Simple explanations of complicated phenomena are attractive but often dangerous. A guest on a late-night interview show drove that home for me recently. Jim Rogers, a successful investor and foreign exchange speculator, expounded on global economic conditions and plugged his book, arguing that anyone can get wealthy in commodity speculation.
Much of Rogers’ evaluation of the economic situation made sense. The author of “Hot Commodities: How Anyone Can Invest Profitably in the World’s Best Market” said that declining value of the U.S. dollar signaled more fundamental underlying economic problems. I agreed. The administration was far too casual about borrowing a trillion dollars from the rest of the world every 22 months or so. Certainly.
The longer it takes for an adjustment to occur, the more traumatic it will be, he said. Absolutely. A low national savings rate was one of the root causes. Of course. The reason we have a low savings rate is that our income and estate taxes punish savings and investment. Whoa, wait a minute.
Rogers was correct on one level. Taxes create incentives. Taxes on interest and dividend income reduce the incentive to buy bonds or stocks just as taxes on wages reduce the incentive to work. A tax on estates at death reduces incentives to amass a large net worth (although it also motivates transferring wealth to the next generation before death).
If he simply had argued that our tax system contained some disincentives to savings and that these were part of a larger problem, I would have continued nodding in agreement. His argument, however, seemed to be that tax disincentives were the only cause, an obvious no-brainer that prudent citizens should set aright.
The historian in me reacted strongly. The U.S. savings rate has declined erratically for three decades. In the 1950s and 1960s, we had far higher income tax rates than now on interest, dividends and capital gains. Yet we saved a higher proportion of our national income then.
Before changes in the late 1970s, the federal estate tax hit much smaller estates. A substantially higher proportion of all estates paid some tax. Moreover, many states still imposed state inheritance or estate taxes.
From the Eisenhower administration until now, taxation of investment income has dropped, but so have national savings rates. From the 1970s to now, effective levels of death taxes also shrank, but so have savings rates. Reagan era cuts in taxation from all sources and more recent reductions in tax rates for capital gains and dividends have not caused measurable increases in household savings.
One way to raise national savings would be to cut the federal budget deficit. Doing so involves raising taxes, if not on capital income then on labor income or consumption.
Raising private level savings might include changing tax provisions, but much more is involved. Simplistic explanations of complex problems are seductive and self-destructive.
© 2005 Edward Lotterman
Chanarambie Consulting, Inc.