Friday, February 15, 2013

U.S., Denmark Are Not a Good Retirement Saving Comparison

At a time when the U.S. retirement savings structure is a potential target for generating new tax revenues to balance the federal budget, the last thing  the industry needs is high-profile, big-name research that undercuts its value.  That is just what seems to have happened, with the release of a study authored by Raj Chetty and John Friedman of Harvard University, and several Danish counterparts.  Their study evaluated the effects of recent Danish tax changes that reduced retirement saving incentives for some workers.
Chetty and his fellow researchers drew the following conclusions. 

1.       The vast majority of workers are “passive savers,” meaning they do not respond to tax incentives.    

2.       Those who do respond to retirement tax incentives (the study determined it to be 15 percent) would still save without incentives, just in a different kind of savings vehicle.

3.       The net result is that for every dollar’s worth of tax incentives or subsidies provided to workers, total savings increased by only one (1) cent;

To their credit, Chetty and his fellows did also conclude that automatic contribution arrangements were likely to be the best answer to increasing U.S. savings rates, essentially forcing saving behavior on those who are unlikely to act on their own.
Before pointing out some very important differences between the Danish tax and social environments and those of the U.S., it is worth noting that this study has already been seized upon by some as a pat answer to the question of whether incentives increase real saving, or are worth the cost.  Perhaps worse, some are repeating the same inaccurate characterizations of the tax treatment of U.S. retirement saving.

For example, Boston College economist, professor and retirement researcher Alicia Munnell was quoted in her Encore blog, printed in the February 8th Wall Street Journal Market Watch, as saying that “The federal government provides generous tax subsidies for retirement saving.  These subsidies cost the Treasury more than $100 billion annually in foregone tax revenues.”

It is one thing to question how effective the current system of employer tax deductions and employee tax deferral is in increasing saving.  It is quite another to say that their cost is $100 billion annually, and that the Treasury forgoes these revenues.  The impression left by such statements is that these are truly lost revenues.  This is hardly the case.  Using data from the IRS Statistics of Income compilations, in 2010 alone (the latest year available), some $753 billion—that’s with a “b”—in retirement assets were distributed from employer plans and IRAs and included in taxable income.  So, in most cases, taxation is delayed until a future date, not lost.  Delayed use is the whole point of retirement saving!
Those entrusted with making our laws and shaping and guiding our economy and social policy should be made aware, and take the time to inform themselves, that most amounts saved for retirement on a tax-advantaged basis do eventually generate taxes, and do not result in a permanent tax loss.  It is a peculiarity of the federal legislative scoring and budgeting process that revenue credits and debits are usually calculated over a very limited five-year window.  I believe this is an unrealistic snapshot of the net effect of retirement saving incentives on the federal budget.  But it has led far too many people to conclude—or to propose policy—on the premise that deferred taxation equals lost taxation.

The Employee Benefit Research Institute (EBRI), a well-respected industry analytics group, thoughtfully questioned the Harvard study’s conclusions about the importance of tax incentives in Denmark versus the U.S.  Here are just two EBRI observations.
Non-governmental retirement plans in Denmark are primarily established by worker unions, not by individual employers, as is the case in the U.S.  A reduction in tax incentives is unlikely to prompt widespread plan termination there, whereas American employers have repeatedly declared that meaningful tax incentives are central to their continuing to sponsor retirement plans.  Without a meaningful business tax deduction, and the opportunity for business owners themselves to save substantially in a tax-advantaged fashion, many employers are likely to conclude that the effort, expense and potential liability are not worth the trouble.  If this happens, few should doubt that a much smaller number of U.S. workers will be financially prepared for retirement.

EBRI indicated that a large and growing share of accumulated U.S. retirement assets will be spent on health care, whether it is in insurance premiums, co-pays, or out-of-pocket expenditures.  It is estimated that a 65-year-old U.S. couple retiring today will need roughly a quarter of a million dollars for health-related expenses over typical life expectancies.  This is over and above their living expenses, and that RV they envision purchasing to travel and enjoy their supposedly golden years.  As EBRI points out in its analysis of the Harvard study, Danish citizens have taxpayer-funded universal health care, so this potentially huge additional retirement expenditure is absent there.  The absence of this cost would seem to lead to a lesser sense of urgency when it comes to retirement savings.  As such, we believe that comparing the experience in that environment to the US is a comparison of apples to oranges.
Ms. Munnell and others are correct in suggesting that workers’ lack of responsiveness to saving opportunities argues for greater use of automatic enrollment in retirement plans, as well as automatic increases over time.  But without employer tax incentives to establish and maintain plans in the first place, the best guess is that there would simply be fewer plans in which to auto-enroll or to auto-escalate, and fewer employees prepared for retirement.