The economic mobility ladder is not the same for everybody. The ascent is more arduous for some than others. Beyond personal attributes, the degree of difficulty depends on a range of characteristics, including the role of parents, educational attainment, and a variable often overlooked--the extent to which individual households can accumulate, control, and deploy assets, starting with financial savings.
The links between savings and mobility seem logical in theory. At a minimum, families facing tough economic times need savings to buffer against job loss, medical expenses, and other contingencies that threaten their stability. Building even a modest nest egg allows families and individuals to become less dependent on credit cards, payday lenders and other expensive forms of credit, the overuse of which has become a prime cause of downward mobility. But hard evidence has been illusive--until now.
A recent report released by the Economic Mobility Project, an Initiative of the Pew Charitable Trusts, takes a closer look at the connection between savings and mobility, identifies barriers to saving, and lays out concrete steps to help Americans achieve improved economic mobility and realize the American Dream. It is state of the art data and research. I should know (I was a co-author). But Daniel Cooper of the Boston Fed and Maria Luengo-Prado, an economist at Northeastern University looked at household finance data over an extended period of time (using data from the Panel Study of Income Dynamics, for all you wonks out there). They found that children of low-income, high-saving parents are more likely to experience upward income mobility. If your parents have low incomes and low savings, you are significantly less likely to be upwardly mobile.
Specifically, 71 percent of children born to high-saving, low-income parents move up from the bottom income quartile over a generation, compared to only 50 percent of children of low-saving, low-income parents. Higher personal savings also promotes greater upward mobility of individuals within their own lifetimes. Among adults who were in the bottom income quartile from 1984-1989, 34 percent left the bottom by 2003-2005 if their initial savings were low, compared with 55 percent who left the bottom if their initial savings were high.
In general, the mobility picture is not as good as we should want it to be as Americans. Movement up the income ladder is fairly limited for children of low-income parents--42 percent of children born to parents on the bottom rung of the income ladder remain on the bottom rung a generation later.
Despite the importance of savings, most Americans, particularly those with lower incomes do not appear to be saving enough. When savings are not available, families often turn to alternative and more expensive sources of funding, such as payday loans and credit cards that potentially lock families in a cycle of debt that undercuts their abilities to save for the long-term. According to the Federal Reserve's 2007 Survey of Consumer Finances, 77 percent of American families are carrying debt with a median value of $67,300 and the poorest fifth of American families are carrying a median debt value of $9,000, with a median income of only $12,300.
It appears that one way to begin remedying this is to help more families save. Using public policy to promote savings, then, would appear to be a potentially beneficial strategy for enhancing upward economic mobility. The questions becomes how well is policy doing this now. You can read the report to get the long answer but short of it is we're not doing that well at all.
The vast majority of federal incentives to increase savings, estimated to exceed $130 billion in 2010, are delivered though the tax code. The government gives you a break (in various forms) when you contribute to a special, designated account. When taking a closer look at the wide array of tax-preferred savings accounts, such as IRAs, 401(k)s and the like, we find a confusing terrain. It is so complex that it is probably preventing people from participating.
For instance, while almost all workers are eligible to participate in employer-sponsored savings plans, only half actually do. Many don't take advantage of the savings opportunity even when it is offered by employers. We find that employers that are larger in size, unionized, or in the public sector have much higher sponsorship and participation rates. Contributions to saving plans also increase substantially with income. For 401(k)-type plans, the average contribution of workers with incomes between $120,000 and $160,000 was over $7,400 in 2003, which was more than double that of workers earning between $40,000 and $80,000.
Accordingly, most of the benefits go to upper-income households. About 70 percent of tax benefits from new contributions accrue to the highest 20 percent of tax filers by income, roughly half of the benefits go to the top 10 percent, and 90 percent go to the top 40 percent of the income distribution. The bottom 20 percent of households get virtually no benefit from the income tax exclusion of savings plans.
Unfortunately, the higher income households may just be moving money around to take advantage of the tax shelter. The flip side of this is that the current policy structure leaves out those that might benefit from savings the most. Lower and moderate income households have significant potential to increase net new savings. Existing evidence indicates that these are the families that reduce their consumption in order to save.
So, it is fairly clear that the current policy approach to promote savings through the tax code isn't working very well. It ends up leaving behind families with lower incomes and fewer resources. There are a number of alternative policies that should be considered, such as making sue everyone has access to a low-cost savings plan and creating incentives with meaningful value for households with low incomes. But we are also long overdue to revisit the basic structure of our tax policy.
Tax rules certainly should be simplified and the number of special accounts consolidated. This might entail creating one class of accounts that are only for retirement and another for intermediate goals, such as education, homeownership. Families have needs well before the retirement years and these investments can form the bridge to security later in life. The tax system has many problems that need to be addressed, including its inability to produce enough revenue to avoid compounding deficits. When this work begins in earnest, policymakers should consider increased savings for all Americans as one of the primary objectives of reform.