Saving means different things to different people. To some, it means putting money in the bank. To others, it means buying stocks or contributing to a pension plan. But to economists, saving means only one thing—consuming less out of a given amount of resources in the present in order to consume more in the future. Saving, therefore, is the decision to defer consumption and to store this deferred consumption in some form of asset.

Saving is often confused with investing, but they are not the same. Although most people think of purchases of stocks and bonds as investments, economists use the term “investment” to mean additions to the real stock of capital: plants, factories, equipment, and so on.

Between 1990 and 2005, the annual rate of U.S. net national saving (net national income less private consumption expenditures less government consumption expenditures, all divided by net national income) averaged only 5.3 percent. In contrast, the nation’s saving rate was 7.6 percent in the 1980s, 10.3 percent in the 1970s, and 13.0 percent in the 1960s.

The 2004 rate of U.S. saving of just 2.2 percent is remarkably low, not only by U.S. standards, but also by international standards. Differences in how the statisticians in different countries define income and consumption make comparisons across nations difficult. But, corrected as well as possible for such data problems, America’s saving rate is significantly lower than that of other industrialized countries. This explains, in large part, why the United States has run a very large current account deficit (see International Trade) in recent years. The U.S. current account deficit measures the amount that foreigners invest in the United States net of what Americans invest abroad. Because Americans are not saving very much, they do not have much to invest in the United States, let alone abroad. Foreigners are making up the difference by investing heavily in the United States.

Why do countries save at different rates? Economists do not know all the answers. Some of the factors that undoubtedly affect the amount people save are culture, differences in saving motives, economic growth, demographics, how many people in the economy are in the labor force, the insurability of risks, and economic policy. Each of these factors can influence saving at a point in time and produce changes in saving over time.

Motives for Saving

The famous life-cycle model of Nobel laureate Franco Modigliani asserts that people save—accumulate assets—to finance their retirement, and they dissave—spend their assets—during retirement. The more young savers there are relative to old dissavers, the greater will be a nation’s saving rate. Most economists believed for decades that this life-cycle model provided the main explanation of U.S. saving. But in the early 1980s, Lawrence H. Summers of Harvard and I showed that saving for retirement explains less than half of total U.S. wealth. Most U.S. wealth accumulation is saving that is ultimately bequeathed or given to younger generations. The motive for bequests and gifts from older to younger Americans is unclear. A very large component of the bequests may be unplanned, simply reflecting the fact that many people do not spend all their savings before they die. In this case, people save to consume, not bequeath, but end up bequeathing nonetheless.

In recent years, a much larger fraction of the retirement savings of the American elderly has been annuitized. That is, the savings take the form of company pensions or Social Security that pay regular checks until death, with no payments after the person dies. Having your retirement finances come in the form of an annuity eliminates the risk of living longer than your money lasts. One possible result of the increased annuitization of retirement assets may be that people, especially those who have already retired, have less incentive to save more in case they “live too long.”

The precautionary motive—that is, the motive to save in order to be prepared for various future risks—is one of the key reasons people save. Besides the risk of living longer than expected, people save against more mundane risks, such as losing their job or incurring large uninsured medical expenses. Computer simulation studies show that the amount of precautionary saving can be very sensitive to the availability of insurance against these and other kinds of risks. For example, the decision not to insure low-risk but high-cost health expenditures such as nursing-home care can lead to a 10 percent increase in national saving.

Another issue related to motives and preferences for saving is the role of the rich in generating aggregate saving. Do rich Americans account for most of U.S. saving? Not really. Relative to their incomes, some of the rich save a lot, and some dissave. So, too, for the poor. There is considerable mobility of wealth in the United States, at least over long periods of time (see human capital). The fact that the ranks of the rich are continually changing suggests that some of those who are initially rich dissave and dissipate their wealth, while others who are not initially rich save considerable sums and become rich. Former heavyweight champion Michael Tyson, for example, grossed an estimated $400 million during the heyday of his boxing career but ended up declaring bankruptcy. Sam Walton, who started Wal-Mart, started life in poverty and ended as one of the richest people in the world.

Economic Growth and Demographic Change

A country’s saving rate and its economic growth are closely connected. This follows from the life-cycle model. If there are more young people around than old people because the population is growing, there will be more workers saving for their retirement than there will be retirees who are dissaving, that is, spending down their assets. This will leave overall net saving positive. The higher the population growth, other things equal, the higher will be the saving rate. The same is true of technical change. Suppose there are the same number of young people around as old people, but the young earn more than did the old because of technological change. Then the young will save more than the old dissave, which, again, will imply a positive saving rate.

In an economy not experiencing growth in technology or population, one would expect, at least in the long run, saving to be zero, with the exception of the saving needed to replace depreciating capital. If there is no engine for growth, in the long run the saving the young do for retirement, to leave bequests, or for any other reason would exactly offset the dissaving of retirees, leaving the economy’s total saving at zero. The economy would have positive assets (claims to capital) but would experience no increase or decrease in the level of these assets over time.

That an economy’s overall long-run saving rate is zero does not mean that no one saves or dissaves. Rather, it means that the positive savings of those accumulating assets exactly balance the negative savings of those decumulating assets. For growing economies, long-run saving is likely to be positive to ensure that the stock of capital assets keeps pace with the number and productivity of workers.

Recent years have seen a large increase in the number of workers and in productivity per worker. The increase in the number of workers is due to baby boomers entering the workforce. The increase in productivity is due to the fact that baby boomers are in their peak years of productivity, and also due to a growing capital stock and to technological improvement, especially in information and communications technology. The fact that these factors did not suffice to raise U.S. saving rates means that other forces, to be discussed below, reduced national saving.

Labor-Supply Decisions

National saving is the difference between national income and national consumption. Labor income represents about three-quarters of national income. So changes in labor income, if not accompanied by equivalent changes in consumption, can greatly affect an economy’s saving rate. Take, for example, the recent remarkable increase in U.S. female labor force participation. In 1975 half of the women age twenty-five to forty-four participated in the labor force; by 1988 more than two-thirds were in the labor force. This increase in the female labor supply is a major reason, if not the main reason, for the rise in U.S. per capita income since 1975.

If the additional net-of-tax income these women earned had all been saved, the U.S. saving rate after 1980 would have exceeded 20 percent. Because much of the increase in labor supply was by women age eighteen to thirty-five, particularly married women, one would expect them to have saved some portion of that income for their old age. Assuming this did occur, we need to look elsewhere to understand the puzzle of why U.S. saving fell.

Adding to the puzzle is the ongoing increase in the expected length of retirement. More and more Americans, particularly men, are retiring in their late fifties and early sixties. At the same time, life expectancies continue to rise. Today’s thirty-year-old male can expect to live to age seventy-six, 5.3 years longer than the typical thirty-year-old could expect in 1960. If he retires at age fifty-five, today’s thirty-year-old will spend almost half of his remaining life in retirement. Economic models of saving suggest that aggregate saving should depend strongly and positively on the length of retirement. Thus, with the retirement age decreasing and life expectancy increasing, economists would expect people to save a lot more—not a lot less.

Economic Policy

Government policy also can have powerful effects on a nation’s saving. To begin with, governments are themselves large consumers of goods and services. In the United States, federal, state, and local governments account for more than one-fifth of all national consumption. More government consumption spending does not, however, necessarily imply less national saving. If the private sector responds to a one-dollar increase in government consumption by reducing its own consumption by one dollar, aggregate saving remains unchanged.

The private sector’s consumption response depends critically on who pays for the government’s consumption and how the government extracts these payments. If the government assigns most of the tax burden to future generations by borrowing in the present and repaying principal plus interest on the borrowing in the future, current generations will have little reason, other than concern for their offspring, to reduce their consumption expenditures.

If current generations are forced to pay for the government’s spending, the size of the private-sector consumption response will vary according to which generation foots the bill. The older the people who are taxed, the larger will be the reduction in consumption. The reason is that older people, being closer to the ends of their lives, consume a higher share of their remaining lifetime resources than do younger ones. Thus, taxing retirees, say, instead of forty-year-old workers, will reduce private-sector consumption and increase national saving.

Finally, different taxes have different incentive effects. For example, the government might raise its funds with taxes on capital rather than taxes on labor income. By lowering the after-tax return to saving, taxes on capital income discourage saving for future consumption and thus reduce saving.

Explaining the Decline in U.S. Saving

What explains the recent decline in U.S. saving? One cause that can quickly be dismissed is increased government consumption. In the 1960s, when the national saving rate was 13.0, the ratio of government consumption to national income was 18.6 percent. Since the 1990s, the government’s consumption rate has been 17.5 percent but the saving rate has averaged only 5.5 percent.

Could disincentives to save be responsible for the decline in U.S. saving? Not likely. Marginal personal tax rates on taxable capital income have fallen dramatically over the past two decades. In addition, the effective marginal tax on capital income earned on saving done within a retirement account, such as an Individual Retirement Account, is zero.

The main explanation for the decline in national saving appears to be the major and ongoing government policy of taking an ever larger share of resources from young and future Americans and giving them to older Americans. Because the elderly are close to the ends of their lives and have much higher propensities to consume than younger people and the unborn, redistributing from young and future U.S. generations to older generations raises national consumption and lowers national saving.

The distribution of resources across generations arises through a host of fiscal policies, including deficit finance, the pay-as-you-go finance of Social Security and Medicare benefits, shifts in the tax structure away from consumption and capital income taxation toward wage taxation, and even capital depreciation and expensing provisions. In recent decades, increased distribution to the current elderly has come primarily in two forms. The first is giving the elderly additional medical benefits under the Medicare and Medicaid programs. The elderly receive these benefits in kind, which means the only way they can get the benefits is to use them; one cannot “save” a Medicare payment. The second is cutting the taxes the elderly pay.

The Implications of Low Saving for Baby Boomers

Americans used to save at a fairly high rate. As a consequence, the collective stock of U.S. wealth holdings is still quite large—roughly thirty-five trillion dollars. This is enough to finance all Americans’ consumer expenditures for about five years. But about 60 percent of this wealth is owned by people who are fifty or older, who appear to be spending a good deal of it on themselves. If the elderly do end up spending rather than bequeathing the bulk of existing U.S. wealth, will younger Americans, particularly baby boomers, accumulate enough savings to maintain the standard of living they currently enjoy in their old age?

Based on current evidence, the answer appears to be no. Compared with their parents, baby boomers can expect to retire earlier, live longer, rely less on inheritances, receive less help from their children, experience slower real wage growth, face higher taxes, and replace a smaller fraction of their preretirement earnings with Social Security retirement benefits. Unless baby boomers change their saving habits substantially and relatively quickly, they may experience much higher rates of poverty in their old age than those currently observed among U.S. elderly.


About the Author

Laurence J. Kotlikoff is a professor of economics and chairman of the Department of Economics at Boston University, a research associate with the National Bureau of Economic Research, and president of Economic Security Planning, Inc. He was previously a senior economist with President Ronald Reagan’s Council of Economic Advisers.


Further Reading

Ando, Albert, and Franco Modigliani. “The Life Cycle Hypothesis of Saving: Aggregate Implications and Tests.” American Economic Review 53, no. 1 (1963): 55–84.
Auerbach, Alan J., and Laurence J. Kotlikoff. Dynamic Fiscal Policy. New York: Cambridge University Press, 1987.
Bernheim, B. Douglas. “Taxation and Saving.” In Alan J. Auerbach and Martin S. Feldstein, eds., The Handbook of Public Economics. Amsterdam: North-Holland, 2002. Vol. 3, pp. 1173–1249.
Kotlikoff, Laurence J. Essays on Saving, Bequests, Altruism, and Life-Cycle Planning. Cambridge: MIT Press, 2001.
Kotlikoff, Laurence J. Generational Accounting: Knowing Who Pays and When for What We Spend. New York: Free Press, 1992.
Kotlikoff, Laurence J. What Determines Savings? Cambridge: MIT Press, 1989.
Kotlikoff, Laurence J., and Scott Burns. The Coming Generational Storm. Cambridge: MIT Press, 2004.
Kotlikoff, Laurence J., and Lawrence H. Summers. “The Adequacy of Saving.” American Economic Review 72, no. 5 (1982): 1056–1069.
Kotlikoff, Laurence J., and Lawrence H. Summers. “The Role of Intergenerational Transfers in Aggregate Capital Formation.” Journal of Political Economy 89, no. 4 (1981): 706–732.