Saving Incentives: What May Work, What May Not

Publication Date: June 2006

Publisher: Library of Congress. Congressional Research Service

Author(s):

Research Area: Banking and finance

Type:

Abstract:

Saving is the portion of national output that is not consumed and represents resources that can be used to increase, replace, or improve the nation's capital stock. The U.S. net national saving rate reached a post-war peak of 12.4% in 1965 and has then trended downward since to a low of 0.8% in 2005. Many analysts claim that saving is too low. Among the Organization for Economic Cooperation and Development (OECD) countries, the United States has the third lowest saving rate.

Survey evidence suggests that people know why they should save, but many don't save, especially lower-income individuals and families. Several reasons have been offered to explain the declining personal saving rate and the relatively high proportion of individuals and families that do not save. Economic reasons start from the premise that individuals and families are rational and make optimal decisions about consumption and saving throughout the life course. Low saving rates are then explained by economic disincentives induced by government policy or by life cycle changes in the propensity to save. Behavioral reasons start from the premise that individuals and families do not always make optimal decisions regarding consumption and saving.

The government offers tax incentives to individuals and families to save. The empirical evidence on the relationship of tax incentives to the saving rate mostly comes from examinations of traditional individual retirement accounts (IRAs) and 401(k) plans. The reported results are mixed, but generally indicate small effects. Be that as it may, the tax incentives tend to benefit higher-income individuals and families to a much greater extent than lower-income individuals and families. The primary reasons are (1) higher-income individuals are much more likely to save, and (2) higher-income individuals face higher marginal tax rates and benefit more from sheltering income from taxation.

Furthermore, the tax revenue loss for these incentives lower public saving by reducing the budget surplus or increasing the budget deficit. For FY2006, these tax incentives are estimated to cost the U.S. Treasury $125.6 billion in forgone tax revenues -- almost 40% of the estimated FY2006 budget deficit. The Bush Administration and the President's Advisory Panel on Federal Tax Reform have advocated expanding tax incentives as the primary policy to encourage personal saving. Research has shown that personal saving has been fairly unresponsive to tax incentives, however, and such incentives may substantially decrease public saving (that is, increase the budget deficit). The long-term net effect on national saving and economic growth is likely negative.

This report contains historical data and will not be updated.