Saving out of Different Types of Income

LESTER D. TAYLOR* Universityof Michigan

Saving out of Diferent Types of Income

IT HAS ALWAYSBEEN A SOURCEof professionalpride to me to be able to tell my undergraduatestudents in macro theory that economists know a lot about what makes consumers tick. However, in light of the experience of the past several years, I now state this proposition much more circumspectly, and perhaps should restrain myself altogether. For the fact is that in the last three or four years, the consumer has done few things predicted of him. To be sure, there have been some new elements in the picture: interest rates at the highest levels in a century; a "roaring" inflation, at least by contem- porary U.S. standards; and a temporary tax increase. But even so, the consumer seems to have injected his own element of eccentricity. Among other things, he was thrifty in 1967 and the first half of 1968 on a scale then un- precedented for the postwar period. And while he regained his taste for spending in the last half of 1968, it was rather short-lived. For in the third quarter of 1969, the personal saving rate again began to rise, and from the third quarter of 1970 through the second quarter of 1971, was in excess of the unheard-of level of 8 percent.

* Computationsand researchassistance supported by the National Science Founda- tion. I am gratefulto membersof the Brookingspanel for commentsand criticisms,to Daniel Weiserbsand Angelo Mascarofor researchassistance, and to Joan Hinterbichler and PatriciaRamsey for secretarialassistance. I have also greatlybenefited from access to an unpublishedpaper of H. S. Houthakkerand S. D. Tendulkar,"The Dynamics of Total Consumption and Saving: FurtherResults for the United States with Revised National Accounts Data" (HarvardUniversity, 1965), which explored an early version of the model of this paper.

383 384 Brookings Papers on Economic Activity, 2:1971 The time seemsappropriate, therefore, to beginreassessing the contem- poraryview of the aggregateconsumption function. It is in this spiritthat this paperwas undertaken,though perhaps appropriately enough, it deals not with a new idea, but with one that goes back at least to Marx and Ricardo.In questionis the notion that differentmarginal propensities to consume attach to differenttypes of income. Usually the distinctionin- tendedis betweenlabor income and propertyincome,' but this paperfo- cuseson transferpayments, personal contributions to socialinsurance, and personaltaxes. Becauseof the 1968 surcharge,the liberalizationof social securitybenefits in early1970 and again in 1971,the 1970increase in payroll taxes,and the 1970recession, these three determinants of disposableincome in recentyears have all experiencedfairly abrupt changes, and accordingly it seemsappropriate to look to themin tryingto explainthe unusualrecent behaviorof personalsaving. I shouldlike to warnthe readerat the outsetthat he is likelyto be some- what shockedby the results.For one thing, probablynearly every fiscal policyeconomist believes that one of the quickestand surestways to stimu- late consumerspending is to increasetransfer payments. If taken literally (andI shallargue they should not be takenliterally), the resultshere suggest the contrary-that only about 15 centsof eachdollar of increasedtransfers is spentwithin three months of the increase.For anotherthing, the results indicatethat a dollarincrease in employeepayroll taxes leadsto a prompt reductionof more than two dollarsin personalsaving, thus indicatinga superrationalityon the part of the consumerthat may seem counter- intuitive.Finally, the resultssuggest that in the short run the bulk of the

1. In the theoreticalliterature, see especiallyNicholas Kaldor, "MarginalProductivity and the Macro-Economic Theories of Distribution: Comment on Samuelson and Modigliani," Review of Economic Studies, Vol. 33 (October 1966), pp. 309-16, and "AlternativeTheories of Distribution,"Review of EconomicStudies, Vol. 23 (1955-56), pp. 83-100. In the empiricalliterature, see LawrenceR. Klein and A. S. Goldberger, An EconometricModel of the UnitedStates, 1929-1952 (Amsterdam:North-Holland, 1955); Lawrence R. Klein and J. Margolis, "Statistical Studies of Unincorporated Business," Review of Economicsand Statistics, Vol. 36 (February 1954), pp. 33-46; Irwin Friend and Irving B. Kravis, "EntrepreneurialIncome, Saving and Investment," AmericanEconomic Review, Vol. 47 (June 1957), pp. 269-301; IrwinFriend and Stanley Schor, "Who Saves?"Review of Economicsand Statistics,Vol. 41 (May 1959), pp. 213- 48; and H. S. Houthakker, "An International Comparison of Personal Savings," Bulletinde PInstitutde StatistiqueInternational, Vol. 38-2 (November 1961), pp. 55-69, and "On Some Determinantsof Savingin Developedand Under-DevelopedCountries," in E. A. G. Robinson (ed.), Problemsin EconomicDevelopment (London: Macmillan, 1965). Lester D. Taylor 385 adjustmentto a changein personaltaxes falls on savingrather than consumption. I, too, have reservationsabout these findings:(1) They obviouslycon- tradictmuch current conventional wisdom; (2) theyare based only on aggre- gatetime seriesdata; and (3) they arederived in the contextof one particular model. But I believethat they have sufficientvalidity to raise serious questionsabout what ArthurOkun has recentlytermed the "fundamental premise"of fiscalpolicy economics-the notion that a dollar of incomeis basicallya dollarof incomeregardless of its source.2

The Model

The analysisbegins with the followingidentity from the nationalincome accounts:Disposable personal income equals labor income(L) plus propertyincome (P) plus transferpayments (TR) less personalcontributions for social insurance(SI) less personaltax and nontaxpayments (T). Laborin- come is definedas the sum of wage and salarydisbursements and other laborincome, while property income consists of proprietors'income, rental incomeof persons,dividends, and personalinterest income. Sincethe nationalincome accounts do not breakdown savingin a man- ner correspondingto disposableincome, it is not possibleto estimatea saving function for each categoryof income taken separately.3As a result, separatevalues of the marginalpropensities to save must be estimatedas the coefficientsin an equationin whichtotal savingis regressedon the sev- eralcomponents of disposableincome. The analysishas in generalbeen conducted in the frameworkof the "zero- depreciation"theory of saving elaboratedby H. S. Houthakkerand myself.4According to this theory,personal saving is assumedto be a linear functionof the existingstock of financialassets and income: (1) S(t) = a + bA(t) + sY(t),

2. Arthur M. Okun, "The Personal Tax Surchargeand ConsumerDemand, 1968- 70," BrookingsPapers on EconomicActivity (1:1971), p. 171. 3. It would also be desirableto have taxes broken down by type of income, but these data, too, are not available. 4. H. S. Houthakkerand Lester D. Taylor, ConsumerDemand in the UnitedStates: Analysesand Projections (2nd ed., HarvardUniversity Press, 1970). 386 BrookingsPapers on EconomicActivity, 2:1971 where S = personal saving A = stock of financial assets Y = disposable personal income, all quantitiesbeing assumedto be measuredat time t. S and Y are flows, while A is a stock. The stock of financialassets is assumedto be non- depreciating-thusgiving the modelits name-with the resultthat the relationshipbetween the stock and its flow is givenby (2) A(t) = S(t), the "dot" on A denotingthe rate of changeof the stock of assetswith respectto time. The basicnotion underlyingthis model is that the consumer(considered as a fictiverepresentative individual) adjusts his savingso as to bringhis stock of financialassets into line with his level of income.The model can thusbe interpretedas embodyinga Stone-Nerlovestock adjustmentprocess on the stock of wealth,with the provisothat the depreciationrate on this stock is zero.An importantconsequence of this assumptionis that in a long run, steady-stateequilibrium, saving is zero.5Accordingly, the conceptof a marginalpropensity to savemust have reference to somelimited interval of time. More particularly,s refersto the instantaneousmarginal propensity to save definedby the conditionthat the underlyingstock of financialassets is constant;that is, s measuresthe responseof savingto a changein disposableincome in the intervalbefore the stock of assetsis affectedby the changein saving.This interval will be referredto as the shortrun, and is not to be confusedwith a periodof one quarter. The presentapproach is controversialin denyingthat saving is deter- minedpassively as the differencebetween disposable income and consumption. Indeed,the model in (1) leavesconsumption to be determinedresid- ually.Hence, the presenceof real inventoriesin the case of durablegoods, and of psychologicalfactors giving rise to inertiain the case of servicesand somenondurables, does not enterinto the determinationof the savingrate. These quantitiesplay an importantrole in determiningthe allocationof total consumptionamong goods and services,but for total consumption the stock adjustmentoperates with respectto the stock of financialassets.

5. The steady state is definedby the condition that the stock ceases to change. Since the stock does not depreciate,saving must be zero. Lester D. Taylor 387

RELATIONSHIP TO THE MODIGLIANI-BRUMBERG LIFE CYCLE HYPOTHESIS Additionalinsight into the model can be gainedby noting its kinshipto the consumptionfunction evolving from the life cycle hypothesisof saving originallyformulated by Modiglianiand Brumberg.6The savingfunction expressedin equation(1) can be madeequivalent to the Modigliani-Brum- bergconsumption function simply by replacingcurrent disposable income (Y) by its value expectedin the futureand assuminga to be zero. In this case, the coefficientsb and s must be interpretedas dependingupon the lengthof the life cycle and the age distributionof the population. However,the relationshipof the two models in their long-runlimiting formsis even closerand does not dependupon the identificationof current with expectedincome. A well-knownimplication of the life cycle model is that in the contextof steadyexponential growth in income,the savingrate is proportionalto this rate of growth.7This is also true for the present model, for it be can shown8that in conditionsof long-rundynamic equilibrium,or "goldenage" growth,the saving-incomeratio approachesthe value

(3) Y(t) g-b' wheres and b are coefficientsas definedfor (1), g is the exponentialrate of growthin income,and the "hat"on S denotesthe goldenage.

DISAGGREGATION OF DISPOSABLE INCOME The particularobjective of this inquiryrequires disaggregation of disposableincome into the componentslisted at the beginningof this section,

6. See Franco Modigliani and Richard Brumberg,"Utility Analysis and the Con- sumptionFunction: An Interpretationof Cross-SectionData," in KennethK. Kurihara (ed.), Post-KeynesianEconomics (Rutgers University Press, 1954), and "Utility Analysis and AggregateConsumption Functions: An AttemptedIntegration" (unpublished paper, 1953).This section does not imply that the model reportedin this paper is based on life cycle notions. Its purpose is merely to note that, especially in the context of steady growth, the presentmodel has life cycle implications. 7. See Franco Modigliani, "The Life Cycle Hypothesis of Saving, the Demand for Wealthand the Supplyof Capital,"Social Research,Vol. 33 (Summer1966), pp. 160-217. 8, See Houthakkerand Taylor, ConsumerDemand, pp. 288-89. 388 BrookingsPapers on EconomicActivity, 2:1971 postulatinga separateshort-run marginal propensity to savefor each.Thus,

(4) S(t) = a + bA(t) + sIL(t) + s2P(t) + s3TR(t) + s4SI(t) + s5T(t). Since savingsare the epitomeof a durablegood, b should be negative, whichis to say that the stock of wealthis expectedto influencesaving in the sameway that the stock of automobilesinfluences the purchaseof new cars. Thecoefficients s1 ands2 are,of course,expected to be positive,and on theo- reticalgrounds s2 shouldbe greaterthan sl, as will be discussedbelow. As for the othercoefficients, s4 and s5 are naturallyexpected to be negative. Since contributionsto social insuranceleave the contributorswith a claimto futureincome-rather thanjust a tax receipt-the size of S4 will de- pend upon the extentto whichsocial insurancesubstitutes for regularsav- ing. At an extreme,S4 couldbe in the neighborhoodof -2, sinceemployees' contributionsare matcheddollar for dollarby employers.Finally, according to the prevailingview, S3, the short-runmarginal propensity to save out of transferincome, is fairlysmall.

THE STEADY-GROWTH SAVING RATE While, as has alreadybeen noted, the long-runmarginal propensity to save out of all types of incomeis zero in a steady-statestatic equilibrium, it is positivefor a regimein which each componentof disposableincome growsat some constantexponential rate. Thus, analogouslyto the goldenage savingrate given in equation(3) for nondisaggregateddisposable income, it can be shown that, in such a regime,

(5) S _ sg L + s2g2p + +S5g5 T Y gl-b Y g2-b Y g5-b Y' whereg, is the rateof growthin laborincome, g2 the rateof growthin property income,and so forth. Consequently,the steady-growthsaving rate is seento dependon each of the s parametersas well as on b and the shareof each componentof disposableincome in the total. Sincein particularthe steady-growthsaving rate depends upon s1 and s2, it is importantto recallthe theoreticalreasons why the marginalpropensity to save out of propertyincome is expectedto be higherthan that out of labor income.The literatureprovides at least three. One, stressedby Klein and Goldberger,assumes that labor income and propertyincome representdifferent points on the incomedistribution.9 The argumentis that 9. Klein and Goldberger,An EconometricModel of the UnitedStates. Lester D. Taylor 389 those receivingproperty income have higherincomes on the averagethan those receivinglabor income.The highermarginal propensity to save out of propertyincome then follows from the assumptionthat the marginal propensityto save increaseswith income. The second and third arguments,which, though venerable,are most closely identifiedin the recentliterature with Kaldor and Samuelsonand Modigliani,stress the functionalrather than the size distributionof income.10Samuelson and Modiglianiappear to believethat the highermar- ginalpropensity to save out of propertyincome is an attributeof the class receivingthe income,while Kaldor argues that it is intrinsicto the natureof the income.In Kaldor'sview, the prosperityof businessenterprise requires continualexpansion, and, for a varietyof reasons,it is necessarythat a por- tion of the capitalrequired be generatedinternally.11

ESTIMATION FORM OF THE MODEL As formulated,the model contains a quantity,the stock of financial wealth(A), whichcan be measuredonly with difficulty,and accordingly,it is desirablethat this quantitybe eliminated.Moreover, the modelis formulated in continuoustime and must be translatedinto discretetime inter- vals.12Once all this is done, the reduced-formestimation equation, with an errorterm (u) added,is: (6) St = BjSt_1 + B2ALt + B3APt + B4,ATRt+ B5LXSIt+ B6ATt + Ut. The estimatingequation is thus seen to have a particularlysimple form, requiringonly the regressionof personalsaving on its own valuein the pre- cedingperiod and on the firstdifferences of the componentsof disposable income. The coefficients,B1, . . , B6 are functionsof the structuralpa- rametersb, sl, . ., s4 (a unfortunatelyis indeterminate),and estimatesof the formerare readilytransformed into estimatesof the latter.13 10. Kaldor, "AlternativeTheories of Distribution,"and "MarginalProductivity"; and Paul A. Samuelsonand Franco Modigliani,"The PasinettiParadox in Neoclassical and More General Models," Reviewof EconomicStudies, Vol. 33 (October 1966), pp. 269-301. 11. Neitherthe Kaldor nor the Samuelson-Modiglianiargument rules out the Klein- Goldbergereffect arisingfrom the size distributionof income. Wealthyproperty owners may save a higher proportion of their incomes than do their poor brethren,and the same may also be true of wealthyand poor wage earners. 12. The details of this elimination and translationare set out in Houthakkerand Taylor, ConsumerDemand, pp. 13-17. 13. For the formulas, see ibid., p. 17. 390 BrookingsPapers on EconomicActivity, 2:1971 However,the finallyestimated model containsone additionalvariable, the firstdifference of the yield on Baa bonds.This variablewill be denoted by r and its coefficientin the structuralequation (2) by m. The reasonsfor includingan interestrate in a modelof personalsaving are evident and need no elaboration.

DATA AND PERIOD OF ESTIMATION With the exceptionof the yield on Baa bonds, whichis publishedin the Federal Reserve Bulletin, the data are taken from Table 2.1, "PersonalIn- come and Its Disposition,"of the nationalincome accounts, published in the Survey of CurrentBusiness and its supplements.The nationalaccounts data are seasonallyadjusted and expressedas annualrates. They have been deflatedby the implicitdeflator for personalconsumption expenditures, and are thus expressedin constant(1958) dollars. Two modelshave been esti- mated.In the first,the datahave been deflatedby the population,while in the second,they are left as aggregates.In each case, the observationsare quarterly,and coverthe period1953 :1 through1969:4. The sampleperiod thus involvessixty-eight quarterly observations.

EmpiricalResults

The empiricalresults are tabulatedin Tables 1 and 2. Coefficientsand measuresof goodness-of-fitfor the estimatingequations are givenin Table 1 andstructural coefficients and their standard errors in Table2.14 Six equa- tionshave been tabulated. Equation (1) representsthe full model;it is based on the disaggregationof disposableincome discussedabove and includes the yield on Baa bonds as an additionalpredictor. Equation (2) is intended as a benchmarkfor comparison,and differsfrom equation(1) in that disposableincome is not disaggregated.Equations (4) and (5) correspondto (1) and (2) except that saving and income have not been deflatedby the population.Finally, since, as it turns out, the short-runmarginal propen- sitiesto save out of laborand propertyincome cannot be distinguishedsta- tisticallyfrom one another,the modelshave been reestimatedin equations (3) and (6) withlabor and propertyincome combined (hereafter referred to as grossincome), and with the coefficienton grossincome denoted by sl.

14. The standarderrors for the structuralcoefficients are only approximateand are calculatedaccording to the proceduredescribed in ibid., pp. 51-52. 10 104 10 .1

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0 X R~ ~v6z 00' Lester D. Taylor 393

THE STATISTICAL GAIN FROM DISAGGREGATION From a comparisonof equations(1) and (2)-or, alternately,of (4) and (5)-the gain from disaggregationis seen to be fairly considerable.The coefficientof determination(R2) for equations(1) and (2) is increasedby about 4?/2percentage points, and the standarderror of estimate(Se) is correspondinglyreduced by about $1.50 per capita. In equations(3) and (6), in whichlabor and propertyincome are combined,all t-ratiosare sub- stantiallyin excess of 2 (in absolutevalue) and each sign is as expecteda priori.

THE POPULATION EFFECT Comparisonof equations(1) and (4) showsthat it makeslittle difference to the resultswhether the data are expressedper capitaor in the aggregate, since, except for the yield on Baa bonds, the coefficientsare nearly the same.While the R2 is higherin the aggregateequation, this improvementin fit is only apparent.When the R2s are computedon a comparablebasis, they are virtuallyidentical.15

THE EFFECT OF THE RATE OF INTEREST Disaggregatingdisposable income increases the statisticalimportance of the yield on Baa bonds,for the t-ratiofor this variableis only 1.46in equation (2) but is 2.26 in equation(3). A priorione cannot say whetherthe sign on the rate of interestshould be positive or negative,for it can be eitherdepending upon whetherthe incomeor substitutioneffect predomi- nates.The positivesign indicatesthat the substitutioneffect is the stronger -that is, that an increasein the rate of interestbrings substitution of future for currentconsumption.16 The elasticityof savingwith respectto r (calcu-

15. "Comparablebasis," in this context, means that both refer either to per capita saving or to aggregatesaving. In terms of the latter, equations (3) and (6) both yield an R2 of 0.899. 16. This result is at variance with the recent findings of Warren E. Weber, "The Effect of InterestRates on AggregateConsumption," American Economic Review, Vol. 60 (September1970), pp. 591-600, and "InterestRates and the Short-runConsumption Function," AmericanEconomic Review, Vol. 61 (June 1971), pp, 421-25. They also divergefrom an earlierresult, reportedin Houthakkerand Taylor, ConsumerDemand, pp. 293-96. In both cases, however,the period of fit ends before interestrates took off to their historic highs of 1970-in 1965 for Weber and in 1966 for Houthakker and Taylor. 394 BrookingsPapers on EconomicActivity, 2:1971 lated at the point of means)from equation (3) is 0.78, while fromequation (6) it is 0.88. Becausethe rate of interestis includedas a nominalrather than a real rate, I have consideredsome equationsin whichcurrent and past (percentage) changesin the implicitdeflator for personalconsumption expenditures are includedas predictors.When the currentprice change is in the model,it takes on a coefficientof 13.87with a t-ratioof 2.42, whilethe coefficientof Ar dropsto 5.54 with a t-ratioof 0.54. The sum of the coefficientsis 19.41, which is very close to the coefficientof Ar in equation(3). A statistically strong positiveprice effect in this case would have to be interpretedas a strongreal-balance effect that operatespractically instantaneously. While nothingin the logic of the modelforecloses this, I am inclinedto discountit and to viewthe pricechange as a proxyfor the changein the rate of interest ratherthan the reverse.Accordingly, I have done no furtherexperimenta- tion with currentprice changes. Past pricechanges, however, were included with a lag of up to five quarters, but the resultsmade little sense.The most plausibleresults were those obtainedusing the percentagechange in the deflatorfor personalconsumption expendituresover the precedingfour quarters.The coefficientis positive, therebygiving evidence of a real-balanceeffect, but its t-ratiois only 1.18and that for Ar falls to 1.61.

STRUCTURAL COEFFICIENTS Table2 revealsthat b is negativeas expected,but that in equation(3) it is smallerin relationto its approximatestandard error than the other coefficients.This may reflecta misspecificationarising from the assumptionthat b is the samefor all types of income.However, it is impossibleto eliminate this assumptionwithout a disaggregationof savingcorresponding to that of disposableincome.'7

17. In his discussion of this paper, James Duesenberrynoted that the coefficienton S,-1 is close to unity and offered that as one reason to suspect that stock adjustment evaporates.However, in equations (3) and (6), 1 - b has t-ratios of 1.83 and 2.25, respectively,which does not suggestthe absence of stock adjustment.Furthermore, I have estimatedthe counterpartto equation (3) with a constant term (the constant is absent from the estimatingequation because of the assumptionthat the depreciationrate is zero; however,one can be justifiedif the errorterm u in equation(6) is assumedto have a non- zero mean).The result is a b of 0.866 with a standarderror of 0.062. This yields a t-ratio for 1 - b of 2.16. Once again stock adjustmentwould not seem to be absent. Lester D. Taylor 395 As has alreadybeen mentioned, the s coefficientsshould be interpretedas short-runmarginal propensities to save and m as the short-runresponse in savingto a changein the yield on Baa bonds.18

Discussionand Defense of the Results

Some of the resultspresented in Table 1 may be regardedas unusualor even anomalous: (1) A marginalpropensity to save out of propertyincome that is lower thanthat out of labor income.19 (2) A short-runmarginal propensity to save out of transferincome that is exceedinglyhigh. (3) A very largenegative coefficient on personalcontributions to social insurance. (4) A largenegative coefficient on personaltax and nontaxpayments.

THE LOW COEFFICIENT ON PROPERTY INCOME Of the severalunusual coefficients, that on the changein propertyincome is perhapsthe easiestto rationalize.The argumentssummarized earlier, in particularthose of Kaldorand of Samuelsonand Modigliani,referred to the incomeearned by propertyowners rather than the incomeactually received.Business retentions and capitalgains typically make the lattercon- siderablylower than the former.And becausethe differencebetween the two is in effectentirely saved, it is not surprisingto find a fairlylow marginalpropensity to save out of the incomeactually received. An additional

18. Recall that the short run in this context is definedby the conditionthat the under- lying stock of financialassets does not change, and should not be confused with a time period of one quarter;for implicit in the procedurethat approximatesthe continuoustime model (4) with the discreteversion (5) is the assumptionthat the feedbackof an increasein the stock of assets on savingbegins in a periodshorter than one quarter.On the other hand, if the short run is definedas one quarter,then the short-runcoefficients are those given by the estimatingequations. In the discussionthat follows, these two "short runs" will often be used ambiguously.The context will make clear which is intended. 19. This hypothesisis tested througha t-test on the differenceof the two coefficients. This differenceis 0.089, with a t-ratio of 0.31, substantiallybelow that required,at conventional levels of significance,to reject the hypothesis.However, neither equation (1) nor (4) supportsrejection of the hypothesisthat the marginalpropensities to save out of labor and propertyincome are the same. 396 BrookingsPapers on EconomicActivity, 2:1971 influencearises from the significantportion of propertyincome that is imputedas the rentalincome from owner-occupiedhousing. Since an identical amount is also imputedto consumption,saving out of this part of propertyincome is zero.

THE HIGH COEFFICIENT ON TRANSFER INCOME Unfortunately,no such ready explanationspresent themselves for the largecoefficient attaching to the changein transferpayments. Theoretically, part of the explanationcould stressthe fact that any part of transfersallo- catedto retireexisting debt would be savedin its entirety,but as a factual matterthis can hardlybe of significance.The permanentincome hypothesis could also providean explanationif one werewilling to arguethat transfer income is viewed as temporary,but since transferpayments are heavily composedof social securitybenefits, medicare, and aid to dependentchil- dren,this, too, seemsa dubiousargument. The question,therefore, is whetherany plausibleargument can account for this high coefficient.One mighttry to rationalizethe findingsalong the followinglines: Assumethat thereare only two categoriesof individuals65 or overwho receivetransfer payments, rich and poor. Thereis little reason to supposethat the richwill spendan increasein retirementbenefits imme- diately,for such incomeis likely to be viewedlike any other income.In- deed, for the veryrich, increasedsocial securitybenefits are unlikelyin the shortrun even to be muchnoticed. Thus a high coefficienton transfersto the rich shouldnot be foundunreasonable. For poor retirees,on the otherhand, the dominantconsideration is prob- ablyuncertainty-about the numberof yearsstill to live and aboutthe ade- quacyof incomefrom all sources.In short,what is presentis one of Irving Fisher'sclassic motives for saving,namely, uncertainty of the future.Con- sequently,for poor retireesas well as for the rich,a highshort-run marginal propensityto saveout of transferincome need not be viewedas implausible. Finally,the only other study that I know of that treatstransfer income separatelyfrom other income(in this case using surveydata) also finds a high short-runmarginal propensity to save out of transfers,though not quite as high as that reportedhere.20 In view of the argumentjust made,it

20. Robert Holbrook and Frank Stafford, "The PropensityTo Consume Separate Types of Income: A GeneralizedPermanent Income Hypothesis,"Econometrica, Vol. 39 (January1971), pp. 1-21. Lester D. Taylor 397 is of particularinterest that the Holbrook-Staffordresult is based on data excludingsocial security and otherretirement benefits.

THE COEFFICIENT ON PAYROLL TAXES The coefficienton personalcontributions to social insurancecan be read as implyingthat the typicalconsumer sees socializedsaving as regularsav- ing.As alreadynoted, since the contributionsby employeesare matched by employers,a coefficientin the neighborhoodof -2 is to be expected,given that view by the taxpayer.21On the other hand, if householdsview these contributionsas a tax that will neverbe recovered,the coefficienton ASI shouldbe close to that on AT. Thus, the resultsseem to supportstrongly the view that householdsconsider contributions to social insurancea form of savingand even offsetit slightlymore than dollarfor dollar.22 However,before acceptingthis conclusionunreservedly, at least three otherfactors must be considered.First, the relationshipbetween changes in payrolltaxes (withrespect to both rate and base) and futurebenefits is ex- tremelyloose at best.In this case, a coefficientof -2 requiresthe consumer to have either a "highlysophisticated irrationality," or a strong implicit trustthat the governmentwill returnlater what it takesnow-and with interest.Secondly, increased payroll taxes in the aggregatecan come aboutin any of four differentways: (1) increasedincomes, (2) a highertax rate,(3) a highermaximum wage base subjectto taxation,or (4) increasedcoverage.

21. This result, incidentally,is consistentwith a recentfinding of R. J. Gordon about the effect of increasesin payrolltaxes on money wage demands.In "Inflationin Reces- sion and Recovery," BrookingsPapers on Economic Activity (1:1971), pp. 121-22, Gordon concludesthat, while in the long run the incidence of these payroll taxes-the employer'scontribution as well as the employee's-is borne by the employee,in the short run he attemptsto escapethe tax throughan increasedmoney wage. If this is so, the fact that the burden of the tax in the short run is borne entirelyby saving is preciselywhat should be expected. 22. GeorgeKatona, in PrivatePensions and Individual Saving (University of Michigan, Institutefor Social Research,Survey Research Center, 1965), claims to have shown with survey data that pension plans stimulatevoluntary saving. This would not be the first time that cross-section and time series analyses of saving have led to an apparent contradiction,but in this instance,the matteris obscuredby Katona'sunusual definition of saving(see his p. 44). He definessaving as the changein liquidassets, thus disregarding nonliquidassets (such as houses and equities in life insuranceand pension funds) and liabilities. In Katona's regressions,moreover, only certain dummy variables, loosely relatedto the amount of saving, but neverthe actual amount of savingitself (even on his definition),are used as dependentvariables. 398 BrookingsPapers on EconomicActivity, 2:1971 Obviously all four of these have operated over the period of the sample, but because they have proceeded sporadically and at differentialrates, the large negative coefficient on ASI could result from unknown errors of aggrega- tion. Finally, in a year when the maximum wage base for the payroll tax increases, the actual collection of payroll taxes is affected for the most part only in the third and fourth quarters.However, in anticipation, the Office of Business Economics changes its seasonal factors, with the result that, when seasonally adjusted, the data will show a change in the first and second quarters as well as the third and fourth. This practice, too, could bias the estimate of the coefficient. Unfortunately, the effects of these factors are uncertain and could, in principle, lead the coefficient to be too low rather than too high. Their im- portance, therefore, remains at this time a matter of judgment. Finally, it should be noted that because of the way personal saving is de- fined in the national income accounts, the results on payroll taxes are some- what inconsistent with the basic logic of the zero-depreciationmodel, which holds that in the (static) long run saving is zero. Since payroll taxes are included neither in disposable income nor in saving, this result implies that when the official estimate of saving is zero, actual saving is equal to the sum of employees' and employers' contributions to social insurance.23

THE COEFFICIENT ON PERSONAL TAXES Arthur Okun has recently observed: Ever since economistshave becomeinterested in fiscalpolicy, they have operated generallyon the fundamentalpremise that changesin after-taxincome resulting from a changein personaltax rates are basicallyequivalent in their influenceon consumptionto changesin income arisingfrom other sources.24 The large negative coefficient on AT-which in absolute value is significantly different statistically from the coefficient on gross income-strongly con- tests this view. However, as Okun notes in the sentence following that just quoted, the support for the "fundamental premise" is primarily analytical. As far as previous empirical support is concerned, the experience following 23. In principle, one could allow for the long-run coefficienton personal contributions to social insuranceto be other than zero by includingin (6) the past level of SI as well as its firstdifference. This makeslong-run equilibrium saving in (6), when St = St-I, a function of the level of equilibriumSI. I triedthis, but the resultmade little sense (even to me). 24. Okun, "The PersonalTax Surcharge,"p. 171. Lester D. Taylor 399 the big tax cut in 1964is consistentwith the premise,but the evidencesur- roundingthe surtaxin 1968is somewhatmixed.25 In principlethe model should allow a separatetax coefficientfor each type of income. Since the unavailabilityof a breakdownof tax payments accordingto incomesource makes it impossibleto do this,the coefficienton AT will thereforebe an amalgamof the coefficientsattaching to all of the componentsof personalincome, but especiallyto labor and propertyincome, sincethey are the most important. In an effortto allowfor the errorsin aggregationintroduced by the use of a singlevariable,26 I have experimentedwith including a trendin the coefficient on AT. This coefficientwas negative,possibly reflecting the growing importanceof labor incomein the total, but its t-ratiowas less than 1, and consequentlyI havenot tabulatedthe results.In light of this and also of the factthat the marginalpropensities to saveon laborincome and property income do not seemto be verydifferent, my opinionis that no seriouserror is involvedin using a singlevariable for tax payments. Perhapsmore seriously, my estimatesimplicitly assume that variationsin tax paymentsarising from changes in the generallevel of economicactivity have the same influenceon saving and consumptionas variationsarising from changesin tax rates.This, unfortunately,is a tough questionto iso- late, becausethe extentto whichthe assumptionis valid will dependupon what happensto asset values, consumers'expectations, and the income distributionwhen tax ratesare changed, and also uponthe particulargoods affectedby the publicexpenditure (or lack thereof). Any final assessmentof the coefficienton AT-indeed, of all of the coefficientsin this model, exceptthat on St1-must take accountof the fact that it refersonly to developmentswithin one quarterof any change.In the (static)long run,the fundamentalpostulate, cited by Okun,that consumers behaverationally with respect to theirbudget constraints is necessarilysat- isfiedsince all disposableincome is consumedirrespective of source.In this context,saving is a transitoryphenomenon, and, accordingly,I find no

25. See ibid.; and Robert Eisner, discussion of Okun's paper, BrookingsPapers on EconomicActivity (1: 1971),pp. 207-09, and "Fiscaland MonetaryPolicy Reconsidered," AmericanEconomic Review, Vol. 59 (December1969), pp. 897-905. 26. No errorsof aggregationwould arise if (1) a common tax parameterattached to all types of income, or (2) all types of incomegrew at the same rate. Thereis little a priori basis for assumingthe first, and the second is factuallyincorrect since labor income has grown somewhatrelative to propertyincome during the postwar period. 400 Brookings Papers on Economic Activity, 2:1971 a priorireason why it should be influencedin the same wayby a changein taxes as by a changein earnings.27

FurtherAnalysis of the Results The results appearingin Table 1 have been subjectedto furthertests. First, I have investigatedthe patternof intercorrelationamong the variables.Next I have splitthe sampleperiod at 1962,estimating the model for 1953-61and then againfor 1962-69in orderto test for homogeneityof underlyingstructure over the entiresample period. And finally,I have experimentedwith a moreflexible lag structure.

THE PATTERN OF INTERCORRELATION One possibleexplanation of the anomaliesthat have been found is that they are purelystatistical phenomena arising from an unfortunatepattern of intercorrelationsamong the predictors.While the magnitudeof the t- ratios arguesagainst this as a likely factor, it deservesmore explicit in- vestigation.Table 3 recordsthe correlationsfor the variablesappearing in equations(1), (2), and (3) of Table 1. The simplecorrelations among the in- dependentvariables appearing in equation(3) are quitesmall, and accord- inglythere is no pictureof a systemof predictorsthat is highlyinterdepen- dent.Hence it seemsreasonable to takethe coefficientsas reflectionsof real phenomenarather than simply as statisticalflukes arisingfrom poor ex- perimentaldesign on the part of history.28

27. Robert Hall has pointed out that, while the s's in the structuralequation repre- sent short-runderivatives, the long-runasset-income ratio is determinedby their ratios to b (see Houthakkerand Taylor, ConsumerDemand, p. 288). To illustratethis, suppose the model is simplifiedto S = bA + s, Y + s2 T. In the (static) long run, S = 0, so that

A SI S2 T Y b b VY which shows that, since both b and S2are negative,the ratio of financialwealth to before- tax income varies inverselywith averagetax rates. At a glance, this does not seem implausible. On the other hand, the high ratio implied for transfersis puzzling, as Hall states. 28. Because of the presence of the lagged dependent variable as a predictor, the Durbin-Watsoncoefficient has not been provided as an indicator of the presence or absence of autocorrelationin the error term. Instead, autocorrelationhas been tested for by the new method recentlyproposed by JamesDurbin, "Testingfor SerialCorrela- Lester D. Taylor 401

HOMOGENEITY WITHIN THE SAMPLE PERIOD Splittinga sampleperiod into two or more subperiodspermits a test of the hypothesisthat the underlyingstructure governing the phenomenabe- ing studiedis homogeneousover the entireperiod of the sample.In the current contextit is of particularinterest and importanceto find out whether the coefficientsattaching to the changesin transferpayments, personal contributionsto social insurance,and personaltaxes mightbe due simplyto a few isolatedextreme observations. The vehiclefor makingthis determination is a well-knowntest involvingthe analysisof covariance.29The proce- dureis to estimatethe modelfor eachof the subperiodsand then to examine by meansof an F-testwhether doing so producesa significantreduction in unexplainedvariance as comparedwith estimationof the model over the entireperiod.30 Theequations for the two subperiodsare as follows(data are per capita): 1953:1-1961:4 (7) St = 0.966 Si-, + 0.482 (AL + AP)t + 1.410ATRt - 2.176 ASI! (45.62) (4.18) (2.33) (-2.11) - 0.729 AT, + 0.579 Art. (-1.70) (0.05) R2= 0.690,Se = 8.89. 1962:1-1969:4 (8) St = 0.974 St-, + 0.353 (AL + AP)t + 0.722 ATRt- 2.216ASIt (21.41) (1.68) (1.69) (-2.38) - 0.930 ATt+ 31.93 Art. (-3.74) (2.36) RI= 0.839,So = 12.58. tion in Least-squaresRegression when Some of the RegressorsAre Lagged Dependent Variables,"Econometrica, Vol. 38 (May 1970), pp. 420-21. For several of the equations, there is a suggestionof slight negativeautocorrelation, but this can be dismissedas being of no consequence. 29. For a description of the test and its underlyingtheory, see Gregory C. Chow, "Tests of Equality between Sets of Coefficientsin Two Linear Regressions,"Econo- metrica,Vol. 28 (July 1960), pp. 591-605; and Franklin M. Fisher, "Tests of Equality between Sets of Coefficientsin Two Linear Regressions: An ExpositoryNote," Econ- ometrica,Vol. 38 (March 1970), pp. 361-66. 30. The sample period was split at 1962 because (1) it is near the mid-point of the sample; (2) it can be taken as markingthe real start of the sustainedupward movement of the 1960s; and (3) the two subperiodscoincide almost exactly with occupancyof the White House by differentparties. 5^N ON en ON 0 t- 0

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0 0,f Cd Lester D. Taylor 403 Here and in the followingequations, the numbersin parenthesesare t- ratios.These two equationsare to be testedagainst equation (3) of Table 1. The data for the analysisof covarianceare set out in Table4. To rejectthe hypothesisthat the two subperiodshave a commonstruc- turerequires an F-ratioof at least 3.80 (at the 0.05 level of significancewith 56 and 6 degreesof freedom).Consequently, since the observedF is only about one-thirdof this value,the hypothesiscannot be rejected. The biggestdifference revealed in a comparisonof values of individual coefficientsfor the two subperiodsis in the coefficientfor the changein the yield on Baa bonds. Indeed,the interestrate has no influenceat all in the earlierperiod, and its importancein the equationfor the entire period clearlyderives from the observationsat the end of the sampleperiod when interestrates were taking off to theirhistoric highs in 1970. The coefficienton the changein personalcontributions to social insurance shifts little betweenthe two subperiods,and, though the difference betweenthe two coefficientson the changein personaltaxes is sizable,the valueof -0.73 in the earliersubperiod is stillmuch larger (in absolutevalue) than that on gross income.Another coefficient with contrastingvalues is that on the changein transferpayments. But hereagain, even the smallerof the two values-0.72-is remarkablylarge.

Table 4. Analysis of CovarianceTest for Stability of Coefficients of Saving, 1953:1-1961:4, and 1962:1-1969:4 Equation Residualsum Degrees of Mean andstatistic Period of squares freedom square (3), Table 1 1953:1-1969:4 7061.57 62 113.90 (7) 1953:1-1961:4 2360.24 30 78.67 (8) 1962:1-1969:4 4115.22 26 158.28

Sum of residualsum of squares"within" regressions ... 6475.46 56 115.63

Reduction in residual sum of squares due to different regressions ... 586.11 6 97.69 115.63 F F=97691.1811 97.69 Fo.o6(56,6) 3.80 Source: Based on data in Table 1. 404 Brookings Papers on Economic Activity, 2:1971

A MORE FLEXIBLE LAG STRUCTURE The lag structureimplicit in the model expressedin equation(4) is very restrictive.It allows a changein any of the componentsof disposableincome to have only one directshot at saving;any retardedeffect is reflected in the adjustmentof savingto changesin the underlyingstock of financial wealth.In additionto this simplicity,the lag structureis also ratherinflexi- ble in that each componentof disposableincome is forced into the same patternof adjustment.In view of these possibledefects in specification,I have estimatedan equationin whichthe currentand two most recentpast changesare includedas predictorsfor the componentsof disposableincome andthe yield on Baa bonds.This inclusion,of course,consumes quite a numberof degreesof freedom,and, even more serious,multicollinearity is likelyto accompanythe introductioninto the systemof so manynew in- dependentvariables. Still, sincethese are all firstdifferences, possible problems with multicollinearitywould not seem to be so great as to preclude estimatingthe model.The resultsare as follows(data are per capita): (9) St = 0.951 St-, + 0.431 (AL + AP)t + 1.071 ATRt (38.90) (4.66) (2.94) - 1.633 ASIt - 1.095 ATt + 22.043 Art - 0.102 (AL + AP)t1 (-2.33) (-5.16) (2.02) (-0.93) + 0.448 ATRt-1 + 0.780 ASIt-J + 0.406 ATt-, + 2.628 Art- (1.15) (1.14) (1.93) (0.22) + 0.097 (AL + AP)t2 - 0.368 ATRt-2 + 0.258 ASIt-2 (0.85) (-1.02) (0.38)

- 0.315 ATt-2 -2.614 Ar,-2. (-1.42) (-0.22) RI = 0.871, So = 10.46. Theseresults do not supporta conclusionthat the ratherrigid lag structureimplicit in equation(4) amountsto a seriousmisspecification, for none of the laggedterms appears with a t-ratioof 2 or greater.Lagged effects (ex- ceptfor the geometriclag implicitin the presenceof Sf_1)seem to be absent altogetherfor the changein gross income and in the yield on Baa bonds, and to be only weaklypresent for the changein transfersand in personal contributionsto social insurance.Only for the changein personaltaxes do lags of any importanceappear, but the switchingof signs suggeststhat multicollinearitymight be a factor. LesterD. Taylor 405 All in all, the tests of this sectiondo not vitiatethe resultsobtained with the modelembodied in equations(2), (3), and (4). The largecoefficients on transferpayments and personal taxes remain intact, and the largecoefficient on personalcontributions to social insuranceis not greatlymodified. Only the yield on Baa bonds exhibitsa basicchange in structurewithin the sample period,and this is consistentwith the view that only in the most recent quartersof the samplehave interestrates been sufficientlyhigh to influence savingdiscernibly.

Forecastsof the PersonalSaving Rate for 1971:1-1972:4

Table5 presentsestimates and projections of the personalsaving rate using the equationstabulated in Table 1 for the sixteen quarters1969:1- 1972:4.These quarters involve three separate periods: 1969 is the last year of the sampleperiod, and the forecastsfor these four quartersare simply the fittedvalues from the equationsconverted to savingrates. The figures for the period 1970:1 through1971 :2 are forecastsbeyond the period of fit, and use actualvalues for disposableincome and its componentsand the yield on Baa bonds, but predictedvalues of laggedsaving. In currentpar- lance, the simulationfor those six quartersis thus dynamicrather than static.Finally, the numbersfor 1971:3-1972:4 areprojections. For disposableincome and its componentsbeginning in 1971:3,I haveused the values, somewhatmodified, appearing in the WhartonMark III Model forecastof May 21, 1971.The Baa bond rateis also basedon the Whartonforecast of that date.3'The valuesof the predictorsare also givenin Table5. Two features of these forecasts are particularlyworthy of note: the markeddifference between the equationswith disposableincome disaggregated and those with disposableincome taken in the aggregate;and the especiallygood performanceof the disaggregatedsaving functions-espe- ciallyequation (3)-over the six quartersof actualforecast 1970:1-1971:2. The disaggregatedequations signal strongly the sharpincrease in the saving ratebetween the last quarterof 1969and the thirdquarter of 1970.The nondisaggregatedfunctions, on the otherhand, anticipated this risescarcely at all. The factormaking for the sharpincrease in the savingrate forecast for 1970:2by equations(3) and (6) is the $7 billionincrease in transfersre-

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FinalAssessment

If the resultsof this paperwere taken at face value,current views regard- ing the use of fiscalinstruments in short-runstabilization of the economy would be due for majorreassessment. However, in theirpresent form, the resultsquite clearlycannot-and should not-be taken at face value. A greatdeal more testing is requiredbefore this can be done, andin its course, some (or even all) of the puzzles may disappear.The additionaltesting shouldinvolve cross-section as well as time seriesdata, and shouldemploy alternative,and perhapsmore suitable,definitions of savingand income.32 The analysishere has ignoredany effectsof capitalgains on saving, and these,too, requireinvestigation. Finally, there is the whole questionof announcementeffects, which may cause consumersto adjust their saving priorto the time that policy changesactually occur. Nonetheless,I am quite convincedthat the resultsobtained here are of sufficientvalidity to raiselegitimate questions about the view that a dollar of incomeis a dollarof incomeno matterwhat its source;Indeed, this is the principalconclusion that I wish to draw.

32. Of the several suggestionsfor definitionalchanges, the easiest to execute is one by George Jaszi to augmentthe officialmeasure of saving by the statisticaldiscrepancy. Doing this yields, among otherthings, an increasein the coefficienton ATRto 1.24 and a decreasein the coefficienton ASI to -2.34. Commentsand Discussion

James Duesenberry:I am a little perplexedin commentingon Lester Taylor'spaper. I think it is a very interestingand valuablestudy, but it producessome startlingresults that I am not preparedto accept.Yet the resultshave a certainrobustness; they stand up when collinearity,additional lags, and subperiodsare investigated. There is somethinghere, in my judgment;but the interpretationmay not be exactlywhat the authorhas in mind.At first glance,the model ap- pearsto be a standardstock adjustmentmodel with the specialfeature that the assetsare supposedto be limitedto financialones. In fact, that limita- tion is not quitetrue sinceequity in housesand unincorporatedbusinesses mustbe included.On a closerlook, however,it is not reallya stock adjustment model, becauseas a result of some transformationsand a shift to first differences,the asset term evaporatesand is replacedby the lagged savingflow variable.Since that variabledoes not accuratelymeasure the changein wealth,since strong serialcorrelations so often appearin time series analyses,and since the coefficienton lagged savingis very close to unity, I suspectthat the resultis very close to a first differencemodel in flows ratherthan a stock adjustmentmodel. What does it mean?If the stock adjustmenttheory is to be taken seriously, one would have to be concernedabout durablegoods purchases, capital gains, and other elementsthat make the increase in household wealthdifferent from the officialconcept of personalsaving. Instead, Tay- lor allowsthe asset effectto evaporateso that it has little or nothingto do

408 Lester D. Taylor 409 with the results.That procedurehas some significancefor the meaningof the coefficients.As Taylor pointed out, what he presentsare impact coefficients.These coefficients try to tell us whathappens to saving(and pre- sumablyto consumption)in a single quarterif there is an increaseof a certaintype of incomein that quarter. Factorsthat mightinfluence the basic longer-runpropensity to save are irrelevantin this context.In the case of propertyincome versus labor income, for example,the questionof relativeclass positions or of different levelsof familyincome really has littleto do withimpact effects. One would expectthe short-rundifferences to be dominatedby timingconsiderations or the stabilityof the variables.If entrepreneurialincome were very un- stable,one certainlywould expectto find a high propensityto save out of one-quarterchanges in it. In fact, the broaderconcept of propertyincome containsseveral very smooth series,including, as Taylorpointed out, the imputedincome from housing, and also includingmuch of the imputed financialincome, interest credited at savingsbanks not directlyreceived by depositors,and corporatedividends. It is, therefore,not surprisingthat the propertyincome coefficientdoes not behave the way one would expect entrepreneurialcoefficients to behave.In general,what governsthe one- quarterbang from a particulartype of buck may be differentfrom what determineshow much people are going to spendover a couple of years of the dollarsthey get from some particularsource. It is importantto bear this in mind in interpretingthe results. Futureinvestigations building on Taylor'sfindings should devote more attentionto the longer lags. More attentionwill also have to be paid to incorporatingthe asset effect.The coefficientsof Taylor'sstudy implicitly leave a lot of moneyunspent. One of two thingshas to happen:Either the longerlags will revealthat peoplerespond directly by spendingthis income over time, or else the incomehas to pass throughthe asset accumulation mechanismand enter the spendingstream through wealth effects.In the latter case, it would be very difficultto strain out the impacton assets of particularsources of income, since data would have to be collected on assetsby the compositionof incomeof the asset holders. Whenone recognizesclearly that the coefficientsmeasure only the one- quarterimpact, some of the resultsseem less implausible.It may well turn out that people do not spendmuch out of increasedtransfer payments in the initialquarter, even though they might,over a year,spend considerably morethan peoplereceiving income from some other source.That remains 410 BrookingsPapers on EconomicActivity, 2:1971 an open question,because Taylor's interesting test for lags is too limited to be conclusive. Tayloroffers very sensibleobservations as to why the impactsaving coefficienton transferincome might be particularlyhigh. Suppose low income peoplewith modestamounts of assetsare tryingto stretchtheir means out over a long period of time, and meanwhileinflation has squeezedthem into depletingtheir asset holdings.When they get an increasein social securitybenefits, it mightwell go initiallyto replenishthe assetpot that has been drawndown. A numberof additionalfactors could influencethe resultson transfer payments.For one thing, there may be some anticipationeffects on con- sumptionthat distortthe coefficient,since people often know a couple of quartersahead of time that a social securityincrease is forthcoming.Sec- ond, medicarehas contributedmuch to the growthof transfersin recent years.Medical expenses are very closelyrelated, I think, to asset manage- ment and saving.Without medicare, payments for some verylarge medical costs would have requireddipping into assets. Medicarehas reducedthe need for dissavingand thus, almost mechanically,has bolsteredpersonal saving. The resultson social insurancecontributions are too good to be true. There is, in fact, no close relationshipbetween expected social security benefitsand contributions.There is only a very loose kind of connection, dependingon the recipient'sage, how many quartershe has paid at the ceilingin the past, and otherconsiderations. Nobody knows exactlywhat he is ultimatelygoing to get out of social security.Even though people generallyget out a lot more than they put in, thereis a lot of slippagebe- tween the inflowsand outflows.It would be a remarkablecoincidence if people acted as though they were savingthe contributionand responded as Taylor'scoefficients indicate. The technical problem, which Taylor notes, aboutthe way in whichincreases in the wage base for social securitytaxes are recordedin the nationalincome accounts,may have somethingto do with the findingthat the net coefficientis changedsubstantially by con- sideringa couple of lagged quarters. I cannot offer any solid explanationfor the high saving coefficienton personaltaxes. I do not know why there shouldbe virtuallyno impacton consumptionin the particularquarter in which taxes are changedwhile thereis a sixty-centimpact per dollarin any quarterin whichlabor income changes.This resultmay reflectanother complication in the bookkeeping. Lester D. Taylor 411 Thereis a differencebetween the tax accrualsand tax paymentsin the personal income tax, creating another seasonal adjustmentcomplication, whichmay influencethe coefficient.Finally, the interestrate coefficientis very suspicious,and I would be inclinednot to pay too much attentionto it, since it does not show up at all in the 1953-61 subperiod,but only in the 1962-69period. In summary,these resultscertainly ought to be followedup. They make a good runningstart on determiningthe impactson savingand consumption of incomeby component,particularly those componentsthat can be manipulatedby fiscal policy. A good deal more informationis necessary, however,before policy can be guided on the basis of these coefficients. This is particularlytrue since they are limitedmainly to the impactin the currentquarter, and tell us very little about what happenssubsequently.

RobertHall: In readingTaylor's paper, I hoped to be enlightenedabout the peculiarrecent behavior of saving, and I am franklydisappointed. I do not find Taylor'sexplanation of the high savingrate in 1970-71 at all convincing.The basic explanationoffered is that transfershave gone up remarkablyand that a particularlylarge fractionof transferpayments is saved.Consequently, the savingrate rises when the compositionof income shiftstoward transfers. I just do not believethat. Insteadof providingre- liableinformation about saving out of differentcomponents of income,the paper really shows, as I see it, that an aggregateconsumption or saving equationthat looks prettygood superficiallybegins to crumbleapart once one probes beneaththe surface.What we discoverin taking apart such aggregateequations is that they ignoremany important things and do not performas well as we initiallythought. Thereare severalsources of troublein the paper.The firstis an ambigu- ity about what those savingcoefficients measure. This is an acceleration theory of asset accumulation,which impliesthat, if incomeis steady,the level of assetswill also ultimatelybe steady.According to the theory,the structuralcoefficients measure the long-runrelationship between the income flows and the correspondingasset stocks, and not merelythe impact effect. In particular,they imply that a certainlevel of assets corresponds to each component of income. And the specificestimates for transfers implythat the assetsheld by a personwho receivestransfer income are very muchhigher than those held by peoplewith the samelevel of incomecom- ing from other sources. I believe that peculiardiscovery cannot be ra- 412 BrookingsPapers on EconomicActivity, 2:1971 tionalizedalong the lines of the theory.Hence I readit as a possiblesymp- tom of some pathologicalcondition in the whole equation. Second,I feel that a life cycle model oughtto take accountof the demo- graphiccomposition of the population.I haveno reasonto believethat the demographicshifts of the last few yearswould contribute to an explanation of the high savingrate. On the contrary,the increasein the relativenumber of youngpeople in the workingpopulation might be expectedto lowerthe saving rate. Nonetheless,I am concernedthat the age make-up of the populationis ignoredin spite of the very strongimportance assigned to it in the life cycle kind of theorythat motivatesthis work. A furtherand serioussource of difficultyis the relianceon the definition of personalsaving embodiedin the nationalincome accounts.That view fundamentallyidentifies the wealth of consumerswith the real wealth of the economy.The stock market,for example,is ignored,and owners of equitiesare taken as simplyowning the real assets of corporations.That occursbecause capital gains and losses are ignored,and savingis taken as equalto investment.In actuality,there is a substantialgap between the real wealth of the economy and the marketvaluation of the assets owned by consumers.The stock marketwas fluctuatingover this period and may have contributedto the peculiarlyhigh savingrate of 1970 and 1971. A treatmentof that issue would requirea definitionof savingdifferent from the one in the nationalincome accounts. Additionalproblems arise from the use of the definitionof consumer durablesin the nationalincome accounts. Purchases of consumerdurables should not be consideredconsumption expenditures. Rather, durables should be treatedthe same way as housingwith the flow of servicesre- garded as consumptionexpenditures. That approach smooths out the fluctuationsin purchasesof durablesthat have taken place in the last few years. Finally, the national income accountsdo not treat corporateretained earningsas incometo the consumerand thus do not take accountof the substantialfluctuations in retainedearnings of recentyears. I'm not sure of the right way to handle retainedearnings, but certainlythe problem shouldbe confrontedrather than ignored. A fundamentalproblem in this study is the econometricproblem of identification.Nothing in the equation specifiesit as a saving equation ratherthan an investmentequation. Since savingequals investment (with some adjustment),the equationcould be relabeledan investmentequation Lester D. Taylor 413 and it would representan acceleratormodel of investmentrather than an acceleratortheory of saving.Given all these problems,it seemsto me that one cannottrust the conclusions,which seem so vastlydifferent from what commonsense suggests. Hence, after I finishedreading Taylor's paper, the peculiarbehavior of personal saving in the past three years remains a mysteryto me.

GeorgeJaszi: I want mainlyto supplyadded emphasis to a few pointsthat have alreadybeen raisedabout the data and concepts.Duesenberry mentioned that some of the quarterlyseries on income componentswere smootherthan others. Much of the smoothnessis a reflectionof the way estimateshave to be maderather than of the workingof the economy.For instance,the quarterlyseries on propertyincome is very smooth because only annual data are availablefor many of the items includedand the quarterlyfigures are essentiallyinterpolated. In the case of income of un- incorporatedenterprises, use is made of quarterlyinformation on sales, but no quarterlydata are availableon the variationin profit margins. Quarterlyinformation is availableon wages, salaries,and transferpayments; they are genuinelyfluctuating series and have a minimumof statistical smoothing. All other income items essentiallyrepresent, to an extent, an artificialquarterly series. This distinctionmay have important implicationsfor the regressionresults. The treatmentof social securitytaxes is a peculiarlydifficult problem. Thereis no good answerto the problemposed by an increasein the ceiling on wagessubject to tax. I know OBE'spresent procedure is not good, but I much preferit to any alternativeI have heardsuggested so far. There are similar, althoughnot identical,timing difficultieswith the treatmentof year-endor final settlementson personaltaxes. They affect the accountsheavily in the first and secondquarters of the year following the year of liability.This createsbulges, if the finalsettlements are large, or negativebulges if refundsare large.The resultingstatistical peculiarity of the seriesmay createproblems in a regressionanalysis. Sincepersonal saving is measuredas a residualwithin the frameworkof the nationalincome accounts,one should recognizethat personalsaving plus the statisticaldiscrepancy is an equallylegitimate alternative measure- ment of householdsaving. It would be interestingto know whetherthe results of the regressionequations would hold up using that statistical measure of saving. 414 BrookingsPapers on EconomicActivity, 2:1971

GeneralDiscussion

Severalparticipants argued that the time seriesdata could not provide reliableanswers to the importantquestions posed by Taylor, no matter how much effortand ingenuityhe applied.Both ThomasJuster and R. J. Gordonfelt that a time span of a single quarterwas too short, given the statistical"noise" in the data and the variabilityof actual consumerbe- havior.Gordon noted that, becausepersonal saving is measuredresidually as the differencebetween income and consumption,the errorsof measure- ment in both incomeand consumptionget built into the savingseries; this may introduce spurious correlations.He suggestedexperimenting with variablesmeasured as averagechanges over two or three quartersin an attemptto reducethe influenceof quarter-to-quarternoise. Justerwarned that eventhe modestamount of collinearityamong variables (reportedin Table3) could createproblems in the multipleregression approach.Moreover, the explorationfor lagged effects surely ran into seriouscollinearity problems in an attemptto pick out the relativestrength of relationshipsof particularvariables to a currentquarter's saving and previous quarter'ssaving, respectively. Lawrence Klein consideredit desirable to buildin some a prioriconstraints on the time seriescoefficients based on cross-sectiondata from consumersurveys. Although the surveydata are not good enoughto establishthe whole relationship,they can be reliedon for pieces of informationon eitherthe relativesizes of variouscoefficients or the magnitudeof particularcoefficients like that on transferincome. The optimalresearch strategy, according to Klein,required a blendingof cross- section and time seriesevidence. The discussionalso returnedto the conceptualand definitionalissues involvedin personalsaving. Klein noted one hiddenvirtue of the definition: It was so far removedfrom investmentthat he doubtedany serious problemof identificationremained, in contrastwith RobertHall's concern aboutthis issue. Justerstressed the heterogeneityof personalsaving. Very differentforces influencesuch diversecomponents as the extensionand repaymentof consumercredit, increases in housingequity, and liquidasset accumulation.It is hardto believethat the forcesaffecting important parts of personalsaving do not influenceits total. Henceit seemeddoubtful that saving behavior could be adequatelyexplained by means of the componentsof aggregateincome, given the heterogeneityof aggregatepersonal saving. Lester D. Taylor 415 Nancy Teeterspointed out that, furthermore,recipients of transferpayments were not a homogeneousgroup. The behavior of social security beneficiaries,who arenot subjectto a meanstest, is probablyquite different fromthe behaviorof recipientsof welfareand othertypes of benefit,who are. LawrenceKlein, in turn, questionedthe uniformityattributed to the lag structure.Taylor's use of lagged personalsaving impliedthat saving reactedin the samedynamic fashion to changesin the variouscomponents of income. There are good reasons to suspectthat the time patternsof responsemight be quite differentfor differentcomponents. R. A. Gordonsuggested that it mightbe usefulto inspectthe errorsof the equationsin those quarterswhen jumps in some variablesoccurred as a resultof discretepolicy changes,such as variationsin personaland social securitytax ratesor in transferbenefit programs. The announcementeffects of such policy measurescould createdisturbances in the savingrate both before and after importantpolicy changes. The dynamicpatterns here mightdiffer considerably from those associatedwith changesin incomeor in taxes that take place more graduallyand continuously. R. J. Gordon questionedthe treatmentof the interestrate variable.He contendedthat it was inconsistentfor the interestrate to be scale-freein a regressionwhere all the other variableswere expressedas dollarchanges. Furthermore,he suggestedthat the effortsto determinehow much of the interestrate effect really stemmed from the differencebetween nominal and real rates shouldhave employedthe secondrather than the firstderivative of the pricelevel. Presumably, after a time,the levelof interestrates reflects the rate of changeof prices;it would be pushedup furtheronly by an ac- celerationof prices. Since the entire impact of the interestrate variable occursin the secondhalf of the sampleperiod, it raisesthe possibilitythat the interestrate variableis recordinglargely the impactof inflationon saving. FrancoModigliani suggested, however, that the interestrate variable may be pickingup some of the effectsof largemovements of interestrates on stock pricesand, via that route, on consumption. Modiglianistated that, despiteall the reservationsabout the resultsex- pressedby the authorand the discussants,the equationswere impressive in trackingsaving behaviorin 1970-71. In particular,that recentperiod was not includedin the sampleperiod for fittingthe equations.Although Taylor'sresults may reflectin largemeasure peculiarities in the way certain componentsof disposableincome are estimatedin the nationalincome accounts, his equationmay still be useful for short-runforecasting of the nationalincome accounts saving rate.