The Tax Laws Should Be Reformed to Encourage Saving
THE TAX LAWS SHOULD BE REFORMED TO ENCOURAGE SAVING
A nation’s saving rate is a key determinant of its long-run economic prosperity. When the saving rate is higher, more resources are available for investment in new plant and equipment. A larger stock of plant and equipment, in turn, raises labor productivity, wages, and incomes. It is, therefore, no surprise that international data show a strong correlation between national saving rates and measures of economic well-being. If a nation’s laws make saving attractive, people will save a higher fraction of their incomes, and this higher saving will lead to a more prosperous future. Unfortunately, the U.S. tax system discourages saving by taxing the return to saving quite heavily. For example, consider a 25-year-old worker who saves $1,000 of her income to have a more comfortable retirement at the age of 70. If she buys a bond that pays an interest rate of 10 percent, the $1,000 will accumulate at the end of 45 years to $72,900 in the absence of taxes on interest. But suppose she faces a marginal tax rate on interest income of 40 percent, which is typical of many workers once federal and state income taxes are added together. In this case, her after-tax interest rate is only 6 percent, and the $1,000 will accumulate at the end of 45 years to only $13,800. That is, accumulated over this long span of time, the tax rate on interest income reduces the benefit of saving $1,000 from $72,900 to $13,800 or by about 80 percent.
The tax code further discourages saving by taxing some forms of capital income twice. Suppose a person uses some of his saving to buy stock in a corporation. When the corporation earns a profit from its capital investments, it first pays tax on this profit in the form of the corporate income tax. If the corporation pays out the rest of the profit to the stockholder in the form of dividends, the stockholder pays tax on this income a second time in the form of the individual income tax. This double
A nation’s saving rate is a key determinant of its long-run economic prosperity. When the saving rate is higher, more resources are available for investment in new plant and equipment. A larger stock of plant and equipment, in turn, raises labor productivity, wages, and incomes. It is, therefore, no surprise that international data show a strong correlation between national saving rates and measures of economic well-being. If a nation’s laws make saving attractive, people will save a higher fraction of their incomes, and this higher saving will lead to a more prosperous future. Unfortunately, the U.S. tax system discourages saving by taxing the return to saving quite heavily. For example, consider a 25-year-old worker who saves $1,000 of her income to have a more comfortable retirement at the age of 70. If she buys a bond that pays an interest rate of 10 percent, the $1,000 will accumulate at the end of 45 years to $72,900 in the absence of taxes on interest. But suppose she faces a marginal tax rate on interest income of 40 percent, which is typical of many workers once federal and state income taxes are added together. In this case, her after-tax interest rate is only 6 percent, and the $1,000 will accumulate at the end of 45 years to only $13,800. That is, accumulated over this long span of time, the tax rate on interest income reduces the benefit of saving $1,000 from $72,900 to $13,800 or by about 80 percent.
The tax code further discourages saving by taxing some forms of capital income twice. Suppose a person uses some of his saving to buy stock in a corporation. When the corporation earns a profit from its capital investments, it first pays tax on this profit in the form of the corporate income tax. If the corporation pays out the rest of the profit to the stockholder in the form of dividends, the stockholder pays tax on this income a second time in the form of the individual income tax. This double