By:
Sondra Beverly, Michael Sherraden, Min Zhan, Trina R. Williams Shanks, Yunju
Nam
Center for Social Development
Washington University in St. Louis
and
Reid Cramer
New America Foundation
March 2008
| This report was prepared for and funded by the U.S. Department of Health and Human Services, Office of the Assistant Secretary for Planning and Evaluation (DHHS/ASPE) under Order Number GS23F8198H / HHSP233200400131U to the Urban Institute and its collaborators at the Center for Social Development (CSD) at Washington University in St. Louis, and the New America Foundation. This report was prepared between September 2004 and March 2006. John Tambornino, Jeremías Alvarez, and Linda Mellgren at DHHS were project officers, Signe-Mary McKernan of the Urban Institute was overall project director, and Michael Sherraden directed the work at CSD. The views expressed are those of the authors and should not be attributed to the Urban Institute, its trustees, or its funders. |
Project Home Page:
Poor Finances: Assets and Low-Income Households
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http://aspe.hhs.gov/hsp/07/PoorFinances/determinants/
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Executive Summary (in PDF format - 6 pages)
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Appendix (in PDF format - 10 pages)
Exhibit ES-1. Determinants of Saving and Investment Action and Asset Accumulation
Exhibit 1. Summary of Neoclassical Economic Theory Related to Saving and Asset Accumulation
Exhibit 2. Summary of Psychological and Sociological Theory Related to Saving and Asset Accumulation
Exhibit 3. Summary of Behavioral Economic Theory Related to Saving and Asset Accumulation
Exhibit 4. Summary of Institutional Theory Related to Saving and Asset Accumulation
Exhibit 5. Determinants of Saving and Investment Action and Asset Accumulation
Exhibit 6. Value of Select Asset-Building Tax Expenditures, Fiscal Year 2006
Exhibit 8. Distribution of Mortgage Interest Deduction Benefit, by Income Class (2003)
The report has benefited from comments of the entire project teams at the Urban Institute and the Center for Social Development, as well as helpful comments from Jeremías Alvarez, Alana Landey, Gretchen Lehman, and Linda Mellgren of ASPE, from Elizabeth Lower-Basch and Michael Wiseman formerly of ASPE, and from John Tambornino and Leonard Sternbach of the Administration for Children and Families/DHHS.
The authors, most of whom are affiliated with the Center for Social Development (CSD), are grateful to the university for indirect support that makes this work possible. This work is informed by a large body of previous work at CSD, involving many staff members on saving-related research projects. Although this work cites these reports and publications, it does not adequately convey the authors’ gratitude toward all who contributed to the thinking and empirical work that underlie this report.
CSD’s research on saving has been funded by many organizations. For applied research contributing to this report, special acknowledgement is owed to the Ford Foundation, Charles Stewart Mott Foundation, Annie E. Casey Foundation, F.B. Heron Foundation, Ewing Marion Kauffman Foundation, and MetLife Foundation.
The authors’ primary affiliations are as follows: Beverly, School of Social Welfare at the University of Kansas; Sherraden, George Warren Brown School of Social Work at Washington University in St. Louis; Cramer, New America Foundation; Zhan, School of Social Work at the University of Illinois, Urbana-Champaign; and Shanks, School of Social Work at the University of Michigan.
Mark Schreiner contributed to this report in multiple ways. Jennifer Adhima, Eunhee Han, Jung Hee Han, Jennifer Kim, and Lin Zhang provided valuable research assistance.
[ Go to Contents ]
Although research on the determinants of saving and asset accumulation is extensive, it remains inadequate for public policy purposes. Most existing theories of saving point to individual characteristics to explain low levels of wealth. Relatively few studies offer research that could inform policy for increasing wealth. This report examines the following question: What factors determine financial asset building? In particular, the report presents a conceptual framework for the determinants of saving and asset accumulation.
The goal is to develop a framework that explains saving and asset accumulation in ways that can inform policy decisions. Thus, the emphasis is both narrow and broad. It is narrow because of the focus on decisions and outcomes related to assets, not decisions and outcomes related to consumption, income, participation in means-tested programs, and liabilities. A broader conceptualization of the economic life of low-income households might also be useful, but is beyond the scope of this report. At the same time, the emphasis is broad because the report seeks to develop a framework that explains saving and asset accumulation across the entire population, while accounting for low levels of saving and wealth in the low-income population. The goal is not to develop theory that applies only to the poor because this theory would not support broad knowledge development and would not connect with larger bodies of work on saving and asset accumulation. That said, the report does give specific attention to three disadvantaged populations — low-income households, minority households, and single-mother households.
The emphasis on assets does not imply that income- and consumption-oriented strategies are undesirable. Economic constraints are very real and probably go a long way toward explaining low saving rates and limited asset accumulation in low-income households. The optimal decision for some very low-income households may be not to save, because saving would require harmful reductions in consumption. Thus, programs and policies that increase incomes and provide important supports, especially health insurance, are critical for the economic well-being of families. Both income generation and asset building are essential in the economic lives of everyone, rich and poor alike. The series to which this report belongs focuses on assets because policymakers (and others) have generally undervalued the role of assets in the economic well-being of low-income families (see Sherraden 1991) and because much more could be done to support the asset-building efforts of low-income families through public policy.
This report is organized as follows: Section II summarizes existing theories of saving and asset accumulation and discusses strengths and limitations, with an emphasis on ability to explain asset building in low-income households. Section III presents the conceptual framework. When applicable, this section considers how the hypothesized relationships might differ substantially for low-income, minority, and/or single-mother households. Because the aim is to develop a conceptual framework that will be of use to policymakers, this section also presents additional conceptual points related to public policy. Section IV reviews empirical evidence that supports or challenges the proposed framework, noting where findings seem to differ for low-income, minority, and single-mother households. The report concludes in Section V with a summary of strengths and weakness of existing empirical evidence and possible directions for future research.
[ Go to Contents ]
This section summarizes and assesses existing concepts and theoretical models of the determinants of saving and asset accumulation. These “theories,” which are at various stages of development, may be classified into three categories: (1) neoclassical economic; (2) psychological and sociological; and (3) behavioral economic. Exhibits 1, 2, and 3 summarize these perspectives, emphasizing their abilities to explain low saving and asset accumulation in low-income households. The last column of each exhibit summarizes explanations for low saving and asset accumulation implied by each perspective. A fourth theoretical category emphasizes institutional determinants of saving and asset accumulation (see Exhibit 4), and is the approach adopted and developed here. This section describes this emerging theory in the context of the conceptual model presented below.
Neoclassical economic theory assumes that individuals are rational beings who respond in predictable ways to changes in incentives. From this perspective, there are two broad determinants of individual behavior: opportunities (or constraints) and individual preferences (Pollak 1998). Preferences are generally assumed to be stable and exogenous (e.g., unaffected by opportunities and constraints). Many economic models also assume that individuals have perfect knowledge and access to perfect markets. Individual utility (i.e., happiness or satisfaction) is usually assumed to be a function of consumption, and economic models often treat savings as a residual, those resources that remain after consumption decisions are made.
The starting points for much neoclassical economic research on saving and asset accumulation have been the life cycle hypothesis (LCH) (Ando and Modigliani 1963; Modigliani and Ando 1957; Modigliani and Brumberg 1954) and the permanent income hypothesis (PIH) (Friedman 1957). Both of these theories assume that individuals and households are concerned about long-term consumption opportunities and therefore explain saving and consumption in terms of expected future income. These models assume that saving is a way to “smooth” consumption in the face of income fluctuations. Since consumption is determined by anticipated lifetime resources (rather than only current resources), saving over short periods of time (e.g., a year) is expected to reflect departures of current income from average lifetime resources. In other words, according to these theories, when current income falls below average expected lifetime income, saving decreases, and individuals and households may even borrow to finance consumption. When current income exceeds average expected lifetime resources, individuals and households save (or repay debt).
| Common Assumptions | Key Constructs | Explanations for Low Saving and Asset Accumulation |
|---|---|---|
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As its name suggests, the life cycle hypothesis posits that consumption and saving reflect an individual’s stage in the life cycle, which is generally proxied by age. Since retirement, for most people, is the most substantial and enduring “income fluctuation,” this model emphasizes saving for retirement as a primary motivation for deferred consumption. Young households are expected to have negative saving since they typically have relatively low earnings and incur debt for education, home purchase, and other expenses. In the middle period of the life cycle, saving is expected to be positive because individuals pay their debts and begin to save for retirement. Upon retirement, households are expected to dissave (i.e., spend money previously saved). Thus, differences in consumption and saving among households are believed to be partly the product of age differences, and the pattern of saving and dissaving creates an inverted U-shaped pattern across age categories and/or over time (Ando and Modigliani 1963; Modigliani and Ando 1957; Modigliani and Brumberg 1954).
In recent years, economists have extended the LCH and PIH. Some models consider the desire to leave a bequest (e.g., Hurd and Mundaca 1989; Menchik and David 1983). “Buffer-stock” models (e.g., Carroll 1997; Carroll and Samwick 1997; Deaton 1991) emphasize a precautionary motive for saving, particularly for younger households and for households facing greater income uncertainty. These households are expected to accumulate small stocks of assets (buffer stocks) to smooth consumption in the face of short-term income fluctuations and liquidity constraints. The pattern of asset accumulation predicted by buffer-stock models is very different than the inverted U-shape predicted by the LCH: Wealth is expected to remain fairly constant (assuming that households have accumulated and can maintain their optimal buffer stocks) until about age 50 when households begin saving for retirement (see Carroll and Samwick 1997, Figure 3). Other models, sometimes called “augmented” life cycle models, have attempted to incorporate the effects of public policy on precautionary saving motives (see Hubbard, Skinner, and Zeldes 1994; 1995, discussed in more detail below in Sections III.D and IV.D, under “Incentives”).
Psychological and sociological theories of saving consider additional determinants of saving and asset accumulation, including personality characteristics, motives, aspirations, expectations, and peer and family influences. Some of the propositions emphasize the effects of relatively stable personality characteristics on asset building. Other psychological and sociological propositions assume that saving-related preferences and aspirations are not fixed and in fact seek to explain how motives, aspirations, and expectations are shaped. The propositions that emphasize relatively stable personality characteristics typically come from psychology. For example, psychologists have examined the effects of “thrift,” “conscientiousness,” “emotional stability,” “autonomy,” “extraversion,” “agreeableness,” “inflexibility,” and “toughmindedness” on saving (e.g., Nyhus and Webley 2001; Wärneryd 1996). The propositions that seek to explain how motives, aspirations, expectations, and even preferences are shaped come from both sociology and psychology. Some scholars have emphasized social norms, suggesting that the norm of “conspicuous consumption” leads people to over-spend (and thus to under-save). Some researchers consider the effects of families and peers. For example, Stack (1974) suggests that demands from social network members for money or other material assistance can sabotage efforts to save. And, the literature on financial socialization (e.g., Chiteji and Stafford 1999; Cohen 1994) suggests that social network members can strongly influence an individual’s consumption patterns, saving-related beliefs, and aspirations and expectations for saving. For example, a child who knows that her family spends carefully and saves regularly, who overhears and perhaps participates in conversations about stock performance, and who is encouraged to have her own savings account is expected to be more financially sophisticated and more inclined to save as an adult than an individual raised in a family that does not save and does not make use of a variety of financial products.
| Key Assumptions | Key Constructs | Explanations for Low Saving and Asset Accumulation |
|---|---|---|
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Other researchers have emphasized the effects of individual experiences. For example, Duesenberry (1949) wrote about personal norms, suggesting that individuals may strive to maintain past consumption levels even when income falls. Economic psychologists (e.g., Furnham 1985; Katona 1975) have proposed that past savings experiences (good and bad) shape individuals’ beliefs about their abilities to save in the future.
The emerging behavioral theory of saving attempts to explain how people actually behave with regard to financial matters. Unlike neoclassical economic theory, these models do not assume that people are rational and all-knowing. As the title of an article by Thaler (2000) suggests, behavioral theory attempts to explain (and make assumptions that are consistent with) the behavior of “Homo sapiens” not “Homo economicus.” Behavioral theorists also assume that financial planning has significant nonfinancial costs.[2]
Behavioral theorists have identified a number of common human characteristics that shape financial behavior, including lack of self-control (people tend to place too much weight on current consumption relative to future consumption); limited cognitive abilities (for example, people do not always learn from their mistakes, and people tend to become overwhelmed by too many choices); inertia (people tend to continue doing what they are currently doing); the tendency to interpret default options as “advice”;[3] and the tendency to use mental accounting techniques.[4] Often, according to behavioral theory, these tendencies lead individuals to behave in ways that are inconsistent with their own priorities or inconsistent with maximizing long-term consumption. For example, the lack of self-control often causes people to over-spend and under-save, even when they are saving for a specific, much-desired goal. Also, limited intellectual capabilities and inertia lead people to postpone making financial decisions.
If people are aware of these tendencies, they may try to compensate for them. For example, people may attempt to control their spending by imposing “precommitment constraints,” such as arranging for direct deposit to saving and investment vehicles. Even if people are naïve about their limitations, saving and investment programs may facilitate saving by deliberately attempting to compensate for these common human characteristics. In fact, behavioral theorists have begun to propose some programmatic reforms and innovations such as simplified investment options and automatic enrollment in 401(k) plans.[5] These program reforms are institutional arrangements that will require an institutional theory for knowledge building that can inform policy and program design.
| Key Assumptions | Key Constructs | Explanations for Low Saving and Asset Accumulation |
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In their current stages of development, none of the existing theories provides a suitable explanation for saving and asset accumulation in low-income households. Neoclassical economic models tend to be specified clearly and tested rigorously, and there is an extensive body of scholarly work. But these models tend to make unrealistic assumptions, such as the assumptions that individuals have near-perfect knowledge and are forward-thinking and rational. In reality, the decisions required to optimize consumption (and other financial goals) over the life course are “extraordinarily complex” (Bernheim and Scholz 1993, 87), and empirical studies suggest that the majority of Americans lack the financial sophistication and information to make even basic economic calculations (Bernheim 1994). Since low-income individuals may also have limited financial sophistication, they may have trouble making optimal long-term decisions regarding saving and consumption. Neoclassical models also assume that saving-related preferences are fixed. The lack of discussion about origins of preferences suggests that preferences are the product of stable personality characteristics. Thus, neoclassical economic models may implicitly “blame” individuals for low rates of saving and asset accumulation, and they may offer no policy pathway for improvement.
Psychological propositions that emphasize personality characteristics also “blame” individuals and have little to offer in the way of policy implications. Some of the propositions offered by psychologists and sociologists attend to the origins of preferences and aspirations and so are less likely to imply that individuals are solely responsible for limited asset accumulation. Relatively few of these propositions have been tested, however.
Behavioral theory is an important advance. This theory is rooted in neoclassical economic theory and tends to have the theoretical rigor of neoclassical models, but it makes more realistic assumptions about individuals (see Exhibit 3). These assumptions (which partly flow from systematic observation of individuals) might be thought of as psychological variables. Thus, behavioral theory complements and advances psychological as well as economic theories of saving.
The number of empirical studies examining behavioral propositions is growing rapidly. Although these studies largely examine the behavior of middle- and upper-income individuals who are eligible for retirement plans, most of these studies provide support for behavioral theory. The section on empirical evidence below provides a summary and assessment of several of these studies. Although behavioral theory appears to describe most individuals quite accurately, it sometimes emphasizes individual deficiencies. Theory could move beyond this focus on individuals to emphasize institutions that can encourage saving and asset accumulation by accounting for, and perhaps even taking advantage of, individual tendencies. The behavioral literature seems to be moving in this direction, and a merging of behavioral and institutional theory seems likely in the future.
[ Go to Contents ]
This section develops a conceptual framework to explain saving and asset accumulation in a way that can inform public policy. The framework is based on an institutional theory presented below, wherein both institutional and individual constructs affect saving and investment, which in turn lead to asset accumulation. Interhousehold sources of asset accumulation through inter vivos transfers and inheritances are also acknowledged but are not the focus of this discussion.
First, individual constructs,[6] including economic resources and needs, informal social support, financial literacy, and psychological variables, such as future orientation and saving-related attitudes are discussed. Next, institutional constructs, that is, characteristics of saving-related programs and policies that can shape saving-related behavior are discussed. The aim of this section is to offer a set of propositions with direct relevance to asset-building policy. The framework places less emphasis on individuals than the theories of saving and asset accumulation described above. However, individual constructs are relevant because individual choices can affect asset accumulation. In addition, knowledge of individuals can lead to the design of institutions that more effectively encourage saving and asset accumulation.
This emphasis on institutions warrants a careful explanation. In neoclassical economic theory, rational and omniscient individuals have preferences and then make decisions in the context of constraints. Behavioral economics modifies this theory by assuming that individuals are not usually all-knowing and rational and that preferences are not fixed. Essentially, behavioral economists are specifying new aspects of the individual for study. In this section, a similar approach to the other “half” of neoclassical theory is presented. This approach attempts to specify the vague area that individuals interact with, known as “constraints,” thus providing a richer, more detailed description of factors that individuals face when making choices.
In economic reasoning, individual preferences (neoclassical view) or cognitions and emotions (behavioral view) determine action. But it can work the other way around. Sometimes an institution will change the action of an individual, and then she changes her “preferences.” For example, participation in a 401(k) plan may result in asset accumulation that can change a participant’s time horizon and assessment of future possibilities. This is the opposite of standard economic understanding, which is that future orientation leads to saving. Both views are probably correct to some extent, that is, forward-looking cognition causes saving, and savings cause forward-looking cognition, a virtuous circle (Sherraden 1991; Yadama and Sherraden 1996).
The institutional theory presented here and behavioral economics can be viewed as different sides of the same coin. Institutions exist and, to some extent, act on their own, and people also respond to them with their saving behaviors. In extreme cases, the saving action is completely due to institutions, or completely due to individual characteristics, but most often it is due to the interplay between these. Thus, individual-level theory and institutional theory are not mutually exclusive, but indeed are complementary. In saving theory and research, however, more emphasis has been placed on individual variables than on institutional variables.
So what does the institutional theory presented here say about saving and asset accumulation? This theoretical perspective places primary emphasis on purposeful institutional arrangements that structure and support asset accumulation (see Exhibit 4). The discussion here builds on an emerging body of work at the Center for Social Development at Washington University in St. Louis. The focus on the role of institutions in saving by the poor was initiated by Sherraden (1991); detailed in Beverly and Sherraden (1999) and Schreiner et al. (2001); and extended in Schreiner and Sherraden (2007), Sherraden, Schreiner, and Beverly (2003), and Sherraden and Barr (2005).
| Key Assumptions | Key Constructs | Explanations for Low Saving and Asset Accumulation |
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The term institutions refers to purposefully-created policies, programs, products, and services that shape opportunities, constraints, and consequences. In the social sciences, the term is often used much more broadly, but the focus here is narrowly on conditions that are put in place on purpose, as in a public policy. Institutions affect world views — and thus actions — because they shape constraints and consequences and expose people to knowledge of opportunities and choices. For example, laws against theft matter not only because people weigh the benefits and costs of theft but also because people — due to limited time, effort, knowledge, and cognition — often skip the benefit-cost calculus completely and instead assume from the mere existence of the law that the net benefits of theft are negative (Schreiner and Sherraden 2007).
From an institutional perspective, saving and asset accumulations are in large part the result of structured mechanisms involving “explicit connections, rules, incentives, and subsidies” (Sherraden 1991, 116). For the non-poor, these mechanisms include deductions for home mortgage interest and property taxes, exclusions for employment-sponsored pension contributions and earnings, tax deferments for Individual Retirement Accounts (IRAs) and Keogh Plans, and employer contributions and tax deferments for employee pension plans. Low- and moderate-income households, with little existing savings, do not have the same access or receive the same incentives from institutions that promote and subsidize asset accumulation (Howard 1997; Seidman 2001; Sherraden 1991). For example, the poor are less likely to own homes, and when they do own homes, they receive little or no subsidy because they have low or zero marginal tax rates and the tax benefits are not refundable.
Some of the institutions that influence saving include formal laws and regulations, financial enterprises, and financial products. From a neoclassical economic perspective, these institutions reduce the cost of saving. A behavioral economic perspective (e.g., Thaler 2000) would emphasize, in particular, that these institutions reduce the need for cognitive processing and self-control on the part of individuals. For example, when firms automatically deposit a portion of income into a retirement account unless the employee opts out, institutions may reduce transaction costs to close to zero and eliminate the need for cognitive processing. In this case, the institution is doing all of the “choosing” and “acting,” and the individual is essentially passive.
The major propositions of the conceptual framework are illustrated in Exhibit 5 and discussed in detail in the following subsections. Many of these propositions appear to be common sense, but it is useful to state them because a theory must be well-specified to be evaluated and tested. And, as the section on empirical evidence shows, some hypotheses that seem common sense have rarely been tested or have less empirical support than one might assume.
Exhibit 5.
Determinants of Saving and Investment Action and Asset Accumulation
Saving action and investment action appear to affect asset accumulation. Saving action refers to “decisions” and “behaviors”[7] that influence the amount of money or other resources held aside as savings (i.e., not consumed). Saving action includes deposit frequency and deposit amounts. It also includes variables related to dissaving, such as withdrawal frequency and withdrawal amounts, because asset accumulation occurs only when individuals “protect” their savings (Beverly, Moore, and Schreiner 2003). Investment action refers to “decisions” and “behaviors” that influence where savings are kept, that is, portfolio composition. Portfolios may include informal saving vehicles (e.g., cash kept at home and savings held by a trusted family member), as well as formal vehicles. Measures of portfolio composition might include dichotomous variables indicating whether or not a household owns various assets (or has money stored in various informal ways) and percentage of total assets held in each of these.
The conceptual framework presented here focuses on simple measures of asset accumulation, such as net worth, net financial worth, and levels of liquid savings, home equity, and retirement savings.[8] The link between saving and investment action and asset accumulation is described in the following simple propositions: (1) deposit patterns affect asset accumulation, (2) withdrawal patterns affect asset accumulation, and (3) portfolio composition affects asset accumulation. The first two propositions are essentially truisms. The third proposition refers, of course, to the fact that some assets have greater returns than others. This proposition is stated very broadly and has nearly universal acceptance in this form. A more specific and “controversial” subquestion — whether homeownership increases the asset levels of low-income households — is the focus here. This question is particularly relevant because home equity tends to be the primary asset for low-income households with assets and because — despite the fact that homeownership is key component of “the American Dream” — there are reasons that low-income, minority, and single-mother households might receive below-average, and even negative, rates of return on housing.
Rates of return on housing are strongly influenced by location and timing of purchase and sale. The supply of and demand for housing vary dramatically by neighborhood, and these affect prices. In addition, real estate markets tend to be cyclical, and rates of return are strongly influenced by whether home prices were inflated at the time of purchase and sale. Because residential neighborhoods are highly segregated by race and class, location is a particularly salient variable for the subgroups of interest. Put simply, the homes that low-income families can afford to purchase tend to be in “less desirable” neighborhoods. As a result of racial and ethnic segregation, minorities tend to have access to even fewer neighborhoods. This spatial concentration may weaken housing markets in these areas, resulting in lower returns (Gyourko, Linneman, and Wachter 1999). Stuart (2003) extends this argument, claiming that current mortgage practices tend to concentrate people with poor credit in particular neighborhoods. Weakened housing markets lead to lower returns and limited opportunities to sell if families experience financial trouble. As a result, he argues, families are more vulnerable to default and foreclosure.
Stuart’s (2003) emphasis on mortgage default calls attention to issues of timing. Presumably, low-income households are more likely than others to experience financial crises that create pressure for them to sell their homes. In these cases, households cannot consider whether market conditions are favorable for sellers in their neighborhoods. Low-income households may therefore be more likely to sell at a loss. A final factor that may reduce rates of return for low-income households is difficulty maintaining homes. When financial strains make it hard for families to make repairs, returns to housing are likely to be much lower.
This section explores several individual constructs expected to shape saving and investment action: economic resources and needs, informal social support, financial literacy, and psychological variables.
As noted in the introduction to this report, economic resources and needs appear to be important predictors of saving and investment action. By definition, low-income individuals have limited financial in-flows, so they have less “extra” money to save. It is also difficult for low-income individuals to finance saving by reducing consumption because reductions in consumption are more costly when consumption is near subsistence level. At the most fundamental level, therefore, low income is a persistent obstacle to saving.
Some specific expenses, however, such as medical expenses, vehicle expenses, and debt payments, probably depress saving in many low-income households. Of course there are other large expenses, such as rent or mortgage payments and, for families with children, child care expenses. And because people move money around within their household budgets, it is probably impossible to say with certainty that a specific expense reduces saving. These three expense categories are the focus here because there is evidence that some low-income families believe these specific expenses create financial hardship and make it difficult to save or maintain assets. As noted in Section IV, however, there is little quantitative research directly linking these specific expenses to saving outcomes.
The first expense category that may be an obstacle to saving is medical expenses, which are heavily influenced by health insurance coverage. Families without health insurance may incur large health expenses, especially when a family member has a chronic condition or experiences a serious acute illness or injury. Even those who have insurance may have large medical expenses if their insurance premiums are not subsidized by an employer or by federal and state governments. Thus, lack of access to subsidized health insurance is probably a barrier to saving and asset holding, although there appears to be little empirical literature on this topic.
Descriptive studies do show that the number of uninsured Americans is rising, that medical expenses are growing and are burdensome for many families, and that low-income and minority families are especially at risk. For example, Census data reveal that almost 16 percent of Americans were uninsured in 2005 and that this percentage has been rising (DeNavas-Walt et al 2006). More than 24 percent of low-income individuals (people with incomes below $25,000), almost 20 percent of African Americans, and almost 33 percent of Hispanics were uninsured in 2005.[9] According to the Kaiser Family Foundation and Health Research and Educational Trust’s Survey of Employer-Sponsored Health Benefits (2004), health insurance premiums rose almost five times faster (59 percent growth rate) than average earnings (12 percent growth rate) between 2000 and 2004. Merlis, Gould, and Mahato (2006) found that 23 percent of families had high health care costs (including insurance premiums, deductibles, co-payments, and other direct costs not covered by insurance) relative to their income over the period of 2001-02.[10]
A second potential obstacle to saving is expenses incurred when vehicles break down (i.e., expenses for car repair and purchase). Empirical evidence regarding the magnitude of these expenses is difficult to find, but it is common knowledge that low-income families tend to drive older, more problem-prone vehicles. Expenses related to vehicle breakdown are probably smaller, over the course of a year, than the other expenses discussed here, but they are mentioned fairly frequently in qualitative studies of low-income families (see below), perhaps because they are irregular and somewhat unpredictable and because families do not budget for them.
The third financial obstacle to saving is partly related to these other two — monthly debt payments, including payments for credit card debt and medical debt. One indicator of problematic debt burden is having total debt payments greater than 40 percent of income. According to data from the Survey of Consumer Finances (SCF), 27 percent of families in the lowest quintile of annual income met this criterion in 2001. This was 2.5 times higher than the figure for all U.S. families (11 percent) (Aizcorbe, Kennickell, and Moore 2003). Another indicator of debt repayment problems is making late debt payments. Data from the 2001 SCF show that 13 percent of debtors in the lowest income quintile were sixty or more days late with at least one loan payment in the previous year, a slight increase from 1998. In the overall U.S. population, seven percent of families were late in making debt payments (Aizcorbe, Kennickell, and Moore 2003). These findings suggest that many low-income households are over-burdened with debt. It may be in a household’s best interest to pay down debt before attempting to accumulate savings, and reducing debt increases net worth, but debt obligations can nonetheless depress saving, including deposits to incentivized accounts.
As Sherraden, McBride, et al. (2005) have noted, households accrue debt in a variety of ways. Some are in debt because of unwise financial decisions, but many accumulate debt gradually because their incomes never quite cover necessary expenses. Others become burdened by debt due to crises, such as health problems, divorce, or job loss. One study of about 1,800 people who filed for personal bankruptcy in 2001 finds that almost half of the bankruptcies may have been due to medical causes (Himmelstein, Warren, Thorne, and Woolhandler 2005).[11]
On average, minority and single-mother households have substantially lower incomes than white households (DeNavas-Walt et al 2006), so, all else equal, they are particularly likely to have trouble saving due to limited economic resources. There are additional economic barriers for single-mother households (regardless of race or ethnicity). A large number of single-mother households do not receive child support; even when they do, they may still struggle to cover basic expenses. By definition, these households have children, and if mothers are employed, the family may have to pay for child care. One study examines the burden of child care expenses for employed mothers with children under age 14. The ratio of weekly child care expenses to monthly household income was 10 percent for never-married mothers and 12 percent for ever-married mothers, compared to 6 percent for currently-married mothers (U.S. Census Bureau 1999). Another Census Bureau report (U.S. Census Bureau 2004) shows that single-mother families are less likely than married-couple families to have health insurance, even though they tend to have poorer physical and mental health (Altman and Taylor 2004). Therefore, single mothers may have higher medical expenses, relative to income, than others. Other studies show that single-parent households are more likely than married-couple households to experience material hardship (e.g., Lerman 2002).
The second individual construct identified here is informal support from social network members. Section III.E “Intergenerational and Interhousehold Transfers” discusses transfers of money, such as assistance with a down payment on a home. Here, the focus is on less-tangible support, that is, the degree to which social network members encourage or hinder efforts to save and maintain assets. It is likely that informal social support affects saving action. For example, encouragement, positive reinforcement, and reminders to save are likely to send the message that saving is desirable and to make saving easier. Social network members may discourage saving by sending the message that “extra” income should be shared with others. This second hypothesis flows from a ground-breaking ethnographic study by Stack (1974), showing that frequent demands from social network members make it difficult for blacks to accumulate assets. For cultural reasons, the pressure to share savings with others may be stronger for black families than for white families.[12] The pressure may also be stronger for low-income families of any race, who are more likely than middle- and upper-income families to have social network members who are struggling to meet basic expenses.
The third individual construct is financial literacy, including both knowledge and skills. Financial literacy likely affects saving and investment action. It seems common sense that people will save more and make better investment decisions when they know how much money is needed to achieve a certain goal, understand compound interest, know how to create a budget, are familiar with saving strategies, understand the trade-off between risk and return, recognize predatory lending practices, and so forth. In fact, the belief that financial literacy affects saving and investment is the fundamental premise of financial education initiatives. The relationship may be weaker than many would assume, however. Financial knowledge may have fairly strong effects on intended behavior, but intentions often do not directly translate into action. The direction of causality is also ambiguous. Following recommended financial practices may lead to increased financial literacy, rather than the reverse. For example, accumulating wealth may motivate people to obtain financial knowledge so that they can better manage their assets (Kotlikoff and Bernheim 2001). Finally, a third variable, such as motivation or future orientation, might influence both financial literacy and financial behavior.
Economists and others have long assumed that personality characteristics and attitudinal variables affect saving and asset accumulation. This report hypothesizes that three psychological variables — future orientation, motives for saving, and perceived ability to save — affect saving and investment action. It is not that these are the only important psychological variables or even the most important ones, but these hypotheses help to illustrate how psychology might affect asset building. Economists, economic psychologists, and other psychologists have done some important theoretical and empirical work in this area, and there is room for more.
Future orientation is defined here as a willingness to invest in one’s future, even when one must postpone pleasure. In different disciplines, future orientation goes by many names. Neoclassical economists have referred to the “rate of time preference.” This is defined as the ratio of the utility of a current dollar and the utility of a dollar delayed one year. People with a high rate of time preference are “impatient”; they require a large compensation to postpone a reward. More recently, behavioral economists have discussed “self control.”
As noted above, the rapidly growing literature in behavioral economics assumes and/or suggests that many if not most people have trouble postponing pleasant experiences. One implication, of course, is that people have trouble saving because saving requires them to postpone consumption, and numerous theoretical articles have suggested that self-control problems lead to under-saving (e.g., Laibson 1997; O'Donoghue and Rabin 1999; Strotz 1956). Consistent with this literature, this report presents the hypothesis that future orientation shapes saving action, that is, that “patient” people deposit more and withdraw less.[13]
The notion of saving motives encompasses two phenomena: how important saving is to an individual and the goal or purpose of savings.[14] This report offers the hypothesis that those with salient and specific saving motives are more likely to save. Neoclassical economists typically emphasize four motives for saving: (1) maintaining consumption during retirement; (2) preparing for income shocks and other emergencies (precautionary saving); (3) transferring wealth to future generations (bequest motive); and (4) purchasing “big ticket” items such as consumer durables, education, or a vacation (target saving). The first three are expected to influence long-term saving, and the fourth to affect short- to medium-term saving and dissaving (Sturm 1983).
In addition to future orientation and motives for saving, aspirations and expectations of success are likely to affect saving action.[15] This report predicts that those who expect saving attempts to be successful are more likely to save (e.g., more likely to deposit, more likely to enroll in saving programs, and so forth). Conversely, those who expect their saving attempts to be “unsuccessful” are less likely to save.
In part, individual saving-related aspirations and expectations are likely to be determined by past experiences, including past asset-accumulation experiences. According to aspirations theory (Lewin, Dembo, Festinger, and Sears 1944), an individual’s aspirations are raised (lowered) according to her success (failure) in achieving them. Applying this proposition to economic behavior, Katona (1975) suggests that an individual who makes progress toward a savings goal is more likely to raise that goal. Conversely, those whose saving attempts are unsuccessful are likely to lower their saving aspirations. If these propositions are true, then there is a potential virtuous circle (people who save and accumulate assets become more confident in their saving ability and so save more) and a potential vicious circle (people who fail in their attempts to save lose confidence in their ability to save and so are less likely to try to save in the future). If low-income families have had limited success with saving in the past, these propositions suggest that they may not even attempt to save money. At the very least, they are likely to set lower savings goals. The experiences of social network members may also be important. If an individual has rarely seen someone else achieve a savings goal, she may not believe that she can be successful. Conversely, if she has seen others save successfully, she is probably more likely to believe that saving is feasible.
Seven institutional constructs are the heart of the conceptual framework offered here. These constructs appear to be important aspects of institutions designed to promote saving and asset accumulation. This particular formulation of an institutional framework is created with an eye toward application, that is, each of the constructs has direct policy relevance. The constructs are: (1) access; (2) information; (3) incentives; (4) facilitation; (5) expectations; (6) restrictions; and (7) security. These seven constructs have emerged from research on individual development accounts (IDAs).[16] As Exhibit 5 shows, the focus is on effects of these constructs on saving and investment action. In other words, it is suggested that the effects of institutional constructs on asset accumulation are largely indirect, through saving and investment action. There are important exceptions. For example, incentives and security almost certainly have strong direct effects on asset accumulation, perhaps moderating the relationship between portfolio choices and asset accumulation.[17] These relationships should be specified and examined in light of empirical evidence. To keep the framework simple, however, the focus here is on the effects of institutional constructs on saving and investment action.
This report hypothesizes that access affects saving and investment action. Access refers to eligibility and practicality. As discussed below, many U.S. households are not “eligible” for programs and policies that encourage asset building — for example, a large portion of the population does not have access to a pension plan in the workplace — and eligibility varies substantially by race and class. Regarding practicality, distance is a major barrier to financial services and other markets in rural areas. Even though markets may exist at a distance, transaction costs in reaching them can make them unavailable. In these circumstances, it is not fully informative to interpret saving and asset accumulation outcomes as resulting solely from individual characteristics and choices; some people have greater access than others.
This report posits that financial information shapes saving and investment action. This information may be general (e.g., basic information about the need for retirement savings, about the trade-off between risk and return, or about the advantages and disadvantages of different types of products); it may also be specific to a particular financial product or program. For example, to participate successfully in a traditional IRA, a person must know that an IRA is available and that she is eligible. She must also know how to choose an appropriate investment, how to make contributions, how to receive the tax deduction, and, later, how to make withdrawals. Some individuals (probably those who are more educated and more comfortable with financial matters) will seek out this type of information, but many will not obtain information unless it is delivered to them in an accessible format.
This report proposes that incentives and disincentives shape saving and investment action. Incentives come in at least three forms: nonfinancial rewards, subsidies, and rates of return. Nonfinancial rewards may include peer relationships, status, or opportunities to learn. The report focuses on financial incentives because it appears that, overall, financial incentives tend to be more important than nonfinancial incentives.[18]
Subsidies are direct or indirect “payments” to those who save in particular saving plans or hold particular kinds of wealth. Often these subsidies directly increase wealth, as in the case of matching contributions for deposits into 401(k)s and IDAs (unless people save less in other forms to offset these subsidies). Other times, these subsidies are not deposited into saving vehicles, so recipients may choose whether or not to save them. For example, tax benefits associated with homeownership and IRA contributions reduce tax liability but do not directly increase home equity or IRA savings. Schreiner and Sherraden (2007) argue that matches in IDAs may encourage saving by low-income people for at least three reasons. First, of course, matches increase the reward to saving and may help compensate for the sacrifice required to defer consumption. Second, matches may motivate people to save by translating a given level of saving into a stock of wealth that is large enough to use for a major asset, such as a house or a college education. Third, the match may be the program feature that catches a participant’s eye and motivates him to enroll in the first place. The first characteristic of matches may be somewhat less relevant to high-income people than to low-income people because deferring consumption is less painful for those with higher levels of consumption. The second characteristic might also be less relevant to high-income people[19] and/or to those considering contributions to 401(k)s, for example, rather than IDAs.
Rates of return are also incentives. The fact that investors seek the highest possible rate of return for a given level of risk provides some evidence that financial incentives shape financial decisions. To consider this proposition more carefully, however, one must ask whether incentives affect: (1) participation in a particular saving plan or program, (2) levels of contribution to the plan or program, (3) and overall (net) saving. The effect of financial incentives on net saving is the subject of much debate. According to economic theory, an increase in the rate of return will not necessarily increase saving for two reasons. First, changes in the rate of return on savings may simply result in the “reshuffling” of the form of assets, with no new saving. Second, for net savers, an increase in the after-tax rate of return has two contradictory effects. Individuals may choose to save more because the price of current consumption increases relative to the price of future consumption (the substitution effect). On the other hand, with higher rates of return, individuals can save less and still enjoy the same amount of future consumption (the “fixed-goal effect,” according to Schreiner and Sherraden 2007).
Common disincentives for saving are unattractive or even negative rates of return, often due to inflation, high fees, and/or investment risk. Reasons that low-income, minority, and single-mother households might receive lower rates of return on owner-occupied housing have been mentioned earlier. Other types of disincentives reduce the need for or even the desirability of assets. Means-tested income transfer programs, such as Temporary Assistance for Needy Families (TANF), Food Stamps, and Supplemental Security Income, are expected to create saving disincentives for two reasons: (1) they provide a certain level of income at the time of economic emergencies; and (2) they have restrictive asset means tests (Hubbard, Skinner, and Zeldes 1995; Ziliak 2003). The first phenomenon is often called the “consumption-floor effect.” Because income transfer programs guarantee a minimum level of income (to some), they create consumption floors. These consumption floors are expected to reduce the precautionary saving motive (the perceived need to save in preparation for sudden economic losses) and are therefore expected to lower saving rates in general. Asset means tests are expected to discourage the accumulation of financial assets because households must spend down or keep their financial assets below asset limits in order to be eligible for transfer benefits. Presumably, asset means tests affect those who are likely to participate in these programs as well as those who are currently receiving benefits (Hubbard, Skinner, and Zeldes 1995; Neumark and Powers 1998). [20] These disincentives, then, are relevant to low-income households (by definition the only households eligible for these programs) and to minority and single-mother households (because they are more likely than non-Hispanic whites and married couples to participate in these programs).
This report posits that facilitation shapes saving and investment action. Facilitation refers to any form of assistance in saving, especially making saving “automatic.” Common examples are automatic payroll deduction and automatic transfers into saving products. Usually, people must arrange for automatic transfers, but after signing up, they no longer have to make conscious decisions to save. In agreement with other research (Beverly, Moore, and Schreiner 2003; Maital and Maital 1994; Shefrin and Thaler 1988), this report posits that these “precommitment constraints” increase deposits because funds for saving are never “in hand” and are therefore much less likely to trigger spending temptations.
Another type of facilitation involves automatic enrollment into a savings plan. For example, employees in a particular firm might be automatically enrolled in the company’s 401(k) plan, with a default investment option, unless they actively opt out or choose a different investment option. (These plans are often called “opt-out” plans.) Automatic enrollment is likely to shape saving and investment action because, as behavioral theory suggests, people often postpone financial decisions and remain with the status quo.
A third and perhaps surprising source of facilitation is the federal income tax system. Many households — especially low- and moderate-income households — receive sizeable federal tax refunds.[21] Building on the notion of mental accounting, Thaler and others have argued that people are more likely to save “irregular” income than regular wage and salary income, especially when the irregular in-flows are large (see Shefrin and Thaler 1992; Thaler 1990). This proposition implies that people are more likely to save out of tax refunds than out of wage and salary income, especially when refunds are large. Thus, by providing sizeable refunds to many households (through the Earned Income Tax Credit and Child Tax Credit, for example), the income tax system may shape saving action.
Expectations are implicit or explicit suggestions about desired saving, investment, or asset accumulation. They are embodied in institutional features such as match caps (amount of money that earns matching deposits), saving targets, and social pressure of peers and staff of saving programs. For example, the fact that up to $4,000 in contributions to a traditional IRA is tax deductible may set up an expectation that individuals save $4,000 a year for retirement. This report hypothesizes that people respond to these implicit and explicit expectations, that expectations shape saving and investment action.
Restrictions are prohibitions, rules that restrict access to or use of assets. Most subsidized saving policies have restrictions. For example, money in 529 college savings plans must be used for college education, and 401(k) savings are not available until retirement.[22] This report hypothesizes that restrictions shape saving action, specifically by helping people resist temptations to spend savings. This hypothesis is consistent with a growing literature in behavioral economics about self-control problems and the tendency to over-spend (e.g., Laibson 1997; Thaler and Shefrin 1981; Thaler 1994). In addition, the fact that people deposit money in simple restricted accounts (such as “Christmas club” accounts) that do not provide higher interest rates than basic savings accounts suggests that some people believe restrictions help them accumulate savings.
Of course, for every individual who makes use of a restricted account, there may be others who desire liquidity. In this case, there is a need for a variety of saving products. If no unrestricted accounts are available, then restrictions might actually decrease saving because some people will choose not to put any money in restricted accounts.
Security refers to freedom from unreasonable risk in saving and asset holding. All households need a safe place to put their money. Therefore, it seems probable that security shapes saving and investment action, specifically that people are more likely to deposit, less likely to withdraw, and more likely to have a diverse portfolio when they can participate in a variety of secure saving policies, programs, and products. Security can be considered at two levels: micro and macro. Micro security refers to protection from risks of lost assets for a particular household and in the shorter-term. Macro security refers to protection from risks for the political economy as a whole and in the longer-term.
Micro security includes both risk of property loss and investment risk. Property loss risk refers to threats of misplacement, theft, and destruction (e.g., through catastrophes such as fire or flood). For most middle- and upper-income savers in the United States, security from property-loss risk of savings is taken for granted with deposits into a financial institution. Not everyone in the world has ready access to and trust in such institutions, however. Where such access and trust cannot be taken for granted, (lack of) security may be the dominant institutional construct in explaining saving action and savings outcomes.
At the micro level, a second type of risk is investment risk. The topic of investment risk is well-developed in microeconomics, usually in relation to rates of return. It is commonly understood that, in competitive markets, riskier investment options, over time, can offer higher rates of return. Therefore, some degree of investment risk is desirable for asset accumulation over the long term, and “security” from this risk can have negative consequences.
Discussion of security would not be complete without also mentioning macro risks to which all asset accumulations are vulnerable. Macro risks have to do with the competence and integrity of the political system, integrity of the financial markets, and management of the macro economy. Whenever assets accumulate, as in a defined contribution retirement plan, these assets may be subject to depletion through mismanagement or corruption. Fortunately, the United States has exceptionally strong, efficient, and transparent financial markets, so macro risks in financial markets are relatively limited. Fiscal and monetary policies greatly affect investment returns. Indeed, inflation risk is often the single greatest threat to long-term asset accumulation.
In addition to individual and institutional constructs, the conceptual framework proposed in this report suggests that intergenerational and interhousehold transfers shape asset building. In particular, this report posits that interhousehold transfers affect investment action (the mix of assets held) and asset accumulation. Transfers take a variety of forms. They may involve living people (inter vivos transfers), or they may occur at death (bequests). They may consist of money, material assistance, or time. Transfers may be consumed or saved. Transfers that are saved increase the recipient’s wealth. Even transfers that are consumed can indirectly facilitate asset accumulation. For example, parental assistance with educational expenses can allow a young adult to graduate from college with little or no debt. The absence of debt in turn makes it easier for the graduate to save and makes her more attractive to mortgage lenders (Shapiro 2004).
One common phenomenon is for parents or other family members to give money to young adults for a down payment on a first home. This down-payment assistance may make homeownership possible for some families. In all likelihood, it reduces the recipient’s monthly mortgage payment — by reducing the mortgage amount and perhaps by eliminating private mortgage insurance — and so frees up money for saving (Shapiro 2004). And when down-payment assistance allows families to purchase homes in neighborhoods that they otherwise could not afford, it can improve their neighborhood environments, their social standing, and their children’s educational opportunities. Shapiro argues that these transfers can have lasting effects: “These head-start assets set up different starting lines, establish different rules for success, fix different rewards for accomplishments, and ultimately perpetuate inequality” (p. 3). As discussed below, low-income families are less likely to receive substantial down-payment assistance.
Another phenomenon is worth mentioning here: The availability of financial help from others may reduce saving for some individuals. For example, individuals who believe that family members will provide money in the event of job loss might be less motivated to accumulate precautionary savings. And those who expect a large bequest or substantial down-payment assistance may save less for retirement or homeownership. On the whole, it seems likely that bequests and inter vivos transfers increase the wealth of recipients, but more empirical evidence on this topic is needed.
The goal of this report is to develop a conceptual framework of relevance for public policy. Therefore, this section describes how public policy currently shapes institutional constructs, illustrating how institutional supports for saving tend to be delivered in “bundles.” This section also describes existing federal asset-related programs and policies that are targeted to low-income households.[23]
Applied social theory and research is complicated by many “real world” factors, one of which is “bundling” of multiple constructs within a single policy, program, or other intervention. Seldom does an intervention represent a single theoretical construct. In asset-based policies, for example, the constructs discussed above — access, information, incentives, facilitation, expectations, restrictions, security — and perhaps others, rarely appear alone, but instead are usually bundled together in some form.
The challenges for researchers are to (1) identify the constructs that may be present; (2) develop measures for each of them; (3) assess each construct in an applied setting; and (4) employ analytical procedures to sort out which constructs may be causing the outcome(s) of interest. In quantitative research, a typical approach would be to use multiple regression, controlling for many individual and program characteristics, to assess which factors predict an outcome — such that the results are statistically significant and effect sizes are large enough to matter for program or policy purposes.
An analytical step beyond this would be to test for interaction effects among constructs of interest. It could be, for example, that information and expectations both independently predict a savings outcome, but have even greater predictive power when they occur together. Or it could be that incentives are not predictive in and of themselves, but the interaction of incentives with access has a strong effect. Testing interactions is one pathway for beginning to understand effectiveness of various bundles of constructs that may be represented in a policy or program.
It seems likely that bundles of constructs for saving action tend to come in common forms. For example, there may be a form that provides mostly security in a “rainy day” fund (e.g., a passbook savings account in the private sector). Other forms may have strong elements of incentives, facilitation, expectations, and restrictions designed for long-term asset accumulation (e.g., a 401(k) retirement savings plan). Thus, some bundles may be better for particular purposes. If inclusive (universal and progressive) asset accumulation is the goal, structured saving plans that represent large bundles of key constructs are likely to be the most effective policy package (Clancy and Sherraden 2003; Clancy, Orszag, and Sherraden 2004; Sherraden 2005). Current examples of savings plans — all of which are created by public policy — include 401(k) plans in the private sector, 403(b) plans in the non-profit sector, the Thrift Savings Plan for federal employees, and 529 plans.
Currently, asset-building bundles tend to be delivered through employment settings and through the tax system. Federal expenditures on the initiatives that provide these bundles of supports are large (see Exhibit 6). For the most part, those who have jobs with benefits, those who are homeowners, and those who are investors have access to these bundles. The next three subsections present the major bundles of institutional supports and show that low-income, minority, and single-mother households have less access to these bundles than others.
The primary institutional supports delivered through employment settings come through retirement benefits, both defined benefit (DB) and defined contribution (DC) plans. These retirement plans support asset building in several ways. Perhaps most importantly, they provide incentives for asset accumulation. Employer matches directly increase wealth (unless recipients offset these matches by saving less in other forms). When employer contributions require a corresponding employee contribution, they also create potential incentives for saving. The federal government provides an additional subsidy and incentive by deducting employee contributions from income (in income tax calculations).
These retirement plans also provide facilitation. When participation is mandatory, deciding to save and acting on this decision require no mental effort. Even when participation is voluntary, the use of automatic transfers allows individuals to precommit, and this greatly reduces the mental effort required to save. The automatic-enrollment or “opt-out” plans described above provide even greater facilitation, by automatically enrolling individuals in voluntary plans unless they elect otherwise.
Employer-sponsored retirement accounts are almost always restricted. In many DB plans, funds are not available until workers reach a certain age. In most DC plans, there are substantial penalties for early withdrawals. Although a sizeable proportion of families do withdraw funds before retirement, especially when changing jobs,[24] on the whole, these restrictions probably help protect retirement savings. Employees who have access to employer-sponsored retirement plans often have access to financial education as well, especially if they work for medium-size or large firms. These educational initiatives — often newsletters or optional group seminars — attempt to motivate and inform employees.
| Asset-Building Tax Expenditure | In Millions of Dollars |
|---|---|
| Housing | |
| Deductibility of Mortgage Interest on Owner-Occupied Housing | 76,030 |
| Deductibility of Property Tax | 14,830 |
| Capital Gains Exclusion on Home Sales | 36,270 |
| Exclusion of Net Imputed Rental Income on Owner-Occupied Housing | 29,720 |
| Subtotal Housing | 156,850 |
| Investment | |
| Reduced Tax Rate for Some Capital Gains | 28,370 |
| Exclusion of Small Corporation Stock from Capital Gains | 250 |
| Step-up Basis of Capital Gains at Death | 28,760 |
| Carryover Basis of Capital Gains on Gifts | 290 |
| Exclusion of Interest on Life Insurance Savings | 24,070 |
| Subtotal Investment | 81,740 |
| Retirement | |
| Net Exclusion of Pension Contributions: Employer Plans | 51,050 |
| Net Exclusion of Pension Contributions: 401(k) Plans | 48,140 |
| Net Exclusion of Pension Contributions: IRAs | 7,310 |
| Net Exclusion of Pension Contributions: Saver’s Credit | 1,170 |
| Net Exclusion of Pension Contributions: Keogh Plans | 9,980 |
| Subtotal Retirement | 117,650 |
| Source: Office of Management and Budget 2005b, Table 19.1 | |
Subsidies, facilitation, restriction, and education all send the message that saving and asset accumulation are desirable. The terms of matching contributions may also set up specific expectations for saving. If a worker receives the maximum employer contribution when she contributes five percent of her earnings to a 401(k) plan, for example, then the plan may create an expectation that employees save five percent of earnings. Similarly, the terms of automatic-enrollment plans may communicate specific expectations about saving for retirement.
Low-income individuals are less likely than middle- and upper-income individuals to have access to these benefits. For example, the first row of Exhibit 7 shows that the percent of full-time private workers employed at firms that sponsor pension plans increases substantially with earnings.[25] Minorities and women also tend to have less access to employer-sponsored pension plans than non-Hispanic whites and men. For example, in 1999, 47 percent of white, non-Hispanic private-sector workers were covered by these plans; the comparable figures for black non-Hispanic and Hispanic workers were 41 percent and 27 percent, respectively. Forty-seven percent of male workers were covered, compared to 40 percent of female workers (U.S. Department of Labor Employee Benefits Security Administration n.d.).
When low-earning workers do have access to pension plans, they are less likely to participate (Exhibit 7).[26] Limited ability to save is almost certainly one important reason for lower participation rates. And, when low-income households are able to save, they may choose to save for more immediate goals than retirement (and may thus prefer less-restricted saving vehicles). Institutional variables probably also play a role. The tax-favored treatment of pension contributions is worth less to households in lower tax brackets than households in higher tax brackets, and worth nothing at all to households with no income tax liability.[27] As Gale, Iwry, and Orszag (2004, 2) have written,
The tax system in general provides little incentive for participation in tax-preferred saving plans to households who most need to save more for retirement and who, if they contribute, are most likely to use the accounts to raise net saving. By contrast, the tax code provides its strongest incentives to those who are generally already better prepared for retirement, and who are more likely to use tax-deferred vehicles as a shelter than as an opportunity to increase overall saving.
| Less than $20,000 | $20,000 - $40,000 | $40,000 - $60,000 | More than $60,000 | |
|---|---|---|---|---|
| Percent of Workers Employed at Firms that Sponsor Pension Plans | 42 | 65 | 78 | 80 |
| Percent of Eligible Workers Who Participated in Pension | 68 | 85 | 92 | 94 |
| Source: U.S. Census Bureau Current Population
Survey, cited in Purcell (2001) Note: Sample includes full-time, year-round, private sector, non-agricultural workers age 25 to 64. |
||||
Homeownership also comes with a bundle of institutional supports. In this case, facilitation and restriction are probably most important. When an individual takes out a mortgage to purchase a home, she has a contractual obligation to make monthly payments, and the portion of each payment that goes to principal directly increases her wealth. Since most people will go to great lengths to avoid mortgage default, little or no mental energy or extra effort is required to “save” monthly in the form of home equity. Also because people will go to great lengths to avoid default and because the transaction costs of selling a home are very high, home equity is quite illiquid. These “restrictions” help protect home equity.[28]
In addition to facilitation and restrictions, there are incentives and subsidies for homeownership. Interest payments on home mortgages and state and local property taxes for owner-occupied homes may be deducted from income (if deductions are itemized). These tax benefits reduce the cost of homeownership (and/or send the message that homeownership is “good”) and so may encourage people to purchase homes.[29] This is important because home equity is the primary asset for many people. In some time periods in some locations, home values have appreciated dramatically. These high rates of return directly increase wealth, and the possibility of “passive” asset accumulation may serve as an additional incentive for saving in the form of home equity. The exclusion of capital gains on the sales of principle residences from federal income tax also provides an incentive and subsidy for homeownership.[30]
Although owner-occupied housing is the primary asset for many low-income, minority, and single-mother households, these groups have less access to homeownership and receive fewer benefits from ownership than others do. The two primary prerequisites for homeownership are assets (to make a down payment) and evidence of “credit worthiness” (to qualify for a mortgage). For a conventional loan, mortgage lenders typically require a down payment equal to 10 to 20 percent of the purchase price.[31] Some evidence suggests that first-time home buyers are having a harder time financing down payments. Using data from surveys of first-time home buyers in 18 major U.S. cities, Mayer and Engelhardt (1996) find that, between 1985 and 1993, the average number of years that households had saved for down payments increased while the average down payment as a percent of purchase price decreased. In addition, the percent of down payment coming from personal savings (rather than gifts or loans, for example) decreased.
A first-time home buyer typically has two main sources for her down payment: her own personal savings and/or transfers from others. Mayer and Engelhardt (1996) find that 21 percent of first-time buyers received gifts for down payments in the late 1980s and early 1990s. For recipients, this assistance was substantial: The average gift equaled 51 percent of the total down payment. Using 1996 PSID data, Shapiro (2004) reports that 54 percent of white and 88 percent of black first-time home buyers said that their down payments came entirely from their own savings. These figures suggest that a substantial proportion of white buyers (and a smaller proportion of black buyers) receive down-payment assistance. These figures may underestimate the importance of transfers because an individual’s savings may have come from earlier gifts or bequests.
In addition to down payments, a potential home buyer must demonstrate the ability to repay her mortgage, and evidence suggests that low-income, minority, and single-mother households have limited access to mainstream credit.[32] Lenders’ assessment of “credit worthiness” depends upon level of income, stability of income, savings, and credit history (Belsky and Calder 2004). By definition, low-income households do not fare as well as others on the first criterion. In addition, many low-income, minority, and single-mother households have fairly volatile incomes because they work seasonally, because they have experienced unemployment, and/or because some or all of their earnings come from informal employment. And, as documented in another report in the Poor Finances series, these households are less likely to have savings.[33]
Credit history provides additional insight to lenders about an applicant’s credit worthiness. Those who have been identified as “credit risks” are unlikely to qualify for mainstream credit. Some of the factors that lead to this label are having a debt-to-income ratio above a certain threshold, a history of missed payments, or a history of personal bankruptcy. Low-income individuals are more likely than others to be identified as credit risks. Other households may be unable to demonstrate credit worthiness because they have little or no documented credit history. Those without bank accounts and credit cards are particularly likely to have this problem (Belsky and Calder 2004). Low-income and minority households are less likely than others to have bank accounts and credit cards (see Aizcorbe, Kennickell, and Moore 2003; Hogarth, Anguelov, and Lee 2005). Single-mother households are slightly less likely than others to have bank accounts and credit cards (Hogarth and Lee 2000).[34] Racial discrimination may serve as an additional barrier to homeownership for minority households. Using PSID data, Charles and Hurst (2002) find that blacks are twice as likely as whites to have applications for home mortgages rejected, even when they control for wealth and proxies for credit history.
This report has already argued that homeownership may be a risky investment for low-income, minority, and single-mother households. In addition, low-income households benefit less than others from homeownership because the subsidies for homeownership are delivered through the tax system. To benefit from the deductions for mortgage interest payments and state and local property taxes, a household must itemize deductions. According to 1998 data from the SCF, only 13 percent of homeowners in the bottom forty percent of the income distribution itemized (Glaeser and Shapiro 2002). In addition, these deductions are not refundable, so households benefit only if they owe taxes. Families that owe taxes but are in the lowest tax brackets benefit less than families in higher tax brackets. Finally, the homes owned by low-income households are likely to be modestly priced, and deductions for mortgage interest payments and property taxes are more valuable for expensive homes (or large mortgages) than for modestly-priced homes (or small mortgages).
Empirical evidence confirms that these deductions disproportionately benefit higher-income families. According to the Joint Committee on Taxation (2003), in 2003, more than half of the benefits of the mortgage interest deduction accrued to households with annual incomes of $100,000 or more (Exhibit 8). Less than ten percent of the benefits accrued to households with incomes below $50,000, and less than two percent accrued to households with incomes below $30,000. Among recipients, the average benefit for households with incomes between $10,000 and $20,000 was about $250; the average for households with incomes between $100,000 and $200,000 was over $2,500. Results from the simulation cited by Woo, Schweke, and Buchholz (2004) predict that, in 2006, the bottom 60 percent of taxpayers by income will receive less than five percent of the combined benefits from the mortgage interest and property tax deductions. The top one percent of tax payers by income is expected to receive almost 11 percent of the combined benefits.
| Annual Income | Amount (in millions) |
Amount (as percent of total) |
Average benefit for recipients |
|---|---|---|---|
| Below $10,000 | $10 | 0.02 | $125 |
| $10,000 to $20,000 | $226 | 0.38 | $246 |
| $20,000 to $30,000 | $898 | 1.52 | $473 |
| $30,000 to $50,000 | $4,600 | 7.80 | $751 |
| $50,000 to $75,000 | $9,829 | 16.66 | $1,088 |
| $75,000 to $100,000 | $11,091 | 18.80 | $1,647 |
| $100,000 to $200,000 | $18,818 | 31.90 | $2,870 |
| $200,000 and over | $13,512 | 22.91 | $6,305 |
| Total | $58,984 | 100.00 | $1,761 |
| Source: Joint Committee on Taxation 2003. | |||
Finally, a bundle of institutional supports is available to “investors,” that is, to those who hold specific, fairly sophisticated saving and investment vehicles. Of particular interest here are individual retirement accounts, such as traditional IRAs, Roth IRAs, and Keogh plans.
The most important institutional supports provided by these programs are incentives, restrictions, and expectations. Incentives are provided through the tax system. For example, contributions to traditional IRAs are deductible (although withdrawals are taxable). Contributions to Roth IRAs are not deductible, but earnings and allowed withdrawals are not taxed.
Traditional IRAs and Keogh plans are restricted. For example, withdrawals taken from a traditional IRA before age 59½ are subject to a 10-percent penalty unless used for higher education or first-time home purchase or unless the account-holder becomes disabled. The maximum deductible contributions for these individual retirement programs may also set up expectations for saving. Unlike employer-sponsored retirement plans, participation in individual retirement plans must be initiated and structured by individuals. Thus, accessing these institutional supports requires effort and financial sophistication, as well as wealth.
Low-income households are eligible for traditional and Roth IRAs, but the participation rate is extremely low. According to estimates by Burman et al. (2004, Table 6), in 2004, only 0.2 percent of tax units in the lowest income quintile contributed to a traditional IRA, and only 0.3 percent contributed to a Roth IRA. The comparable figures for all tax units were 2.7 percent and 2.8 percent. Low-income filers were also much less likely than high-income filers to contribute the maximum amounts.[35] Financial constraints and the desire to save for shorter-term goals almost certainly limit participation by low-income households. Again, however, it is important to note that tax benefits are worth less to households in lower tax brackets. Because the ability to make deductible contributions phases out at higher income limits, low- and moderate-income households receive a greater proportion of the tax benefits for these accounts than they do for the other tax benefits discussed here. Still, Burman et al. estimate that 58 percent of the tax benefits for traditional and Roth IRAs accrue to the top income quintile, and 85 percent to the top two quintiles.
Low-income, minority, and single-mother households have limited access to the federal subsidies related to long-term capital gains, life insurance and annuities, and capital gains transferred through estates. These groups tend to hold more conservative saving and investment products, and the tax-preferred products require greater financial sophistication and/or greater risk-tolerance than vehicles like savings accounts and certificates of deposit. And, these subgroups are much less likely than others to leave sizeable bequests.
The previous paragraphs show that low-income households are much less likely than others to benefit from the policy bundles just described. The federal government, however, has a number of asset-building policies and programs that are targeted specifically to low-income households. The following sections describe some of these major targeted asset-building initiatives and discuss the extent to which these targeted programs provide institutional supports. Federal asset-building initiatives for low-income households include both discretionary spending programs and tax expenditures. Targeted policies exist in at least four categories: homeownership, IDAs, small business development, and tax credits (see Exhibits 9 and 10).
In recent years, the U.S. Department of Housing and Urban Development (HUD) has focused increasingly on promoting homeownership for lower-income households, spending about $2 billion of HUD’s overall discretionary budget of $32 billion on targeted homeownership programs. By far, the largest HUD program promoting homeownership is the HOME Investment Partnership Program (HOME). HOME can be used to support homeownership and provide rental assistance. State and local officials have flexibility to determine how to best address their community’s low-income housing needs, and in recent years, the percentage of funds devoted to homeownership has increased. Support for homeownership includes down-payment and rehabilitation assistance. In 2003, a new set-aside within HOME, the American Dream Downpayment Initiative, was authorized. These funds provide grants of up to $10,000 to low-income, first-time homebuyers for down payments and closing costs. Funds may also be used for some rehabilitation and home repair of housing acquired with assistance.
Another source of federal assistance for low-income homebuyers is the Community Development Financial Institutions Fund (operating under the Treasury Department). This fund promotes economic revitalization and community development by investing in and providing assistance to community development financial institutions. These institutions, in turn, provide loans, investments, financial services, and technical assistance to underserved populations and communities.
A third important source of federal assistance for low-income home buyers is the Federal Housing Administration (FHA). FHA has recently expanded its suite of products, but its primary mission is to provide mortgage insurance on loans made by FHA-approved lenders. A significant portion of low-income borrowers use FHA products when purchasing a home, and these products help reduce the barriers to homeownership. The FHA generates money for the federal government.
While IDA programs are relatively new, they have received some support from the federal government through the Assets for Independence Act (AFIA) and the Office of Refugee Resettlement. Enacted in 1998, AFIA created the first federally-funded national demonstration program for IDAs. Through AFIA, the Office of Community Services in the Administration for Children and Families (ACF) within the Department of Health and Human Services (HHS) awards five-year grants to nonprofit organizations and to government or financial institutions partnering with nonprofits. Grant recipients must provide an equal amount of funding from private sources. Federal funds may be used to administer programs and to provide matching funds for IDA deposits. IDA funds must be used to purchase a first home, pay for higher education, or capitalize a small business. As of 2005, 216 agencies and community-based groups across the nation had been awarded grants to implement 317 AFIA projects. There are more than 1,100 subrecipient agencies and organizations active in these projects. In these AFIA projects, participants had established more than 34,000 IDAs and had saved a total of $24.8 million.
| Actual 2004 |
Estimated 2005 |
Requested 2006 |
|
|---|---|---|---|
| Department of Housing and Urban Development | |||
| Self-Help Homeownership Program | 25 | 52 | 30 |
| Housing Counseling | 40 | 38 | 40 |
| American Dream Downpayment Fund | 87 | 50 | 200 |
| Family Self-Sufficiency – Voucher Program | 48 | 46 | 55 |
| HOME Investment Partnership Program | 1,859 | 1,788 | 1,730 |
| Department of Treasury | |||
| Community Development Financial Institutions | 63 | 56 | 8 |
| Department of Health and Human Services | |||
| Assets for Independence Demonstration Program | 25 | 25 | 25 |
| Small Business Administration | |||
| Microloan Program (loans) | 23 | 10 | 0 |
| Microloan Program (technical assistance) | 15 | 15 | 0 |
| Program for Investment in Microentrepreneurs | 5 | 5 | 0 |
| Source: Office of Management and Budget 2005a | |||
| Earned Income Credit | Child Tax Credit | Saver’s Credit | |
|---|---|---|---|
| Phase-Out Range (2004) | |||
| Married Filing Jointly | $15K - $35.5K | $110K - $170K | $30K - $50K |
| Head of Household/Single | $14K - $34.5K | $75K - $135K | $15K - $25K |
| Number of Claimants (2002) | 21.9 million | 25.7 million | 5.4 million |
| Total Value of Claimed Creditsa (Estimated, 2006) | $39.5 billion | $46.0 billion | $1.2 billion |
| Sources: Internal Revenue Service 2005;
Office of Management and Budget 2005a a The total value equals the value of outlays (refunds) plus the value of tax expenditures (forgone tax payments). |
|||
In a separate program, the HHS/ACF Office of Refugee Resettlement (ORR) awards grants to nonprofit organizations providing IDAs to refugees. Since 1999, ORR has awarded approximately $78 million which has funded approximately 20,000 IDA participants. While there is no specific budget line to support refugee IDA programs, it has been funded through the ORR discretionary budget. This budget item has fluctuated in recent years; the most recent ORR IDA program announcement was issued in FY 2007.[36]
The federal government offers a number of programs to support small business capitalization, mostly through activities of the U.S. Small Business Administration. Only a few of these programs — including the Microenterprise Development Initiative, Microloan program, and Program for Investment in Microentrepreneurs — are targeted to lower-income borrowers. Most of these programs are small and primarily provide loans and technical assistance to microenterprises.
As noted above, several large tax expenditures support asset building for primarily middle- and upper-income households. Two tax expenditures, the Saver’s Credit and the Earned Income Tax Credit (EITC), are targeted to low-income households. A third, the Child Tax Credit (CTC), is available to a broader segment of the population but also benefits low-income households. These tax expenditures are described here.
The Saver's Credit was created in 2001 to encourage low-income people to save for retirement. It provides up to a 50-percent tax credit for up to $1,000 in contributions to retirement accounts, including 401(k) plans and IRAs. This credit, however, is nonrefundable, so it benefits only those with federal tax liability.
The EITC is a federal income tax credit for low-income workers. In tax year 2004, working families with children were eligible for the EITC if they had incomes below about $30,000 to $36,000, depending on number of children in the family and filing status (Internal Revenue Service n.d.). That same year, the average EITC claim was $1,834 (Kneebone 2007).[37] The EITC is refundable, so an individual receives a refund if the credit amount exceeds her tax liability.
The EITC was not explicitly designed to encourage asset building.[38] There is evidence, however, that it does facilitate asset accumulation, especially (perhaps) when linked to initiatives explicitly designed to encourage saving and asset accumulation. As discussed earlier, behavioral theory suggests, and some empirical evidence confirms, that people view lump-sum refunds differently than wage and salary income and may be more likely to save and/or purchase assets with refund payments. This has led both for-profit and not-for-profit organizations to offer a variety of saving products at the time of tax preparation, including low-fee bank accounts (Beverly, Romich, and Tescher 2003), IRAs (Duflo, Gale, Liebman, Orszag, and Saez 2005; Tufano and Schneider 2004) and IDAs. Another program encouraged EITC recipients to “split” their refunds, directing part to a savings account and receiving the rest in the form of a check for consumption (Beverly, Schneider, and Tufano 2006).[39]
The CTC is also a federal income tax credit, worth up to $1,000 to eligible tax filers for each qualifying child. In tax year 2004, eligibility began to phase out at $75,000 for single heads of household and $110,000 for couples filing jointly. The CTC is only partially refundable. Like the EITC, it is not explicitly an asset-building initiative, but it does affect the potential of a lower-income family to build assets by reducing its tax liability and perhaps increasing the size of its tax refund.
It is not yet possible to say, with confidence, whether targeted asset-building programs described above substantially increase the assets of participants. This important question requires detailed information about a variety of assets and some reasonable estimate of how asset levels would have changed in the absence of the programs. IDAs are probably the most-researched of all the initiatives listed here, and a small body of research suggests that some IDA saving is “new” saving (see discussion under “Incentives” in Section IV.C). In the absence of more information about impact, the scope of these targeted initiatives and the level of institutional support provided is described here.
The low-income targeted initiatives described here may be assessed, in part, by the amount of appropriations designated for each. For fiscal year (FY) 2006, about $2 billion was requested for the HOME Investment Partnership Program and the American Dream Downpayment Fund (Exhibit 9). Expenditures for the Saver’s Credit were expected to be about $1.4 billion (Office of Management and Budget 2005a), and $25 million was requested for the Assets for Independence demonstration program. No funding was requested for the microenterprise programs under the Small Business Administration (Exhibit 9).[40]
The targeted initiatives may also be assessed in regard to their accessibility. IDA programs often require that participants be employed, and the IDA programs funded by the Office of Refugee Resettlement are limited to refugees. The EITC is limited to individuals with earnings, and childless workers who are eligible for a small credit. Small business programs are available to those who have or are starting their own businesses. In addition, an application or a meeting with a case manager may be required for individuals who wish to participate in a homeownership, IDA, or small business programs. Such requirements may limit participation.
With regard to information, it is difficult to say whether information needed to participate successfully in targeted programs is more available or less available than information related to homeownership and retirement saving benefits. One study suggests that less than two-thirds of low-income parents knew about the EITC in 1999 (Phillips 2001). The authors are aware of no empirical evidence about knowledge of the other targeted programs described here. Presumably, social service agencies provide information about these targeted programs to potential participants, but individuals who are not connected to these agencies may have no source of information about these programs.[41] Moreover, the motives or incentives for providing information differ for targeted programs, compared to homeownership and retirement saving initiatives. For the targeted programs, the motivation to educate comes from the “good will” of nonprofit organizations and staff members, that is, from the desire to provide resources to disadvantaged families. For homeownership and retirement saving initiatives, there are individuals and organizations — realtors, lenders, and investment companies, for example — that receive clear benefits when new “participants” are recruited. Also related to information is the fact that most of these targeted programs require some degree of financial sophistication. It takes financial knowledge and confidence, for example, to purchase a home or start a small business.
Of the targeted programs described here, IDAs have the most obvious incentives for saving. These incentives are generous in percentage terms, but benefits are capped, and the dollar amount transferred can be far less generous than, say, retirement pension benefits. In addition, federally-funded IDA programs are small, in budgetary terms and in terms of people served, and do not have permanent funding streams. Also, to receive AFIA funds, nonprofit organizations must provide match money, a requirement that does not exist in the tax expenditure programs supporting homeownership and retirement savings. The Saver’s Credit also provides an incentive for saving, but this program is limited in scope because only filers with federal income tax liability benefit.[42]
With regard to facilitation, automatic enrollment is not often available for these targeted programs. For some, automatic transfers can be arranged, if the participant has a bank account or, in the case of the Saver’s Credit, access to a 401(k) plan. The EITC and CTC provide some facilitation, to the extent that income tax refunds are more “save-able” than more regular income. In some IDA programs, staff actively encourage and sometimes assist participants in making a monthly saving deposit.
As discussed below (Section IV.C, under “Expectations”), there is some evidence that IDA programs create expectations for saving and asset accumulation. IDA program staff create these expectations, and some participants come to view the monthly IDA saving target itself as an expected saving amount. These expectations seem to help some participants save. In theory, the Saver’s Credit could create expectations for retirement saving, but there is no empirical evidence on this topic.
Most of the targeted programs discussed here have restrictions. For example, financial assistance from homeownership programs may be used only for homeownership, support from microenterprise programs is restricted to small business efforts, matching funds for IDA deposits may be used only for approved purposes, and deposits that qualify for the Saver’s Credit go into restricted retirement accounts. There are no restrictions associated with the use of the EITC and the CTC (consistent with the fact that these are not explicitly designed as asset-building programs).
Very likely, for most participants, these targeted programs are perceived as secure. Although there are risks involved with investing in a small business, purchasing a home, and contributing to a retirement savings plan, receiving additional support for these activities through these targeted programs creates no additional risk.
In sum, these targeted programs provide much less institutional support for saving and asset accumulation than the homeownership and retirement saving initiatives that operate through the tax system and through employers. In large part, this is due to substantial differences in size and scope. Targeted programs reach far fewer people, they are primarily available only to those with earnings, and the financial benefits provided are typically much lower in dollar terms. Like the “non-targeted” initiatives, targeted programs provide restrictions and security, and some provide incentives and expectations. But these institutional supports are available only to the small portion of the low-income population that applies for assistance and satisfies eligibility requirements. In the case of employment-based retirement pensions, institutionalization of saving can be almost total and continuous; that is, the participant does nothing month after month, year after year, and the savings continue to accumulate. Targeted programs do not lend themselves to such ex