US Savings Rate Based On Outdated Methods of Calculation

We are always hearing about the negative US Savings Rate and how we are "living on credit." It is only a matter of time before our bubble bursts and we are plunged into recession / depression or what ever else negative "ssion" they can come up with. Let's just ignore the number you see. Why? The method used to arrive at a number we always see, while accurate 50 years ago, in today's investor economy gives us a false number. Here is how.

Today savings is calculated as:

Income - Federal taxes - Expenditures= Savings

Sound easy enough, correct? Wrong - and here is why:

1- Excludes capital gains

Let's say I bought 300 shares of Sears Holdings (SHLD) in 2004 for $23 a share spending $6,9000. Wanting to pay for my kids college, I sold them last month for $180 a share pocketing $54,000 or a profit of $47,100.

According to the current savings calculation, that $47,100 is not counted as income.

2- Includes all Federal Taxes

Now, Of that $47,100 I now have to pay 15% long term capitol gains taxes of $7,050. That tax bill is included in the "taxes paid" portion of the saving equation even though the income that generated it was not.

3- Includes the spending of the gain

The remaining $40,050 that is sent to the college, is now counted as an expenditure in the calculation.

So for what I just illustrated, the income and expenditures and taxes all equal out to zero. BUT, for the National Savings Rate, it looks like this:

Income = 0
Federal Taxes = $7050
Expenditures= $ $40,050

This gives me a NEGATIVE savings on this transaction on $41,000 when in reality, it should be zero.

Another factor? 401Ks.

How many retired people are getting an income from a 401K? If you are, that number is NOT being counted as income, BUT the things you buy with it are being counted as expenditures, giving you an artificial negative savings rate.

Own a home? Has it increased in value? The increase in that value is NOT counted as savings either. When you sell it and have a gain you then roll over into another house, you have the same mythical spending with no income from our stock transaction. The money you put down on the new house and the taxes you may pay on the sale of the old are counted as expenditures, but the gain on the sale of the old house is not counted as income.

Perhaps this is then reason that even though we have a "negative savings rate" as a nation, our household wealth is at all time highs.

Comments

[7c-ranch:]

Everyone, I thought, knew this. It is curious that we are just now publicly recognizing that Americans do save.

2007 May 30 11:34 AM

[Futures Lover:]

My Monetary Economics professor told the class that the reason why the Federal Government did not include the profit from stock and house sales were due to the fact that they did not have a reliable way to calculate the "profit" of the sale from the data provided by all sources. In hind sight, it would take too much manpower to generate a number from IRS tax returns in each year. Maybe with the computers that are currently in place, we might be able to, if a valid equation can be devised. Can you imagine the headache in tracking of each house that is bought, sold, refinanced, foreclosed and then resold to a new buyer? Stock data is even worse as according to GAAP accounting rules, depending on how you purchased the shares of an individual stock depends on how you calculate the price per share you paid (dollar cost averaging). So, this is why the Federal Government has done this and yes, it is not an accurate picture of what Americans do to "save" - savings account, buying stocks or bonds, or purchasing a house. BTW, I read in Barrons (or maybe WSJ) that your house is not an "investment" like stocks or bonds. I agree, as it is very ill-liquid. I personally agree that owning one's home is a much better use of one's housing dollars on a yearly basis. I would consider rental property that is leased out to generate income as a valid "investment" where Real Estate is concerned. Living in a duplex and renting out the other side usually can be very profitable if done correctly. With Real Estate values falling, a savvy investor can do this and have the majority of their housing costs covered over time.

2007 May 30 04:42 PM

[rhodope:]

Capital gains from stocks seems like a weak leg of that argument. Assuming that "The richest 10 percent own 85 percent of all stock" The top 10% are reaping 85% of the benefits of owning stock. How many Joe sixpacks own stocks, let alone do so profitably. On the whole though I thank the author for opening the door on an issue I think needs further development.

2007 May 30 05:35 PM

[Paul Meisel:]

The number of people with 401K, 403B, and IRA holdings is enormous and most of their profits are as yet unrecognized capital gains.....

Which renders the traditional savings measurement worse than useless.

2007 May 31 09:38 AM

[Bruce Merri...:]

After over 200 years, by 1980, household American wealth totaled about $3 Trillion. Now it totals about $56 Trillion. Approximately 94% of all houshold Americam wealth has been created just since 1980, and has been continuing to rise at the rate of about $3 trillion each year. This in effect, is a macroeconomic index of both "saving" and "productivity, both of which our current Governmnent data hopelessly mis-calculate.

Bruce Merrifield

2007 May 31 11:13 AM

[Alex S.:]

"Let's say I bought 300 shares of Sears Holdings (SHLD) in 2004 for $23 a share spending $6,9000. Wanting to pay for my kids college, I sold them last month for $180 a share pocketing $54,000 or a profit of $47,100.

According to the current savings calculation, that $47,100 is not counted as income."

The situation described is indeed an example of negative savings.

When you sell stocks that you had previously bought, you are not making income--you are taking money out of savings in the exact same way as when you take money out of a bank account, a CD, or any other financial instrument you can think of.

The act of savings is giving cash to a second party today in exchange for some expectation of appreciation (understanding that there is some variability and potential for loss). From a macroeconomic standpoint, this is what we care about, because households saving money drives capital formation by firms.

2008 Jun 27 11:41 AM

[JasonC:]

The last comment on this old article is correct, the example is dissaving. Moreover, the new stock buyer had to pay for the funds the dissaver used, somehow. If that new stock buyer saved them out of income, then there is dissavings by the seller and savings by the buyer, net savings, zero. If instead he sold other stock to fund the purchase, it only changes which position one requires savings to finance. If instead a position along the chain is financed by increased margin debt, then net new financing can be substituted, but forms (correctly) a net dissavings.

The original author's mistakes are (1) to confuse his personal accounting with society wide accounting and (2) to confuse savings, an allocation within income, with the change in wealth. Net savings are one input to the change in wealth - they change the *book value* of wealth. But what wealth is worth today to investors today is up to them, and varies with their time preference aka the rate they discount future cash flows etc.

By the same token, the reduction in asset values now occurring is *not* a form of dissaving. Every stock and every debt is owned now as it was last year. Every future cash flow they represent claims against, they are claims against just as they were last year. The future cash flows of American business are always owned, and owned exactly once, and no change in the *price* of security claims against them, can change the actual future cash flows so owned, by one dime. Whether upward or downward. The poker games and ponzi schemes among investors all net to zero.

Only what the businesses themselves actual earn and pay out to their owners - as dividends, or cash paid in share buybacks, or cash takeovers, or interest - are actual net payments to investors as a group. And those pass through their *income* statements. Until they do, there is no particular reason to believe the valuation put on them one day, as opposed to some other day, which will vary with every fluctuation of interest rates, risk premiums, investment fads, etc.

2008 Dec 05 02:38 PM