Saving Grace

Next week the Commerce Department will release a pedestrian report that should produce a shocking headline in the papers: America’s Savings Rate at Lowest Level since the Great Depression. Indeed, 2006 marked the second consecutive year that the country’s personal savings rate was negative, matching the dubious performance of that bygone decade. Not only is our spending exceeding disposable income, but consumer debt is at record levels, making families especially vulnerable to rising interest rates and fluctuating incomes.

This wasn’t always the case. We used to be a nation of thrift. Historically, this didn’t mean being cheap or stingy; it meant wise spending that created future wealth. Reviving our savings culture would produce both individual and collective benefits. At the household level, savings could be tapped to make investments that pay off down the line or serve as a security blanket to weather income disruptions, which are on the rise with income volatility. For families with lower incomes and fewer resources, savings are valuable because they can be converted into assets -- homes, post-secondary education -- that lead toward greater economic stability. In this sense, savings should be seen as an essential piece of an anti-poverty policy strategy. At the national level, meanwhile, savings create pools of capital available for investment that are necessary to sustain economic growth and keep interest rates low.

Besides our current fiscal policies, which have produced budget deficits and lowered national savings, the incentives our policymakers have crafted to promote personal savings are expensive, often wasteful, and largely ineffective. Higher-income households receive the overwhelming majority of the $110 billion in annual tax subsidies that accrue to those contributing to IRA-type accounts. Not only do these families not need a boost, but they can get rewarded for shifting assets around rather than for actually generating net new savings. Moreover, other federal regulations actively discourage savings by lower-income families. Eligibility for many federally-sponsored assistance programs, such as food stamps, TANF, and Medicaid, is linked to an asset limit test, so a family must deplete their resources before qualifying for help.

A better approach would be to increase the rate of savings at the household level, up and down the income scale. Given the current state of consumption in America and the powerful pressures to increase it no matter what the costs, this appears unlikely to happen on its own. Fortunately, research has shown that when the savings process is easy and accessible, even people with low incomes can and will save.

Recently, much has been made of the potential to automatically enroll employees in employer-run 401K plans. It’s a good idea to establish an "opt-in" default for these plans (that is, an employee would have to take the affirmative step of actively dropping out of the 401K), but it would be a much better idea to ensure that everyone has access to this type of savings plan. The problem now is that about half of all employers don’t offer 401Ks. What we need is a national savings plan, which would serve as the ultimate default.

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This national savings plan could be called AutoSave, and if it builds on what we have learned from the field of behavioral finance, it could make the process of savings easy, accessible, and productive. That’s because people save more when the process is automatic and supported by a savings plan structure.

Here’s how it would work. AutoSave would serve as a universal savings plan for all workers. Any employer that makes payroll deductions will be required to make deposits to the AutoSave system on behalf of their employees, while self-employed workers would be able to make deposits into the AutoSave system at their discretion. Employers would shoulder no extra costs but would facilitate automatic deposits. AutoSave would offer a limited set of low-cost investment options, such as index funds, which could be administered by professional money managers. Similar to many 401(k) plans and the government’s own Thrift Savings Plan, these funds can track different sections of the market, such as the S&P 500, and also include a lower risk fund tied to government bonds, as currently offered by the TreasuryDirect program. (This program facilitates the electronic purchase of securities directly from the U.S. government.)

Initially there may be restrictions on where smaller deposits are held, but ultimately, individuals would have a choice about where their money is invested among these options. For those who don’t actively choose, a default setting can be established so savings opportunities are not lost. What is most essential is that money is diverted automatically through payroll deduction into the AutoSave system, without workers having to choose to participate.

Money deposited in this system belongs to the individuals, and since deposits will come from after-tax dollars, normal tax rules apply. An account management system will be created that will be independent of employers and accessible to participants, so they can track deposits and move their money around. Individual can take out their savings whenever they want for any purpose -- as our president might say, it’s their money -- and they will have the flexibility to opt out of the system altogether at any time if they choose. A default contribution rate can be set at 2 percent of pay but can be changed by the employee at any time. At this rate, someone earning $50,000 a year would have $1,000 diverted directly into savings. These funds could be tapped at any time, but AutoSave would be designed to take advantage of one of the most tried and true savings techniques -- inertia.

For the individual, it will be advantageous to have access to a portable savings plan, not tied to the employer. But employers will be able to assist in boosting savings performance if they choose to, by educating their employees about the benefits of savings and how the system works, and by providing additional incentives to save. Since there would be a public benefit from increased savings, especially by workers with lower incomes, the public sector could support targeted incentives. For example, savers with low incomes could be eligible for a match if they keep their money invested for an extended length of time. This innovative approach would reinforce savings behavior and provide additional resources to those who would benefit most from building up their savings.

There are many ways to design this type of savings platform, with various roles filled by the private, non-profit, and public sectors. What is most essential about AutoSave is that it is available to anybody earning a paycheck. Right now, too many of our savings policies leave out large chunks of the population, whether they are those without employers that offer 401(k) plans or those without high enough incomes to take advantage of the associated tax preferences. If saving and asset building policies are to matter to those currently neglected, they must be made inclusive.

This means that policy must be delivered in the form of a savings plan, one offering features that enhance savings behavior and investment performance, such as low-cost administration, outreach and education, diversified investments, and centralized accounting. While individual investors often see their return erode as a result of high administrative costs, savings plans can take advantage of economies of scale and keep these costs down, passing along the savings to their participants. Maybe more importantly, the plan structure has the potential to establish a set of default settings and other practices that maximize returns; these include automatic enrollment, direct deposit and payroll deduction, and linking rising contributions to increases in earnings.

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The promotion of savings should be central to a progressive policy agenda. There’s a reason why saving was once called "virtuous": building assets and making productive investments pay off over a lifetime. Progressives can build on this message and offer tangible benefits to the class of working Americans that don’t receive any benefits from our current savings policies, which are both upside down and backwards.

Previous savings proposals have been developed in the context of retirement security. The AutoSave plan focuses on pre-retirement savings because it is often the investments made earlier in life that best enhance security during the retirement years. For instance, using savings to get an education increases one’s income potential. Similarly, becoming a homeowner and building up home equity can serve as both a forced savings plan and a valuable asset. In this sense, savings and assets serve as bridges connecting different stages of life and provide a path to enhanced retirement security.

Too much attention in savings policy has been given to those in the upper reaches of the income scale, and this clearly has not served the public well. A recent study by Citibank economist Ajay Kapur shows how the very well-off are most likely responsible for the collapsing savings rate. Over time he shows how the greater the share of income in the top 1 percent, the lower the savings rate has been. This finding undermines the claims for extending tax cuts for wealthier households, since they appear inclined to just plow the savings into more consumption.

Given the strains on the federal budget and the imperative to jumpstart a savings campaign, it makes sense to scrap the expensive and ineffective tax subsidies, remove asset tests for the poor, and replace them with a savings plan structure accessible to all. This would ensure that benefits flow to those who actually save rather than just move assets around. The greatest bang-for-the-buck strategy will target those with fewer resources, as evidence shows this is the group that responds more readily to such inducements and are the households that would benefit the most from building up their stock of assets.

But the key point is that everyone will benefit if we not only increase savings in the aggregate but raise the extent to which most Americans save. Many Americans are already maxed out, and others, especially lower-income families, have been victimized by payday loans and other practitioners of predatory lending. Cracking down on these nefarious activities could have additional benefits as well, particularly if it is combined with widespread financial education and access to a support structure that promotes savings. The innovation of AutoSave is the establishment of just such a structure. It would not only provide an inclusive platform open to all working Americans, but would serve as a giant teaching tool, highlighting the best practices for a revived savings nation.