The Savings Rate Problem
Jon Henke has an informative post on one of the problems facing the U.S., the dismal savings rate.
By all accounts, the US is drowning in the Twin (Budget and Trade) Deficits. The effect on the dollar has already become obvious, and Paul Volker has suggested there is “a 75% chance of a currency crisis in the United States within five years“. Heightened interest rates, recession, and the fall of the dollar as a world currency are being discussed as anything from distinct possibilities to probabilities.
In looking at the chart, the savings rate started to decline in 1992, and declined throughout the rest of the 1990’s at a pretty consistent pace with periodic swings in each direction. Around 2000 it leveled off somewhat but it still looks like there is a downward trend. Why? I don’t know.
One possible solution is to stop taxing income and in particular interest income from savings. To some extent this happens with 401k plans that have deferred taxes (yes I know the taxes are deferred not eliminated). This would raise the after-tax interest rate to be equal to the pre-tax interest rate. This would induce both more people to save and those who are already saving to save more.
Another policy response is a consumption tax. However, the consumption tax provides a tax break only for new savings. Income that is spent from “old” savings would still be taxed. Thus, the asset value of existing savings is eroded away. Think of it this way, suppose you have $10 in your savings account. You withdraw it and spend it. Under an income tax you pay no taxes. With a consumption tax you’d pay taxes on the $10 you want to spend and in effect you couldn’t spend the $10, but something like (1 – t)$10 (where t is the consumption tax).
Thus, there could be a problem in making a swicth from the income tax to the consumption tax. The person with that $10 in the bank would have an incentive to withdraw it prior to the implementation of the consumption tax and spend it. Thus, prior to the implementation of the consumption tax, the savings rate could drop even lower. Another consideration is that a consumption tax would pretty much have to get rid of the interest deduction. The deduction for things like home mortgage interest acts as an incentive to spend (buying a house) and the idea here is to promote savings, not spending.