August 18, 1992
"No, IRAs Won't Do the Trick - How to Increase Personal Savings"
San Jose Mercury News
By Timothy Taylor
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RAISING INVESTMENT is crucial to creating higher paying jobs, increasing the average standard of living, and keeping the U.S. economy competitive in a cutthroat global economy. But where is the money to come from?

Borrowing from abroad, and then repaying foreign investors with interest, has some obvious disadvantages. Reducing federal borrowing, by cutting the budget deficit to free up funds for private industry, would be nice, so nice, so nice -- but now that you've awakened from that sweet daydream, it still doesn't seem imminent.

So some economists are focusing on a third possibility: policies to increase the household savings rate. After all, if saving is the water pumping into one end of a hose, investment funds are the flow coming out the other end.

The 1980s offered the Individual Retirement Account as a way to increase savings, and late last week, "restoration" of IRAs was back in the headlines. The Senate has voted to reduce limitations placed on IRAs in 1986.

You see, back in 1981, IRAs offered a tax break in two ways: money deposited into the IRA was tax deductible, and the saver could defer paying taxes on interest earned until after retirement. But the Tax Reform Act of 1986 limited the deductibility of contributions to IRAs.

The only problem with returning IRAs to the happy legal status of the early 1980s is that they didn't seem to work very well at the time. The amount of money held in IRA accounts increased, but overall household savings declined sharply, falling from 8.8 percent of disposable income in 1981 to 6.0 percent in 1986.

Economists are still trying to disentangle what happened, but the evolving theory seems to be that different people had various reactions to IRAs.

Some increased savings, as the lawmakers had hoped. Some just shifted money that would have been saved in taxed investments, and put it in into tax-free IRAs instead. And some noticed that the IRA tax break allowed them to meet their long- term savings goals while putting aside "less" money, since the tax break made up the difference.

While IRAs didn't have much effect on household savings, they did cost tax revenue, and thus raise the budget deficit.

If IRAs have little effect, what might work better? The Center for Economic Policy Research at Stanford University and the John F. Kennedy School of Government at Harvard University recently sponsored a conference on tax and budget policy in Washington, D.C., and one of the sessions was devoted to the question of how to raise household savings.

Jonathan Skinner of the University of Virginia pointed out that some forms of government assistance discourage savings. For example, if you think you might someday need to receive welfare or (Medicaid-supported) nursing home care, why save?

If you don't have funds, after all, government assistance kicks in almost right away. If you have a lot of savings, and then need a nursing home, the government requires that you spend down most of your assets before receiving help. So under the current rules, the main beneficiary of your saving ends up being the government, which can postpone offering assistance. If every government program allowed recipients to have, say, $10,000 in assets, this disincentive to save would be reduced.

Richard Thaler of the Russell Sage Foundation and Cornell University noted that the majority of personal savings is "forced," either withheld through taxes, or deposited by an employer into a pension plan. Thus, he advocated higher rates of withholding on taxes, government support for expanded pension plans, and other steps that would encourage people to lock up their money.

If these approaches to encouraging savings seem timid, Paul Romer of the University of California has been considering the merits of a brute force plan. Consider this idea: everyone is required by law to put 5 percent of their income into a restricted savings account, or you lose the money. The idea is all stick, no carrot.

No tax break would be offered for the required level of savings, so that unlike IRAs, it wouldn't cost the government anything. The government would not hold or control the savings, either; the funds could be deposited in any financial institution.

Withdrawals of the money might be allowed for buying a house, college tuition, getting through a spell of unemployment or disability, for a nursing home after retirement, or for other reasons. Romer adds that if everyone had such a required savings account, government would come under less pressure to offer costly assistance for home-buyers or student loans or nursing homes. People would have saved on their own.

Romer's proposal has a lot of loose ends; at this stage, it's more thought experiment than legislative intent. But it does concentrate the mind. After all, if a senator supports IRA tax breaks because of the vital need to encourage savings, shouldn't that senator think that Romer's plan of guaranteed higher savings is even better?

Rather than stampeding off, yet again, after a glitzy, popular, and ineffective IRAs tax break, these other methods of raising personal savings deserve a closer look.

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