To verify whether that rate of return could possibly be right, I consulted Jermey Siegel’s new bible on the financial markets, Stocks for the Long Run (McGraw Hill, 1998). There I found basically the same conclusion. Siegel reports that for roughly the past 200 years the average annual rate of return in the stock market has been more than 10 percent. There has never been a 40‐year period in American history when the markets have deviated significantly from that long‐term trend.
It is often said these days that lower‐ and middle‐income Americans should avoid the stock market because it is so “risky.” The facts suggest that stocks are not very risky at all if held for the long term. Over time, even the poorest Americans can accumulate substantial wealth by investing. My favorite example is Theodore R. Johnson, who never made more than $14,000 a year working at United Parcel Service. But he plowed every penny of savings he had back into UPS stock, and when he reached the age of 90 last year his net worth was a cool $70 million.
Alas, there is a catch to all of this. We have forgotten about taxes. In the example of the grandparents and parents who put $100 a year in a mutual fund starting in 1926, the $2.36 million would have shrunk to $973,000 if they had been in the 15 percent tax bracket. Even at this lowest income tax rate, taxes would eat up 59 percent of the gain.
What if they paid a combined federal and state income tax rate of 50 percent, as many Americans do today? Then the nest egg would not be $2.36 million but just $101,000. No, this is not a misprint. Taxes would have confiscated 95 percent of the return!
Economists and political pundits in Washington sermonize that Americans should save more. Lester Thurow of MIT moans that America had “negative savings rates in late 1998.” But why should we save? The tax code punishes us for thrift. The double and triple taxes on saving claim up to 90 percent of the rewards from investing. We are rewarded for consuming as much as possible right now.
There is a logical policy prescription: universal savings accounts. Tax free individual retirement accounts (IRAs) should be made available to all Americans regardless of their incomes and with no limitation on how much they can save. Presidential candidate Dan Quayle has proposed just such a plan. More than 25 million Americans — mostly low‐ and middle‐income workers — have IRAs, but stupidly we limit the amount they can place in those accounts to a few thousand dollars. It is a fundamental principle of all tax reform proposals — including the flat tax and the national sales tax — that savings should never be double taxed.
If Congress would allow taxpayers to build up more wealth in untaxed universal savings accounts, Americans could be weaned from paternalistic government programs, like Social Security, Medicare, unemployment insurance and student loans. The Quayle plan would allow workers to take funds out of IRAs to pay for educational expenditures, health care costs and, of course, retirement.
We as a nation will save more and take more control of our own destinies and those of our families if Congress will simply let us. The best children’s program that Washington could possibly devise is one that allows Americans to build up wealth for their own children and grandchildren. It doesn’t take a village to raise a family, but it may take a smarter tax code.
How Income Taxes Punish Savings
$100 per Year Investment
|First Year of Investment
||No Income Tax
||15% Tax Bracket
||50% Tax Bracket
|Source: Savers & Investors League, www.savers.org, 1998.