Is lowering taxes for the wealthy an effective way to raise domestic savings?

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lowering taxes

Lowering taxes for the wealthy is an effective way to raise domestic savings in the face of the largest deficit since records began, says James Sproule. He writes that saving and investing will bring us a brighter, prosperous future  

Sometimes it is useful to remind oneself just why certain basic economic concepts are important: one such measure is savings. An adequate stock, and continuing growth in savings and investments, are critical to a country’s long-term economic health. In part, because savings allow individuals to fund large purchases – and of course give them a degree of independence in retirement. But savings are equally important in that they are the basis for businesses to fund investment, and that investment is what underpins so much of our productivity and ultimately our standard of living. So far, so uncontroversial.

If we look at the way in which people save, the following becomes apparent. Saving and investment are what you do after other fixed costs have been taken care of; so if taxes are increased, savings and investments tend to fall. Similarly, if for instance energy costs fall, savings and investments can be increased. Moreover, it is important to remember that, yes, taxes have fallen for many of the low paid, but it is the better paid who have a much higher propensity to save and invest.

Leaving aside how much money the wealthiest already contribute to the exchequer’s revenues, any tax rises hitting this part of the population are going to have a disproportionate effect on the savings rate. So if we are looking to increase domestic investment, reducing taxation on the wealthy is one of the most effective ways to raise domestic savings.

When there are not sufficient domestic savings to fund investment, businesses are left seeking money from international investors. This is the situation in which we unfortunately now find ourselves. For many years the UK has run a current account deficit, but the deficit in trade was to a large extent offset by earnings from assets held overseas: no longer.

Matters are now taking a turn for the worse, as receipts from overseas investments have fallen and the current account shortfall has widened to five-and-a-half per cent of GDP. This is the largest deficit since records began in 1948. In the fourth quarter of 2014 alone our deficit was £25bn. The inescapable conclusion is we are now consuming well beyond our means.

All this leaves us in a fragile position. International capital flows are more volatile than domestic savings and in times of trouble such flows have a tendency to dry up just as businesses are most in need of cash. If we are to enjoy the sort of standard of living we are accustomed to, we are going to need to invest a good deal to raise our productivity.

The danger, in the next parliament, is that not only will we seek to raise taxes, but we will raise them on the wealthiest, with dire long-term consequences for our ability to save and invest. Government can do many things; effectively saving for the future is not one of them. Only business can give us the ability to enjoy sustainably prosperous livelihoods, and businesses need to invest – and that investment requires saving.

We undermine our ability to save at our peril.

James Sproule is the IoD’s chief economist and director of policy

@jamesrsproule

Watch more from James Sproule on the Director magazine YouTube channel

About author

James Sproule

James Sproule

James Sproule has been Chief Economist and Director of Policy for the Institute of Directors since January 2014. Prior to joining the IoD James led Accenture’s UK Research and Global Capital Markets Research. He started his financial career as a merchant bank economist working with both Bankers Trust, Deutsche Bank and Dresdner Kleinwort, and eventually helped to found the boutique bank Augusta and Company.

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