A paper released this week by the New America Foundation makes the case for tax code reform that would make the most basic financial aspiration more attainable for lower-income Americans: the ability to save money. The report begins by taking on a critical hole in the current policy – that it “allocates a large portion of the nation’s resources to promote retirement security amounting to almost 1 percent of GDP in 2013, yet it offers few supports for low- and middle-income earners seeking to build a personal safety net.”
There is, of course, something to this. Past studies have shown that low-income families are strikingly underprepared to weather financial emergencies. According to the Urban Institute, over three-quarters of low-income working families are “asset poor”, or without the necessary funds to finance three months of poverty-level spending.
An infographic, originally published by NPR, shows that people across the income spectrum spend similar percentages of their income on all costs except retirement savings. For retirement savings, the percentage steadily grows as you move up the income range, from 2.6% to 15.9%.
While this might seem a problem with a very obvious root at first – that poor people simply don’t have money to save – the research suggests the reality is more complicated. Another study by the Urban Institute found a very large degree in variation between the savings patterns of the poorest families surveyed (those below the poverty line more than 50 percent of the time) over a thirteen-year period. The 80th percentile of families in this poorest group accumulated more than 29,000 dollars. The 20th percentile lost $3,694,which means that financial choices are hugely important even for those without a lot of spare cash lying around.
This suggests that, even for this lowest-income group, there may be a policy angle in encouraging savings.
Furthermore, given what we know about the benefits of savings, encouraging them should be a policy priority. Savings not only diffuse a financial blow that may have otherwise pushed a family below the poverty line, perhaps irreversibly, they also increase the possibility of college and homeownership for low-income people. Both, of course, have obvious links to economic success.
Even a small cushion can do a lot to weather the blow of unexpected financial hardships. According to a 1989 paper by Susan Mayer and Christopher Jencks, just 500 dollars in savings is as useful in weathering such an emergency as a three-fold increase in income.
The solution that the New America Foundation offers up is reforming the tax code, specifically the provisions that aim to incentivize savings but end up directing most of their benefit to the already-wealthy.
For instance, half of ten major tax expenditures, including the mortgage interest deduction and preferential tax rates on capital gains and dividends, disproportionately benefit the wealthy, according to the paper, with 50% of their benefits going to the top 20% of earners. In addition, one of the most expensive expenditures for the government, the exclusion of pension assets and retirement contributions from taxable income, disproportionately benefits the highest income quintile. 66 percent of those benefits go to this richest group.
The paper proposes two solutions. The first is the creation of a so-called Financial Security Credit, which would allow earners to open an account on their federal income tax form, thus introducing people who may not have had an opportunity to save before to a vehicle for doing so. The Credit would also match every dollar that low-income filers deposit up to $500.
Another proposal is the establishment of a universal 401(k), which takes a page out of what has been an effective incentive to save in the private sector. The government would match the money put in by low-income savers, which has been an idea tossed around before.
It would be paid for, of course, by closing all of those deductions that go toward the wealthiest earners. We could start, perhaps, with some of the 110 billion dollars the government spends in excluding the richest quintiles’ retirement and pension assets from taxable income – all of which, it’s worth noting, probably would have been saved anyways.
A discussion about the practical blocks to savings that exist for lower-income families is a much-needed part of the overall push for tax reform. Now that politicians and policymakers are focusing on what inefficiencies can be trimmed, it may also be the time to talk about what the tax code can correct if done better.
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