Many have sounded alarms to a looming crisis in retirement savings in America, citing statistics like these:
- The median amount a working-age American family has saved for retirement is only $5,000.
- Nearly half of working-age Americans (45 percent) have no personal retirement savings.
- Americans stow away just 3.8 percent of their disposable income for retirement — a remarkable drop from several decades ago, when the rate was over 10 percent.
Frequently, these issues are approached with a micro perspective on the problem of individuals’ undersaving, and standards are set to encourage the shortsighted grasshopper of the fable to be more like the ant, who gathers provisions in the summer of its working life in order to gain comfort and safety in the winter of retirement. To encourage people to save more, various policies are in place: tax breaks on 401(k) contributions, penalties for early withdrawals from those accounts, a cap on capital gains income taxes, and a maximum level of income ($118,500) on which employees are required to pay into Social Security at the standard rate of 6.2 percent.
Current savings policies, such as tax-deferred savings accounts, were designed to encourage savings, thereby increasing households’ retirement nest eggs and stimulating investment in the economy. But two University of Virginia professors — Daniel Murphy of the UVA Darden School of Business and Andrew Hayashi of the UVA School of Law — argue for a reconsideration of these policies in light of the recent recession. They propose that, during long recessions, these savings policies may fail to meet their objectives (increasing retirement nest eggs and stimulating investment) — and worse — they may even be counterproductive. After all, in normal economic times, “savings” mean investment, as a household may be motivated to obtain a risk-free bond with the promise of future return. But as the interest rate approaches zero, where is the incentive to let go of cash?
The savings policies in place, Murphy and Hayashi contend in their paper “Savings Policy and the Paradox of Thrift,” almost exclusively focus on microeconomic factors and are designed for normal economic times. But that approach is incomplete. It doesn’t account for periods of low interest rates and high unemployment, as the United States experienced in the years following the onset of the Great Recession in December 2007. In fact, the following decade is, in this regard, without precedent in the country’s history — and yet, no one has stopped to rethink saving policy design in light of the macroeconomic picture of such circumstances. Consequently, these policies may have done more collective harm than good.
Adjusting for a Recession
Since December 2015, the Federal Reserve has been gradually raising interest rates, but in the eight years after the Great Recession, interest rates were near zero (0.25 percent and lower), therefore unable to decrease further to encourage investment from companies or individuals. That situation, which economists refer to as the Zero Lower Bound, means other methods of stimulus are necessary to grow the economy. Despite this context, Murphy and Hayashi point out, retirement savings conventions didn’t change much. Amidst a skyrocketing federal deficit, retirement-account-related tax breaks continued to reduce federal revenues, leaving the government fewer resources to stimulate the economy with job-creating investments (e.g., in infrastructure). And so the economy continued to sputter, and the disparity between rich and poor widened as lower-income households fell further and further behind.
From a macro perspective, everyone should be concerned, because everyone — even a wealthy person with a decent-sized nest egg — is affected for good or for ill by the economy as a whole.
It’s a Catch-22: The more people stash away money for retirement during a recession, the less ammunition the economy has to recover — and the cycle continues, leading to less savings later for everyone. At such times, if wealthier people can instead be induced to spend more through policies that reduce the appeal of saving, the results can boost everyone, Murphy and Hayashi argue.
“The private vice of overspending may in fact be a public virtue” during recessions, the professors summarize.
Based on their cost-benefit analysis, Murphy and Hayashi believe that, in a recession, pro-savings policies should in fact be turned upside down — just for a time — to account for the macroeconomic situation. They suggest various adjustments could be made to current saving policy design:
- During recessions, either reduce 401(k) tax deductions to reduce the federal budget deficit and increase revenues that the government can then use to stimulate the economy — e.g., through job-creating infrastructure investments — or eliminate retirement account withdrawal penalties to incentivize individual spending by wealthier people (as contributors to these plans tend to be higher-income households).
- Tie default retirement account contributions to interest rates or unemployment rates, thus reducing the contribution amounts during slower economic times and promoting spending.
- Introduce a more progressive Social Security tax rate structure. An income-adjusted rate would ensure that the lowest-income Americans could save sufficient income to support a baseline level of consumption in retirement. It would also help stabilize consumer spending during recessions: When more people experience low income in a recession, their take-home pay (as a fraction of income) would increase, potentially stimulating spending and helping remove slack in the economy. Conversely, savings rates would automatically increase in economic expansions, reducing pressure on prices and funneling resources towards investment.
- Possibly do away with capital income preferences in the tax system, which may also improve the federal budget and incentivize spending.
To clarify, the authors aren’t suggesting that pro-savings policies be completely eliminated in a recession, or that people (especially those in the lower- and middle-income brackets) cast off all restraint when it comes to consumption. Households should continue to save wisely! But on the whole, fewer and reduced incentives for retirement saving during deep recessions will help temporarily stimulate spending, increase federal revenues, lift up lower-income groups (those hardest hit in a recession) and bolster the economy so it can get back on its feet again. Once interest rates recover and normal conditions return, the policies can revert to status quo.
A possible objection to these recommendations is that wealthier people may not spend more despite the lower incentives to save. The effect of their actions may indeed be muted, but federal revenues would still increase as a result of fewer tax deductions — thus, the federal budget would still be helped. Others may contend that middle-income households (those who could most benefit from a retirement contribution tax deduction) would end up with smaller nest eggs. But these same families would also benefit from the macroeconomic stimulus, and adjustments to the Social Security tax structure would allow them sufficient consumption in retirement, even if it’s not smoothed over their lifecycles.
The bottom line is that, for too long, policymakers have largely ignored a major piece of the retirement-savings puzzle: the macroeconomic perspective. There’s an important, aggregate effect of lower spending and lower interest rates in a recession economy. When that effect is considered, we might just realize — as counterintuitive as it might seem — that a little less saving and more spending could be the best thing for everyone.
Daniel Murphy and Andrew Hayashi co-authored “Savings Policy and the Paradox of Thrift,” forthcoming in the Yale Journal on Regulation.
 “Working age” is defined as 32 to 61 years old. Kathleen Elkins, “Here’s How Much the Average Family Has Saved for Retirement at Every Age,” CNBC, 7 April 2017, http://www.cnbc.com/2017/04/07/how-much-the-average-family-has-saved-for-retirement-at-every-age.html.
 As of 2013; Robin Wigglesworth and Barney Jopson, “U.S. Building Up to Pension Crisis,” Financial Times, 20 September 2016, https://www.ft.com/content/bcd092de-7e81-11e6-bc52-0c7211ef3198
 “Another Penny Saved: The Economic Benefits of Higher US Household Saving,” Oxford Economics, https://www.asppa.org/Portals/2/PDFs/White%20Papers/Another%20penny%20saved_FINAL.pdf.