Friday, July 25, 2008

You're not good enough, not smart enough, to save for your retirement 

Visiting St. Cloud yesterday to promote his "Kitchen Table Tax Plan", Al Franken had a bit of trouble explaining his plan to end IRAs and replace them with a 401(u) plan.

The retirement plan would be funded by eliminating an existing income tax deduction for Individual Retirement Accounts for people who participate in the new program, which would be voluntary, Franken said.

�Tax deductions help people who make the most money, but they don�t help those who don�t make enough to pay income taxes to begin with,� he said. �I think Social Security will still be around years from now if we don�t privatize it, but we need something else to help people save for their retirement.�

Pressed to explain how a voluntary system could raise enough money to pay the subsidy if those with higher incomes who benefit more from existing deductions don�t switch, Franken referred people to his campaign Web site and said �it�s a wash.�

Well, OK, we went to his web page about his 401(u).
What would it cost?
The shift from tax deductions to matching contributions is close to revenue-neutral.
That's the entire entry for "What would it cost?" Oh, that's MUCH clearer now.

The 401(u) isn't a new concept. It's the "automatic in, opt out" plan that Obama has been pushing. It requires employers to take a portion of a worker's check and put it into a plan, where it receives a 30% match from government (in the Franken plan), if the company doesn't have a retirement plan for employees (and has more than 10 employees.) This relies heavily on the idea from behavioral economics that people do not often enough choose to save. If this is true, why does the Franken plan allow families to"shape their account to fit their unique needs"? If they aren't smart enough to opt in, how are they supposed to do that? The funds would at the outset be placed in "responsibly in low-cost, diverse portfolios." Who chooses those?

Mark Thoma wrote about such plans (when a Republican supported them for Social Security):
In general, I hate opt-out programs. I don�t want to spend my time filling out forms and checking boxes telling people all the things I don�t want to buy. If I�m convinced there is market failure in the market for bicycles resulting in too few being purchased, is the proper solution to drop bicycles in people�s yards unless they remember to send in the proper paperwork? I remember being in music clubs like that when I was younger� Maybe a better answer is to work a little harder on the incentives and ease of opting-in.

Last, I worry we have forgotten the Lucas critique yet again. Change the rules and change the behavior. I can imagine that if you impose opt-out now when it is uncommon participation might be high. But as it becomes more common and institutionalized people will more easily opt-out. In addition, it also seems participation rates will fall in the long-run as people hit financial stress points. If you can opt-out at will, then the first time a family faces financial distress, they will likely opt-out. Unless they are somehow brought back into the program later, participation rates will fall as time passes and revenues may not meet projected values.

I agree with Thoma, though see Beshears et al [2006] for a more positive report. Someone pointed out to me as well that one of Franken's justifications for this bill is that the tax deductibility of the 401k isn't a value to about half the workers in America, because they don't pay any or too few taxes. How ironic that it would be Franken to point out one of the effects of the Bush tax cuts!

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