Savings' Death Is Exaggerated

Capital-gains taxes skew the rate

What a difference a data revision can make. Only a few months ago, economists were pointing out that the slide in the personal-savings rate--saving as a percent of disposable income--was exaggerated because of a problem in the way the number was constructed (BW-June 29).

Then, in midsummer, the Commerce Dept. revised the rate downward, from around 3.6% to just 0.6% in the second quarter, setting off alarm bells in the financial markets. If people were really spending virtually all of their income, the reasoning went, a sharp retrenchment in consumer spending could be in the wings.

Moreover, the specter of disappearing savings was cited as evidence that consumption and economic growth were being driven by a "wealth effect"--that is, by people with big capital gains in the stock market who had decided to rev up their spending and draw down their savings. This implied that the expansion was acutely vulnerable to a stock market correction.

What has escaped notice, however, says economist Peter D'Antonio of Citibank, is that the latest revision in the savings rate still fails to address the basic problem with the numbers: the inconsistent treatment of capital gains and capital-gains taxes.

The savings rate is expressed as a percent of disposable personal income, which by definition includes current income such as wages and salaries, interest, dividends and rent--but doesn't include realized or unrealized capital gains. Yet capital-gains taxes are subtracted from personal income to calculate "disposable income." And since capital gains have exploded in recent years, taxes on these gains have soared as well--reducing disposable income and the reported savings rate.

The upshot, says D'Antonio, is that half of the decline in the savings rate over the past year can probably be attributed to the sharp rise in capital-gains taxes rather than to a jump in spending. Joel L. Prakken, chairman of Macroeconomic Advisers in St. Louis, estimates that the current rate would be well over a percentage point higher without the tax effect. (His own view is that a better measure of savings would reflect both capital-gains taxes and realized and unrealized capital gains.)

To Citibank's D'Antonio, all of this implies that the wealth effect is less powerful and slower acting than many analysts seem to believe. Personal savings are not as depressed as they appear, and fears of a sudden sharp contraction in consumption caused by a market correction are exaggerated.

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