The Middle Class's Lost Future

Americans need to save more -- and the government needs to make that easier.

| Tue Aug. 30, 2005 3:00 AM EDT

Article created by the Center for American Progress (link)

The middle class is in an economic bind. The savings rate reached zero percent in June 2005. This is not because many households don’t want to save more, but because they often can’t. Stagnant wages and rising prices have caused families to borrow record amounts of money to make ends meet. Many families’ financial situation is actually worse than it appears on paper because the majority of their wealth is in the housing market, which is likely vastly overvalued. A reasonable correction in the housing market could quickly lower household wealth relative to families’ incomes. Without sufficient savings as a safety net for emergencies and as something to rely on in retirement, many more families will continue to struggle not only in their working years, but also well beyond. A reasonable savings policy could address this shortfall by increasing middle-class families’ income growth and providing them with adequate tax incentives to save.

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On August 2, the Bureau of Economic Analysis reported that the personal savings rate had dropped to zero percent in June 2005. Personal savings are the share of personal income that is not used to pay taxes and that is not spent on consumption, such as food, clothing, cars, health care, and housing, among other things.

Hidden in this calculation is the fact that employers’ contributions to pension plans and health insurance are counted as personal income. That is, a zero savings rate means that families not only spent all of their take home pay, but they also spent the equivalent of what their employers contributed to pension and health insurance plans by borrowing.

It is often contended that the U.S. is a society of consumers and that people value shopping today more than saving for the future. After all, U.S. personal savings rates tend to be lower than those in other industrialized countries.

However, this assumption only explains a low savings rate, not a declining one. According to this argument, middle-class families should have become increasingly enamored with going to the mall. The reality is that given low levels of wealth for many middle-class families, longer life expectancies, the loss of employers’ pension and health insurance plans, rising oil prices, and general middle-class anxieties, middle-class families are limiting their spending to necessary items. Hence, stagnant wages and rising costs for crucial items – health care, college education and housing – have left less in the pockets of middle-class families to put away for their future.

Another argument states that middle-class families have no need to worry since their inability to put money away today is offset by the fact that whatever assets they own have grown in value. In recent years, household wealth has risen largely because of the rapid appreciation of homes. This appreciation has been so fast that, even though families have typically taken out mortgages faster than their homes have appreciated, the absolute value of their home equity has still climbed. Ignoring for a moment that household wealth is very unequally distributed, total wealth grew on average to five times the disposable income of households in early 2005 – about the same level of household wealth at the end of the last business cycle in March 2001.

However, most observers agree that the housing market is overvalued. By reasonable calculations, housing prices have risen 20 to 30 percent faster than comparable items, i.e. rents. If housing prices had dropped by 20 to 30 percent, household wealth would have declined to about four and a half times disposable income. Much of what households now show on their balance sheets may turn out to be a mirage. The decline would be worse for many middle-class families who already have little equity in their own homes due to massive new mortgages. After all, while the value of a home declines, the money owed to the bank does not.

Importantly, it doesn’t look like families will necessarily start saving more if the values of their homes decline. Despite the massive wealth losses incurred in the stock market crash after 2000, families continued, by and large, to save less than before. This reflects again the fact that many households do not save more because they don’t want to, but because they often cannot afford to.

Without adequate savings, households are moving towards a bleak future. Many households are already struggling financially, leading them to declare bankruptcy in record numbers. Moreover, if vast swaths of middle-class families continue to save little for their future, they will either have to work longer than expected or retire with substantially less income in the future.

Getting America’s middle class to save more is in the national interest since it would mean that fewer families would have to endure the hardships of bankruptcy, that people could be more self-reliant in their old age, and that America would have to borrow less money overseas to compensate for the lack of domestic savings.

A reasonable savings policy could accomplish this. The first lesson is that many families do not save more because they don’t want to, but because often they simply can’t. Promoting policies that would allow families to earn a decent living, such as a higher minimum wage or the right to join a union, would go a long way to help America’s middle class save more for its future. Other policies could end the upside-down tax incentives for savings, which give the biggest rewards to high-income people, who often already save enough, and the smallest or no incentives for many middle-class families. Instead, the government could broaden existing matches for lower-income families to save, expand them to middle-class families and make them refundable, so that families too poor to pay income taxes would actually receive benefits from such a policy.

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