We are always hearing about the negative US Savings Rate and how we are “living on credit”. It is only a matter of time before our bubble bursts and we are plunged into recession / depression or what ever else negative “sion” they can come up with. Let’s just ignore the number you see. Why? The method used to arrive at number we always see, while accurate 50 years ago, in today’s investor economy gives us a false number. Here is how.
Today savings is calculated as:
Income – Federal taxes – Expenditures= Savings
sound easy enough correct? Wrong and here is why.
1- Excludes capital gains
Let’s say I bought 300 shares of Sears Holdings (SHLD) in 2004 for $23 a share spending $6,9000. Wanting to pay for my kids college, I sold them last month for $180 a share pocketing $54,000 or a profit of $47,100.
According to the current savings calculation, that $47,100 is not counted as income..
2- Includes all Federal Taxes
Now, Of that $47,100 I now have to pay 15% long term capitol gains taxes of $7,050. That tax bill is included in the “taxes paid” portion of the saving equation even though the income that generated it was not.
3- Includes the spending of the gain
The remaining $40,050 that is sent to the college, is now counted as an expendtiture in the calculation..
so for what I just illustrated, the income and expenditures and taxes all equal out to zero BUT, for the National Savings Rate, it looks like this:
Income = 0
Federal Taxes = $7050
Expenditures= $ $40,050
This gives me a NEGATIVE savings on this transaction on $41,000 when in reality, it should be zero.
Another factor? 401k’s
How many retired people are getting an income from a 401K? If you are that numbers is NOT being counted as income, BUT the things you buy with it are being counted as expenditures, giving you an artificial negative savings rate.
Own a home? Has it increased in value? The increase in that value is NOT counted as savings either. When you sell it and have a gain you then roll over into another house, you have the same mythical spending with no income from our stock transaction. The money you put down on the new house and the taxes you may pay on the sale of the old are counted as expenditures but the gain on the sale of the old house is not counted as income.
Perhaps this is then reason that even though we have a “negative savings rate” as a nation, our household wealth is at all time highs?
10 replies on “US Savings Rate: Ignore It”
Great post, but I would be interested in where you got that definition of the savings rate. I have no reason to doubt it, but am just curious.
Andy,
Thank you for reading. I am actually a fan of your site.
http://www.kc.frb.org/publicat/econrev/PDF/2Q06garn.pdf
Todd
Don’t you have to give Barron’s some credit here? This topic was their cover story over the weekend.
Or did you come up with this independent of their story?
Anon,
thank you for reading. I think if you read both, mine is totally different and gives a much simpler example for people to read. the link in the prior comment is where my research came from.
on another note, we all cover various topics during the day and they invariably overlap, it is the take on the subject that matters (how many posts on Google and it search #’s have you read today). Barron’s really did not have an opinion (I think anyway) but I clearly do
I agree that the formula is off, but spending your 401k is dissaving. Housing is consumption because it is not a productive asset. Just because home prices rise doesn’t make it savings, the costs of property taxes and insurance wipe out much of the gains.
For most people, Income-Taxes-Expenditures=Savings is correct. In your example, you sell the SHLD to pay for education. But how did you buy it? With a previous year’s savings. (Just like someone had to save money this year pay for the SHLD you sold them.) But when dissaving is going on year after year, that means the amount of assets is declining. The only explanation that is not bad news is boomers retiring.
matt,
i think you missed it. the formula is correct, but they are not counting all the income.
the capital gains are taxed as income, but not included in the formula, that artificially lowers the rate.
when i bought the stock, that purchased was included in the expenditure, the gain from it was not recognized..
when the formula was determined 401K’s did not exist and almost no one owned stock, bank accounts were the only savings..
today’s reality is far different
If I cash in a $5,000 CD and buy furniture, the $5,000 is not income. Similarly, if I have $50,000 in MO, and $35,000 of that is capital gain, it doesn’t change the fact that I have $50,000 in assets at the moment. I understand the tax issue, but they should just back out capital gains taxes from the equation. It’s an act of dissaving, shifting capital from a productive resource to a destructive one, when one consumes.
matt,
no the $5000 is not, you are correct. but the interest is income.
i don’t care if they back out the taxes or included the income but the way they do it now, they are only including 1/2 the equation which is wrong.
Discounting Inflation in your proposed equation, you have an apprehension that stocks and housing prices would always go up. Recession being part of the reality of a market economy would
usually decrease the value of these assets therefore depressing the national savings rate further in a bad economy. The savings rate computed right now would be the best way possible to measure a person’s liquidity in this kind of scenario.
Well even if recessions don’t exist
Do majority of Americans invest in stocks per se as illustrated in #1, and see their houses as investment or just a place to call home?
Unless the majority are not working
a 9-5 job with a median household income of $50000, the proposed equation wouldn’t picture the savings rate of an average American.
anon,
thank you for reading. i am not making any assumption on value, just that the realized profits or losses should effect the income portion of the equation that the tax effect does.
my point here is that any formula that only considers 1/2 the equation is incomplete and therefore provides an inaccurate picture