Do Americans really need to be more thrifty?

January 7th, 2020

January 7, 2020

Few economic virtues are more universally applauded than thrift.

Going back at least to Ben Franklin, Americans have equated greater thriftiness with greater worthiness. Progressives decry the limited saving and wealth accumulation of middle-income families and express alarm over the widely reported “fact” that 40 percent of Americans cannot come up with $400 in an emergency. Conservatives applaud thrift as an aspect of self-reliance and propose ideas such as health-savings accounts to help families prepare for emergencies. Moderates believe universal social insurance programs such as Social Security and Medicare, which they label as entitlements, should be modest or even curtailed out of fiscal prudence.

In the current economic context of extremely low interest rates, however, these views are more wrong than right. The federal government should provide more, not less, social insurance. If it did, the result would be reduced inequality, a more secure middle class and a stronger economy.

The immediate financial insecurity of the middle class has been exaggerated. That frequently cited 40 percent figure comes from a Federal Reserve survey asking how individuals would meet an unexpected $400 expense. About 60 percent said they would meet the expenditure by dipping into cash or its equivalent, which in turn is the basis for the claim that 40 percent of families would have to borrow on credit cards or from family members. But the same Fed survey found that 85 percent of adults could meet a $400 expense while still paying all their bills.

The real challenges that keep middle-class families up at night are retirement, economic dislocation and supporting their children as they go to college and then buy a first home. These cost far more than $400 and are not best met by personal saving. Rather, a generous and well-functioning society in which Social Security meets retirement needs, appropriate unemployment and wage insurance programs cushion economic shocks, adequate public funding holds down college costs, and health insurance has generous coverage would greatly reduce the need for most households to save.

It is highly inefficient to rely on individual saving rather than universal public programs to deal with life’s contingencies. Social Security, for example, pays out close to 99 percent of the revenue it collects in benefits. In contrast, individuals saving for retirement or the proverbial rainy day can over a lifetime dissipate as much as 20 percent of their savings in commission payments to financial institutions. Similar, and probably greater, efficiencies are associated with government provision of other forms of insurance.

There is the further point that self-reliance is an especially implausible way to deal with catastrophes such as disability or the loss of a good-paying job without the availability of an alternative. Genuinely preparing for such contingencies would involve building up a large nest egg at a substantial cost in terms of current consumption. Meanwhile, the feared contingencies never arise for most people. That’s why pooling risk through insurance is the best strategy.

All of this has always been true. What makes this an especially propitious time to expand, rather than contract, government-provided social insurance is the current macroeconomic environment. After adjusting for inflation, the interest rate on safe debt securities is essentially zero.

Suppose the government expands Social Security by raising taxes on payrolls by, say, 2 percentage points and pays the proceeds to the retired generation, then continues this policy indefinitely. The generation currently retired would get a windfall gain. And each subsequent generation would earn a return on the taxes it pays equal to the economy’s growth rate, which is well above rates of interest.

The combination of the economies available from having the government provide insurance services, plus the return premium made available by such pay-as-you-go finance, makes public programs the right way to strengthen the middle class. This becomes even more true once it is recognized that, as long as initiatives are financed at least in substantial part from highly progressive taxes, the result will be to reduce inequality.

And finally there is the observation that more social insurance, even if fully paid for by contributions, will raise demand in the economy by reducing households’ need to save. By increasing normal interest rates, this will push the economy forward and contribute to financial stability.

The clear verdict: We don’t need fewer entitlements for the American middle class. We need more.