Freeing up an enormous nest egg

October 16, 2013 — A news analysis in The New York Times this month neatly summed up the conventional wisdom that drives the proposals and rhetoric of a broad political spectrum from Tea Party Republicans to Democratic centrists, wins grudging acceptance even among some elements of the center-left, and is constantly reinforced in the media: “the United States must confront the rising costs of the benefit programs, especially Medicare and Medicaid but also Social Security.”

But the “unsustainability” argument — presented by the reporter as an unchallengeable fact — ignores completely another perspective: that a focus on reducing financial insecurity instead of reducing benefits would likely yield not only important psychological benefits to millions of senior citizens but also important gains for both national and local economies in the medium and short term.

For example, a growing body of economic research shows that the risk of high medical and long-term care expenses makes retirees in the U.S. uncommonly unwilling to spend such retirement savings as they have. With greater financial security, seniors would be less likely to deprive themselves of enjoyable activities or to defer needed medical care. 

Moreover, if retirees were freed from their concerns about health-related expenses, they would likely spend far more of what turns out to be, in the aggregate, trillions of dollars in untapped capital. This change in habit would represent a great economic boon to the U.S. and to the localities where retirees live.

The implications work both ways: if the safety net is restricted further, seniors will be even more compelled to hang on to their money, and the communities that rely on their spending will suffer as a result.

Yet these considerations and others like them are absent when there is talk in Washington about the need to be “realistic.” The AARP Public Policy Institute, for instance, recently released a report tracking the effects of Social Security spending throughout the nation, finding that every dollar generates two in economic output for an added total of $1.4 trillion. But Gary Koenig, the Institute study’s principal author, said it’s difficult to get a word in edgewise in a budget-obsessed debate.

“It seems to me that we’re in a world right now where spending is characterized as bad, and high taxes are characterized as bad, and both are characterized as disastrous to the economy,” Koenig said. “And that leads you to one conclusion, which is that we need to achieve fiscal balance in our budget only through spending cuts.”

“It’s a very narrow, limited focus,” Koenig added. “I think it misses the bigger picture.”

You Can’t Take it With You

American retirees are notoriously thrifty. Data from the University of Michigan’s Health and Retirement Study on median household net worth illustrate the point. As of 2006, heads of household aged 90 had a median household net worth of about $75,000. This is higher, as a proportion of net worth at age 65, than in most other industrialized countries. Among economists who study patterns of saving and spending across lifetimes, this has always been something of a puzzle. If, as the saying goes, there are no pockets in a shroud, then why do the elderly hold on to their money instead of spending it?

The desire to leave an inheritance is one explanation, though it has been found to be a relatively minor concern among households that aren’t very wealthy. Instead, a number of recent studies have found that a more significant factor is the potential of having to pay large sums out of pocket for medical and long-term care, the fear of which compels retirees to leave their nest eggs undisturbed.

In a working paper funded by the Retirement Research Consortium, Irina A. Telyukova and Makoto Nakajima, economists at the University of California, San Diego and the Federal Reserve Bank of Philadelphia, respectively, compared the spending rates of American retirees to those of several other countries, mostly European. Focusing on relatively liquid financial wealth (rather than housing assets), they found that, consistently, the countries with higher retiree spending rates were those where public insurance programs reduced or eliminated the risk of health-related expenses.

Telyukova and Nakajima zeroed in on a comparison between the U.S. and Sweden in part because the retirement picture in the two countries is similar: ratios of savings to income upon retirement, homeownership rates, and so forth. They key difference is in social programs. While Swedish retirees, regardless of income, have free access to medical and long-term care, Americans have only limited medical insurance through Medicare and, except for Medicaid assistance to the very poor, no public coverage of long-term care.

Telyukova and Nakajima found that, by the time they’re pushing 90, American households have spent down only about one third of their financial assets, while Swedes have spent nearly three quarters. They found, moreover, that the majority of this difference — around 70 percent — can be accounted for by the disparities in the countries’ healthcare safety nets.