.

So if the problem you want to solve is low savings or low savings by the poor the solutions may be very different.

Remember the lower half of the income distribution only has 2.5% of the wealth and wealth is more closely related to savings then income.

[bakho]

I'm with Spencer. Plus many young people have college loans to pay off that prevent them from saving. Young people must also decide whether to save or make that downpayment on a house. Americans traditiionally save by home purchases. We have been through a period of negative returns followed by below average returns. Since part of savings depends on compounding, that contribution to savings has been lost or below average.

[anne]

Spencer:

"Before we can address the savings issue we need to know why the savings rate has fallen.

"Research by the Fed implies that the bulk of the decline has been from the top quintile of the income distribution."

Could it be that as income and wealth is concentrated towards the wealthiest, even the upper middle class to moderate wealthy are feeling pressured? Are they pressured or simply feeling this way? What are we missing? I do wish however that student costs at public universities could be lowered in dramatic fashion.

[dWj]

I've always counted "paying off [debt]" as saving, and so does NIPA -- it amounts to a current consumption that is lower than income.

I think the idea of people saving when they're young is oversold; a typical college graduate sees a more rapid increase in income in the first decade out of school than thereafter, and anyone making payments on student loans in the first year in the workforce without consuming more than what is less is probably doing fine, as long as salary increases aren't met too quickly by spending increases.

I'm very much with Mark, though, on a curiosity about the market failure. I particularly had trouble arguing in favor of saving when short-term rates were below 1%; where they are and will be for the next couple years, it's still not clear that we have a capital shortage that demands large amounts of savings. The presumption seems to be that interest rates, for demographic reasons, will have to go up over the course of the next generation; perhaps that true. That would make saving more compelling.

[ilsm]

Consumption in the US is the source of economic "growth". We have been growing by consumpotion.

Saving is bad!!!

It (less consumption re income) will stop growth and cause a recession.

Actually, I think 'bad' in terms of the Bush report card.

Imagine Bush sitting in the back of a classroom cowboy boots, fighter pilot jacket and feet up sleeping through Macro.....