It should come as no surprise that behavior which usually brings nothing but misfortune isn't likely to be carried out often. A case in point is the issue of the savings rate in America. The average American saves on the order of 4 percent of his income, as opposed to 12 percent and 17 percent for his German and Japanese counterparts respectively. While it is fashionable to blame this disparity on all kinds of supposed shortcomings in American cultural life, there is a much more straightforward, though admittedly less exciting, culprit -- the punitive nature of the American Capital Gains Tax.
The fact of the matter is that, thanks to the present tax system, it simply doesn't pay to save in this country. Let us take for instance, the case of the generous (here perhaps "foolish" might be more appropriate) soul who decides to invest his money in 90-day Treasury Bills over the 1960-1984 period. For his thrift and willingness to help service his country's debt, he will receive a negative real rate of return after taxes for more than half the period, and will have watched his capital decline in purchasing power to less than 60 percent of his original investment. All this without touching his capital too! He'd have been better of keeping his money under the bed, or even spending it all as it came in.
But things get stranger yet. Suppose one starts the decade with $100,000 in savings and invests in the stock market. Suppose one then goes on to make an annualized unadjusted return of 2 percent a year, while inflation runs at 3.5 percent a year. At the end of the decade one is left with an illusory 22 percent "gain," which after adjusting for inflation comes out to a woeful $14,000 loss. But the disaster isn't over yet, as the IRS then steps in to tax the illusory gain at a mere 28 percent. One is left with a nominal 15.7 percent gain, which translates into a loss of $18,000 in real terms. In effect, the IRS taxes one on one's losses! With incentives of this sort, who needs to save? One hasn't even mentioned the fact that the capital gains tax is double taxation, since one already pays taxes on one's earnings.
The accumulation of capital stock is vital in enhancing a country's economic productivity and output. Whether we benefit very much of only moderately from high savings rates on the part of those who can afford to, we still do benefit. Only a mind motivated by envy would prefer an outcome where everyone's income stagnates to one where his neighbor's real income increases by 40 percent while his increases by "only" 15 percent. It is crucial then, for the sake of all Americans, that something be done about such a perverse tax system, even if greater inequality of wealth results.
Some have proposed that the IRS index capital gains for inflation before levying taxes, but this really doesn't go far enough. One has to ask why such a praiseworthy activity as saving should be penalized at all. There are quite a few places in the world without a capital gains tax, and they seem to be doing just fine -- Hong Kong, the Netherlands, Belgium, Germany even!
Americans have the highest standard of living in the world, not at first apparent if one looks only at nominal per capita incomes. Japan, for instance has a nominal per capita income level of about $31,000, as compared to America's $25,000. When adjusted for price levels in the different countries, however, Japanese income levels fall to only $21,000 per head, still using Americans' as the base figure. This is despite the fact that the Japanese worker works some 11 percent more hours annually. Adjusting for this work disparity means the average American earns an impressive 32 percent more than his Japanese counterpart per hour worked.
The superior total factor productivity Americans enjoy is only partly explained by labor productivity. In fact, one study suggests that it is not so much the productivity of the American worker that accounts for this success as the very high levels of capital per worker in the U.S. vis-a-vis other countries. Since the mid 1970's at least, the convergence of other OECD countries' productivity levels towards that of the U.S. has been largely based on relatively faster capital accumulation. To speak plainly, people in those countries have tended to save more. And why not? Their governments have given them more reason to.
Some say the abolishment of the capital gains tax will lead to a sharp decline in federal revenue. Even granting the truth of this, the government's tax revenues are not an end in their own right, but a means for ensuring the welfare of America's citizens. A good government should be willing to forego the extra income if it will do more good in the hands of its private citizens, which in this case it certainly will. If extra income is needed so badly, it should come, not from punishing saving but expenditure - a national sales tax, for example.
