Arnold Kling  

Trade Deficit, Saving, and Tax Policy

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Prosecute Rent-Seekers?... New Energy Legislation...

I argue that our trade deficit is really a savings deficit.


Increasing exports relative to imports is not a matter of beating up on China to live up to its commitments in the World Trade Organization. It is not a matter of prohibiting U.S. firms from outsourcing to India. It is a matter of increasing national saving.

I suggest that to reduce its trade deficit, the United States could

use tax policy to encourage work and thrift rather than as a tool to redistribute income. We should change the mix of taxes to favor saving rather than consumption. That would increase private saving.

Edward J. McCaffery also argues that we should

abandon the attempt to have an income tax altogether and move instead to a consistent consumption tax. This is the right path to take. It means eliminating all attempts to tax savings directly under the income tax—having unlimited savings accounts, no capital gains taxes, no tax-law concept of “basis.” It also means eliminating the adjutants or “backstops” to the income tax’s porous and flawed commitment to taxing capital, namely the corporate income and gift and estate taxes

For Discussion. What other policies might serve to increase national saving?



COMMENTS (50 to date)
Bob Dobalina writes:

Dr. Kling,

We need _more_consumption_.

The newspaper told me so!

Steve writes:

How do you propose we deal with the massive recession this would cause as companies who sell "stuff" are no longer able to sell it because everyone is "turning Japanese" and not spending?

bob writes:

I live in a small place that has mostly consumption taxes (there are no income taxes, but some transaction fees). The result: it has gone from extreme poverty to relative prosperty (compared to other countries in the region) in one generation. For more details: http://siliconisle.com/taxes.html

Boonton writes:

Here we go again, how we divide our consumption between domestic goods and imported goods is not relevant. In fact, Arnold will be the first to cheer the argument that trying to distort that decision through tax policy would be counter productive.

Yet for some strange reason the market that helps consumers divide their consumption between imported goods and domestic goods just doesn't work when people decide for themselves how much of their income will go towards savings and how much towards consumption. The right refuses to explain why the market can determine nearly every variable in the economy with amazing efficiency except for savings, which requires gov't intervention to bias the incentives in favor of savings and 'hard work' (BTW, they are not the same thing).

If you want incentives for 'hard work' then exempt ditch diggers, landscapers, fast food workers, moving men etc. from all taxes. In fact, if you have such a fetish for hard work, you could take a clue from Keynes and have the gov't hire people to dig holes and bury bottles filled with $50 bills.

However, if you are generally an advocate of the market then you should be so kind as to justify the need to veto the market's decisions about such things.

Steve writes:

So you didn't export your way to prosperity like every other small poorer country on the planet has?

Lawrance George Lux writes:

A very good argument can be made for the irrelevance of Savings to the Economy, except in the province of Household capitaliztion. An efficient Central Banking system eliminates the need for aggregation of capital.

Consumption taxes reduce Consumer Demand, but more so; a very convoluted argument even suggests Consumption taxes will actually reduce total volume of Savings. I personally believe a Capital Gains tax with real bite actually acts a the best spur.(seems like it would be the reverse, but it actually reduces the production and consumption of luxury items). lgl

Boonton writes:

We should also note, again, that monetary savings does not equal additional investment in an economy. 'Increased' savings that goes into the stock market (or even old fashioned bank savings accounts) can just as easily be channelled into consumption. Every share of stock purchased must be sold by someone else. There is no law saying the proceeds cannot be consumed.

Steve writes:

I don't know if this has been suggested, but how about shifting to a consumption tax?

Monte writes:

Adjusting the CPI to more accurately reflect cost-of-living increases resulting from inflation will increase national savings by inducing lower consumption.

Boonton is indignant over the fact that market advocates are willing to entertain policy changes to correct for any perceived inefficiencies. I would suggest that they’re forced to do so because government policies typically bring about those inefficiencies in the first place.

Ever since Keynes’ General Theory duped policy makers into believing they could fine-tune an economy, free market enthusiasts have been kept busy digging up bottles filled with $50 bills…

Boonton writes:

It would seem to be the point of the entire thread. Why would this be a good idea?

Monte writes:

http://www.clev.frb.org/research/com/1015.htm

Mcwop writes:

With 30+% of workers not saving in the defined contribution plan, which usually offers match dollars and is almost always pre-tax - I doubt tax policy will dramitically change people's behavior. I know first hand, as I did employee educational meeting on the subject for two years. I did 800+ meetings speaking in front of a total of 30,000 workers.

These meeting were effective in changing attitudes, and many of the reasons why people don't save is because of the lack of financial education and perceptions formed by media (All the "bad news" reported make people feel like the mattress is safer).

Boonton writes:

"Boonton is indignant over the fact that market advocates are willing to entertain policy changes to correct for any perceived inefficiencies. I would suggest that they’re forced to do so because government policies typically bring about those inefficiencies in the first place."

Monte, which gov't policies force free market supporters to advocate gov't policies to choose savings over consumption? If anything, gov't policies are already biased towards the choice of savings over consumption.

1. Most states have sales taxes as well as specific taxes on consumption goods like tobacco, hotel rooms, gas etc.

2. Capital gains income is taxed at a lower rate than wage/salary income. You are better off making $100 in the stock market than by putting in a few hours of overtime.

3. 401K's, IRA, Roth IRA's, College Savings Plans etc. provide a significant tax benefit to savings. Aside from the ability to deduct medical expenses and charitable contributions, I'm unaware of any consumption tax benefit that can even be remotely comparable to these savings tax benefits.

Long and short Monte, if you want to advocate a policy to address a government created distortion in the market then you would advocate additional taxes on *savings* because the bias is already in that direction. No, I don't see any intellectually honest case for free market believers to advocate additional pro-savings tax policies except market failure. That again raises the question of why the market has failed.

OldSteve writes:

Since there are now two people calling himself "Steve" I shall be "OldSteve".

Nobody has addressed the fact that increased savings will destroy any hope at recovery. Please, explain to me how we could possibly save our way to economic growth?

You see, the Economic elite forget that we need JOBS to have money to put into savings. Very important factor.

Boonton writes:

"With 30+% of workers not saving in the defined contribution plan,.."

Which raises some additional problems;

1. Increasing the rewards for savings both encourages & discourages savings. If I'm saving for a specific goal (retirement, new car etc.) then increasing my return allows me to achieve that goal with LESS savings.

2. Since many lower & middle income people are not fully utilizing the existing opportunities to save tax free or at tax advantage, additional savings generated by tax policy would have to come from the wealthy. However, the wealthy already save a large part of their income. Even if you are living very large, it is actually hard to not be a heavy saver when you have millions or billions.

3. If additional savings is unlikely to come from consumers, then you are left with corporate savings (gov't savings isn't being addressed much in Arnold's article). Now we have to ask what is the point? Are corporations out of control consumers? If so, then what will they do to save more? Cut back on wages or investment spending?

Monte writes:

Boonton,

My comment was made more in the context of what seems to be your objection to the market as the best arbiter of economic activity.

More specifically, current tax codes and government spending programs discourage savings.

1. The tax code, by imposing multiple layers of taxation on capital (in spite of lower marginal rates), reduces incentives to save and invest and creates a bias towards consumption. Taxes on interest, dividends, capital gains, and estates raise the cost of savings vs. capital and drain capital from the economy.

2. Government programs eliminate or reduce the motivation for households to save. SS, by forcing individuals to participate, has become an inadequate proxy for voluntary retirement savings. Additionally, Medicare/Medicaid, UI, and programs designed to assist consumers with financing the purchase of a home or a college education have crowded out personal savings incentives.

Finally, savings isn’t governed by the market mechanism so much as it is by those things Mcwop identified in his comment above (financial education, media perceptions, etc.).

Generally, the market only fails if the government steps in to protect us from it.

Boonton writes:

I'll grant you that the above may have a negative effect on savings but it is not countered by the large incentives to savings the gov't has created. As I pointed out, capital gains are taxed at a reduced rate so you are better off tax wise by earning $100 from investing than $100 from working overtime. Forced SSI taxes have the result of increasing gov't savings which if you read Arnold's article is part of the national savings rate.

I will grant you that the gov't may increase consumption by subsidizing college educations indirectly (although its questionable if this is really consumption). Is this in any way comparable to the hundreds of billions that are saved in various accounts that are either tax free or have some type of tax advantage built into them? Look even deeper, how much *potential* savings could there be if everyone took full advantage of the existing tax incentives to savings?

"Finally, savings isn’t governed by the market mechanism so much as it is by those things Mcwop identified in his comment above (financial education, media perceptions, etc.). "

This is perhaps one of the most unbelievable statements ever written. Savings isn't governed by market mechanisms?! It's governed by 'media perceptions' and 'financial education'! What on earth does that even mean?

Mcwop writes:

>>Posted by Boonton on November 18, 2003 02:53 PM
This is perhaps one of the most unbelievable statements ever written. Savings isn't governed by market mechanisms?! It's governed by 'media perceptions' and 'financial education'! What on earth does that even mean?http://gsbwww.uchicago.edu/fac/richard.thaler/research/published.htm

Mcwop writes:

oops my previous post was cropped.

>>Posted by Boonton on November 18, 2003 02:53 PM
This is perhaps one of the most unbelievable statements ever written. Savings isn't governed by market mechanisms?! It's governed by 'media perceptions' and 'financial education'! What on earth does that even mean?http://gsbwww.uchicago.edu/fac/richard.thaler/research/published.htm

Mcwop writes:

Maybe the 3rd time is a charm.

>>Posted by Boonton on November 18, 2003 02:53 PM
This is perhaps one of the most unbelievable statements ever written. Savings isn't governed by market mechanisms?! It's governed by 'media perceptions' and 'financial education'! What on earth does that even mean?

Boonton writes:

So the model of the 'rational economic man' does not conform to the decisions that individuals are observed making in experiments? Without going through each paper, this is a pretty weak argument for rejecting market results and adopting what basically amounts to a government planned savings rate.

Boonton writes:

Also, the market tends to be much stronger than the sum of its parts. Take the stock market, usually described as nearly as close as you can easily get to the model of the pure market. It is well accepted that many...even most...of the players in the stock market are a long way from the classical rational economic man model:

1. Their information is limited.
2. They apply irrational interpretations to the information they have.
3. They are often poorly educated (or mis-education).
4. They are suspect to fads, media inventions, rumours and so on...

Yet anyone advocating that gov't needed to manage the stock market by using tax policy to set an 'ideal' stock price would be given a very rough time.

Mcwop writes:

Boonton, not sure I understand the full extent of your comment.

Boonton writes:

Let me restate it:

It is being argued that the gov't should intervene in the decision to save vs. consume because such decisions are being made by 'non-market' factors such as irrationalism, people with poor financial education, 'media perceptions' etc.

The theory that markets are efficient allocators of resources has been well tested and found to be very strong. The idea that a more efficient allocation of resources can be achieved by vetoing the market has been mostly rejected except in a few cases of market failure (monopoly and such...).

My comparison with the stock market simply serves to illustrate this point. I suspect you and many other advocates of the 'we need gov't savings incentives' school would be horrified at the thought of the gov't saying something like 'tech stocks but utilities are too high, we will provide tax incentives to sell utilities and buy techs'.

Yet we know stock prices are determined by people who have 'poor financial education' or who are suffering from 'media perceptions' and a host of other irrational factors.

Monte writes:

Boonton,

We’ve discussed this before and I’m not inclined to retrace my steps, but the market doesn’t allocate savings in the same way it does normal goods and services. I didn’t say that savings wasn’t governed by the market, period. I said that it isn’t governed “so much” by the market as it is education and experience. Savings (like consumption) is a behavior, not a commodity whose supply and demand is determined by price.

And I find it difficult to believe somebody as intelligent as you fails to understand how a lack of education in personal finance or advertising aimed at influencing consumption behavior might undermine savings.

Mcwop writes:

Boonton, gotcha. I agree. I was trying to make the point that tax policy will probabaly not be successful in this arena. After all many companies paid dividends for years when tax policy favored cap gains.

In your example of iraationality in stock prices I would add that market forces ususally catch up to that irrationality at somepoint.

Alex writes:

The market is simply pricing in Moore's law.

If the marginal $1 today will purchase $2 of goods tomorrow, but I anticipate needing only $1.20 of goods tomorrow, it makes sense for me to spend the marginal $.40 today. If I anticipate needing $1.90 tomorrow, I'll spend only $.05 today.

If I already have a laptop and a cellphone and think they will still be functional tomorrow, I will expect to spend less than someone who does not yet have these devices and doesn't need them right now.

Poor countries expect to spend more in the future than rich countries and therefore, given Moore's law, it makes sense for them to save more today.

Boonton writes:

"Savings (like consumption) is a behavior, not a commodity whose supply and demand is determined by price. "

What then should be the savings rate? How much should it be increased? Should it always be increased? Can it ever be too much? If so how would we know? Your position seems to be based on no coherent reasoning other than saving feels like a good type of behavior therefore resources should be expended to encourage it.

It should be disturbing that the same arguments are often used to advocate policies economists know are false. Exports are a 'good thing' but that is not enough to defend a policy of protectionism...for example.

Boonton writes:

There's a big difference, IMO, between an 'education' campaign to encourage savings than a policy to create market distortions to encourage additional savings.

Education can be rejected by the student if he thinks he is on to a way that works better for him. There are good arguments that increased savings are not rational. Arnold, for example, has speculated that we may be on the verge of a massive productivity growth boom. If that is true, then the need to save today is highly diminished because income tomorrow will be much higher than it is today.

One thing a market is good at is consolidating various conflicting theories and ideas...both rational and less than rational. The stock market is a powerful example because most of the participants are operating under theories that are either entirelly irrational or operating on only partially rational theories. In fact, it wouldn't be impossible for the entire stock market to be irrational...yet the prices are reasonably rational over time!

Monte writes:

“What then should be the savings rate? How much should it be increased? Should it always be increased? Can it ever be too much? If so how would we know? Your position seems to be based on no coherent reasoning other than saving feels like a good type of behavior therefore resources should be expended to encourage it.”

My reasoning now, as before, is that the savings rate ultimately constrains the rate of investment. In other words, low levels of national savings lead to low levels of investment in the long run, with potentially important implications for our country’s future standard of living.

The personal savings rate has steadily declined from over 10% in late 1992 to a low of 0.4% by the end of 2000. This strikes me as a rather disturbing trend when contrasted against the record levels of public and private debt that is staggering by any historical measure.

That’s why I welcome any policy designed to encourage savings or create incentives to save or invest, perhaps even to the point of legislating some form of forced savings plan that must obviously exceed any expectations of SSI.

“In fact, it wouldn't be impossible for the entire stock market to be irrational...yet the prices are reasonably rational over time!”

Sort of like “irrational exuberance” and reversion to the mean?

Boonton writes:

"That’s why I welcome any policy designed to encourage savings or create incentives to save or invest, perhaps even to the point of legislating some form of forced savings plan that must obviously exceed any expectations of SSI. "

That's interesting because two investment incentives were presented as part of the problem, policies that make it easier to finance buying a home and a college education. Both of these are investment activities. A home is an investment good because it provides a 'consumption' good year after year (aka a place to live...or rent out), a college education (while often accompanied by some consumption....esp. in the beer family) also provides additional goods year after year through what one expects would be a better paying job.

Let's do a thought experiment:

Imagine a country ruled by Puritans who despised consumption. So the tax system is entirely a consumption tax. Suppose that they decided to eliminate all consumption so they put a very high rate on consumption over some minimal level needed to keep living. Say 500% or more!

So now you have a country whose saving rate may be 90%, here's my question: Would there be any benefit to increasing the rate to 90.1%? Probably not.

Like any other 'good thing' too much of it leads to diminishing returns. If the 100% savings society is crappy then there is clearly a point between 0% savings and 100% where things go from getting better to getting worse. Where is that point? That is a very hard question and who knows if it is even stable (maybe it was 20% in 1980 but is 5% today)?!

But markets are a great mechanism to find such answers and the rule of thumb should be, IMO, trust the market unless you have very clear reasons why not! A valid reason to veto the market may be that you have ethical objections to its results. So you prohibit slavery even though the market may want it, or maybe you require some minimal welfare system. Another valid reason to veto the market would be in cases of market failure. There's a whole body of research and debate about market failure & some even assert that it is a myth.

I don't see much of an ethical argument for boosting savings. Keeping people from starving to death is a fine cause to rally behind, some % savings rate plucked from a hat is not. Those supporting such a economic policy, therefore, should tell us why the market has failed and how the gov't can do better. This may seem like a tough question but I don't think it is an unfair one to ask.

gerald garvey writes:

God for you, boonton. Arnold must have had an MIT moment in his premise that increasing national saving is a good thing per se. I also would point out that a lot of advertising today is not about current consumption but about investment vehicles. Now most of it is crap but I don't think the crap proportion is higher than for advertising of consumption goods

Bernard Yomtov writes:

If I may state what I understand to be Boonton's point a different way, what is the optimal level of savings?

Arnold seems to feel that our savings level is too low. OK. What should it be then? If your doctor tells you your blood pressure or cholesterol is too high, he is comparing it to some healthy level.

What is the healthy level of national savings? If you can't answer that, even in an indirect way, how can you claim the current level is to low?

joe shropshire writes:

Can somebody help me out here. The McCaffery quote includes this phrase "porous and flawed commitment to taxing capital", from which I infer that McCaffery (and Kling?) take for granted that taxes should be targeted on capital as opposed to the other pieces of the economy (income? savings?) Now, what I know about economics I got from weblogs and Bazooka Joe wrappers, so my knowledge of theory's kind of thin. Can somebody explain what part(s) of the economy economists believe taxes should hit hardest, and if economists don't agree, what are the major schools of thought. Thanks

Hi, Joe.

You asked:

>Can somebody explain what part(s) of the economy economists believe taxes should hit hardest, and if economists don't agree, what are the major schools of thought.

The two main "schools of thought" are
1. Taxes should cause the least possible disruption to the economy's overall efficiency, and
2. Taxes should redistribute wealth to improve the condition of some people even though it comes at the expense of some others.

All economists agree about 1., but there are substantial disagreements about 2. because 2. involves value judgments (i.e., the decision about which group of people is more deserving).

If we stick to 1. for the moment, the principle is this: All taxes cause _some_ disruption and inefficiency, because any tax changes people's incentives and behavior. A tax on cigarettes causes people to consume (and produce) fewer cigarettes. A tax on income causes people to earn less income. (Think of the extreme case to see this. If the government taxed away _all_ your income, why work at all?!)

Some economists consider a "head tax" amongst the least disruptive. That is, if you could tax every citizen, man, woman, and child, equally, there is not much room for people to change their behavior. But even a head tax does change long-run incentives: people have fewer children, or emigrate to other countries with lower taxes.

Returning to the question as you asked it in your post, the way to think of a tax on capital is that less capital will be produced if it's taxed. Less capital ultimately means less future production, so taxing capital is something akin to taxing our futures and our children's futures. Taxing consumption goods, on the other hand, causes people to turn toward saving more, thus producing _more_ capital goods. But less consumption makes people less happy today, even though by saving more they may be a little happier in the future. It's hard to measure which effect is more disruptive for an economy, so the question sometimes becomes one of how to meet other objectives, such as underbudgeted programs like Social Security or Medicare. Often, people fall back on their gut feelings, their own personal desires about savings, etc., which ultimately brings us back to item 2. in my original list.

So that I don't go on endlessly, you can read more about these questions here:

http://www.econlib.org/library/Enc/TaxationAPreface.html

Mark Anderson writes:

I do agree with the idea that the trade deficit represents a giant savings deficit. However, I don't believe the author even understands economics.

There is nothing more wicked than the way the government manages to use up savings, discourage saving, and suppress interest rates all in one motion. Anybody who understands the time-preference theory of interest can easily grasp the horrible consequences of this action by the government.

Of course, the government does this by creating all new money out of thin air. This is done by the government taking a bond and selling it to, ultimately, the Federal Open Market Committee.

When the government does this, they are injecting new funds into the loan market. By increasing the supply of loanable funds, nominal rates tend to fall. On top of that, the real rate of interest falls, since debtors can now pay back lenders (i.e., savers) with a devalued dollar.

Now, thanks to these inflationary tricks, saving is impossible. You can try, but the government has effectively outlawed saving. To prove my point, look around and see what you can get for $100. Keep that $100, and in a few years, see what you can then get with the same sum.

Now, within the construct of a free market, with organic money (i.e., gold), savings would be much more abundant. The natural rate of interest would be low.

But with this scheme (i.e., inflation) where the government can use up savings, discourage saving by making it unprofitable, AND THEN SUPPRESS INTEREST RATES, we have got some problems of monumental proportions. Saving is totally unprofitable.

I once had somebody respond to this by suggesting that savings are not scarce, and then they cited the M2. The problem is, the M2 doesn't measure real savings. Otherwise, all that is needed is the government keeps inflating, and then, magically, savings will soar, since the M2 will soar.

So, what is savings, exactly? To be honest, I don't think 20 economists in the whole United States can define savings. We know what the act of saving is (i.e., deferred consumption). But what is savings? I don't believe savings is something that can be quantitatively measured. I believe savings is the substance of capital (i.e., real wealth).

Now, will a consumption tax help savers? BWAHAHAHAHA! Lest we forget that producers need to consume in order to sustain production. A consumption tax IS A SAVINGS TAX. What is the best thing we can do for savers? HAVE THE GOVERNMENT CEASE INFLATING! Tragically, I don't see this happening, since too many "economists" suffer from the "fragments-of-the-economy-are-hermetically-sealed-off-from-eachother syndrome."

joe shropshire writes:

Lauren: thanks.

Boonton writes:

Mark,

The last 20 years demonstrate that inflation does not need to be a problem in a non-gold monetary system. Also gold based money has its own problems. Deflation can hit if gold discoveries do not keep pace with economic growth, inflation strikes if gold is discovered too quickly.

"Now, thanks to these inflationary tricks, saving is impossible. You can try, but the government has effectively outlawed saving. To prove my point, look around and see what you can get for $100. Keep that $100, and in a few years, see what you can then get with the same sum."

$100 try a savings bond, a savings account, a regular bond etc. As long as the return is higher equals inflation you've managed to save $100. If the return is higher than inflation you've managed to save & earn investment income.

Hi, Joe.

A quote you'll recognize:

>Now, and I muse for why and never find the reason,
>I pace the earth, and drink the air, and feel the sun.
>Be still, be still, my soul; it is but for a season:
>Let us endure an hour and see injustice done.

(---"Be still, my soul, be still," Housman, A Shropshire Lad, 1896)

Why it is that people fight most vehemently over what can be least-well determined objectively, is an everlasting question. Would that it were only a season! It takes longer than that for others to ask questions as deep as yours, so they can indeed drink the air and feel the sun. But probably that was Housman's point: how long understanding--ours individually and society's collectively--does take.

Best regards.

Mcwop writes:

Bernard writes: "If I may state what I understand to be Boonton's point a different way, what is the optimal level of savings?

Arnold seems to feel that our savings level is too low. OK. What should it be then? If your doctor tells you your blood pressure or cholesterol is too high, he is comparing it to some healthy level.

What is the healthy level of national savings? If you can't answer that, even in an indirect way, how can you claim the current level is to low?"

I relate the level of savings to important needs such as retirement. Retirement is important for a few reasons, it helps companies get rid of higher paid workers, and it is a pure consumption phase. The adequate level depends on the needs of the individual. Needless to say 50+% of people are not saving adequately for retirement. Many need a savings rate of around 10%. Just a ballpark, but much higher than many people are doing now, unless you include payroll taxes (which I would not consider savings).

Boonton writes:

How is this 10% rate figured? Does it include home payments since many people use their houses as a de facto retirement account (which is perfectly legitimate)? If people are willing to have a less bountiful retirement than the 401K brochures depict then they can get away with a lower savings rate. If people are expecting to work longer and retire later then they can make due with a lower savings rate.

The other million dollar question is can the market put additional savings to productive use by increasing the production of consumption goods in the future by investing now? If the market currently has all the savings it needs then additional savings will do the overall economy no good (although it will benefit the individual saver).

On one side of the equation you have people who want to get their hands on savings. These would be businesses looking for investment funds, stock brokers, retirement planners etc. On the other side of the equation you have those who provide savings...in this case we are talking about individuals and businesses.

The market provides a mechanism that balances both sides. If, for whatever reason, savers are irrationally reluctant to 'save enough' then this should be seen as a shortage of savings driving up interest rates and a lowering of stock prices (thereby increasing their return). There appears to be no shortage happening. In fact, we have just come out of a boom that was marked by a huge increase in investment. The telecommunications industry alone has probably laid enough fiber optic cable to last 5 years.

What may be sensible for a particular individual may not be for all of society. Achieving a 10% savings rate by having the top 1% save 60% of their income will not address the individual problem of people not providing enough for their retirement. So you are left back at square one, explaining why the market supposedly is not working correctly to get Americans to save enough.

Lawrance George Lux writes:

Joe,
Neither of the main schools of thought on Taxation are right. The second can be dismissed easily, transfer payments never wind up helping anyone; this because Labor and industry develops to absorb the transfer payments given, while leaving the proposed beneficiaries with the same approximate standard of living.

The first school on Taxation does not understand Taxes fulfill a valid economic service, this being payment for basic communal Capitalizations of Defense, Law Enforcement, Transportation facilities, and Adjudgation services. They compound their error by refusing to admit Government deficits provide far more damage to the Economy, than does excess Taxation. lgl

Tom Dougherty writes:

The economics of an excise tax tells us that an excise tax causes the marginal cost of producing the taxed good to rise. The increased marginal cost causes marginal firms who were earning zero economic profit to leave the industry. As marginal firms become submarginal and leave the industry, the supply of the goods fall. The price of the taxed good then rises. Who pays what portion of the tax - consumer and producer - is determined by the elasticity of the supply and demand curves. The main point of this is that the cost of the tax is NOT simply shifted forward on to the consumer from the producer. The price of the good rises only when the supply of the good is reduced. I think most good economists still believe that supply and demand determine price; price is not determined by cost.

Two lessons from this are: 1) supply and demand determine the price and 2) the cost of the tax cannot be simply shifted forward on to the consumer.

A national sales tax would be a tax on all goods, not just a tax on one good like the example above. Murray N. Rothbard, in his book “Power and Market”, shows that a consumption tax will simply be a tax on income. He argued that the same principles that apply to an excise tax also apply to a national sales tax, i.e., 1) supply and demand determine price 2) the cost of the tax cannot be simply shifted forward on to the consumer. What this means is that without a reduction in supply caused by the tax prices will not rise. In the case of the excise tax, submarginal firms and resources leave the taxed industry to be employed somewhere else in the economy. However, there are no untaxed industries for firms and resources to go to with a national sales tax. Only to the extent that resources become unemployed will prices rise.

Firms then will be burdened with the entire tax. Although taxes cannot be simple shifted forward on to the consumer without a reduction in supply, taxes can be shifted backward on to the factors of production. The reduction in net income to firms will be imputed back on to the factors of production. The reduction in net income will mean less interest earn by capital, less rent earned by land, and less wages earned by labor. What Rothbard has shown is that a general sales tax is not a tax on consumption, but actually a tax on income.

I have tried to present his argument as briefly as possible, but as a result, I have done some injustice to his argument. His chapter on taxation in “Power and Market” should be consulted for the entire argument.

Finally, I will say that this is not necessarily an argument against the sales tax. There are other aspects to a national sales tax that may be superior to an income tax, but his argument raises doubts about whether a sales tax can actually tax consumption.

Mark T writes:

is part of the problem that savings are traditionally measured as a flow item, taking no account of the stock of accumulated wealth? If the return I am getting on my existing investment exceeeds my required return, then logically I should actually dis-save. This is the equivalent of a pension fund holiday. Is it a coincidence that those with the highest savings ratio ie Japan also have the lowest return on capital? Is it not also connected that they are major buyers of US assets - at various times bonds, equities FDI and property - delivering a capital account surplus. And does not that capital account surplus identically create a current account deficit?

Joe, lgl:

lgl makes some good observations. I'd like to focus on this particular remark:

lgl>The first school on Taxation does not understand Taxes fulfill a valid economic service

Most economists do tend to agree that there are some valid government services, and that taxation to finance those services is a legitimate exercise. Thus, let's rewrite my item 1. as:

1. Assuming some given amount is to be collected in taxes, taxes should be chosen to cause the least possible disruption to the economy's overall efficiency.

lgl is right that there _are_ some economists who argue that that given amount ought to be zero because all taxes are disruptive to efficiency in some way.

However, most economists do believe that at least some government services are warranted; and they proceed by trying to select those taxes which are least disruptive in order to achieve the total tax amount.

Don Boudreaux writes:

Arnold Kling’s blog is one of the very best. I disagree, though, with his claim that trade deficits are really savings deficits. In so describing them, he shares the general (mis)perception that trade deficits are a problem or a symptom of a problem.

Trade deficits – to be precise, deficits in the current-account – are exactly and fully offset by surpluses in the capital-account. A U.S. capital-account surplus means that foreigners invest more in the U.S. than Americans invest abroad.

There are several reasons to not worry about a current-account deficit. But the most fundamental of these is revealed by asking the following question: what difference does it make to the economy as a whole if investment funds come from someone living in Kyoto or someone living in Kalamazoo? Certainly from each individual American’s perspective it should make no difference. I might save too little, too much, or just enough; that issue is personal to me and my family. But my life and economic prospects are no different if the principal investors in American firms and in domestic government debt carry U.S. or foreign passports.

Having capital invested in productive uses is the critical thing. The nationalities of the investors is irrelevant.

I add, for the record, that Kling is certainly correct to oppose policies that artificially discourage saving.

Mark Anderson writes:

Boonton:

You write, "The last 20 years demonstrate that inflation does not need to be a problem in a non-gold monetary system."

Inflation does not need to be a problem in a non-gold monetary system? That is akin to saying that space need not be a concern for a prison cell. I haven't heard of inflation with organic money. The very fact that we are not on a gold standard is why we do have inflation.

Of course, the statist intelligentsia will tell you that inflation isn't a problem. It is. Why do you think the economy has been so poor?

You also say, "$100 try a savings bond, a savings account, a regular bond etc. As long as the return is higher equals inflation you've managed to save $100. If the return is higher than inflation you've managed to save & earn investment income."

One, I can't think of too many savings bonds, CDs, or savings accounts that give returns which exceed the rate of inflation. Two, purchasing a savings bond, a CD, or a savings account (thanks to fractional reserve banking) are not acts of saving. Saving should require nothing other than foregoing consumption. Do not confuse investment and/or speculation with saving.

Thanks to the fact the government inflates, holding onto currency makes you an automatic loser. That is NOT healthy. You mentioned something about the fact that on a gold standard, there would be price deflation. Right. And that is its main excellence, as the politicians cannot keep driving up prices by inflating.

Steve writes:

How does one own a house if one expects constant price deflation? How does one commit to long term investment?

Let's see, 87% popular home ownership or "no more inflation, constant thread of spiralling deflation". Even a two-armed Economist would say "easy choice".

JK writes:

The US has a savings deficit because the tax system discourages saving, and the tax system discourages saving because if it didn't then some (actually many) families would get very rich over time.

Rich enough not to have to rely on government hand-outs and tax breaks, which would not suit the politicians or the bureaucrats.

Robert Monical writes:

Couple of comments:

1. I could argue that with Social Security, Medicare, and a paid for house that I don't need to save anything (I don't). When I can no longer keep the house, I exchange it for a Medicaid subsidized retirement in an assisted living facility. The issue here is that the government has made not saving a non-issue for Americans of modest means. A "comfortable" retirement is beyond them even if they saved a significant portion of their wages.

2. Even if savings were higher, I think the trade deficit would continue. Foreign economies are conditioned to run trade surpluses with the United States. I recall Japan re-investing some of their surplus in making un-wise asset acquisitions in the 80s and 90s. I suspect that part of the stock market bubble was trade deficit dollars making their way back into American assets (and then getting erased!). I continue to be perplexed by Asian support of the dollar. My impression is that that these will end up having been enormous contributions to the US economy when the dollar finally falls.

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