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Papers to shock the unwary
The lead article in the August 2006 Journal of Political Economy offers the following abstract:
We solve each household's optimal saving decisions using a life cycle model that incorporates uncertain lifetimes, uninsurable earning and medical expenses, progressive taxation, government transfers, and pension and social security benefits. With optimal decision rules, we compare, household by household, wealth predictions from the life cycle model using a nationally representative sample. We find, making use of household-specific earnings histories, that the model accounts for more than 80 percent of the 1992 cross-sectional variation in wealth. Fewer than 20 percent of households have less wealth than their optimal targets, and the wealth deficit of those who are undersaving is generally small.
In other words, most Americans are saving enough for their retirements. The authors (John Karl Scholz, Ananth Seshardi, and Surachai Khiatrakun) stress that their data cover only the early 90s, although if anything they believe this biases their estimates downwards by missing out on later capital gains. Here is the paper.
Notes: This result does not deny that America may face coming demographic problems for funding social programs, most of all Medicare. But next time you read that "the U.S. savings rate is zero," think back on this blog post and on that paper.
Posted by Tyler Cowen on September 10, 2006 at 04:46 AM in Economics | Permalink
Comments
On quick read, the paper uses a 2.2% real discount rate to compute the present value of retirment needs and a 4% real rate of return on investments. This can cause them to understate the net worth needed to generate adequate income.
Posted by: Richard at Sep 10, 2006 8:42:49 AM
Add to this paper the bogusosity of official definitions of the savings rate: they undercount about half of retirement plan income (because they count the money going into plans, rather than the money coming out, which is substantially greater due to investment gains); and they do not count realized capital gains at all. That yields about a ten percentage point difference in savings rates. And don't forget unrealized capital gains, too, though I have not seen a savings rate estimate that considers these.
Posted by: Bill Conerly at Sep 10, 2006 1:16:18 PM
Yes -- although if you actually go out and talk to moderately wealthy retirees, you will learn that some of them took a bath in the last stock market crash, and are depending upon Social Security much more than they thought they would. Every retiree I have spoken with, from richest to poorest, says Leave Social Security alone!
Posted by: Lee A. Arnold at Sep 10, 2006 10:25:31 PM
res savings. I understand that there are economics reasons why all of this wasn't considered savings, but for me it was, it was deferring huge portions of my income for retirement. I called that savings, and decided that additional investments needed to be in realestate to balance my assets.
Soc. Sec. 14 per cent (considered self employed so paid both halves. Retirement deduction 19 per cent. Hence I was putting aside 33 percent for retirement. And at a low income I was suppose to live on less! Rob
Posted by: Rob at Sep 11, 2006 12:00:23 AM
"Every retiree I have spoken with, from richest to poorest, says Leave Social Security alone!"
Given that their return on Social Security at the margin is now infinite, I'd say that's not a surprising response.
Posted by: Keith at Sep 11, 2006 12:26:39 AM
Can anyone explain what the "US savings rate" means? Does it include IRAs, 401ks, etc.? Or is it just money that's in CDs and the like?
Posted by: Klug at Sep 11, 2006 8:34:30 AM
Lee Arnold wrote: "Although if you actually go out and talk to moderately wealthy retirees, you will learn that some of them took a bath in the last stock market crash, and are depending upon Social Security much more than they thought they would."
This sounds like moral hazard to me. It's a lot easier to put your life savings into internet stocks when you know Social Security will bail you out.
Posted by: DK at Sep 11, 2006 8:57:41 AM
So how is he government savings rate calculated. what does it mean, that it is "negative"?
Posted by: WS at Sep 11, 2006 10:27:03 AM
The savings rate is income less spending and the spending
includes that financed by borrowing. Simple.
So saving includes the initial contribution to IRAs,401's,
etc., but does not include the capital gains in such
accounts.
It is negative because we spend more then we earn -- simple.
Here we are only talking about what individuals do.
If you want to look at total national savings add this to business and govt savings -- a big negative -- and you get a savings -investment gap that is equal to what we borrow from foreigners to consume more then we produce.
I'm not sure this is the paper I remember and I have not read it but isn't the biggest factor in the good position in consumer savings the value of defined benefit retirement programs that have massively declined since the early 1990s . If this is what I think it is -- without reading it- because of how it treats defined benefit pensions it is way, way, way too optimistic about current conditions.
Posted by: spencer at Sep 11, 2006 10:39:07 AM
DK: "This sounds like moral hazard to me. It's a lot easier to put your life savings into internet stocks when you know Social Security will bail you out."
You must be joking! Nobody is going to gamble in the stock market because they can get $2000 a month in their dotage if they fail. Nobody will loaf away his or her own life because they will get $2000 a month at age 65 or 67 or 69 or whatever it's going to be. Your mind would have to have stopped growing at about the age of 20. I suppose it's possible...
Posted by: Lee A. arnold at Sep 11, 2006 11:51:04 AM
I live in a relatively rich area (Fairfax County VA). Bssed on anecdotal statements from many of my friends, who are high earners by they way, people are not saving enough for retirement. I see so many people borrowing on their houses for current consumption. So many people obviously living beyond their current and reasonably anticipated future income. And we are not even talking about people in the less fortunate areas of the US. How does anyone earning at the median income or less save anything?
I recognize that this is anecdotal and not strictly evidenced based. But I see it over and over.
Posted by: Murphy at Sep 12, 2006 11:38:00 AM
As I understand it, in order for savings rates to come out adequate in this simulation, it turns out that massive numbers of people have to declare bankruptcy. Since they assume that bankruptcy has only positive effects, people can undersave with the knowledge that they'll be bailed out.
Posted by: Ian D-B at Dec 11, 2006 3:40:48 PM
Actually, personal savings rates do NOT include 401K contributions or traditional IRA contributions (although Roth IRAs do count) because it's computed on disposable income, which is computed on taxable income. 401Ks and traditional IRAs are not part of taxable income. Also, the employer match on 401K is not counted as personal savings, although most people would think of it that way. And as mentioned, investment growth doesn't count either, but passive income that's saved does count...
I realized that my wife and I had a negative savings rate by the national calculations last year because we had maximally funded our 401Ks and paid cash for a car. But if 401K contributions were counted, we saved 20% of our gross, even if the car is counted as pure consumption (which we do...)
Posted by: Foobarista at Dec 12, 2006 2:47:15 AM
