Why Don't Americans Save Their Money?

We must kill Social Security in order to save retirement.

One-third of Americans have nothing saved for retirement, according to a study published in August by the financial data aggregator Bankrate. That grim factoid joined a growing chorus of reports highlighting Americans' dismal savings habits. In 2013, the National Institute of Retirement Security (NIRS) determined that 84 percent of Americans are falling short of "reasonable" retirement savings targets. Data from the Center for Retirement Research at Boston College reflect a similar trend, and a recent PBS poll found that 92 percent of Americans believe we face a retirement crisis and that government should act now.

The reality is not quite as grim as these reports suggest. The American Enterprise Institute's Andrew Biggs took a hard look at the NIRS numbers and concluded that "the substance of the NIRS study should give pause to anyone considering drastic policy actions." One reason is that the study uses savings guidelines outlined in a 2012 Fidelity Investments report. But Fidelity suggests that people have enough money saved to enjoy 85 percent of their working income, while the Social Security Administration says most financial advisors recommend a lower 70 percent pre-retirement earnings target. The study also ignores that lower-income earners receive larger Social Security payouts, so their savings do not need to be as high.

Still, there's plenty of bad news to go around. America's personal savings rate is a fraction of what it once was. According to data from the Federal Reserve Bank of St. Louis, personal savings rates fell from a high of 17 percent in April 1975 to a low of 2.2 percent in September 2005. Since September 2007, there has been a noticeable increase in savings-probably because the experience of watching assets melt in the crisis triggered an impulse to pay down debts. But if history is our guide, this uptick in savings is likely to be short-lived.

This is problematic, because low savings means less capital accumulation, without which economic growth slows and well-being stagnates. A long list of academic papers documents the connection between the decline in savings over the decades prior to the recession and declines in things like domestic investment and real wage growth.

At the Brookings Institution, economists Ian Hathaway and Robert E. Litan recently released a paper showing that American business is increasingly dominated by older firms. That finding has troubling implications. The literature shows that young firms are the engine of job creation in America-not small businesses, despite what you read in the press and hear from the politicians-so fewer new businesses means fewer new jobs. And one reason for the decline in the number of new businesses, says the Cato Institute's Mark Calabria, is the decline in the personal savings rate. "According to the Census Bureau's Survey of Business Owners, the number one, by a long shot, source of capital for new businesses is the personal savings of the owner," he has written.

Faced with this evidence, progressives would like to beef up Social Security. But the program already faces a $10 trillion funding shortfall, and economists have found that its existence creates disincentives to work and save. In other words, a bigger Social Security program could make a serious problem worse. "Workers' payroll taxes are used to fund Social Security benefits, and some studies have estimated that every $100 of Social Security wealth crowds out $40 in private saving," says Jason Fichtner, an economist at the Mercatus Center and former Social Security administrator. Fichtner also noted in testimony before a House Ways and Means subcommittee in May 2013 that Social Security's "current design offers substantially negative incentives to work, especially for younger seniors and for secondary earners." Exiting the labor force earlier does not just decrease the individual's income security; it decreases the net output and productivity of the economy as a whole.

Fichtner thinks the government should give people incentives to save more. "For those in lower-income brackets, tax credits could be expanded to provide better incentives for saving," he wrote. "Even something [like] encouraging auto-enrollment whereby employees would automatically be enrolled in a retirement savings plan (with the option to opt out) could go a long way toward increasing personal savings."

Not everyone agrees. Matthew Mitchell, also of Mercatus (where I work), is opposed to the government creating incentives to save. "People often talk as if saving is always objectively better than consuming," he says. "But that is like saying beer is objectively better than wine. The truth is that value is subjective. I may think that right now in my life, it makes sense to save the next dollar I earn rather than to spend it. But just because that is the right choice for me does not mean it is the right choice for you."

Fichtner wants to increase private saving so that taxpayers are not asked to foot the bill for people's bad decisions. A reasonable concern, but when government tries to encourage people to do one thing over another, it usually leads to malinvestment. Resources artificially flow to certain goods above and beyond the point where any real value is created. That leads to bubbles, and when they pop, as the Great Recession has shown us, the loss of wealth can be disastrous.

If people are saving too little but incentives to save more could lead to malinvestment, what should be done? Let's start by eliminating policies that penalize savings or artificially boost consumption. Replacing our current tax system with a consumption-based tax would create a more level playing field between consumption and savings. Ending the Federal Reserve's zero-interest policies would eliminate their large disincentive to defer consumption. And eliminating efforts to buoy homeownership would get us out of the business of encouraging people to take on more personal debt in exchange for an investment that, thanks to the Fed's monetary policy, offers weak returns.

Replacing Social Security with private accounts would help as well. In a 1997 paper for the Federal Reserve Board of Governors, economist Julia Lynn Coronado looked at the quasi-privatization of social insurance in Chile. Its effect, she found, was an increase in national savings of 2 percent of GDP.

Social Security is broken. Future seniors already face a 25 percent cut to their benefits when the trust funds dry up in 2033. We might as well put the program out of its misery and, in the process, remove one of the biggest disincentives to save.