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Tuesday, June 29, 2010

Whatever Happened to Thrift? Why Americans Don’t Save and What to Do about It

Keynesianism is back in vogue, and prominent economists are dusting off their discussions of the “paradox of thrift.” So amid the apologies for bigger government   deficits, it is refreshing to read Ronald Wilcox’s Whatever Happened to Thrift? For those interested in the subject of saving, this volume is a good read.

Too often when I have read handwringing over “the” savings rate, the worrier doesn’t feel the need to explain why we should care about savings in the first place. After all, the consumption/saving tradeoff is a reflection of individual preferences. If you want to save more, fine, go ahead—but don’t force your views on the rest of us!

Wilcox, a professor at the University of Virginia’s Darden School of Business, easily handles such an objection from standard economic theory. He cites a survey which found that 68 percent of workers thought their savings rate was too low, then says, “Even if we take [the economist’s view], the fact that many people report feeling uncomfortable with their level of savings and seek ways to increase it should give us pause.” If the reader gives him a chance, Wilcox shows that he is not some bossy sermonizer. On the contrary, he shows that there are reasonable senses in which we can say, “Americans don’t save enough.”

Take the issue of Americans’ financial literacy. In a survey Americans over the age of 50 were asked to evaluate this claim: “Buying a single company stock usually provides a safer return than a stock mutual fund.” Only 52 percent considered the statement false. One doesn’t have to be a paternalistic busybody to be disturbed by such findings.

If we concede that many Americans are financially illiterate, then it is a simple step to concluding that they probably don’t save enough. After all, the cost of saving—forgone consumption in the present—is obvious, whereas the benefit (higher consumption in the future) is remote. The virtues of discipline, abstinence, and thrift all work together. Someone who is ignorant of basic finance is likely to err on the side of saving too little.

Of course, even if one thinks Americans ought to save more, it doesn’t follow that the government should tinker with tax policy to encourage a change in behavior. Sure, switching to a consumption tax might help people save more, but is that really any business of the government?

Yet that’s too glib a dismissal of the problem, for the income tax really does introduce a bias into the consumption/savings decision. After receiving his take-home pay, a worker can either spend the money now “at par” or use the after-tax income to buy an investment such as a bond or share of stock. The return on these investments reflects the tradeoff between present and future consumption. And yet the income tax mutes the attractiveness of future consumption because any dividends from the investment are taxed anew in the following period. For tax and psychological reasons, Wilcox declares, “[S]upplanting the current federal income tax system with a broad-based consumption tax is the single most potent policy tool for increasing the savings rate of U.S. households.”

Of course, it would be naïve to think that a mere technical adjustment to the tax code can provide a sound footing to the economy. The real threat to the economy is how much the government seizes in resources year in, year out. Moreover, it is highly unrealistic to think that politicians would leave incomes alone in exchange for a new federal tax on consumption. We should get rid of the income tax, with its anti-saving bias, and replace it with no new or increased taxes.

Another problem with the book is that Wilcox’s suggestions “start with the government because sound policies there can pave the way for enlightened private-sector solutions as well.” For example, he recommends that the government “reinvigorate the marketing of U.S. Savings Bonds.” But why devise new or improved schemes to increase lending to the federal government, which squanders any resources it touches? Rather than focusing so much attention on government, Wilcox should have devoted his efforts to persuading his fellow citizens that a higher rate of saving would be beneficial.

All in all, Wilcox’s book provides a quick yet nuanced summary of the relevant ideas and statistics in various fields in order to gain perspective on the American “savings problem.” Although its proposed solutions often fall short, the book identifies an important national problem.