Fortune issue: February 15, 1999
ECONOMICS: THE HARD TRUTH BEHIND A SILLY STATISTIC
Are We a Nation of Spendthrifts?
First Principles
By N. Gregory Mankiw
Sometimes a meaningless statistic can call attention to an important problem. What is an economist to do? Point out the statistic's emptiness or be grateful that the problem is getting some attention, even if for the wrong reason?
The statistic I have in mind is the U.S. personal saving rate, which actually became negative a few months ago. A negative personal saving rate might seem to suggest that Americans aren't putting away enough for the future. And in fact, many economists argue that we aren't saving enough. But this assessment doesn't follow from the personal saving data.
National income accountants measure personal saving by taking household income--including wages, dividends, interest, and rental income--and subtracting taxes and household outlays on goods and services. The problem is, this completely omits capital gains on stock and other assets.
To see how meaningless this statistic can be, imagine what we might find if we were to apply this approach to, say, Bill Gates. Although I don't know Gates' personal income, it's probably not as impressive as you might think. He has about $75 billion in Microsoft stock, but it doesn't pay dividends. To finance his billionaire lifestyle, therefore, he sells small amounts of stock over time. This allows his spending to exceed whatever salary he receives, which national income accountants would record as a negative personal saving rate.
Of course, Mr. Gates probably isn't worried about his financial security. While he may not be saving much personally, Microsoft is doing so on his behalf. As long as Gates' holdings keep appreciating, the Gates family can live with a negative personal saving rate for generations to come.
The lesson from this example is that personal saving by itself doesn't mean very much. And indeed, the Gates example is in some ways reflective of what's happening in the U.S. economy: The fall in personal saving has to a large extent been driven by the stock market boom. Since 1994 the market has added about $6 trillion to household wealth. Even if people spend this windfall prudently--say 5% per year--it would mean an extra $300 billion in annual consumer spending. This is more than enough to explain the drop in personal saving over the past five years.
So the dramatic drop in the personal saving rate is not particularly significant. But the attention being paid to it may have a beneficial side effect--getting people to think about how much they save. Economists have long argued that U.S. saving is not nearly high enough. While negative personal saving may be reasonable for the many Americans who have been enjoying the stock market boom, plenty of others have no exposure to stocks or, indeed, any other financial assets. Households living paycheck to paycheck are not well equipped to handle the uncertainties inherent in living in a market economy, and they are unlikely to be financially prepared for retirement, which is worrisome in an era when Social Security is in peril.
The best case for increased saving, however, is simply that it is the surest way to promote more rapid economic growth. Estimates put the before-tax return to capital at about 10% per year. With the magic of compounding, this means that society can take $1 of consumption, invest it in additional capital, and turn it into about $15 of consumption for the next generation. This tradeoff is too good to turn down, but that is precisely what we are doing.
How can policymakers get people to save more? One proposal popular among economists would be to revise the tax code so that people pay taxes based on what they spend rather than on what they earn. In essence, all saving would become a tax deduction, as if it automatically went into an IRA or 401(k) account. After all, if we don't tax income until it is spent, people should respond by spending less and saving more. The result would be greater financial security and more rapid economic growth--and, as economist Robert H. Frank argues in his new book, Luxury Fever, it may have the additional benefit of curtailing the scourge of conspicuous consumption.
The idea of a consumption tax is hardly new: It's been advanced by David Hume, Adam Smith, and John Stuart Mill. Of course, the fact that some of the world's most celebrated thinkers have advocated a consumption tax has not been enough to make it a reality. But maybe with the recent decline in the personal saving rate--however meaningless that might be--the consumption tax will finally get the attention it deserves.
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N. GREGORY MANKIW is an economics professor at Harvard and the author of Principles of Economics.