Rebuilding Family Balance Sheets, Rebuilding the Economy: Five Ideas for Rebuilding Balance Sheets

May 22, 2013

Ray Boshara describes two main public policies that determine the ownership of wealth in the U.S.: income maintenance (or the "getting by") policies and economic mobility (or the "getting ahead") policies. Income maintenance policies, which represent $1.3 trillion, or 10 percent of GDP, generate zero-to-negative wealth-building incentives. On the other hand, economic mobility policies, which represent $746 billion, or 5.7 percent of GDP, offer $547 billion worth of tax incentives for homes, retirement, investments and education. The challenge: How can the U.S. re-orient income maintenance policies toward asset building and economic mobility, and how can it re-target economic mobility policies to benefit lower- to middle-income families? Boshara concludes with five ideas to help rebuild family balance sheets.

Presentation (PDF)


Ray Boshara: So that's just a sample of the ways in which balance sheets matter for helping families move forward. We're going to turn now to some ideas for helping to rebuild balance sheets, as Bill said, figure out how to get out of this mess. So let me mention a few things. The first thing to understand is that if you look at public policy in the United States, we really have two very distinct policies.

The first is that—you know, it's important to understand that policy, public policy, plays a very significant role in determining who does well in this country, whether they move up or whether they stay the same. The two policies are what I call income maintenance or the "getting by" policies and economic mobility, which is the "getting ahead."

On income maintenance, we spend $1.3 trillion a year to help families get by. These are social insurance programs like welfare and food stamps, which are critically important, making sure families don't fall through the bottom. But they are geared to just help people get by. They have no wealth incentives, or they actually penalize people who try to save and build assets while they're on welfare. And the real challenge, I think, with those policies is to reorient them towards assets and mobility.

The other policy we have is economic mobility, what I call the "getting ahead" policies. Here we don't spend quite as much, about $550 billion less per year, $746 billion per year, of which about 3/4 of that are tax breaks, tax breaks in the form of mortgage interest deductions, a tax break for saving in IRAs and 401(k)s, preferential treatment of capital gains, tax breaks for saving for college.

You know, if you bundle all these policies together, all these tax breaks, they come to about $550 billion per year. That's fine. These policies have helped a lot of people build more wealth than they would have. The problem is that they are primarily helping people who would build wealth anyway. From a public policy perspective, these are not very efficient policies. You don't want to subsidize an economic activity that would occur absent the subsidy. And that's essentially what we're doing. And the problem with tax policies generally is that they don't reach people who don't pay a lot of income taxes.

So, you know, and I think the challenge with that policy is that you have to retarget some of those incentives to better reach the bottom half of the population. We're not trying to get rid of these policies. I think our purpose here is to say, if we have policies to help Americans save and build wealth and have healthy balance sheets, let's see if there's a way to make those policies work for the whole population, not just for the upper half. So that's really the objective here.

So that's kind of the big picture on how social policy divides up its incentives—get by or get ahead—with the vast majority of the wealth incentives helping people who are better off. By one study, 90 percent of the benefits, the tax benefits to save and build wealth, go to families making more than $50,000 a year. And the higher your income, the higher the benefit.

So it's not surprising when you have a policy like that that is rewarding wealth accumulation for people who already make a lot of money that the distribution of wealth is far more concentrated than the distribution of income. If you look at some of these numbers here, you can see that the top 1 percent has about 17 percent of the nation's income, but about 30 percent of the nation's wealth.

If you add the purple and the green together on both charts, the top 10 percent has about—I'd say about four out of every $10 in income, but in terms of wealth, they have about two out of every $3 of wealth. And, as Bill said, some families even have negative wealth. These don't show up on these charts. But it turns out that one in six white Americans do not have any—they have zero or negative wealth. But it's actually one in three nonwhite Americans who have zero or negative wealth.

So, you know, some of you may have been reading about inequality. It turns out that these two are records. Inequality, both income and wealth, are at historic highs. And a big part of the increase in wealth inequality is—I'm sorry, in income inequality—is due to the increase in wealth inequality. About a third of why wealth inequality, income inequality, is growing is because of the concentration of wealth at the very high end. So these policies—you know, this distribution is not surprising.

The reason I show that is just to demonstrate we have a real challenge, I think, in broadening the distribution of wealth, the ownership of wealth in this country. And I think what we have to do is be guided by lessons, what's worked. You know, what have we learned over the last 20, 30 years in how you actually help people save and build wealth? And there's been a huge influence from this field of behavioral economics. Some of you might have heard of this behavioral science.

You know, traditional or neoclassical economics says that we are rational. We make, you know, sound economic decisions. We align our behavior in accordance with what's the right thing to do. And the behavioralists have said, "Well, we don't have such an optimistic view of human beings. There's a huge gap between what we intend to do and what we actually do." Right? Very pessimistic view of human nature. You know, Socrates didn't have it right. To know the good is not to do the good. Right?

And so I think the field of behavioral economics has said, "How can we close the gap between people's intentions and their behavior?" And so this whole field has sprung up around that. And so that's the whole point of this. And I think what we're seeing here, just as an aside, many people when they hear, "Well, we need to build savings and wealth," the first thing they think is financial literacy. Right? A lot of people think that that's what we need to do. And we do need to do that. But if we only do that, we're not going to close that gap between intentions and behavior.

And what turns out, what you actually need to do is you have to combine financial education with the ownership of an account. You have to do financial education at the right moments in life—when you're starting college, when you're getting a car loan, when you're buying a home, when you're about to start a business, when a child is born.

And the third thing we've learned is that you have to do financial education in conjunction with some kind of an institution—a government, an employer, a financial institution, a nonprofit. If you do financial education in combination with those things, it's much more likely to be effective. So, you know, and basically what's going on here is you're trying to get the institution to behave so you don't have to.

That may sound odd, but, you know, in many ways the reason that so many people are able to build wealth in this country is because institutions behave for them. Think about the 401(k) plan that you are opted into automatically when you sign up for a job, the tax deduction that takes, you know, two seconds to transfer how much mortgage interest you had to your tax return. This is how the vast majority of wealth is accumulated in this country is through these institutions.

So what we're trying to do here is to take those insights and those ideas and apply them to the bottom half of the population, or the bottom 60 percent, in particular to the families that Bill talked about that have lost a lot of wealth in the recession. So let me just mention a couple of lessons briefly. Opt-out policies work better than opt-in. Think about your 401(k) plan. If you had to actively go sign up for your 401(k), how many of you would do it? Versus your company putting you in the plan, and you have to choose to get out of it.

When they did experiments, it turns out that there was a 48 percent increase among new hires in their participation in the 401(k) plan when they were opted in. And I'm really struck by these numbers for women, that the participation rate went from 36 to 86 percent, Hispanics 19 to 75, and for those making less than $20,000 a year, from 13 to 80 percent. This is the simple difference between opt-in and opt-out.

Second finding, easy and automatic is best. There's a program called "Save More Tomorrow." Basically, what it says is that you agree when you start that when you get a raise, your retirement savings contribution will go up automatically, say 1 or 2 percent. You make that decision before you get the raise. Well, it turns out that the savings rate tripled at one firm that did that. And overall, that one change has resulted in $7 billion of new savings per year around the U.S. from this what's called auto-escalation.

Third finding, social norms are very effective. In Britain they were having a hard time getting, you know, deadbeats who weren't paying their taxes to pay their taxes. And so they figured out, if you keep sending them stern letters, you know, that, "Hey, we're going to come get you and you need to do this," it didn't work very well.

What they tried instead is they said, "Hey, 15 percent of the tax collections in..." I'm sorry, "Nine out of 10 people in your community,"—and they would insert whatever community you lived in—"actually pay their taxes." There was a 15 percent increase—15 percent increase in the number of people who paid their taxes.

And then, finally, this idea of anchoring works too. And here, there's an experiment with TurboTax. Many of you probably use that. 1.2 million people who do the Free File with TurboTax received a refund, and they were asked what they wanted to do with it, if they wanted to save it. And they were given different—in the experiment, in one version some people were suggested that they save 25 percent, another 50, and the third 75.

Well, it turns out people basically saved at those amounts. If you say, "You should save 25 percent," they did. If you say, "You should save 50," they did. So anchoring—this is called anchoring—this becomes the reference point. This turns out to be very effective. So this is a very small sample of the things that we're learning, primarily from behavioral economics, on how you can make savings work, how you can make it easy and automatic, dare I say how you can make it thoughtless.

You have to make it very easy, automatic. You have to use references. You have to use social norms. You know, the idea that you're going to learn how to save and then take your paycheck and go to the bank and do the right thing, it's just not very effective. And we're finding out that these are the kinds of things that are. So let me close with a few ideas to rebuild family balance sheets. There's a lot of ideas, of course. I have just a few here.

We have five goals. One is to build short-term and emergency savings. Many of us would like to have a rainy day fund, something to fall back on, something to weather an economic mishap, you know, to make a small investment in a home. You know, it turns out that that's really critical. Various strategies are out there. You can now take your tax refund and split it into three different accounts. You can also, if you have a mortgage payment or a debt management plan, automatically save a portion of—you know, you set up like an escrow. You put an escrow in a savings plan.

And something called "Magic Mojo." This is a really interesting idea. When you're about ready to do an impulse purchase, what you do is you resist that. You send a text message to this app, and it automatically transfers the amount of money that you would have splurged on into your savings account. (Laughter) You know, this thing is actually working, you know. So there's all kinds of really interesting ideas like that.

Secondly—and this gets to Bill's point, especially when talking about minority families and younger families—you really have to diversify your assets beyond homeownership. Could we think about, you know, a low-cost index fund for a greater number of Americans, small business ownership, and unrestricted savings? Retirement savings is—if you work someplace where they offer a plan, then you want to do the things that I just mentioned already—auto-escalation and auto-enrollment, things like that. But if you don't, there's a proposal in Congress to set up what's called an "AutoIRA." Basically, you know, there would be an automatic payroll deduction into a privately held IRA since your company doesn't offer one. And that would affect about 70 million workers.

Start saving early in life, especially for education. You saw the devastating effect that student loans are having on family balance sheets. We recommend equity-based approaches to financing college. Of course, we need to do all kinds of things, like tame college tuition, you know, rein in the student loan industry, or at least parts of it. But I think the really smart thing to do is to start family saving early in life. You saw the amazing outcomes that are associated with that.

The College Board has come out with something called "Early Pells." Pell Grants, of course, are need-based grants to low-income kids. What if you gave those grants to kids when they were five, when they started college? And then the United Kingdom, here in St. Louis, the City of San Francisco, State of Maine, State of Oklahoma, they're setting up savings accounts at birth for kids or when kids enroll in kindergarten.

And, finally, a couple of ideas. Given how negative equity and excessive mortgage debt is still bringing down the economy in families, we encourage mortgage modifications and to reduce tax and policy bias toward homeownership and borrowing.

This popular lecture series addresses key issues and provides the opportunity to ask questions of Fed experts. Views expressed are not necessarily those of the St. Louis Fed or Federal Reserve System.

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