Believe it or not, Americans used to save about one-tenth of their after-tax income. By the 1990s, that percentage had dropped to less than 5 percent, and from 2003 to 2012 the average savings rate had fallen even further.
We can point to many reasons for this decline. An important unrecognized culprit is the American university — and not just because the costs of higher education have far exceeded inflation. Colleges impose a very high private penalty on savings, giving people incentive to consume rather than save. Moreover, this penalty — call it a tax — has grown substantially over time in a stealth fashion with rising college attendance, soaring tuition charges and more aggressive tuition discounting by colleges.
First, let’s look at the general savings numbers. I examined government data on the personal savings rate over the past 50 years, taking decennial average rates. (Annual data are often overly influenced by the business cycle.) In the period encompassing mostly the 1960s and 1970s, the savings rate was in the 9 percent to 10 percent range. From 2003 to 2012, by contrast, the average savings rate was a paltry 3.8 percent. While international comparisons are a bit tricky for various technical reasons, the latest Organization for Economic Cooperation and Development data I have seen show that the European Union had a notably higher average savings rate than that of the U.S.
People save because they expect their financial outlays to exceed their income at some point, necessitating drawing on accumulated assets or borrowing. The big three items requiring savings are: income for retirement, the purchase of a home and payment of college expenses.
Because people are living longer, the motive to save for retirement has actually increased, so that doesn’t explain falling savings. Indeed, low savings have caused some older Americans with high health-care costs to lose all their assets. Nor do any fundamental changes in housing markets account for the reduced savings. On the contrary, as house sizes have expanded along with housing prices over the years, the motive to save enough for a home has increased.
But college degrees have become the new educational norm, and tuition costs have soared over the past generation, more than doubling in real terms, rising far faster than family incomes. The possibility of financing school through parents’ belt-tightening during the college years, along with student employment, simply isn’t doable now for most. But why borrow, via student loans, rather than save in anticipation of that expense? The colleges brutally punish those who go the savings route.
Consider two young people who have identical potential for success in college based on high-school grades, test scores and so on. Let’s say both are accepted at an upscale private school costing $50,000 a year, or $200,000 for four years. Both kids come from moderately prosperous families with $125,000 in annual income. Student A comes from a family that saved a lot for college by scrimping, buying a modest $200,000 house and paying it off. This family has managed to accumulate $100,000 to defray much of their child’s college costs.
Student B comes from a big-spending family that has a $350,000 house with a big mortgage, and a vacation condo and nice cars, all bought with borrowed money. This family has no college-savings account as a consequence.
Colleges exploit this situation with the assistance of the federal government’s Free Application for Federal Student Aid form, which requires the student to give detailed family financial and other personal information — income, debts, alimony payments, number of other dependent children and their age, and so on. The college uses this information to determine what the student will pay (up to the $50,000 sticker price).
My guess, based on considerable anecdotal evidence, is that the student from the free-spending family will get a tuition discount of perhaps $25,000, while Student A will get only $10,000. Because that will probably apply for four years, Student A will end up paying $60,000 more than Student B — solely because of the $100,000 in accumulated savings. The college is imposing the equivalent of a 60 percent tax on the income saved for college.
Moreover, to save $100,000 for college, Student A’s parents would probably have to earn about $150,000 because of taxes. So out of $150,000 in earnings, their child gets only $40,000 closer to paying for college than Student B.
Between real taxes and the private tax imposed by the college’s anti-savings policies, the financially prudent family has to pay more than 73 percent of earnings, a crushing burden that the free-spending family avoids by consuming, rather than saving their money.
But that isn’t all. Student B is forced to borrow more via the college-loan program, which the federal government subsidizes. The implicit value of that loan subsidy is greater to Student B than to Student A — the federal government implicitly discriminates against those who are frugal and fiscally responsible. This doesn’t even include other anti-saving provisions in federal tax law, such as the impact of double taxation of income at the corporate and individual level.
Surprisingly little academic work has been done on this form of taxation, perhaps because college professors indirectly benefit from this policy. While colleges have raised their sticker prices a lot because of the availability of relatively low-cost federally subsidized loans, they have increased actual fees paid by high-saving families through stealth means, exploiting family-financial information uniquely given to them and not to other sellers of goods and services.
In the interest of promoting higher savings (with all sorts of positive macroeconomic implications, such as lower interest rates and greater capital formation), why doesn’t the federal government abolish the Free Application for Federal Student Aid form and make it a criminal offense to solicit private family-financial information? At the minimum, all information on family finances, other than overall income (which could be provided to colleges by the Internal Revenue Service), would be excluded.
In sum, let’s abolish the stealth tax on savings.