[Economic Report of the President (2012)]
[Administration of Barack H. Obama]
[Online through the Government Printing Office, www.gpo.gov]


 
CHAPTER 7

Preserving and Modernizing the Safety Net

Today's dynamic, global economy, driven by rapid technological change, offers abundant benefits and opportunities--but also entails many risks. The Great Recession has made clearer than ever that a strong and flexible economy requires a robust safety net to protect families against major risks and to reduce the likelihood that temporary economic shocks will inflict permanent harm on families and the economy.

In the first weeks after President Obama was inaugurated, the
President and the Congress enacted policies to expand and strengthen the safety net in response to the ongoing economic crisis. The American
Recovery and Reinvestment Act of 2009 (the Recovery Act) provided
increased funding for a number of key safety net programs, including unemployment insurance (UI), Temporary Assistance for Needy Families
(TANF), Medicaid, and the Earned Income Tax Credit (EITC). These and
other safety net programs have been critical in cushioning American
families from the effects of the Great Recession and in stabilizing
the economy by supporting aggregate demand.

One way to gauge the impact of the safety net is to consider the
number of American families that would have been in poverty were it
not for the support provided by specific programs. These effects are
significant. In 2010, the official poverty rate was 15.1 percent,
which translates to roughly 46 million people living in poverty.
According to U.S. Census Bureau estimates, were it not for
unemployment insurance benefits, 3.2 million more Americans would
have been in poverty in 2010. This figure includes about 2.3 million
nonelderly adults, 900,000 children, and 100,000 adults age 65 and
older. Among families participating in the program, the receipt of
UI benefits has the effect of cutting the poverty rate roughly in
half (Gabe and Whittaker 2011).

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Data Watch 7-1: The Census Bureau's Supplemental Poverty Measure
The official poverty measure was developed in the 1960s. According
to this measure, a family is considered to be poor if its before-tax
income falls below a "poverty line" that varies according to family
size and composition.
In 2011, the Census Bureau released an alternative to the
official poverty measure that presents a more complete picture of
poverty and of the effects of policies to support low-income
families. This Supplemental Poverty Measure (SPM), developed early
in the Obama Administration, is based on an approach recommended in
1995 by the National Academy of Sciences. Like the official poverty
measure, the supplemental measure compares the resources available
to a household with a threshold level of income that takes into
account household composition. It differs from the official measure,
however, both in how it calculates resources and in how it sets the
thresholds. The supplemental measure adds in-kind assistance such
as nutritional assistance and subsidized housing to household
resources and subtracts necessary expenses such as taxes, child
care, and other work-related expenses, as well as medical
out-of-pocket costs. Its thresholds are calculated differently than
those for the official poverty line, and they reflect geographic
differences in housing costs.
Overall, 16.0 percent of all Americans were estimated to be in
poverty in 2010 according to the supplemental measure, compared with
15.2 percent using the official methodology.a Differences between
the two measures vary across demographic groups. For example,
because they disproportionately benefit from programs like the
Earned Income Tax Credit (EITC) and the Supplemental Nutrition
Assistance Program (SNAP), children are more likely to be in poverty
according to the official measure, which does not account for
support from these programs. By contrast, the poverty rate for
elderly Americans is higher according to the supplemental measure,
since unlike the official measure, it subtracts out-of-pocket
medical expenses from income.
The supplemental poverty measure allows researchers to isolate more
accurately the effects of a specific policy, source of income, or
category of expense on the prevalence of poverty. Among the programs
studied by the Census Bureau, the EITC has the largest antipoverty
effect; according to the supplemental measure, in the absence of
the tax credit, an additional 6.1 million people would have been in
poverty in 2010. Accounting for medical out-of-pocket expenses in the
supplemental measure, on the other hand, moved 10 million
individuals into poverty in 2010.
--------------------------------------------
/a/ This official estimate differs from the usual published rate
(of 15.1 percent) as unrelated individuals under 15 years of age are
included in the universe.


The official definition of poverty does not account for the
effect of taxes paid and tax credits, such as the Earned Income Tax
Credit. Nor does it incorporate the value of in-kind benefits. As
a result, the official measure does not reflect the benefit that
American families receive from the EITC or important safety net
programs, such as the Supplemental Nutrition Assistance Program
(SNAP), on the official poverty rate. However, such a calculation is
possible using an alternative measure of poverty, known as the
Supplemental Poverty Measure (Data Watch 7-1). Using the
supplemental measure, the Census Bureau estimated that in the
absence of the EITC another 6.1 million Americans, nearly half of
them children, would have been in poverty in 2010. In that same
year, SNAP benefits lifted 2.9 million adults and 2.2 million
children out of poverty. Considered all together, it is estimated
that the social insurance and means-tested transfer programs that
make up the safety net reduce the number of Americans falling below
the poverty line by more than half (Ziliak 2011).
Safety net programs can improve economic efficiency by
supplementing private markets if they fail to provide adequate
insurance against major economic risks. A fundamental market failure
common to both insurance and annuity markets is adverse selection,
which arises when consumers know more than insurers about their own
risk their expected medical claims, their likelihood of becoming
unemployed, or their expected longevity (Rothschild and
Stiglitz 1976). If insurance or annuity contracts are priced
according to the average risk in a population, coverage will be
attractive to those who know that they are at high risk and
unattractive to those who know that they are at low risk. To the
extent that high-risk consumers are more likely to purchase
insurance, the cost of coverage will rise, which in turn will make
coverage even less attractive to their low-risk counterparts. The
gravity of the adverse selection problem will vary across types of
insurance and, for a given type, across market segments. Some types
of insurance, such as unemployment insurance, have virtually no
private market. Private health insurance and annuity markets exist,
though not without substantial support from tax and regulatory
policies; even with this support, coverage remains costly and
incomplete.
In addition to addressing specific types of market failure, a
strong safety net can promote growth and entrepreneurship. By
providing a basic level of security, well-designed safety net
programs help create an environment that encourages people to
engage in value-creating activities such as changing jobs or
starting a new business. A strong safety net is especially important
in a global economy in which international trade and financial
integration can bring both substantial benefits and increased
risk. Robust cross-country evidence finds that economies that have
stronger safety nets also tend to pursue more efficient economic
policies (Rodrik 1998). Safety net programs also protect workers and
their families from the labor market disruptions that can arise from technological change and other sources of fluctuation in demand.
Finally, safety net programs can be an important component of
automatic stabilizers--providing expansions in aggregate demand that
help counteract the weakening of the economy during economic
downturns.
An effective and efficient safety net must adapt and evolve in
response to changes in technology and economic conditions. This
chapter provides an overview of the key components of the safety net
in the United States, emphasizing recent policy developments and
proposals to keep the nation's safety net strong.

UNEMPLOYMENT INSURANCE

Unemployment insurance has long been an essential component of
the safety net for workers who have lost a job through no fault of
their own. In the recent period of high unemployment, the basic UI
program and emergency extensions have provided critical support for
millions of American families. In 2010, almost 10 percent of
households received UI benefits--and that share is expected to fall
back toward the pre-recession average of about 4 percent as the
economy recovers.
Unemployment insurance is a joint Federal-state program that
covers nearly all civilian workers. During normal economic times,
workers and employers contribute to state systems that pay benefits
to unemployed workers for up to 26 weeks. During periods of high
unemployment, extended benefits (EB) are available to workers who
have exhausted regular UI benefits, with the costs normally shared
between the Federal Government and states. Benefits are determined
as a function of past wages, up to a cap. Although key program
parameters vary across states, on average UI benefits replace
roughly half of a recipient's lost earnings. In 2011, the average
weekly benefit was roughly $300.
Historically the Federal Government has funded benefits for
extended periods while the economy recovers from a serious downturn.
It did so once during the 1950s, once during the 1960s, twice
during the 1970s, and once each during the early 1980s, the 1990s,
and the early 2000s. In each instance since the 1970s, extended
benefits have been reauthorized, usually multiple times, in reaction
to continued weakness in the labor market. In June 2008, Congress
enacted the Emergency Unemployment Compensation (EUC) Program that
added 13 weeks of Federally funded UI benefits. As the labor market
continued to deteriorate, Congress extended the program for workers
in the hardest-hit states several times. In addition, starting in
February 2009, Congress provided full Federal funding of extended
jobless benefits. Together these policies allow workers in
high-unemployment states to qualify for up to 99 weeks of benefits.

The Economics of Unemployment Insurance
Unemployment insurance benefits enable workers to minimize
disruptions in spending caused by unanticipated income shocks
(Baily 1978). Economic research indicates that this
consumption-smoothing effect is important. According to one study,
in the absence of UI, a typical family whose household head becomes
unemployed lowers spending on food by 22 percent, while a family
receiving UI benefits spends only 7 percent less on food
(Gruber 1997). In addition to helping families whose income has
been reduced due to job loss, by providing income to families that
they can spend, UI benefits mitigate the impact of the recession on
the broader economy.
These benefits must be weighed against the cost of longer spells
of unemployment potentially induced by the availability of
Ui--although in the current environment, any effect on spell length
is likely to be comparatively small. Theoretical models of labor
supply and job search predict that unemployed workers covered by
more generous UI systems can take longer to find a new job
(see, for example, Mortensen 1977). More recent work has shown
that it is important to distinguish among reasons why UI
increases the duration of unemployment. Traditionally, economists
have interpreted the relationship between UI and duration in the
context of a worker's choice between work and leisure, assuming
that UI reduces the effort devoted to job search. An alternative
view, given that a large fraction of unemployed workers have
limited assets, is that UI benefits allow workers to meet their
basic needs while they search for a job that is a good match for
their talents (Chetty 2008). Better matches generally translate
to higher wages (leading to higher tax revenues), increased job
satisfaction, and greater employment stability (which reduces
employers' hiring costs).
The empirical research literature on the relationship between
UI benefits and unemployment duration is sizable. Recent research
suggests that UI benefits have small effects on unemployment
duration even when the economy is strong (Card and Levine 2000).
In periods of high unemployment, the consumption-smoothing benefit
of UI will be especially valuable to workers, and any negative
effects on worker search effort will be less important because of
the scarcity of jobs (Kroft and Notowidigdo 2011; Schmieder, von
Wachter, and Bender 2012). Consistent with this premise, research
suggests that the recent expansion of extended and emergency
benefits has had a minimal effect on the duration of unemployment
spells and the unemployment rate (Farber and Valletta 2011;
Rothstein 2011; Daly et al. 2012). Moreover, to the extent that the
extension of benefits has affected the measured unemployment rate,
it has done so not by reducing the probability that unemployed
workers look for and find jobs, but by reducing the number of
unemployed workers who have given up on searching for a new job
(Rothstein 2011). This finding is important in light of evidence
suggesting that during periods of high unemployment, many older
workers who exhaust their UI benefits end up applying for Social
Security Disability Insurance (Rutledge 2011).

Recent Trends in UI Receipt and Its Effect on Household Income
The share of households receiving UI rose from 4.1 percent in
2007 to 9.6 percent in 2010. Over the same period, the average
annual amount received by households benefiting from UI rose from
$4,400 to $8,340, mainly because of longer duration of benefit
receipt but also because of the extra $25 in weekly benefits
provided through FY 2010 by the Recovery Act. This money was
crucial to keeping many families in their homes and able to pay
other household expenses. As noted, UI lifts millions of families
out of poverty. However, because a large share of benefits flows
to middle-income workers, these antipoverty effects understate the
economic impact of the program on participants. Households that
received UI benefits in 2010 had a median income of $55,000 the
previous year, which is only slightly less than the median income
of working households that did not receive UI. Among all
recipients, UI payments represented 23 percent of household income
in 2010. The share of income represented by UI ranged from 15
percent for multiple-earner households without children to almost
36 percent for households with a single worker and no children
(Figure 7-1).
In addition to providing income insurance to families of
unemployed workers, the UI system helps the economy as a whole
(Auerbach and Feenberg 2000). Unemployment insurance is an
automatic stabilizer that leans against the negative cycle of
increased unemployment leading to reduced consumption, which leads
to a further decline in economic activity. Since unemployed workers
tend to spend rather than save their benefits, the impact on
aggregate demand is fairly immediate. Because of the way that the
emergency and extended benefits programs increase economic activity,
they generate partially offsetting income and payroll tax revenues
for the Federal Government and help state and local budgets by
increasing sales tax revenues. In addition, without the income
support provided by these programs, more families would draw on other public programs. For these reasons, the Congressional Budget Office notes that extending UI benefits is the most timely and cost-effective policy for increasing economic activity and employment (CBO 2011).

Policy Innovations
The U.S. unemployment insurance system dates to the Great
Depression of the 1930s. Originally, most covered workers were
employed in manufacturing. At its inception, the UI system allowed
for income smoothing for workers who would ultimately return to
their old job or one like it. Research based on data from the early
1980s suggests that at that time 60 percent of UI spells ended with
the worker being recalled to his or her original job (Corson and
Nicholson 1983; Katz and Meyer 1991). Today, temporary layoffs are
less common; increasingly, workers receiving UI benefits have been
dislocated as the result of structural changes in the economy and
must find a new industry or occupation. In many cases, wages in the
new jobs these workers find are significantly lower than their
former wages. Thus, workers today need income support while they
are searching for a new job, but they also need training, job search
support, and other assistance to help ease what can be a difficult
transition.


The first step to modernize the unemployment insurance program
was taken in the UI Modernization Act, a part of the Recovery Act.
The UI Modernization Act made $7 billion available to states that
made reforms to their UI programs. States could receive a part of
the incentive payment for using the most recent quarter as a part of
the base period of earnings on which UI eligibility and benefit
amounts are determined. This made it more likely that recent labor
market entrants would meet the minimum earnings threshold for UI
eligibility. States could receive the other part of their apportioned
payment by adopting two of the following policies: allowing workers
who were employed part-time previously to continue receiving UI
while looking for part-time work, providing UI benefits to those
who left their jobs for certain compelling family reasons, allowing
workers to continue receiving UI for an additional six months if
in an approved training program, and providing additional benefits
for households with more dependents. These small incentive payments
resulted in 36 states changing their UI laws.
Building on these reforms, in the American Jobs Act the
President called for further steps to improve the unemployment
insurance program and expand reemployment services and job training,
and has made these reforms a part of the FY 2013 Budget proposal.
Although most UI policy innovations target workers who have already
lost their jobs, another important policy goal is to reduce the
number of workers who are laid off in the first place. One
promising initiative is work-sharing. Under a work-sharing
arrangement, workers whose hours are reduced in lieu of temporary
layoffs receive partial UI benefits while remaining on the job and
keeping their skills sharp. By allowing employers to retain skilled
workers at reduced hours rather than laying them off, work-sharing
makes it easier and less costly for employers to scale up production
when orders increase. Twenty-four states now have work-sharing
programs, and in the American Jobs Act, President Obama proposed
incentives to help expand the program to more states.
Workers who have been laid off need help finding a new job.
The American Jobs Act included the Reemployment NOW program, a set
of reforms to help UI claimants get back to work more quickly.
The FY 2013 Budget continues this support. As a part of this
initiative, the Administration has proposed requiring states to
provide reemployment services, such as career and job search
counseling, skills assessments, and assistance in identifying
helpful resources to EUC recipients to speed their return to work.
Face-to-face contacts also provide an opportunity to assess
recipients' eligibility for UI benefits. Research suggests that
these services can lower program costs by reducing spells of UI
receipt and eliminating payments to ineligible individuals
(Black et al. 2003).


Because entrepreneurship is key to a dynamic economy, a
modern UI system should make it easier for displaced workers to
start their own businesses. The Administration has proposed allowing
states to use Reemployment NOW funds to expand Self-Employment
Assistance programs that pay UI benefits to recipients who are
working full-time to establish a new business. Seven states already
permit a similar use of unemployment insurance benefits. Under
this program, entrepreneurship training would be facilitated
through One-Stop Centers in collaboration with the Small Business Administration. A demonstration project, Growing America Through Entrepreneurship (Project GATE), provided training and one-on-one
counseling to anyone interested in creating, sustaining, or expanding
a small business. A recent study found that GATE had a positive
effect on new business starts for unemployed participants and higher
total earnings after five years than a comparison group (Michaelides
and Benus 2010).
For jobless workers seeking to change occupations, lack of
experience can be a significant barrier. With Reemployment NOW
funds, states could experiment with Bridge to Work programs, which
would allow EUC  recipients to get short-term work-based experience
that helps them maintain or enhance their skills. Under this program,
private employers would be able to take on EUC recipients for up to
38 hours a week for a trial period of up to eight weeks with the
workers receiving compensation through the EUC program.
In addition, all program participants would be covered by
workers' compensation and be guaranteed at least the minimum wage.
Finally, to support state creativity and flexibility, upon
approval of the Secretary of Labor, states would be permitted to
use Reemployment NOW funds to implement their own innovative
strategies for connecting the long-term unemployed to employment
opportunities.
In addition to these efforts that build upon the existing
Federally-financed unemployment compensation system to help with
getting the long-term unemployed back to work, the President's
Budget includes other important and complementary initiatives that
will contribute to the goal of ensuring that every American who
wants a job can find one. As discussed in Chapter 6, these
initiatives include streamlining training and employment services
so that job seekers can visit a single location or go to a single
web site to find the help they need; providing a universal core
set of services to serve all dislocated workers; and introducing
a new Pathways Back to Work fund to support employment opportunities
for low-income youth, low-income adults and the long-term unemployed.

OTHER SAFETY NET PROGRAMS

Several means-tested programs also provide support to American
families, especially those who have experienced adverse economic
shocks. Table 7-1 reports the number of participants and Federal
cost of several important programs. One of the largest Federal
programs targeted at low-income families is the Earned Income Tax
Credit, a refundable tax credit for low-income workers. The
assistance is available only to those with earnings, and the amount
of the credit increases with a worker's earned income up to a maximum
level and then phases out at higher income levels. The maximum
benefit amount increases with the number of children in the family,
and the income level at which the credit begins to phase out differs
according to taxpayer filing status (single or married couple filing
jointly). As part of the Recovery Act, Congress created a new
category with a higher credit for taxpayers with three or more
children, providing those families as much as $600 extra, and
increased the income level at which the credit phases out for married
couples filing jointly by $3,000 over 2008 levels. The Tax Relief
and Job Creation Act of 2010 extended these changes through 2012.
Over 26 million working families and individuals received the
EITC on their 2010 tax return, with the average claimant receiving
$2,220.
The benefits of the EITC go beyond the amount of the credit
received. Studies have found that the EITC increases participation
in the labor market (Eissa and Liebman 1996; Meyer and Rosenbaum 2000), improves maternal health outcomes (Evans and Garthwaite 2010) and
helps low-income individuals acquire additional experience that
contributes to higher earnings growth (Dahl, DeLeire, and Schwabish
2009).
The Supplemental Nutrition Assistance Program (SNAP) is another
critical safety net program targeted at low-income families. SNAP
benefits are funded by the Federal Government and administered by
states. Families and individuals qualify if their income and assets
are sufficiently low. Participants usually receive their benefits on electronic benefit transfer cards that can be used only to purchase
food. Nondisabled adults who have no dependents and who are not
working or participating in a work training program can usually
receive SNAP benefits only for three months over a three-year period.
Roughly half of all SNAP participants were children, and more
than three-quarters of all participant households included a child,
an elderly person, or a disabled nonelderly person. Roughly a
quarter of all children participated. In FY 2010, the average
household participating in the SNAP program received monthly
benefits worth $287; 40 percent of participating

[GRAPHIC NOT AVAILABLE TIFF FORMAT]

household received maximum benefit for their family size --for example,
$668 a month for a family of four.
Both participation and expenditures are strongly countercyclical in
the SNAP program, increasing during economic contractions and
decreasiing during expansions. Current projections are that SNAP
enrollment will begin falling next year, as the economy continues to
recover. Thus, like UI, SNAP not only provides direct benefits to
participant households, but also has a stabilizing effect on the
economy by limiting declines in consumption during economic
downturns.
The Recovery Act established the Emergency Contingency Fund
for state Temporary Aid for Needy Families programs, which provided
$5 billion to states for increased spending for basic assistance,
nonrecurrent short-term benefits, or subsidized employment. States
expanded efforts in all three areas, including committing $1.3
billion to the largest targeted employment initiative in the history
of welfare reform. Thirty-nine states in addition to the District
of Columbia, Puerto Rico, and the Virgin Islands established
subsidized employment programs, with an estimated 260,000 job slots
created for adults and youth, many of them involving subsidies that
created jobs with private sector employers. While most of these subsidized employmentefforts were not sustained at previous levels after
Recovery Act funding ended, many jurisdictions have maintained
programs at a smaller scale. Based in part on the success of this
initiative, the President has proposed the Pathways Back to Work Fund
(discussed in Chapter 6) that would provide employment opportunities
for low-income individuals and the long-term unemployed.
Housing is the largest component of virtually every family's
budget, especially low-income families. The Federal safety net
includes several programs designed to ensure that financial stress
does not result in home-lessness. Stable housing allows families to
weather labor market shocks and is a precondition for children's
educational success. In addition to the 2.3 million families
assisted by the Department of Housing and Urban Development's
project-based rental assistance and public housing programs, the
largest Federal program aimed at low-income households is the
Housing Choice Voucher program. The Housing Choice Voucher program
served 2.1 million families in FY 2010, of which 90 percent included
children, the elderly, or individuals with disabilities. As discussed
in Chapter 4, the Administration has also developed new programs that help unemployed homeowners avoid foreclosure.
Two other programs that are critical to the safety net provide
benefits to Americans with disabilities. Social Security Disability
Insurance (SSDI) is a social insurance program designed to offset the
loss of wages of workers with long-term health conditions that prevent
"substantial gainful activity." Individuals with adequate Social
Security-covered employment history, or children (disabled
before age 22) of a retired, deceased, or disabled worker entitled
to Social Security benefits, are covered by the program.
Beneficiaries receive a cash benefit based on their income before
becoming disabled, adjusted upward by wage inflation. In December
2010, more than 10 million people received SSDI benefits. Recipients
become eligible for Medicare after two years, offsetting the loss of
employer-sponsored health insurance.
A second Federal program that assists persons with disabilities
is Supplemental Security Income (SSI), a means-tested entitlement
program that provides cash benefits to needy aged, blind, or
disabled individuals. In December 2010, roughly 7.9 million
Americans received SSI benefits; of that total, about 6.6 million
qualified on the basis of a disability. The program is a particularly
important source of income for older working-age adults: roughly
one-quarter of all participants are between the ages of 50 and 64.
A recent study illustrates how critical these programs are to
their participants (DeCesaro and Hemmeter 2008). Using data from
2002, the study shows that nearly a quarter of SSDI and roughly half
of SSI beneficiaries had family incomes that fell below the
Federal poverty level. However, the programs play an important role
in keeping their beneficiaries out of extreme poverty, which is
defined as having an income below 50 percent of the Federal poverty
threshold. According to this study, the majority of SSDI recipients
relied on that program for at least 75 percent of their income.
While only 5 percent of SSI beneficiaries were in extreme poverty,
taking away SSI benefits would have raised that figure above 40
percent.

HEALTH INSURANCE
In March 2010, the President signed into law the Patient
Protection and Affordable Care Act (the Affordable Care Act). When
fully implemented, the Affordable Care Act will significantly
strengthen the health care safety net, substantially increasing
the number of Americans with health insurance and providing new
protections and benefits to those who are already insured. The
Affordable Care Act builds on and maintains the strengths of the
current private system of employer-sponsored health coverage and
insurance provided through Medicare, Medicaid, and the Children's
Health Insurance Program (CHIP). Therefore, the changes brought
about by the new law need to be considered in the context of the
current system.

The Economics of Employer-Sponsored Health Insurance
One of the defining features of the U.S. health care system is
the central role played by employers. Today, roughly nine in ten
Americans with private health insurance obtain their coverage
through the workplace, either through their own employer or through
the employer of a family member. Employer-sponsored insurance is
generally much less costly for workers' who pay for coverage through
reductions in their wages as well as direct premium
contributions--than coverage purchased directly in the individual
market. There are three main sources of savings.
First, employer-sponsored group coverage greatly mitigates the
problem of adverse selection. Because employer-sponsored groups are
formed for reasons other than purchasing health insurance, they
represent stable risk pools. Employer policies themselves contribute
to this stability and to the spreading of risks. Within firms, the
amount that employees are required to contribute toward premiums
generally does not vary with health risk. Common employer and
insurer policies--such as limiting periods when employees can sign
up for coverage and requiring a minimum employee participation
rate--prevent employees from declining coverage when they are
healthy and joining the plan only when they need medical care.
A stable risk pool translates to lower administrative costs as
insurers need to devote fewer resources to underwriting.
Administrative savings also come from economies of scale in
marketing and administration. Because important costs vary with the
number of contracts rather than the number of individuals covered
by a contract, it is less expensive on a per-person basis to sell
to a group of 1,000 than to sell to 1,000 individuals.
Third, because employer expenditures on health insurance
premiums are exempt from Federal and state income taxes and Social
Security payroll taxes, employer-sponsored insurance can effectively
be purchased with pretax dollars. For a typical worker in the
15 percent tax bracket, the tax exclusion reduces the cost of
insurance by roughly one third (Gruber 2010). Overall, the estimated
FY 2011 tax expenditure associated with the exemption from Federal
taxes is $282 billion.
Although the cost savings associated with employer provision of
insurance can be large, the savings are not evenly distributed among
employers. The advantages of more efficient risk pooling and
economies of scale in marketing and administration increase with
firm size. The value of the tax exemption is not explicitly tied to
firm size, but because compensation tends to be higher in larger
firms, this advantage is correlated with size as well. As a result,
the larger the firm, the greater the probability it will offer
health insurance. Figure 7-2 illustrates that, whereas nearly all
firms with more than 50 employees offer health benefits, less than
half of those with 2 to 24 employees do. Between 2000 and 2010, the
share of private sector establishments with fewer than 50 workers
that offer health insurance benefits declined from 47.2 percent to
39.2 percent.
Firm size affects more than just whether workers are offered
coverage. Among firms that offer insurance, large firms are
substantially more likely to offer a choice of plans: more than 80
percent of private sector establishments with 1,000 or more
employees offered a choice of health insurance options in 2010,
compared with 18 percent of establishments with 50 or fewer
employees. Employees who have a choice of plans tend to report
greater satisfaction with their insurance coverage and their health
care (Schone and Cooper 2001). And some very large firms have
actively promoted strategies to improve health care quality and
patient safety.
Over the past two decades, rising health care costs have eroded
the accessibility of employer-sponsored health insurance, especially
for middle-class families who experienced relatively little income
growth over that period. Figure 7-3 plots the percentage of workers
who lack health insurance (left axis) against an estimate of their
per capita health spending divided by their median income
(right axis). Because the growth in health spending is a principal
determinant of rising insurance premiums, this ratio can be seen to
capture changes in the affordability of health insurance. The figure
indicates that during the 1980s insurance became less affordable as
health care costs



grew faster than median incomes and the percentage of workers without
coverage grew. In the mid-1990s, health care spending grew less rapidly
and a strong economy caused median income to rise. As a result of this
confluence, the affordability index remained relatively constant, and insurance coverage stabilized. However, health care cost growth
picked up again in the late 1990s and has outstripped income growth
for the past decade, causing coverage to decline once again.

Medicaid and CHIP: A Health Care Safety Net for Children
As insurance coverage has declined among working-age adults over
the past two decades, coverage among children has actually increased
because of expanded eligibility for public programs. Until the
mid-1980s, Medicaid eligibility was tied to eligibility for Aid to
Families with Dependent Children, the cash welfare program. Starting
in 1986, the two programs were delinked, and income eligibility
limits for Medicaid were increased. The most significant eligibility
expansions came as part of the Omnibus Budget Reconciliation Acts of
1989 and 1990. As the data in Figure 7-4 depict, with these
expansions the share of children without health insurance began to
decline, even as the share of uninsured adults rose. By 1997, while
18 percent of nonelderly adults were uninsured, the share of children
who were uninsured was 14 percent.



That same year, Congress established the State Children's Health
Insurance Program (initially referred to as SCHIP, now CHIP) as part
of the Balanced Budget Act of 1997. Like Medicaid, CHIP is funded
jointly by states and the Federal Government, although CHIP allows
states more flexibility in designing their programs. States began
implementing CHIP in late 1997, and by 2000 every state program was
up and running. Today, the income eligibility limit in 47 states and
the District of Columbia is 200 percent of the Federal poverty level
or greater. As a result of Medicaid and CHIP, the percentage of
children who are uninsured has fallen since the late 1990s and is
now less than half the adult rate.
President Obama has built on the success ofMedicaid and CHIP by
making these programs even stronger. In the early days of the
Administration, the President signed the Children's Health Insurance
Program Reauthorization Act of 2009, which extended funding for CHIP
through September 2013. This legislation also introduced
administrative reforms that improve program effectiveness, including
new performance bonuses for states that successfully increase
coverage by streamlining eligibility and enrollment procedures. Also
in 2009, the Recovery Act provided additional support to states by
boosting the Federal share of Medicaid at a time when program
enrollment was increasing and state budgets were in crisis. Between
2008 and June 2011, over



4.4 million children gained coverage through Medicaid and CHIP.
In 2010, the Affordable Care Act extended funding for CHIP through 2015.
Because of Medicaid and CHIP, insurance coverage of children
tends to be less sensitive to changes in macroeconomic conditions
than that of adults. Research suggests that, holding other factors
constant, a 1 percentage point increase in the national unemployment
rate translates to almost a 1 point decrease in the percentage of
nonelderly adults and children covered by employer-sponsored
insurance (Holahan and Garrett 2009). Without a strong public
insurance safety net for adults, more than half of the working-age
Americans who lose employer-sponsored insurance during an economic
downturn end up uninsured. For children, however, the loss of private
coverage is mostly offset by an increase in public insurance. This
discrepancy between the experience of adults and children will change
with the full implementation of the Affordable Care Act, described
below.
Many studies indicate that the expansion of Medicaid and CHIP
has also significantly improved access to health care. One study
using data from the 1980s and early 1990s found that eligibility
for public insurance roughly halved the probability that a child
failed to have at least one physician visit a year
(Currie and Gruber 1996a). Other research shows that increased
Medicaid eligibility for children leads to an increase in
hospitalizations overall, but a decrease in "preventable" admissions
(that is, those that are avoidable if a child receives appropriate
primary care) (Dafny and Gruber 2005). Improved access to care
translates into better health outcomes, ranging from improvements
in subjective health status (Currie, Decker, and Lin 2008) to
reduced child mortality (Currie and Gruber 1996a, 1996b).

Expanding Health Care Coverage: The Affordable Care Act
The Affordable Care Act builds on the strengths of
employer-sponsored insurance and on the success of earlier
expansions of Medicaid and CHIP to expand and strengthen the
health care safety net. By 2019, the Affordable Care Act is
expected to increase the number of Americans with health
insurance by more than 30 million. Roughly half of the coverage
gain will come from raising Medicaid eligibility limits to 133
percent of the Federal poverty level. Because income eligibility
limits for CHIP in all states already exceed this level, the law
will expand Medicaid coverage mainly among nonelderly adults.
Although the primary responsibility for administering Medicaid
will remain with the states, funding for the expanded coverage
will come almost entirely from the Federal Government.
Most of the remaining coverage gains will come from private
insurance purchased through state-level Affordable Insurance
Exchanges. Individuals and families with incomes up to 400 percent
of the Federal poverty level who do not have access to affordable
employer-sponsored coverage that meets a minimum value will be
eligible for premium tax credits that they can use to purchase
coverage through an Exchange. These new tax credits are targeted
at lower- and middle-income families who currently receive little
or no benefit from the large tax subsidies that implicitly support
the system of employer-sponsored insurance. The Affordable Care Act
also establishes a Small Business Health Insurance Options Program
(SHOP) in each state that gives small employers and their employees
access to private health insurance plans and small business health
insurance tax credits as well.
The state-level Exchanges will extend to workers at small firms,
the self-employed, part-time workers, and nonworkers many of the
advantages of employer-sponsored insurance already enjoyed by
employees of large firms: more efficient risk pooling and greater
administrative economies of scale than are available in the current
individual and small group market. Within an Exchange, consumers
and employers will be able to choose from a broad menu of plans.
To improve consumer choices, Exchanges will provide transparent
information on premiums, benefits, cost-sharing, and plan
quality--information that will help cut the high consumer search
costs that push up premiums in the small group and individual health
insurance markets (Cebul et al. 2011). By creating a marketplace in
which consumers can easily compare plans on the basis of price and

quality, the Exchanges should increase competition among insurers. Considerable evidence from large employers shows that when employees
are given a choice of health plans and clear information about
premiums and benefits, they switch plans in response to small
differences in premiums (Buchmueller 2009).

The Affordable Care Act establishes new consumer protections
for health insurance coverage purchased either through an Exchange
or in the outside individual or small group market, many of which
are already in effect today. Insurers will not be allowed to deny
or limit coverage on the basis of an individual's health status.
Within certain limits, premiums may vary by age, geography, and
smoking status, but not by individual health status, gender, or
other factors. The Act also includes a requirement that individuals
who can afford insurance maintain minimum essential coverage.
These market reforms fill an important gap in the health care safety
net.

Provisions of the Affordable Care Act Now in Place
Many of the insurance market reforms, along with the expansion
of Medicaid and the creation of the Exchanges, will not take effect
until 2014. Some provisions of the Affordable Care Act, however,
have already been put into place. Insurers are now prohibited from
retroactively cancelling coverage because of honest mistakes made
on the application. The Act also eliminates lifetime dollar limits
on essential health benefits and restricts the use of annual dollar
limits. (Annual benefit limits will be eliminated completely
by 2014.) Since July 2010, consumers who are uninsured and unable to
get insurance because of a pre-existing condition can find subsidized
coverage through the Pre-Existing Condition Insurance Plan.
This temporary program gives uninsured individuals with costly
conditions access to affordable insurance until the full set of
consumer protections takes effect in 2014. As of the end of 2011,
45,000 individuals were enrolled.
Another coverage-related provision of the law that is already in
force allows young adults to remain on their parents' private
insurance policies until they reach age 26. This policy targets a
population that is disproportionately uninsured. Although one
reason large numbers of young adults have no health insurance is
that people in this age group tend to be in good health and do not
perceive a need for health care (the "young invincibles" hypothesis),
a second important reason is lack of access to affordable coverage,
because many young adults have not yet settled into full-time jobs
that offer health benefits. As a result, the probability of being
uninsured jumps between the ages of 18 and 19, as many young adults
lose coverage under their parents' employer-sponsored insurance.
This loss of coverage translates to a significantly lower use of
health care services (Anderson, Dobkin, and Gross 2012).
The dependent coverage provision of the Affordable Care Act took
effect on September 23, 2010. Data from several independent sources
indicate that the policy has significantly increased the insurance
coverage of young adults. Figure 7-5 presents data from one such
source, the National Health Interview Survey, highlighting the
change in insurance coverage for youth age 19 to 25 in comparison to
a slightly older group, age 26 to 35. Because these two groups should
face roughly similar labor market conditions, the experience of
the older group provides a sense of what would have happened to
the younger group had this provision of the Affordable Care Act
not gone into effect.
Estimates from the third quarter of 2010 show that 35.6 percent
of the younger group was uninsured, compared with 27.7 percent of the
older group. Between the third quarter of 2010 and the second
quarter of 2011, insurance coverage was essentially unchanged for
the older group. In contrast, among the younger group the share
uninsured fell 8.3 percentage points. This change translates to a
gain in health insurance coverage for approximately 2.5 million
people. Because even before this policy, college students were able
to stay on their parents' insurance plans or obtain coverage through
their school, the coverage gains arising from the Affordable




Care Act have been concentrated among non-students and recent
graduates. Many of these newly insured young adults are from lower
middle-class families who are working to maintain their position
in the economy in the face of not only the recent economic downturn,
but long-run forces that have been working against the middle class for decades.

The Economic Benefits of Expanding Insurance Coverage
Expansion in health insurance coverage from the ACA can be
expected to positively affect access to care, health, and financial
security. These effects and the impact of other provisions of the
Affordable Care Act will be important topics of research
(see Data Watch 7-2).
Research on previous coverage expansions suggests that health
insurance can significantly improve all three outcomes. As noted,
considerable research has examined the benefits of health insurance
for children. One recent study (Finkelstein et al. 2011) examines
the effect of insurance coverage on low-income adults. The study,
which uses data from Oregon's Medicaid program, has two especially
notable features. First, its population sample is similar to the
group that will gain Medicaid coverage as a result of the Affordable
Care Act. Second, because of budgetary constraints, access to
Medicaid coverage was determined randomly by a lottery, in the same
way patients are assigned to treatment and control groups in a
randomized control trial. As a result, the study avoids the
fundamental problems of inference inherent to observational studies.
The study finds that in the program's first year insurance
coverage significantly increased the use of outpatient and inpatient
care and of prescription drugs. The added care led to increases in
the share of men and women screened for high cholesterol and high
blood sugar and in the share of women receiving mammograms and Pap
tests. The study also noted significant gains in several
self-reported measures of physical and mental health. These findings
are especially striking because the health benefits of improved
access to care are likely to grow over time.
In addition to improving access to appropriate care, health
insurance protects individuals and families from the financial risk
associated with uncertain and potentially catastrophic medical
costs. Today few uninsured families have the resources to cover the
cost of a serious illness. According to one recent study, about a
third of uninsured families have no financial assets at all, and
the average uninsured family can afford to pay only 12 percent of the
cost of a single hospitalization (Chappel, Kronick, and Glied 2011).
The Oregon study used several financial outcomes to assess economic
benefits of insurance. It found that individuals with health
insurance were less likely to have unpaid bills sent to a collection
agency and that they were significantly

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Data Watch 7-2: Health Data for Policy
Health policy formulation and evaluation requires high-quality data
on a broad range of outcomes. Federal surveys have provided the basis
for a large research literature that informed the design of the
Affordable Care Act. These surveys along with other Federal data
programs will be important resources for monitoring the impact of
the Act.
One objective of the Affordable Care Act is to substantially
increase the number of Americans with health insurance. The National
Health Interview Survey (NHIS) sponsored by the Department of Health
and Human Services (HHS) and three other surveys conducted by the
Census Bureau--the Current Population Survey's Annual Social and
Economic Supplement, the Survey of Income and Program Participation,
and the American Community Survey--provide data on various aspects
of insurance coverage. Increased insurance coverage should lead to
improved access to care and improved population health. The NHIS
and another HHS survey, the Household Component of the Medical
Expenditure Panel Survey (MEPS), combine information on insurance
coverage with information on medical care utilization and health
status. Another component of the MEPS surveys employers on key
features of the health insurance they offer employees. Additional
information on utilization comes from HHS surveys of health care
providers, including office-based physicians, ambulatory care
facilities, and hospitals.
Two Federal data programs--the National Health Expenditure
Accounts, produced by the Centers for Medicare and Medicaid Services,
and the National Income and Product Accounts, produced by the Bureau
of Economic Analysis--rovide independent estimates of national
health spending. Efforts also are under way at the Bureau of Labor
Statistics to improve the collection of health data to better
measure health sector prices and productivity (Bradley et al. 2010).
Current initiatives by Federal agencies and academic researchers
are aimed at developing data systems that support disease-based
estimates of health spending (Aizcorbe, Retus, and Smith 2008).
Research in this area focusing on selected conditions has shown
that disease-based measures allow for a more nuanced understanding
of what drives the growth in health spending. The results suggest
that failing to account for changes in the inputs used to treat a
particular condition and for improvements in health outcomes leads
to an overestimate of health care inflation and an underestimate of
productivity gains in the health sector (Aizcorbe and Nestoriak
2011). Whether this conclusion can be generalized is the subject of
ongoing research.

less likely to report having to borrow money or skip paying other
bills to pay medical expenses. These findings are consistent with
earlier research showing that the advent of Medicare in 1965
generated large benefits in the form of reduced exposure to
out-of-pocket medical expenditure risk (Finkelstein and McKnight
2008).
The benefits of the Affordable Care Act's coverage expansion are
likely to spill over to the labor market as well. Because small
firms cannot offer health insurance that matches in cost and quality
the insurance offered by larger firms, they often find it difficult
to compete with large firms in attracting and retaining workers.
Similarly, the lack of affordable insurance options in the individual
health insurance market poses a barrier to workers who would like
to start their own business, work part-time, or retire before they
are eligible for Medicare. Indeed, numerous studies find that the
link between health insurance and full-time employment distorts
decisions regarding labor supply, job mobility, and retirement
(Gruber and Madrian 2004). By improving the health insurance options
available to small employers and expanding the availability of
affordable individual coverage, the Affordable Care Act should
greatly reduce if not eliminate these distortions.

The Affordable Care Act and Medicare
Given the high and uncertain medical expenses faced by seniors,
the health insurance coverage that Medicare provides for individuals
age 65 and older is a critical component of the health care safety
net. The inability of private markets alone to provide adequate
health insurance coverage for seniors is a classic example of
adverse selection (Akerlof 1970). Indeed, before Medicare was enacted
in 1965, only an estimated one-quarter of seniors had meaningful
private insurance (Finkelstein 2007). Today Medicare covers roughly
40 million elderly Americans and 8 million people under age 65 who
qualify on the basis of disability.
Although the Affordable Care Act's coverage expansions and
insurance market reforms are targeted at nonelderly Americans,
the new law has important implications for Medicare as well. It
provides new benefits to seniors by eliminating cost sharing for
recommended preventive services, adds an annual wellness visit, and
reduces out-of-pocket costs for prescription drugs in the Medicare
Part D coverage gap. By the end of 2011, more than 24 million elderly
Americans have benefited from the elimination of cost sharing for
preventive benefits, and 3.6 million beneficiaries have received $2.1
billion in drug discounts.
The Affordable Care Act also puts in place several strategies for
reducing the growth in Medicare spending. Such efforts to "bend the
cost curve" are essential to maintaining the long-run fiscal status
of the program and reducing long-run Federal budget deficits.

The Act includes important changes in the way Medicare pays doctors,
hospitals, and other health care providers to create strong
incentives for providers to redesign the way they deliver care,
both to improve health and to use scarce resources more efficiently.
The Medicare Shared Savings Program, for example, encourages
physicians, hospitals, and other organizations to form Accountable
Care Organizations (ACOs) to provide cost-effective, coordinated care
to Medicare beneficiaries. Both the Shared Savings program and a
similar Affordable Care Act initiative developed through the Center
for Medicare and Medicaid Innovation (the Innovation Center) reward
ACOs that are able to reduce the growth in health care spending
while achieving high standards for clinical quality and patient
satisfaction.
The mission of the Innovation Center is to help transform the
Medicare, Medicaid, and CHIP programs to deliver better health
care, better health, and reduced costs. The center's portfolio of
initiatives includes demonstration projects that test new
strategies for providing higher-quality health care more
efficiently. These strategies include models of enhanced primary
care; the use of episode-based bundled payments to improve care
coordination; and a challenge grant program that will award up to
$1 billion in grants to applicants who will implement the most
compelling ideas for delivering better health, improved care, and
lower costs to people enrolled in Medicare, Medicaid, and CHIP.
Because of Medicare's outsized role as a purchaser of health care,
these initiatives are likely to spur similar innovations by
private insurers.
RETIREMENT SECURITY
For older Americans, retirement savings in combination with
Social Security benefits are a critical element of the safety net.
These savings and benefits together allow retirees to maintain the
living standards they had during their working lives and to protect
themselves against downturns in the financial markets, unexpectedly
high health care costs, and the risk of running down one's assets.
In addition, some Americans elect to accumulate additional savings
in hopes of bequeathing assets to their heirs. From a broader
societal perspective, private retirement savings fuel capital
accumulation. Capital thus accumulated leads to greater investment,
which in turn leads to a more productive workforce and stronger
economic growth. In this sense, saving not only bolsters the
standard of living in retirement for participating workers but
also raises the quality of life for future generations.
Over the years, policymakers have implemented a variety of policies
to encourage capital accumulation, to protect retired households
against economic shocks, and to increase the likelihood that

Americans enjoy the same quality of life during retirement that
they enjoyed during their working years. The most prominent of
these programs is Old Age and Survivors' Insurance, also known as
Social Security, which pays retiree benefits to more than 95 percent
of elderly individuals in the United States. Social Security is
the nation's retirement security bedrock, paying out $596.7 billion
to 44.4 million beneficiaries in 2011--an average annual benefit of
$13,561. Social Security payments, combined with private savings and
employer-provided retirement benefits, provide sufficient income to
enjoy a comfortable retirement, and for many others, make the
difference between meeting basic needs and living in poverty.
In 2010 Social Security income lifted an estimated 13.8 million
elderly Americans out of poverty. The program also provides a key
safety net for survivors of deceased workers, helping roughly 6
million surviving spouses and children.
Even as Social Security helps provide a stable source of income
in retirement, tax preferences for retirement saving give working-age
households greater incentive to accumulate assets toward retirement.
Most tax-preferred accounts allow workers and their employers to make
pre-tax contributions to a retirement account and also allow earnings
on those contributions to accumulate tax-free; other accounts allow
after-tax contributions to grow and be withdrawn tax-free. Many
American households have responded to these tax incentives by building
assets toward retirement, with total balances in defined-contribution
and individual retirement accounts (IRAs) rising to nearly
$9.2 trillion in 2010. The overall tax expenditure for the principal
retirement saving incentives is substantial, totaling almost $120
billion in fiscal year 2010.

Declining Retirement Preparedness
Despite the availability of tax-related incentives to spur
saving, many households have not accumulated sufficient assets to
overcome the potential risks faced in retirement. By some estimates,
the proportion of households with adequate retirement saving has
been in decline for decades. As illustrated in Figure 7-6, the
share of households "at risk" of experiencing marked declines in
consumption in retirement rose from 31 percent in 1983 to 51 percent
in 2009, with much of the recent change owing to declining housing
values.  For members of Generation X (individuals born between

the mid-1960s and 1972), the situation is even more troubling, with
nearly three in five households in that age group in danger of
becoming unable to maintain their living standard in retirement
(Munnell, Webb, and Golub-Sass 2009).
Although retirement preparedness has been in decline in the
aggregate, specific demographic groups are particularly vulnerable.
Single individuals and low-income households are all especially
likely to enter retirement with insufficient assets. For example,
one estimate for 2009 identified 60 percent of low-income
households as inadequate savers, compared with 42 percent of
high-income households (Munnell, Webb, and Golub-Sass 2009).
Another estimate found that 60.2 percent of single men had
insufficient retirement wealth to maintain preretirement
consumption, compared with 45.2 percent of married couples
(Haveman et al. 2006).
Recent economic shocks have impacted individuals nearing
retirement. Between 2007 and 2009, Americans aged 55 to 64 saw their
real median household income decline by 5 percent and their median
net worth fall 15 percent--from $258,000 to $222,000
(Bricker et al. 2011). In addition, the value of housing--key source
of wealth for older Americans has dropped 34 percent since the
housing market's peak in April 2006. The value of financial assets
also declined precipitously following the financial crisis and has
yet to rebound fully to pre-recession levels. The combination of
declining asset values and lower income has further weakened retirement preparedness.

Challenges to the Retirement Safety Net
Several developments have contributed to the problem of
inadequate retirement saving. A first-order concern is declining
participation in employer-sponsored retirement plans. Between 2000
and 2010, the share of private sector workers between the ages of 21
and 64 who participated in an employer-sponsored retirement plan fell
from 48 percent to 39 percent.
The past several decades have also seen changes in the nature of
private employer retirement plans. The share of private-sector
workers covered by defined-benefit pension plans fell from 38 percent
in 1980 to 20 percent in 2008 as many private employers switched to
defined-contribution plans like 401(k) plans. Section 401(k) and
other defined-contribution plans offer workers particular benefits,
such as portability, high potential for growth, and flexibility.
However, the shift to 401(k) plans (and to a lesser degree a shift
from traditional defined-benefit pensions to hybrid defined-benefit
plans such as cash balance plans) has also transferred substantial
risk away from employers, placing greater responsibility on workers
to accumulate and manage assets and exposing them to greater
financial risk.



To take full advantage of the wide array of incentives for
retirement saving, workers must assess complex details associated
with establishing an account, making contributions, managing
investments, and eventually making withdrawals. In the face of
complex saving and investment decisions, some workers put off
enrolling in employer-sponsored retirement programs or taking
advantage of tax-preferred saving vehicles outside of employment.
Such delays are costly in terms of lifetime asset accumulation.
(See Economics Application Box 7-1 for more information on common
mistakes made by retirement savers.)
Another challenge to the retirement safety net is the uneven
distribution of the benefits of the tax code's generous incentives
for retirement saving. Because these tax incentives are often
provided as a deduction or exclusion from income, they are most
valuable for taxpayers in higher tax brackets. In the aggregate,
these incentives flow disproportionately to upper-income households;
almost 80 percent of the total tax benefit is projected to go in
2012 to the richest 20 percent of households and more than 40
percent to households in the top 5 percent of the income
distribution (Toder, Harris, and Lim 2011).
The availability of employer-sponsored retirement saving options
also varies by firm size. As with health insurance, small employers
face significant challenges in establishing retirement plans.
High per-participant administrative costs, frequent employee turnover,


uncertain revenues, and lack of familiarity with plan design and
characteristics all discourage small business owners from providing
retirement plans. Their inability to provide these plans not only
threatens retirement security for employees of small businesses but
also can make small businesses less attractive to workers than
larger employers are.
These obstacles to retirement saving keep account balances low
for many households. In 2011, more than half of all workers reported
that the total value of their household's savings is less than
$25,000; 29 percent said they have less than $1,000 in savings
(Helman, Copeland, and VanDerhei 2011). Although some of these
workers may participate in defined-benefit pensions, others will
enter retirement with little income outside of Social Security. One
analysis of households aged 65 to 69 in 2008 showed that the median
household had just $15,000 in financial assets and $5,000 in private
retirement assets (Poterba, Venti, and Wise 2011). Most households
in the sample had more wealth in housing equity than in liquid assets
(Table 7-2).
One of the toughest retirement challenges involves uncertainty
about how long retirees are likely to live. With extended longevity
comes the possibility that an individual will live longer than
expected and will thus outlive his or her accumulated assets. This
possibility increases as the time between retirement and expected
age of death lengthens. In 1970 a worker retiring at age 65 could
expect to live another 15.2 years; by 2008 that figure had grown to
18.7 years. Although extending life expectancy is an exceptional
achievement for the United States, it also increasingly exposes
retirees to the risk of outliving their assets outside of Social
Security. In 2010, just 17 percent of Americans aged 65 to 69 relied
on Social Security for more than 90 percent of their income, but the
share almost doubled, to 33 percent, for Americans age 80 and older
(Figure 7-7).
Another serious risk is costly health shocks. Even with the
protection provided by Medicare, many retirees face high
out-of-pocket health expenditures, diminishing their retirement
assets and threatening their well-being. Recent research estimates
that for a 65-year-old couple, the expected present value of
lifetime out-of-pocket medical costs exceeds $250,000, with a 5
percent risk that expenses will exceed $570,000
(Webb and Zhivan 2010). As discussed in Data Watch 7-1,
out-of-pocket health costs can push retirees into poverty.
The risk of large health expenditures and the possibility of
outliving one's assets force retirees to face difficult decisions
about how much of their assets to consume in any given year.
Uncertainty about lifespan, inflation, investment return, and
unexpected medical expenses makes the "decumulation decision"--how much to withdraw from accumulated

[GRAPHICS ARE NOT AVAILABLE IN TIFF FORMAT]

saving--exceptionally complicated. Retirees who live longer than
expected might find themselves with insufficient assets in the later
years of life, at a time when they are most vulnerable and in need of
a reliable stream of income. While private annuities can serve to
mitigate many of these risks, annuities markets face a host of
obstacles including regulatory barriers,



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Economics Application Box 7-1: Financial Literacy and Common
Mistakes Made by Retirement Savers

A generation ago, when many workers were covered by
defined-benefit plans, retirement savings decisions were relatively easy
Today, workers must take much more responsibility for ensuring that they
have adequate income throughout retirement. Achieving that goal requires
avoiding some mistakes commonly made in saving for retirement. Below
is a list of five mistakes that people often make.
Missing out on the tax benefits of saving. The tax code affords
strong incentives for retirement saving. Participation in an employer-
sponsored retirement plan or individual retirement account can yield
thousands of dollars of extra retirement wealth over time.
In addition, low- and middle-income households can take advantage of
the Saver's Credit, which effectively provides workers with a
Government match on new saving.
Workers can substantially increase their retirement savings by
contributing early and taking advantage of tax benefits for retirement
saving. For example, if a 25-year-old contributes $1,000 toward
retirement in a taxable account, that $1,000 can be expected to grow
to approximately $7,300 in today's dollars by the time the worker
reaches age 65. Taking advantage of tax benefits for saving can
substantially increase this amount. If the same worker contributes
$1,000 to a Roth IRA, that $1,000 can be expected to grow to nearly
$10,300 in today's dollars by the time the worker reaches age 65. As
illustrated in the figure below, the benefits of tax-preferred saving
increase over time.


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Failing to participate in an employer-sponsored retirement plan.
Some employer-sponsored retirement plans provide an employer match
for money that an employee deposits into a retirement account.
Taking advantage of an employer match is one of the best ways to
leverage retirement contributions and rapidly accumulate saving.
Many workers, especially new hires and young employees, however,
leave this "free money" on the table by failing to sign up for a
retirement plan. In 2001, only 57.5 percent of workers aged 20-29
participated in a company retirement plan even when one was offered
(Kawachi, Smith, and Toder 2006).
Failing to diversify retirement savings. Investment needs and
risk appetites vary across households. However, concentrating all
assets in one particular type of investment can prove risky,
especially if that asset is stock in an employee's company. One
study found that in 2002, nearly 4 million workers invested in excess
of 80 percent of their employer retirement plan assets in own-company
stock (Mitchell and Utkus 2002). In general, investors can protect
themselves against risk by spreading their assets across various
types of investments.
Losing investment returns to high fees. High fees can inhibit
rapid accumulation of retirement wealth. Savers should pay attention
to all investment fees, including those charged at purchase of a
mutual fund, ongoing fees, fees charged by brokers and registered
investment advisors, and fees charged on the purchase of annuity
products. Although these fees are ordinarily charged for legitimate
services provided, investors should incorporate the cost of fees
in their purchase decisions.
Cashing-out retirement savings. When workers leave a job, some
fail to rollover their pension wealth into an IRA and pay a penalty
for cashing out their retirement savings. These leakages in
retirement savings make it difficult to arrive at retirement with
adequate amounts of savings. In 2006, workers aged 15 to 60 cashed
out $74 billion in retirement assets when changing jobs (GAO 2009).
Failing to protect against longevity and health care risk in old
age. As lifespans increase, more Americans will face the prospect of
running out of money in old age. Planning for and protecting against
the risk of outliving family assets as well as the need for long-term
care is an essential part of the retirement security picture.
---------------------------------------------------------------------
behavioral aversion to annuities, and inadequate savings to purchase
an annuity (Benartzi, Previtero, and Thaler 2011).

Policies to Address Retirement Saving Challenges
The President has proposed several policies to bolster Americans'
retirement saving behavior and lead to a more secure retirement for
millions of families. Perhaps the most significant policy is the
establishment of automatic IRAs for tens of millions of workers.
This proposal builds on a broad literature showing that automatic
enrollment can dramatically increase participation rates in
workplace retirement plans. For example, Madrian and Shea (2001)
show that the participation rate after one year of employment at a
large corporation increased from 37.4 percent to 85.9 percent
following the adoption of automatic enrollment.
The President's proposal would require most firms without
qualified employee retirement plans to offer employees an automatic
IRA option. By default, automatic IRA contributions would be funded
by payroll deductions equal to 3 percent of pay, unless employees
opted out of the program or elected to contribute a different amount.
Firms would not contribute on behalf of the employee, and companies offering the automatic IRA to workers could claim a tax credit for the employer's associated expenses up to $500 for the first year and $250 for the second year along with an additional tax credit of $25 per employee--up to a maximum of $250 a year for six years.
The automatic IRA would transform the retirement saving
landscape. Employees who previously accumulated little or nothing
toward retirement would begin accumulating assets immediately. Upward
of 40 million workers, all previously ineligible for workplace
retirement saving plans, would be covered by the new proposal. About
80 percent of these workers would be low- and middle-income employees
with less than $50,000 in annual wages, indicating that the IRA
would primarily be targeted at workers who are more likely to have
accumulated little savings.
The Administration also proposes to increase the tax credit for
small businesses that adopt, for the first time, a qualified
employee retirement plan. Under current law, small businesses can
receive up to $500 in tax credits--each year for up to three
years--for establishing an employee retirement plan. The President
proposes to double the maximum credit to $1,000 annually to provide
a stronger incentive for small employers to establish workplace
retirement plans.
The Administration's Budget eases the compliance burden for
retirement savings by exempting retirees with modest accumulated
saving from minimum required distribution (MRDs) rules. MRDs are
established to ensure that retirees with high accumulated retirement
assets direct those assets towards retirement, and not use retirement

accounts to shelter their income from estate taxes. The
Administration proposes to exempt retirees with less than $75,000
in retirement savings from these rules. This move would simplify
tax compliance for millions of elderly Americans, who would no longer
need to calculate the amount and timing of their minimum required
payouts. It would give millions of seniors greater freedom of choice
as to when and how rapidly to spend their limited assets in
retirement, while also adding flexibility to purchase lifetime
income products--such as longevity annuities--that might violate MRD
regulations.
The Administration has made a commitment to financial literacy as
a means of assisting Americans in making sound decisions regarding
saving and investment. In 2010, the President signed an Executive
Order creating the President's Advisory Council on Financial
Capability to assist the American people in understanding financial
matters and making informed financial decisions. In addition, the
Wall Street Reform and Consumer Protection Act of 2010 created the
Consumer Financial Protection Bureau, which is charged with
educating consumers about financial matters and enabling them to
make sound financial decisions. And, in 2011, the Financial Literacy
and Education Commission, established to coordinate Federal efforts to
promote financial literacy, developed a new national strategy to
enable Federal agencies to coordinate and promote all the Federal
initiatives aimed at helping Americans make better financial
choices.
Taken together, these policies will lead to a more inclusive
retirement saving landscape. Workers who would defer retirement
saving because of financial inertia or behavioral obstacles will
automatically be put on a path toward better saving. Easing MRD
rules will simplify financial decisions in retirement for millions
of elderly Americans. A coordinated national financial literacy
campaign will help Americans become more active savers and will
lead to improved investment decisions and smarter consumer behavior.
More active saving, coupled with improved investment behavior,
will increase the level of assets earmarked for retirement saving,
leading to a more stable retirement for millions of Americans.

CONCLUSION
A strong and dynamic economy requires a robust and modern safety
net to protect families against economic shocks and to provide a
level of security that promotes entrepreneurship and economic growth.
The challenging economic times of the past decade have made clear
the important role that public policy can play in this area. In
particular, unemployment insurance benefits, the Earned Income Tax
Credit, and the Supplemental Nutrition Assistance Program have kept

millions of American families out of poverty. Medicaid and the
Children's Health Insurance Program have ensured that children are
able to maintain health insurance coverage even if their parents
lose access to employer-sponsored plans.
New policy initiatives will further strengthen the safety net.
Although the current system of unemployment insurance has provided
critical support for dislocated workers, the system can be
modernized and improved. The President has proposed a number of
innovative programs that would make it easier for jobless workers to
invest in new skills or even start their own businesses.
These proposals build on current programs that have been proven to
work.
The Affordable Care Act represents the most significant
improvement in the health care safety net since the advent of
Medicare and Medicaid in the mid-1960s. By 2019, the Act is
expected to increase the number of Americans with health insurance
by over 30 million, and it will put in place new consumer protections
ensuring that health insurance coverage remains available and
affordable for all Americans regardless of an individual's health
status or medical history.
In the area of retirement security, the President has proposed
a number of policies that will boost retirement savings, making it
more likely that Americans will enter retirement with adequate assets
to maintain their desired level of consumption. These efforts to
strengthen the safety net will provide tangible benefits for the
economy and families in the coming decades.