Taxes, Saving, and Macroeconomics

By Buchanan, Neil H. | Journal of Economic Issues, March 1999 | Go to article overview

Taxes, Saving, and Macroeconomics

Buchanan, Neil H., Journal of Economic Issues

[To institute tax incentives] on the assumption that they will have commensurate effects in increasing investment must . . . rest essentially on faith. Faith is indeed sometimes rewarded. But for our part, in this instance, we remain agnostic.

- Robert Chirinko and Robert Eisner, 1983

Proposals for tax reform have been part of the American political landscape for as long as there have been taxes. However, with the Republican party majority having taken over both houses of Congress in 1995, a serious political movement arose to reform the tax system in a much more radical way by "tearing the current system out by its roots," in the words of U.S. Representative Bill Archer. The general idea is that we should replace the current income tax-based system with one of a variety of systems intended to raise the U.S. economy's long-term growth rate through encouragement of saving. Saving, it is claimed, leads to higher investment, productivity, international competitiveness, and long-term economic growth.

As radical as the political rhetoric has been, the basic economic reasoning behind these plans is anything but new. Neoclassical economists have been calling for ways to increase saving for decades. Even 50 years ago, James Tobin [1949] could reasonably describe such efforts as having "a long history." Moreover, politicians have taken this advice to heart. While the United States, along with every other industrialized country, continues to use an income tax system, inducements to saving have always been a politically popular part of the tax code (a fuller discussion of which is provided below). As is so often the case, therefore, everything old in politics is new again. There is another saving "crisis," and the tax code can set everything right.

Most analyses of the various proposals to date (including the so-called Flat Tax, a national sales tax, the "USATax," etc.) have concentrated on the distributional impact of the plans, along familiar lines of progressivity and regressivity. Surprisingly little critical attention has been paid to the macroeconomic implications of these tax reform plans, particularly to the claims about saving. This essay will offer such an analysis by reviewing recent work on causal relationships crucial to the political arguments of those who favor changing the tax code as a way to increase saving. I will also review arguments well known to most readers of this journal that are too often overlooked in public discussion.

Saving in the United States

It would be difficult to find more agreement about the desired direction of a non-policy variable than the rate of saving in the United States. Virtually everyone with an opinion on the subject seems absolutely certain that saving is currently too low and needs to go up if the future is to be saved (no pun intended). The very repetition of this conclusion, moreover, creates its own legitimacy, causing those without a well-thought-out opinion on the issue to adopt it as a default and intimidating those who would dare to question this obvious "truth."

Since the concept of "saving" is often defined in inconsistent and contradictory ways, it is useful and important to look at alternative definitions of the term and to examine the trends in various measures of saving in the U.S. economy. Among other things, this investigation will show that the most inclusive and macroeconomically important saving rates are not moving downward.

Of course, institutionalists have long known that the concept of saving is broadly misunderstood. Several good examples of institutionalist critiques of the mainstream approach to saving and fiscal policy have appeared in this journal. The interested reader should consult Walter C. Neale [1991] and L. Randall Wray [1989, 1992].

Difficulties in Defining Consumption and Saving

In discussions of an economy's rate of saving, it is common to emphasize the rate of personal saving - the ratio of take-home pay not spent on goods and services to total take-home pay. …

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