Don't Spend Your Tax Rebate!

The IRS was so confident in the legendary observation of Oliver Wendell Holmes, Jr. that “taxes are the price we pay for a civilized society” they chiseled it above the entrance to their Washington D.C. headquarters. Still each year Tax Day makes incumbent politicians uneasy—especially at times when recession fears mount and fall elections loom. This year this perilous combination spurred them on to take prompt and bipartisan action. Who wants to be accused of sending families their tax bill as economic growth slows and hardship spreads?

The bipartisan prescription to jumpstart the economy was to deliver over $100 billion in rebate checks back into household coffers. Once again, in times of potential peril, our leaders appear to be issuing a deafening call for Americans to continue their consumption habits and carry on as usual. The message is so loud that one would be forgiven for thinking that failing to spend these rebate checks would be downright unpatriotic. Contrary to lawmaker assumptions, many Americans recognize a greater need to reduce personal debt and increase savings. A recent Pew Research Center poll found that 47 percent of those interviewed intended to use the rebate to pay down their debt and another 23 percent say they are planning to save the money. This would not be the first time that the reality of the kitchen table will confound the fantasies of Washington.

Although few doubt the need for an economic kick start, our policy makers need to find more ways to helping working families save for their future and ensure their long-term financial stability. As it is now, we do a terrible job of facilitating the savings process for these families. The majority of our savings incentives and institutional support systems flow to higher income earners who benefit when their employers automatically deduct savings from payroll, transfer sums into 401(k) savings plans, and provide additional matching deposits. The government then kicks in generous tax deductions which are only valuable to households looking to offset tax liabilities. All told, over $110 billion in tax breaks are provided each year to boost retirement savings. Unfortunately, well over 90 percent of these benefits flow to earners on the upper half of the income distribution curve. Our current approach leaves out exactly the families we should be crafting policies to support.

Yet as the Pew survey findings suggest, the problem for many of these families is not that they are hopelessly addicted to spending and unwilling to save, it's that saving has never been incentivized or encouraged. While the federal government can provide relief to those families unexpectedly stressed by recessionary forces, public policy should do a better job of meeting families' financial needs over the long-term by enabling them to save. A recent proposal by Senator Robert Menendez of New Jersey offers an innovative approach that deserves some attention. He wants to offer targeted households a Saver's Bonus if they commit to savings when they file their tax returns.

Under his Saver's Bonus proposal, which is soon to be introduced in Congress, savings contributed to eligible savings products could be matched on a dollar-for-dollar, up to $500. . These products could include individual retirement accounts, educational savings plans, or U.S. Savings Bonds. Those who do not currently hold bank accounts or participate in savings plans will be able to open accounts and access savings products right on their tax returns. Eligibility for the bonus will be available to anyone qualifying for the Earned Income Tax Credit (EITC) and the bonus will be delivered through the tax filing and tax refund process. Tax filers would receive the bonus if they deposit a portion of their refund into a savings product or report that such deposits have been made.

This proposal has many promising features. For starters, it uses the tax filing process as a gateway to savings and financial services. Each year, the IRS issues refunds averaging over $2,000 to 130 million tax filers, including many lower-income families that qualify for the EITC. Providing the Saver's Bonus at tax time has the advantage of leveraging the tax filing process to ensure that people have access to effective savings products, for short-term savings needs and longer-term savings goals. Second, targeting eligibility to families that receive the EITC gets resources to the working families that need additional support. Not only does this proposal create a meaningful incentive to save, but it also ensures that everyone has access to appropriate savings products, which is a major step in helping to bank the un-banked and in providing a gateway to mainstream financial services.

The cost of this proposal would depend on the size of the bonus, the number of people eligible, and how many of them adjust their behavior to qualify for the bonus. As a point of reference, it would cost $10 billion a year to increase the EITC by $500 per person for current recipients. If we made the receipt of this $500 contingent upon saving it, we should expect a price tag of $2.5 billion a year assuming 20 percent of eligible families take up the offer. This will remain a small fraction of the public resources that we currently devote to higher earners. Other policy details will have to be worked out, including decisions as to what types of savings products would qualify to trigger the bonus and how the bonus would be delivered to the designated account. These challenges can be addressed as the proposal gets refined but moving money around electronically has become a core competency of government.

The arrival of the stimulus rebates is still several months away. In the meantime, more economic bad news will undoubtedly lead to additional calls for congressional action. The Saver's Bonus and other ideas to promote savings should be included in the mix in order to offer families more support in responding to economic uncertainty. And when the rebates do show up in mailboxes and bank accounts, people will have every right to decide what to do with them. Hopefully, the influx of cash will offset some recessionary pressures, but families should not feel selfish if they decide to stash their money away for another day. In the long run, these savings can fuel investments that stimulate economic growth and job creation over the long term, making us all better off. There is nothing wrong with a short-term infusion of cash to keep the economy growing but, by creating a targeted Saver's Bonus, Congress can also provide a means to help working families jumpstart the process of building up their own economic reserves.