David R. Henderson  

McArdle Advocates Paternalism

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And it's expensive paternalism.

Megan McArdle of Bloomberg, who is normally a first-rate analyst of economic issues, has written an inaccurate attack on 401(k) plans and, worse, proposes a huge paternalistic government program for retirement in her column "The 401(k) Problem We Refuse to Solve."

She writes:

"The great lie is that the 401(k) was capable of replacing the old system of pensions," former American Society of Pension Actuaries head Gerald Facciani told the Journal. "It was oversold."

This is true.


No it's not.

What's her basis for thinking this charge is true? Is it that people who, with their employers, sock away 10 to 15% of their annual income in diversified investments don't do well? No.

Just before this negative conclusion about 401(k)s, she gives her reasons, writing:

Investment returns have proven variable, and individuals are often prone to making idiotic mistakes (like selling everything when the market crashes, which is literally the worst possible time to do so). And that's only for people who have a 401(k); many people decline to participate in a plan, even when their employer offers matching grants. And according to the Wall Street Journal, the early boosters are turning sour on the whole idea.

Let's look at those charges one by one.

Investment returns have proven variable.
That's true. That's why it's important to diversify: to have stock index funds that buy U.S. stocks, such as the Vanguard Total Market Index, but also to have index funds in foreign funds, and some bonds. That's hardly a mark against 401(k)s.

[I]ndividuals are often prone to making idiotic mistakes (like selling everything when the market crashes, which is literally the worst possible time to do so).
That's true. But this isn't an argument against 401(k)s. Rather, it's an argument for managing one's 401(k) wisely.

And that's only for people who have a 401(k); many people decline to participate in a plan, even when their employer offers matching grants.
That's true too, and it is generally a really bad idea not to invest when one's employer offers a match. But this is the strangest charge of all. 401(k)s are oversold because people don't use them? If people aren't using them, wouldn't a reasonable reaction be that they are undersold?

And according to the Wall Street Journal, the early boosters are turning sour on the whole idea.
They are. But a look at the WSJ article she links to shows why: people are generally saving way too little in their plans, assuming that their goal is to use 401(k)s as a major part of their retirement income, and often paying exorbitant fees.

There's a relatively easy fix for employers: choose plans that don't have high fees. And there's a relatively easy fix for employees: save more.

Now, you might say that this last fix isn't easy. And, for many people, that's probably right.

But what does McArdle suggest: A huge government intrusion to make people save. If you don't like my fix because it's not easy, then you should dislike her fix even more because she would force people into it.

She writes:

The funny thing is that, for all the people arguing that some dire problem in one of these three retirement systems [defined benefit plans, define contribution plans (like 401(k)s, and Ponzi-style--the polite term is pay-as-you-go--"social insurance" schemes] urgently requires that we switch to another kind at once, the major problem with all three is exactly the same. It's even a problem that's easy to state and easy to fix -- no need for extensive blue-ribbon commissions or elaborate white papers. Here's the solution: Pick whichever system you prefer; it really doesn't matter. Now slap a 10 to 15 percent surcharge on a worker's wage income, and divert that money into the system for the worker's future use. Problem basically solved, because in all three cases, the only flaw that actually matters is that they're badly underfunded.

A 10% to 15% surcharge is huge. There's another solution, although unraveling our current Social Security Ponzi scheme makes it hard: Let people make their own decisions. Will many of them make bad decisions? Based on what McArdle reports about 401(k) experience, yes. But then don't blame it on 401(k)s. Put the responsibility where it lies: with the decider.

Moreover, if she's saying that it doesn't matter which of the three systems one chooses, then she's saying that one of the systems, Social Security, is fine as long as the government forces people to save 10 to 15% of their income in it. But the government does that now. The combined employer and employee FICA tax is now 12.4% of all "earned" income up to $127,200 (in 2017). 12.4% is almost exactly midway between her bounds of 10 and 15. Which means that McArdle, by her own reasoning, should be claiming that Social Security is working just fine. But she's not. She's claiming that most people covered by Social Security haven't saved enough on top of Social Security.

Back to her 10 to 15% surcharge. Think what that would do to a young person who's trying to save money to buy a house or condo. That would make it much harder. It would also prevent the person from doing a more life-cycle approach to retirement saving: saving a few percent of income from his late 20s to his mid-30s, then saving a higher percent from his late 30s to his mid 40s, then saving a larger percent from his late 40s to retirement in his 60s. What did I just describe? My saving behavior with my 401(k).

Coerced one-size-fits-all solutions don't fit all. Normally, Megan McArdle recognizes that. In this case, she didn't.


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CATEGORIES: Regulation , Social Security




COMMENTS (23 to date)
John Goodman writes:

What is true is that in the past workers were making choices that they probably wouldn’t make if they were better advised.

For example, many workers left the employer match on the table. Others would fail to select a portfolio and they were being defaulted into money market funds. These were typically low-wage employees.

So, Peter Orszag and I got together (in a left-right effort) and with some assistance from former governor Pete du Pont we persuaded Congress to include in the last pension reform bill a safe harbor for employers that allowed them to auto enroll employees in 401(k) plans with diversified portfolios without fear of being sued if the market went down. This in-unless-you-opt-out approach has proved to work exceedingly well – as the behavioral economists never tire of telling us.

One thing I wanted that was not in the legislation: auto annuity (with the right to opt out) at the other end.

HH writes:

I think McArdle's article reads mostly as a musing on what to do when faced with people who 1) don't save enough for retirement, 2) live well past the time they can earn income, and 3) will die without money. It's fine to say people SHOULD save more, or to say that those who haven't should face the consequences. It's harder to look at the human conferences of that without acting.

khodge writes:

I, too, was confused by McArdle's concepts of equivalency and coercion.

Yes, people are going to fail to take care of themselves and their futures. No, having government attempt to "solve" the problem will only exacerbate it. Rather than legislating the state solve the problem, the basic principle still holds: What you want to encourage you incentivize what you want to discourage you tax.

john hare writes:

My problem with the forced whatever is that it acts as a brake on the investing I prefer. I prefer investing in my own company and building it up so that it is a money earner now and well past the time I can physically work. I have gone broke three times so far over the last 34 years, mostly because of bad decisions and sometimes outright stupidity on my part. That shouldn't be your problem as taxpayers, it should be mine as a responsible, or irresponsible, entrepreneur.

Recovering from my various blunders takes more time and effort every time it happens as I get older and less physically capable of the hard work and long hours. It's concrete work and I'm 60 now. I typically put every dollar I can back into the business. I drive well used vehicles, don't smoke, live in a very modest house, and average $100.00 a year each on alcohol and gambling. My various recoveries from going broke are accelerated by cheap living, and retarded by regulations, taxes and other legally required expenses*. I think it is possible that my current net worth could be different by one or even two decimal points if I could have recovered quicker from the down times.

In short, the opportunity costs to entrepreneurs is probably higher than most people believe. The secondary cost in available jobs from those entrepreneurs is also likely to be high.

*Some regulations, taxes, and legally required expenses are definitely necessary, but I think many of them act as a brake on wealth creation and standard of living for entrepreneurs, their employees, and their customers.

Jeff writes:

The trouble with voluntary programs is that some people will choose not to save and some others will make unfortunate decisions. In either case, they get to a point where they can no longer work and they don't have enough money to retire.

The question is, what happens then? Are we going to just leave them in poverty? David Henderson says it's their own fault, let 'em starve. Or beg for (private) charity. Megan McCardle, however, recognizes that the polity of this country has demonstrated repeatedly that they will not allow this to happen. One way or another, the system is going to tax the rest of us to support the indigent, no matter how they got to be indigent.

So what McCardle wants is a second-best solution. If people won't save for their retirement voluntarily, make it mandatory. A system like that is in place in Chile and is working pretty well.

David, you forget that politics is the art of the possible. And leaving millions of impoverished old people to fend for themselves, even if they deserve no help, is just not possible in this society.

Thaomas writes:

True, McArdle's plan does not fit the 1% (is it that large?) of 401k investors who will save enough in well diversified, low cost plans that pay out actuarially fair pensions. For the rest, it would be an improvement, although financing part of the pension and all of Medicare from a consumption tax rather than a wage tax would be even better.

Mike W writes:

@Jeff "If people won't save for their retirement voluntarily, make it mandatory. A system like that is in place in Chile and is working pretty well."

"Are we going to just leave them in poverty? David Henderson says it's their own fault, let 'em starve."

As DH noted, a mandatory system is already in place in the US...and is working pretty well. I think the current Social Security and Medicare programs already keep the elderly out of extreme poverty. If that is true, then the question is, I think, should society do even more?

As DH says, "She's claiming that most people covered by Social Security haven't saved enough on top of Social Security."

What's "enough"?

David R. Henderson writes:

@Jeff,
It’s difficult to turn my “don’t use force on them” to “let them starve.” But nice try.
I don’t forget, as you say, that “politics is the art of the possible.” Try, as a mainstream politician, imposing a 10 to 15% surcharge on people for their own good. See how far you get.

Glen Smith writes:

Don't see any fault in her arguments against the 401k. In fact, the argument that people make mistakes in investing their 401k IS the problem with the 401k

David R. Henderson writes:

@Glen Smith,
Don't see any fault in her arguments against the 401k. In fact, the argument that people make mistakes in investing their 401k IS the problem with the 401k
Would you apply the same argument to food? Food is bad because many people eat too much of it and some people eat too little of it?

James writes:

The mistake everyone seems to make in discussing retirement funds is failing to recognize that investment returns are a positional good.

If one person invests a large fraction of his income in a portfolio with high returns he increases his own purchasing power in retirement over what he would get if he were to invest a smaller fraction of his income in a portfolio with lower returns. But that does not generalize to entire cohorts.

The fallacy McArdle commits is in thinking that forcing everyone to invest more money in better portfolios can somehow improve everyone's purchasing power. Only an increase in the amount of goods and services available for purchase can do that. At best, a government program forcing people to save can only change the distribution of purchasing power.

In a world where people respond to incentives (i.e. this one) any program that reduces people's freedom to decide what to do with their income would reduce real output and therefore reduce average and total purchasing power for every cohort in retirement. So the public would get less freedom and less total purchasing power so that people like McArdle can enjoy knowing that there is more equality in purchasing power among retirees.

If that is what McArdle really wants, perhaps she can explain why her preference is important enough to warrant that the government use force to compel everyone else to act contrary to their own preferences.

Fred Anderson writes:

James says, "The fallacy McArdle commits is in thinking that forcing everyone to invest more money in better portfolios can somehow improve everyone's purchasing power. Only an increase in the amount of goods and services available for purchase can do that."

I am not an economist (and I don't read the McArdle quote as saying anything about better portfolios) but . . . .

Don't we generally equate savings (forced or otherwise) with investments? And wouldn't we expect greater investment to result in the greater amount of goods and services available (and necessary to improve everyone's purchasing power / experienced level of consumption)?

Fred Anderson writes:

Being impressed by the magic of compound interest, I took a spreadsheet and played with some numbers. The results are probably subject to many a caveat, but . . .

If a person started at age 20, and were forced to save $727 toward their retirement and let it grow at 6%.* And if each year thereafter they were forced to increase their contribution by 6%, by age 65, they would have $450,000 saved in total.

If she then retired and took out a steady $30,000 per year (while letting the balance still grow at 6%), the money would last until she was 97 -- ten years beyond the 21.6 years a 65 year old female can expect.

Admittedly, $30,000 is pretty minimal, but it's still almost double the official poverty level for a two-person household. Medicare is likely picking up most her medical bills. And (we hope) she may, by this point, no longer have a mortgage to deal with. So this likely achieves "survival".

*The 6% figure was lifted -- and adjusted -- from Peter Diamond's 1999 Center for Retirement Research article "What stock market returns to expect for the future?", which said the markets had averaged 7% since World War II, but that a 7% figure was probably an unwisely high estimate.

Jacob Egner writes:

David Henderson:

Excellent post. Thanks for making many great points.

Back to her 10 to 15% surcharge. Think what that would do to a young person who's trying to save money to buy a house or condo. That would make it much harder. It would also prevent the person from doing a more life-cycle approach to retirement saving: saving a few percent of income from his late 20s to his mid-30s, then saving a higher percent from his late 30s to his mid 40s, then saving a larger percent from his late 40s to retirement in his 60s. What did I just describe? My saving behavior with my 401(k).

You make an excellent point about how people benefit from being able to save for pre-retirement expenses, but I don't understand your point about "life-cycle approach to retirement saving".

Yes, it is a true fact about this world that people tend to increase their savings rate over time (until they retire), but there are heavy advantages to saving earlier rather than later.

For example, assume 5% annual rate of return and retirement at age 65: investing $1 at age 25 gets you $7.04 at retirement and investing $1 at age 55 gets you $1.63 at retirement. Each $1 invested at age 25 is worth $4.32 invested at age 55. At age 55, I'll probably make less than 4.32 times what I made at age 25.

If you're presenting your case to someone who is already okay with the idea of coercing people to save/invest differently than what they would voluntarily do, I don't think they'd be very swayed by the "life-cycle approach" being common.

Is your mention of the "life-cycle approach" being common an extension of your point about pre-retirement expenses (house/condo/etc) or is there something I'm missing?

Also, for the record, I am against coercing people to save. I'm just hoping to understand your points better.

Thanks,
Jacob

AntiSchiff writes:

Dr. Henderson,

Have you ever thought about the idea of replacing taxes with the forced purchase of US Treasuries, with maybe 12.5% forbidden to be sold to replace Social Security? And if you like that idea, how about perpetual GDP securities as well, that pay dividends based on economic growth? Such a plan wiuld not only give taxpayers much more control over their money set aside for government, but would also endow them with incentives to support more efficient government spending, especially meaning limiting spending to only those items deemed absolutely necessary and/or to items that actually increase efficiency.

So, to be clear, there would be some forced savings rate for a given period of time, but also some proportion of Treasuries and GDP equity instruments that could be sold immediately, if desired.

It's a hybrid forced savings, cap and trade type plan to replace traditional taxation.

James writes:

Fred Anderson,

I am guilty of lumping McArdle together with the large number of people who would like to have the government direct people's investing in terms of both how and how much. She does favor having the government tell people how much to invest. What are the odds she also thinks that government should tell people what to invest in?

If you equate investing in the stock market with saving and capital formation, you are making an understandable error but it is an error nonetheless. If I spend $100 to build a business that did not previously exist, that represents $100 of investment. If I then sell you a $50 stake in my business the next day, would you say that investment in the economy was $150? Of course not, because my sale and your purchase net out to zero.

Your numerical exercise is great for understanding what would happen to an individual's nominal account balance but it does not address the issue of purchasing power. Do you understand what is meant when something is said to be positional?

James writes:

AntiSchiff: What party would pay the dividend on a GDP security?

David R. Henderson writes:

@Jacob Egner,
Excellent post. Thanks for making many great points.
Thank you and you’re welcome.
If you're presenting your case to someone who is already okay with the idea of coercing people to save/invest differently than what they would voluntarily do, I don't think they'd be very swayed by the "life-cycle approach" being common.
You could be right. By the way, I’m not sure why you think that the life-cycle approach is common. It may or may not be. But back to your point. What motivated me to write this was seeing Instapundit highlighting her paternalistic proposal as if it's a good idea. So I am pushing back against people who normally oppose such coercion. My post might persuade them. But for people who want to tax sugar, ban drugs, require seat belt usage, etc., my post might not be persuasive.
Is your mention of the "life-cycle approach" being common an extension of your point about pre-retirement expenses (house/condo/etc) or is there something I'm missing?
I didn’t mention the life-cycle approach being common. So you are missing that. But yes, if people want to buy houses early in life, say, before they are 40 years old, McArdle’s solution makes that very difficult. Also, note that buying a house is often a way of getting large compound returns when one is in one’s 20s or, more likely, 30s.

AntiSchiff writes:

James,

The government would pay interest and dividends.

R Richard Schweitzer writes:

This is amazingly unlike Megan:

"If productivity is growing quickly, then it is easier to maintain our pre-retirement lifestyles with a smaller pool of savings, because that savings will buy more."

Not with fiscal profligacy that produces recurrent compounded inflation.

"Savings" are one thing, "investment" is another. If the "investment" of coerced savings were to follow those of the present coercive system into the general cash flow available for political dissipation, the results will be no different.

A prospect of "coerced savings" must presume either a surplus from productive labor (which would be as subject to variances as the variations of investment returns); or, a reduction in consumption (and related impacts on economic activities).

Production and distribution can produce surpluses (profits). Currently much of those have been sequestered and not redeployed, distributed, or assigned to future benefits.

Observing the fluctuation in wages and wage distributions does not reveal assured and continuing surpluses of wages, or their distribution, from which coerced savings might be extracted in any event.

Certainly we have learned that any investment of coerced savings cannot be entrusted to a politically directed process.

Jacob Egner writes:

David Henderson:

Great, thanks for the explanation.

I’m not sure why you think that the life-cycle approach is common.

In that the "life-cycle approach" is that people generally increase their savings rate over time (until retirement)? Because it seems that young people save very little or even a negative amount (student loans, house loans) and then as people get older and retirement looms larger in their minds, they increase their savings rate (it also helps once mortgages are paid off and kids are out of college).

Also, data like the chart near the top of this page seem to agree with my impression (going by the expenses definition rather than the assets definition of savings rate).

Seth writes:

Doesn't Obamacare force people to buy health insurance?

I would like like Megan to tell us what distinguishes things that should be forced and not.

Set writes:

Also...

"Moreover, if she's saying that it doesn't matter which of the three systems one chooses, then she's saying that one of the systems, Social Security, is fine as long as the government forces people to save 10 to 15% of their income in it. But the government does that now."

It would be good for McArdle to clarify how SS doesn't already accomplish her recommendation.


Also II...

Has anyone plotted the retirement savings rate over time relative to the SS tax rate and/or expected SS benefits?

I Googled it and couldn't find that exactly, but by eye-balling the "Savings Struggle" chart in the WSJ article McArdle links to and SS historical tax rate, it appears the savings rate has come down while the SS tax rate has gone up.

Could it be that as the SS tax rate has gone up, people chose to save less for retirement because they expect SS to provide a chunk of their retirement rather than it being any of the problems McArdle et al points out about 401k's?

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