The problem with savings is that they can be taxed

Today’s Saturday View show on RTE (about 35 minutes in) carried a Vox Pop asking why people were saving so much. They said: “I’m worried about my job”, “I’m worried about them cutting my wages because I’m a public sector worker”, “I don’t know what’s going to happen so I’m watching every penny”. The savings rate is now so high in Ireland, the Minister for Finance is asking us to get out and spend. Prof. Brian Lucey made the following point to Minister Roisín Shorthall: “Tell us your plan so we can make ours. Otherwise we have to plan (save) for the worst”.

Following on from a previous post, I’d like to discuss savings, the savings rate, and a potential tax on those savings from our cash-strapped government in the light of their stated plans. The government has publicly committed to neither raising income taxes or cutting social welfare. The budget deficit—the difference between the government’s spending and income—will be 15 billion euros if the cost-cutting measures from the last budget are fully implemented. The government spends roughly 1/3 of its income on wages and pensions, 1/3 on social welfare payments and other transfers, and 1/3 on everything else. Given that everything else is getting squeezed through the EU/IMF austerity programme, and the 1/3 on social welfare payments is now protected, then the 1/3 on wages and pensions seems likely for a chop. Further decreases in wages to public sector pensions have been ruled out under the Croke Park Agreement. Something has to give if the budget deficit is to be narrowed.

Both of the non-Irish readers of this blog may not know that the media in Ireland sometimes functions as a gigantic focus group organizer for public policy. So, ‘a source’ floats the idea, in rough form, to the media that property and carbon taxes are being considered. The media then report the strength of the public backlash, through talking heads — often paid by special interest groups–; the odd celebrity economist and media debate on radio phone in shows (the joe-duffy effect). Through this ad hoc consultation process the government knows if their idea is a runner or not. Look for the next idea being floated, they normally come out about once a month. This blog looks at one possible ‘floater’.

Given the scale of the problem, and the government’s commitment to following a programme of austerity mandated by the EU and IMF, the fact that the government has publicly committed to keeping wages in the public sector, fixed, no new income taxes, and no cuts to social welfare, could an increase in taxes on savings be under consideration?

Savings equal investment in the classic textbook analyses every sorry economics undergraduate has to plough through. When the rate of savings goes up, that means people are consuming less today, in order to consume more tomorrow. The act of stuffing the money into a bank rather than buying a big screen TV tends to depress consumption today and increase it tomorrow, especially if there is no functioning credit distribution mechanism to translate savings into investment, as is the case in Ireland.

Savings go up for all kinds of reasons. Sometimes the real interest rate on deposits is high enough to ensure people would like to keep some of their money in interest-bearing deposits rather than blowing it all in a shop. At other times, people will save as a precaution, to provide a buffer between themselves and hard times. Different countries have different approaches to saving. John Maynard Keynes wrote about the ‘paradox of thrift’. The paradox of thrift is a fallacy of composition, wherein each person in an economy, suddenly deciding to begin saving 20% of their incomes, will depress national income by 20%, even though they are helping themselves (and the economy) in the long run. Keynes’ point was that too much saving at the wrong point in the business cycle can be a bad thing. Finally, some cultures have historically saved much more than others. For instance, Chinese savings rates have been as much as 20 times higher than US savings rates in the past decade, depending on the year you look at, of course.,.

Let’s think about the second order effects of savings increases. If everyone saves more, demand for goods and services  drops, which leads to increased unemployment as firms lay people off, leading to further decreases in demand and increases in uncertainty and precautionary saving.

Then there’s the European dimension. I’ve already pointed out that countries have different attitudes to saving. So if German citizens save more today, Irish people don’t see demand for their goods and services. More attention needs to be paid to savings rates in the EU, especially by region. Too often we worry about inflation and unemployment—and these are important, of course—while neglecting other economic indicators, like the savings rate.

The chart below shows the household net saving ratio from 2005 to 2012. We can clearly see Germany maintaining its level of savings throughout the period, with Ireland and Estonia experiencing dramatic changes in savings behavior as a result of the economic downturn. Estonia in particular experienced a large change in its net saving ratio from -11% in 2005, meaning Estonia hoovered up the savings of other nations to consume, to +5.4 in 2012. Ireland saved only 0.03% in 2007, only to watch that ratio shoot up to 14.4% by 2012. (Click the image to enlarge it).

So Irish people have cash in the bank, or are paying down debt at a fast rate, as do Estonians. German behaviour hasn’t changed much at all. This is important because cash-strapped governments are looking to tax holdings of wealth to balance their budgets. Could an increase in taxes on savings be on the cards? I certainly think so, given the large amount of savings projected to be here in 2012.

(An edited version of this will be up on the Guardian blog at some point)

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