Relationship between personal savings and taxation

Relationship between personal savings and taxation

 

There are many reasons why people choose to save money in a depository institution such as a bank, savings institution, or credit union that accepts deposits and grants loans. These reasons include: interest income, the safety of deposits, meeting household expenses, and preparing for retirement (Canto & Laffer 2003). Money saved in a depository institution earns interest. Interest is the return that savers receive for their deposits. The interest rate is stated as a percentage; hence the interest rate could be expressed as 2%, 3%, and so on. Interest rates vary depending on the type of savings account one chooses to open and on the depository institution that a person chooses do business with. When credit card bills appeared each month, people found themselves spending not only their disposable incomes on these bills, but also their savings. The decline in personal savings is a cause for some concern, particularly for households that have no savings cushion for emergencies or unanticipated expenses. Despite the decline in the personal savings rate there are other sources of savings in the nation’s gross savings rate. On the income side of the national income identity, which equates total output, incomes and final expenditures, the savings and profits of the household sector are the balancing item. If demand and output grow slower than expected, then profits automatically decline to balance the books (Faille & O’Connor 2000).

 

In national income accounting practice, as has been indicated, personal savings are estimated as a residual that matches estimated expenditure with estimated income. The difference between income and expenditure is defined as personal savings. Furthermore, in practice, it is extremely difficult, if not impossible, to separate the business from the other economic activities of households. For this reason, unincorporated businesses are regarded as part of the household sector. Thus, the retained profits of unincorporated businesses end up as part of personal savings. Any statistic derived as a residual, or balancing item, is unlikely to be very reliable. Any errors in estimating the other items will be reflected in the residual which make measures of personal saving not especially reliable (Fox 2002). Both the Keynesian and the supply-side approaches predict that a reduction in tax rates will stimulate the economy. However, the source of stimulus is quite different. In the Keynesian framework, the reduction in tax revenues and the consequent increase in disposable income lead to higher aggregate consumption, which through the multiplier effect leads to an increase in overall economic activity. In a supply-side framework, the stimulus originates in the reduction of tax rates, which yields higher rates of return to market activity and hence increased output. A reduction in income tax rates also increases the rate of return to saving, which results in a postponement of current consumption. As a result of higher real after-tax return, aggregate consumption would be expected to decline below where it otherwise would have been. The lower tax rate will result in higher after tax rates of return of existing and new machines (Tanzi 2000).

 

The reduction in distortions will result in a more efficient economic system, the result being a higher level of output from existing physical and human capital. This higher output will result in an upward revision of existing physical and human capital. The tax rate cuts will result in a rise in private wealth. The rise in private wealth will increase the permanent consumption level of the economy, and, as a consequence, saving out of current income will decrease. Tax rate increases will have the opposite effect. The experience of the United States during the last two decades indicates a negative relation between changes in household net worth and the personal savings rate (Kantor 1997). Governments generally attempt to cover their public spending through taxation. Reflecting their own specific preferences, different countries are likely to perceive their public expenditure needs differently. Some governments wish to spend more than others. As a consequence, they aim at raising a higher share of national income or of gross domestic product (GDP) in tax revenue. The higher the tax rate, the lower the propensity to save. This implies that there are two fundamental aspects to the taxation of capital in an integrating economy: the extent to which the playing field is being leveled, and the tax rate at which the field is leveled. A less fundamental but still very important aspect is the extent to which the field that determines the rates at which personal savings are taxed is also being leveled. Even in the USA, with its highly developed capital market and relative tolerance of debt, as well as a tax system that allows borrowers to deduct the interest expenses of borrowed capital and not the opportunity cost of equity capital, corporate savings are far more important than personal savings (Dixon 1999). Personal savings are being taxed by the government since it adds to the income levels of a country. For each country a different rate of tax is being implemented. The tax from one personal savings is added to the tax of another, together this contributes to government funds and finances to build the things needed by the citizens of a country. Taxation of a personal gives a problem to individuals since it gives them added expense and it reduces their savings. 

 

References

Canto, VA & Laffer, AB (eds.) 2003, Monetary policy, taxation

and international investment strategy, Quorum Books, New York

 

Dixon, J 1999, Social security in global perspective, Praeger,

Westport, CT.

 

Faille, C & O’Connor, DE 2000, Basic economic principles: A

guide for students, Greenwood Press, Westport, CT.

 

Fox, WF 2002, Sales taxation: Critical issues in policy and

administration, Praeger, Westport, CT.

 

Kantor, B 1997, Understanding capitalism: How economies work,

Boyars/Bowerdean, London.

 

Tanzi, V 2000, Taxation in an integrating world, Brookings

Institution, Washington, DC.

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