FIXING THE SAVING PROBLEM
How the Tax System Depresses Saving, and What to Do About It
by Stephen Entin on 05/16/2001
Pages
How low is the personal saving rate? In early 2000, despite strength in the stock and bond markets and in the U.S. economy overall, the rate of personal saving — that is, saving as a percent of disposable after-tax income — ; was nearly zero. This represents a decline from about 9 percent in the mid-1980s and from about 2.5 percent in 1999, just one year earlier. Since business saving has scarcely changed as a share of the economy, this also means that total private saving represents a lesser share of gross national product (GNP).
In its potential impact on taxpayers, particularly baby boomers, this very low saving rate is alarming. In 2016, baby boomer retirements will plunge the current Social Security system into deficit. To supplement the system’s modest benefits, a retired individual or couple in good health will need — in today’s dollars — $20,000 per year, the income one might expect from a retirement annuity of $250,000. Yet extrapolations from the Federal Reserve Board’s most recent “Survey of Consumer Finances” suggest that the typical household retires with less than $50,000, for a possible annuity income of $4,000 per year.
In more national terms, the very low saving rate restricts investment, which in turn considerably retards the growth of productivity, wages, and employment, and slows the growth of individual income and wealth. Further, it makes the U.S. economy more vulnerable to international forces. If policy makers were to adopt a less favorable investment tax treatment or if inflation were to return, key foreign investors might flee.
Why is the saving rate so low? In a word: taxes. Washington imposes high taxes that reduce the private sector's ability to save by depriving individuals and businesses of income they would be saving, and it reduces the incentive to save by taxing income used for saving more heavily than income used for consumption. Over many years, those in the White House and on Capitol Hill have made the tax burden on saving unfavorable and the tax code on saving ever more complex.
At this point, the tax bias against saving is pervasive. The bias is built into the progressive income tax, the corporate profits tax, and the estate and gift tax. The bias against saving even extends to Social Security recipients and Earned Income Tax Credit recipients, some of whom can face marginal tax rates exceeding 100 percent.
How can the tax bias against saving be eliminated? One way is to extend a tax deferral to all saving and then tax withdrawals: the saving-deferred approach. The second way is to allow no deduction for income as it is saved but exempt the returns: the returns-exempt approach. Major tax reform proposals — the Flat Tax, National Sales Tax, and USA Tax, for example — use one of the two ways to make saving as attractive as consuming.
Moving to a neutral tax treatment of saving and investment could add 25 to 30 percent to the stock of capital, boost productivity and wages, and raise national income by 10 to 15 percent in 15 years. Such tax changes would mesh smoothly with Social Security privatization. Together, the reforms would allow baby boomers, their parents, and their children to look forward to 2016 not with apprehension, but with confidence.
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