Wednesday, January 09, 2008

The Fair Tax and the National Savings Rate

The national savings rate in the United States is zero, or even negative. It is a large reason why the credit crunch and the housing market collapse have the potential to hurt the American economy so greatly - Americans haven't saved and thus have no safety net. Rising inflation in the United States contributes to a disincentive to save, as does America's culture of consumerism. Additionally, the Federal Reserve faces pressure, and indeed has bowed to pressure, to lower interest rates in order to stimulate America's economy, further reducing the incentive to save. A healthy savings rate is crucial, especially for an economy that faces a growing fraction of workers who will soon pass their peak earning years and approach retirement, as does the United States. Savings allow investment, which sparks long-term growth and economic health. How can America increase its savings rate in face of growing incentives to do just the opposite?

Mike Huckabee's Fair Tax is purported to be a fix-all solution to America's economic woes - it is said to increase the savings rate, simplify America's tax code, bolster the competitiveness of domestic goods and allow for more economic freedom. It will indeed help America's dismal savings rate. The Fair Tax is a flat sales tax that would replace the income tax - in effect, such a tax would provide an incentive to consume less and save more. Such is perhaps the Fair Tax's most redeemable quality - it almost makes the Fair Tax worthwhile. The tax however, has numerous disadvantages: it will indubitably lead to tax evasion and higher unemployment, it is inherently regressive, it stunts international trade by its system of rebates, it would require huge administrative effort and cost and will result in endless political bickering, and perhaps most importantly, it is not politically feasible in the United States. So if not the Fair Tax, then what?

The most effective explicit tool in manipulating the savings rate is the interest rate set by the Federal Reserve. A higher interest rate yields higher savings. Unfortunately the interest rate is likely to be lowered further in response to continuing economic concerns and slowdown - although a higher interest rate promotes more savings, a lower interest rate does promote growth, which is also needed. The interest rate, however, is not the most healthy means by which savings should be encouraged. A culture of savings must arise in America, not simply savings dictated by the will of the Fed chairman. In order to accomplish this, systemic changes must occur.

Americans' savings rate probably decreased over the past 10 years as a result of their increasing economic well-being, in addition to low interest rates. Not only did Americans take money out of savings and place it in the stock market and treasury bonds, they also simply consumed more, thinking that considering America's economic success (and especially the increasing value of their homes, which they could borrow against more and more easily), they were economically secure and did not have to allow as much for future "rainy days." In light of America's recent economic woes, savings will in all liklihood increase, but changes must still be made to ensure that higher rates of saving become permanent, not just reactionary.

There are a few ways that a higher savings rate can be encouraged - in my opinion, tax reforms that encourage saving by shifting the tax base towards consumption are most beneficial. This, of course, invokes Huckabee's Fair Tax - but a value added tax, coupled with lowered but more even more progressive income taxation, is a far better solution.


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