Easing the Tax Squeeze on Savers

By Christopher Byron

It needs to be done, but the question is how

Has inflation turned the U.S. into a nation of spendthrifts? And if so, is the tax-cut package that Ronald Reagan has placed before Congress the proper medicine to cure America's wastrel malaise? Those are some of the questions Congress now faces as it passes judgment on President Reagan's economic program.

Economists generally agree that the level of savings in the U.S. is now too low. Greater savings would provide needed capital for firms to modernize equipment or build new plants. That would both help fight inflation and make American products more competitive in world trade. But as inflation has roared ahead in recent years, consumers have chosen to spend money on products that they believe will shortly be more expensive rather than save funds that will soon have less buying power. In 1975 Americans salted away 8.6% of their earnings in bank accounts, pension funds, stocks, bonds or other savings. Now they put aside only 4.7% of earnings. Savings have also been discouraged because as much as 70% of interest earned on investments can be taxed away by the Government.

Americans both save less and are taxed more on their investment income than are citizens of most other advanced countries. The savings rate in West Germany, for example, is 13.5%, while in Japan it is 19.5%. The nation with the highest level of savings is Italy, where 24.5% of earnings go into investment. A study published earlier this year by the accounting firm of Price Waterhouse showed that the tax rate on savings in the U.S. is the second highest among leading industrial nations, after Sweden. In the middle-income brackets, the U.S. rate is often about twice that paid on investment income in Britain or Japan. In West Germany and France, an investor usually pays no taxes at all on interest and can even receive a small tax credit that may be used against his regular income.

Just as important as the amount of a country's savings is the composition of savings. Money invested in a house is good for the housing industry, but it does not do much to improve productivity. Such currently fashionable investments as Krugerrands, rare stamps and antiques provide no benefits at all for economic growth. By contrast, money put in a stock, bond or bank account swells the pool of financial capital available to business. As investment money becomes more plentiful, interest rates decline, investment picks up and real wealth begins to increase for the nation as a whole.

Although most economists and politicians agree on the need for greater savings, they are sharply divided about the best way to spur savers. The Reagan Administration has made the Kemp-Roth bill, which would cut personal income tax rates by 30% over the next three years, the basis for its tax bill. Pointing to the experience after the two-year, 18% reduction in income tax rates during the mid-1960s, when the savings rate rose from 5.4% to 8.1%, the Reaganauts argue that Americans would put a large amount of the money from any tax cut into savings. Treasury Secretary Donald Regan points to a new survey by the U.S. Chamber of Commerce that shows that 82% of taxpayers would use at least some of the money from a tax reduction either for savings or to repay debts. Many of those polled said they would save at least half the money.

Critics of the Reagan proposal, however, doubt that this would occur. They argue that consumers are more likely to spend the money provided by the tax cut, thus encouraging more demand in the economy and fueling inflation. Says Stanford University Economist Michael Boskin, one of the earliest supporters of supply-side economics: "The President's tax cut will simply not have a large impact on savings. The bulk of the effect will be to increase spending." Adds Democratic Economist Lester Thurow of M.I.T.: "The Reagan tax cut is simply not supply-side economics. Only about 6% of it would be saved at all, and we simply cannot afford to waste $94 out of every $100."

Many economists are urging a package of more precisely focused tax changes that would give direct incentives to savers. There are now more than 100 different bills before Congress that are armed at stimulating savings and investment. Some of the leading alternatives to the Reagan program:

Interest Exclusions. Beginning this year, Americans do not pay any tax on up to $200 per year ($400 for a joint tax return) on income from savings account interest and stock dividends. But much of such income is paid to people who already receive more than $200 in interest income yearly. To encourage these people to save more, bills in the House would exclude up to $10,000 of interest and dividend income for individuals and even unlimited amounts for elderly taxpayers. Senator Harrison Schmitt of New Mexico has introduced a bill that would exempt the first 25% of interest or dividend income up to $50,000 a year per taxpayer. That would cost the Treasury up to $26 billion in cumulative lost tax revenue by 1986 but might boost savings by about $27 billion.

Interest Tax Reductions. At present the maximum tax rate on earned income is 50%. But income from savings and investments can be taxed up to a maximum of 70% for people with taxable incomes of $108,300 a year. House Ways and Means Committee Chairman Dan Rostenkowski of Illinois has proposed reducing the maximum tax rate on investment income to the same 50% that applies to salary income. Several bills now in Congress recommend a so-called two-stack approach to the taxation of earned and unearned income: tax each at the prevailing rates for earned income, up to a top bracket of 50%. The net effect would be to lower the tax on investment income sharply, but at a cost to the Treasury of $17 billion.

Interest Tax Deferrals. At present, self-employed taxpayers who want to set up a retirement pension fund can put as much as 15% of earned income, up to a maximum of $7,500 yearly, into a tax-free savings account. Individual Retirement Accounts, or IRAS, offer a more modest $1,500 yearly in tax-deferred savings for workers employed by firms that do not have their own pension programs. Congress is now looking into ways to broaden the tax-free accounts or make them available to more people. Bills would eliminate the 15% ceiling, lift the maximum amount to $15,000 yearly and open accounts to taxpayers already covered by pension plans. Variations would allow tax-deferred accounts for contributions to pay for a child's education, or to buy a first house. Senator John Chafee of Rhode Island proposes a super-account for retirement, housing and education all rolled into one. Cost: $2.8 billion in the first year.

The Reagan Administration opposes these specifically targeted savings incentive proposals on the grounds that they would create distortions by giving incentives to some sectors of the economy and not to others. Said Assistant Treasury Secretary for Economic Policy Paul Roberts: "Our approach does not introduce the distortions that targeted schemes create. Any economic group that is left out would be penalized, whereas those that get included would benefit unfairly."

No matter what the ultimate shape of a plan to spur savers, there seems little doubt that the tax bill will cost the Treasury more in lost revenue than the U.S. would gain in increased savings, at least for the first couple of years. Yet it is equally clear that some sort of income tax cut is essential, no matter how much it costs at the start. The economy is now groaning under the heaviest peacetime tax burden in history, and a return to sustained growth seems impossible if the burden continues to mount.

Social Security taxes have already risen 34% since 1979 and will increase 49% more in the next three years. Meanwhile, taxpayers are being hurt by so-called bracket creep, which keeps pushing them into higher tax categories as their inflation-bloated paychecks increase. Without a reduction in those rates, millions may soon find themselves paying the top 50% rate, which was originally intended for only the nation's wealthiest taxpayers. Congressional leaders and the Administration need to find a plan that will both lessen the tax burden and improve the climate for savings in the U.S. -- By Christopher Byron.

Reported by Gisela Bolte/ Washington, with other U.S. bureaus

With reporting by Gisela Bolte, U.S. bureaus

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