Wealth More Issue of Choice Than Chance

In the era of IPOs and “dot-coms” and 1,000% instant returns, old-fashioned saving seems a bit out of date--quaint, s-o-o-o 20th century.

And the flip side is that many families may figure that unless they can pick the next Dell Computer or Cisco Systems, there isn’t much hope of achieving such goals as a comfortable retirement.

But a recently published study of the lifetime earnings and current wealth of a large number of American fiftysomethings concludes that neither of these views is correct.

Saving does work, the study found, and the most important factor in long-term wealth accumulation is the act of saving itself. Getting into the game at all is far more important than how you play it.

In fact, the data indicate that many households with relatively low lifetime earnings manage to accumulate six-digit nest eggs. And while higher-income families generally accumulate more by retirement age than do those that are less well-off, the study found that there is wide variation in wealth among families with similar earnings.

“It’s clear that some people with low incomes do save relatively large amounts and that some people with high incomes don’t,” one of the study’s authors, David Wise, a professor at Harvard’s Kennedy School, said last week.

In reaching this conclusion, the study also raises what is already one of the hot-button issues of this year’s presidential campaign: To what extent does the current federal tax system--including income taxes and estate taxes--penalize the frugal, no matter their income level, while rewarding the prodigal?

After examining the role of chance factors, such as poor health on the downside or a windfall inheritance on the upside, and the role of investment choices, such as stocks versus bank accounts, “We conclude that the bulk of” the variation in wealth among families with similar earnings histories “results from the choice of some families to save while other similarly situated families choose to spend,” Wise and co-author Steven Venti of Dartmouth College wrote in their study.

Chance factors and investment choices play a much more modest role, they found.

Their paper, “Choice, Chance and Wealth Dispersion at Retirement,” was published earlier this year by the National Bureau of Economic Research, a private group in Cambridge, Mass.

The findings come at what may be a pivotal time for the future well-being of American families.

First, the future of Social Security is uncertain, both as to the system’s ability to continue benefits at today’s levels and as to what remedy might be adopted to deal with possible shortfalls.

Second, private pensions are increasingly shifting to plans such as the 401(k), whose benefits depend on the worker’s own investment success. Traditional gold-watch pensions, with funds invested by the employer and guaranteed by the government, are becoming less common.

And third, the nation’s savings rate is at historic lows, with personal annual savings rates down to 2%, or even in negative territory, depending on whose figures you use.

Policymakers so far have been reluctant to tackle the saving issue in more than a marginal way. There are a number of proposals to boost individual retirement accounts and 401(k)-type retirement savings plans, and to allow or compel workers to invest at least a portion of their Social Security taxes in the private marketplace.

But there is clear reluctance to face the core issue here: To what extent do we wish to be a society in which people manage their own finances, keeping the winnings and living with the consequences of failure, and to what extent do we wish to penalize the winners to repay the losers?

Historically, the United States has tended to regard its social programs, public and private, as a form of insurance--a mechanism that helps people deal with difficulties encountered through no fault of their own.

But in recent years, this model has come into question. In many circumstances, the payers/savers have begun to wonder if they are being taken advantage of by people who don’t save.

An example that middle-class families can identify with is college financial aid. Initially meant to assist the deserving poor, aid programs have been expanded to help the middle class as costs soared beyond many families’ reach.

But the formulas in these programs tend to penalize the family that watched its spending, denied itself luxuries and saved for college, while providing more generous assistance to those that spent all their income and then threw themselves on the mercy of the financial-aid office.

Wise and Venti believe that current tax policies do somewhat the same thing by penalizing savers. They note that people who are highly successful in saving over a lifetime face higher taxes on Social Security benefits, they may be forced to liquidate their assets to qualify for nursing-home care under Medicaid (the Medicaid “spend down”), and “pension assets left as a bequest can be virtually confiscated through the tax system.”

“The issue raised here is not about progressive taxation, but rather about the differences in tax imposed on persons who spend tomorrow versus today, given the same after-tax lifetime earnings,” they wrote.

In their view, current policy is implicitly based on the assumption that wide disparities in wealth are largely the result of chance, and that taxing those who succeed to help those who fail is therefore neither unjust nor a disincentive to saving.

But Wise and Venti conclude that in the aggregate, accumulation of wealth by wage earners is more a matter of choice than chance. And if that is true, then tax policies represent a specific penalty on virtuous behavior, much like the college-aid formula.

“The evidence that differences in retirement wealth [are due] largely to saving choices [made when people are younger] brings into question this tendency” to tax such wealth, they conclude.

“Although the distribution of the tax burden will inevitably be based on many factors, most observers believe that the extent to which older persons with more assets are taxed more should depend in part on how they acquired the assets. . . . Accumulation by choosing to consume less while young, while others chose to consume more while young, weighs against heavier taxes on those who accumulate assets for retirement,” Wise and Venti said.

Besides food for thought about the policy issues of this and future elections, the paper also provides encouragement for Americans wondering about their economic futures. The findings indicate that with discipline and time, even moderate-income families can build up a meaningful cushion for retirement, and they can do it even if they aren’t really good or really lucky investors.

Obviously, choosing higher-return investments, such as stocks and stock mutual funds instead of bank certificates of deposit or money-market funds, will help. But the biggest difference is not between the stock pickers and bank depositors--it’s between those who save and those who don’t.