Given Tax Cuts, Rich Americans Save Instead of Spend
(Bloomberg) — Hand the wealthiest Americans a tax cut and history suggests they will save the money rather than spend it. Tax cuts in 2001 and 2003 under President George W. Bush were followed by increases in the saving rate among the rich, according to data from Moody's Analytics Inc. When taxes were raised under Bill Clinton, the saving rate fell.
The findings may weaken arguments by Republicans and some Democrats in Congress who say allowing the Bush-era tax cuts for the wealthiest Americans to lapse will prompt them to reduce their spending, harming the economy. President Barack Obama wants to extend the cuts for individuals earning less than $200,000 and couples earning less than $250,000 while ending them for those who earn more.
"I would tend to wonder how much the tax cut actually influences spending behavior," said Chris Cornell, an economist who mined government reports back to 1989 for West Chester, Pennsylvania-based Moody's Analytics. "Spending by the top 5 percent of households seems much more closely tied to business-cycle issues than it does to tax-cut issues."
The Moody's research covering couples earning more than $210,000 found that spending by the wealthy is more likely to be influenced by the ups and downs of the stock market than changes in income-tax rates.
Stock-market performance is the "primary factor that is driving the savings of the top 5 percent of households," said Mustafa Akcay, economist and co-researcher of the savings data.
Federal Reserve Data
The Moody's economists examined saving rates by income groups back to 1989. Their study uses statistics from the Federal Reserve's quarterly Flow of Funds report, which gauges the net worth of households, and the Fed's triennial Survey of Consumer Finances, a measure of balance sheets, pensions and incomes of U.S. families. When tax legislation was signed by Clinton in 1993 — raising the top tax rate to 39.6 percent from 31 percent — the saving rate fell from 12.1 percent in the second quarter to 9.5 percent in the first quarter of 1994. The Standard & Poor's 500 Index rose 1.9 percent from July through September, after little change the previous three months.
When the first Bush tax cuts were signed into law in June 2001, pushing the top rate down to 35 percent, the wealthy boosted savings. The saving rate climbed to 2.8 percent in the first quarter of 2002 from minus 2 percent in the second quarter of 2001. The increased savings coincided with a 1.1 percent decline in the S&P 500 index.
After the second round of Bush tax cuts in May 2003, the rich also increased their saving, with the rate climbing to 7.6 percent in the first quarter of 2004 from 2.2 percent in the second quarter of 2003, the Moody's data show.
The analysis found some similarities across income levels in the 2001 and 2003 data. The wealthy and the remaining 95 percent of Americans both saved more of their incomes after the Bush tax cuts. The saving rate is defined as personal savings as a percentage of after-tax income.
The political debate over extending the Bush-era tax cuts, which expire at the end of the year, is intensifying with the approach of congressional elections in November. Obama, at a White House news conference on Sept. 10, said the push by Republicans to extend cuts for the wealthiest Americans is a "bad idea" because it would cost $700 billion in government revenue at a time of record budget deficits.
Republicans including Senate Minority Leader Mitch McConnell and House Minority Leader John Boehner contend that tax cuts should remain for all and any attempt to target the wealthy — the top 2 percent to 3 percent earners in the country — could hurt growth and investment.
Boehner on Sept. 13 said he was prepared to compromise with the Obama administration and would vote for middle-class tax cuts even if it meant eliminating reductions for wealthier Americans, which he said would be "bad policy."
"If the only option I have is to vote for some of those tax reductions, I'll vote for it," the Republican from Ohio said on CBS's "Face the Nation" program. He added: "I am going to do everything I can to fight to make sure that we extend the current tax rates for all Americans."
Some economists voice caution about the promised effects of a change in tax rates. The nonpartisan Congressional Budget Office in January analyzed policy options and possible short-term effects on growth. "Policies that temporarily increased the after-tax income of people who are relatively well off would probably have little effect on their spending because they generally would be able finance their consumption out of their income or assets without such a change," CBO director Douglas Elmendorf testified to Congress on Feb. 23.
On the other hand, tax relief for families with "lower income, few assets and poor credit would probably" spur spending, he said. Elmendorf said because of job losses and a drop in assets over the past two years more families "probably fit that description now."
Guy LeBas, chief fixed-income strategist at Janney Montgomery Scott LLC in Philadelphia, who follows consumer spending, said it's hard to predict the impact of changes in tax policy. "We don't know what's going to happen when sizeable tax cuts are likely to be reversed," he said. The Bush-era cuts "coincided with a lot of volatile happenings in the U.S. market," said LeBas, including the Sept. 11, 2001, terrorist attacks.
Year of Crisis
Cornell and Akcay also looked at 2009 — a year of financial crisis — and found wealthy Americans again saved less as the stock market revived. High-income earners saved at a 9 percent rate in the first three months of 2009, when the S&P 500 dropped to a 12-year low on March 9. As stocks recovered, the saving rate fell to minus 0.5 percent in the second quarter and remained negative through March 2010.
Cornell and Akcay said higher-income earners were spending more than their disposable income, suggesting they used stock-market gains to support their spending. Interest and dividends account for nearly 8 percent of the household income of the top 10 percent of Americans, according to the Fed's 2007 Survey of Consumer Finances.
Economist Harm Bandholz said discouraging the wealthy from spending could weaken the economy, something Republicans argue will happen if the Bush-era tax cuts expire. "Most of the consumption growth is coming from the higher- income groups," said Bandholz, chief U.S. economist at UniCredit Global Research in New York. "The lower income groups, they are barely living hand-to-mouth."
David Dyson, who co-owns an insurance company in Bethlehem, Pennsylvania, said he's more concerned about the state of the economy than the prospect of a tax increase, which he figures will cost him as much as $30,000. "I have more than enough money to live on and probably will go out to eat as much as I do," said Dyson, 58. On the other hand, he may decide to postpone building an addition to his house. "That's primarily on hold because of the economy, not necessarily my taxes," he said.