November 2011 » Putnam perspectives

Savings, Solvency, and the American Promise
Robert L. Reynolds President and Chief Executive Officer

Key takeaways

• America’s debts have put us on the road to insolvency • Our workplace retirement system provides a great base for increasing our savings • Now the target of budget scrutiny, retirement savings incentives can actually help keep the American promise

I think we all know in our bones that America is at a critical inflection point. We really do face a choice between decline and renewal. If we want to keep the American promise of a better life for our children, we absolutely must make a transition away from public debt, leverage, and excessive debt-fueled consumption to a new economic model based on higher personal savings, public solvency, more investment, more exports, more new business formation, and more rapid job creation. That won’t be easy, but the alternative is worse. The status quo course we’re on right now is dangerous and unsustainable. The road to insolvency Since the turn of this new century, America’s fiscal health has taken a drastic turn for the worse. Back in the good old days of 2000, the Congressional Budget Office [CBO] projected that by 2011 ten years of record federal surpluses would turn the federal debt into a net surplus of $2.3 trillion dollars — that’s the falling debt line we see in Figure 1 as the national debt is paid down past zero! You may remember that some people actually worried about what might happen if the federal government didn’t need to issue any new debt. Well, we’re not losing sleep over that anymore, are we?

If we want to keep the American promise of a better life for our children, we absolutely must make a transition away from public debt, leverage, and excessive debt-fueled consumption to a new economic model based on higher personal savings, public solvency, more investment, more exports, more new business formation, and more rapid job creation.

PUTNAM INVESTMENTS | putnam.com

NOVEMBER 2011 | Savings, Solvency, and the American Promise

A “lost decade” of deficits fuels a surge in America’s national debt a surge in America’s national debt Figure 1. A “lost decade” of deficits fuels
($) 10 8 6 4 2 0 PUBLICLY HELD FEDERAL DEBT ($T)
Actual debt 2000–2011 $10.2 trillion

debt
$12.5T

-2 2000

surplus
2005

CBO projected debt -$2.3 trillion
(CBO, January 2001)

2011

Source: Pew analysis of Congressional Budget Office (2001–2011) data.

Source: Pew analysis of Congressional Budget Office (2001–2011) data.

What happened? History took us by surprise. Instead of big surpluses, we had a decade of deficits, lifting the national debt held by the public to over $10 trillion by 2011, $12.5 billion more than the CBO had projected at the start of the new century. There were multiple causes for that, including: •Tax cuts under both Presidents Bush and Obama •9/11, the wars in Afghanistan and Iraq, and other new defense costs •Major new spending on discretionary programs •A new drug entitlement program for seniors •Massive stimulus spending to try to fend off another depression after the crash of 2008

But the single most damaging cause of these deficits, shown here in red and accounting for more than a quarter of total deficits — twice as much as the Bush tax cuts — was the lower revenue flows caused by slower economic growth, which was well below what the CBO had projected. In other words, economic growth, or the lack of it, is the most powerful variable in America’s fiscal health. Unsustainable deficits Today, federal deficits already claim a large share of our economy, much more than that claimed by toprated peers like the United Kingdom, France, Canada, Australia, and Germany. Our total national debt — and this includes internal government debt like the Social Security trust funds — is on track to reach $15 trillion by the end of this year. Fifteen trillion dollars is a mindboggling number and difficult to imagine.

The single most damaging cause of these deficits … was the lower revenue flows caused by slower economic growth … In other words, economic growth, or the lack of it, is the most powerful variable in America’s fiscal health.

2

America’s deficits, as a percentage of GDP, now rank among the world’s largest
Figure 2. America’s deficits now rank among the world’s largest

PUTNAM INVESTMENTS | putnam.com

2010 budget deficit as a percentage of GDP
2010 budget deficit as a percentage of GDP

U.S.

U.K.

France

Canada

Australia

Germany 3.3%

5.5% 7.0%

4.6%

10.6%

10.4%

Note: IMF calculations for the U.S. differ differ from Congressional Budget Office figures, deficit put the U.S. Note: IMF calculations for the U.S.from Congressional Budget Office figures, which put the U.S.which at 8.9% GDP. deficit at 8.9% GDP. Source: International Monetary Fund. All information as of 12/31/2010. Source: International Monetary Fund. All information as of December 31, 2010.

As shown in Figure 3, $15 trillion measured in $100 bills would stack up into a solid block of hundreds bigger than a football field and more than half as tall as the Statue of Liberty. Total federal debt could reach $15 trillion Figure 3. Total federal debt could reach $15 trillion by year-end 2011

by year-end 2011

Source: Federal Reserve and www.USdebtclock.org. Sources: U.S.U.S. Federal Reserve andwww.USdebtclock.org

And the forward outlook is worse. The Congressional Budget Office advises us that President Obama’s most recent budget would raise total national debt held by the public from roughly 63% of GDP today to more than 90% by 2020, with no end in sight! That is a debt-to-economy ratio that America hasn’t seen since World War II.

3

…and rise from there for years ― NOVEMBER 2011 | Savings, Solvency, and the American Promise threatening our national solvency
Figure 4. Our national debt is on track to reach 90% of GDP by 2020
(%) 200 150
World War II 108.6% Over 90%

U.S. FEDERAL DEBT AS A PERCENTAGE OF GDP
148%

100
The Great Depression

50
22%

Vietnam War era

“Crash” of 2008

Interest costs alone on America’s debt could nearlyHeritage Foundation compilations 2020 U.S. Department of the Treasury, Institute for the Measurement of Worth Sources: quadruple by of data from
Sources: Heritage Foundation compilations of data from U.S. Department of the Treasury, Institute for the Measurement of Worth (Alternative Fiscal Scenario), Congressional Budget Office, Office of Management and Budget. (Alternative Fiscal Scenario), Congressional Budget Office, and White Houseand White House Office of Management and Budget.

0 1930

1940

1950

1960

1970

1980

1990

2000

2010 2020E 2030E

Figure 5. Interest costs alone could nearly quadruple by 2020
$800B $600B $400B $200B
Actual Projected

INFLATION-ADJUSTED DOLLARS (2009)

$768.2

$280.1

$186.9

$0 2000

2005

2010

2015

2020

Source: White House Office of Management and Budget, 2010 estimates.
Source: White House Office of Management and Budget, 2010 estimates.

Simply put, it’s a path to insolvency. And while this fiscal time bomb keeps ticking, interest costs on the debt are exploding. Unless we change course, those costs will nearly quadruple by 2020, reaching close to $800 billion a year. This, by the way, is happening at a time of historically low interest rates. A sustained rise of just 1% in interest rates would add $150 billion more a year to this burden. Albert Einstein once described compound interest as “the most powerful force in the universe.” We’re gambling against it, and we’re doing that with other people’s money.

We now depend on other countries to finance us We now depend on foreign creditors to finance nearly half of our debt, about ten times as large a share as they held in 1970. So far, these foreign creditors still believe that America can and will get its act together. Their faith that America will right its course, plus the fear generated by the even worse financial mess in Europe, is the only reason why the U.S. Treasury can still borrow huge sums of money 10 years out at rates of 3% or less. But America’s dependence on foreign buyers at our Treasury debt auctions makes us increasingly vulnerable. If global investors should ever conclude that our political leaders are unable or unwilling to deal with our deficits and debt, we could be plunged into crisis by surprise — and virtually overnight.
4

PUTNAM INVESTMENTS | putnam.com

We now depend on foreign creditors to finance nearly half of our debt, about ten times as large a share as they held in 1970. So far, these foreign creditors still believe that America .…Leaving us vulnerable to the foreign countries can and will get its act together.

who now finance nearly half of our deficits….
Foreign holdings
Foreign holdings Figure 6. Other countries hold nearly half of our debt today

5%

19%

47%

1970 Debt held by public: $283B
Source: U.S. Department of Treasury.

1990 Debt held by public: $2.4T

2010 Debt held by public: $8.4T

Source: U.S. Department of Treasury.

So, the way I see it, America doesn’t really have a choice about coming to grips with its debts and bringing government spending under control. The real choice we face is whether to act or be acted upon by some very ruthless global markets, the same markets now driving the sovereign debt crisis in Europe.

The key driver is demographics: an aging America Here’s the key driver of our deficits. America is aging. Life expectancy is rising. Baby boomers are now turning age 65 at the rate of about 7,000 a day. Over the next twenty years, the number of Americans over age 65 will nearly double, from 40 million to 72 million.

America doesn’t really have a choice about coming to grips with its debts and bringing government spending under control. The real choice we face is whether to act or be acted upon by some very ruthless global markets, the same markets now driving the sovereign debt crisis in Europe.

5

The key driver is demographics: NOVEMBER Aging2011 | Savings, Solvency, and the American Promise of retirees itself is forming a “nation”
Americans over age 65 Figure 7. A nation of retirees
Americans over age 65

40 million today

72 million by 2030

Source: U.S. Bureau of the Census, August 2008. Most recent data available.
Source: U.S. Bureau of the Census, August 2008.

Congress can’t vote down this demographic wave; the president can’t veto it. We have to deal with the stress it will put on our old-age support programs, and the longer we delay, the tougher that gets. Absent reform, entitlement costs will dominate federal budgets

Unless there is reform, entitlement costs will dominate future federal budgets
Three major entitlements and tax revenues, 2000–2050

Unless we see substantial reforms to Social Security, Medicare, and Medicaid, these three entitlement programs alone will grow by 2045 to absorb as much of America’s economy as the entire federal government budget has averaged since World War II — over 18% of GDP. Figure 8. Absent reform, entitlement costs will dominate future budgets

Three major entitlements and tax revenues, 2000-2050

Sources: Spending projections from Congressional Budget Office, alternative fiscal scenario in “The Long-Term Budget Outlook,” Sources: Spending projections from Congressional Budget Office, alternative fiscal scenario in “The Long-Term Budget Outlook,” June 2009. June 2009.

So if we want the government to pay for anything else, whether that is the Marine Corps or National Public Radio, we will have to get serious about curbing entitlement costs and about raising some additional revenues to meet these demographically driven obligations.

Precentage of GDP

6

PUTNAM INVESTMENTS | putnam.com

The real risk to our creditworthiness is not economic or financial. We do have the resources. The real risk is political paralysis, the seeming inability of our two-party system to find common ground, to compromise, and to craft a workable solution.
Both political parties will have to make some painful concessions, which neither seems quite ready to do. It would be tragic, for example, if the current Select Committee on Deficit Reduction does not find some common ground and at least meet its target of saving $1.2 trillion over the next decade. And $1.2 trillion, by the way, is just 2.6% of the $46 trillion the federal government is projected to spend in the next ten years. My gut tells me that if the Super Twelve fail, there could be very nasty reactions in global markets. America’s own leaders would, in effect, be validating the S&P downgrade we saw this summer. Enough on the budget context and bad news. I want to turn now to the positive side of the ledger. And let me suggest to you that action to strengthen America’s public and private retirement systems, not undercut them, could play a vital role in reviving confidence and sustaining growth in our economy. The good news: Our DC retirement system

The good news is that we have created a robust defined contribution workplace savings system — predominantly 401(k) — that reaches more than 83 million workers. This system has shown to be strong, resilient, and always open to improvement. This suggests to me When you actually read that S&P report, one thing is that if we can strengthen the defined contribution [DC] crystal clear. The real risk to our creditworthiness is not system and extend its reach, we can take huge strides economic or financial. We do have the resources. The toward shoring up Americans’ belief in their own futures. real risk is political paralysis, the seeming inability of our And there’s every reason to believe we can. Because two-party system to find common ground, to comprowith the passage of the Pension Protection Act of 2006 mise, and to craft a workable solution. [PPA], we transformed the DC system qualitatively, enabling 401(k) workplace savings to become America’s The good news: DC workplace savings are a huge primary retirement system.

success story — and offer a great base to build on
Figure 9. DC workplace savings offer a great base to build on American workers covered
100

American workers covered

83 75 62 48 38 35 40 20 38 39 40 42 42 42

(Millions)

75 50 25 0 1980 1985 1990 1995

DC plans

DB plans
2000 2005 2008

Sources: Private Pension Plan Abstract of Abstract5500 Reports, U.S. Department of Labor, December 2010. of Labor, December 2010. Bulletin, 2008 Form of 2008 Form 5500 Reports, U.S. Department Sources: Private Pension Plan Bulletin, Collective Bargaining Status of Pension Collective Bargaining Status ofPlans, Total Plans, Total Participants by Type of Plan. Pension Participants by Type of Plan.

7

…And the Pension Protection Act (PPA) has revitalized the DC system
Figure 10. The Pension Protection Act has

NOVEMBER 2011 | Savings, Solvency, and the American Promise

Estimated revitalized DC DC system2015 growth in the assets by

$4.1 trillion
2009

$5.5 trillion

workplace savings world. People who have access to workplace savings plans and who participate — and who also defer more than 10% — have the potential to replace over 100% of their pre-retirement incomes once you add in Social Security. There are millions of these people, by the way, so this is not some freak anomaly. And most interestingly, the income of the best prepared is no higher than that of the least prepared. This tells me that if we could find ways to provide all workers with access to workplace saving, get them to start saving, and convince them to defer 10% or more, we could potentially immunize America’s workforce against the risk of elderly poverty. But here’s the terrible irony that we face today. Just as we’ve discovered how to design workplace savings plans that can build reliable lifetime nest eggs, just as we’re recovering from the “black-swan bite” of 2008, now we face a new potential risk aimed right at the heart of retirement savings. It stems from well-intentioned, but misguided efforts to cut federal deficits.

2015

Source: The Asset Management Industry: Now It’s About Picking Your Spots. McKinsey & Company, September 2010.

Source: The Asset Management Industry: Now It’s About Picking Your Spots. McKinsey & Company, September 2010.

The DC system is currently being revitalized, and workplace savings are projected to grow to over $5.5 trillion just in the next few years. The reason why is that PPA endorsed three game-changing elements of defined contribution savings plan design: auto-enrollment, savings escalation, and guidance to wise asset allocation. The law also gave plan sponsors who adopted these best practices strong “safe harbor” legal protection. Today, the evidence on these policy innovations is in, and the good news is we have essentially solved the challenge of accumulation. We have not fully implemented the solution — not by a long shot — but we do know what works. Recent research by the Employee Benefit Research Institute [EBRI] shows that workers in their 20s and 30s whose employers adopt auto-enrollment plan designs will be able to replace between 40% and 60% of their pre-retirement incomes, just from their DC plans! That’s before you count Social Security, other savings, home equity, life insurance holdings, or any other assets they may have. Just this summer, in a study that Putnam did with Brightworks Partners,* we found that there is a fantastic success story taking place already within the existing

People who have access to workplace savings plans and who participate — and who also defer more than 10% — have the potential to replace over 100% of their pre-retirement incomes once you add in Social Security.
Retirement incentives should not be budget items To understand this risk, you need to see savings tax deferrals through a very bizarre lens, the one used by all too many “budget hawks” in Washington. Too often, budget experts in Washington view the temporary tax forgiveness that retirement savers get for putting funds in an IRA, K-plan, or variable annuities as “tax expenditures,” forgetting that these assets will be taxed as ordinary income the minute they are drawn on by retirees.

8

PUTNAM INVESTMENTS | putnam.com

But retirement savings are now Figure 11. Retirement savings are now in the in the cross-hairs of budget-hawkscross hairs of budget hawks
Major Income Tax “Expenditures” 2010 to 2014
Health benefits Retirement savings deferrals Mortgage tax breaks Lower capital gains and dividend taxes Earned income tax credit Deductions for state and local taxes

Major income tax “expenditures” 2010 to 2014

$0

$100

$200

$300 $400 (Billions)

$500

$600

$700

Source: Douglas Elmendorf, CBO Director, Testimony to Select Committee on Deficit Reduction, September 13, 2011

Source: Douglas Elmendorf, CBO Director, Testimony to Select Committee on Deficit Reduction, September 13, 2011.

Figure 11 shows the so-called “tax expenditures” that were submitted in September in testimony before the Select Committee on Deficit Reduction. As you can see, retirement savings deferrals for DC and DB plans are right up there, second only to the tax costs associated with employer-based health care, and just ahead of tax breaks for mortgages and capital gains. So make no mistake. The deferrals that help make workplace savings and IRAs feasible are in the cross hairs of budget hawks right now, and they look like a very juicy target. That’s partly because Congress’s current budget rules allow only a 10-year “window” to analyze the impact of tax deferrals. That methodology seriously overstates the costs to Treasury of savings tax deferrals, by 55% to 77%, according to expert studies that American Society of Pension Professionals and Actuaries itself developed earlier this year. What’s more, budget hawks also have no way to take account of any dynamic benefits that savings may bring — by lowering the cost of investment capital, for example. So it’s not surprising that one proposal being considered would cap total savings deferrals at $20,000 a year or 20% of salary, whichever is lower. Now that may not seem terribly menacing. But take my word for this. I know from experience that once savings

tax deferrals are on the table, they are in play. The temptation to cut deeply into them is great. That is exactly what happened in the last major tax code overhaul in 1986, when ceilings for 401(k) contributions were severely slashed and so many complications were imposed on IRAs that their growth was stymied for years. I want to be clear here. We absolutely do need to get deficits under control. But whatever we do to curb federal deficits, retirement savings incentives should be held harmless. It would be a truly grotesque policy mistake — immoral, in my view — to try to curb public deficits by undercutting tax deferrals for private thrift. Every dollar that retirement savers set aside is one less dollar that will ever be asked for as government aid in the future. Every company that offers a workplace savings plan is helping to meet a real national need. And the incentives for workplace savings do encourage employers, especially of small businesses, to offer savings plans to low- and middle-income workers, not just to the owners and their key executives.

We absolutely do need to get deficits under control. But whatever we do to curb federal deficits, retirement savings incentives should be held harmless.

9

Share of “tax expenditures” vs. share of federal income taxes paid — by income levels
Figure 12. DC tax breaks favor lower-income workers
60% 52%

NOVEMBER 2011 | Savings, Solvency, and the American Promise

40% 30%

32% 27% 18% 8% 11% 23%

20%

0% Under $50,000 $50,000–$100,000 $100,000–$200,000 $200,000 or more

Participants with access and retirees with account balances Share of federal income taxes (after credits) paid

Source: American Society of Pension Professionals and Actuaries, 2011.

Source: American Society of Pension Professionals and Actuaries, 2011.

Figure 12 shows the distribution of the tax deferrals for workplace savings by income level, alongside the federal taxes that people at these income levels pay. Sixty-two percent of these tax deferrals go to people earning less than $100,000, 38% to those earning more. Some on the political left see this as an unfair tax break to the affluent. But let’s compare these tax deferrals — again, let me note these are just postponements, not full forgiveness — with the federal taxes people actually pay. What we see is that while 62% of these tax deferrals go to those earning less than $100,000, these low- and middle-income workers pay just 26% of federal income taxes. So they get more than twice as large a share of tax deferrals as the share of income taxes they actually pay. Thirty-eight percent of the tax deferrals go to those earning more than $100,000, but these people pay 75% of all federal income taxes. In other words, more affluent earners get only about half the share of savings tax breaks as they pay in taxes. That seems pretty fair to me. You might even say progressive. My point is this: The potential gains to the Treasury from cutting tax deferrals is vastly overstated, but the damage such caps could inflict is vastly underestimated. That’s because access to workplace savings is the prime determinant of whether low- and moderate-income workers save at all.

The potential gains to the Treasury from cutting tax deferrals is vastly overstated, but the damage such caps could inflict is vastly underestimated. That’s because access to workplace savings is the prime determinant of whether low- and moderate-income workers save at all.
Restricting access to workplace plans would be harmful EBRI research tells us that over 71% of workers earning between $30,000 and $50,000 do save for retirement, but only if they have access to payroll deduction savings plans at work. Among moderate-income workers who lack access to savings at work, fewer than 5% open taxadvantaged Individual Retirement Accounts. So capping or eliminating incentives for workplace and other retirement savings could have devastating impact — sending millions of low- and moderate-income workers toward retirement with essentially no savings. I trust that everyone will stand with me in opposing any reduction in savings incentives. Retirement savings deferrals are not some special-interest privilege we defend just because they’re good for our businesses. Retirement savings are a good thing for all Americans. They are a source of dignity and self-reliance for millions of working people. They are the seed corn of our economic future.
10

The impact of access: Percent of moderate income workers ($30,000–$50,000) who save for retirement
(%) 80
60 71.5%

PUTNAM INVESTMENTS | putnam.com

Figure 13. The impact of access of moderate-income workers who save for retirement

40 20 4.6% 0
With access to workplace plan Without workplace plan — IRA only

Source: Employee Benefits Research Institute (2010) estimate using 2008 Panel of SIPP (Covered by an Employer Plan) and EBRI estimate (Not Covered by an Employer Plan-IRA only).

Source: Employee Benefit Research Institute (2010) estimate using 2008 Panel of SIPP (Covered by an Employer Plan) and EBRI estimate (Not Covered by an Employer Plan — IRA only).

Instead of cutting savings incentives, we should be doing everything we can to expand workplace savings coverage for the many millions who lack it. We should be advancing ideas like the auto-IRA payroll deduction proposal — a very reasonable, cost-effective way to draw many millions of lower-income workers into retirement savings and give them a stake in our freeenterprise system for the first time ever. The auto-IRA is a bipartisan idea, by the way, and it reflects what should be a bipartisan consensus: that national solvency and personal solvency go together. We should never pit one against the other. We need policies that foster both. Yes, the struggle to restore fiscal sanity in this country is real, as we’ve just seen. America’s deficits and debt are now dangerous enough to raise a real national security issue. Those politicians and special interest groups who refuse to admit that we even face a serious fiscal problem, or say we don’t need to make any serious changes in Social Security or Medicare, are simply in denial. If their view wins, they will lead America straight into a globally driven debt crisis, and then into truly awful austerity under ruthless market pressure, just as we’re seeing happen in Europe.

But there are many elected officials and policymakers who are seeking good-faith, bipartisan solutions to curb federal spending and bring our deficits under control. This will require both common sense and some very uncommon political courage — in other words, leadership. But the gains we could achieve far outweigh the sacrifices we are going to have to make anyway, someday.

Instead of cutting savings incentives … we should be advancing ideas like the auto-IRA payroll deduction proposal — a very reasonable, cost-effective way to draw many millions of lower-income workers into retirement savings and give them a stake in our free-enterprise system for the first time ever.
If, for example, we could see real action to make Social Security solvent, we would also see a huge surge in confidence at home and around the world, proof positive that Americans can control their own destiny. If we then link a solvent Social Security system to reforms that strengthen and extend private workplace savings to reach virtually all working Americans, we would also be financing a new burst of economic growth. And as we saw when looking at the drivers of our deficits, economic growth is the most critical variable and the best way to cure our budget woes in the long term.

11

NOVEMBER 2011 | Savings, Solvency, and the American Promise

If, for example, we could see real action to make Social Security solvent, we would also see a huge surge in confidence at home and around the world, proof positive that Americans can control their own destiny.

Retirement savings can help keep the American promise So please, everyone, bring this message to our leaders in Congress: Robust retirement savings are key to keeping the American promise. They fuel the capital markets that drive innovation and growth. They enable retirees to live in dignity and not burden their children. Every penny of retirement savings spares government the potential need to help elders who would much rather help themselves. And when young and middle-aged workers know they can count on strong, solvent public and private retirement systems, they, too, can be freed up to take risks, to change jobs, to learn new skills and maybe even start their own business, and to reach for their own American dreams. Isn’t that the American promise we all believe in? Let’s send that message to our Congress — loud and clear.

1The Putnam Lifetime Income Survey, with research methodology provided by the Putnam Institute, was conducted online by Brightwork Partners and completed in the first quarter of 2011. The survey of 3,290 working adults age 18 to 65 was weighted to U.S. Census parameters for all working adults. The views and opinions expressed are those of Robert L. Reynolds, President and CEO of Putnam Investments, are subject to change with market conditions, and are not meant as investment advice. Based on remarks to the American Society of Pension Professionals and Actuaries, Maryland, October 24, 2011.
Putnam Retail Management | One Post Office Square | Boston, MA 02109 | putnam.com
271681 11/11

Sign up to vote on this title
UsefulNot useful