My latest FEE article. An excerpt:
The “correct” amount of saving, in terms of economic theory, is that which people choose in a free market. People have underlying preferences for present versus future consumption, and they engage in mutually advantageous trades — guided by interest rates — to rearrange the timing of their income and consumption.
It is true, as many critics complain, that the income tax imposes a “double tax” on labor income if it is saved and invested. However, the real problem here (from the point of view of resource allocation) is that a tax on dividend and interest income imposes an artificial penalty on future consumption versus present consumption. This is the sense in which a flat income tax of 10 percent will cause more economic inefficiency than a flat consumption tax of 10 percent, and it is the basis of many proposals to reform the tax code.
Yet, the problem here isn’t the government’s failure to reward (or encourage) saving; the problem is that the income tax artificially punishes deferred consumption relative to immediate consumption.