The IRS' saving grace

August 24, 2006|By Reid Cramer

WASHINGTON -- It's not often that we look to the dastardly IRS to come to our rescue. But the IRS recently announced the advent of a new tool that just might help avert a growing crisis - the disappearance of savings in the American economy.

Beginning next year, taxpayers will be allowed to use direct deposit to divide their tax refunds among several accounts rather than receiving them in a lump sum. This will allow funds to go directly into savings, checking and retirement products. Because the IRS distributes more than $220 billion in refunds each year, and more than three-quarters of the nation's taxpayers receive them, this policy will create an ideal opportunity to connect tax refunds to saving opportunities.

The average taxpayer receives a refund of more than $2,000, so the tax-filing process is a logical place to support and encourage savings. In fact, tax filing should be further redesigned so that it simplifies money management, maximizes taxpayer choices, encourages financial planning and facilitates savings.

This new rule is a start. It might seem like a small change, but studies show that small adjustments in financial transaction structures have a surprisingly large effect on financial behavior. Take 401(k) savings: Empirical research confirms that direct deposit enrollment greatly increases savings activity in these plans.

The IRS' new rule could jump-start a campaign that would generate enormous savings for Americans. Moving 25 percent of refund deposits to savings products could net more than $55 billion in new savings each year.

But this goal can only be achieved by remaking the tax filing process. This opportunity is particularly relevant for the millions of lower-income households that receive refunds through the earned income tax credit. For many of these families, tax refunds present their only realistic opportunity to save during the year.

Millions of Americans, even those with low incomes, choose to pay someone else to prepare their return. For many, this choice sets them back even further if their preparer sells them an expensive refund-anticipation loan. These types of loans can be made obsolete if refunds arrive at their destination swiftly via direct deposit. A better use of a paid preparer would be to review the tax and nontax benefits of saving.

Up and down the income scale, American households are failing to save, and the decline has reached startling proportions. A recent study by the Center for Retirement Research at Boston College found that about half of current working-age households are at risk of seeing their standard of living fall in retirement as a result of low savings. Perhaps more troubling, last year was the first year since the Great Depression when household spending exceeded disposable income - meaning the net savings rate was actually negative. At the same time, consumer debt and personal bankruptcies are at or near all-time highs. This is a perilous combination, one that undercuts the country's economic security and threatens long-term prospects for growth.

Americans know how to consume, but we need to learn how to save and invest. The process of tax filing and the prospect of splitting tax refunds offer an invaluable teachable moment. The next step is to inform taxpayers of this option and inaugurate a national savings campaign. More aggressive promotion will be needed to resurrect the savings habit.

We might not regain our propensity for thrift overnight, but the future success and prosperity of the American economy will require that we reverse our savings decline.

Reid Cramer is research director at the New America Foundation in Washington. His e-mail is

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