TaxProf Blog

Editor: Paul L. Caron, Dean
Pepperdine University School of Law

Friday, March 3, 2017

Weekly SSRN Tax Article Review And Roundup

This week, Erin Scharff (Arizona State) reviews a new article by Andrew Hayashi (Virginia) and Daniel Patrick Murphy (Virginia), Savings Externalities in a Second-Best World (Virginia Law and Economics Research Paper No. 2017-03):

Scharff (2017)We live in a brave new world of indefinitely low interest rates.  When I teach my basic tax students classic tax shelter cases, they are often shocked by the interest rates then available to the taxpayer. For many of my students, who began college well after 2008, the idea of significant interest income from a savings account is quite foreign. 

Hayashi and Murphy’s fascinating new paper explores the ways this new world of the Lower Zero Bound might affect our appraisal of savings incentives in the tax code and beyond, and along the way, they make a case for considering macroeconomic consequences of tax policy more broadly, following some recent work by Yair Listokin, among others.

Their paper begins by providing a concise overview of two traditional justifications for tax-induced savings and savings default interventions.  As they write, “private savings are invested by institutions where they are deposited and investment leads to increased economic growth, which is good for everyone.”  The second justification is rooted in the now familiar behavioral economic insight that many of us are grasshoppers, and not ants.  (Those reading carefully might note the paper’s second footnote is a citation to Aesop, which always makes me wonder how classical economic assumptions ruled for so long.) 

In the next two parts of their paper, Hayashi and Murphy show how “everything is upside down in the Zero Lower Bound,” and the justifications for savings interventions fall apart. When interest rates approach zero, savings may not increase investment but instead remain as cash. And because consumption spending may increase economic activity, savings can create a negative externality. In such an economic climate, it’s the grasshoppers among us who are best equipped to offset this externality. 

Challenging the conventional assumptions justifying tax-induced savings provisions would be contribution enough, but the authors admirably also suggest some ways their macroeconomic perspective might inform the design of savings incentives. 

They argue that the best way to do this is to design incentives that have automatic stabilizers, rather than rely on a dynamic legislative response to changing economic conditions.  By applying these macroeconomic to savings incentives, Hayashi and Murphy suggest more precise countercyclical tools.  As they note, “[w]hereas other scholars focus on how to increase income transfers to households from the government during downturns; we describe how the law can help those transfers multiply most efficiently to generate additional income.”

The paper suggests several ways that we might adjust current savings incentives to respond to macroeconomic conditions, such as tying the contribution limits to 401(k)s to the interest rate or, more directly, tying the tax rate on new savings to economic indicators like the interest rate or unemployment.  On the defaults side of the equation, they suggest ways of adjusting default contributions in response to changes in the economy.  Most intriguingly, they argue that macroeconomic concerns may justify a progressive rate structure for Social Security, noting that because of the income cap, as wages fall, FICA grabs a greater percentage of household income. 

The article makes a persuasive case that encouraging savings in the Zero Lower Bound is likely bad policy. I wonder, however, how quickly we want savings decisions to respond to macroeconomic conditions.  I’m reminded of the number of times I’ve heard or read that the best savers make savings a habit.  Would such responsive policies undermine the ability of these savings incentives to work as well once interest rates rise and the economy looks “more normal?” 

Maybe the answer is the potential downside of a protracted period of low interest rates and a stagnant economy suggest that is a risk well-worth taking.  But if anything, the article makes me more sympathetic to the authors’ most radical policy suggestion, eliminating these savings incentives entirely. 

More broadly, the authors make a strong case for considering the macroeconomic affects of tax provisions as part of the standard policy analysis, and they make the case quite accessible for readers without economics degrees. 

Here’s the rest of this week’s SSRN Tax Roundup:

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