Incentives For Saving Versus Giveaways to Rich People

Annie Lowrey has a tour de horizon piece about the tax cut debate that highlights the conservative incoherence on the subject. As she observes, many tax cutters are proposing tax cuts for the richest two percent of Americans as effective demand-side stimulus, even though it’s one of the least-stimulative deficit-increasing measures out there. Then she notes that other proponents make the reverse argument:

Nevertheless, some Republicans argue that the money the rich save would still have a positive economic impact. Speaking on the Senate floor yesterday, Sen. Jon Kyl (R-Ariz.), for instance, noted that people do not save money by burying it in their backyard. “Any person who saves money either puts in the bank…or they invest in a stock or a bond, equities usually,” he said. “Well, what is that investment [doing]? It is providing capital to business.”

This is true over the long-term, but the government can’t increase the savings rate by borrowing money.

The tragedy here is that if the Kyls of the world were willing to calm down for a minute and perhaps reduce their fanatical commitment to the financial interests of rich people, it ought to be possible to find a broadly acceptable path to his goal. I’m prepared to concede that a more pro-saving tax code would boost long-term term growth. You could, for example, eliminate the current patchwork of tax incentives for savings and simply make all saving tax deductible. That would incentivize savings, but it would create two problems. One is that it would deprive the government of a lot of revenue, and the other is that it would be regressive. The solution would be to then raise tax rates on high earners and make the rate structure more progressive by adding several additional brackets at the high end. Unlike the policy Kyl is pushing, this would actually increase savings and unlike the policy Kyl is pushing, it wouldn’t be a huge giveaway to rich people. Whether Kyl would deem that a favor or a bug is hard to say.

Moving to a consumption tax base would have an additional benefit of making discretionary fiscal policy much more workable. The thing that politicians are most inclined to do in terms of fiscal policy is cut taxes. But tax cuts don’t actually work very well as stimulus. Except they would work well if the only thing being taxed was consumption. In that case, 100 percent of the fiscal impact of temporary tax cuts would take the form of a temporary boost in aggregate demand.