Tax Incentives Show Little Effect on Saving

A study suggests factors other than tax subsidies for employer-sponsored retirement plans have a greater effect on increasing savings.

Using data from Denmark’s pension system to make projections about the United States’ retirement system, the researchers found that every dollar the Danish government spent on tax breaks increased total savings by about one cent. In contrast, policies that automatically saved a portion of a worker’s income increased total savings by a substantial amount.

When individuals in the top income tax bracket received a larger tax subsidy for retirement savings, they started saving more in retirement accounts. But the same individuals reduced the amount they were saving outside retirement accounts by almost exactly the same amount, leaving total savings essentially unchanged.

The study goes on to question, if subsidies have little impact on retirement saving, are other policies more effective? Researchers found that “nudges,” such as automatic contributions by employers, have much greater effects on savings. When individuals switched to firms with higher automatic employer pension contributions, their savings rates increased significantly. Research indicated that most individuals are passive savers who do not pay attention to employer pension contributions and therefore do not offset contributions by saving less in other accounts.

While there is no way to guarantee the patterns in the two countries are identical, they both have similar pension systems—with a state-provided defined benefit plan, employer-provided defined contribution accounts and individual defined contribution accounts—and the new research fits with previous findings about American saving habits, the researchers acknowledged.

The topic is timely as the U.S. government looks to renew tax policy and industry groups are worried about the effect on retirement plans. (See “ASPPA Launches ‘Save My 401(k)’ Campaign.”)

“Active vs. Passive Decisions and Crowd-Out in Retirement Savings Accounts: Evidence from Denmark” is available here.