As the United States has stepped back from public options in housing (much the way it did in education), the larger problem is that policies intended to aid low-income families have operated against a backdrop of political, residential, and economic segregation that has tended to isolate poor families and to cluster them in specific areas.48
Looking ahead, a new generation of housing policies can—and should—target racial and economic isolation. For instance, new public housing might be built with greater attention to building mixed-income and mixed-race communities. Low-income housing, whether public or subsidized, might be mixed together with moderate-income housing. And vouchers might be redesigned to help families move out of high-poverty areas.49
America’s Romance with Private Markets
Today, public options like the U.S. Postal Service, public libraries, Social Security, and public schools continue to serve the vast majority of Americans very well. Ninety percent of Americans consider public libraries important to their communities.50 More than 80 percent of Americans are willing to pay Social Security taxes because the program provides security and stability to citizens. A majority of Americans give their local public schools high grades for quality.
But even as public options like these continue to define what it means to be American, the idea of direct government services has fallen out of favor. Since the 1970s, U.S. policy makers have been engaged in a romance with the free market. Libertarian ideas were fringe stuff in the 1960s, but by the end of the 1970s, politicians of both parties had succumbed to the allure of the “free market.” Economists in the government and the academy spread the gospel, preaching that free markets are best and that government is too bloated and too corrupt to provide reliable services.
But the Great Recession that began in 2008, if it taught us anything, taught us to be skeptical of claims about the honesty, transparency, and efficiency of private firms. This book is a post-romantic effort: we think that analysis rather than faith should guide policy makers. We don’t have blind faith in public administration, but neither do we have blind faith in private firms. It’s fair and right to ask which is the best form of administration given a particular context, history, and the nature of the task at hand.
Moreover, one of the key contributions of public options is that we need not give an all-or-nothing answer. We see public options as a way of harnessing government’s best features and power while also preserving the best features of markets. In the next few chapters, we challenge the status quo and show why public options are worth taking seriously once again.
Part Three
THE PUBLIC OPTION AND PUBLIC POLICY
7
Retirement
The daily news coming out of the Trump White House has pushed other public concerns to the side. And that’s a big problem, because policy makers are distracted from dealing with America’s retirement crisis, as well as other pressing issues. The typical middle-class household nearing retirement has just $60,000 in pension wealth—not much when retirees can now expect to live twenty years past age sixty-five. Low earners have half that sum.1 The sobering fact is that more than half of American households are at risk of running out of money in retirement.2 Social Security will continue to provide a secure floor that staves off the worst destitution, but it was never intended to fully fund anyone’s retirement.
From the era of the Treaty of Detroit onward, the plan was that retirement security would be provided in three complementary ways. First, Social Security would provide a baseline public option for a retirement pension.3 Second, employer-based pensions wouldn’t make the ordinary worker rich, but they would add a hefty amount to Social Security’s baseline to ensure that retired couples could maintain their middle-class lifestyle.4 Traditional pensions guaranteed workers a secure monthly benefit, usually calculated as a percentage of their income in a top-earning year. The guaranteed income let middle-class retirees plan ahead—and look forward to a decent living standard in retirement.5 A generation of middle-class snowbirds flocked to retirement communities in Florida and Arizona, among other places, in part because they had secure, guaranteed pensions on top of Social Security. And third, for those who wanted a little more, private savings would top up retirement income.
Today’s workers face a harsher retirement climate. Workers live longer, but they have less financial security. Social Security wasn’t meant to bear the whole burden of retirement savings; it simply doesn’t cover enough of the cost of living. Many employers dropped pension plans to contain costs. As more workers took service jobs and part-time and temporary work, the percentage of workers with any employer pension plummeted.6
Workers with a pension also receive less retirement income than before, largely because defined-benefit pensions have been replaced with defined-contribution pensions.7 New-style pensions, including 401(k)s, shift risks away from firms and onto workers. Workers’ retirement security now depends on their ability to save money out of their paychecks—a tough choice when middle-class families already struggle under the weight of heavy student debt and rising prices for housing and child care. The new pensions also expect workers to decipher the arcane world of finance. The stakes are high: savers who make risky choices or who fail to read the fine print can see their hard-earned money evaporate. Just as bad, a financial crash—like the American market implosions of 2000 and 2008—can decimate pensions for anyone, no matter how frugal and prudent they are.
The looming failure of the U.S. retirement system will affect all of us. Most of us will be old one day. And in the meantime, we care that our parents and coworkers have a secure retirement income. When older people lack retirement security, we all pay the price—because our parents need money or because older colleagues keep working when they can’t afford to retire. A secure retirement is part and parcel of freedom and equality for all Americans—and especially for a mobile workforce striving to meet the challenges of the new economy.
The good news is that America can do better. We can’t bring back old-style pensions any more than we can bring back the rest of the Treaty of Detroit. But new-style pensions do not need to shift so many risks onto workers’ backs. In fact, a better system already exists, and we propose to build on it. Federal employees have a fantastic 401(k)-type savings plan, the Thrift Savings Plan, or TSP, that provides sound investments at a low administrative cost. The TSP is a model for a competitive public option that could be made available to all workers. No one would be required to participate, and market options would compete side by side with it. But a new public option along the lines of the TSP could provide a secure vehicle for retirement savings. Adding to the appeal of the public option is that it would cost the government exactly zero dollars, because savers would pay (modest) fees to defray the system’s costs.
Along with the public option, we can—and should—redesign government subsidies for retirement. Today, the federal government subsidizes retirement savings to the tune of $180 billion a year (that’s above and beyond the $600 billion Social Security budget). But the subsidies mostly find their way into the pockets of well-off workers who don’t need them. In 2013, two-thirds of the government’s subsidies for pensions went to the richest 20 percent of taxpayers.8 Properly redirected, that money could be redeployed to improve retirement security for a wider range of Americans.
Causes of the Retirement Crisis
To see why a public option offers a sensible solution, we need to tease out the multiple problems with today’s pension system. At a macro level, the problem is that American retirement policy has never recovered from the implosion of the Treaty of Detroit. The U.S. pension system was engineered on the dual foundation of Social Security and employer pensions. Private savings accounts, like 401(k)s, were meant as a small supplement, a nice-to-have rather than a must-have.9 So when old-style employer pensions crumbled, Social Security and 401(k)s were left to bear a load beyond their tolerance, as employers shifted four risks of retirement onto workers. Any one of these risks co
uld imperil a worker’s retirement. Taken together, the four spell disaster for all but the very wealthiest Americans—those rich enough to fund their own retirement without much help.
Risk #1: No Pension at Work
The first risk that workers face is having no pension at all. The law doesn’t require firms to provide pensions, and many employers do not. A recent study showed that only 42 percent of private sector workers have any kind of workplace pension at all.10 And while policy wonks can debate exactly how to measure pension coverage, by any measure fewer workers have pensions today than in 1979, in large part due to the decline in unionized jobs and the rise in service jobs.11 Compounding the problem, lower earners and minority workers are least likely to work for firms that offer retirement plans.12
Even workers with pensions at work may not be able to save steadily. Today, most workers change jobs pretty often. (Government economists estimate that typical middle-aged workers have held eleven jobs before age fifty.)13 The result is that many people will have spells of time without pension coverage, either because they take a job with a firm that doesn’t offer pensions or because they can’t sign up for the pension plan right away. These interruptions in pension savings can be very costly.14
Some workers who lack pension coverage at work can save on their own, through individual retirement accounts. But the tax rules are complicated, and it isn’t easy to figure out who gets a tax benefit from an IRA. Not everyone does, and the rules span pages and pages of fine print, with variables including whether you choose a regular or Roth IRA, whether you’re married, and how much you make.15 What is certain is that low earners typically receive very little, if any, tax benefit from an IRA.
Compounding the hassle factor, enrollment isn’t automatic. To be sure, it’s easy enough to find a bank or brokerage willing to take your money—most of them advertise their IRAs. The hard part is figuring out which company offers the best investment options at the lowest cost.
And the whole thing works only if employees can set aside money on a regular basis—something that can be difficult for even middle-class families to do. As student debt balloons and prices rise for basics like housing and child care, it can seem daunting to set aside money for a distant retirement.
Risk #2: Defined Contributions
Even workers with a retirement plan at work are not home free. Once upon a time, a pension meant a monthly income paid by the employer, usually for life. Workers could plan for retirement, because they knew that their company pension would pay a fixed amount, such as 50 percent of the salary they earned in their highest-earning year at the company. Under such a defined-benefit pension plan, a worker who made $50,000 would know that she’d have a retirement pension of $25,000 per year, typically for life.
But as the Treaty of Detroit faded from memory, employers rewrote the pension rules to shift key financial risks off their books and onto workers. Defined-benefit plans have a clear advantage: workers can plan for the future, and any shortfall is the employer’s problem. (That’s one reason why Social Security is such a stable and successful public option—because it provides a defined benefit.)
Today, though, the vast majority of workers who still have pensions at work have defined-contribution plans, which don’t guarantee any level of benefits at all. Instead, workers are guaranteed only whatever money they set aside, plus (or minus) investment gains (or losses). About 70 percent of workers now covered by a pension plan have access to this kind of plan.16 These are sometimes called 401(k) plans (after the section of the tax code that authorizes them).
The change from defined benefit to defined contribution sounds technical, but it’s far from minor. A defined-contribution plan shifts the financial risk of pension saving away from employers and onto workers. Put another way, in this brave new world, retirees are no longer guaranteed an income for life. Instead, they are guaranteed only some unknown amount that’s based on a host of contingencies, including their savings rate, their investment choices, and their tax rate at retirement.
Defined-contribution plans shift investment risk onto workers. If workers choose risky investments, they can win big—or lose big. If they choose safe investments, they may not lose much, but they won’t make much, either. Economists call this the risk-reward trade-off, and it means workers face a difficult choice.
Part of investment risk lies in choosing the right portfolio of investments, and that simply isn’t easy. Even professional money managers, with all the training, talent, and resources that Wall Street can buy, cannot reliably beat the stock market. Warren Buffett, the “Sage of Omaha,” is a famous investor who has made money in good times and bad. But he has one simple piece of advice for most investors: Don’t try to pick individual stocks. Instead, buy what’s called an “index fund,” which is a diversified fund that rises and falls with the stock market. And don’t pay high fees to do it.
But when ordinary workers have a pot of money, and when their retirement depends on it, it may be tempting to invest in the latest big thing. And there is no shortage of brokerage firms and so-called financial planners that will help you buy and sell individual stocks (for a fee, of course). To take just one example, the home page for the company E*Trade invites investors into the world of trading: “Trade equities and options. ETFs and mutual funds. Bonds and fixed income. Even futures. They’re all here, on one platform.” How on earth is a real person with a real job, not to mention a family, supposed to wade through all that? But the jargon sounds impressive, and the ad may make people feel that they could make more money if only they traded more.
Even when investors take Warren Buffett’s advice and invest in low-cost index funds, they’re still hostage to the piece of investment risk that accompanies the boom-and-bust cycle of the stock market. That risk may seem small in good times, like the late 1990s, when tech stocks drove the market to new heights. Some middle-aged, middle-class people became “retirement millionaires” for a few months, as the stock market pushed their retirement accounts to new heights.
But these investors learned, to their horror, that a market crash can decimate retirement accounts. In 2000 the NASDAQ (a stock index heavily weighted toward tech stocks) declined by a whopping 78 percent, and many retirement accounts lost huge portions of their value.17 Another stock market crash accompanied the Great Recession of 2008. This time, the damage wasn’t confined to people heavily invested in tech stocks. The average older participant in a 401(k) lost 25 percent of her money, and many lost more.18
How well is the new defined-contribution system working? The news is not good. The typical American with a 401(k) at work has accumulated about $110,000 as he approaches retirement.19 (That figure excludes the large group of people, around 40 percent at any given time, who do not have a pension plan at all.) That may sound like a substantial nest egg, but it amounts to just $4,400 per year in retirement income.20
Risk #3: Being Cheated by Wall Street (or Your Employer)
Most people aren’t financial whizzes, and the conventional advice is to seek out an expert to help with money matters. But these experts can take advantage of ordinary workers by overcharging them for subpar financial products. The prospect of being cheated by Wall Street isn’t just hypothetical. Law professor Ian Ayres and his coauthor Quinn Curtis studied 401(k) plans and found widespread abuse. Many plans charge exorbitant fees of nearly one percentage point over the cost of basic index funds (like the ones Warren Buffett recommends). A common strategy is to pad investment menus with funds that don’t offer any investment advantage over the basic option—yet charge higher fees.21
Quibbling over a one-percent difference in investment fees may seem like much ado about not very much. But a little math shows how money management fees can add up. A twenty-five-year-old worker who contributes $5,000 per year to her 401(k) plan will have about $475,000 by age sixty-five if she pays an investment fee of, say, 1 percent per year. She will have just $377,000 if she pays a typical higher fee of 2 percent per year.22 That extr
a 1 percent fee translates into nearly $100,000 in lost savings.
In addition, some financial advisors got kickbacks from certain funds as a reward for pushing their customers toward those investments. Funds would send investment advisors on vacations, buy them electronic devices, and even give them cars.23 This conflict of interest was perfectly legal until 2016, when the Obama administration required that investment advisors act as fiduciaries. (A fiduciary is simply a person who must act in investors’ best interests.)24 You’d think that a regulation holding investment advisors to that standard would be a big yawn. But investment firms have lobbied massively against it, and the Trump administration has signaled that it may repeal the rule.25
Risk #4: Outliving Your Savings
The final risk is one that many older people can appreciate. Retirement is always risky because you sacrifice some financial self-sufficiency. No longer can you count on a regular paycheck. And if illness or serious disability strikes, you may not be able to get another job if you need money. So the prospect of running out of money in retirement strikes fear in most of us.
Back in the once-upon-a-time days, workers with pensions didn’t have to worry about outliving their savings. Employers typically paid out pensions in the form of an annuity—a monthly sum guaranteed until the worker died. Put another way, the old defined-benefit pension system put longevity risk on employers. Usually it all averaged out: some retirees might live to a hundred, but others might die in their sixties. Prudent employers could also hedge their bets by buying annuities to cover their pension obligations, and the insurance companies that sold those annuities could forecast, with pretty good accuracy, the average longevity of workers in the pension plan.
The Public Option Page 12
