National Saving: Current Saving Decisions Have Profound Implications for Our Nation's Future Well-Being
Published: 2006-04-06T00:00:00

Fast Facts:

Highlights:
section_title: Why GAO Did This Study
paragraphs: The Chairman of the Senate Committee on Finance asked GAO to testify on our nation's low saving and discuss the implications for long-term economic growth. National saving--the portion of a nation's current income not consumed--is the sum of saving by households, businesses, and all levels of government. National saving represents resources available for investment to replace old factories and equipment and to buy more and better capital goods. Higher saving and investment in a nation's capital stock contribute to increased productivity and stronger economic growth over the long term.
section_title: What GAO Found
paragraphs: Our nation faces a number of deficits, including our nation's budget deficit, a saving deficit, and a current account deficit. Unfortunately, America has been heading in the wrong direction on all three deficits in recent years. In 2005 our nation's budget deficit was around $318 billion or 2.6 percent of GDP. For the first time since 1934, net national saving declined to less than 1 percent of GDP and the personal saving rate was slightly negative in 2005. While the United States has run a current account deficit--or borrowed to finance domestic investment--over most of the last 25 years, the current account deficit hit an all time record--$782 billion, or over 6 percent of GDP in 2005. Despite low national saving in recent years, economic growth has been high. However, we cannot let our recent good fortune lull us into complacency. If the net inflow of foreign investment were to diminish, so too would domestic investment and potentially economic growth if that saving is not offset by saving here in the U.S. Also, our nation faces daunting fiscal and demographic challenges, which provide even more of a reason to address our nation's low saving rates. Greater economic growth from saving more now would make it easier for future workers to bear the burden of financing Social Security and Medicare, but economic growth alone will not solve the long-term fiscal challenge. Tough choices are inevitable, and the sooner we act the better in order to allow the miracle of compounding to turn from enemy to ally.

section_title: Letter
paragraphs: I appreciate the opportunity to talk with you today about national saving  and the central role it plays for our nation’s long-term economic growth  and future living standards. National saving—the portion of a nation’s  current income not consumed—is the sum of saving by households,  businesses, and all levels of government. National saving represents  resources available for investment to replace old factories and equipment  and to buy more and better capital goods. Higher saving and investment in  a nation’s capital stock contribute to increased productivity and stronger  economic growth over the long term.
As our 21st century challenges report notes, the United States faces  serious long-term challenges in several areas, some of them  unprecedented in their size, scope, complexity, and potential impact. One  of the primary challenges is demographics. The U.S. workforce growth  rate is slowing and will continue to slow. This means that just when  increasing numbers of baby boomers start to retire and draw benefits,  there will be relatively fewer full-time workers to help support these  retirees. What’s more, people are living longer. In the very near future, our  aging population will begin to put enormous strains on our nation’s  pension and health care systems. Other emerging trends that warrant close  scrutiny are globalization, new security threats, rapidly evolving  technology, and a range of quality-of-life concerns affecting everything  from education and health care to energy and the environment.
Comptroller General Walker has spoken frequently about the fact that our  nation faces a number of deficits, including three that are directly related  to this hearing. These three interrelated deficits are our nation’s budget  deficit, a saving deficit, and a current account deficit. He has noted that  our growing fiscal imbalance threatens our future economic growth, our  future standard of living, and even our future national security.  Unfortunately, America has been heading in the wrong direction on all  three deficits in recent years. Nonetheless, we have a window of  opportunity to turn things around, but we need to act and act soon  because the miracle of compounding is currently working against us.
Today’s saving and investment decisions have profound implications for  the level of well-being in the future. Increasing personal saving is an  important way to bolster retirement security for current workers and  increasing national saving will allow future workers to more easily bear  the costs of financing federal retirement and health programs while  maintaining their standard of living.
In my testimony today, I will describe these three deficits and why they  raise concerns about our nation’s long-term growth and its ability to  finance the health and retirement needs of an aging population. Finally, I  will lay out a few ideas for how the federal government can help increase  national saving.
My remarks are based on our previous work on a variety of issues,  including a report on national saving and GAO’s work on the long-term  fiscal challenge. These efforts were conducted in accordance with  generally accepted government auditing standards.
subsections: section_title: The Budget Deficit
paragraphs: The first deficit we face is the federal budget deficit (see fig. 1). In 2005 the  unified federal budget deficit was around $318 billion or 2.6 percent of  gross domestic product (GDP). This figure is an approximation of what the  federal government absorbs from private saving. Although a single year’s  federal deficit is not a cause for concern, persistent deficits are. Federal  deficits reduce the amount of national saving available for investment.  They also lead to growing federal debt, on which net interest payments  must be made by current and future generations.
section_title: The Saving Deficit
paragraphs: A budget deficit represents dissaving by the government, but the U.S.  suffers from an even broader national saving deficit. National saving is the  sum of personal saving, corporate saving, and government saving. Last  year, for the first time since 1934, net national saving declined to less than  1 percent of GDP and the personal saving rate was slightly negative (see  fig. 2). Remarkably—and unfortunately—the United States has returned  to saving levels not seen since the depths of the Great Depression.
A negative saving rate means that, in the aggregate, households are  spending more than their current income by drawing down past saving,  selling existing assets, or borrowing. No one is sure why the personal  saving rate has declined. One possible explanation is increases in  household wealth, which surged in the late 1990s due to the stock market  boom and more recently due to the run-up in housing prices. Household  wealth relative to income increased from 4.7 in 1990 to 5.8 in 2005 (see fig.  3). If people feel wealthier, they may feel less need to save. Continued  financial liberalization and innovation have made it easier for Americans  to borrow, particularly against their real estate wealth, which may have  lead to greater consumption.
Clearly, as the Comptroller General has said, many Americans, like their  government, are living beyond their means and are deeply in debt. This  trend is particularly alarming in an aging society such as our own. Those  Americans who choose to save more will certainly live better in  retirement. Those Americans who choose to save less are rolling the dice  on whether they will have adequate resources for a secure retirement.  While Social Security provides a foundation for retirement income, Social  Security benefits replace only about 40 percent of preretirement income  for the average worker. As a result, Social Security benefits must be  supplemented by private pensions, accumulated assets, or other resources  in order for individuals to maintain a reasonable standard of living in  retirement compared to their final working years. Though the aggregate  wealth-to-income ratio remains relatively high, it is a misleading indicator  of financial status of the typical household because wealth is highly  concentrated among a few households. While the median net worth of all  families was $93,100 in 2004, the top 10 percent of the families had a  median net worth of over $1.4 million and the bottom quarter of the  families had a median net worth of about $1,700. Moreover, measures of  wealth are largely based on market values, which on occasion can exhibit  substantial swings. This is illustrated by the sharp run-up in stock prices in  the late 1990s and their subsequent decline beginning in 2000.
The only components of national saving that have not shown a long-term  decline are corporate and state and local saving. In fact, corporate saving  is actually high by historical standards. After declines in corporate profits  in 2000-2001, corporate saving has rebounded to almost 4 percent of  GDP—a level not seen since the late 1960s. The state and local sector as a  whole experienced a deficit from 2002 to 2004 but has since returned to a  slight surplus.
section_title: The Current Account Deficit
paragraphs: Now let me turn to the third deficit: our current account deficit. The  current account deficit is the difference between domestic investment and  national saving. That is, it is the amount of domestic investment financed  by borrowing from abroad. Over most of the last 25 years, the United  States has run a current account deficit, but in 2005 the current account  deficit hit an all-time record—$782 billion, or over 6 percent of GDP (see  fig.4). That is twice what it was only 6 years earlier.
Funds from overseas have been pouring into the United States. One  explanation for these inflows is that high productivity in the U.S. raised  the perceived return on U.S. assets. Moreover rising federal budget deficits  and declining personal saving rates have necessitated foreign borrowing to  help finance domestic investment. Another possible explanation for  persistent U.S. current account deficits may be the weakness of foreign  demand and the efforts of some countries to support their exports by  keeping their own currencies from strengthening. Also, other countries’  populations are aging more rapidly than the U.S. population and they may  be investing in the U.S. in order to build up a stock of assets to prepare for  their retirement spending.
Whatever the reason for high current account deficits, policymakers  should be aware of the implications these financial inflows have for the  nation’s economic growth and for future living standards. While current  account deficits support domestic investment and productivity growth,  they also translate into a rising level of indebtedness to other countries.
Figure 5 shows that the net foreign ownership of U.S. assets grew to more  than 20 percent of GDP in 2005. The fact that our net indebtedness to  other nations is rising more rapidly than our income raises concerns that  the U.S. current account balance is on an unsustainable path.
Despite the growth of foreign asset holdings in the United States in recent  years, the United States earned more in interest, dividends, and other  investment returns from other countries than it paid on U.S. assets held by  foreigners. This may seem counterintuitive to the notion that U.S. assets,  on average, pay a higher return than foreign assets and thus attract a large  amount of foreign investment. The positive net income receipts reflect  differences in the composition of foreign and U.S. investment and the  higher rate of return that U.S. firms earn on their direct investments  abroad compared to the earnings of foreign companies from their U.S.  subsidiaries. A larger share of foreign-owned assets in the U.S. is held in  portfolio investment, such as stocks, bonds, loans, and bank deposits,  which pay a lower yield than U.S. direct investments abroad. A recent  study by the Congressional Budget Office (CBO) attributed this to three  factors. First, U.S. subsidiaries abroad have generally been in business  longer than foreign-owned subsidiaries in the U.S., which contributes to  greater profitability. Second, investors of U.S. subsidiaries abroad may  require higher returns because they face greater political and economic  risks than subsidiaries of foreign-owned corporations. Finally, some  observers argue that U.S subsidiaries abroad may overstate their profits  for tax reasons, while foreign-owned subsidiaries in the United States  understate their profits. However, given the nation’s increasingly negative  net international investment position, it is not clear how long the U.S. will  continue to earn more on its foreign investment than it pays on foreign  investment in the U.S.
The effect of large foreign borrowing on our economy also depends in part  on how the borrowed funds are used. To the extent that borrowing from  abroad finances domestic investment, the foreign borrowing adds to the  nation’s capital stock and boosts productive capacity. Thus, even though  some of the income generated by the investment must be paid to foreign  lenders, the investment—and hence the borrowing that financed it— augments future income. However, if the borrowing from abroad is used to  finance consumption, this is not true. Short-term well-being is improved  but the ability to repay the borrowing in the future is not.
Both economists and policymakers are concerned about whether the  United States can maintain its reliance on foreign capital inflows to sustain  domestic investment. Investors generally try to achieve some balance in  the allocation of their portfolios, and U.S. assets already represent a  growing and significant share of foreign portfolios (see fig. 6). Although  the United States accounts for 29 percent of global GDP, it received  70 percent of the net saving exported by countries with current account  surpluses in 2004. Observers suggest that the United States’ favorable  investment climate, including the potential for high rates of return, may  explain why the U.S. absorbs such a large share of the world’s saving.  However, it is probably not realistic to expect ever-increasing foreign  investment in the United States. Imagine what would happen to the stock  and bond markets if these foreign investors began to lose confidence and  lowered their rates of accumulation, or worse yet, started to sell off their  holdings. We would likely face some adverse effects in the form of higher  interest rates, reduced investment, and more expensive imports.
section_title: Why Does It Matter?
paragraphs: Economic growth in recent years has been high despite the fact that  national saving was low by U.S. historical standards. This is because more  and better investments were made. Each dollar saved bought more  investment goods, and a greater share of saving was invested in highly  productive information technology. Also, as discussed earlier, the United  States was able to invest more than it saved by borrowing from abroad.
However, we cannot let our recent good fortune lull us into complacency.  While the U.S. has benefited from high levels of foreign investment in  recent years, this is not a viable strategy for the long run. Many of the  nations currently financing investment in the United States face aging  populations and their own retirement financing challenges that may  reduce foreign saving available for U.S. domestic investment. If the net  inflow of foreign investment were to diminish, so too would domestic  investment and potentially economic growth if that saving is not offset by  saving here in the U.S. Also, our nation faces daunting fiscal and  demographic challenges, which may be even more of a reason to address  our nation’s low saving rates. Saving and economic growth will be key  factors to prepare future generations to bear the burden of financing the  retirement and health costs of an aging population.
subsections: section_title: Nation Faces Long-term Fiscal Challenges
paragraphs: Given our nation’s long-term fiscal outlook, acting sooner rather than later  to increase national saving is imperative. The federal government’s current  financial condition and long-term fiscal outlook present enormous  challenges to future generations’ levels of well-being. No one can forecast  with any precision what the next 75 years will look like—that would  require the ability to predict changes in the economy and future  legislation. However, there is a fair amount of certainty in one major driver  of our long-term outlook—demographics. As life expectancy rises and the  baby boom generation retires, the U.S. population will age, and fewer  workers will support each retiree. Over the next few decades, federal  spending on retirement and health programs—Social Security, Medicare,  Medicaid, and other federal pension, health, and disability programs—will  grow dramatically. Absent policy changes on the spending and/or revenue  sides of the budget, a growing imbalance between expected federal  spending and tax revenues will mean escalating and eventually  unsustainable federal deficits and debt that will threaten our future  economy and standard of living. As Comptroller General Walker has said,  “Simply put, our nation’s fiscal policy is on an imprudent and  unsustainable course.”
Neither slowing the growth in discretionary spending nor allowing the tax  provisions to expire—nor both together—would eliminate the imbalance.  Although revenues will be part of the debate about our fiscal future,  assuming no changes to Social Security, Medicare, Medicaid, and other  drivers of the long-term fiscal gap would require at least a doubling of  taxes—and that seems highly implausible.
GAO’s long-term simulations illustrate the magnitude of the fiscal  challenges associated with an aging society. Indeed, the nation’s long-term  fiscal outlook is daunting under many different policy scenarios and  assumptions. For instance, under a fiscally restrained scenario, if  discretionary spending grows only with inflation over the next 10 years  and all existing tax cuts expire as scheduled under current law, spending  for Social Security and health care programs would grow to consume over  80 percent of federal revenue by 2040 (see fig. 7). On the other hand, if  discretionary spending grew at the same rate as the economy in the near  term and if all tax cuts were extended, by 2040 federal revenues may just  be adequate to pay only some Social Security benefits and interest on the  growing federal debt (see fig. 8).
GAO’s long-term simulations show the squeeze on budgetary flexibility  that the combination of demographics and health care cost growth will  create. The burden on the budget and on the economy mean that letting  current policy continue will leave few resources for investment in new  capital goods and technology and result in slower income growth.
section_title: National Saving Critical for Long-term Economic Growth
paragraphs: There are three key contributors to economic growth—labor force growth,  capital input, and total factor productivity (or increased efficiency in the  use of capital and labor). Figure 9 shows the slowing in labor force growth  (potential hours worked) over the next decade. Indeed, the Social Security  and Medicare trustees project labor force growth to slow after 2010 and be  negligible after 2020. Without improvements in managerial efficiencies or  increases in capital formation, low labor force growth will lead to slower  growth in the economy—and to slower growth in federal revenues at a  time when the expenditure demands on federal programs for the elderly  are increasing. This illustrates the imperative to increase saving and  investment and explore other efficiency-enhancing activities, such as  education, training, and R&D.
Greater economic growth from saving more now would make it easier for  future workers to achieve a rising standard of living for themselves while  also paying for the government’s commitments to the elderly. While  economic growth will help society bear the burden of financing Social  Security and Medicare, it alone will not solve the long-term fiscal  challenge. Closing the current long-term fiscal gap would require sustained  economic growth far beyond that experienced in U.S. economic history  since World War II. Tough choices are inevitable, and the sooner we act  the better.
section_title: The Federal Government’s Role in National Saving
paragraphs: Although there may be ways for the government to affect private saving,  the only sure way for the government to increase national saving is to  decrease government dissaving (the budget deficit). Each generation is a  steward for the economy it bequeaths to future generations, and the  nation’s long-term economic future depends in part on today’s decisions  about consumption and saving. To address our nation’s daunting long-term  fiscal challenges, we must change the path of programs for the elderly and  build the economic capacity to bear the costs of an aging population.
From a macroeconomic perspective, it does not matter who does the  saving—any mix of increased saving by households, businesses, and  government would help to grow the economic pie. Yet, in light of the  virtual disappearance of personal saving, concerns about U.S. reliance on  borrowing from abroad to finance domestic investment, and the looming  fiscal pressures of an aging population, now is an opportune time for the  federal government to reduce federal deficits. Higher federal saving—to  the extent that the increased government saving is not offset by reduced  private saving—would increase national saving and tend to improve the  nation’s current account balance, although typically not on a dollar-for- dollar basis.
subsections: section_title: Reduce Federal Deficits
paragraphs: As the Comptroller General has said, meeting our nation’s large, growing,  and structural fiscal imbalance will require a three-pronged approach:   restructuring existing entitlement programs,   reexamining the base of discretionary and other spending, and   reviewing and revising existing tax policy, including tax expenditures,  which can operate like mandatory spending programs.
Increased government saving and entitlement reform go hand-in-hand.  Over the long term, the federal government cannot avoid massive  dissaving unless it reforms retirement and health programs for the elderly.  Without change, Social Security and Medicare will constitute a heavy drain  on the earnings of future workers. Although saving more yields a bigger  pie, policymakers will still face the difficult choice of how to divide the pie  between retirees and workers. It is worth remembering that policy debates  surrounding Social Security and Medicare reform also have implications  for all levels of saving—government, personal, and, ultimately, national.
Restoring Social Security to sustainable solvency and increasing saving are  intertwined national goals. Saving for the nation’s retirement costs is  analogous to an individual’s retirement planning in that the sooner we  increase saving, the greater our benefit from compounding growth. The  way in which Social Security is reformed will influence both the  magnitude and timing of any increase in national saving. The ultimate  effect of Social Security reform on national saving depends on complex  interactions between government saving and personal saving—both  through pension funds and by individuals on their own behalf. Various  proposals would create new individual accounts as part of Social Security  reform or in addition to Social Security. The extent to which individual  accounts would affect national saving depends on how the accounts are  funded, how the account program is structured, and how people adjust  their own saving behavior in response to the new accounts.
As everyone here knows, health care spending is the major driver of long- term government dissaving. This is due to both demographics and the  increasing cost of modern medical technology. The current Medicare  program largely lacks incentives to control health care consumption, and  the cost of health care decisions is not readily transparent to consumers.  In balancing health care spending with other societal priorities, it is  important to distinguish between health care wants, needs, affordability,  and sustainability at both the individual and aggregate level. Reducing  federal health care spending would improve future levels of government  saving, but the ultimate effect on national saving depends on how the  private sector responds to the reductions and the extent to which overall  health care spending is moderated. For example, reforms that reduce  federal deficits by merely shifting healthcare spending to state and local  governments or the private sector might not increase national saving on a  dollar-for-dollar basis.
Tax expenditures have represented a substantial federal commitment over  the past three decades. Since 1974, the number of tax expenditures more  than doubled and the sum of tax expenditure revenue loss estimates  tripled in real terms to nearly $730 billion in 2004. On an outlay-equivalent  basis, the sum of tax expenditure estimates exceeded discretionary  spending for most years in the last decade. Tax expenditures result in  forgone revenue for the federal government due to preferential provisions  in the tax code, such as exemptions and exclusions from taxation,  deductions, credits, deferral of tax liability, and preferential tax rates.
These tax expenditures are often aimed at policy goals similar to those of  federal spending programs; existing tax expenditures, for example, are  intended to encourage economic development in disadvantaged areas,  finance postsecondary education, and stimulate research and  development. A recent GAO report calls for a more systematic review of  tax expenditures to ensure that they are achieving their intended purposes  and are designed in the most efficient and effective manner.
section_title: Saving Incentives
paragraphs: The federal government has sought to encourage personal saving both to  enhance households’ financial security and to boost national saving.  However, developing policies that have the desired effect is difficult. Tax  incentives may affect how people save for retirement but do not  necessarily increase the overall level of personal saving. Even with  preferential tax treatment for employer-sponsored retirement saving plans  and individual retirement accounts (IRA), the personal saving rate has  steadily declined. For example, although tax benefits seem to encourage  individuals to contribute to these kinds of accounts, the amounts  contributed are not always new saving. Some contributions may represent  saving that would have occurred even without the tax incentives—and  may even be shifted from taxable assets or financed by borrowing.  Economists disagree about whether tax incentives have been or could be  effective in increasing the overall level of personal saving. The net effect of  a tax incentive on national saving depends on whether the tax incentive  induces enough additional saving by households to make up for the lower  government saving resulting from the government’s revenue loss. The  bottom line is that we have many saving incentives but very little  information on whether they work and how they interact.
section_title: Saving Education
paragraphs: A leading obstacle to expanding retirement saving has been that many  Americans do not know how to save for retirement, let alone how much to  save. The need to improve consumers’ financial literacy—their ability to  make informed judgments and effective decisions about the management  of money and credit—has become increasingly important. Congress has  responded by passing legislation, such as the Savings Are Vital for  Everyone’s Retirement Act of 1997 (SAVER Act).  In addition, in the Fair  and Accurate Credit Transactions Act of 2003, Congress created the  Financial Literacy and Education Commission, which is charged with  coordinating federal efforts and developing a national strategy to promote  financial literacy. Also, GAO has identified financial literacy as a 21st  century challenge.
In a July 2004 Comptroller General forum, we discussed the federal  government’s role in improving financial literacy. Among other things,  forum participants suggested that the federal government serve as a leader  using its influence and authority to make financial literacy a national  priority. Some federal agencies already play a role in educating the public  about saving. For example, as mandated by the SAVER Act, the  Department of Labor maintains an outreach program in concert with other  public and private organizations to raise public awareness about the  advantages of saving and to help educate workers about how much they  need to save for retirement. Also, individualized statements now sent  annually by the Social Security Administration to most workers aged 25  and older provide important information for personal retirement planning,  but knowing more about Social Security’s financial status would help  workers to understand how to view their personal benefit estimates.
section_title: Concluding Observations
paragraphs: Increasing the nation’s economic capacity is a long-term process. Acting  sooner rather than later could allow the miracle of compounding to turn  from enemy to ally. This is why the Comptroller General has called for  reimposing budget controls; reforming Social Security, Medicare and  Medicaid; and reexamining the base of all major spending programs and  tax policies to reflect 21st century challenges. As I said before, every  generation is in part responsible for the economy it passes on to the next.  Our current saving decisions have profound implications for the nation’s  future well-being.
Mr. Chairman, this completes my prepared statement. I would be happy to  respond to any questions you or other Members of the Subcommittee may  have at this time.
section_title: Scope and Methodology
paragraphs: My remarks are based largely on our previous report National Saving:  Answers to Key Questions and other related GAO products. We updated  the information from the National Saving report with the most recent  published data from OMB, BEA, the Federal Reserve Board, CBO and the  IMF. We also reviewed some recently published studies and statements  from academic journals, Federal Reserve officials, the IMF, CBO and other  sources.
section_title: Contacts and Acknowledgments
paragraphs: Contact points for our Offices of Congressional Relations and Public  Affairs may be found on the last page of this testimony. For further  information on this testimony, please contact Thomas J. McCool at (202)  512-2700 or mccoolt@gao.gov or Susan J. Irving at (202) 512-9142 or  irvings@gao.gov. Individuals making key contributions to this testimony  include Rick Krashevski, Assistant Director; and Melissa Wolf, Senior  Analyst.
section_title: Related GAO Products
paragraphs: 21st Century Challenges: Reexamining the Base of the Federal  Government. GAO-05-325SP. February 2005.
Highlights of a GAO Forum: The Federal Government’s Role in  Improving Financial Literacy. GAO-05-93SP. Nov. 15, 2004.
Federal Debt: Answers to Frequently Asked Questions, An Update. GAO- 04-485SP. August 2004.
National Saving: Answers to Key Questions. GAO-01-591SP. June 2001.
See also http://www.gao.gov/special.pubs/longterm/ for information on  GAO’s most recent long-term simulations and  http://www.gao.gov/special.pubs/longterm/longtermproducts.html a  bibliography of GAO’s issued work on the long-term fiscal outlook.
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