Thursday, April 13, 2006

A way to increase savings without radically changing the tax system

First I shall explain the a few of the problems I have with "flat tax" proposals.

1.) They are highly, highly, and I repeat, highly regressive. They will in effect place much of the tax burden of the country on the middle class, and the poor, while giving the rich a free ride to get much much richer.

2.) Many of the proposals are unworkable, and would require a tax system even larger and more invasive than todays. For instance one idea of having no consumption tax for those who are poor, which would require proving they are poor at every point of sale transaction, not to mention no taxes on second hand goods, which would create a glistening black market in goods that "fell off the back of the truck", not to mention a shitload of paperwork to "prove" you are selling used goods. And then there's pre-bating people under a certain amount of income with free income, which would require a load of federal outlays with much paperwork.

3.) It leaves no discretion to utilize tax incentives. Which is both a good and a bad thing, it means you cannot subsudize pork-barrel projects, but you can also not subsidize infant industries, environmentally or socially healthy products, it would also mean you couldn't write off charitable contributions or the interest on buying a new house (which is something I'm not alltogether entirely against).

Honestly I think much of the bloated aid systems could be done away with by utilizing a combination of a Basic Income Guarantee and a Negative Income Tax Credit.

But if the goal is merely to increase savings (as it is for many economists) I would also warn them that policies which too heavily favor savings are likely to both a.) Increase inequality and b.) Slow growth. For an example of the former: See Third world Tax havens. For an example of the latter: See Japan.

I am wholly sympathetic with simplifying our current tax system, however I think I have a proposal for increasing savings which may work out very well.

The proposal is simple, require everyone that makes some percentage above the poverty line to save a small portion of their income in private savings for a short period of time. For our example we'll say everyone who makes 300% of the poverty line for their family size, and 5% of their income, after deductions. The period would be for two years. Every two years they could draw out the amount they had put in two years prior, plus its interest. It would be a private account, and subject to long term capital gains taxes, unless wholly invested in tax free investments of course. The trick here is that it would be in private accounts, and could be any risk level, rather than the low risk low yeild federally mandated private accounts as proposed by the bush administration.

The beauty of this is, it does not lock people into savings that they will "never see", so it will appeal to their short term time horizons, while still encouraging savings. Likewise, if they so choose (and I think on average many people will) they can learn to play the market. In otherwords it will encourage average people to take active roles in their investments. And if they choose not to, they can just pick a "lifestyle" mutual fund and do nothing else with it. The net effect will be a vast increase in the proportion of private savings, without dramatically lowering consumption. And since the time horizon is low, it will keep people from doing stupid things like they do now with very long time horizon investments like IRA's and 401k's, emptying it out with a tax penalty everytime they change jobs or want a new toy. Now they can have their windfall every couple of years while increasing national savings on average. And without a tax penalty.

Now, my own proposal goes slightly further; everyone that makes 150% of the poverty line or less should get a "credit" equal to 10% of their income invested for them. Those that make between 151% and 299% would recieve no credit, but would also not be required to put any of their money in such an account. The hope is, that by giving the poor a credit, and allowing them to choose how they invest it, they would on average still choose to invest at least part of their income as they move up the economic ladder.

I think much of the problem with savings is not so much involved in tax schemes, in so much as it is involved in ignorance at how savings works. Most people I know consider savings to be their bank savings account. Their 401k (if any) is usually something that they select from a limited number of funds allowed by their employer, by checking a box, and then never pay attention to.

Another thing we could do to dramatically improve savings is to make money management and rudimentary personal economics a required class in all highschools. I maintain that it is not primarily a problem of of the tax system in so far as it is a problem of information. When many economists wonder why people do not behave in a manner compatible with their best economic interests...perhaps the first thought that should pop into their head is that they may not be aware of it. Most specifically they may not know how to manage their finances in accordance to their best economic interests.


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April 29, 2006 at 6:09 PM  

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