Day Trading & Forex Forum

Could it be that people are saving more because they are being taxed less? Logically, this makes sense because people will have more ability to save and invest if they are having less in taxes withheld from their paychecks. The positive impact for investing can not be overstated assuming that the tax cuts are made permanent, because it suggests that going forward there will a growing supply of investment dollars available to be allocated into stocks, bonds and other assets classes.

Figure 1

An alternative explanation offers the absurd rationale argued by some economists who claim that people save more after a tax cut because they believe they will be taxed more in the future, and so they want to put aside savings for that purpose. But this makes about as much sense as saying that people saved less during the years when the government was running a budget surplus because they figured they could rack up consumer debt and spend with impunity because future tax cuts would allow them to pay down their credit card balances. Government tax receipts climbed to a post WWII high of 20.85% of GDP in 2001. This suggests that despite making record net tax payments to the government, individuals continued on a consumer spending binge by going deeper into debt. The chart in Figure 2, which graphs a ratio of total consumer credit to disposable personal income, lends support to this view.

Of course, an increase in private sector borrowing would translate into a net decline in savings. But, why would a government budget surplus cause private borrowing to go up? The answer to that question may not be intuitively obvious, but one thing is clear; consumer spending continued at a robust pace even as total consumer credit, as tracked by the Federal Reserve, consisting roughly two thirds of auto loans and one third revolving credit card debt, started to pitch sharply higher in the mid to late 1990’s. It will be interesting to see as the data becomes available for fiscal year 2003, if the ratio of consumer credit to personal income starts to trend down again. This would be consistent with the recent upturn in the savings rate seen in Figure 1.

Figure 2

So, if past is prelude to the future, and the latest government forecasts of a federal budget deficit approaching $525 billion for 2004 fiscal year are borne out, it implies that consumer debt loads will ease and private sector savings will continue to rise. By extension, this means that the markets will receive fresh infusions of capital to be invested in the year ahead as more investors feel comfortable enough to go back into the water seeking the higher after tax return on capital from the new and improved low tax rate environment.