Morningstar Magazine - April/May 2018 - 18

Dispatches

U.S. Wants to Help
Investors. Does It?
We review the tools
the government
deploys and how
they've worked.

POLICY

Aron Szapiro and
Jake Spiegel
Working on policy research at Morningstar,
we get a lot of questions asking why the
government is (or is not) doing something and why
government bureaucrats think an approach
will be helpful. We find that many people have
an idea of how the government operates
that fundamentally misses how it tries to
accomplish policy goals. In this column, we will
discuss the tools the government uses
to help investors. We hope it provides a better
understanding of the government's policy
decisions. It is a summary of a longer white paper
we plan to release later this spring.
Despite popular perception, governments
are not top-down hierarchies that directly carry out
social programs through their bureaucracies.
Rather, as Lester Salamon argues in The Tools of
Government, governments typically try to
induce third parties to carry out their policy goals
with a variety of tools.1 For example, to promote
homeownership, the U.S. Congress set up
loan-guarantee programs with banks and provides
generous tax benefits for buying a home.
Instead of providing the poor with "government
cheese," food assistance programs provide
vouchers for people to buy groceries at stores.
To get people to eat better food, the government

requires food and beverage makers to
disclose nutritional information on packaging,
and it imposes excise taxes on some junk food
and alcohol.
Similarly, for investors-particularly people
saving for retirement-the U.S. government mainly uses three tools to help them invest
for their future:
3 Tax incentives, which promote investing
for retirement.
3 Disclosures, which help people understand which
investments might best suit them.
3 Regulation, which governs the standards
of conduct for financial advisors.

We'll examine how effective these tools have been
in achieving their policy goals and which tools
hold the most promise for helping investors meet
their goals in the future.

small businesses to provide retirement plans
for their workforce. While 91% of workers at large
employers (those with more than 500 workers)
have access to a defined-contribution plan,
only 48% of workers at small employers (those with
fewer than 50 workers) do.
In fact, past efforts to increase the tax incentives
for retirement have not improved retirement
security. The Economic Growth and Tax
Relief Reconciliation Act of 2001, and the increased
defined-contribution deferral limits that came
with it, did not seem to spur more small employers
to offer retirement plans for their workers.
A 2011 analysis by the U.S. Government
Accountability Office found that the number of
small plans rose from 697,000 in 2003 to 705,000
in 2007. It seems unlikely that further gains
in retirement savings and the number of retirement
plans will be achieved solely using tax incentives.
Disclosures

Tax Incentives

To encourage people to save for retirement,
the government provides tax incentives. As all
financial planners know, contributions to
traditional retirement accounts are tax-free, and
the accounts are not taxed until retirement.
Even more importantly, these incentives
are designed to encourage employers to offer
retirement plans to their workers because
company contributions are tax-free as well; the
principals at a business can personally
benefit from setting up a plan that helps both
them and their workers.
These tax incentives-while undoubtedly effective
at nudging some workers to save for retirement-
have had mixed results. According to the
Boston College Center for Retirement Research,
there's still a significant shortfall between
what workers have saved and what they ought to
have saved to maintain a similar standard
of living in retirement. Half of all households are
projected to be unable to maintain their current
lifestyle in retirement. Furthermore, tax incentives
have proved to be insufficient to encourage

To help investors become more informed
and bring transparency to capital markets, the U.S.
government requires companies to make
numerous financial disclosures. Since 1934, the
SEC has required public disclosures for publicly
offered securities. Other disclosures, such
as filing documents for registered advisors (Form
ADV) and annual defined-contribution plan filings
(Form 5500), are designed to help regulators
look for potential problems, but they also can shed
light on investments and investment advisors.
Disclosures have undoubtedly helped many
investors make more-informed choices about how
they invest their money, but disclosures are
insufficient to markedly improve investors'
outcomes. This is because many investors lack
basic financial literacy, which undermines
some of the value that disclosures provide. In a
2012 study mandated by the Dodd-Frank Act, the
SEC found that, in general, "investors have
a weak grasp of elementary financial concepts and
lack critical knowledge of ways to avoid
investment fraud."2 The SEC further found that
women, African-Americans, Hispanics, and

1 Salamon, L.M., editor. 2002. The Tools of Government: A Guide to the New Governance (New York: Oxford University Press).
2 SEC. 2012. "Study Regarding Financial Literacy Among Investors." August. https://www.sec.gov/news/studies/2012/917-financial-literacy-study-part1.pdf

18

Morningstar April/May 2018


https://www.sec.gov/news/studies/2012/917-financial-literacy-study-part1.pdf

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