What has happened to Savings in America? A number of factors may be affecting America's shrinking savings rate such as: the wealth effect, declining interest rates, and easier credit options. What can we do? Consider the following:
• America's personal savings rate, defined as savings divided by disposable income, has been falling steadily for more than two decades and is among the lowest in the industrialized world (Source: Federal Reserve Bank of St. Louis Review, November/December 2007).
• According to the U.S. Commerce Department's Bureau of Economic Analysis (BEA), Americans spent more than they saved in 2005, for the first time since the Great Depression (Source: Bankrate.com, March 2006).
• In a recent survey, nearly two-thirds of Americans admitted they don't save enough, and more than a third said they often (11%) or sometimes (25%) spend more than they can afford (Source: Pew Research Center Publications, January 2007).
In the mid-1980s, the savings rate stood at more than 10%. As of March of this year, it was a measly 0.4% (Source: Employee Benefit Research Institute, March 2008). These and a host of other data point to a disturbing reality: America is experiencing a savings crisis that threatens its economic future.
Savings are the source of capital investment in new products and services that increase productivity and contribute directly to economic growth. As domestic sources have dwindled, U.S. business and government alike have had to rely on foreign sources of capital, resulting in a growing outflow of billions of dollars a year in the form of interest and dividend payments. Instead of the world's banker, the U.S. has become the world's largest debtor, with a growing trade deficit and a weakening dollar that threaten a shrinking economy, rising unemployment, and lower standard of living.
What's Behind It All?
Economists point to a number of factors that are driving America's shrinking savings rate, including:
The wealth effect. Beginning in the early 1990s, American household wealth skyrocketed as a result of booms in the stock and real estate markets. It's an economic axiom that when household assets increase rapidly, people perceive less need to save while their appetites for spending increase.
Declining interest rates. After peaking in 1980 to 1981, interest rates began a long decline, fueling the economy by encouraging borrowing and spending while gradually discouraging saving. The prime rate, at 21.5% in 1980, fell to 4.0% in 2003, and 30-year mortgage rates declined from an average high of 16.63% in 1981 to 5.83% in 2003 (Source: The Wall Street Journal, 2008). Meanwhile, rates on six-month certificates of deposit slid from a high of 17.98% in 1981 to a scant 1.02% in 2003, and even now are hovering below 3% (Source: Federal Reserve, 2008).
Easier credit and ways to borrow. Creative financing mechanisms, including zero-down, interest-only, and adjustable-rate mortgages; home equity lines of credit; and the securitization of debt, made it easier for consumers to borrow money to buy anything from homes for investment to cars, vacations, jewelry, and the latest in digital consumer electronics.
These were only the latest developments in a 63-year period of virtually unbroken U.S. prosperity that has reshaped America from a nation of savers to a nation of shoppers. Even policymakers recognize that the consumer is responsible for upward of 70% of all spending in the U.S. economy and is largely responsible for fueling GDP growth since the fall-off in capital spending early in this decade.
The concern, however, is that in the midst of these mechanical disincentives to save, two-plus generations of Americans have forgotten how to postpone immediate gratification. Now that we have entered an extended period where assets may no longer grow at the same rate as consumers have recently become accustomed, the fear is that the saving habit may not return to fuel needed investment in our economic future.
What Can We Do?
Some of what needs to be done to stimulate American personal saving has recently been accomplished, but there's more to do. Some steps that would help turn the decline in personal savings around include:
Continue to encourage automatic 401(k) enrollment. The U.S. Pension Protection Act of 2006 made it easier for companies to enroll workers in 401(k) retirement saving plans without their prior permission. Instead of deciding to opt in to these tax-advantaged payroll savings plans, employees have the choice of opting out. Employers can determine a minimum contribution rate of up to 10% of pretax income, mandate higher contribution levels over time, and direct the investment of employee contributions. The plans are growing in popularity with employers: a survey found that 23% of 401(k) sponsors are automatically enrolling participants, compared to 14% a year earlier (Source: Deloitte Annual Benchmarking Survey, 2008).
Publicize the split tax refund option. IRS regulations were updated for 2007 to allow taxpayers receiving a refund via electronic deposit to target up to three different accounts, including savings and IRAs. Observers note, however, that many people still aren't aware of the opportunity, which requires filing IRS Form 8888 with their return.
Expand the Savers' Tax Credit. Enacted in 2001, this provision offers taxpayers who earn $50,000 or less up to a $2,000 tax credit for contributions to an IRA, 401(k), or other employer-sponsored retirement plan. Originally slated for extinction after 2005, the federal Savers' Tax Credit was made permanent by the 2006 Pension Protection Act. It also indexed income limits to inflation, a previous shortcoming that contributed to only five million taxpayers taking advantage of it in 2005. Advocates call for expanding the credit to create refunds for lower-income savers who don't have a tax liability.
Create automatic payroll-based IRAs. The Retirement Made Simpler Coalition, backed by the American Association of Retired Persons and the Financial Industry Regulatory Authority (FINRA), advocates the creation of automatic workplace IRAs for the 57% of American workers who aren't covered by a 401(k) plan (Source: The New York Times, April 27, 2008). As with automatic 401(k) plans, employers would enroll participants automatically, but enable them to opt out. Investment management would be contracted to private sector financial institutions, which would maintain no-frills accounts making maximum use of electronic technology. Once account balances reached a predetermined amount, participants could roll over to full-service accounts at providers of their own choice.
Introduce government-matching contributions. Among the most radical proposals to stimulate saving comes from The Brookings Institution, a nonprofit public policy research center and economists from MIT. They urge the federal government to scrap tax deductions for contributions to traditional IRAs and 401(k) plans in favor of universal 30% government-matching contributions. They argue that the proposal would be tax-revenue neutral, but stimulate greater savings among low- and middle-income households, who benefit less from tax deductions than high-income taxpayers.
Americans' rapidly declining rates of savings aren't just bad for the nation's economy -- they're bad for your future, too.