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Presidential Candidates Duck Hard Issues on Savings

June 17, 2008

For all the rhetoric about change, the current Presidential candidates have proposed precious little that will address the United States’ problem of historically low levels of household savings.  And unless something is done, and soon, our public policy hands may be tied into the types of solutions that no one wants, large tax increases to fund the many impoverished or nearly-impoverished elderly.

John McCain started the campaign season on a positive note, vowing to cut capital gains taxes.  Few results in economics have as much across-the-board support among those who study tax policy as the impact of capital gains taxes on savings and investment. Capital gains taxes discourage savings by reducing the expected returns to savings and inhibit businesses from expanding their operations. All taxes distort economic activity in some way or the other, but it is the capital gains tax that is most pernicious.

That is why it is disappointing that Mr. McCain recently reversed his decision to push for cuts in capital gains taxes. An interesting question emerges as to why Mr. McCain made this decision. One view might be that he thought the tax cut too expensive.  If that is the case he certainly has not communicated this message.  And appeals to tax cuts being too expensive are not part of his recent political language. An alternate, and in my mind more persuasive, interpretation is that he is bowing to the fact that most of the benefits of a capital gains tax cut would accrue to wealthier Americans and he does not want to be attacked by Mr. Obama on this basis. This nod to populism would be consistent with his uber-populist gas tax holiday proposal. Is Mr. McCain using quiet shifts in tax policy in an attempt to grab the populist mantle that Mrs. Clinton has now laid down? It sure looks like it.

Mr. Obama has forwarded some modest proposals for enhancing personal savings. The first is a small-business IRA plan that looks very similar to the “Automatic IRA” plan that has been floating around the Brookings Institute and Heritage Foundation for quite some time. Mr. Obama’s plan would require small businesses to offer their employees access to a direct deposit retirement account of the type we now see in large companies. What is left unsaid is how small businesses would pay for this arrangement; many would be too small to be able to generate the pools of money that would be interesting to private-sector financial services providers. Perhaps Mr. Obama is advocating a government-run plan, but from the current state of his policy briefs it is impossible to tell.

He has also advocated a cash-match savings program for lower- and middle- income Americans. In this plan, individuals would receive a match of fifty cents on the dollar and could contribute up to $1000 for money set aside in a designated retirement fund.  These kinds of cash matching programs for lower income Americans have previously been tried on a much smaller scale and have produced some success at increasing savings rates. What is striking about Mr. Obama’s version of the plan is the income cap for eligibility, $75,000. With that kind of cap, it is sure to be a very expensive program. And it is hard to come up with a compelling reason for taxpayers to fund savings match plans for someone making $70,000 per year.

The larger issues that would affect savings are being completely ignored. Taxing income creates disincentives to work. Taxing capital creates disincentives for investment. Taxing consumption creates disincentives for…..well consumption.  Consumption taxes are the right approach for incentivizing savings relative to spending.  And despite cries to the contrary, a consumption tax can be made just as progressive (even more progressive) than the income tax.  It is also hard to find an economist who doesn’t have some good things to say about how consumption taxes would benefit the economy, and even the environment, as a whole.  While, as in any profession, political opinions vary; the preponderance of the evidence for income versus consumption taxes indicate the latter would be a boon for the economy. Neither Mr. McCain nor Mr. Obama has addressed this more fundamental issue.

Looming over each of the candidates’ laundry list of proposals is how much they will cost.  Continued large budget deficits implicitly tax our savings, making future tax increases inevitable and reducing the proportion of our savings we will actually have to spend. The nonpartisan groups that have looked at the cost of each candidate’s proposals have been consistent in their view that Mr. McCain’s proposals will create larger budget deficits than Mr. Obama’s.

If we are serious about increasing household savings in the U.S. we have to take a hard look at the disincentives the current tax regime imposes on savings. And we need to play the role of deficit hawks, making sure what we save today isn’t mortgaged to pay the bills tomorrow.

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One comment

  1. No matter how progressive one makes the rate on consumption taxes it doesn’t address, in my mind, that folks on the lower end of the scale don’t save. If I have a lot of capital, I may not spend due to the tax burden, hoarding my capital. Eventually though all spending is wages for someone and consumption taxes makes the “trickle down” trickle even more slowly.
    If one wants to incent a behavior by a particular group, in this case saving by low to middle income people, one should target their behavior with specific programs. Achieving anything with broad tax policy is extremely clumsy. Low income people will pay virtually no taxes in either an income or consumption tax regime so I don’t know how this helps.



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