Peter Orszag, Sebago Associates
A Progressive Pension Package
Sound pension reform entails directing more of the pension-tax incentives to middle- and lower-income workers. Three pension reforms could become components of such a progressive pension package. First, a progressive government matching formula - one that provides relatively larger matches to lower-income workers than higher-income workers and is available to all lower-income workers - would be highly beneficial. Second, certain plan rules could make it easier to save. In particular, participation is significantly higher if workers are enrolled in a savings plan unless they specifically opt out of the plan, compared to the participation rate if workers are not enrolled in the plan unless they specifically opt in. Third, financial education appears to be effective in bolstering private retirement saving and elective pension contributions, particularly among lower-income workers.
Towards a Progressive Pension System: Three Proposals for Reform
Given the gaps in the current pension system, sound reform entails directing more of the pension-tax incentives to middle- and lower-income workers who currently are saving little, if anything, in pensions. This emphasis would increase the likelihood that any pension contributions reflect new saving rather than just shifts in assets (since low-income workers are less likely to have significant other assets to shift into tax-preferred pensions). In addition, basic fairness suggests that pension reforms should be progressive. About two-thirds of the benefits from existing tax preferences for pensions accrue to those in the top fifth of the income scale. Any additional preferences should be less skewed.
Perhaps the most auspicious approach to bolstering retirement income security among lower- and moderate-income workers involves a progressive government matching formula. Under such a program, the government would contribute some amount for each $1 deposited by a lower-income worker. The government "match" rate would be set higher for contributions made by lower-income workers than for contributions from middle-income workers, making the matching system progressive.
Data on participation rates in 401(k) plans among lower- and moderate-income workers suggest such a progressive matching approach could be highly beneficial. About half of lower- and moderate-income workers participate in a 401(k) plan if offered the chance. Unfortunately, the vast majority of lower-income workers are not offered such a chance. To be sure, those offered the opportunity to participate in a 401(k) plan may be different (in terms of their propensity to save) from the rest of the low-income population. But the evidence suggests that a progressive government matching formula - one that provides relatively larger matches to lower-income workers than higher-income workers and is available to all lower-income workers - would be useful. Several variants of a progressive government matching contribution have been proposed and merit consideration.
The second component of a progressive pension package involves making it easier to save. The evidence suggests that whether workers must affirmatively indicate they want to participate or whether they can be automatically enrolled in a pension plan (unless they object) significantly affects participation rates. In particular, participation is significantly higher if workers are enrolled in a savings plan unless they specifically opt out of the plan, compared to the participation rate if workers are not enrolled in the plan unless they specifically opt in. The Internal Revenue Service has recently extended automatic enrollment options to a wider array of defined contribution plans. In addition, several recent proposals have involved a "payroll deduction" IRA, which would facilitate easier participation in IRAs. Such reforms may help to bolster retirement savings.
Third, financial education appears to be effective in bolstering private retirement saving and elective pension contributions. Financial literacy is surprisingly low in the United States. As one example of the "education gap," a 1998 Employee Benefit Research Institute (EBRI) survey concluded that only 45 percent of workers have even attempted to figure out how much they will need to save for their retirement. The evidence also suggests that the impact of employer-provided financial education on lower-income workers is greater than on higher-income workers. Expanded financial education campaigns and more encouragement to firms to provide financial education in the workplace may prove beneficial in raising retirement security for lower- and moderate-income workers.