For
the first time since the Great Depression, the U.S.
personal savings rate has "
gone
negative." In 2005 and 2006, U.S. citizens spent
more than they made. Economists disagree about just how
ominous this is, but they generally agree on why it's
happening. Americans are "overspending."
Why are we
doing this? Partly because we're acquisitive consumers
obsessed with instant gratification and toys. Partly
because soaring real-estate and stock markets make us
feel rich. But also partly because we're not suckers.
Perverse tax laws for investments discourage saving, so
it's no surprise we spend.
If I said to you, "You can have $10,000 to spend
now—or $9,500 to spend in 10 years," which would you
choose? Probably the $10,000 now. And in doing so, you
would be making the same choice many Americans make when
deciding whether to save or spend their hard-earned
cash.
The problem is how we tax investment gains. Over the
past 80 years, the average annual return on Treasury
bills (a proxy for savings accounts) has been 3.7
percent per year. Inflation, meanwhile, has averaged 3.1
percent per year. This combination has produced a "real
return" of a paltry 0.6 percent per year. If you got to
keep that 0.6 percent, you might still have an incentive
to save: A $616 real gain on $10,000 in 10 years
wouldn't be much, but it would at least be $616 more
than you have now. Unless you're so poor that you're
exempt from taxes, however, or so flush that you can
afford to lock up cash for decades in a tax-deferred
annuity or retirement account, you won't be keeping that
0.6 percent. You'll be giving all of it—and probably
more—to the government.
How does the math work? Let's say your T-bills return
3.7 percent. If you stash $10,000, you'll make $370
before taxes and inflation in the first year. Taxes are
assessed on the nominal gain (before adjusting
for inflation) instead of the real gain, so if
you're in the 15 percent tax bracket, you'll then pay
$56 to the government—and lose about $310 of value to
inflation. In other words, you'll eke out about a $5
real gain on a $10,000 investment (an 0.05 percent
return). If you're in higher brackets, meanwhile, you'll
actually lose about 0.5 percent of value every
year. The only time you'll generate real gains is when
"real" rates of return are significantly higher than 0.6
percent (as they are now). But when real rates are
negative, as they were a few years ago, you'll be losing
a lot more than 0.5 percent per year.
Fine, you say. T-bills are for chumps. Stocks provide
a far better long-term return, and—if you don't
trade like
Jim Cramer—they're more tax efficient: Hold your
stocks for more than a year, and you'll pay only
long-term capital gains tax, not income tax. And you'll
get sweetheart rates on dividends, too.
If your time horizon is long enough, this is true.
Unlike T-bills or bank accounts, stocks compound tax
free, so you won't owe tax until you sell them (except,
again, on the dividends). Yet even stocks aren't ideal
for savings. For one thing, there are those annoying
bear markets: The S&P 500 is still below where it was
seven years ago, even before adjusting for inflation.
Then there are dividend taxes: In the 20th
century, nearly half of the average 10 percent annual
return on U.S. stocks came from dividends, not price
appreciation, and you pay taxes on dividends every year.
Lastly, there's the absurd way that the IRS accounts for
"realized gains." Once you're in the black on a stock or
fund, current tax policy forces you to stick with it—or
get socked with a capital-gains tax bill. In other
words, even if your stock's best gains are behind it, if
you switch to a better stock, it might be years after
paying your tax bill before you get back to even.
Can you reduce savings taxes? Yes, if you're skilled
and well-informed, you can "harvest losses," buy
"tax-managed" funds, and implement other
tax-minimization strategies. Doing so will usually
consume money and time, however, and be a major
headache. And you'll still have the bear-market problem:
Unless you're in your 20s or 30s and saving for
retirement, stocks are too risky to represent your
entire portfolio. So, given current tax policy, it's no
wonder we're not saving anything.
How could we fix this?
For starters, we could do the same thing for regular
savers as we do for real-estate investors: Change the
definition of a "realized gain." Real-estate investors
can take advantage of a "1031 Exchange," which allows
them to take gains from the sale of one property and
reinvest them in another without triggering a tax event.
The same system should apply to other investments: If
you own a stock or fund that has doubled, you shouldn't
be forced to hang onto it just to avoid triggering a
taxable gain. Instead, you should be able to sell it and
invest the proceeds in another stock or fund. Gains
should only be "realized" when you take the money out of
your investment account and spend it.
Second, to avoid encouraging too much risk-taking, we
should treat interest earned in long-term savings
accounts as capital gains, not income. This would remove
the tax-disadvantages associated with owning safe,
income-generating assets as compared to more volatile
stocks.
Third, if we really want to encourage
saving, we should make long-term savings tax exempt.
Even today's retirement vehicles are only tax-deferred:
Your money compounds tax-free, but then you have to fork
over income tax on withdrawals (neutralizing much of the
advantage). Tax-exempt savings accounts don't sound so
radical, but when the Bush administration proposed them
back in 2003, the insurance industry went nuts: Such
accounts might reduce demand for expensive tax-deferred
annuities! There were also protests that such accounts
would disproportionately benefit those who could afford
to save—an issue that could easily be addressed through
limited per-year contributions or regular tax rates
above a certain level of earnings. In any case, the
"Lifetime Savings Accounts" idea now seems to be dead.
So, what our current tax code is saying is, "Don't be
a sucker: Spend every dime." And as the personal-savings
figures show, that's just what we're doing.
