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Are Savings Too Low?

July 14, 1999

Tags Financial MarketsCapital and Interest Theory

With the personal savings rate at historic lows, consider the comments of Richard Vedder, who offers an Austrian perspective
on these data (from the Spring 1999 Austrian
Economic Newsletter

AEN: What do you make of the Commerce Department's data showing historically
low savings?

VEDDER: It is true that the rise in equity prices have made people seem wealthier.
And there is a well-known rule in economics that people's consumption and income depend not
only on their income levels but also on their perceived well-being. If people perceive themselves
to be well-off, they feel they don't need to save out of current income.

The way the government defines savings is subject to some debate and scrutiny. Economists
usually think of savings as the changes in the flow of wealth minus consumption over a period of
time. Well, that's not the way the Commerce Department looks at it. The government says
savings is the residual income that isn't consumed. That creates all sorts of inaccuracies. That's
why the Fed's superior data diverge sharply from the Commerce Department's.

Again, aggregate statistics have to be handled with care.

AEN: You're not suggesting that the savings decline is entirely artificial.

VEDDER: I think we can still grant that our savings rate is low. I think the main
reason is that we tax savings as capital at punitive rates in this country. The double, triple, and
quadruple taxing of capital punishes savings because savings is converted into investments and
financial capital in the process of creating real physical capital. If you tax capital high, the
incentives to save are going to be reduced.

We have corporation income taxes at 35 percent, on top of state income taxes. If the corporation
makes $100, $40 are taxed away. Let's say half of the remainder is given to the shareholders in
the form of dividends, leaving only $30 to keep as retained earnings to build new machines and
expand production. The shareholders will pay a tax of about a third on those earnings. If the
shareholder sells the stock, the capital is taxed again.

If you somehow survive all of this with some money intact, you get taxed again if you try to pass
wealth on after your death. The federal estate tax table starts at 37 percent and runs as high as 55

Remember too that some of these gains are mythical because they are brought about through
inflation. Let's say your aunt bought $10,000 in stock in 1971. She kept it until 1997, when the
stock was now worth $40,000. She then decided to sell it. The government tells her that she
made a $30,000 profit, and 20 percent is due to the federal government. After the state
government gets its cut, she ends up paying about $7,000 in taxes.

The reality is that because of inflation, the price of everything has quadrupled since 1971. The
purchasing power of the initial value is nearly identical to its purchasing power in 1997. There
are no real capital gains, and yet she pays the government anyway. Under these conditions, why
save? Why not consume?

Many other countries have higher taxes than we do. But they don't have as high taxes on capital
as the U.S. does. As a consequence--again granting the problems with this data--most every
developed country has higher savings than we do. Until recently, we have saved about a nickel on
the dollar. Well, France and Germany save over 12 cents. Italians save 14 cents--three times as
much as Americans. Japan and Britain save between 10 and 15 cents. The reason: taxes on
capital are very high in the U.S.

AEN: What about indirect taxes on capital and savings?

VEDDER: Certainly, there is the regulatory tax. OSHA regulations require
companies to spend billions, not to expand output, but to meet some government mandate. This
is a disguised tax. If you add these taxes, you've got something on the level of quintuple taxation
on capital. This is gross over-taxation.

Forced savings programs like Social Security end up discouraging savings too. Martin Feldstein,
who has limitations, has nonetheless made his reputation demonstrating that this program
directly reduces personal savings. The aggregate national savings rate is not increased in the way
that people think. I think he is right. There's this fiction that companies don't really pay the
Social Security tax, but in fact they do.

The tragedy for younger people is that the money taxed for Social Security is not going to be
given back at any respectable rate of return. One solution, that of diverting revenue to higher-
return investments, could potentially lead to a government takeover of the stock market. This
would be a disaster. The devil is in the details of these plans.

Ideally, I would like to see a total opt-out option: young people surrender their claim to future
benefits in exchange for no longer paying the tax. That would eliminate a huge portion of the
liabilities in the system. It's possible to do it without a costly transition.

A quick warning: take all predictions about Social Security's future with a grain of salt. If you
change assumptions modestly--such as assumptions about the growth in future benefits--the
numbers change dramatically. All these calculations you read about in the newspapers are very

AEN: To your mind, is there a preferred level of savings?

VEDDER: The Austrian position is that there is not, which is why I am a little
uncomfortable with warning about declining savings. Mises and Rothbard were right: there is no
optimal level of savings. I believe that Americans save too little, not because I in my wisdom
think people ought to save more, but because it is manifestly clear that the government
discourages savings, causing them to be below what they otherwise would be.

The optimal rate of savings depends on human action as it operates through the subjective notion
of time preference. Whether people want things now or later determines how they allocate their
consumption and savings decisions. Part of the idea of the free market is that we allow the price
system to signal people to make their own choices. The prices in this case are interest rates, which
variously reward and discourage the saving-consumption choice.

This is where Austrians have so much to contribute. A lot of the problems we have in
macroeconomics are due to mainstream economists' lack of understanding in this area. When the
central bank manipulates the interest rate, it creates distortions very much like those that are
created by price controls. The Federal Reserve interferes as much with the market system as a
price-control board.

"Surely an economist favoring the free market must grant that the market’s voluntary
consumption/investment allocations are optimal and that any government interference in this
proportion, from either direction, is distortive of that market and of production to meet the wants
of the consumers. There is nothing, after all, particularly sacred about savings; they are simply the
road to future consumption. But they are, then, clearly no more important than present
consumption, the allocations between the two being determined by the time preferences all
individuals. The economist who balks more at interference with free-market savings than he does
at infringement on free-market consumption is therefore implicitly advocating statist interference
in the opposite direction. He is implicitly calling for a coerced distortion of resources to lower
consumption and increase investment."

Murray N. Rothbard
Man, Economy, and State, p. 800.

See also John S. Irons's essay on savings on About.com.


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