Wealth, Savings, and Behavior

Recent research suggests that people differ greatly in their willingness to save, and that this helps determine their position in the class structure of wealth. As Thomas Stanley and William Danko put it in the popular bestseller The Millionaire Next Door, "ordinary people can become wealthy." They can do so by adopting a frugal lifestyle that provides ample room for saving for retirement.

Last month, Hal Varian argued that too many people rely on Social Security instead of saving for retirement. In his column, he reported on research by Stephen F. Venti and David A. Wise on saving behavior. What Venti and Wise found is that there are high-income people with very little in savings, and vice-versa.

They concluded that most of the observed variation in retirement wealth is primarily a result of different propensities to save.

If ordinary people can become wealthy by saving, then one policy implication is that people should be encouraged to save. Today's New York Times has an article suggesting that many people need to be tricked into saving. For example, people who will not contribute to an IRA now might be willing to commit to contribute their next raise to an IRA.

A less subtle way to encourage saving would be to reduce the tax burden on people who save. Along those lines, many economists favor moving away from an income tax and toward a tax only on consumption. Income that people devote to saving would not be taxed.

Discussion Question. If we abolished the income tax and replaced it with a consumption tax, then people who save would get rich and yet have much of their income exempt from taxes. Is that a cause for concern?