Welcome to the 29th issue of Allison’s Ode to the Second Moment, a newsletter that explains why your tax-deferred 401(k) contributions should make you happy, even if nothing else will.
We’ve never had it so good and been more miserable.
Many basic tenants of economics have been under attack lately. Most of the time, I don’t think these criticisms are valid, as supply and demand do hold up pretty well, labor is more or less paid its marginal product, and inflation risk is still a thing. But there is one article of faith that does not seem to be true any longer. We generally assume greater welfare has something to do with more consumption. Many economic models assume what you eat, the trips you take, what you buy, and time off are what really matter—not money, capital, or productivity. From a consumption/leisure perspective, there’s never been a better time to be alive.
Just think about how much living standards have improved since the 1980s, or even 1990s. In rich countries, once unimaginable luxuries—mobile phones, air travel, big houses, and large TVs—are now commonplace. True, health care is more expensive, but it is also much better. Most rich countries’ residents live longer than ever. Yet people seem so miserable, enough so they are demanding radical political changes. According to our economic models, they should be delighted with the state of the world.
I suspect the problem is many economic models don’t meaningfully account for risk. It is not enough to have more stuff, you also need to feel secure you’ll have the same, or more, stuff tomorrow. You also need to feel certain your children will have even more stuff one day. While living standards are higher, there are also elevated levels of economic anxiety.
People may feel less secure for a variety of reasons. Households don’t save enough to have a decent emergency fund and face a variable income. There is also more uncertainty about job security or even what the future economy might look like.
I also think workplace fissure is the biggest thing to happen to the labor market. More firms are out-sourcing admins, janitors, and IT-type jobs to contract firms. That means big companies are full of non-employees. They are usually paid more per hour, but work fewer hours and so their take-home pay is lower than when they were on staff. That may be why we see less wage compression within firms, which has worsened inequality. Or fissure was caused by inequality because skill-based technological change makes wage compression more expensive. Fissure also implies more risk and uncertainty—not only because hours and pay are less certain but also because there is less of a sense of community and belonging among co-workers.
Nonetheless, fissured workers report higher levels of job satisfaction. They enjoy the flexibility and more time off. It’s another example of having more of what we want, but it is undermined by less security.
A tax wonk’s dream comes true—with a catch
Exciting news! There is a scant outline of a bold and ambitious tax reform. Reading most commentary, it feels like the single criteria by which we judge all tax policy is how much rich people pay. But good tax reform balances fairness, progressivity, improves efficiency, and pays our bills.
We don't know much about the details. But so far, there are some things to like and some things to hate. I am pretty psyched to see more broadening of the tax base and a territorial tax system. But the fiscal conservative in me is worried about how we’ll pay for it. Because even if we scrapped all taxes and replaced them with the economists’ favorite, a consumption tax (the most efficient tax of them all), growth would probably only be 0.5 percentage point higher. I like an efficient tax system more than anyone because it means fewer distortions and less waste, but pays for itself?! Probably not.
And don't get me started on entitlements.
401(k)s’ near-death experience
For about 10 minutes this week, it seemed like tax reform would eliminate our beloved 401(k). Turns out it was just a communication error. But talk of scrapping the 401(k) didn’t come out of nowhere. The administration was seriously rethinking 401(k)s’ tax treatment.
Following the communication snafu, I learned lots of people Twitter think 401(k)s are “terrible.”
First, it is not clear that 401(k)s have been an unmitigated disaster. People are only starting to retire with them and replacement rates aren’t as low as some argue. It may be tempting idealize DB benefits or think we should just expand Social Security, but that doesn’t make retirement cheaper or financing it less risky. All it does is transfer the risk to the government and future taxpayers. So much risk in one place is not efficient or desirable. I firmly believe private accounts are just fine; we just need to make them better.
Whether we should eliminate the tax deferral on 401(k) contributions is a fair question. After all, there is evidence that the tax deferrals don't increase saving. But I think the tax treatment is important and worth preserving.
1. A big issue with individual accounts is no one knows how much to spend post-retirement. As 401(k)s are tax deferred, you do have to pay taxes on that income some day. The government makes sure you do pay, it requires retirees to withdraw some of their savings each year. There is evidence this requirement has a meaningful impact on consumption. In 2009, retirees had the option of suspending taking RMDs and many exercised that option. By giving up the tax advantage, the government loses a useful policy lever to modify consumption and tax revenue flows.
2. Tax deferral means higher tax revenue in the future. We are already screwing future generations. The tax deferral is the one gift we’re giving them, which I guess means its time is limited
3. Killing the tax deductibility would mean people could access their accounts without paying a penalty, which, on one hand, isn’t terrible because more than a retirement saving crisis, people lack liquid emergency funds. On the other hand, that means less saving for retirement.
Rather than trash the beleaguered 401(k), we should focus more on expanding coverage. The world is a risky place. It is getting riskier and that makes people anxious. Some people might think the government should bear all that risk—and it certainly has an important role to play. But nothing says security like individual savings.
Until next time, Pension Geeks!