Personal Savings Up, National Savings Down
Saving is the engine that drives long-run economic growth by providing funds for investment in capital and projects, which then produce output in the future. Since the early 1980s the personal savings rate, the fraction of after-tax (or disposable) income households save, has trended downward. Household savings end up as investment either directly, like when a household directly purchases equity, or indirectly, when a household puts its savings in a bank, which uses those funds for lending.
In 1982, the personal savings rate was nearly 11 percent of disposable income. In contrast, by 2005 personal savings represented only 1.4 percent of disposable income. This steady decline in the savings rate of U.S. households has concerned economists, so it may be seen as promising that the trend reversed direction during the latest downturn. In 2008, the personal savings rate rose to 2.6 percent and in 2009 reached 4.3 percent, its highest level since 1998.
To understand the reason for this uptick, it helps to know how the savings rate is calculated. The personal savings rate can be expressed as one minus the ratio of household personal outlays (that is, spending) to disposable income (personal income minus personal taxes). This leads to the following simple equation:
This equation shows that changes in the personal savings rate must be associated with at least one of the following: increased personal income, reduced personal outlays, or decreased personal taxes. Let’s take a look at the trends in each of these components in turn.
Over the past five years, personal income growth has slowed. Personal income grew at annual rates of 7.5 percent in 2006 and 5.6 percent in 2007, but following the onset of the last recession, income slowed to 2.9 percent in 2008 and fell in 2009 to −1.7 percent. Taken in isolation, a declining trend in personal income reduces the personal savings rate. Since the personal savings rate has risen, the cause for the increase must be found in the other two factors.
Turning to the second component, personal outlays, primarily households’ expenditures on consumption goods and services, have also declined, though less precipitously than personal income. After growing at an average annual rate of 5.7 percent from 2005-2007, personal outlays grew in 2008 by only 2.9 percent, and in 2009 shrank slightly (−0.6 percent). A decline in outlays does move the personal savings rate upward, but it cannot be the main factor behind the rise in the rate because personal income fell by an even greater percentage.
The rise in the personal savings rate then must be driven by the third component, personal taxes. The tax cuts in the 2008 and 2009 stimulus packages caused personal current taxes to fall by annual rates of 3.9 percent and 23.1 percent. This decline in tax liability more than offset the fall in personal income, meaning disposable income rose by 3.9 percent and 1.1 percent in 2008 and 2009, respectively. The positive growth in disposable income generated by these large reductions in tax liabilities, combined with the modest reductions in household expenditures, has led to the recent increase in the personal saving rate.
One may wonder if this change in household savings signifies a long-lasting change in households’ saving behavior. For now, the answer is not certain. Surely, some of the decline in consumption expenditures has been caused by the sizeable downward adjustments to households’ net worth from the financial crisis. As the economy recovers and net worth increases, households may revert back to their previous low levels of saving. We cannot look to persistent increases in disposable income from tax breaks to keep increasing the personal savings rate either. The federal government cannot continue to shrink tax liabilities at the current rates because it must manage future budget challenges. Over the long term, increases in the personal savings rate must come from reductions in household consumption relative to income, not from short-run tax breaks.
Finally, we should consider whether the current increase in private savings has had much impact on national savings. National savings consists of personal, business, and government savings. Of these, personal savings has made up nearly 55 percent of net savings by the private sector over the last thirty years. Yet despite the rise in the household savings rate and a similar rise in business savings, net national savings have declined rapidly. In fact, in 2008 net national savings became negative for the first time since the Great Depression. As a result, the shortfall in national savings must be made up through borrowing and investment from abroad. The costs to the U.S. of using more foreign financing are that a fraction of the gains from future growth must be paid back.
How is this decline in national savings possible given the documented rise in household and business savings? The answer is that government savings has become so negative that it overwhelms the savings of the private sector. This has been due in large part to increases in government spending, but the reduction in government tax revenues has also played a role. The recent gains to personal savings from decreased tax liabilities to households were completely offset by corresponding losses to government savings from reduced tax revenue.