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Thursday, June 29, 2006

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.

    Posted by on Thursday, June 29, 2006 at 12:42 AM in Economics, Market Failure, Policy, Saving | Permalink  TrackBack (1)  Comments (10)


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    Hal Varian, writing on the Economic Scene (NY Times), thinks about how to improve the incentives for people to save. One promising proposal has been to set defaults for enrollment in 401(k) plans so that employees are automatically enrolled in... [Read More]

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