Kill the 401(k)?
The accounts cost the government billions—and they might not be helping us save.
Harvard economists Chetty and Friedman embarked on this project primarily because they wanted to inform American rather than Danish tax policy, and they have gotten some pushback on whether it’s appropriate to apply their Danish findings to U.S. taxpayers. This skepticism strikes me as misguided. It’s surely the case that Danes and Americans have different preferences—Danes love herring, rye bread, and socialized medicine in a way that many Americans find puzzling. But it’s harder to make the case that the average American is more attentive to his pensions and taxes than the average Dane.
If the study’s findings do indeed have universal application, it suggests that the world is divided into two types of people—what the authors call “passive” and “active” savers. Most of us—about 85 percent—fall into the passive camp, where behavioral "nudges"’ make us save more without even thinking about it. By contrast, as a means of boosting savings, tax incentives seem twice damned—most of us don’t pay enough attention to respond to them, and those who do simply undo their effects by shifting funds in and out of other savings accounts; there’s not necessarily a net gain in savings.
It’s unlikely that Republicans would agree to a national “nudge” like a defaultpension contribution that could be changed only through deliberate action. It would strike libertarians as another case of heavy-handed government treading on individual liberty. And they may have a point—as Glenn Hubbard, the dean of Columbia Business School (where I teach) and economic adviser to the Romney campaign points out, who is to say what the “right” level of default savings should be? For example, it’s important to have savings on hand for a rainy day, and locking people into savings instruments that can’t be touched until retirement could have many negative consequences. This problem could be exacerbated by the fact that it’s the passive, unsophisticated savers who are most likely to blindly stick with the default—at least some of these unsophisticated savers are also likely to find themselves with pressing money problems.
But getting rid of the tax shelters that burn a $100 billion hole in the government balance sheet might be one reform both sides can get behind. In a recent conversation with me, Hubbard echoed the study’s sentiments that 401(k)s and IRAs are essentially subsidies to relatively wealthy households that are well-informed enough to take advantage of them. Or, in Hubbard’s words, these types of programs act as “a tax on the unaware.”
If we decide it is a national priority to promote savings, maybe there’s a middle ground that would at least partially satisfy both sides. For example, the government could provide tax incentives to companies—who presumably are sophisticated about their tax bills—to provide savings ”nudges” to their workers, perhaps choosing the default that best suits their employees. That way, at least the decision is made by a local manager rather than a Washington bureaucrat.
But the biggest takeaway from this study may be that we don’t need across-the-board cuts in deductions or exemptions—they’re not all created equally. Some—like savings tax shelters—starve the government of tax revenue without doing much to encourage retirement savings or furthering other policy objectives. Distinguishing which well-meaning programs accomplish their objectives and which ones misfire is a delicate task. And it’s where research like the Danish tax study comes in, to guide policymakers toward more efficient policies and a more effective government.