Saving and Investment

Difference Between Savings And Wealth

Opponents of President Reagan's tax cuts were elated when they discovered a sharp drop in savings rates immediately following the tax cuts. It wasn't until the Reagan tax cuts and Federal Reserve Board Chairman Paul Volcker's tight money policies of the 1980s took full effect that savings rose to earlier highs. In fact, the Reagan era saw the longest sustained increase in savings (properly measured) of the past seven administrations.

National savings and financial wealth are two very different economic concepts.

  • The government measures savings as that portion of income that people don't consume, simply income minus consumption.

  • Wealth, on the other hand, is usually measured by the real increase in household net worth at current market prices.

To illustrate the difference, imagine two people.

  • The first earns $100,000 in a given year and consumes the entire amount -- which, by government standards, means zero savings.

  • But this person started the year with an investment portfolio worth $500,000 and, by savvy investments or pure luck, wound up with $2.5 million -- an increase of $2 million in wealth, which would not be measured as savings by the government.

  • Person number two also earns $100,000, consumes $50,000, saves $50,000, then loses it through disastrous investments -- which the government would also measure as zero saved.

But when savings are measured as the total market value of household net wealth, we see that:

  • After President Kennedy's tax cuts, savings were very high.

  • President Johnson's 1967 tax surcharge and expensive Great Society programs wreaked havoc on the nation's savings rate.

  • Nixon's doubling of the capital gains tax rate, devaluation of the dollar, 10 percent import surcharge, and wage and price controls drove the average true savings rate below zero for a number of years.

  • President Ford's 5 percent tax surcharge also kept savings low.

  • In 1978, with California's Prop. 13 and the federal capital gains tax rate reductions, savings took off sharply.

But savings fell once again, after Reagan left office and Presidents Bush and Clinton raised taxes. Tax cut proponents say that presidential candidate Dole's tax plan has the capacity to lift savings rates once again -- thus spurring capital investment, technological innovations and job creation.

Source: Arthur B. Laffer (Laffer, Canto & Associates), "Creating Wealth, Not Just 'Savings,' " Wall Street Journal, October 15, 1996.

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