The challenge of getting Americans to save more

By A.C.S. | NEW YORK

CLIVE CROOK nails the retirement problem. The issue is not Social Security per se; its finances can be put on track (not quite as painlessly as Mr Crook suggests, but it's manageable) and the sooner that happens the better. The problem is confusion about who'll get what. Social Security tries to be many different things. It is both insurance against poverty in old age and income replacement for the middle class. Its muddled mission means people tend to see it as a saving scheme, where their contributions entitle them to a comfortable retirement, but that's not technically true. On the other hand I often hear people say “Social Security will not be there when I retire”; that's also not true. This level of confusion is a major problem.

No matter what happens, Social Security will not provide enough retirement income for most people. A 45-year old who earns $35,000 can only expect about $16,000 a year from Social Security when he retires. If he earns the median income, about $50,000, he'll get about $20,000. According to the 2009 Survey of Consumer Finance the median financial (does not include housing) wealth for people approaching retirement is about $70,000. That will provide about $3,500 of inflation-protected income a year in retirement—not much to live on. People need to save more.

More retirement income can come from two sources: encouraging people to save more or increasing the generosity of government benefits (that is, taking money from the young). Future demographics suggest the latter is neither realistic nor desirable, so that leaves only the possibility of more saving. That can be achieved with greater access to private accounts and strong incentives to contribute. Mr Crook and others advocate government-sponsored private accounts where people must make contributions. This is actually similar to George W. Bush's plan. His was a political bust, because using the words "private" and "Social Security" in the same sentence tends to incite hysteria. That's unfortunate, because expanding access to private pension accounts most benefits the working poor and lower middle class, people who do not have retirement accounts through their employer.

Private accounts give people responsibility for their own future and provide transparency about what the true nature and extent of their retirement assets (outside of places like Argentina or Hungary, that is, where private accounts were recently seized by the government). I do have some concerns with Mr Crook's plans to finance the change:

How, specifically, might this be done? I'd recommend, as a start, that an additional 5 percent be deducted from wages and invested in a choice of pooled accounts holding a mixture of domestic and foreign assets. Pooling and central administration would keep fees very low. Balances would accumulate tax-free until retirement; distributions would then be taxed. I'd also advocate that taxpayers provide a subsidy to those on low incomes, sufficient to cover the whole deduction for those earning the minimum wage, so that everybody could afford to save through their retirement account. To help meet the cost of this taxpayer subsidy, narrow the existing tax preferences for saving, which flow to those on higher incomes who least need the help.

True, minimum-wage earners don't have 5% of their income to spare, but they are not the most vulnerable. The progressive nature of Social Security means that very low earners get a fairly high benefit relative to their income. Rather than giving them cash it would be better to offer them the account, but not require them to make such a high contribution. The populations I worry about most are lower middle- to middle-class workers, many of whom are not saving and face the possibility of a dreadful retirement. Putting 5% of their salary in an illiquid retirement account will be enough of a struggle for many middle-class families; I am not sure why they should also subsidise low income earners when they already do that through Social Security.

Narrowing tax preferences for saving, as Mr Crooks suggests, is problematic for several reasons. First of all, as a matter of macro policy it's better to encourage saving over consumption (or more precisely, not to penalise future consumption relative to current consumption), so a progressive consumption tax would be more desirable. We should also be careful about removing incentives for higher earners. People earn and save more as they age. A 45-year old probably is not saving much because he still has children to support and a home to pay for. People often do not get serious about saving for retirement until they reach advanced middle age, just when lifetime income is at its peak. Is it wise to remove saving incentives just when people finally make it a priority? True, very high earners would save without the deduction, but there is now a limit to how much they can contribute tax-deferred; there's not a lot of untapped revenue there.

But quibbling about financing for saving accounts is penny-wise pound-foolish. Offering people access to cheap accounts and giving them incentives to contribute, or even requiring it, is the best approach to increase retirement saving. Otherwise we'll have a generation of people facing poverty in retirement: a much bigger fiscal burden.