A 2024 Health Care Agenda

Progress on health care and health insurance appears to be two steps forward followed by one step back. This memo outlines ongoing health insurance problems and proposed solutions.


Introduction:

The ACA reduced the number of people without health insurance coverage by creating state exchange health insurance markets and expanding Medicaid coverage.  The Biden Administration expanded the premium tax credit for state exchange insurance and facilitated additional continuous Medicaid coverage.  However, the Biden-era reforms will lapse.

The enhanced premium tax credit will remain in place through 2025.  A Covid-era program facilitating continuous Medicaid coverage expires April 1, 2023.

Many health insurance and health care problems persist.  Some appear to be worsening.

Cost sharing, including deductibles, maximum allowable out-of-pocket limits, and coinsurance rates, for people with comprehensive health insurance coverage has increased for decades.  

People with employer-based health insurance are still susceptible to a loss of health insurance coverage, increased premiums, and additional out-of-pocket costs during job transitions.  Loss of coverage and increase uninsured costs will still routinely rise during recessions.

Middle-income adults with state-exchange insurance still pay substantially higher premiums than middle-income adults with employer-based health insurance.  

Workers at firms with relatively few health insurance options are usually ineligible for the premium tax credit for state exchange insurance and are often locked into a policy that is not best suited for their needs. (The Biden administration did eliminate the family glitch impacting the affordability of family-plan state-exchange policies.  However, many families with an offer of employer-based insurance are still precluded from claiming the premium tax credit for state-exchange policies even when the state-exchange policy is superior to the employer-based policy.)

Many households unable to afford comprehensive health insurance have purchased short-term junk insurance policies that leave them de-facto uninsured and exposed to high medical expenditures. 

Despite passage of the no-surprises act many households are still receiving bills from out-of-network providers, especially out-of-network specialists at in-network facilities. 

Many narrow-network health insurance plans do not provide sufficient access to top hospitals or specialists.

The memo outlines potential policy responses to these health insurance problems.  A more in-depth discussion of the problems and proposed solutions can be found in A 2024 Health Care Reform Proposal available at Sellwire and at Kindle.

Potential 2024 Health Care Policy Proposals:

Proposal One: Modify Rules Governing Health Savings Accounts and Flexible Savings Accounts to mitigate problems associated with higher cost sharing between insurance companies and households.

Issues:  Health plan deductibles and other forms of cost sharing between insurance companies and households have been increasing for the last two decades.  Many low-income and middle-income people either cannot afford to fund their health savings account or can only fund the health savings account by reducing contributions to their retirement accounts. The growth of out-of-pocket health care expenses has resulted in higher levels of medical debt, has caused some people to reduce savings for retirement to fund health savings accounts or flexible savings accounts and has resulted in many people foregoing necessary medical procedures and drug regimens.   

Potential Solutions:

Many of the problems associated with the use of high-deductible health plans, health savings accounts and flexible savings accounts can be remedied with changes to tax rules.   Proposed changes include:

  • Expand eligibility for contributions to health savings accounts to people with health plans that have modest deductibles and other forms of cost sharing including high coinsurance rates and high deductibles.
  • Replace the deductibility of contributions to health savings accounts with a tax credit to better assist low-income and middle-income households.   Alternatively, provide a tax credit for contributions to health savings accounts for low-income households and deductibility of contributions for households with income greater than a specific threshold.
  • Modify rules governing unused funds in flexible savings accounts to allow individuals to transfer some unused fund to an Individual Retirement Account or a 401(k) plan.

Proposed changes to rules governing high-deductible plans and health savings accounts could improve health outcomes and financial security and could increase retirement savings.

Proposal Two: Modify rules governing the premium tax credit for state-exchange insurance and the employer mandate to maintain continuous health insurance coverage during job transitions and to reduce disparities in health insurance outcomes and costs.

Issues:  The existence of separate employer-based and state-exchange health insurance markets causes disruptions in coverage during job transitions and disparities in health insurance costs and outcomes.  Three issues need to be addressed. 

  • Most people with employer-based insurance must find new health insurance or experience a disruption in coverage during a job transition.  Loss of health coverage is always high during economic downturns.
  • Middle-income young adults with state-exchange health insurance pay substantially more in health insurance premiums than a similarly situated middle-income young adult with employer-based coverage.
  • Many people with employer-based coverage are ineligible for the premium tax credit for state exchange health insurance even if the employer-based plan is not the best plan for the household.  

Proposed Solutions:

  • Allow employers to contribute to the purchase of state-exchange health insurance instead of purchasing employer-based health insurance.
  • Allow for conversion of employer-based insurance to state-exchange insurance when employees are being laid off.
  • Create a new tax credit covering part of the cost of state-exchange insurance for workers at small firms with income less than 400 percent of the federal poverty line.
  • Maintain a premium tax credit that limits workers share of premiums to 8.5 percent of income.
  • Modify the employer mandate to guarantee a minimum subsidy of premiums by large employers.  The combination of the new tax credit and the employer subsidy will pay the entire health insurance premium for most households.  Some low-income households would be eligible for additional assistance through the premium tax credit.  

Proposal Three:  Outlaw most short-term health insurance policies and create a new private/public low-cost health insurance option.

Issues:  A 2019 Trump Administration rule expanded the use of short-term health plans which did not cover essential health benefits. Many problems are associated with the use of short-term health plans.

Short-term health insurance plans provide extremely limited coverage.  Common problems include – (1) Denials of benefits for life-saving procedures (2) Strict limits on reimbursements for hospital stays, surgeries and for doctors. (3) Denial of benefits by requiring extensive documentation after a procedure has been conducted.  Short-term health plans often lack coverage for pharmaceutical benefits, maternity benefits, and mental health services. People with short-term health plans can often not obtain needed health services or have large financial exposures if they become ill.  

Insurance companies are allowed to deny short-term coverage to people with pre-existing conditions and to base premiums on the health status of the individual. As a result, the existence of the short-term market undermines the state-exchange markets.

Potential Solutions:

  • Abolish all health plans that do not provide coverage for essential health benefits as defined by the ACA.
  • Create a new lower-cost health plan that imposes an annual health expenditure limit.
  • Allow automatic enrollment in Medicaid for people with the new low-cost plan that meet the annual limit.
  • Limit enrollment in the new low-cost health plan to people who cannot afford current state exchange plans with no annual limits.

The combination of private insurance with an annual limit with public insurance coverage above the limit could in principle be applied to all workers.  Such an approach would lower costs and provide universal coverage while maintaining private control over health decisions.

Proposal Four:  Create additional regulations to limit surprise medical bills and assure that insurance companies provide adequate provider networks.

Issues:  Increasingly, health insurance and employers are attempting to reduce health expenditures by limiting access to providers.  Many health insurance policies impose higher deductibles and higher cost-sharing for out-of-network services. HMOS prevent consumers from ever going out-of-network.  (This approach is in many ways unique to the health insurance and health care industries. In most instance, competition is increased, and prices decreased when consumers have access to many service or good providers.)

Consumers with a narrow-network health plan are most likely to experience a surprise medical bill when they are forced to go outside their network for emergency services or when they go to an in-network facility that hires out-of-network providers.  A recently enacted no-surprises law attempts to reduce unexpected costs when consumers are forced to go out-of-network.

The no-surprises law does not fully address issues caused by narrow-network health plans.

  • The no-surprises law allows consumers to waive their rights to an in-network provider at facilities that offer both in-network and out-of-network providers.  It is often difficult to obtain timely non-emergency service without hiring at least on out-of-network provider.
  • Health care facilities often enter and exit a network.  In some part of an in-network facility could be out-of-network.  (I recent found that the hospital scheduled to give a biannual heart stress test was inside the network, but the radiology department was outside the network.) 
  • The responsibility of determining whether a network is inside or outside of the network lies on the individual consumer, not the insurance company or the provider.  Sometimes information obtained from the insurance company or the provider about network status is incomplete or not up to date. 
  • Some people with narrow-network plans often have a hard time obtaining access to specialists.  This problem is most severe for extremely narrow specialties and in rural areas.
  • Many narrow-network plans do not offer access to top hospitals, especially cancer hospitals.

Proposed Solutions

  • Create rules requiring insurance companies to provide reimbursement to all providers working at in-network facilities.
  • Create and enforce additional network adequacy regulations.
  • Require insurance companies to cover expenses for all providers working at an in-network facility.
  • Expand dispute resolution rules under the no-surprises act to cover all out-network situations, especially those involving use of specialists.
  • Create an insurance subsidy for high-cost health expenditures couple with a requirement that insurance companies provide greater access to top hospitals and specialists.

The recently enacted No-surprises law had bipartisan support.  However, the approach leaves many problems associated with narrow network health plans unresolved and does not incentivize insurers to broaden their networks.

Concluding Thoughts:   The 2020 health care debate in the Democratic Party involved a discussion on the merits of modifying the ACA versus the merits of replacing the existing health care system with a single-payer system.  The single-payer option was both politically and economically unfeasible. The Biden-era modifications to the ACA did not result in meaningful permanent changes to health insurance or health care. 

The Biden-era changes to the premium tax credit lapse in 2025. The changes in Medicaid eligibility rules, under the Covid emergency, expire in April 2023.  Problems related to cost sharing and high deductibles persist and were not addressed.  The issue of future loss of insurance coverage during economic downturns has not been addressed.  Despite elimination of the family glitch many disparities in health care price and outcomes persist due to the separation of state-exchange and employer-based health insurance outcomes. Short-term junk health insurance problems still exist.  The No-Surprises Act addressed some but not all problems associated with narrow-network health plans.

Long-term permanent solutions to health care problems can only be achieved if the Administration prioritizes health care over other concerns, including the spending in the Build Back Better Bill, some of the proposals for discharge of student loans, and even the expansion of the child tax credit.  Several of the health insurance reforms discussed here deserve prioritization over other proposals because the reforms also enhance financial and retirement security.

David Bernstein is the author of the 2024 Health Care Reform Proposal, a memo that is available at Sellwireand at Kindle. This paper does a good job discussing the academic literature and providing background on the health insurance problems and policy proposals outlined in this memo. David has also written David has also written Alternatives to the Biden Student Debt Plan.

The Debt-Limit Debate and Entitlement Spending

The Republican party is linking increases in the debt limit to cuts in entitlement spending. This approach will not lead to beneficial entitlement reform. A default on the debt would lead to catastrophic economic and political impacts. The 2023 fiscal debate should concentrate on how to phase out COVID-era relief benefits, instead of entitlement reform.


Introduction

A debt limit crisis that leads the United States to default on its financial obligations would be catastrophic. A U.S. debt default would lead to the demise of the dollar as the world’s reserve currency, increase interest rates, and reduce American influence abroad.  MAGA Republicans, who supported the insurrection and are supportive of Putin’s war in Ukraine, may not be opposed to these outcomes. 

GOP members of congress are threatening to refuse to support a debt-limit discharge unless the Senate and the President agree to cuts in Social Security.  Go here for some Republican ideas on linking increases to the debt limit to changes in Social Security and Medicare.  

The Debt Limit and Entitlements:

Many older people have very little in private retirement savings and are totally dependent on both Medicare and Social Security.  Efforts to change retirement and Medicare benefits must be preceded by reforms that decrease the number of older households with low levels of retirement assets or reserves for health expenditures.  

A proposal to increase the minimum age for Social Security benefits from 62 to 63 or longer would reduce the future debt to GDP ratio.  Financial markets are forward looking, hence the future expected debt to GDP ratio is a more important financial variable than current-year government deficits.  Entitlement reform should be more focused on the more important debt measure.

Immediate changes to entitlement spending would be detrimental to the economy, would reduce current consumption and would increase poverty among older households.

Reductions in entitlement spending cannot be implemented until after private retirement savings is increased, especially for households that currently do not save enough for retirement.

Efforts to expand private retirement savings will increase government deficits. 

Restrictions on government spending and tax expenditures for pension, health and other savings incentives stemming from a stringent debt limit will delay efforts to increase private retirement savings and will delay the needed increase in the retirement age.

The debt limit is not the only lever to force changes in entitlement spending.  The Trustees of the Social Security Trust fund project the trust fund will be depleted in 2035.  The projected depletion of the Trust fund will, under current law, lead to the automatic benefit cuts.   The avoidance of automatic benefit cuts, not the debt limit, is the best way to motivate actions on entitlement reform.

Concluding Thoughts:

Republicans do not have the votes for benefit reductions including changes in mean testing or increases in the retirement age.  Immediate changes in benefit formulas would be disastrous to current retirees and worker nearing retirement.  There is no support for MAGA-style entitlement reform in the Senate or in the current Administration.  The Democrats can’t link any entitlement change to a temporary increase in the debt limit because such an agreement would only lead to demands for additional changes in entitlements once the debt reaches the new limit. 

The 2023 fiscal discussion should center on efforts to reduce COVID-era emergency expenditures rather than efforts to force immediate changes in entitlement spending.  These debates will also be difficult and could lead to a government shutdown, an admittedly undesirable outcome but one that is less catastrophic than a default on the U.S. debt.  

David Bernstein, an economist living in Denver Colorado, is the author A 2023 Healthcare Reform Proposaland Alternatives to Biden Student Debt Relief Proposals

What is going on at the lower end of the yield curve?

Why is the 6-month T-bill rate so much higher than the 4-week T-bill rate?

Why is the 6-month T-bill rate so much higher than the 4-week T-bill rate?

Many analysts are concerned about the inversion between the 2-year and 10-year bond rate because such inversions typically foretell a recession.  There is a different story at the lower part of the yield curve.

The 6-month T-bill rate was 83 basis points over the 4-week T-bill rate in December 2022.  The average spread over 2001 to 2022 period was 17 basis points.  The median spread, 10 basis points.

The 6-month to 4-week spread had been elevated throughout 2022.

Why is the 6-month interest rate now so elevated compared to the 4-week rate? 

Investors could place 1/6 of their short-term assets in separate 6-month assets purchased at the beginning of each of 6 months.  This staggered schedule would allow access, if needed, to 1/6 of short-term assets each month.

The only reason why investors would choose to put all funds in a 4-week asset is the desire for increased liquidity without any price risk from selling an asset.  Why are investors now turning down the 83 basis points to put more funds in a 4-week T-Bill rather than staggering investments into 6-month T-bills with purchase and maturity dates in six consecutive months?

The author, an economist in Denver Colorado, has written a 2024 Health Care Proposal, which can be downloaded at Sellwire, https://app.sellwire.net/p/2Uv and at kindle https://www.amazon.co.uk/2024-Health-Care-Reform-Proposal-ebook/dp/B09YPBT7YS

Evaluating the Secure Act 2.0

Most of the provisions in The Secure Act 2.0 have at best a modest impact on 401(k) participation and retirement savings. The proposals do not target households likely to have inadequate retirement income. Congress should not enact this law. An alternative approach would expand incentives for people without employer-based retirement plans.

Introduction:

The major provisions of the Secure Act 2.0, summarized here by CI Private Wealth, include changes to rules governing required minimum distributions (RMDs), increased access to 401(k) plans for part-time workers,  larger catch-up contributions for older workers, changes to qualified charitable distributions, employer matching contributions  to 401(k) plans for student loan payments, mandatory automatic enrollment into 401(k) plans, and employer matching contributions for Roth 401(k) accounts.

There are merits to some aspects of these proposals.  However, changes to pension rules currently in Secure Act 2.0 do not provide major benefits to people who are struggling to save for retirement. 

Larger improvements to retirement savings for more households could be achieved at lower cost to the government by expanding Individuals Retirement Accounts (IRAs) instead of expanding firm-based retirement plans.

Discussion of Specific Proposals:

Modifications to RMD rules:  

Changes:

The Secure Act 2.0 has a proposal to delay required minimum distributions from retirement accounts.  The current RMD age is 72.  The proposal increases the RMD age to 73 in 2023, 74 in 2024, and 75 in 2031.  The Secure Act 2.0 also reduces the penalty for not making a RMD from 50 percent to 25 percent.

Comments:

These proposals are unlikely to benefit people with relatively modest income who must withdraw more than the RMD from their retirement account to fund current needs in retirement. This change will NOT reduce the number of households who might outlive their retirement savings.

It is unlikely that workers currently saving for retirement consider the RMD when makings savings decisions because tax savings from contributions to retirement accounts are already large. These changes to RMD rules will not incentivize increased retirement savings for current workers. 

RMD requirements only pertain to traditional retirement plans.  Roth accounts do not have RMD requirements.  These changes could discourage some workers from contributing to Roth accounts or converting traditional retirement assets to Roth assets.  

Many investment firms will automatically limit retirement plan disbursements to the RMD amount and will automatically increase the rate of spending of non-retirement assets for individuals who have not reached the RMD age.  This approach will increase fees to the firm managing the 401(k) plan but may be detrimental to the investor.  The major beneficiary of this proposal is pension fund managers who will receive more fee income because of the slower disbursements from retirement accounts.  

The increase in the RMD age will increase distributions and tax payments once the RMD age is reached because the retirement plan balance is larger, and the expected future life span is shorter.  The increased RMD age delays disbursements and taxes but could increase total lifetime tax payments for some households.  The increased RMD age could increase early depletion of Series I Savings bonds, (an asset outside of retirement accounts) leaving investors less prepared for an increase in inflation later in life.

Increased Access to 401(k) plans for part-time workers:

Changes:

The Secure Act 2.0 reduces the waiting time for part-time workers to make contribution to 401(k) plans.  The current waiting period is three years.  The proposed waiting period is two years.

Comments:

Many small firms with a large percentage of part-time workers do not offer 401(k) plans.

This proposal will not help part-time workers without a continuous employment history.   Many part-time workers are seasonal and do not have continuous employment at a firm.

This reduced waiting period does not affect vesting requirements.  Part-time workers are subject to the waiting period and the vesting requirement.  A part-time worker at a firm with a 401(k) plan that has a three-year vesting requirement would have to work at the same firm for five years to fully vest.

401(k) plans at firms with a high proportion of part-time workers tend to have high fees.  Many part-time workers would be better off contributing to a low-fee IRA instead of a high-fee 401(k).

It would be easier and more effective to motivate retirement savings for part-time workers by increasing incentives for contributions to IRAs.  This approach benefits all workers as soon as they are employed, workers at firms that do not offer 401(k) plans, and workers with multiple jobs.  

Larger catch-up contributions for older workers:

Changes:

The Secure Act 2.0 increases catch-up contribution to firm-sponsored retirement plans for people aged 62-64 from the current level of $6,500 to $10,000.  The current catch-up contribution remains the same for people between age of 50 and 61.  The proposal indexes the current catch-up contribution for IRAs to inflation and provides for a more modest increase in catch-up contributions for Simple Plans.


Comments:

The Secure Act 2.0 increases the disparity between allowable catch-up contributions for employer-based retirement plans and IRAs.  The goal of pension reform should be reducing all disparities between employer-based retirement plans and IRAs including disparities in catch-up contributions because the people most in need to additional retirement assets currently do not have access to employer-based plans.

Many low-income and middle-income workers nearing retirement are better off reducing debt than increasing contributions to 401(k) plans.  Go here for a post documenting the advantages of debt reduction prior to retirement.

Changes to Qualified Charitable Distribution Requirements:

Changes:

The Secure Act 2.0 increases potential charitable distributions from retirement plans and associated tax benefits.    The charitable distribution is also indexed to inflation.

Comment:

This is a useful change for well-heeled savers, charities and people benefiting from charities.  However, this provision does nothing for people with limited retirement resources who may out-live their retirement wealth.

Student Loan Matching:

Changes:

The Secure Act clarifies the tax code to make clear employers are allowed to contribute matching funds to retirement plans for workers making student loan payments, even if the worker does not make contributions to the plan. 

Comments:

This proposal does not benefit workers at firms that do not offer a retirement plan or workers at firms with a retirement plan that do not match employee contributions.  As a result, this provision will disproportionately benefit workers with better jobs and will do little to reduce student loan debt burdens for people most affected by student debt.

Mandatory Automatic Enrollment:

Changes:

The Secure Act 2.0 requires employers with an employer-based retirement plan to automatically enroll new employees who are qualified for enrollment into the plan.  The initial automatic enrollment is set at 3.0 percent of income.  The automatic enrollment is increased by 1.0 percent per year up to 10 percent of income.

Comments:

The government sanctioned automatic enrollment provision implies that the government believes that contributions to firm-sponsored retirement plan are the best use of funds.  This argument may not be correct in many circumstances including when workers have high debt levels, when the employer does not match contributions, and/or when the plan charges high fees.  

The case for automatic enrollment in 401(k) plans is strongest when firms match employee contributions.  A modified automatic enrollment provision limited to firms with matching contributions for contributions up to the amount needed to receive the entire match would be superior to the current provision.  Automatic enrollment of funds beyond this level is difficult to justify given the existence of other investment options including Roth IRAs and Series I Savings Bonds.

The case for automatic enrollment for newly eligible employees is stronger than the case for automatic increases in contributions.  Employers or plan managers could provide advice about desired contribution levels instead of assuming one strategy fits all workers.

Other automatic pension changes including automatic rollover of high-fee 401(k) funds to low-fee IRAs when employees leave a firm and automatic enrollment of workers at firms without a 401(K) plan into IRAs should be considered.

Matching Contributions to Roth Accounts:

Changes:

Starting in 2023, employer-matching contributions could be placed in a Roth account.  Current law places employer-matching contributions in a conventional account while the employee contributions are placed in a Roth account.

Comments:

Under current law, employer contributions are not taxed in the year of the contribution. A provision an untaxed employer contribution into a Roth account would result in the contribution never being taxed.  Presumably, if the employer contribution is placed in a Roth account it would be fully taxed in the year of the contribution.  

The proposal only benefits workers at firms with a 401(k) plan that matches contributions and has a Roth option.

This proposal does not pertain to Roth IRAs because no employer contributions are allowed in any IRA.  An expansion of matching contributions to IRAs would better assist households who are having difficulty saving for retirement.

Concluding Remarks:

The Secure Act 2.0 is not yet law.  It must be reconciled with Senate provisions that include provisions for expanded access to emergency funds through retirement accounts.  A blog post describing these proposals can be found here.  

The Secure Act 2.0 is not an effective way to improve retirement security for American workers. 

Many of its provisions give larger benefits to investment firms than to workers saving for retirement.  The bill provides scant assistance to the workers who are having the most difficult time saving for retirement. A more effective approach involves expanding saving through individual Retirement Accounts instead of firm-sponsored retirement plans.

Authors Note:  David Bernstein, an economist and author, has written An Alternative to the Biden Student Debt Plan.  This paper is a must read now that the Biden plan is tied up in court.  David is an economic consultant taking on new clients.  He can be reached here or can be emailed at Bernstein.book1958@gmail.com

Should Retirement Plans Include an Emergency Fund?

Many workers are currently disbursing a substantial share of their retirement fund prior to retirement. The addition of an emergency fund inside a retirement plan should be coupled with new limitations on pre-retirement disbursements

The House has passed a bill enacting several changes to rules governing IRAs and 401(K) plans.  The Senate is considering modifications to the House bill that will make it easier for workers to use retirement funds for emergencies.  This blog post examines three proposals that are currently under consideration by the Senate.

Proposal One:  The Emergency Savings Act of 2022:  A bill offered by Senator Booker and Senator Young would allow employers to create an emergency fund inside a firm-sponsored retirement plan.  The money in the emergency fund could be disbursed without penalty or tax at any time.   

Comment One:  One purpose of the emergency fund is to facilitate increased contributions to 401(k) plans by people with limited liquidity.  Paradoxically, the emergency fund might not increase funds for emergencies if the household is living paycheck to paycheck.  The new fund does not increase total financial resources available to households.    The new fund does not prevent households from overspending.  An increase in 401(k) contributions associated with lower rates of repaying consumer or student debt could make some households worse off.

Comment Two:  The bill does not increase liquidity or savings incentives for people with a Roth retirement account.  The Roth account already allows disbursements from contributions without penalty or tax prior to age 59 ½. An alternative way to increase use of retirement funds for emergencies is to encourage increased contributions to Roth rather than traditional retirement accounts.

Comment Three: The rationale for a tax deduction for contributions to 401(k) plans and IRAs is that the tax deduction incentivizes savings and makes both the worker and society better off. This bill gives workers a tax deduction even if they immediately spend all funds placed in the emergency account. The bill does not prevent workers from distributing all funds in their 401(k) plan by paying a 10 percent penalty and tax on the distribution.  The goal of facilitating retirement savings and the goal of having emergency funds could be better balanced if the new emergency fund was coupled with a limitation on pre-retirement withdrawals.  

Proposal Two:  The Refund to Rainy Day Proposal: This plan requires the Secretary of the Treasury to create a mechanism through which people can place part of their tax refund into a Rainy Day Fund.  

Comment One:  The Treasury already allows for direct deposit of refunds to financial institutions. Private financial firms could set up a direct deposit to an emergency fund. The Treasury Direct site could create an option where some of the proceeds were automatically invested in short-term Treasury securities.

Comment Two:  People with large tax refunds are probably less in need of emergency funds than people who owe taxes because people with little liquidity have a large incentive to increase their claimed exemptions to meet current needs.  This tax refund provision does not assist the people most in need of emergency funds.

Comment Three:  It is not clear why the government should favor direct deposit of tax refunds into emergency funds over other priorities including direct payments of student loan debt or direct contributions to health savings accounts.

Comment Four:  I don’t see anything in this bill that increases the financial capability of households or alters household savings behavior.

Proposal Three:  The Enhancing Emergency and Retirement Savings Act of 2021:

This plan offered by Senator Lankford and Senator Bennet would provide a penalty-free distribution from retirement plans, both in firm-sponsored plans and individual retirement accounts.  The plan provides for one emergency distributions per year if the account has $1,000 vested funds.  The maximum withdrawal would be $1,000. The legislation requires replenishment of the withdrawn amount prior to additional withdrawals.  

Comment One:  A worker who is replenishing an initial withdrawal has an incentive to reduce 401(k) contributions to maintain consumption.  This proposal will have at best a modest impact on retirement savings, especially for workers entering the workforce with substantial student debt.

Comment Two:  I presume (perhaps falsely) that this penalty-free option is optional.  Some firm 401(k) plans and some IRA management firms might choose to not offer this option to keep administrative costs and fees down. The impact of the provision on administrative costs and returns on retirement funds could be considerable. 

Comment Three:  Some 401(k) plans will provide emergency distributions and 401(k) loans.  Workers who take both an emergency distribution and a 401(k) loan will owe substantial funds to their plan.  Many of these workers will not replenish the emergency fund or repay the loan.  Many of these workers will have an incentive to tap their entire 401(k) plan if they switch jobs.  It would be easier to justify the creation of an emergency fund inside a 401(k) plan if the proposal were linked to some limitation on complete disbursements prior to retirement.

Concluding Remarks:  

The proposals considered in the Senate increase access to retirement funds for emergencies.  One goal of these provisions is to incentivize workers to increase contributions to retirement plans.  However, under the current system many workers routinely distribute and spend substantial funds in their retirement prior to retirement.

Several studies indicate that the use of 401(k) funds prior to retirement is widespread and is a major factor impacting the number of households who might retire with inadequate financial resources in the future. Research from E-Trade financial, reported on CNBC in 2015, revealed that nearly 60% of millennials had already taken funds out of their 401(k) account. A study by the Employment Benefit Research Institute (EBRI)reveals that 40% of terminated participants elect to prematurely take out 15% of plan assets.  A recent study by Wang, Zhai, and Lynch found that over 40 percent of employees cashed out their 401(k) plan at separation.

Intuitively, the people most likely to tap funds from their 401(k) plans prior to retirement are struggling financially.   My own study found here, reveals that people tapping funds prior to retirement tend to have high levels of debt and poor credit ratings.  The sheer magnitude of the number of people who are both lacking in liquidity and tapping retirement funds suggests leakages from 401(k) plans will weaken retirement security for many households.

Any revisions to rules governing emergency distributions from retirement plans should be coupled with rules limiting distributions from retirement plans prior to age 59 ½. 

Authors Note:  David Bernstein, a retired economist has written several papers advocating for innovative centrist policy solutions.

The kindle book Defying Magnets:  Centrist Policies in a Polarized World has essays on policies student debt, retirement savings and health care.

The paper A 2024 Health Care Proposal provides solutions to health care problems that are not currently under consideration.

The proposals in Alternatives to the Biden Student Debt Plan are less expensive to taxpayers than the Biden student loan proposals.  The reforms presented here provide better incentives and reductions for future students while the Biden debt-relief proposal offers a one-time improvement for current debtors.

Political Insights for the 2022 Midterms

I find writing this column every two years on or near election day cathartic. I have never seen this much hype and so many unforced errors on both sides. My resolution after clicking publish is to stay off cable news for a long time.

Some political insights – November 7, 2022

I find writing this column every two years on or near election day cathartic.  I have never seen this much hype and so many unforced errors on both sides.  My resolution after clicking publish is to stay off cable news for a long time.

Some insights:

The analysis on TV seems more motivated by campaign goals than data.  Republicans are talking up surprise victories in senate races in New Hampshire, Colorado, Washington, even though Senate races in North Carolina, Wisconsin, and Ohio are far closer. Republicans are exciting their voters to the poll.  Democrats are scaring their voters to the poll.   The Democrats may overperform in the Senate because they have good candidates in NC and OH and WI and NV are reasonably close.

Wisconsin should have been an easy pick up for the Democrats because the Republican candidate is a certifiable crazy. However, their 35-year-old nominee has not been able to address concerns about crime that were highlighted by unrest and vandalism in Kenosha.  

My methods when analyzing elections in Wisconsin is to compare them to races in the adjacent state of Iowa.  The states almost always vote for the same presidential candidate.  The 2016 poll numbers in Iowa suggested to me that Wisconsin could turn red and it did.  This year it is highly possible that the moderate Senate candidate in Iowa will overperform and the more liberal Democrat in Wisconsin will underperform, and the Democrats will lose both races. I expect Evers to win the governor’s race but could be wrong. 

The Democrats are highly dependent on the black vote and the party has nominated several black candidates in states that are overwhelmingly white.   The Democrat’s candidate for governor in Iowa, Deidre DeJear, an extremely young black woman with no experience in government had no opposition in the primary. She is 20 points behind and is not helping the Senate race.  The initial competition to Barnes. Demings, and Beasley was also non-existent or dropped out prior to the primary.  Republicans have tougher intra-squad games, which helps them in the regular season. 

Splits between the Senate and gubernatorial outcomes in several states including, PA, AZ, WI, OH are possible.  This should undercut Republican claims of rigged elections.

Voters in both parties are having buyers’ remorse in PA.  Fetterman should have been transparent about his health and Oz is not a smart wizard.  I personally could never vote for Oz and would vote for Fetterman if I lived in Pa.  However, an independent who sides with Republicans on some issues and wants robust discussion of debates could conclude that Fetterman, due to his health would be a rubberstamp.  The Democrats should have examined Fetterman’s health after the stroke, I believe in May prior to the primary and put in a pinch hitter.

Democrats may lose the House.  I hope it is close. Because centrist could unite and elect a centrist speaker.  Go here for a discussion of why the House is important.

Trump could be the big loser if Republicans underperform and if the most Trump-friendly candidates lose.

Concluding Thoughts:  The Democrats central message is you must vote for the Democrats because the Republicans don’t believe in democracy and a Republican victory will lead to dictatorship.  Well, if true, we have no choice and Democracy is already gone or on life support.

 Eventually, the Republicans will win a cycle.   If the Gambler’s Ruin Problem describes payouts dictatorship is inevitable. 

 Hard to see how Biden wins reelection in 2024 if Trump is gone and 2024 becomes a change election.  Trump may run to freeze the Democratic field.

Authors Note:  David Bernstein, a retired economist has written several papers advocating for innovative centrist policy solutions.

The kindle book Defying Magnets:  Centrist Policies in a Polarized World has essays on policies student debt, retirement savings and health care.

The paper A 2024 Health Care Proposal provides solutions to health care problems that are not currently under consideration.

The proposals in Alternatives to the Biden Student Debt Plan are less expensive to taxpayers than the Biden student loan proposals.  The reforms presented here provide better incentives and reductions for future students while the Biden debt-relief proposal offers a one-time improvement for current debtors.

2024 Economic Issues: The Case for Expanding and Improving Individual Retirement Accounts (IRAs)

Workers without access to firm-sponsored 401(k) plans often do not save enough for retirement. Insufficient retirement savings caused by lack of access to 401(k) plans could be more effectively reduced by expanding and improving Individual Retirement accounts (IRAs) instead of expanding the use of 401(k) plans.

Introduction:   A recent GAO study found that most retirees and workers approaching retirement have limited financial resources.  Many people start their careers with substantial student debt and for a variety of reasons overspend and fail to save enough for retirement.    

Part of the disparity in retirement savings stems from lack of access to firm-sponsored 401(k) plans, which allow for much greater retirement saving than IRAs.  Part of the shortfall in retirement savings stems from the common practice of workers spending savings in retirement plans prior to retirement.  

The most effective way to reduce disparities in retirement wealth is to expand and improve Individual Retirement Accounts.  The approach outlined here differs sharply from the proposals in Secure Act 2.0, which favor expansion of 401(k) plans.  The proposed improvements to IRAs include a new tax credit, a mechanism for simultaneous contributions to traditional and Roth IRA accounts, increases in the allowable annual contribution, and alterations in rules governing distributions prior to age 59 ½.   Specific policy changes that should be implemented include:

  • A tax credit for contributions of 20 percent of contributions to an IRA.
  • Allow employers to make employer contributions to IRAs instead of a 401(K) plan.
  • A new rule allocating part of the IRA contribution to a traditional IRA and part to a Roth IRA.  (Eighty percent of employee contributions would go to the Roth account. Twenty percent of employee contributions and all employer contributions would be allocated to the traditional account.)
  • Prohibit all disbursements from the traditional account until the account holder reaches retirement age.
  • Increase the allowable annual contribution to an IRA to the current contribution limit for 401(k) plans.
  • Allow automatic contributions to IRAs and opt-out rules like the automatic enrollment and opt-out rules currently applied to 401(k) plans.

Comments:

Comment One:  The use of a tax credit instead of a tax deduction favors low-income households with lower marginal tax rates.  These household often have the most difficulty saving for retirement.

Comment Two: The new IRA contribution rules allow for the benefits of both Roth and traditional accounts.  The contribution to the Roth account reduces taxes in retirement.  The contribution to the traditional account reduces current-year taxes.  The plan described here would provide benefits comparable to benefits received from a Roth 401(k) where the employer match is allocated to a traditional 401(K) and employee contributions are allocated to the Roth component of the plan.  Many firms do not offer a 401(K) plan, do not offer a Roth 401(k), or do not match employer contributions.  The new rules would allow all workers to allocate funds to both traditional and Roth plans, regardless of what their firm offers.

Comment Three:  Current tax law allows for unlimited disbursements from retirement accounts subject to tax and penalty.  The rules governing penalty and tax on disbursements differ for traditional and Roth accounts, however, in both cases taxpayers are allowed to withdraw the entire balance of their retirement account prior to retirement.  This often happens when workers leave a job and take a disbursement rather than maintain their retirement account or roll over funds into an IRA.  The new rule requires the amount of the IRA contribution equal to the tax credit and the amount of the contribution received from the employer remain in a traditional account until age 59 ½.  Call this the George Bailey rule after the banker in A Wonderful Life who refused to close people’s accounts during a rush on the bank.

Comment Four:   Some people may be more receptive to contributing to a 401(k) plan instead of an IRA because some firms allow 401(K) owners to borrow from the plan.  Loans from IRAs are not allowed. However, contributions to a Roth IRA can be withdrawn without penalty or tax at any time.  The combination of a tax credit and early use of funds contributed to ithe Roth component of the new IRA should facilitate contributions by people with limited cash flow for emergencies.

Comment Five:  Current IRA contribution limits are substantially lower than current 401(k) contribution limits.  This proposal eliminates this disparity.  

Comment Six:  The IRS allows firms to automatically enroll employees into the firm-sponsored 401(k) plan and allow employees to opt out if they do not want to contribute.   Vanguard has found that automatic enrollment into 401(K) plans has the potential to substantially increase 401(k) participation.  Automatic enrollment into IRAs could have a similar effect, especially when combined with a new tax credit for IRA contributions and other proposed enhancements to IRAs.

Comment Seven:  Congress is currently considering the Secure Act 2.0, which would expand the use of 401() plans and create an incentive for 401(k) contributions for people who are currently prioritizing student debt repayment over retirement saving.  Even if the Secure Act 2.0 is enacted many small firms would still not offer a 401(k) plan, due to limited resources. For example, the Secure Act 2.0 would do little to increase retirement savings for people working at multiple part-time jobs.  The tax credit for IRA contributions described here would be available for all workers.  The new rules governing early distributions from IRAs would better balance the need for all workers to save for retirement while reducing debt and preparing for emergencies.

Authors Note:  David Bernstein, a retired economist has written several papers advocating for innovative centrist policy solutions.

The kindle book Defying Magnets:  Centrist Policies in a Polarized World has essays on policies student debt, retirement savings and health care.

The paper A 2024 Health Care Proposal provides solutions to health care problems that are not currently under consideration.

The proposals in Alternatives to the Biden Student Debt Plan are less expensive to taxpayers than the Biden student loan proposals.  The reforms presented here provide better incentives and reductions for future students while the Biden debt-relief proposal offers a one-time improvement for current debtors.


Ukraine and the race for the next speaker of the House

The more conservative members of the Republican House and the more liberal members of the Democratic House are adopting Putin’s position on the war in Ukraine. Can centrists of both parties unite to support Ukraine?

Initially opposition to assistance for Ukraine came from the right. 57 House Republicans opposed assistance in a May vote.  More recently, Kevin McCarthy the potential future speaker stated the House could target Ukraine funding. Former President Trump is supportive of Putin’s position on the war.

A recent letter from 29 members of the progressive caucus inside the Democratic party called on the Administration to support “vigorous diplomatic efforts” to support a negotiated cease fire and a cease fire.   Hard to understand how this approach could lead to success when Russia is bombing civilians and infrastructure, committing war crimes and controls around 20 percent of Ukraine.   

Withdrawing support from Ukraine or putting pressure on Ukraine to accept an immediate cease fire when Russia commits war crimes, has forced deportations of Ukrainian citizens, and still controls substantial Ukrainian territory, is incomprehensible to me.

The extremist Republican and extremist Democrats who basically support Putin’s position in Ukraine are a minority of the House and a minority of America.

Most pundits believe that the Republicans will have most of the next House.  They would force a reversal in U.S. policy toward Ukraine and do other detrimental things including shutting down the government and breaching the debt limit.

Speaker Pelosi has been a strong supporter of Ukrainian aid, but she is under intense pressure from her left flank on a wide variety of issue.

A centrist Democrat or Republican could run for the job of speaker.  The next speaker could be a centrist who supports Ukraine if centrist Democrats and Republicans unite.  

The Speaker of the House does not have to be a member of Congress.  The House could choose to elect a non-partisan respected figure outside of Congress to be the next speaker.

This action would result in America doing the right thing in Ukraine, could prevent future shutdown and debt-limit emergencies.  A speaker who is respected by members of both parties could facilitate the dialogue on a wide range of issues and create a process that leads to more sensible centrist policies.

Authors Note:  David Bernstein, a retired economist has written several papers advocating for innovative centrist policy solutions.

The kindle book Defying Magnets:  Centrist Policies in a Polarized World has essays on policies student debt, retirement savings and health care.

The paper A 2024 Health Care Proposal provides solutions to health care problems that are not currently under consideration.

The proposals in Alternatives to the Biden Student Debt Plan are less expensive to taxpayers than the Biden student loan proposals.  The reforms presented here provide better incentives and reductions for future students while the Biden debt-relief proposal offers a one-time improvement for current debtors.

Ukraine is the most important issue of our time.  The conflict today in Ukraine reminds me of the conflict in the 1930s in Spain against Franco and fascism.  Kevin McCarthy must not become speaker.

Should gig workers be employees?

A proposed Biden Administration rule reclassifying gig workers as employees, which intends to expand health and retirement benefits, would have adverse consequences. The proposed rule would reduce opportunities for people seeking flexible work hours, reduce employment options during economic downturns, cause some firms to reduce benefits, and worsen health insurance outcomes for some workers. Modifications to the tax treatment of individual retirement accounts and health insurance premiums would more effectively expand benefits than reclassification of work status.

Introduction:   A proposed Department of Labor rule, described here, would make it more difficult for companies to treat workers as independent contractors instead of employees. The proposal would classify workers as employees instead of independent contractors if they are economically dependent on a company. 

The purpose of the new rule is to increase health and retirement benefits for people currently employed as gig workers.   The proposed reclassification of gig workers to full-time employees does not automatically lead to better benefits for all workers and could have the unintended side-effect of decreasing opportunities in the labor force. 

  • Cost to firms maintaining current benefits packages would increase.
  • Some firms would reduce benefit packages to reduce the increase in costs stemming from the new regulation. 
  • Some firms would respond to the regulation by hiring fewer full-time employees and more part-time employees.
  • Some workers might leave the workforce because they would be unable to obtain employment offering flexible hours. 
  • Some workers with state-exchange health insurance would lose access to a premium tax credit and could receive a less generous health insurance package from their employer.

The reduction of disparities between the retirement and health benefits received by gig workers and employees could better be achieved through modifications of the tax treatment and rules governing health insurance premiums and individual retirement accounts than by the proposed regulation.  

Labor Market and Macroeconomic Issues:  

Supporters of the gig economy point out that many workers need or prefer a position that offers flexible hours.  This need is especially pronounced for people with young children.  Lack of affordable and reliable day care and was the cause of a decrease in workforce participation during the pandemic.  The forced reclassification of gig workers to employee status could reduce available flexible positions.

The existence of the gig economy may reduce loss of employment during recessions, if people who lose full-time traditional employment can find work in the gig economy.  One recent article explored the relationship between county unemployment and the proportion of county residents working online at a particular platform.  The article found that a 1.0 percent increase in county unemployment is associated with a 21.8 percent increase in the number of county residents working on-line at the platform.  This finding suggests that new regulations that reduce access to the gig work option could increase unemployment during a recession.

Health Insurance Issues:

Most working-age employees and their dependents obtain their health insurance from their employer and many employers pay a substantial portion of the health insurance premium.    Since the enactment of the Affordable Care Act, workers without an offer of employer-based insurance are eligible for a premium tax credit for health insurance on state exchanges.  The employer mandate, created under the Affordable Care Act, fined firms with more than 50 employees that did not provide health insurance to their full-time workers. 

The reclassification of gig workers as employees would reduce the role of state-exchange markets.  There is substantial disparity in the cost and quality of employer-based insurance.

In some cases, the reclassification of a gig worker to employee status will improve health insurance outcomes.  In other cases, the converted gig worker would have worse or more expensive insurance.

The reclassification of gig workers to employee status could benefit young middle-income workers with no dependents when employers pay a large share of premiums.  Many young adults receiving their health insurance on state exchanges pay 100 percent of their health insurance premium because the premium tax credit is not available when premiums are less than 8.5 percent of income.  These workers would realize lower insurance costs if they were reclassified as employees and if their new employer paid a share of the health insurance premium.

In other cases, the reclassification of gig workers to employees worsens outcomes.  Many employers offer only one health insurance plan with limited benefits, narrow networks, and high premiums for workers.  The existence of the offer of employer-based health insurance makes employees ineligible for the premium tax credit and makes state-exchange insurance unaffordable. 

A regulation leading to the reclassification of gig workers to full-time worker would cause firms that do not change their health insurance or employment policies to either increase purchase of health insurance for workers or pay a fine for full-time workers who receive their health insurance from state exchanges.  

Some firms would respond to the regulation by reducing hours worked, by increasing the number of part-time employees, thereby decreasing fines under the employee mandate.   Some firms would reduce insurance costs by increasing plan deductibles or by adopting a narrow health provider network.  Some firms would reduce the amount of their premium subsidy.

A better way to assist workers in the gig economy is to expand and improve subsidies for premiums on health insurance purchased on state exchanges while merging the markets for employer-based and state exchange insurance.  Three reforms that deserve consideration are:

  • Provide tax incentives for employer subsidies of state exchange health insurance instead of employer subsidies of firm-specific employer-based health insurance.
  • Modify the premium tax credit to provide some subsidy for young adults without an employer subsidy.
  • Create a new employer mandate consistent with the new subsidies.

The modified health insurance subsidy outlined here reduces costs of state exchange health insurance for all young adults who do not currently receive a subsidy.

The merger of state-exchange health insurance and employer-based health insurance markets and the modification of the premium tax credit will assist workers with multiple part-time jobs and will allow workers to maintain continuous health insurance coverage through periods of unemployment and job transitions. 

The merger of state-exchange and employer-based health insurance markets allows all households to search for the most suitable health insurance plan.  It prevents a situation where a worker needs specialized care perhaps at a top cancer hospital is tied to a single employer-based plan that does not offer access to the desired provider.

A more complete discussion of this health care reform proposal can be found here.   

Retirement Plan Issues:   

Many firms offer full-time employees a 401(k) plan.  Workers at firms that do not offer a 401(k) plan and gig workers must save for retirement through an Individual Retirement Account.

401(k) plans are more generous to employees than IRAs.  First, employers are allowed to directly contribute to a 401(k) plan and/or match employee contributions to the plan but are not similarly allowed to contribute to a worker’s IRA.  Second, the maximum allowable employee contribution to a 401(k) plan in 2022, ($20,500 or $27,00 if over 55 years old), is substantially higher than the maximum allowable contribution to an IRA, ($6,000 or $7,000 if over 55).

The reclassification of gig workers to employee status could lead to higher costs for firms and firms could take actions to offset the increase in costs.

Some firms will respond to reclassification of gig workers by reducing the number of workers who are eligible for participation in the firm-sponsored retirement plan.  This could occur by increasing the share of employees working part time.

Some firms could reduce employer contributions to 401(k) plans or eliminate the 401(k) plan altogether.

An alternative superior way to expand retirement benefits for gig workers is to increase the generosity of Individual Retirement Accounts and to allow firms to contribute to individual retirement accounts owned by employees and accounts owned by contractors.  Specific changes that should be implemented include.

  • Allow firms to directly contribute matching funds to Individual Retirement Accounts for employees and for independent contractors. 
  • Increase allowable worker contribution limits into Individual Retirement accounts to the level that exist for 401(k) accounts. 
  • Replace tax exemptions and deductions for Individual Retirement Account contributions with a tax credit.

The use of a tax credit for contributions to an Individual Retirement Account favors low-income workers who are in a lower marginal tax bracket.   The change from a tax deduction to a tax credit will also disproportionately benefit gig workers who tend to be in a low marginal tax bracket. 

Contributions to Health Savings Accounts are also tax deductible. Distributions from health savings accounts used for qualified health expenses are not taxed. The replacement of a tax deduction with a tax credit for contributions to health savings accounts would benefit low-income workers and could also disproportionately benefit gig workers.   Firms should also be allowed to make direct contributions to health savings accounts owned by employees and independent contractors.

The pension reforms currently being considered by Congress, discussed here, appear to increase the role of 401(k) plan and could exacerbate the gap between gig and employee pension outcomes.  Congress is not currently moving towards the pension reforms outlined in this memo.

Concluding Remarks: The typical gig worker receives less in health and retirement benefits than the typical employee.  However, the newly proposed rule that would convert gig workers to full time employees is an economically inefficient solution to this disparity.  The new rule would reduce the availability of positions with flexible work hours, reduce labor force participation among parents with young children, and could worsen unemployment during economic downturns.  The rule would result in many firms reducing health and retirement benefits.  Also, some gig workers that lose access to the premium tax credit for state exchange health insurance could be made worse off depending on the quality of the employer-based health plan received after reclassification.

A better solution to the disparity between health and retirement benefits offered to gig workers and full-time employees could be achieved through modification of rules governing health insurance premiums and rules governing Individual Retirement Accounts.

How far can ARKK sink?

The ARKK fund is down over 60 percent for the year but is still overvalued and is not a buy. Investors interested in the tech sector should consider individual holdings or a more stable ETF.

Introduction:   ETF investors often buy when the fund price declines and sell when it rises. However, a decline in the asset price does not mean the asset is correctly valued.

Even though ARKK has fallen more than 60 percent in the past year, it contains several holdings that are still overvalued, and its PE ratio is undefined because of negative overall earnings.

Empirical Analysis of Current ARKK Holdings:  The ARKK fund is an actively managed fund that invests exclusively in companies that the fund manager believes will disrupt the economy.  Data on the holdings of the fund was obtained from Zachs.  It has 34 companies and a small amount in a fund that has government securities.   Financial data on the 34 equities in the funds was obtained from CNBC.  Here is the link to financial data for Tesla the fund’s largest holding.

Financial variables for the 34 ARKK holdings indicates that despite large declines in share prices most of the holdings in the ARKK fund remain overvalued.

  • Only four of the 34 holdings (Tesla, Zoom, Nvidia, and Materialise), around 17 percent of the holdings of the fund, reported positive earnings per share.  

The weighted average of net earnings was negative making it impossible to report a PE ratio for ARKK. Firm PE ratios are undefined for firms with negative earnings. ETF PE ratios are undefined when the denominator of the PE ratio, a weighted average of earnings per share is negative.  

An alternative valuation metric used when earnings are negative is the difference between share price and earnings per share price over share price.  High values of (P-E)/p correspond to high valuation measures.  

A value of (P-E)/P equal to 0.98 is equivalent to a PE ratio of 50.  A value of (P-E)/P greater than 1.0 is undefined due to negative earnings.  The use of (P-E)/P allows for the inclusion of firms with negative earnings in comparisons of portfolio valuations. Go here for a discussion of the alternative valuation statistic.

  • The value of (P-E)/P for ARKK is 1.082.

High valuation measures are acceptable when firms are investing and growing.  Early investors in firms like Apple and Amazon did quite well despite years of high valuations.  The ARKK holdings are not similarly situated.

  • 33 of the 34 ARKK stocks experienced a decline in price over the past 52 weeks.  The average stock price over the last 52 weeks was down 63.1 percent.   The lower stock price makes it expensive for these firms to raise additional funds in equity markets. 
  • 9 of the 34 companies had an earnings per share loss that exceeded 25 percent of the stock price.   The existence of larger losses relative to share price could be indicative of concerns about future liquidity. 
  • ARKK owns more than 5.0 percent of the shares in 16 of its holdings.   These relatively high stakes could limit the ability of ARRK to reallocate and reduce exposure without exacerbating declines in stock prices. 

The empirical analysis reveals several red lights on the future of ARKK including — high valuations, previous large stock price declines, existence of several holding with large losses compared to equity, and high exposure in some positions.

Discussion of ARKK holdings:  The rationale behind investing in potential disruptors is the likelihood of one or more large successes leading to large returns.  Some of the ARKK investments are interesting and could be considered once the tech market nears a bottom.  However, ARKK has a lot of companies that are unlikely to prosper.

I looked at some of the news and analyst on the 10 largest ARKK holdings.  Here is what I found. 

Tesla: symbol TSLA Tesla is the largest position and ARKK’s most successful investment.  Tesla has been a true disruptor.  However, its valuation is high $642.3 billion more than the rest of the world’s auto industry.  Tesla sold fewer than a million vehicles in 2021 compared to over 9 million by Toyota alone.  Tesla makes most of its money from the sale of cars but does have some other energy streams.  Tesla is the leader in electric vehicles, but Porsche may have the better high-end car and other firms are entering.  At current stock prices Tesla is a better buy than ARKK but may not be a good long term buy.  Even with other income streams it is difficult to justify a price on Tesla that makes a relatively small auto company more valuable than the rest of the industry. I am not currently a buyer of either the TSLA or ARKK.

Zoom: symbol ZM, Zoom did extremely well due to at-home work during the pandemic, but the pandemic growth rate is over, and the company is facing new competition from Microsoft and possibly other larger firms.

Roku: symbol ROKU, Roku attempts to make it easier and more affordable for people to watch multiple TV shows.  ROKU’s top competitors are Apple, Net Flix, Amazon, and Microsoft.  Stock price is falling.  If you google ROKU and problems, you get several links on how to deal with technical ROKU issues.  Other applications and services may be more reliable than ROKU.   I have no reason to believe that ROKU will win this competition.

Unity:  Unity Software, symbol U. is a software developer and may benefit from the metaverse.  The company might be acquired by a larger firm.  A speculator might be better off purchasing a small amount of U rather than ARKK.

Block inc., symbol SQ, is a financial services firm.  Visa and Paypal appear to be better positioned than Square.

Teledoc, symbol TDOC, has several active competitors.   Go here for one list.  Two funds owned by Cathie Wood have invested in Teledoc.  She may not be able to get out of these positions without causing a large decline.  I would not buy Teledoc either by itself of through ARKK.

UI Path, symbol Path, is an artificial intelligence company that helps automate routine tasks.  It has viable products but it stock price has fallen by nearly 80 percent.  Path is a company that might be worth looking at once the tech sector bottoms.  ARKK bought it too soon.

CRISPR, symbol CRSP and BEAM therapeutic, symbol Beam: are two gene editing companies owned by ARKK.  Combined they are around 8.5 percent of ARKK holdings.  Hard to understand why ARKK holds so much of these two firms and no Moderna.

Coinbase, Symbol COIN:  Coinbase is a bad apple in an industry that is looking for a reason to exist.  Google Coinbase and allegations and get this.

Some of the ARKK holdings deserve consideration, but ARKK is not the best way to participate in these opportunities.  Interested investors should consider purchasing the better companies directly or investing in a more diversified tech fund, like VGT.

 Concluding Remarks:

I have nothing against a fund that seeks out disruptive firms but believe ARKK is poorly designed and not an appropriate investment vehicle.

The ARKK fund did well when expectations of tech returns were high and interest rates were abnormally low. It is wrong to attribute the sinking of ARKK over the past year to higher interest rates since rates today are still below their historic medians.

The investment philosophy behind ARKK is reminiscent of the gamblers ruin problem.  The gambler playing a game, or in this case several highly correlated games, with a negative expected value will eventually go broke.  

The disruptor fund might put 50 percent in a small number of disruptors and 50 percent in a safe asset.  The fund would take profits and invest in the safe asset in successful years and invest in bargains during downturns.

Authors Note:  David Bernstein has written Financial Decisions for a Secure and Happy Life, a manifesto that will improve your life and save you tens if not hundreds of thousands of dollars.