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
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
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
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
"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."
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
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.
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
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
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
"I'd say if it turned out to be a wash, we'd be lucky," Auerbach said.
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
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
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,"
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
And that, in a nutshell, sums up Congress' dilemma.
© 1998 Congressional Quarterly Inc. All rights reserved.