(FORTUNE Magazine) – JUST WHEN EVERYONE from car dealers to home sellers to your neighborhood ( clothier is trying to get you to spend, spend, spend for the sake of economic recovery, why should anyone worry that Americans aren't saving enough? The answer: Because anemic savings are the biggest and most pernicious threat to America's prosperity. Saving provides the capital to finance investment in new plant and equipment, modern infrastructure, and a first-rate education system. The shortfall of the past decade has already cost dearly in lost output and living standards. Without a dramatic change, which will require new tax and pension policies, the worst is yet to come. Says Lawrence Summers, chief economist at the World Bank: ''Low saving is a slow but inevitable path to economic decline.'' Both by historical and international comparisons, the U.S. saving rate is pathetic. Every component is scraping bottom. Government budget deficits, in effect public sector ''dissaving,'' swelled to 2.4% of gross national product last year from just under 1% in the 1970s. Business saving, measured as retained corporate earnings after depreciation, has fallen below 1% of GNP, some two percentage points lower than its postwar average. Personal saving by households, which accounts for 82% of all private saving, has dropped to 4.5% of after-tax household income, down about a third from the average for 1946 to 1980. Largely because of this decline, U.S. saving -- $88.2 billion in 1990 -- is about one-sixth the Japanese rate. ECONOMISTS refer to saving as ''forgone consumption,'' but a declining saving rate can be called ''forgone growth.'' Ethan Harris and Charles Steindel, economists at the Federal Reserve Bank of New York, calculate that if the net national saving rate in the 1980s had remained unchanged from its 7.5% annual average of the postwar period, GNP today would be $250 billion, or some 5%, higher than it currently is. One illustration of what that means: After taxes, the average American household income would be $1,000 higher this year. If the saving rate remains unchanged over the coming decade, the cumulative lost output could rise to as much as $750 billion. The sacrificed growth would put a big crimp in Americans' lives. Harris and Steindel estimate that consumption will be ten percentage points lower by the early 21st century. Why don't Americans save more? The question continues to baffle economists, but fresh thinking in recent years points to several causes: changing demographic patterns, easy credit, growing household wealth, indexed Social Security payments, and barriers to pension fund contributions. According to the most pedigreed economic model, American savings should have risen to new heights during the Eighties. The so-called life-cyle hypothesis, for which MIT economist Franco Modigliani was awarded a Nobel Prize, is based on observed human behavior. A young couple raising children and buying a first home take on debt. By the time they're middle-aged they're at the peak of their careers, their home and children's education are paid for, and as they look forward to retirement they save a larger portion of disposable income. Retirees spend their accumulated wealth. The national household saving rate would reflect the proportions of each age group in the society. But as the Eighties dawned and the first wave of baby-boomers began hitting 35, their savings dropped -- by 1.7 percentage points over the decade, according to a study by economists Barry Bosworth and Gary Burtless of the Brookings Institution, and John Sabelhaus of Towson State University. Those putatively thrifty middle-agers were even more disappointing. Their saving fell a full seven percentage points. What happened? The baby-boomers married older, postponed having children, and bought their first homes later than their parents. The average retirement age fell, which should have offset some of the shrinkage as would-be retirees built up stakes for their longer spell of golden years. But the generations raised in postwar prosperity may have seen less need to save than the oldsters who experienced the adversity of the Depression. Changing life cycles don't fully explain the shortfall. The habit of thrift has always been under strain in America, thanks to what Harvard business historian Richard S. Tedlow calls the country's success at ''the democratization of consumption -- one of America's unique contributions to the world.'' The rise of this consumer society since the late 19th century exerted a moral appeal no less powerful than the traditional call to thrift, because it embodied the ideals of democracy and equality. The mission of bringing to all citizens the liberating fruits of technology and industry was a motive nearly as powerful as self-enrichment to such great manufacturers and entrepreneurs as Henry Ford and Richard Sears. Though at first consumers paid for these goods by patiently saving, American inventiveness quickly created a better solution: installment credit, which < took off in the 1920s. Economic historian Martha L. Olney of the University of Massachusetts at Amherst reports that by 1929, some 75% of major appliance purchases were made on credit, up from just 20% a decade earlier. Thrift, nourished only by moral imprecations and by the frugal habits of hardworking immigrants, didn't stand a chance against the credit-financed consumption boom and the restless mobility of American society. The balance tipped decisively in favor of consumption with the Depression and its intellectual response, Keynesian economics. The Keynesians diagnosed the ongoing crisis as a deficiency of aggregate demand. Their remedy: Stimulate public and private consumption, and both employment and growth would recover. Keynes's interpreters, says economic historian David M. Tucker of Memphis State University, ''demoted thrift from a virtue and a motor of progress to a vice.'' A BIT STRONG PERHAPS, but postwar prosperity did make thriftiness look almost quaint. While governments in Europe and Japan campaigned vigorously for saving to rebuild their war-ruined economies, Americans enjoyed uninterrupted growth and rising incomes. Use of general purpose credit cards, introduced in 1949, took off after the mid-1970s. By 1984, fully 71% of all Americans ages 16 to 65 were card-carrying chargers. Saving in advance of making a major purchase was reduced from a necessity to a peculiar personality quirk. Says Lewis Mandell, a finance professor at the University of Connecticut: ''Thrift as a cultural norm is a superego thing -- it imposes self-restraint. Credit cards are all libido.'' Americans have plenty of opportunity to indulge their plastic libidos. Japan's archaic and inefficient retail distribution system and Germany's restrictive store hours throw up walls of inconvenience that discourage shopping. In the U.S., it's wall-to-wall malls, open round the clock and hyped by the world's most aggressive marketing and advertising. It's not that Americans were seduced into foolish behavior by the glittering cornucopia marketers presented them. Tax laws until 1986 allowed full deduction of personal interest payments. Expanding social welfare programs, particularly Medicare and indexed Social Security payments, made the old more secure. Many economists think these have substantially offset the need to save for retirement. Thus Americans polled by the Survey Research Center of the University of Michigan say the main reason to save is for ''emergencies.'' Even this is not much of a reason. A credit card will buy a hot-water heater; a home equity loan -- the Eighties' contribution to the credit explosion -- will replace the roof; and employer-paid health insurance covers most medical emergencies. Finally, why save when you think you're getting rich just by sitting still? The combination of the Seventies housing boom, the long economic expansion of the Eighties, low inflation, and high real interest rates sent the value of total household assets soaring. David Wilcox, an economist at the Federal Reserve Board, calculates that the ratio of Americans' household wealth, including financial assets and real estate, rose from 3.75 times annual disposable income in 1974 to 4.5 times today. At $10 trillion, total household wealth, adjusted for inflation, has grown nearly $4 trillion over the period. Wilcox estimates that the growth in personal wealth accounts for a 3.5 percentage point drop in the household saving rate. Given that many trends of the past decade have now reversed themselves -- for example, the seemingly automatic increases in wealth and the expansion of consumer credit -- you might wonder if saving won't start rising of its own accord. But the Eighties undermined it in other critical ways. During the Seventies, employer contributions to private pension and profit-sharing plans became the principal source of personal saving. Congress had long encouraged pension plans by allowing companies to deduct contributions from pretax profits. But the 1974 Employee Retirement Income Security Act required companies that guaranteed pension benefits to fully fund their plans. From the time the act was passed until 1981, new pension and profit-sharing contributions rose steadily by a total of some $432 billion in 1982 dollars, according to Stanford economist John B. Shoven. Propelled by surging stock market and real estate values, pension fund investment portfolios rose some $1 trillion (adjusted for inflation) during the Eighties, accounting for practically all the total increase in the nation's wealth. Since 1981, however, employer contributions have fallen back to the level of 1973, shrinking the pool of new saving. Why? Because nearly three-quarters of all existing pension plans offer a defined benefit, a guaranteed monthly payment to each vested retiree usually calculated as a proportion of final pay. As pension plans accumulated enough money to cover future obligations, employers lost tax incentives to make additional contributions. % Defined-benefit plans took another hit four years ago, when Congress, in its never-ending search for new revenues, rolled back some of the tax breaks and changed the formula by which employers could compute those future obligations. Instead of letting pension managers anticipate wage and salary increases, Congress required them to base their estimates only on current payroll levels. The result, according to the Association of Private Pension and Welfare Plans, an employer-supported lobbying group: Benefits paid annually out of the plans are running better than three times the amount of new funds going into them. Says Shoven: ''Just when we should be providing more incentives to use pensions to save for an aging work force, we are providing fewer.'' LOWER MARGINAL TAX rates on personal income and higher capital gains taxes further accelerated the shift from saving to consuming. More and more shareholders got their rewards from leveraged buyouts and share repurchases, rather than dividends -- Summers and Federal Reserve Board economist Christopher Carroll estimate that such payments rose to 4% of disposable income in the mid-Eighties from just 0.1% in 1975. Traditional economic theory suggests that the payouts should have been reinvested. But referring to what he calls a ''mailbox effect'' -- the sudden arrival of the proceeds from repurchased shares -- MIT economist James Poterba estimates that fully half the hot cash was spent, accounting for better than a one percentage point drop in national saving. There is little reason to expect that saving will revive in the 1990s and beyond. Though the graying baby-boomers could turn from being binge buyers to serious savers, they have little incentive to do so. This generation stands to inherit the greatest windfall in the nation's history -- some $6.8 trillion before estate taxes -- from the wealth their parents amassed. It may well be counting on the bequest to finance its kids' college educations and its retirement. If that thinking is wrong, the baby-boomers will have many regrets ahead. Projecting demographic trends, economists Alan J. Auerbach of the University of Pennsylvania and Laurence J. Kotlikoff of Boston University estimate that household saving will rise one percentage point during the 1990s and no more through 2040. As the boomers retire, they will be succeeded by a smaller work force obliged to shoulder, through increased payroll taxes, the rising medical and Social Security costs of their elders. Concludes Auerbach: ''The saving + rate, already low, will fall further.'' Waiting for saving to recover by itself clearly won't do. Americans will need convincing that it is in their interest -- and the nation's interest -- to save more. Though there's no magic number to shoot for, a rate roughly in line with the postwar average would pay off handsomely for the economy. No single policy will be persuasive enough. What's needed, argues Princeton economist B. Douglas Bernheim, is a concerted campaign to rebuild what he calls a ''culture of thrift.'' Says he: ''U.S. policy toward saving is uncoordinated, inconsistent, and generally ineffective. New social norms must be backed by substantive economic incentives.'' Economists like Bernheim and Cornell's Richard Thaler are looking to the behavioral sciences to explain why people don't always do what economists think is rational. Sometimes, they find, what counts most is a mechanism for self-discipline -- remember those low-interest and no-interest Christmas Club schemes that fattened bank profits so nicely before financial deregulation? The proponents of this ''psychological paradigm,'' as Bernheim calls it, argue for reinforcing behavior that makes consumers more inclined to save. Throughout most of the postwar period, for example, the Japanese government allowed families to deposit up to $100,000 a year without having to pay taxes on the accumulating interest. An estimated 70% of all personal saving in Japan are held in these tax-favored accounts. Partly to meet U.S. complaints that Japan's saving rate was too high, the Japanese government in 1988 reduced some of the tax incentives. Since then household saving has fallen some, but not as much as anticipated. Education campaigns waged for years by the Bank of Japan and the Finance Ministry on how to prepare for the purchase of a home or for retirement instilled a durable habit of thriftiness. How can lessons like these be applied to the U.S.? Based on what University of Virginia economist Jonathan Skinner calls Americans' numero uno rule of thumb -- pay the tax man as little as possible -- the most direct way would be to make all saving tax-exempt. Summers and Poterba, among others, favor a ''consumed income'' tax -- that is, a levy only on income that is spent. To limit the bite on government revenues, advocates suggest that Congress abolish the current tax exemption on home equity loans and reduce the full deduction of home mortgage interest payments. That would channel into business investment much of the saving that goes to real estate. But with Congress and the President both fearful of the wrath of homeowners and the powerful real estate lobby, a major tax overhaul is remote. THE NEXT-BEST APPROACH is not bad. No form of saving is simpler than automatic payroll deductions for employer-based pension plans: Money that's never seen can't be spent. Most such plans these days are so-called defined- contribution plans -- employees make pretax payments that employers may or may not match. But Congress has made it hard for companies to pay into them. Preoccupied with the issues of ''fairness,'' it imposed stringent new tests in 1986 to make sure that employers would not discriminate against lower-paid employees. The complex and ever-changing regulations have led many a company to simply give up (see Managing). The burden falls heaviest on businesses with 15 or fewer people on payroll. Shoven calculates that their average costs are nearly ten times greater than the $53 per capita for companies with 10,000 or more employees. The result: Both saving and fairness are frustrated. Says Sylvester Schieber, a vice president with Wyatt Corp., a benefits consulting firm: ''Well-paid managers can save through other means. The people who get hurt are lower-paid workers -- and indirectly the economy as a whole. Pensions are the most egalitarian form of saving we have.'' Congress should undo the damage. The risk of discrimination pales compared with the denial of pension benefits to so many people. At the very least, it should adopt the reforms proposed by the Labor Department that would abolish discrimination tests for companies with 100 or fewer employees that want to offer plans, provided they contribute a minimum of 2% of their employees' pay to a retirement account. The department estimates that such regulatory relief could expand pension coverage to as many as 26 million more workers. The proposals would also make it easier for people in all companies to carry their pensions with them when they move to new jobs. GETTING EMPLOYEES directly involved in pension plans helps instill the saving habit. This is particularly true with those defined-contribution plans, such as 401(k)s, where the employer matches savings withheld from the employee's pretax pay. Participants in 401(k) plans have incentives to increase their contributions when stock and bond markets rise. Companies often allow the employee to direct how the funds in her account will be invested. Says Cornell economist Robert Avery: ''People learn how to save by taking an active role in allocating their contributions and tracking the performance.'' Making it easier for smaller businesses to start pension plans could unleash a virtuous cycle of increased saving. Financial institutions would compete to administer the plans for companies too small to handle the job themselves. As more companies learn that they can offer plans without incurring heavy administrative costs, they will come to recognize pension benefits as an excellent tool for attracting and retaining loyal workers. It's also time to make individual retirement accounts more widely available, though not in the form proposed by the Bush Administration or by the Bentsen- Roth plan currently before Congress. Introduced in 1981, IRAs allowed taxpayers to contribute tax-free up to $2,000 a year ($4,000 for married couples filing jointly) toward their retirement savings. From 1981 to 1986, annual IRA savings increased from $5 billion to $38 billion. The 1986 Tax Reform Act slashed the benefits. Now the plans are useful mainly for individuals with incomes under $25,000 or couples with less than $40,000 -- or people not covered by an employer pension plan. Tax reform constrained IRAs out of concern that contributors -- mostly the rich -- merely shifted saving that would otherwise be taxed into the tax-free accounts. The evidence suggests otherwise. Even before the cutback, the overwhelming majority of IRA accounts were held by families with annual incomes of less than $50,000. Just one-third of their IRA savings came at the expense of lost tax revenue, according to a 1987 study by economists David Wise of Harvard and Stephen Venti of Dartmouth. Two-thirds of the contributions resulted from households cutting back their consumption. Though many economists have attacked the Wise and Venti studies, new research continues to bolster their case. Wise recently compared the saving behavior of identical households in 1980 before IRAs were introduced and in 1986 before IRA eligibility was restricted. His finding: The average non-IRA assets of IRA contributors increased 68.6%. Says Wise: ''Rather than encouraging asset shifting, IRAs incline people to save more through other forms.'' And Virginia's Skinner, who originally set out to challenge the Wise- Venti work, found that the 80% of savers who opened IRAs continued contributing to them in the following year -- a sign that the saving habit once formed is easy to keep up. - Both the Bush and the Bentsen-Roth schemes would allow IRA accounts to be tapped without tax penalty for such purposes as making a down payment on a first home or paying college tuition. Instead of allowing tax-free contributions, the so-called Super-IRAs would exempt earnings withdrawn after a minimum holding period. The behaviorists think both ideas are mistaken. Cornell's Thaler contends that people keep their reasons for saving walled off in what he calls ''mental accounts.'' Says he: ''People save for distinct purposes. They don't confuse their saving for a home with their saving for retirement.'' Allowing savers to apply their Super-IRAs to a multitude of purposes would muddy this mental accounting. And Super-IRAs would encourage asset swapping. Foreseeing a looming tuition bill for her 11-year-old daughter, for example, Mom would shrewdly take out a home equity loan and stash the proceeds into a Super-IRA. As the proceeds amass, tax-free, she could also deduct the second mortgage interest payments from her tax bill. Worst of all, by postponing the tax exemption until withdrawal, the Super- IRAs would deprive savers of their greatest pleasure -- pulling a fast one on the tax man. Research by Skinner and Daniel Feenberg of the National Bureau of Economic Research found that taxpayers faced with a choice between writing an $800 April 15 check to the IRS or stuffing $2,000 into an IRA will be far likelier to pick the IRA. OF COURSE, creating a new American culture of thrift must begin by bringing the federal budget back into balance. Says Princeton's Bernheim: ''A profligate government cannot preach thrift to the rest of the nation.'' Critics of measures to raise saving through IRAs and more generous pension provisions complain about the tax revenues that will be lost. Better to cut spending and -- if more revenues are still needed -- to phase in taxes on consumption as the economy picks up. Would a drive for higher saving torpedo the already fragile recovery? No, since people don't lift their saving until they have income left over to put away. It would trim outlays in the years immediately ahead. Once saving recovers, however, the additional growth it spurs will lift both incomes and spending power over the long term. If Americans had saved more yesterday, they would already have more to spend -- or save -- today.

CHART: NOT AVAILABLE CREDIT: NO CREDIT CAPTION: THE DECLINE OF THRIFT

CHART: NOT AVAILABLE CREDIT: SOURCE: OECD FOR GERMANY AND JAPAN, COMMERCE DEPARTMENT FOR U.S. CAPTION: TRAILING THE COMPETITION

CHART: NOT AVAILABLE CREDIT: SOURCE: COMMERCE DEPARTMENT CAPTION: DRAINING THE PENSION POOL