The California Secure Choice Retirement Savings Program: Why pension reform turns inefficiently to the statesPosted: December 5, 2016
This post originally appeared on TaxVox.
By: C. Eugene Steuerle and Pamela Perun
Starting as soon as it can be made operational, perhaps in 2018, as many as 7 million private-sector California workers who currently have no access to a job-based retirement plan will be automatically enrolled in a state-managed savings program. The California Secure Choice Retirement Savings program will start with employee contributions of 3 percent of earnings, though the state board managing the initiative could increase the contribution rate to as much as 8 percent. While workers will be auto-enrolled, they can opt out of the plan.
The new law is an important step toward securing better retirement coverage for those who require it most. Too many people reach old age with far too little saving to meet their long-term needs.
While an interesting idea ,the plan, however, faces limits that would be better served through federal reform. For instance, companies that operate across state borders don’t want to be bogged down with 50 different sets of state regulations. In addition, federal law currently grants employee deposits fewer tax breaks than are enjoyed by employer contributions. Only federal law changes can deal with those challenges.
However, changes to federal law that reduce tax revenues may be blocked by the constraints of the federal budget process.
Here’s the rub. At the federal level, any pension reform that might succeed in securing significantly more retirement saving will be scored as losing revenue to the federal government. Big revenues. And no major tax reform or tax cut in recent years, as well as President-elect Donald Trump’s campaign tax plan, has made pension reform a priority.
Suppose, for instance, that a national reform increases net contributions to traditional retirement plans by $80 billion, or one percent of the $8 trillion of wages and salaries that workers earned in 2016. If those savers reduce their tax on new deposits by 15 percent, revenues would decline by $12 billion in the first year and by more than $100 billion over a decade, even after accounting for taxable withdrawals.
Even if we see big new tax cuts in a Donald Trump presidency, that’s a lot of money. However, state legislators do not face the same budget process constraints as federal lawmakers. They are indifferent to the effects of state law on federal revenues, and the impact of a big tax-advantaged savings plan on state revenues are relatively modest given lower state income tax rates. Hence, for now, all incentives point toward the states acting independently, inconsistently, and inefficiently in tackling our nation’s larger retirement security problems.
There are alternatives. We have proposed an alternative strategy through a federal plan that would greatly simplify current law while broadly encouraging both employer and employee contributions.
Of course, it makes some sense to let states operate as laboratories of democracy. However, the more successful this California effort and similar ones being considered in Illinois, Oregon, and Connecticut, the greater the need for the type of coordination that only the federal government can provide. Until we get our federal budget into some sort of order, however, federal reform likely will continue to be stifled. Catch 22, once again.
Photo courtesy of Randy Bayne/via Flickr Creative Commons.
This post originally appeared on TaxVox.
I have never believed that candidates should lay out detailed policy agendas in their campaigns. While broad outlines are helpful, the specifics are too complex for the stump and often unappealing to voters. So to move beyond campaign promises that seldom add up for any candidate, here is how President-elect Trump could move forward in six policy areas even while facing extraordinary budget constraints. Each issue has a framing that gives it a better chance of garnering bipartisan support.
Workers. Many workers made it clear in this election that they feel forgotten by government. While the left and right disagree over how well our government promotes opportunity for workers, they generally agree it could do better. Trump tapped into workers’ frustrations but hasn’t yet identified how to significantly help them. How about this as a start? Simply ask agencies to assess the extent to which their programs could better promote work, even when that is not their primary mission. This applies to a wide range of programs, from wage, housing, health, and food supports to how well the military helps veterans get a job.
Budget Reform. Even if some adviser tells the President-elect that there is magic money to be had through extraordinary economic growth, tackling budget shortfalls will soon become unavoidable. Never before have so many promises been made for the future, both for unsustainable rates of spending growth and lower taxes. Indeed, all future revenue growth and then some have already been committed for health, retirement, and the interest costs alone. Engaging in more giveaways only exacerbates this problem. One way to cut the Gordian knot and convince the public to buy into longer-run budget goals is to show how interest savings generated by long-run fiscal prudence eventually allows both more program spending and lower taxes than do big deficits.
International Tax Reform. If the US is going to collect tax revenue from US-based multinationals, it will need to get a handle on this issue. It makes no sense administratively to tax these firms based on the geographical location of headquarters, researchers, patents, borrowing, or salespeople. The solution involves taxing corporations less but individual shareholders more, while still engaging corporations to withhold those taxes. Any reform must limit the firms’ ability to shift income and deductions to the most tax-advantageous locations.
Individual Tax Reform. Trump could accomplish some individual tax reform by focusing less on reducing the existing $1 trillion-plus level of tax subsidies and more on limiting their automatically-increasing growth rates. He could use the revenue to either reform the tax code or better target the subsidies. For example, he could redesign housing-related tax preferences so they truly promote homeownership.
Health Reform. Conservative and progressive health experts agree that the Affordable Care Act suffers from at least two problems: It did not sufficiently tackle the issue of rising medical costs, and many people remain uninsured. Trump could generate more bipartisan support if he aims to reform the system to cover more people while generating enough cost saving to make that goal attainable in a fiscally sustainable way.
Retirement and Social Security. President-elect Trump promised to not cut Social Security benefits while Secretary Clinton said she would raise them. But raised or cut relative to what? An average-income millennial couple is scheduled to receive about $2 million in Social Security and Medicare benefits versus $1 million for a typical couple retiring today. Younger people, who often expect no Social Security benefits, seem willing to accept changes that would slow the program’s rate of growth. That’s an opening for Trump to sell the reform as a long-term effort that opens up the budget to some of their needs, such as reducing student debt, while still protecting the current elderly. For many elderly, benefits can even be enhanced through private pension reform to increase individual retirement savings and enhancing Social Security benefits for low-income retirees.
Paraphrasing Herb Stein, who was President Nixon’s chief economic adviser, “what can’t continue won’t.” And that’s true with the nation’s unsustainable fiscal path. Eventually, we will need to take the types of steps that I’ve outlined. With some creative thinking about how to newly frame important issues, President Trump could advance some real possibilities of reform despite a season of ugly campaigning.
Photo courtesy of Gage Skidmore/via Flickr Creative Commons.
By: Joseph Rosenberg, C. Eugene Steuerle, Chenxi Lu, and Philip Stallworth. This post originally appeared on TaxVox.
Both Hillary Clinton and Donald Trump have proposed income* tax changes that would result in less charitable giving. While the effects are indirect, the Tax Policy Center estimates that Trump’s plan would reduce individual giving by 4.5 percent to 9 percent, or between $13.5 billion and $26.1 billion in 2017, while Clinton’s plan would reduce giving by between 2 percent and 4 percent, or $6 billion to $11.7 billion.
The actual reduction in charitable gifts would depend mainly upon how responsive givers would be to smaller tax incentives. However, higher-income taxpayers would be affected the most. Lower-income households would not likely reduce giving since most do not itemize deductions today and would not under either the Trump or Clinton plans.
Figure 1 summarizes the increase in the cost (reduction in incentive) of giving under the two plans. The Clinton plan only affects the cost of giving for those in the top 5 percent, while Trump’s plan raises the cost of giving for those at all income levels.
Start with Trump, who would reduce the tax benefits of charitable giving in three ways:
First, by reducing marginal tax rates he’d increase the after-tax cost of charitable giving. If you give away $100, you don’t pay tax on that $100 of income, so the after-tax cost of the donation for someone in today’s 39.6 percent top tax bracket is only about $60—the $100 gift minus $39.60 in tax savings. But by reducing the top rate to 33 percent, Trump would raise the after-tax cost of that $100 gift to $67.
Second, by raising the standard deduction to $15,000 ($30,000 for couples), Trump would sharply reduce the number of taxpayers who itemize. People who stop itemizing can no longer deduct their charitable contributions and thus lose the tax break. In 2017, 27 million of the 45 million who now itemize would opt for the standard deduction, a decline of 60 percent.
Finally, Trump would cap itemized deductions at $100,000 for singles and $200,000 for joint filers. IRS data indicate that in 2014 taxpayers with over $1 million in adjusted gross income (AGI) deducted an average of $165,000 for charitable contributions and another $260,000 for state and local taxes. Since the state and local tax deduction alone would exceed Trump’s proposed cap on itemized deduction, many high-income taxpayers would lose their tax incentive to give to charity.
While all these changes might discourage charitable giving, Trump’s generous tax cuts would also leave taxpayers more money to give to charity. This would particularly be true for very high income households: In 2017, tax cuts for people in the top 1 percent would average more than $200,000.
Clinton’s plan would do little to change the giving incentives of taxpayers for the bottom 95 percent of the income distribution. She’d slightly increase incentives for low- and middle-income taxpayers to give to charity by boosting their after-tax incomes.
In contrast to Trump, Clinton would significantly raise taxes on high-income households. She’d impose a 4 percent surcharge on adjusted gross income (AGI) in excess of $5 million, increase capital gains rates based on holding periods, create a minimum tax of 30 percent of AGI phasing in between $1 and $2 million of incomes, and put a 28 percent limit on the value of tax benefits from deductions other than the charitable deduction. On net these not only decrease after-tax incomes, but also lead some current itemizers to take the standard deduction and thereby lose the charitable deduction. The proposal with the largest effective on giving incentives is the 30 percent minimum tax (i.e., the “Buffett Rule”), which would reduce the incentive for affected taxpayers.
Overall both candidates would reduce the tax incentives for giving to charity, probably not what either really intended.
*This analysis only includes changes in the federal income tax. Both Clinton and Trump have also proposed significant changes to the estate tax that would impact incentives to donate to charity and leave charitable bequests. Clinton’s proposal to lower the estate tax threshold and increase estate tax rates would increase giving incentives, while Trump’s proposal to eliminate the estate tax would reduce them.
This post originally appeared on TaxVox.
In this year’s presidential campaign, Hillary Clinton’s proposal to double the child tax credit and Donald Trump’s plan replace the dependent exemption with a higher standard deduction have both helped focus attention on tax treatment of families.
Interestingly, both progressives and conservatives oppose extending preferences to children in middle and higher income families. Progressives prefer to “spend” the money on those with less income, and conservatives, especially supply-siders, believe the funds would be better used to reduce marginal tax rates.
But they confuse the two purposes of providing benefits to children. The first is a classic social welfare argument that revolves around spending to subsidize one thing (in this case, the needs of children) at the cost of higher taxes or lower subsidies for another. This is especially powerful when the benefit goes to those with the greatest needs: Concentrating a greater share of spending on lower-income people results in the greatest reduction in poverty.
But there is second goal of adjusting tax burdens for children—and it is based on a tradition that goes back at least to Aristotle: to treat equals equally under the law. Economists call it horizontal equity, but I prefer the term “equal justice.” In the tax system, this means taxing equally those with an equal ability to pay. And it should apply among all households, rich and poor alike.
This is especially important when you think about households with and without children. In almost all transfer and tax systems, benefits are adjusted for household size. For instance, the federal poverty level is about $12,000 for a one-person household and about $4,000 higher for each additional person, or about $24,000 for a four-person household. To put it another way, the guideline suggests that a $24,000 four-person family can live at the same poverty level of consumption as a $12,000 single person.
In the past, the tax system used the dependent exemption to provide equivalence for families with children. But the exemption waned in importance as per capita income rose much faster than the exemption, which for a long time was not indexed and even now is indexed only for inflation. As a result, the relative burden on households with children rose. After I revealed this in the early 1980s, President Reagan supported an increase the exemption. To believe that the current exemption of about $4,000 is the right number, one would have to believe that a couple with no children and $52,000 of income lived an equivalent lifestyle as one with $60,000 of income and two children.
More recently, Congress and presidents Bill Clinton and George W. Bush expanded the child credit in lieu of increasing the dependent exemption. That the credit has been made partially refundable and extends fairly high up the income scale implies that those expansions served both goals of spending on those in need and establishing tax parity among families of different sizes. The current exemption of about $4,000 is worth $1,000 to a family that pays a marginal tax rate of 25 percent, so the current credit of $1,000 plus the exemption grants that family about $2,000 per child in total benefits.
Whatever the right balance between the social welfare and equal justice approaches, most voters judge government on whether they think they are being treated fairly. But if children are both expensive to support and reduce a household’s ability to pay taxes, and if a welfare system separately provides supports for households with low incomes, then shouldn’t adjustment for children put explicitly in the tax system apply to most or all households? It is an interesting and important question and one for which at least politics has led elected officials to answer, “Yes.”
Photo courtesy of Ken Teegardin/via Flickr Creative Commons.
This post originally appeared on TaxVox.
The individual income tax has never taxed the very wealthy much. Donald Trump may have claimed huge losses starting in the early 1990s, but, like other rich investors, he wouldn’t have paid much tax regardless. Despite paying some tax, Warren Buffett’s release of his 2015 tax return affirms that conclusion.
There are two major reasons: first, paying individual income taxes on capital income is largely discretionary, since investors don’t pay tax on their gains until they sell an asset. Second, taxpayers can easily leverage capital gains and other tax preferences by borrowing, deducting expenses, and taking losses at higher ordinary rates while their income is taxed at lower rates. Such tax arbitrage is, in part, what Trump did.
To be fair, some, like Buffett, live modestly relative to their means and still contribute most of what they earn to society through charity. Some pay hefty property and estate taxes and bear high regulatory burdens. And salaried professionals and others with high incomes from work, whether wealthy or not, may pay fairly high tax rates on their labor income. Still, there are many ways for the wealthy to avoid reporting high net income produced by their wealth.
The phenomenon is not new. In studies over 30 years ago, I concluded that only about one-third of net income from wealth or capital was reported on individual tax returns. Taxpayers are much more likely to report (and deduct) their expenses than their positive income. In related studies, I and others found that rich taxpayers reported 3 percent or less of their wealth as taxable income each year.
But your favorite billionaire did not get that way by earning low single-digit returns to his wealth. Buffett’s 2015 adjusted gross income (of $11.6 million) would be around one-fiftieth of 1 percent of his wealth, which in recent years has been estimated to be near to $65 billion. Yet, over the past 5 complete calendar years, Buffett’s main investment, Berkshire Hathaway, has returned an average of over 10 percent annually.
The wealthy effectively avoid paying taxes on those high returns either by never selling assets and thus never recognizing capital gains, deferring income long enough that the effective tax rate is much lower, or by timing asset sales so they offset losses, as Trump likely has been doing to use up his losses from 1995.
When you die, the accrued but unrealized gains generated over your lifetime are passed to your heirs completely untaxed, though estate tax can be paid by those who, unlike Buffett, don’t give most away to charity.
“Tax arbitrage,” the second technique, is simple in concept though complex in practice. It allows an investor to leverage special tax subsidies just as she’d arbitrage up any investment—in this case, to yield multiple tax breaks. If you buy a $10 million building with $1 million of your own money and borrow the other $9 million, you’d get 10 times the tax breaks of a person who puts up $1 million but, because she doesn’t borrow, buys only a $1 million building.
The law limits the extent to which most people can use deductions and losses from one investment to offset income from other efforts, but “active” investors are exempt from most of those restrictions. In real estate it is quite common for the active individual or partner to use the interest, depreciation, and other expenses from a new investment to generate net negative taxable income to offset positive income generated by other, often older, investments.
The main trick is simply to let enough income from all the investments accrue as capital gains. For example, take a set of properties that generate $1 million in rents and $500,000 in unrealized appreciation. If expenses are $1,200,000, net economic income would be $300,000 ($1,000,000 plus $500,000 minus $1,200,000); but net taxable income would be a negative $200,000 ($1,000,000 minus $1,200,000) since the unrealized appreciation is not taxable income.
Real estate owners enjoy other tax benefits as well. They can sell a property without declaring the capital gain by swapping the asset for another piece of real estate—a practice known as a “like-kind” exchange. Often, when a property changes hands it ends up being depreciated more than once.
At the end of the day, tweaks to the individual income tax system, including higher tax rates, are unlikely to increase dramatically the taxes paid by the very wealthy. Instead, policymakers need to think more broadly about how estate, property, corporate, and individual income taxes fit together and how to reduce the use of tax arbitrage to game the system.
Photo courtesy of Stuart Isett/via Flickr Creative Commons.
A version of this post originally appeared on The Washington Post.
+What should the next president do to make Social Security more sustainable?
No one should assess Social Security policy in isolation. What is fair in Social Security must relate to what is fair for the national budget as a whole.
Congressional Budget Office projections indicate that by 2026 we’ll be 21 percent richer, and that tax revenues will rise at a slightly higher rate. That means we stand before an ocean of opportunity. But of the expected $850 billion in additional real revenues, about 150 percent (or about $1.3 trillion) is committed entirely to increasingly expensive payments to Social Security, health care and interest on the debt. And as a result of these commitments, almost anything that represents investment — in our children, infrastructure or the basic functions of government — takes it on the chin.
Even as revenues grow, the number of workers available to pay for Social Security benefits is falling rapidly, meaning that either benefits must be cut, taxes increased, or both. Every delay puts more of the cost on the young.
Social Security maintains a design built around an economy and family structure of the past. People aged 65 now live about six years longer and retire even earlier than they did in 1940 when the system first paid benefits. That means families like Clinton’s, Trump’s and mine will be getting hundreds of thousands of dollars more in lifetime benefits than they would have when the system was first created, while many future elderly will still be left in poverty.
So what must be done? Slow down and reorient the growth in benefits scheduled for future retirees. A typical couple retiring today gets more than $1 million in lifetime Social Security and Medicare benefits; millennials are unrealistically scheduled to get $2 million. That growth can be slowed without being stopped and shifted more toward those who are truly old with low- to moderate-incomes. While Social Security’s long-recognized shortfalls inevitably mean someone must pay, those with above-median incomes are the ones with the money.
Still, no Social Security benefits need to be cut for those currently retired. To do better for those elderly with median or lower lifetime incomes, we should raise minimum benefits and give credit for raising children. We should also fix absurd rules around spousal and survivor benefits and other sources of inequity.
The current system discourages work in late-middle age, something that is no longer easily affordable and which reduces economic growth, personal income and tax revenues. Congress should reduce Social Security’s natural disincentives for work both by adjusting the retirement age as we live longer and saving a larger share of lifetime benefits for later ages, when health needs rise and work is less possible. As lifespan increases, Social Security now promises a typical newly retired couple aged 62 an average of more than 28 years of benefits (today, one of them is likely to make it to 90 years of age). That’s more than enough; there are greater societal needs than the desire for more retirement years.
Finally, the tax issue. While some broadening of the Social Security tax base is possible, government needs to concentrate on raising revenue for high priorities apart from Social Security: our growing national debt, and vital investments such as education, infrastructure and support for working families. Campaigns are about giveaways, but true reform requires looking at what must be done and how, whether we want to or not.
Photo courtesy of The Social Security Administration, Public Domain.
The 2016 presidential election has made student debt a national issue. Two just-released books, one by Sandy Baum and one by Beth Akers and Matt Chingos, have done a great job of identifying the real problems with student debt, while debunking much of the rhetoric that tends to identify wrong problems and come up with wrong solutions. I highly recommend the books, though I am hardly unbiased since Matt and Sandy are colleagues of mine.
By focusing on the real risks associated with the current system, the authors emphasize that we must pay attention to who acquires the debt and who benefits from it. For instance, future doctors and lawyers with high returns to postgraduate education acquire some of the highest levels of student debt. Akers and Chingos emphasize that over 40 percent of student debt is held by those in the top 20 percent of the income stratum. Thus, simply eliminating student debt would help the highest income borrowers most.
Sandy Baum focuses on designing proposals that would prevent so many at-risk students from borrowing for programs unlikely to serve them well. She especially discredits proposals that provide the most assistance to those who are actually in the best position to repay their loans. One example of how all this plays out was shown earlier by some other colleagues: blacks as a group, who are less likely to come out of college with a degree, end up with higher average student debt than whites.
Here I wish to address a more macro question: whether this shift toward higher student debt represents just one more way that government has disinvested in the economy. As students accumulated $1.3 trillion in debt, did government make an equivalent increase in investment in what economists often call “human capital”? Or did government simply shift additional burdens onto these students with few or no significant gains in educational achievement nationwide? Or something in between?
When we look at budgets as a whole, both federal and state, it’s quite clear how resources are being shifted. Average tax rates are about where they have been, maybe a touch higher. Taxpayers may have gotten a break for a while as rates went down a bit and then back up a bit, but that’s not the main story. Both federal and state budgets have adopted huge spending increases for retirement and health care. States have also put a lot more into prisons, while the feds have put much more toward interest costs, though offered a reprieve—if one can call it that—by a weak worldwide economy that has led to low interest rates.
Clearly, a smaller share of revenues and incomes goes for education—not just higher education, but primary and secondary education as well. Almost anything that might qualify as investment, such as infrastructure, has also seen a downturn.
Taking the budget as a whole, therefore, it’s hard to avoid the conclusion that the net effect of federal and state policies, of which student loans become merely one example, has been a disinvestment in the economy as a whole.
This raises an additional issue for those assessing programs by comparing benefits to costs. In the case of student loans, if more borrowing on average increases human capital by more than the value of the loans, we would say it was worthwhile for individuals to take out those loans. Correspondingly, if we were replacing a system with less education and no loans with one that on net created more assets than debt, we would likely conclude that the shift was worthwhile societally, not just individually. However, starting from a society that had financed education more directly, the student loan policy may be a failure.
Put another way, the starting point matters. In this arena and others we usually want government to increase net investment, as well as improving the allocation of funds so as to garner the highest returns on the investment, and we need to figure out the effect across the entire balance sheet of assets and liabilities. The individual perspective compares the personal increase in assets with the personal increase in borrowing and asks whether enough people come out ahead that society is better off. But if the additional loans don’t finance an increase in education societally, whether because some students don’t attain degrees or others don’t acquire any more education than they would have undertaken anyway, then we must ask what we got for our money.
If this debt policy additionally discourages risk taking and marriage after education, then all this debt may even reduce investment over time in education, businesses, and homes combined. Unfortunately, I think this has been the most likely outcome of recent policy. Even the creative reforms that Baum, Akers, and Chingos recommend won’t restore those past losses, though they may help minimize them in the future.
Whatever your take on this issue, this presidential campaign makes clear that higher education reform very likely will be on the national agenda in the next year or two. The Baum and Akers-Chingos studies should be required reading for anyone undertaking that reform.
Photo courtesy of Andrew Bossi-Flickr.
How do people build wealth? How do low-wealth families climb the economic ladder? It’s simple. They save. They get decent or even above-average returns on their savings. And they reinvest those returns over time. Unless policymakers and advocates face up to these simple propositions, policy efforts to reduce wealth inequality will go for naught.
Over many years I have had the privilege of working with groups concerned with wealth inequality and promoting asset growth. One of them, the Corporation for Enterprise Development, has been holding its biennial Assets Learning Conference, engaging over one thousand professionals. I cofounded and work with the Urban Institute’s Opportunity and Ownership initiative, which researches wealth inequality. Because of their concern for the well-being of low-income, low-wealth households, these engaged individuals often try to figure out ways that government can simultaneously support and protect more vulnerable populations. One consequence, though, is a hope and sometimes belief that asset-building policies can increase wealth without reducing consumption and can generate higher returns without requiring risk taking.
But saving by definition means forgoing consumption. Even if government provides the money, it forces individuals to save rather than immediately spend that money.
This fact creates a controversy among progressive advocates. A dollar spent on wealth building means a dollar not spent on food, health care, or other transfers for immediate needs.
Finance 101 further teaches that higher returns on saving come from investment in riskier assets. The expected return on stock is higher than the return on bonds, and the expected return on bonds is higher than the return on savings accounts and Treasury bills. Over several decades the after-inflation investment return on corporate stock has averaged close to 6 percent, whereas the return on five-year government bonds sits at around 2 percent. The expected return on many saving and checking accounts is close to zero. Compounded over time, average stock market investors will see their money multiply about eight times after 36 years; average medium-term bond investors will see theirs double. Savers using only checking and saving accounts, meanwhile, will see little if any growth.
Over short periods, however, stocks have the highest risk of the assets just mentioned, while savings accounts have the least. Over very long periods, the risks reverse. Investing in the stock market is like flipping a coin bent enough that betting on heads on average nets a good return, but there’s a high probability of a loss with a few flips. As the number of flips increase, the odds of having more heads than tails get better and better. John Bogle, founder of Vanguard, said it like this: “The data make clear that, if risk is the chance of failing to earn a real return over the long term, bonds have carried a higher risk than stock.”
It’s possible to buy stock and insure against losses relative to, say, a short-term bond. But the insurance will cost the difference in returns plus additional transactions costs. Thus, attempts to provide low- and moderate-wealth households both higher returns and low risk tend to fail.
Just look at the household assets reported on wealth surveys. Wealthy households hold the vast majority of their wealth in stock and small business assets and real estate either directly or through retirement accounts. They make much of their money not just by saving more initially, but by allowing the saving on higher-return assets to compound. Low-wealth households, meanwhile, own few or no high-return assets, tend to hold more debt relative to their incomes, and often pay higher interest on that debt.
Timing matters, too, especially when it comes to large, infrequent purchases like buying a home. Mortgages became widely available to lower-income households in the early 2000s, when home prices were at a peak, but less available after the Great Recession, when prices were lower and owners were getting capital gains in many regions. As Bob Lerman, Sisi Zhang, and I have pointed out, this created a “buy-high, sell-low” mortgage policy that devastates low-wealth households, including the young.
The policy implications are clear. Simply taxing the rich more or distributing more to low-wealth households will do little to narrow wealth inequality. Transfer programs rarely encourage wealth-holding and may even exacerbate private wealth inequality by imposing asset tests and by favoring renting over homeownership.
None of this means that the rich shouldn’t pay higher taxes or that transfer programs don’t protect vulnerable families or even provide a type of “asset” in the form of income and risk protection. That’s another subject. The subject here is the distribution of private wealth and the power it brings.
Advocates and lawmakers trying to counter wealth inequality, therefore, must find ways to get low-wealth savers into longer-term assets like stock and real estate, mainly through retirement plans and homeownership. Small business ownership also matters. And, subsidies provided by government must encourage long holding periods—that is, saving over time, not short-term deposits. Deposits followed quickly by withdrawals or loans don’t increase saving. Nor do proposals that subsidize borrowing encourage homeownership, since, by encouraging more borrowing, they often reduce net home equity.
Of course, many low-wealth households are not ideal investors in riskier assets. But there are risks and there are risks. Remember that Social Security and Medicare—and, to some extent, traditional pension plans—already require nonelderly adults, whatever their other needs, to “save” some income today to prevent inadequate income in old age.
Successful investment requires forgoing consumption, taking risks, and adopting a long-term view. Those attempting to address wealth inequality must either recognize these fundamental facts—and the related costs involved—or fail in their mission.
Photo by 401(K) 2012 via Flickr Creative Commons.