Is the tax-exempt savings certificate an "enormous vacuum cleaner" that will suck money out of other types of investments? Is it manna from heaven for savings and loan associations? Or is it simply an inefficient, cheap way of subsidizing the ailing thrift industry?
These were some of the questions being asked yesterday in the wake of passage by the Senate Finance Committee of a one-year tax-free instrument pegged to 70 percent of the 52-week Treasury bill yield.
The measure is expected to receive approval today by the House Ways and Means Committee. The administration has indicated it will not oppose the bill provided the current interest and dividend tax exemption of $200 for individuals ($400 per couple) is reduced to $100/$200 for dividends only.
Reginald Green a spokesman for the Investment Company Institute, the trade organization for mutual funds, used the vacuum analogy in charging that the new certificate would draw funds away from the stock, municipal bond and commercial paper markets as well as money market funds. Green lambasted the legislation, which he claimed had the potential for causing a "massive distortion" in markets and a "subsidy for the more affluent."
Green charged that figures released by the U.S. League of Savings Associations were a "gross underestimate" of what could happen. The league estimates that a total of $230 billion will flow into the tax-free certificates, which will be sold for one year. Of that amount, about $200 billion is expected to come from within the banking system; the other $30 billion will be attracted from elsewhere in the financial system, such as Treasury bills and money market funds.
Lower estimates, ranging from $110 billion to $180 billion, have been made by congressional committees. Although savings and loans hope to get half of these funds, there is general agreement their share will be about 40 percent, with the bulk going to commercial banks. By the lower estimate, S&Ls stand to get about $50 billion in tax-free certificates. Since the current discount rate on one-year Treasury bills is 13.1 percent, the tax-free certificates would be selling at 9.2 percent.
That means the Treasury would be offering S&Ls approximately a 4 percent subsidy on $50 billion, or $2 billion. (Were the bulk of the money to come from 14 percent money market certificates, the subsidy would be 5 percent, or $2.5 billion). For the thrift industry, which some analysts estimate may lose as much as $6 billion to $8 billion this year, even a $2.5 billion subsidy might not be sufficient. And, of course, in aiding the thrifts, the legislators have at the same time awarded an even larger subsidy to their affluent rivals, commercial banks.
The plan is expected to cost the Treasury $4.6 billion in revenues over the next three fiscal years, ending in fiscal 1984. (the certificates, which have a one-year maturity, will be on sale for a year, so they can be purchased up until the end of September 1983.) But a reduction in the current $200 exemption for dividends and interest for individuals and $400 for couples to $100/200 for dividends would save the Treasury $7.3 billion, according to the Senate Finance Committee. Thus the Treasury would have a net gain of $2.7 billion.
Responding to cries that the subsidy would benefit the rich, Jim Christian, the U.S. League's chief economist, pointed out that 61.8 percent of all taxpayers who reported interest income on their 1979 tax returns were in tax brackets of 30 percent or higher.
A single person with an income of $16,000 who does not itemize deductions falls into the 30 percent bracket. For a married couple without children that category begins at $26,600, and for a family of four it begins at $28,600. Higher on the scale, a single person with an income of $35,100 is in the 49 percent bracket. For a childless couple, 49 percent comes at $47,800, and for a family of four, $49,800.
The 30 percent tax bracket is the break point at which the yield on the taxable certificate equals that on the nontaxable. A 9.1 percent tax-free rate equals 13 percent after taxes. For those in the 40 percent bracket, a 9.1 percent rate yields 15.1 after taxes; in the 50 percent bracket, 18.2 percent.
At current rates, a person would have to be in the 46 percent tax bracket to get a greater after-tax yield on a tax-exempt certificate than from a money market fund. This week's average yield on money market funds is 17 percent.
How many people will switch out of other investments to tax-free savings certificates? They offer the advantage of being insured and the opportunity to lock in high interest rates for a year at a time when rates seem to be headed down. There is no penalty for early withdrawal, but the tax exemption will be forfeited. The certificates are, however, subject to state and local taxes. Although no minimum deposit has been set by the legislation, the sponsors hope issurers will keep it low, say under $1,000 in tax free interest ($2,000 for couples) during the entire time the plan is in effect, not annually.
Money market funds are fully taxable and not insured, yet they offer complete liquidity, check writing privileges and flexibility should rates change. Municipal securities, which will be competitive with tax-free certificates, generally have a longer maturity, although they are usually free of all taxes and have no ceiling on the amount that is tax exempt.