By Joe Valenti and Christian E. Weller
Could you come up with $2,000 in 30 days to deal with a car breakdown or another emergency? Having even modest savings can prevent families from skipping doctor visits and missing meals when financial challenges such as a medical emergency or an unemployment spell arise. Unfortunately, two in five Americans report that they probably or certainly wouldn’t be able to come up with $2,000 in a pinch, according to a 2012 survey by the FINRA Investor Education Foundation . And the lack of retirement savings will prevent millions of households from maintaining their standard of living in retirement.
Savings are lower for communities of color than for whites. Data from the Federal Reserve, for instance, show that white families’ median wealth—more than $130,000—was six and a half times the median wealth of families of color, at $20,400, in 2010, the last year for which data are available. And communities of color sustained greater wealth losses during the Great Recession from 2007 to 2009.
Although our government offers a lot of financial incentives to save, those incentives are often not targeted to those who need it the most. The federal budget includes $158 billion annually in tax breaks for retirement savings alone, but these tax breaks tend to be of greater value for higher-income earners than for lower-income ones. Congress should establish savings matches that are better-targeted incentives for lower-income families than the current ones.
Most federal tax incentives for saving are in the form of deductions that reduce the amount of taxable income. In other words, a family earning $50,000 per year and saving $2,000 in a tax-deductible retirement account would only pay taxes on $48,000. Because higher incomes are taxed at a higher rate, high-earning families benefit much more from deductions than middle-class families do. For every $2.53 placed in a tax-advantaged savings vehicle such as a 401(k) plan, taxpayers in the highest bracket of 39.6 percent save a dollar in the taxes they owe.
But the incentives are much smaller for taxpayers in lower tax brackets. For a middle-class family earning $50,000, it takes nearly $7 in savings to reduce the income tax burden by a dollar. And for low-income families who pay payroll taxes but not federal income taxes, deductions provide no incentive at all. That’s why 80 percent of the benefits from retirement savings incentives – the bulk of the government’s incentives — flow to the top 20 percent of Americans, who likely would have saved anyway. It’s not surprising that in a speech last week, President Obama called inequality “the defining challenge of our time.”
Yet growing evidence shows that working families can, and will, save when given matching incentives. In 2011, some low-income families in New York, Newark, Tulsa, and San Antonio were offered a 50 percent match —an extra 50 cents for every dollar they contributed—if they saved part of their tax refund and didn’t touch the money for a year. Despite having an average income of only $18,000, two-thirds of participants successfully held onto their savings and kept the match.
Millions of Americans with retirement accounts already know the power of matching contributions. Many employers match contributions to their retirement plans, such as 401(k)s–chipping in an extra 50 percent of the first 5 percent of pay that workers contribute in the case of the typical plan. And in eleven states, some families contributing to college savings accounts can receive a matching contribution from the government to encourage parents to put aside money for their children’s education. These college savings matches, however, are often only available to a limited number of families who apply each year.
Adding progressive, refundable savings credits as government matches would ultimately make savings incentives work better for the families who need them the most. Progressive matches would offer larger matches to lower-income savers than to higher-income ones. And, all eligible savers would receive the full amount of the credit if it is refundable, whether people owe any federal income taxes or not. All savers who qualify would receive a tax credit deposited directly into their savings account in exchange for saving during the year.
In his speech, President Obama noted that many Americans are frustrated with Washington. But he also noted that “their frustration is rooted in their own daily battles—to make ends meet, to pay for college, buy a home, save for retirement.” As Congress considers all aspects of the federal budget, including the efficiency of existing tax breaks, they should focus on putting federal incentives into matching credits for working families –an approach that works to build savings for those that need it the most. These reformed savings incentives will certainly help build the economic security of our communities of color, our economy’s growing driving force.
Dr. Christian E. Weller is a Senior Fellow at American Progress and a professor of public policy at the McCormack Graduate School of Policy and Global Studies at the University of Massachusetts, Boston. Joe Valenti is the Director of Asset Building at American Progress, whose work focuses on improving the ability of low- and moderate-income consumers to participate in the financial sector and to make the most of their resources.