Outlines the two main measures of personal savings and their limitations in accurately reflecting Americans' savings over the last twenty years, and discusses an alternative measure that includes capital gains in household savings

Rudolph G. Penner

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what’s left out of personal disposable incomeafter spending on consumption, non-mortgageinterest, and donations to charities, nonprofits,and other entities. Disposable personal income isdefined as personal income after all taxes arepaid. But, at a closer look, what the NIPA consid-ers personal income is different from what anordinary household might consider income.For one thing, the NIPA measure of savingdoes not include capital gains on assets, such asstocks and bonds or housing. Certainly a house-hold that enjoys a capital gain would think of it as income and, if the money isn’t spent, thehousehold would think of it as savings. The ex-perts who compile the NIPA do not count capitalgains because they are interested in the resourcesavailable for investment. If you sell a stock thathas appreciated $100, the person buying it has todip into his or her savings $100 more than if thecapital gain had not occurred. Therefore, the cap-ital gain brings no net increase in national savingand no extra resources for investment. However,the capital gain has certainly made the seller bet-ter off.Although capital gains are not included inpersonal income, taxes paid on realized capitalgains are deducted from before-tax income to getdisposable personal income. This seems odd tosay the least.2The treatment of pensions is also controver-sial. Employer contributions to defined contribu-tion and defined benefit plans are consideredcompensation. The contributions are, therefore,included in personal income, as are the interestand dividends earned on pension accounts.3Pension accounts, however, cannot be accesseduntil age 59 or older without paying a tax penalty.Thus, households may not regard pension contri-butions and earnings as personal income untilthen because that money is not as accessible.Households may be more likely to consider pen-sion account withdrawals as income, and wouldlikely regard any money that is not spent as sav-ing. Even though withdrawals are not consideredincome by the NIPA, taxes paid on withdrawalsdo reduce disposable personal income.Guidolin and La Jeunesse (2007) argue thatthe treatment of defined contribution plans isMeasuringPersonal Saving: A Tale of AmericanProfligacyRudolph G. PennerThe United States appears to be a nation ofspendthrifts.1 Official measures suggest that per-sonal saving has been declining and some believethat we’re not saving enough for our own retire-ments, given longer life expectancy and rapidlygrowing out-of-pocket medical costs (Bernheim1992; Skinner 2007). And because we’re not sav-ing as much, we’re not doing as much to provideresources for investment, which is financed bypersonal, government, and business savings andborrowing from abroad. Investment adds to ourcapital stock, which helps increase worker pro-ductivity and, ultimately, the wages and livingstandards of current and future generations.Relative to our incomes, we are not leaving asmuch to our children as our parents left to us.Just how little are we saving? The answer isnot obvious. There are two different prominentmeasures of the saving rate—the National Incomeand Products Account (NIPA) measure and theFlow of Funds (FOF) measure. Both suggest arapid decline in saving over the past 20 years, but neither exactly conforms to what most house-holds probably think of as saving. Moreover,other, less prominent ways of looking at savingimply Americans are less profligate.National Income and ProductsAccount MeasureThe measure of saving receiving the most public-ity comes from the National Income and ProductAccounts (NIPA), which defines the personal sav-ing rate as personal saving divided by personaldisposable income. Personal saving is defined asURBAN INSTITUTE Brief Series • No. 21 • May 2008T H E  R E T I R E M E N T  P O L I C Y  P R O G R A M T H E  R E T I R E M E N T  P O L I C Y  P R O G R A M2 May 2008logically consistent, but they question the logic of treating defined benefit pensions in the samemanner. With a defined benefit plan, the em-ployer makes all investment decisions and takesall investment risk. If the defined benefit planearns a surplus, that surplus is not passed on toemployees but nevertheless shows up in em-ployee personal income when it is earned. Later,the employer may reduce contributions becauseof past surpluses, and this would show up as areduction in the employee’s compensation. Theemployee very probably ignores these ups anddowns in measured personal income and is onlyinterested in the expected present value of hispension, which is relatively constant.It may be preferable to ignore defined benefitcontributions and earnings when they occur and,instead, to add them to disposable income whenthey are received. However, the authors pointout that doing so would have a negligible effecton the measured NIPA saving rate.4Purchases of durable goods, such as automo-biles, are not included in saving. Including themnet of depreciation would raise the net savingrate by about 10 percentage points, but it wouldalso raise investment. Therefore, it would notease concern about Americans’ failure to financecurrent investment levels.5The NIPA measure of personal saving is notvery accurate. Personal saving is estimated as thedifference between two very large numbers—disposable personal income and personal outlays. Very small proportionate errors in mea-suring these two items can lead to huge propor-tionate errors in measuring personal saving. As a result, personal saving estimates are oftenrevised by large amounts as the NIPA measure isrefined with more accurate measures of dispos-able personal income and personal outlays.Flow of Funds MeasureThe second measure of saving is derived fromthe Flow of Funds (FOF) tables published by theFederal Reserve Board of Governors. Annualhousehold saving is measured by the net acqui-sition of real and financial assets minus theincrease in household liabilities. The Board ofGovernors provides two measures—one thatincludes net investments in consumer durablesand one that does not. Conceptually, the mea-sure that does not include consumer durablesshould lead to the same result as the NIPA mea-sure. However, significant discrepancies arisebecause the two measures are compiled usingdifferent data sources and there are minor def-FIGURE 1. Personal Saving as a Percent of Disposable Personal Income, 1954–2008–2024681012141618Percent2006Flow of Funds measureNational Income and Product Accounts measure1954 1958 1962 1966 1970 1974 1978 1982 1986 1990 1994 1998 2002Source: Federal Reserve Board and Bureau of Economic Analysis.Note: The Flow of Funds measure of savings includes consumption of durable goods as savings while the NIPA measure does not. Disposable personalincome is from NIPA.T H E  R E T I R E M E N T  P O L I C Y  P R O G R A MMay 2008 3initional differences. The FOF measure includeschanges in pension reserves and thus has thesame problem as the NIPA in treating definedbenefit pensions.Neither the NIPA nor the FOF measurepaints a happy picture. Personal saving, accord-ing to both measurements, has plummeted overthe past three decades. In 2005 and 2006, the per-sonal saving rate fell to well below 1 percent—the lowest level ever. In the third quarter of 2005,it actually became negative. Because capital gainsare omitted in both measures, a negative savingrate does not necessarily mean that householdsare borrowers on average. The extremely lowsaving rate of 2005 and 2006 is sometimes ex-plained by the huge capital gains in housing inthose years. The resulting increase in householdwealth may have made people feel easier aboutlowering their saving rate. It may also haveencouraged borrowing by refinancing mortgagesor by increasing other forms of consumer debt.To some degree, the fall in personal savinghas been offset by an increase in borrowing from abroad. This helps maintain investment levels and the rate of growth of productivity andwages, but we end up sending interest and divi-dends to nonresidents. Our standard of living isnot increased as much as it would be if the samelevel of investment were financed domestically.An Alternative ViewThe NIPA and FOF saving measures create theimpression that households have become lessprudent over the past two decades. However, theFederal Reserve produces another data series thatprovides a very different view. That series trackshousehold net worth by estimating the differencebetween the value of a household’s assets and itsliabilities. Except for bond holdings that are val-ued at cost, assets are valued at market prices.Hence, changes in the net worth of householdsreflect capital gains on assets, and those changesin net worth can be defined as saving.When the changes in net worth are dividedby disposable income, the ratio jumps arounderratically from year to year—probably partlybecause of measurement problems and partlybecause the numerator includes capital gainswhile the denominator does not—but no discern-able trend has emerged over the past 50 years.Does that mean that we really have no savingproblem? It depends on how the saving problemis defined. Net worth is a measure of well-being.The fact that net worth has been growing quitesteadily along with income implies that peopleare better prepared for retirement and for med-ical and other emergencies than is suggested bythe NIPA and FOF saving measures.This more sanguine view of saving is duelargely to the inclusion of capital gains. Althoughcapital gains add to household purchasingpower, they do not provide new resources forinvestment. For that, you need greater saving asmeasured by the NIPA and the FOF.It should also be noted that capital gains canquickly evaporate, as they did when the recenthousing bubble burst. Some also worry that asbaby boomers retire, asset sales will rise rapidlyand cause asset values to fall. But this worry isprobably overstated. Retirees tend to be carefulregarding dissaving and to the extent assets aresold, they will be sold into a world capital mar-ket that, with hope, continues to be buoyed byvery large saving rates in emerging economies(Poterba 2004).ConclusionsThe NIPA and FOF measures of saving paint adismal picture. The rapid decline over the past 20 years means we are not devoting sufficientresources to investment. To the extent that invest-ment levels have been maintained, it is becausethe necessary financing has been found outsidethe United States, but that means that a portionof future interest and dividends will have to bepaid to investors abroad instead of raising theliving standards of Americans.Nevertheless, Americans continue to be bet-ter and better off as measured by their net worth.Much of this improvement stems from capitalgains on old assets. Those capital gains cannot beused to finance new investment, but they do pro-vide purchasing power to households for retire-ment or economic emergencies. Indeed, there isprobably a causal relation between the healthystate of household balance sheets and the lack ofsaving as traditionally measured. Householdsmay not be inclined to sacrifice and save morewhen asset values are accumulating anyway.T H E  R E T I R E M E N T  P O L I C Y  P R O G R A M4 May 2008Recent problems in housing and financial mar-kets may test this proposition.Notes1. This paper leans heavily on the analysis of Guidolin andLa Jeunesse (2007).2. Paid estate taxes are not considered as deductions in com-puting disposable personal income. Estate taxes are de-fined as a capital transfer. Treating capital gains taxes inthe same way may have some merit.3. Payments for the administrative costs of plans are consid-ered to be personal outlays.4. The effect may become more significant as baby boomersstart to retire and begin drawing their pensions.5. Several other measurement issues are not discussed here,including transfers between households and charitableand nonprofit institutions, the use of nominal rather thanreal interest rates in measuring the income from wealth,whether education expenditures should be regarded as aninvestment, and the treatment of stock options. For a dis-cussion of these issues, see Reinsdorf (2005) and Guidolinand La Jeunesse (2007).ReferencesBernheim, B. Douglas. 1992. “Is the Baby Boom GenerationPreparing Adequately for Retirement?” Summary Report.Princeton, NJ: Merrill Lynch.Guidolin, Massimo, and Elizabeth A. La Jeunesse. 2007. “TheDecline in the U.S. Personal Saving Rate: Is It Real and IsIt a Puzzle?” Federal Reserve Bank of St. Louis Review 89(6):491–514.Poterba, James M. 2004. “Population Aging and FinancialMarkets.” NBER Working Paper #W10581. Cambridge,MA: NBER.Reinsdorf, Marshall B. 2005. “Saving, Wealth, Investment,and the Current-Account Deficit.” Washington, DC:Bureau of Economic Analysis. http://www.bea.gov/scb/pdf/2005/04April/PersonalSavingBox.pdf. (AccessedMarch 26, 2008.)Skinner, Jonathan. 2007. “Are You Sure You’re Saving Enoughfor Retirement?” Journal of Economic Perspectives 21(3): 59–80.ABOUT THE AUTHORRudolph G. Penner is a senior fellow at theUrban Institute and holds the Arjay and FrancesMiller Chair in Public Policy. Previously, he was amanaging director of the Barents Group, a KPMGCompany. He was director of the CongressionalBudget Office from 1983 to 1987. Previous postsin government include assistant director for eco-nomic policy at the Office of Management andBudget, deputy assistant secretary for economicaffairs at the Department of Housing and UrbanDevelopment, and senior staff economist at theCouncil of Economic Advisers. THE RETIREMENT POLICY PROGRAMhttp://www.retirementpolicy.orgThe Retirement Policy Program addresses how current and proposed retirement policies,demographic trends, and private-sector practicesaffect the well-being of older individuals, theeconomy, and government budgets.The author thanks the Rockefeller Foundationfor financial support.Copyright © May 2008The views expressed are those of the author and do not necessarily reflect those of the Urban Institute, its board, its sponsors, or other authors in the series. Permission is granted for reproduction of this document, with attributionto the Urban Institute.The Urban Institute 2100 M Street, NW • Washington, DC 20037  •  (202) 833-7200  •  paffairs@urban.org  •  http://www.urban.org

Measuring Personal Saving: A Tale of American Profligacy

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Measuring Personal Saving: A Tale of American Profligacy

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