What Happens if You Tax Savings?
Senior Editor, CNBC.com
Over at Slate, Matt Ygelsias attempts an imaginative solution to the problem of attempting to use monetary policy to juice an economy when interest rates are already at the zero-boundary.
Now we come to the miracle of the cashless society. Stop for a moment and ask yourself why the interest rate can’t be reduced much below 1 percent. The trouble is cash. At any given time, relatively little paper currency circulates in the United States. Instead, most of the American money supply consists of bank accounts and other electronic stores of value. People prefer to keep money in bank accounts because it’s convenient and because you get interest on it. If the rates were driven below zero—in effect a tax on holding cash in the bank—people would just withdraw money and store it in shoeboxes instead. But what if you couldn’t withdraw cash?
What if all transactions were electronic, so the only way to avoid keeping money in a negative-rate account was to go out and buy something with the money? Well, then, we would have solved our depression problem. Too much unemployment? Lower interest rates below zero, Americans will start spending and investing again, the economic will grow, and unemployment will go back down to its “natural rate.”
Unfortunately, this wouldn’t work.
There’s the ordinary political obstacle, of course: People are already outraged about the effect the Federal Reserve’s zero interest rate policy is having on savings income. Actually penalizing savings is a political non-starter.
But this isn’t just a case of political obstacles to good policy. Ygelsias’s policy wouldn’t work even if it could be attempted. In the first place, it’s not at all clear that taxing savings reduces savings. I know it’s standard economist thinking to say that if you tax something, you get less of it. But saving is different.
People do not save out of a fetish for money. They save so that they will be able to spend in the future. Why save to spend in the future? Perhaps you plan to purchase something extraordinarily expensive, beyond the means of your income. So you need income to accumulate to make the purchase.
Or perhaps you anticipate a fall in your income, either because you worry about losing your job or you are planning on retiring. So you spend less of your income now to preserve it for spending later.
Now, let’s say that we’re in a cashless economy with a 10 percent savings tax. If I set aside $1000 this year, it will be worth just $900 next year. Do I save less or more? If I don’t think I’ll need $1000 next year, perhaps I decide to spend that money. But if my financial planning requires me to have $1000 next year, I actually have to save more. In this case, I set aside $1100.
There’s certainly some point at which my desire to save could be overcome with taxation. If you taxed my savings at 100 percent, I’d stop doing it. But I imagine the savings tax rate could go well above 50 percent before it totally overcame the desire to save more against the higher tax rate.
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