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Special Report September 13, 2010, 3:30PM

Given Tax Cuts, Rich Americans Save

Instead of SpendHand the rich a tax cut and they'll save the money rather

than spend it and boost the economy, Moody's says

By Timothy R. Homan

(Bloomberg) Hand the wealthiest Americans a tax cut and history suggests they will save the

money rather than spend it. Tax cuts in 2001 and 2003 under President George W. Bush werefollowed by increases in the saving rate among the rich, according to data from Moody'sAnalytics Inc. When taxes were raised under Bill Clinton, the saving rate fell.

The findings may weaken arguments by Republicans and some Democrats in Congress who sayallowing the Bush-era tax cuts for the wealthiest Americans to lapse will prompt them to reducetheir spending, harming the economy. President Barack Obama wants to extend the cuts forindividuals earning less than $200,000 and couples earning less than $250,000 while endingthem for those who earn more.

"I would tend to wonder how much the tax cut actually influences spending behavior," said Chris

Cornell, an economist who mined government reports back to 1989 for West Chester,Pennsylvania-based Moody's Analytics. "Spending by the top 5 percent of households seemsmuch more closely tied to business-cycle issues than it does to tax-cut issues."

The Moody's research covering couples earning more than $210,000 found that spending by thewealthy is more likely to be influenced by the ups and downs of the stock market than changes inincome-tax rates.

Stock-market performance is the "primary factor that is driving the savings of the top 5 percentof households," said Mustafa Akcay, economist and co-researcher of the savings data.

Federal Reserve Data

The Moody's economists examined saving rates by income groups back to 1989. Their studyuses statistics from the Federal Reserve's quarterly Flow of Funds report, which gauges the networth of households, and the Fed's triennial Survey of Consumer Finances, a measure of balancesheets, pensions and incomes of U.S. families. When tax legislation was signed by Clinton in1993 raising the top tax rate to 39.6 percent from 31 percent the saving rate fell from 12.1percent in the second quarter to 9.5 percent in the first quarter of 1994. The Standard & Poor's

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500 Index rose 1.9 percent from July through September, after little change the previous threemonths.

When the first Bush tax cuts were signed into law in June 2001, pushing the top rate down to 35percent, the wealthy boosted savings. The saving rate climbed to 2.8 percent in the first quarter

of 2002 from minus 2 percent in the second quarter of 2001. The increased savings coincidedwith a 1.1 percent decline in the S&P 500 index.

Second Round

After the second round of Bush tax cuts in May 2003, the rich also increased their saving, withthe rate climbing to 7.6 percent in the first quarter of 2004 from 2.2 percent in the second quarterof 2003, the Moody's data show.

The analysis found some similarities across income levels in the 2001 and 2003 data. Thewealthy and the remaining 95 percent of Americans both saved more of their incomes after the

Bush tax cuts. The saving rate is defined as personal savings as a percentage of after-tax income.

The political debate over extending the Bush-era tax cuts, which expire at the end of the year, isintensifying with the approach of congressional elections in November. Obama, at a WhiteHouse news conference on Sept. 10, said the push by Republicans to extend cuts for thewealthiest Americans is a "bad idea" because it would cost $700 billion in government revenueat a time of record budget deficits.

Boehner, McConnell

Republicans including Senate Minority Leader Mitch McConnell and House Minority Leader

John Boehner contend that tax cuts should remain for all and any attempt to target the wealthy the top 2 percent to 3 percent earners in the country could hurt growth and investment.

Boehner on Sept. 13 said he was prepared to compromise with the Obama administration andwould vote for middle-class tax cuts even if it meant eliminating reductions for wealthierAmericans, which he said would be "bad policy."

"If the only option I have is to vote for some of those tax reductions, I'll vote for it," theRepublican from Ohio said on CBS's "Face the Nation" program. He added: "I am going to do

everything I can to fight to make sure that we extend the current tax rates for all Americans."

Some economists voice caution about the promised effects of a change in tax rates. Thenonpartisan Congressional Budget Office in January analyzed policy options and possible short-term effects on growth. "Policies that temporarily increased the after-tax income of people whoare relatively well off would probably have little effect on their spending because they generallywould be able finance their consumption out of their income or assets without such a change,"CBO director Douglas Elmendorf testified to Congress on Feb. 23.

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Poor Credit

On the other hand, tax relief for families with "lower income, few assets and poor credit wouldprobably" spur spending, he said. Elmendorf said because of job losses and a drop in assets overthe past two years more families "probably fit that description now."

Guy LeBas, chief fixed-income strategist at Janney Montgomery Scott LLC in Philadelphia, whofollows consumer spending, said it's hard to predict the impact of changes in tax policy. "Wedon't know what's going to happen when sizeable tax cuts are likely to be reversed," he said. TheBush-era cuts "coincided with a lot of volatile happenings in the U.S. market," said LeBas,including the Sept. 11, 2001, terrorist attacks.

Year of Crisis

Cornell and Akcay also looked at 2009 a year of financial crisis and found wealthyAmericans again saved less as the stock market revived. High-income earners saved at a 9

percent rate in the first three months of 2009, when the S&P 500 dropped to a 12-year low onMarch 9. As stocks recovered, the saving rate fell to minus 0.5 percent in the second quarter andremained negative through March 2010.

Cornell and Akcay said higher-income earners were spending more than their disposable income,suggesting they used stock-market gains to support their spending. Interest and dividendsaccount for nearly 8 percent of the household income of the top 10 percent of Americans,according to the Fed's 2007 Survey of Consumer Finances.

Economist Harm Bandholz said discouraging the wealthy from spending could weaken theeconomy, something Republicans argue will happen if the Bush-era tax cuts expire. "Most of the

consumption growth is coming from the higher- income groups," said Bandholz, chief U.S.economist at UniCredit Global Research in New York. "The lower income groups, they arebarely living hand-to-mouth."

David Dyson, who co-owns an insurance company in Bethlehem, Pennsylvania, said he's moreconcerned about the state of the economy than the prospect of a tax increase, which he figureswill cost him as much as $30,000. "I have more than enough money to live on and probably willgo out to eat as much as I do," said Dyson, 58. On the other hand, he may decide to postponebuilding an addition to his house. "That's primarily on hold because of the economy, notnecessarily my taxes," he said.