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Executive Summary #1185es on Political Thought

June 2, 1998

June 2, 1998 | Executive Summary on Political Thought

BG1185es: How Government Policies Discourage Savings

There is a strong case to be made that the overall savings rate in America is too low, and policymakers are justifiably concerned. Savings are the key to capital formation, and every economic
theory--including Marxism--teaches that capital formation is necessary to raise wage levels and create long-term economic growth.

Some believe America's low savings rate is the fault of shortsighted individuals and businesses. In reality, however, the primary culprit is misguided government policy. Specifically, the combined effects of the tax code and various government spending programs discourage savings and depress the savings rate. For instance:

  • The tax code, by imposing multiple layers of taxation on capital, reduces the incentives for consumers and businesses to save and invest. As the chart below shows, this treatment
    creates a bias toward consumption.

  • Government programs, especially Social Security, eliminate or reduce many of the traditional reasons that motivate households to save.

American consumers and businesses are not being foolish and shortsighted in choosing to spend rather than save for the future. The nation's low savings rate is a logical response to the perverse incentives not to save that have been created by politicians. If anything, it is a tribute to the American people that the overall savings rate is not even lower. Instead of blaming others, lawmakers who want to boost the savings rate should work to change policies that discourage savings. In particular, Americans would save more if legislators were to:

  • Eliminate the bias against savings in the tax code, preferably by scrapping the Internal Revenue Code and replacing it with a simple and fair flat tax. A flat tax would eliminate the present system's multiple taxation of capital.

  • Replace the bankrupt, low-return Social Security system with a system that allows individuals to build up nest eggs in privately managed accounts. If Australia, Britain, Chile, Hungary, and Mexico can do it successfully, so can the United States. For example, private savings accounts in Australia already contain more than AUS$300 billion in assets.

  • Reform health care entitlements and other government spending programs that weaken incentives for individuals to plan for and control their own lives by saving for the future.

America is not suffering from a savings crisis, but the savings rate certainly could be higher. The way to increase savings is to fix government policies that penalize savings and remove the incentives to save.

Daniel J. Mitchell, Ph.D., is McKenna Senior Fellow in Political Economy at The Heritage Foundation.

About the Author

Daniel J. Mitchell, Ph.D. McKenna Senior Fellow in Political Economy

Related Issues: Political Thought