February 26, 2023
Many people who should know better have been saying silly things about households running down their savings and being forced to cut back consumption. The problem with these sorts of comments is that savings in our national income accounts have little to do with how most of us think about savings in our lives. Less of the former does not necessarily mean that people will have less money to buy things.
Before going into the specifics, let me just make a point to orient people. Saving in the national income accounts is almost entirely a story of the top half of the income distribution, and largely the top 10 percent.
I recognize that there are tens of millions of people who are struggling to get by, and in many cases not getting by. These people are either not saving at all or, insofar as they are, it has a minimal impact on aggregate saving numbers. The saving rate is not about their story.
Aggregate saving is about the people who have the money and the choice of whether to spend it or not. That is not a good picture, it would be great if we had a far more equal distribution of income so that most people did have the option to save, but we don’t. In an economy where the richest 10 percent of households get more than 40 percent of income, aggregate savings is the story of what these people are doing with their money.
Saving by Burning Money
The key point in this story is the definition of savings in the national income accounts. Savings is simply disposable income (income minus taxes) that is not spent on consumption. From the standpoint of the national income accounts, it doesn’t matter what you did with the money that you didn’t spend on consumption. As long as you didn’t spend it on the consumption of a newly produced good or service, it is treated as being saved.
Savings includes all of the things people typically do with their money that we would think of as saving. So, putting money in the bank counts as saving, as does buying a government bond. Buying shares of stock or a plot of land would also count as saving. We may colloquially describe these purchases as “investment” but we are not buying a newly produced good or service, we are just trading assets (cash for shares of stock or a deed to land), so these purchases do not count as investment in the national income accounts.
People may also save in ways that they don’t think of as saving. If they cashed their paycheck and put a few hundred dollars aside to buy a television or some other appliance, but didn’t get around to doing it, then they have saved this money from the standpoint of the national income accounts.
The same would be the case if they pulled a few hundred dollars out of the bank that they intended to spend but somehow lost the money. If the money remains lost, it is saved from a national accounting standpoint.
This is even true if they deliberately destroyed the money. If someone cashes their paycheck and then burns $1,000 to protest George Santos being in Congress, this will be treated as savings in the national income accounts. They did not buy a newly produced good or service.
Capital Gains are Not Income, Therefore They Don’t Increase Savings
If saving is defined as income that is not spent on a newly produced good or service, then we also need a definition of income. Income in the national income accounts is money generated from services provided in the current year. Most obviously, this would be the wages people get from working. It would also be rent paid on land or housing. It also would include interest and dividends paid on bonds or shares of stock.
However, the capital gains on stock do not count as income. (The same applies to capital gains on houses.) The idea here is that stock prices fluctuate month to month and year to year. If we envision a situation where we had the exact same stock of capital on January 1, 2023, as we did on January 1, 2022, and the same labor force, but the value of the market was 10 percent greater (roughly $4 trillion), there would be no asset (tangible or intangible) that corresponds to this $4 trillion increase in value. Therefore, it does not count as income.
If that sounds strange, consider the opposite situation where the market falls by 10 percent over the course of a year. Would it make sense to deduct $4 trillion from national income as a result?
This is important in the current context because many people sold stock after the large pandemic run-up in the market, and have substantial capital gains as a result. Suppose that a household has a normal income of $200,000 from wages. (Yes, this is a rich household.) If they sold stock last year for $300,000, with a capital gain of $100,000, they would have lots of money in the bank.
However, from the standpoint of the national income accounts, their income is still just $200,000. If their consumption was unchanged, then their measured saving would be the same in the year they realized these capital gains as it had been before.
Actually, the situation is somewhat worse than this. They are supposed to pay capital gains tax on this money. If they pay capital gains tax at the 20 percent rate, then they will pay an additional $20,000 in income taxes as a result of their capital gains. This would reduce their disposable income, which is defined as income, minus taxes.
If their consumption is unchanged, their savings would be $20,000 lower because their after-tax income is $20,000 lower. For the country as a whole, if we have a large sell-off of stock after a big run-up, we will see an increase in taxes, which will mean a lower saving rate, other things equal. We did in fact see a big jump in tax payments in 2022, which explains most but not all, of the drop in savings last year. (The saving rate rose in January, despite the big jump in consumption, due to a sharp drop in tax payments.)
The other part of the story is that households may increase their consumption based on their capital gains. If they used some of their gains to remodel their house, buy a new car, or take a vacation, this would mean they have increased their consumption and reduced their savings. Undoubtedly, this is part of the story of the decline in savings reported for 2022.
This is not sustainable in the sense that we would not expect households will have large amounts of capital gains to draw on every year. But this is not a story of households drawing down their savings in any meaningful sense. If the household with the $100,000 gain, spent on extra $20,000 on one-time expenditures, after paying an extra $20,000 in capital gains taxes, their reported savings would be $40,000 lower than in the prior year, but they would still have $260,000 in the bank from selling their stock. This is to a large extent the story of the decline in the saving rate that we saw in 2022.
Dividends and Share Buybacks: An Inconsistency in the National Income Accounts
While households cannot anticipate large capital gains every year, corporate share buybacks is one case where this view would be wrong. The basic story is that share buybacks are a way for companies to give out money to shareholders as an alternative to paying dividends. Buybacks are desirable from the standpoint of shareholders since the money paid out is not immediately subject to taxes, as is the case with dividends. Shareholders will only pay taxes when they sell the stock at a gain.
This situation leads to an inconsistency in the national income accounts. Suppose corporations pay out $200 billion in dividends to shareholders. This money counts as income for shareholders and as an expense for the companies, which reduces their profits and corporate savings.
However, if they instead pay out this $200 billion by buying back shares, this money is not treated as income for shareholders. That is true even if the shareholders immediately sell their stock and take advantage of the higher prices resulting from the buybacks. From the companies’ standpoint, this $200 billion in buybacks does not count as an expense and reduce their profits. Instead, it is treated as though they purchased an asset (their own stock), just as if they had bought land or shares in another company.
This matters when we look at household saving rates since companies can in fact indefinitely pay out the money that would otherwise go to dividends, in the form of share buybacks. For consistency, we really should count this money as part of household income. This would raise disposable income and therefore increase savings.
The Whole Picture
The figure below shows the reported saving rate from the national income accounts from 2015 to 2023. It also shows the ratio of saving, plus taxes, to total income in the years since 2015. While the Trump tax cut did change this relationship in 2017 and 2018, since 2019 we have had no major changes to the tax code. That means that changes in the relationship between tax collections and income were driven mostly by changes in household income, most notably capital gains income. (There were timing issues associated with the pandemic, but using annual data eliminates most of this effect.)
The third line uses a measure of savings if we count share buybacks as part of personal income. This adds dollar to dollar to savings, since its inclusion does not affect consumption. It also raises income (the denominator), since we have to add share buybacks to the measure of personal income in the National Accounts.
Source: BEA, S&P, and author’s calculations.
As can be seen, including personal taxes (Table 2.1, Line 6) eliminates most of the drop in saving reported for 2023. While the official saving rate shows a drop of 3.6 percentage points from the average for the four years prior to the pandemic to 2023 (7.3 percent to 3.7 percent), using the combined taxes plus savings measure the drop is just 0.7 percentage points (18.6 percent to 17.9 percent). Calculating a saving rate that includes share buybacks as income, there is a drop of just 0.3 percentage points (21.7 percent to 21.4 percent).
In short, if we use measures of saving that are more consistent with both what households actually see, and economic logic, there is very little to the idea that the saving rate is falling through the floor. The plunging saving rate is almost entirely an illusion caused by the failure to think about the issue clearly.
 Much of these gains would in fact be taxed at a rate lower than 20 percent for a family earning $200k.