We’ve had the reports back from a few expert working groups now and what was pointed out to me about the tax report, compared to the savings report, is that it had entirely different tax policy recommendations. The Tax Working Group was at pains to align our taxes such that they did not distort peoples’ decisions while the Savings Working Group specifically wanted tax incentives to encourage saving. So who is right? Or can the two views be reconciled?
Let’s think first about what the SWG are saying. They identify a risk to the economy from our high level of foreign liabilities and want increased saving to reduce the risk. So what market failure exists? The most commonly proffered explanation for sub-optimally low saving is that people want to save more but just not today. If that’s the case then there is a good case for the government to give people some incentive to help them save. What the government is doing is helping people to do what they woud do if they didn’t have a problem with self-control. So, if the TWG want to equalise tax rates are they forgetting about that issue?
Well, that would be one explanation but perhaps they’re thinking about it a little more carefully. The best way to overcome the problem of saving too little is to use a precommitment device. Term deposits, savings accounts with withdrawal fees and other such mechanisms allow people to force themselves to save money that they know they’d otherwise spend tomorrow when their self-control waned. If you think these mechanisms are sufficient to overcome the problem then providing incentives to save might actually result in over-saving!
However, some authors argue that these mechanisms are not enough because of how easy it is to get credit these days. Credit cards are so easy to obtain that it’s fairly straightforward to get around the spending restrictions of a term deposit. When you see something you want to buy you just put it on the credit card and pay that off when your deposit matures. In fact, David Laibson’s work suggests that net saving in the US dropped significantly with the advent of easy credit and he speculates that it is for precisely that reason. So perhaps the SWG’s recommendations aren’t out of line with inducing optimal, individual behaviour at all. At least, the best policy is not at obvious.
[Note that these arguments about discount rates don’t necessarily represent the reasons given by the Working Groups: I’m just suggesting that they could explain the position taken on incentive alignment by each Group.]