In response to increasing calls for policies to raise the U.S. saving rate, proposals are once again being offered in Congress to change the tax base from income to consumption. Beyond the important issues of income distribution (that is, outright unfairness) inherent in such a plan, it would simply not work. Indeed, it is based on a fundamental mismeasurement of what counts as saving in the U.S. economy. The logical sequence underlying this proposal is wrong at two crucial points: lowering or eliminating taxes on saving is unlikely to increase saving, and higher saving would be unlikely to increase investment in any case (and would, more likely, decrease investment). The usual crowding-out logic is based on limited evidence and inadequate theory. Finally, the interaction between monetary and fiscal policy is currently perverse. Contractionary fiscal policy (which is what is implied by these proposals) will not be counter-balanced by timely and adequate monetary stimulus. The Federal Reserve is likely to wait too long to respond, either due to excessive caution about the effectiveness of the fiscal policy change or to take advantage of an opportunity to lower inflation still further before allowing the economy to recover.
Available at: http://works.bepress.com/neil_buchanan/14/