12 October 2008

Savings: Outdated idea?

It is easy to blame greedy bankers and Wall Street for the depth of the current financial turmoil, but the primary source is the encouragement of debt and discouragement of savings by the U.S. government. Inflation of the currency, both by blatent printing and debt expansion, always discourages savings, but the list is not limited to inflation-related incentives:

1. People are taxed on capital gains from their savings and investments, after paying tax on the original principle. If they just spend their money instead of saving it, they might even be able to deduct such purchases as business expenses.

2. "Profits" on long-held investments like homes are not adjusted for inflation, so even if the house lost money in real terms, it could be taxed heavily for capital gains due to inflation.

3. Idle cash must be invested or spent simply to keep up with the inflation rate. Cash balances lose money by default. Often even basic savings rates are lower than inflation rates, encouraging savers to seek higher yield, higher risk investments merely to keep from losing their principal.

4. Mortgage interest is deductable from income tax, encouraging people to borrow money for their home and discouraging renting.

5. There is an unlimited allowance for capital gains and income that is taxable, but only $3,000 in losses may be deducted per year. If you make $1 million one year and lose $1 million the next, the full $1 million will be taxed the first year, but only $3,000 may be deducted from taxes the second year. Even if you save the residual income after taxes from the first year, you cannot cover the loss of the second.

6. The arbitrary nature of breaking the tax year into specific segments. All expenses within a given tax year are deductable, but if profits are saved over a period of years to pay for an expense in cash, those profits are taxed every year before the ultimate purchase. If, however, money is borrowed to pay for an expense up front, its cost can be amortized over many years.

7. Richer people, who have more discretionary income to save, are taxed much more heavily than poorer people. The poor don't have much extra money to save to start with, so if we tax away the would-be savings of the rich, we impoversh our capital supplies.

8. Inheritance taxes encourage the consumption of accumulated wealth during one's lifetime rather than inter-generational savings and investment. If you know that a large portion of your life savings will be taken upon death, why not spend it now?

In short, the government creates considerable incentives to borrow and spend, especially via the various effects of inflation, and thus discourages savings. Any society that neglects savings long enough is sure to ultimately find itself with a lack of real capital, leading to a depression when the credit pile crumbles. A society which values savings is one with slower economic growth, perhaps, but fewer economic surprises.

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