President Bush Set to Unveil New Plan to Promote Savings

I am very excited about the prospects of creating these investment vehicles. It's hard to not like this plan. As an aside, the WSJ reports that Fed data indicates that the wealth of American families has almost been restored to 2000 levels, when the market peaked.

The Next Tax Cut

It's hardly news that Americans save too little. Yet for the past two decades, while the personal savings rate has headed mostly down, politicians have mostly only remarked (or despaired, depending on temperament) on that fact.

But now it looks like somebody is going to do something about it. Our good friend, Mr. Rumor, has it that on Tuesday night President Bush will revive the proposal for two new tax-exempt savings accounts in his State of the Union address.

The first, a lifetime savings account, would allow individuals of any age and any income to contribute up to $7,500 a year. Interest and investment income would accumulate tax-free and withdrawals could be made at any time, for any purpose, without a tax penalty. Permitting tax-free withdrawals distinguishes this account from the current, more specialized, medical or education savings accounts by offering savers immediate, penalty-free liquidity.

The second, a retirement savings account, would be similar to a Roth IRA but much more powerful. Like current IRAs, withdrawals would not be permitted until a certain age is reached. Interest and investment income would grow tax-free and withdrawals would also be tax-exempt. But the new account would more than double the contribution to $7,500 a year, per individual, and has no income caps for eligibility. (Currently, to be eligible for a Roth IRA, joint income cannot exceed $160,000.)

These new accounts make a lot of sense. Right now serious savers are confronted with six vehicles: three types of IRAs and three types of specialized education or medical accounts. Each has different requirements and complicated restrictions. Having only two accounts would vastly simplify things. The old accounts could be converted into the new accounts. And the new accounts permit greater savings since, combined, they would permit individuals to sock away $15,000 a year -- a number that will be indexed for inflation.

The new accounts are part of the Bush Administration's drive to create an "ownership society" and to help sell the idea of reforming Social Security. The notion is that as Americans become more familiar, and thus comfy, with private accounts for retirement savings, personal Social Security accounts won't be scary.

Sure. But we can think of another reason to expand tax-exempt savings. Anytime something is taxed, less of it is produced. Just as taxing labor income (as is done through the income tax) results in less labor being offered, taxing savings results in less saving and investment.

People who save must pay taxes on money in the year it is earned and then year after year on the returns generated by that money. A country that taxes savings will produce less savings and, no surprise, might find itself with a drooping savings rate. At some point, capital formation will suffer and growth will not be as robust as it might have been absent the tax on saving.

On the other hand, if a country removes disincentives to save and invest, people will save and invest more; capital formation will be strong and growth faster. That's why we especially like the fact that there are no income caps on either account. Since the rich have more money to save from disposable income, allowing them to shoot for the rafters would turbocharge the impact.

Taxing savings also weakens the economy by creating distortions and inefficiencies. Under the current regime, people spend vast amounts of time scheming to convert unspent money into nontaxable income and putting billions of dollars into suboptimal tax shelters.

Mr. Bush's plan is far superior to anything the Democratic candidates for his job have offered. Most of their plans are nothing more than disguised income redistribution. North Carolina Senator John Edwards, for example, has suggested the federal government subsidize savings by lower-income families, dollar for dollar, with no breaks for upper-income ones.

Mr. Bush's opponents will resort to their usual rhetoric of class warfare, calling the new savings accounts a giveaway to the rich. And, as usual, this critique is bogus. The incontrovertible economic fact is that the higher level of national savings generated by the new accounts will benefit everybody.