Rainy Days Get No Respect As Savings Rate Droops

By Jonathan Weisman, CQ Staff Writer

Pandemonium is breaking out at Regan Ralph's modest Washington, D.C., duplex. As the young mother chats on the phone, the baby sitter bangs on the door to be let in. Two-year-old Sam is loudly letting his mother know he has no interest in the banana that is supposed to keep him occupied.

Ralph's job as a Washington director of Human Rights Watch's Women's Rights Project is richly fulfilling but by no means well-paid. Her husband, Hamada Hanoura, edits videotape at C-SPAN, the public affairs cable television channel.

Though their occupations are uniquely Washingtonian, their struggles are universal. Sam, at 40 pounds, is capable of remarkable mischief. But he also has severe asthma, which has consumed time and money. At the suggestion of doctors and day care workers, Ralph and Hanoura have chosen in-home baby sitting to keep him away from day care center germs. Child care costs them up to $350 a week.

Their home is far from extravagant, but a Washington mortgage can be huge. They never considered a cheaper house in the suburbs. "I don't want to be giving up one to two hours of family life a day for an achingly long commute," Ralph explains.

But such dedication comes at a high cost. By the end of the month, there just is not much money left. The couple remembers the days before Sam's birth when they both contributed to their Individual Retirement Accounts and set aside something in company pension plans. No more. About all they do is participate in a work plan that allows them to use pre-tax dollars for some of Sam's child care. "Parents of young children do very little but spend their resources," Ralph says with a tired laugh as Sam clamors at her feet.

If Ralph and Hanoura lament their inability to save, they might take comfort in numbers. They are not alone.

Despite the burgeoning economy and national mood of optimism, U.S. savings rates are abysmal. In fact, they are as low as they have been since the Depression. The Department of Commerce's Bureau of Economic Analysis calculates personal savings rates as the percentage of total disposable income that someone sets aside, either in savings accounts or investments. Personal savings is a person's total income minus tax payments, purchases, interest payments and transfers of money.

Since August, Americans have been setting aside only 3.8 percent of their personal income, an astoundingly low rate even by the standards of the 1980s, when economists began worrying about savings.

When Ronald Reagan moved into the White House in 1981, personal savings rates stood at 9.4 percent, respectable by international standards, though hardly world-class. Then they started to fall, to 7.2 percent by the beginning of Reagan's second term, and to 5.1 percent by the time George Bush took over in 1989.

During the recession years of the early 1990s, economists and policy-makers began pointing to savings rates as a reason for the United States' declining economic prowess and international prestige. When the nation's economic engine began to purr, such talk died down. Meanwhile, the savings rate slide continued, falling from 6.2 percent in 1992 to 4.3 percent in 1996. The average monthly personal savings rate through November 1997 stood at 3.8 percent, the lowest since the Depression year of 1939. Japanese rates in 1996 were 11.9 percent, according to the Handbook of International Economic Statistics published by the CIA.

One study, by Stanford University economist B. Douglas Bernheim, has concluded that families are saving at only one-third the rate necessary to enjoy the same standard of living when they retire as they now take for granted.

When Congress returns to work this election year, the Republicans have promised a lively debate about tax reform. At the heart of their proposals to shift to a radically restructured tax system will be the savings issue: how to spur Americans to spend less now and to save and invest more for the future. Coercing or coaxing people to save has proved to be devilishly difficult. Even as contributions to Individual Retirement Accounts and other tax-preferred savings vehicles soar, overall savings rates slide, in large part because increased retirement savings have been offset by burgeoning debt.

A move toward a system that taxes consumption and leaves interest and investment earnings unscathed would help, most economists agree. A tax-code restructuring that reduced taxes on savings would increase annual economic growth by up to $270 billion a year, said Stanford economist John Taylor. But there is a cost: raising taxes on the working poor and middle class while lowering the burden on the affluent. Boosting personal savings rates will likely mean shifting dollars from the poor and middle class, who have to spend most of their money on necessities, to the rich, who can more easily save and invest.

Still, researchers say, a debate about America's diminutive savings rate could only help. At least, it would refocus Washington's attention on the problem.

"When things are going poorly and people worry about the future, they naturally think the savings rate is one thing to worry about. When things go well, people don't worry as much," said William Gale, a senior fellow at the Brookings Institution, a Washington think tank. "But that's a mistake. They should be worried."

Orthodoxy Questioned

The economic orthodoxy surrounding savings rates is time-honored and broadly held: High savings rates are the ticket to future economic strength and stability. Banks lend a saver's assets to businesses and industry that wish to invest in plants and equipment, which in turn spark increases in worker productivity. A saver who invests in stocks or mutual funds simply eliminates the banking middleman and puts money directly into corporations. The more money available for borrowing, the lower the interest rates will be for businesses looking for capital.

"If you're not saving enough today to finance tangible assets to make workers more productive in the future, your standard of living will be lower in the future," explained James Poterba, an economist at the Massachusetts Institute of Technology who has studied savings at length. "You can borrow from other countries' savings to make that investment and make workers more productive, but your return on investment will flow abroad."

Of current U.S. savings rates, he said: "It's a bad omen."

Granted, there are cracks in that orthodoxy. Fifteen years of generally declining savings rates, coupled with a growing economy, low unemployment and respectable productivity increases have led some researchers to question the fundamental importance of savings.

A 1996 study by the McKinsey Global Institute, the research arm of the management consulting firm McKinsey & Company, found that the United States' high productivity in both labor and capital has more than made up for the nation's low savings rate when compared with Germany and Japan. The Japanese save much more money, but heavily regulated banks and financial markets have ensured that investors' returns on investment -- in the form of interest rates, dividends or stock prices -- are much lower than in the United States. That, in turn, has scared off international investment. Japanese labor customs have also kept workers relatively unproductive. That is, they produce fewer goods and services over a given time than U.S. workers, McKinsey found.

"Simply put, the Japanese invest a lot of money and a lot of time and energy and get comparatively little back in return," the report said.

Germany's high savings rate is nullified by its high labor costs and its inefficient use of investment money, the study found.

In contrast, the United States is a good investment. U.S. companies and money managers are turning what little savings its citizens have into solid gains in productivity, thus attracting more investment from abroad. As long as other countries such as Japan are saving and money is plentiful, domestic savings are not so significant, this new thinking suggests.

"Savings is a lot like the word 'deficit,' full of emotional significance that is not borne out by reality," said Robert Heilbroner, an economist at the New School for Social Research in New York.

But that new thinking relies on a precarious notion: that there will always be money coming in. The current financial crises rocking the Far East have underscored fears of a "crisis of liquidity" in world financial markets that could emerge early in the 21st century. And as the Baby Boomers move to retirement, existing problems with domestic savings will only get worse. The elderly spend an even higher proportion of their money than the young.

"There's not a danger in the sense that a catastrophe is going to occur, but we will be a slightly less powerful country than we otherwise would be," said Alan Auerbach, a professor of economics and law at the University of California at Berkeley who served in 1992 as deputy chief of staff on Congress' Joint Committee on Taxation.

Liberalized '90s

Congress has been trying to address the problem of savings rates for more than a decade. The 1986 tax law (PL 99-514) made a dent when it did away with the deduction for interest on most personal debt. The earlier creation and expansion of tax deferred savings accounts, such as IRAs and 401(k) plans, were also meant to spur personal savings.

The 1997 tax law (PL 105-34) added still more incentives, with a new IRA, named after Senate Finance Committee Chairman William V. Roth Jr., R-Del., an expansion of existing IRAs, and the creation of a new tax-preferred savings account for higher education.

Yet savings rates have apparently failed to respond. Some economists believe the growth of 401(k) plans and IRAs will make a difference. About 15 million Americans had capital gains income in 1995 from the sale of stocks and other investments, 26 million had stock dividend income and 66 million had interest income, said Steve Venti, an economist at Dartmouth College. People are saving.

But the numbers will not show in the statistics until the next century. Research by Venti and Poterba shows that an average 37-year-old with modest savings will have accumulated $100,000 by 2025, when he retires, about what he can expect from Social Security, as currently designed. That is not much to live on, Poterba concedes, but it is something.

"These vehicles [savings plans] are almost certain to represent the growth of new savings in this country," Poterba said. "It's potentially an absolute sea change in household behavior."

But as the travails of Ralph, Hanoura and Sam attest, not everyone can take advantage of the plans that are offered. Many economists say people who are using such savings vehicles are putting in money they would have put aside anyway. The government comes out the loser, since it gets no real increase in savings, but it loses tax receipts it could just as well have invested on its own. Those economists point to the large picture -- the seeming contradiction of expanding retirement accounts and contracting savings -- as proof that government-sponsored accounts are doing little to increase savings.

Economists do agree on the largest factor that is driving down net savings rates: debt. Easy money is making savings unnecessary in the short run, Gale said. Consumers used to have to save $1,200 to buy a $1,200 couch. Now they can swing financing deals that stretch out payments or put them off for months.

The deduction for interest paid on home mortgages, a survivor of the 1986 tax law that got rid of most other interest deductions, has allowed home buyers to purchase larger houses with smaller down payments. More affluent Americans -- precisely the ones who should be saving the most -- often maximize their mortgage debt to expand their tax write-offs. Credit cards and loans have also reduced the need for a nest egg for bad times, what Gale calls precautionary savings.

"You have to save less to put down a down payment," Gale said. "You have to save less for precautionary reasons. If you're unemployed, you put everything on a credit card for a month or two. All this falls under the financial liberalization of the '90s."

The bullish stock market perversely may be hindering savings, ventured Len Burman, a senior research associate at the Urban Institute. "Because stocks are doing so well, people feel richer. They feel they don't have to save," he said. "People are looking at the 401(k) balances and are saying, 'Hey, I can quit.' "

Tax preferences on these accounts may actually be aiding those good feelings. If people set specific savings targets for their retirement accounts, tax preferences help them reach the target faster and quit saving earlier.

Couple those factors with an increasingly older population that consumes more and you have a recipe for falling savings rates. "And it will get much worse when the Baby Boomers hit 60," Auerbach predicted.

The 1997 tax law in some ways set out to remedy the savings dilemma, but it may have only complicated it. The Roth IRA, which allows retirees and others to withdraw funds tax-free, is a new savings instrument, as is the new education savings account. But most economists do not believe either will appreciably increase savings. The Roth IRA will attract mainly people interested in shifting money from existing IRA accounts, predicts Diana Furchtgott-Roth, an economist at the American Enterprise Institute. And the education account, with its $500 annual limit per child, is just too small.

Moreover, the largest parts of the 1997 law -- such as the $500-per-child tax credit and education tax credits -- are more likely to spur consumption than savings. If a family knows it can receive a credit of up to $1,500 for each of the first two years of college, it may save less for higher education. And the odd quirks of the law that create a host of new marginal tax rates could dissuade some people from earning and saving more.

"I'd say if it turned out to be a wash, we'd be lucky," Auerbach said.

Congress Responds

The disappointing results of tweaking the tax code with savings incentives have given momentum to a movement to remake the tax system into one that rewards savings and taxes spending. Two basic camps have formed in the Republican Party, one pushing a flat income tax rate of 20 percent, the other advocating a tax on goods and services at the point of sale.

The flat tax theoretically should buoy savings because income from interest and investment would be untaxed. The national sales tax would tax only consumption, leaving untaxed any money that was saved or invested (just like the flat tax). A July 1997 review by the Congressional Budget Office found that a consumption-based tax system could raise savings by as little as 3 percent or as much as 25 percent, depending on the economic forecasting model employed. Almost every study has found some positive effect on savings, however.

But as with much in economics, nothing is that simple. The theoretical gains would likely be offset by less tangible changes, the CBO report and economists cautioned. For instance, the growth of IRAs and 401(k)s has spawned a whole industry of brokerage firms, mutual funds, employer-matching programs and other institutions designed to entice people to save. That savings infrastructure could wither away if all savings were treated the same.

"IRAs work because they are widely promoted, narrowly focused on retirement and they lock money away," Venti said. Savings inducements "need to give that psychological effect of cheating the tax man."

The political problems are even more of a hindrance. People have purchased homes expecting to deduct their mortgage interest, just as businesses have invested in plants and equipment expecting to write off much of the costs. Even the most ardent supporters of a new tax structure have said deductions must be grandfathered for existing investments.

But maintaining tax deductions for those investments would eliminate 70 percent of the projected savings-rate gain under the national sales tax or flat tax, according to a study by Auerbach and Laurence J. Kotlikoff, an economist at Boston University.

Then there is the issue of shielding the working poor from the ill effects of tax reform. Under the flat tax proposed by House Majority Leader Dick Armey, R-Texas, a family of four would be given a large, $33,800 exemption, meaning the poorest families would pay nothing in taxes. The national sales tax proposal touted by House Ways and Means Committee Chairman Bill Archer, R-Texas, includes a mechanism to rebate sales taxes paid by the poor.

But any move that shifts the tax burden from the poor to the rich hinders savings gains, since the poor and middle class must spend a larger portion of their income on necessities than the affluent.

"You give away a lot of the benefits of a consumption tax by meeting the charge that this is a regressive tax that has to be dealt with," said Dale Jorgenson, an economist at Harvard University, who calculates that a pure national sales tax would boost personal savings rates to between 5 percent and 6 percent.

With such a large exemption, the Armey plan could have little or no effect on savings rates, he said. Any rebate plan added to the national sales tax could make the exercise pointless. Other proposals that envision maintaining the mortgage interest deduction for political reasons would be worthless, Jorgenson added, because by his calculations, ending the mortgage interest deduction accounts for the lion's share of the savings rate boost.

Instead, Jorgenson argued, Congress should handle the problems of distribution through government spending aimed at the poor and working class, not through tax policy. "Basically, you have to be a purist about this," he said. "You can't get the benefits of a consumption tax with a halfway measure to assuage guilt over distributional impacts."

In Jorgenson's calculations lie the GOP's dilemma: The rank and file would never subscribe to the idea of new government spending, but elected officials are not likely to accept the cold-hearted calculations of theoretical economics either.

Gale of the Brookings Institution said the most sure-fire way to raise national savings rates is to allow the government to save and invest tax money. Paying down the debt would do just that, since the government's current debt offsets national savings.

But that prescription is not likely to fly with some Republicans in Congress.

The fact of the matter is, Gale said, saving now means lowering current standards of living in hopes of raising living standards in the future. That has never been easy for Washington.

"Raising savings is not the same as making people feel better off," Gale said.

Regan Ralph apologizes for not giving fundamental tax reform much heavy thought, although few would chastise her for that. But she is quick to venture an opinion.

"As someone who shovels a fair amount of money into taxes in a year, I would rather see some long-term changes rather than a one-shot deal," she said. "Five hundred dollars at the end of the year is nice, but it's not really a whole lot of help."

Would she favor a flat tax or a national sales tax? "No, that would be terribly regressive."

And that, in a nutshell, sums up Congress' dilemma.

Saturday Jan. 17, 1998

• A Bundle From Virginia
• House GOP Casts a Wide Net In Renewed Scandal Hunt
• Rainy Days Get No Respect As Savings Rate Droops
• Rep. Riggs To Run For Senate
• Special Race in New York's 6th To Feature Dueling Democrats
• Another Costly Run May Prove Too High a Price for Feinstein
• Criticism of 'Corporate Welfare' Heats Up in Congress
• Departure of Bureau's Director Deepens Census Controversy
• California House Race Shapes Up As a Duel of Interest Groups
• Political Advocacy Case Reaches High Court