November 25, 1996

November 25, 1996 | Commentary on Taxes

ED112596a: Why It's So Hard To Save

As any economist can tell you, when you subsidize something, you get more of it. Give welfare checks to people who don't work, for example, and the number of people who don't work increases.

The flip side is equally clear: If you tax something, you get less of it. For example, a few years back the government slapped a "luxury" tax on cabin cruisers and yachts costing more than $100,000. The result: Boat buyers decided not to buy new boats, and several U.S. boat builders went belly up -- throwing their workers into the unemployment line.

Which brings me to the point: Just as taxes on new boats kill demand for new boats, taxes on savings lead Americans to save less. Go ahead, try to squirrel away a few dollars for a rainy day (or a sunny day in Florida or Arizona when you retire). The government will thwart you at every turn, taxing your savings more heavily than just about anything else in the economy.

Think about it: Assume you take $1,000 and put it in a certificate of deposit earning 5 percent. After one year, you've earned $50. Now, you already paid steep federal income taxes on that original $1,000 (between 15 percent and 39 percent) when you earned it. But that's not enough. The government taxes your modest $50 gain too, leaving only $30.50 in your pocket if you're in the highest tax bracket.

Welcome to the tax code: You're taxed when you work for your money, and you're taxed again when your money works for you. It's one of the worst features of our tax system, taxing people twice on money they're trying to save.

About the only way to get some relief from this double tax burden is through Individual Retirement Accounts (IRAs), which let you sock away a few dollars and have the money earn interest tax-free.

But IRAs have their limits, the worst being that the government only lets you contribute $2,000 per year. The government also slaps you with a steep penalty if you withdraw the money before Uncle Sam says you can (currently age 59-and-a-half), so forget about using the money to buy a home or cope with a financial emergency. And don't think you can pass the money in your IRA on to your children without going another few rounds with the tax man. The government forces you to start withdrawing the money at age 70-and-a-half so it can collect income taxes again. Then when you die, the money falls prey to estate taxes and, when your children finally receive what's leftover, inheritance taxes.

Alas, that's Washington: It takes a good idea like saving money -- which provides the capital to grow the economy and create jobs -- and piles on so many regulations, penalties, and layers of taxation that saving hardly becomes worth the effort. If there's so little reward for thriftiness, why not spend, spend, spend?

There's a better way. A proposal by Tom Kelly, president of the Savers & Investors League of Villanova, Pa., would eliminate the red tape and double taxation that makes saving so hard. IRAs? In Kelly's view, they're at best a good start. He proposes Individual Investment Accounts, a more muscular savings tool that would let you deposit as much of your money as you want tax free (no $2,000 limit), withdraw it for any purpose (hello new house), withdraw it at any age (early retirement anyone?), and let you pass it on to your children with no inheritance or estate taxes (sorry Uncle Sam, my kids come first).

It's not a hard concept to grasp: If you want people to save more, you have to tax their savings less. So no more preaching from politicians about our low national savings rate until they do for savers what they've already done for yacht buyers.

Note: Edwin J. Feulner, Ph.D. is president of The Heritage Foundation, a Washington-based public policy research institute.

About the Author

Edwin J. Feulner, Ph.D. Founder, Chairman of the Asian Studies Center, and Chung Ju-yung Fellow
Founder's Office