Make Savings Account Interest Tax Free

In times of great economic distress, when banks are starving for capital and politicians are clamoring about banks taking TARP money and not loaning it out, I've got a very simple component solution.

Make savings account interest tax free. With public confidence in the equities and bond market shot, most people are scurrying to find places to stash their money where they know it won't disappear. While savvy investors may find good places, most people just stuff them into the Treasury market which means many will get hit a second time when this crowded trade clears out or its in a matress which is just as bad.

However, if instead we told those with cash that their savings yields would be tax free - it would allow banks to attract new savings (the actual money they use to make loans) and give them a "government sponsored" boost in competitiveness through tax exemptions boosting their stated yields. If the economy recovers, this exemption could be revoked at varying levels to force capital into more risky assets.

The combination of a tax-free yield and an FDIC guarantee on the deposit would provide a boosted and safe place for everyone with savings ranging from $1 to the FDIC limit and beyond. Secondarily - it would steer fear capital to the banks and allow them to lend at a leveraged rate. Since every dollar of savings could make ten dollars of loans - this private capital infusions could be huge. Doing this would effectively short circuit the current pattern whereby the government issues treasuries at low yields at oversubscribed auctions and then uses these funds to give to the banks or spend in some other economic stimulus. Why don't we just cut out the government middle-man?

Instead of this whole process - the banks could get the deposits they need to make new loans immediately through cash infusions of savings! The savings rate which is too low right now would be bolstered through additional incentive to save and greater compounding, the government would be removed from the normal tax portion of savings and therefore the possibility of pork spending eliminated. The general public might then experience tax adjusted yields of up to 5% or the banks would be able to attract cheaper capital or both.

Moreover - the fact that savings accounts are not tax free currently is ludicrous. 401K retirement savings are, mortgage interest is deductible, so why not general savings?? I don't know the tax liability for the government, but if its potentially huge, just set limits on tax exemption on savings like the FDIC does with insurance.

The main goals should be to direct scared capital to solve the problem of teetering banks. Insure the banks deposits, direct the free cash flow toward them as a safe and smart investment vehicle in a time of crisis and you'll ensure that banks get the most money to stimulate the economy precisely when they need it most. Lastly - to solve the politicians heartburn - new savings, unless used by banks to lend is only a burden on them as they'll need to pay out interest on it - a natural solution to promote new lending as the cash rolls in for them to utilize or sit on and squander.