A major goal in the tax debate is how to use taxcuts to stimulate individual saving. The Reagan administration asserts that a 30 percent across-the-board cut in marginal tax rates will raise saving sharply. But there is no evidence to suggest that taxpayers would save, other than temporarily, much more than 5 to 8 percent of their increased net incomes, the proportion of disposable income saved since 1950.
The Democrats propose cuts "targeted" to pomote saving, but their aim has been poor. They would increase deductions for individual retirement accounts (IRAs) and Keogh plans, and some would add new deductions for special savings accounts set up to accumulate the down payment for a house or to pay college tuition, or increase the amount of dividends and interest or long-term capital gains not subject to tax.
Such proposals have the fatal flaw that they reward people who borrow money or switch prior savings into the tax-favored assets, without necessarily doing any new saving. The present $200 exclusion for dividends and interest ($400 for a married couple) -- which was enacted effective Jan. 1, 1981, for two years to increase saving -- has had no noticeable effect. In fact, the saving rate has declined slightly since this provision went into effect.
If we are serious about increasing total national saving and not merely private saving, the most direct way would be to move toward a surplus in the federal budget. For extra dollar the government reduces its borrowing, a dollar more of lendable funds is available for private investment. In constrast, each extra dollar of federal deficit drains a dollar from private lending, while only a small part of the tax-cut dollar received by individuals is saved.
But if it is agreed that individuals should be encouraged to save more, the best solution would be to give people a deduction or tax credit for their saving and to let them decide how to invest it. This approach neither promotes consumption, as do across-the-board cuts, nor distorts savings patterns, as do the miscellaneous devices now under discussion.
Economists and tax lawyers have devised a method of calculating saving -- the cash flow approach -- which is both simple and fair. Taxpayers would list on a separate schedule their purchases of financial or business assets, the payments on the principal of a home mortgage and increases in bank and savings deposits during the year. From the total of these items, they would deduct sales of financial or business assets, reductions in bank and savings deposits and increases in borrowing. The difference between these two sets of figures is net saving.
As a starter, taxpayers could be allowed to deduct net saving up to some fixed amount, say, $2,000 for a single person ($4,000 for a couple), or they could be given a tax credit, say, 20 percent of these amounts. These limits could be increased in future years. The tax credit has the virtue of giving the same tax cut to individuals who save the same amount, regardless of their tax bracket. A 20-percent credit would halve the tax rate on income saved by taxpayers in the 40 percent bracket and eliminate tax on saving for taxpayers in the 20 percent bracket. The cost of such a credit would be about $3.5 billion if saving did not increase.
The precise effect of the credit on saving cannot be estimated, but it could be significant. If 10 million people saved $1,000 more than they otherwise would, total saving would rise by $10 billion -- an 11 percent increase in personal saving at current rates -- and reduce revenue by an additional $2 billion. More than half of the total revenue loss of $5.5 billion could be offset by repealing the dividend and interest exclusion, which costs more than $3 billion a year.
Although a tax incentive is simple in principle, it would be vital in practice to define saving accurately to forestall creation of still another tax avoidance device. Considerable thought needs to be given to such problems as the treatment of saving and dissaving in successive years, gifts and bequests and the classes of assets eligible for the credit. These problems can be solved.
The administration and Congress are unlikely immediately to embrace the tax credit proposal and to do the necessary technical work in time to include it in the pending tax bill. But much would be gained if the seriously flawed ideas for stimulating saving now under discussion were shelved pending the development of a detailed general savings incentive. The tax staffs of the Treasury and the Joint Committee on Taxation could be directed to work out a feasible plan for the congressional tax-writing committees by late 1981. It would be better to take a few more months to enact a law that can work than to be stampeded into enacting a law that will waste scarce tax resources and is doomed to fail. i