In a related vein think tanker Reid Cramer urges some reforms to encourage increased saving as a means of boosting the economy:
One approach is to take advantage of recent work in the field of behavioral economics, which has shown that saving works best when it happens automatically. Studies show that many more employees will participate in a 401(k) if they are automatically enrolled and given the choice to opt out than if they must make the affirmative effort to sign up themselves.
There is much promise in having savings deposits deducted from paychecks as a matter of course, as they are under 401(k) plans. Such a policy, call it AutoSave, would strategically build on inertia, which, it turns out, is one of the most powerful forces in the universe, along with compound interest. Unfortunately, only about half the workforce currently takes advantage of 401(k) plans with these automatic features, mainly because their employers do not offer them. The Obama administration has proposed remedying this by providing all workers access to a central clearinghouse of savings plans that they could access. It is certainly a step in the right direction, but we should also think more boldly.
What if, for example, the federal government established an account for every American, including children? These lifetime savings accounts could even be started at birth, so children would already have their own account when they reach school age and are ready to learn the value of savings and the basics of financial education.
Working adults could have a small portion of their paychecks, tax returns, and other government payments automatically deposited in these accounts and invested safely. People could always opt out and make withdrawals from their accounts, (with perhaps some funds locked away for special purposes such as education or retirement), but they would have to overcome the natural inertia of human nature to do so.
There are substantial disincentives to saving. Taxation of interest, rising bank fees, and inflation all eat away at savings. If the federal government wanted to encourage individual savings they could just eliminate or reduce taxation on dividends and interest.
There are priorities at stake here and more government revenue and more government spending is clearly a higher priority for lawmakers of both parties than spending has been and, well, we’re paying the price for that now.
I would certainly be willing to support such a plan as a replacement for Social Security.
Why doesn’t anyone talk about progressive dividend / interest taxation? It encourages saving for those that need to do it (well, discourages it less anyway), while not being a complete giveaway for the rich. Even if you could open a tax free savings account for anything (not just retirement and education), a lot of people wouldn’t find the time to do it – and would tend to withdraw and spend it anyway on a job change if they were automatically enrolled. What about exempting the first 10 or 20k of dividend and interest income for instance? It’d also take a ton of hassle out of filing returns; I spend at least 2 hours adding up 50 bucks here and there from several interest-bearing accounts to pay a grand total of maybe $50 more in tax. It would be way more efficient if only people with significant dividend incomes had to report it.
No matter how you cut it reducing taxes on dividends will primarily benefit “the rich”. Half of all taxpayers have no dividend income. The top two quintiles account for almost all of the dividend income.
Conceivably that would change over time when disincentives are removed, no?
You can’t save what you don’t have.
Right now, nothing outside of tax deferred or tax free accounts beats the guaranteed 6% I get from paying my house off early* in terms of risk/reward. Not having to pay tax on a dividend from a fund even if the stupid thing is losing money could make me rethink that strategy.
Also, not being in the bottom 3 quintiles does not exempt you from being a member of “needing to save more”.
* Is home equity in the savings rate?
I would note that providing tax advantages to interest and dividends alone would be great for banks and for publicly traded corporations but might discourage investment in partnerships or closely held corporations.
Here’s an idea that I’ve been batting around–why not keep the same progressive tax rates that we have now, only we separate income earned on W-2 from other income and don’t add them up? In other words, we would use tax brackets for the W-2 income and figue the taxes on W-2 income, then add up the other income and use the tax brackets on that total:
For example:
Under the current system, let’s say that someone had 50,000 in taxable income, as follows:
35,000 – income from employment
10,000 – freelance project work
2,000 – dividends
1,500 – partnership income from brother’s restaurant
500 – interest
Assuming that the above has already accounted for deductions and credits, the total tax this person would owe is $8,687.25 (8,350 * .10 + 25,600 * .15 + 16,049 * .25). Under my system, the total tax owed would be $6,770 (8350 * .10 + 25600 * .15 + 1050 * .25 + 8350 * .10 + 6650 * .15). That’s a tax savings of $1917.25.
The nice thing about this is that for the already wealthy, this produces a tax savings on the margins but not much, but for folks in the working and middle classes trying to save a little extra or to start a side business, there’s a terrific incentive to do so. And the nice thing is that this doesn’t complicate the tax forms at all–you’ll just have two “incomes” that get subjected to marginal rates, but you’ll still enter all the same information.
I’ve been kicking this around so I’m sure there’s flaws I haven’t thought of. Any thoughts?
Why is freelance project work treated separately from wages?
PD – To encourage enterpeneurship and independence. A lot of people who start their own business start it part time, on the side from their primary form of income.
Around here, firemen and state workers would love it.
Dave’s “dividend” link appears to indicate that the median tax filer reports $15 in interest income (and it’s zero for single filers). I like the idea of helping lower and middle class people save, but I’m very skeptical that anything the tax code could offer would provide incentives for drastic change. I also note, that lower and middle class people are forced to save for retirement through payroll taxes of either 6.2% of income or twice that, depending on how you count it.
Alex –
Whacking up personal income by the title we place on the various forms of income such that overall income is taxed at a lower marginal rate is wonderful, but as a practical matter I’d suggest its almost no different than reducing taxes on interest and dividends.
Yours is a fairly stylized example. As a practical matter most people have either employment income or 1099/K-1 income, plus interest and dividends. I think your proposal is great in theory, but perhaps of little practicality.
I also wonder how many people would suddenly show up with tax reducing 1099’s and K-1 income.
But as Milton Friedman once said: they are so rare, I’m for a tax reduction at any time and in any form offered.
“But as Milton Friedman once said: they are so rare, I’m for a tax reduction at any time and in any form offered.”
Even when our debt keeps increasing. Part of our problem.
Steve
Steve –
Even as our spending outpaces the usual rationale: inflation and population growth…………and yet never cures the problems said spending is supposed to cure: say, the 1965 “War on Poverty.”
You, and your tolerance of ineffective spending are the problem. Its simply an empirical fact.
My tolerance? Tell me who to vote for who will cut spending. Please back it up with evidence, which of course excludes our two major parties. I see two parties who spend too much, so I concentrate on getting the best value for money spent. That is really how most of us function anyway.
Steve
With interest rates so low, simple saving is a losing proposition, even assuming people are willing to save.
I think what’s really needed is a cultural shift toward thriftyness, which is something I don’t see happening long-term.