Saving our way to less wealth inequality?

In today’s New York Times Gene Sperling has an opinion piece arguing for the creation of a government-funded universal 401(k) retirement plan. The former director of the National Economic Council under Presidents Obama and Clinton sells the proposal as a way to reduce wealth inequality. Two aspects of the proposal—the use of tax credits and automatic enrollment—deserve more attention to show how changes to our retirement savings system could help boost wealth for low- and medium-income Americans.

In the United States, the personal savings rate has been on the decline for decades, turning negative during the mid-2000s housing bubble before increasing since the Great Recession. But there’s quite a bit of variation in the savings rate across the income ladder. Savings rates for those at the top are much higher than those at the bottom. So getting more Americans to save would certainly help boost retirement accounts, if effective policies are used.

The use of tax preferences to spur retirement savings in the past has provided us with quite a bit of evidence on the topic. Think of the tax preferences for defined-contribution plans such as 401(k) plans or the tax break employers get for providing a pension. Research shows that these tax preferences are highly skewed toward high-income savers. According to analysis published by the Urban Institute, approximately 70 percent of the value of retirement tax preferences goes to the top 20 percent of households while only 12 percent goes to the bottom 60 percent.

Research shows that this inequitable setup is also inefficient. Economists Raj Chetty and John Friedman of Harvard University, Soren Leth-Petersen and Torben Heien Nielsen of the University of Copenhagen, and Tore Olen of the Centre for Applied Microeconomics, looked at the effects of tax preferences on retirement savings in Denmark. The authors look at 41 million observations of savings in retirement and non-retirement accounts. By seeing how savers reacted to changes in tax policy, they can gauge how effective these credits are.

In short, the authors find that about 85 percent of people were non-responsive to changes in tax incentives. The tax policy changes were a nonevent for the vast majority of the population. The other 15 percent of the population, a wealthier group, did respond to the tax incentives. But instead of increasing their savings, these individuals simply switched their savings from non-retirement plans into retirement plans.

In contrast, automatic enrollment in savings plans actually induced most individuals to increase their savings rate. Chetty and his coauthors find that automatic enrollment plans significantly increased the savings rate of a broad swath of the population.

The research shows that one aspect of the Sperling proposal—the use of tax credits—may not be as effective as hoped, while another—automatic enrollment—can be quite useful in boosting savings. Increasing the wealth of low- and medium-income Americans will take quite a few policy steps over the years, especially in the wake of the bursting of the housing bubble. But reforms to our retirement savings system could be an important first step.

July 23, 2014


Economic Inequality

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