Washington, DC, June 19, 2018 --  

Rising inequality is fueled by Americans choosing spending over saving.

When America's unemployment rate hit an 18-year low this month¹, it was just the latest good news about the American economy. More jobs are getting created, consumer confidence is high, and long-stagnant wages are beginning to slowly rise.

One statistic, however, worries economists. The household savings rate has plummeted in the past year, dropping to a near all-time low of 2.8 percent in April, according to the Bureau of Economic Analysis.² This drop is part of a long term trend since the late 1970s, though it rebounded briefly during and after the financial crisis. That rebound is over, and economists worry it might predict another recession.

There's another reason to fret about low savings rates: inequality. Household wealth is a key metric for measuring equality. At the end of last year, one study showed that the top one percent owned over 40 percent of all wealth in America -- the first time in 50 years that had happened.³

Who can't afford to save?

But given that the savings rate has plummeted over the same period, this should surprise no one. if you save over 10 percent of your income every year (like folks did through the mid-70s), you will eventually amass a large amount of wealth. On the other hand, if you start with nothing then don't save money, you end up with nothing.

So why have Americans nearly stopped saving? Conventional wisdom says the failure of wages to keep up with the cost of living has made saving harder and harder. This sounds good, but the data just don't back that up.

Between 1960 and 2017, Americans' real disposable income per capita (average income after taxes) grew from $11,877 to $39,158 -- an increase of nearly four times.⁴ These numbers are already adjusted for inflation. If American incomes have quadrupled since the 1960s, then how can it be true that they are unable to save? Where is this money going?

First, a few caveats: both the savings rate and these income figures are averages. Lots of people either make more or less than that income figure. And lots of people either save more or less than that savings figure. Over time, the distribution changes. There's plenty of evidence that income gains since 1960 (especially since the 1980s) have disproportionately gone to wealthier Americans. So while our incomes might be four times higher than in 1960, for the typical American they probably haven't gone up by nearly that much. Similarly, the savings rate of wealthy Americans probably hasn't gone down so much -- rich people have more money to save after covering necessities.

Other things have changed since the 1970s, too. The cost of buying a home has increased much more than the average inflation rate over this period, so clearly folks are spending more on housing. But this actually boosts homeowners' savings rates. The BEA savings statistics excludes mortgage interest from expenses, so expensive homes do not explain the drop in savings rates.

Changes in consumer spending provides a better explanation.

After homes, Americans' biggest purchase is an automobile. Back in 1972, a luxury car would set you back about $6,390 -- that was the base list price for that year's Cadillac De Ville.⁵ If you adjust that number for inflation, it comes to $39,115 in today's money, Compare this to the MSRP for a Cadillac Escalade, which starts at $74,695.⁶ This is nearly twice the cost of a comparable luxury vehicle in 1972. This is hardly a rare purchase -- just visit any parking lot.

Higher consumer spending isn't limited to cars -- it's on all kinds of stuff. Clothes are cheaper than they used to be, but people make up for that by buying lots more of them. New homes are built with lots of closets for storing stuff. Cable packages run Americans over $100 per month, a cost that just didn't exist in the early ‘70s.

Americans buy all this stuff they don't need even before they have the money. Almost nobody had a credit card in the early 1970s. Now almost everybody does. According to Nerd Wallet's 2017 study of credit card debt, the average household that carries a balance owes $15,654.⁷

Credit card debt absorbs income because interest is high (the average is about 16 percent ⁸) and minimum payments are low. Purchases paid off with the minimum payment end up costing over double the cash price.

Americans don't save anymore because they waste their income on credit-driven consumer spending. If people lived the way they did in the early 1970s -- simpler cars, fewer purchases, and most importantly cash payments rather than buying on credit, there would be plenty of money left over. The personal savings rate would be a whole lot higher. And the distribution of wealth would be a lot more equal, too.

Related Web Columns:

Smarter Than a Spendthrift, August 11, 2009

House of Cards
The Collapse of Credit-Driven Spending, November 27, 2007

Notes: Notes:

1. New York Times, New Milestones in Jobs Report Signal a Bustling Economy , June 1, 2018

2. Bureau of Economic Analysis, Real Disposable Personal Income Increases in April , May 31, 2018

3. Washington Post, The Richest 1 Percent Now Owns More of the Country's Wealth Than at Any Time in the Past 50 Years , December 6, 2017

4. Bureau of Economic Analysis, Real Disposable Personal Income, historical figures as posted June 17, 2018

5. NADA Guides, 1972 Cadillac Deville , as posted, June 17, 2018

6. US News, 2018 Cadillac Escalade , as posted June 17, 2018

7. Nerd Wallet, 2017 American Household Credit Card Debt Study , December 2017

8. Credit Cards.com, What is a Good APR for a Credit Card? May 3, 2018