When the House Ways and Means Committee meets to "mark up" the administration's tax cut bill, the central question relating to the proposal to cut individual tax rates by 30 percent over the next three years will be the impact on individual decisions to save. The press and many in the public seem to believe that since the rate reductions will affect individuals, and since individuals are consumers, most of the increase in disposable dollar income will be spent on consumption, thereby strongly increasing inflationary presures. But supporters of the "10 10-10" tax cut maintain that individual savings will rise markedly and help provide for non-inflationary financing of the federal deficit.
Both logic and experience support the administration view.
Just who will benefit most from the cut in tax rates? Middle-income taxpayers, defined not in the staisticians's image of $20,000 per year in median family income, but in their own image of perhaps $15,000 a year. These families pay 59 percent of all federal individual income taxes and would receive 61 percent of the tax cut. These are families that save, with the amount of saving rising sharply as income levels rise. They are the people who have saved in the past and now hold hundreds of billions of dollars in savings in banks, savings and loan associations, credit unions, savings bonds, money market funds and other forms.
It is ridiculous to charge that these middle-in-come Americans are going to devote all or most of any tax reduction to spending on consumption. In fact, a recent survey by W. J. Fitzgerald, Inc., indicates that, on balance, families below the $15,000 income level are net dissavers; their consumption spending exceeds disposable income, with the shortfall made up by cashing in on past savings or going into debt. This means that at income levels above $15,000 net saving must be sufficient to offset the sissaving at lower income levels in order to result in a net saving rate for all consumers of 5 to 6 percent, the U.S. average of recent years. Since the tax cut is to affect mainly these higher income taxpayers, the amount of the tax cut that will be saved can be several times higher than indicated by the current average saving rate.
How much higher? This depends on the marginal saving rate, or how much of each extra dollar of disposable income received is saved. Common sense tells us that marginal saving rates rise with income, but from what base and how steeply? Writing in 1971 on the basis of 1960-61 survey data, economist Ralph Husby estimated that the short-run marginal saving rate (i.e., the immediate response) was 67 percent among families with the lowest incomes, gradually increasing to 82 percent at the %$41,500 level (the income levels are adjusted to reflect 1980 dollars). According to the Husby analysis, long-run marginal saving rates are lower than short-run rates, ranging from 16 percent in the lowest bracket to 55 percent in the highest. Still, the 16 percent bottom-bracket long-run marginal saving rate was more than twice the level of the average savings rate in the early 1960's, when the survey was conducted.
Personal saving out of the 1964-65 Kennedy-Johnson tax cut was fully consistent with the Husby conclusions. With a 30-percent cut in the lowest bracket rate, 15 to 18 percent for middle-income taxpayers and 23 percent for the highest income taxpayers, the Kennedy-Johnson tax reduction was weighted more toward low-rate savers and dissavers than is 10-10-10. Still, that tax cut had a very big impact on individual saving, with the average personal saving rate rising for 5.4 percent in 1963 to 6.7 percent in 1964 and 7.1 percent in 1965. Comparable results with the Regan tax proposal would provide an increase of more than $25 billion in personal savings in 1982 and upward of $40 billion in 1983.
Critics maintain that today's expectations of high inflation have blunted incentives to save.
This "spend now" philosophy, they argue, drove the individual saving rate to a low of 4.7 percent in the first quarter of 1981 and will surely prevent any repetition of the 1963-65 experience, when prices are rising at less than half the current rate.
The answer to this criticism is that fear of inflation, if indeed it does cause lower saving, is certainly not the only factor. Of at least equal - if not greater - importance is the increasing tax burden on middle-income Americans as they move up to higher tax brackets and are hit with steep marginal rates. To the extent that this tax burden is the culprit, 10-10-10 carries its own solution to the problem of the low saving rate. Middle-income taxpayers will have more disposable income from which to save and will also get a significantly higher after-tax return on each additional dollar that is saved.
Insight into current attitudes toward saving can be found in recent public opinion polls. In August 1980, the Gallup organization asked people what they would do with a 10 percent reduction in their income tax bills, spend it or save it? Forty-one percent said they would spend most of it; 40 percent said they would save most of it. tBut, in fact, that question was poorly worded. Few individuals realize that the act of saving is really a negative act; it is the act of not spending on consumption. Dept repayment is saving. Opinion Research Corporation asked people in late March: "If your tax rates were reduced by 30 percent over three years, would you spend all of the money, or would you save some of it or use it to repay debt?" Fully 82 percent of the respondents said they would save some of the money or use it to repay debt, compared with only 15 percent who would spend it all. Those who said they would save some of the money also said they would save (on the average) almost half of the proceeds of the tax cut.
This response is fully consistent with the range of short-run marginal saving rates as estimated by Husby. Moreover, to the extent the prospect for cutting the inflation rate is recornized by the public, higher saving rates can be expected. In addition, there are strong pressures in Congress to shape the tax bill even more toward stimulation of individual savings. Discussions between congressional leaders and administration officials point to retention of the multi-year approach but with perhaps a five-point cutback in the total size of the marginal rate reduction from 30 to 25 percent. cAs a trade-off, strongly pro-saving provisions might be added, including immediate reduction in the top individual rate from 70 to 50 percent on investment income, a further substantial cut in the capital gains rate, and some type of savings incentive especially attractive to middle-income taxpayers.
In this way, two important goals would be served. The pressing social and economic need to reduce the impact of "bracket creep" on tax-battered middle-income Americans would be met. At the same time, maximum stimulation of individual saving would be obtained, and the tax cut would in significant part "pay for itself" by helping to finance the federal deficit.