Journal Issue

United States of America: Background Papers

International Monetary Fund
Published Date:
October 1995
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VIII. Tax-Assisted Saving in the United States: A Review and Assessment 1/

In the first half of the 1990s, U.S. gross national saving as a share of GDP averaged just under 12 percent, roughly 4 percentage points below the average level in the 1960s and 1970s. While most of the decline was the result of the deterioration in the federal fiscal position, an important factor was a drop in the personal saving rate. The personal saving rate fell during the 1980s from a peak of nearly 9 percent in 1981 to an average of about 4 1/2 percent in the first half of the 1990s, well below the average of the previous three decades (Chart VIII-1).


(In percent)

Source: Bureau of Economic Analysis, U.S. Deportment of Commerce, supplied by Haver Analytics.

The deterioration of the personal saving rate during the 1980s coincided with a number of important changes to the U.S. tax treatment of retirement saving. Host notably, the 1986 tax reform sharply limited the tax deduction for contributions to Individual Retirement Accounts (IRAs), giving rise to concerns that these changes in tax legislation contributed to the weakness in personal saving. Partly in response to these concerns, a number of recent proposals have been made to increase the generosity of tax preferences for retirement saving as a way of boosting the saving rate.

This paper reviews the current and proposed tax treatment of retirement saving in the United States (Sections 1 and 2) and discusses the likely effect of tax preferences on household saving decisions, with reference to a number of recent studies of the issue (Sections 3 and 4). Finally, the hypothesis that U.S. saving incentives have affected recent saving behavior is tested using household survey data (Section 5).

1. U.S. tax assistance for saving

Tax preferences for retirement savings are principally offered through 401(k) plans and Individual Retirement Accounts. 401(k) plans are employer-sponsored retirement saving vehicles, permitted by the Revenue Act of 1978. Contributions to 401(k) plans can be deducted from taxable income and the return on contributions accrue on a tax-deferred basis. The limit on employee contributions was reduced from $30,000 to $7,000 as part of the Tax Reform Act of 1986 (the limit was indexed to inflation and reached $9,240 in 1994). 2/ The features of 401(k) plans depend on the employer; often employers will “match” a percentage of employee contributions, and in some cases individuals may use 401(k) assets as collateral for consumer and other loans. 1/ Income tax is payable on amounts withdrawn; generally a 10 percent penalty also is assessed for withdrawals prior to age 59 1/2 (this penalty can be waived in the event of financial hardship).

Contributions to IRAs also are tax deductible, and income and interest earned on contributions are tax deferred. There are relatively few restrictions on IRA-eligible investments, which can include bank accounts, stocks, or bonds. The amount of contributions that can be deducted from taxable income is limited to $2,000 (or total earnings, whichever is less). This limit is gradually reduced from $2,000 to zero over the $40,000 to $50,000 income range for married individuals ($25,000 to $35,000 for unmarried individuals) who are covered by an employer pension plan. 2/ Taxes are payable upon withdrawal; withdrawals before age 59 1/2 are subject to an additional 10 percent penalty; funds must begin to be withdrawn at age 70 1/2. Individuals not eligible for the income tax deduction may still make contributions to an IRA and defer the tax payable on income earned on contributions. Individuals may finance their contributions to an IRA by borrowing and deduct the interest payments from ordinary income. Generally, only physical assets are IRA-ineligible.

Keogh plans and simplified employee plans (SEPs) are similar to IRAs except that they apply to self-employed individuals and have higher contribution limits.

Chart VIII-2 shows the recent evolution of IRA, 401(k), and Keogh contributions. IRA contributions increased sharply following the introduction of universal eligibility in 1982, rising from $3 billion in 1980 to $38 billion in 1985. However, with the Tax Reform Act of 1986, which eliminated the deductibility for higher Income individuals, contributions declined to $9 billion in 1991. By contrast, contributions to 401(k) plans have steadily increased, and appear not to have been affected by the Tax Reform Act of 1986.


(Billions of dollars)

Sources: U.S. Internal Revenue Service; and U.S. Ponsion and Welfare Benefits Administration.

2. Recent proposals for enhanced saving incentives

FY 1996 budget proposals by the Administration and the Congress contained a number of measures designed to promote private saving. The Administration called for: (i) a doubling of the income limit for the IRA deduction from $40,000 to $80,000 for families and $50,000 for individuals; (ii) the indexation of the $2,000 IRA deduction limit for inflation; (iii) penalty-free withdrawals from IRAs to fund post-secondary education, the purchase of a first home, unemployment relief, care of an elderly parent or grandparent, or medical expenses in excess of 7 1/2 percent of adjusted gross income; and (iv) the introduction of a “Special IRA”. Contributions to the Special IRA would not be tax deductible at the time they were made, but would accrue income on a tax-free basis and could be withdrawn tax free after five years.

Similarly, the tax measures in the Congress’ FY 1996 budget included the establishment of an American Dream Savings Account. These would permit annual nondeductible contributions of up to $4,000 for a married couple ($2,000 for an individual). The limit would be indexed for inflation, and contributions would earn income tax free. Distributions from the Accounts also would not be subject to income tax if made after five years or after the taxpayer had reached 59 1/2 years of age. In addition, tax-free withdrawals could be made to finance first-time home purchases, post-secondary education, medical expenses, and long-term care.

3. A simple analysis of saving incentives

The return to tax-assisted saving plans as compared to other taxable saving vehicles can be illustrated as follows. 1/ Assuming a constant nominal interest rate r, and a constant marginal tax rate r, the value A at the end of T periods of one dollar of pretax income saved through a taxable saving vehicle is:

Alternatively, the value of the pretax dollar invested in an IRA or 401(k) for households who can take advantage of the tax-deductible contribution is (assuming that the before-tax rates of return on taxable and IRA assets are the same, and that the tax rate on all forms of income are the same):

On an after-tax basis, the IRA accumulates income at the rate r while the taxable saving vehicle accumulates income at the rate r(1-τ).

It is important to note that the future value of the IRA investment is not affected by when the deduction is taken. For instance, if instead the taxpayer was unable to deduct the initial dollar invested but was not required to pay tax on the final value of the investment, the after-tax dollars withdrawn would be the same. Another factor that affects the analysis is the taxpayer’s pre- and post-retirement tax rates. The assumption above is that the tax rate is the same. However, if post-retirement income is lower, the tax rate paid on IRA withdrawals likely will be lower than at pre-retirement. This would increase the relative return on IRAs.

Finally, consider a nondeductible IRA (which would be essentially the same as the Administration’s Special IRA and the Congress’ American Dream Saving Account). In this case the taxpayer would invest only (1-r) but would be able to invest it at the pretax rate of r. Upon withdrawal, tax would be payable on the interest earned on the investment (but not on the initial amount deposited). Thus the future value of a dollar saved would be:

For example, suppose that τ=0.3 and r=0.03. Assuming that the individual invests the dollar for 20 and 40 years, alternatively, the value of one dollar invested in the alternative saving vehicles would be:

Future Value of Saving
Sl invested in:For 20 YearsFor 40 Years
Taxable saving instrument (A)$1.07$1.62
IRA (AIRA)$1.27$2.32
Nondeductible IRA (AIRA′)$1.10$1.84

The tabulation illustrates that the tax deductibility of saving (whether frontloaded or backloaded) strongly affects the return on saving. For example, over 20 years the return on the deductible IRA is roughly three times that for the nondeductible IRA. It also demonstrates that the return of the nondeductible IRA improves relative to the deductible IRA as the investment horizon lengthens. In other words, for shorter investment horizons, the existence of the initial tax deduction is relatively important. However, for longer horizons, the importance of the initial deduction begins to wane and the ability to invest at a tax-free rate of return increases. This suggests that younger savers would be more likely to contribute to IRAs in excess of $2,000 (i.e., without deducting the full contribution) than older savers.

4. The effect of tax incentives on saving

While tax preferences can have a substantial effect on the return to saving, there is considerable controversy regarding the responsiveness of total saving to changes in the after tax rate of return. Consumption theory suggests that the effect is ambiguous because of the offsetting income and substitution effects. For example, increasing the return to saving works toward causing individuals to substitute saving for consumption. However, the effect on saving is offset by the fact that an increase in the rate of return increases the present value of individuals’ current saving, which increases wealth and encourages an increase in consumption. This ambiguity has been reflected in much of the empirical literature on saving behavior, in which the elasticity of saving to the after tax rate of return is often found to be small. 1/

The question of whether saving incentives raise private saving rests on whether individuals substitute other forms of saving or reduce consumption to finance contributions into tax-deferred plans. Research using macroeconomic data has generated mixed results. Carroll and Summers (1987) find that the substantial rise in the saving rate differential between Canada and the United States in the mid-1970s was the result of the liberalization of Canada’s tax-deferred savings plan. Skinner and Feenberg (1990) question the effectiveness of IRAs in promoting saving, noting that their importance depends on the definition of saving that is used. 2/

Studies using microeconomic data also have produced conflicting results. Venti and Wise (1993) find that most households finance IRA contribution through a reduction in consumption, suggesting that IRAs promote total saving. 3/Poterba, Venti, and Wise (1993) also present evidence suggesting that tax preferences have promoted private saving. Using data from the Survey of Income and Program Participation (SIPP), they find that total assets of 401(k)-eligible individuals were significantly higher than the assets of those who were not eligible, while non-IRA and non-401(k) assets were comparable across the two groups. They also found that after 1986, IRA contribution rates fell across all income groups and the decline in the IRA contribution rate was largely independent of 401(k) eligibility. Feenberg and Skinner (1989) find, using the IRS-Michigan tax panel, that IRA contributors increased their taxable financial assets by more than noncontributors over the period 1980-84. They conclude that IRAs have promoted an increase in personal saving.

Other authors have used the same data sets to argue that tax assistance for saving has had a limited effect on the size of aggregate saving. Gale and Scholz (1994) estimate a life-cycle model of saving using data from the Survey of Consumer Finances (SCF), and present simulation results that suggest that only 2 percent of an increase in the IRA contribution limit would result in an increase in total saving. The authors suggest that the weak response of private saving to IRA contribution limits results from the fact that most contributors are relatively wealthy and already have contributed the maximum amount to their IRAs. Burman, Cordes, and Ozanne (1990) report similar findings from the IRS-Michigan Tax Panel. Engen, Gale, and Scholz (1995) examine the effect of IRAs and 401(k) plans using data from the SIPP. They compare two groups: participants in 401(k) plans, and nonparticipants in 401 (k) plans but who have IRAs. While they find that saving by 401(k) participants is somewhat higher, they conclude that the increase in private saving would be only slightly larger than the decline in public saving that the tax assistance causes.

Attanasio and Deleire (1994) examine the possibility that saving behavior differs for those households that just opened an IRA with those that already had IRA accounts. They find that IRA contributions are primarily funded through a reduction in the stock of other assets and that less than 20 percent of IRA contributions represent an addition to national saving. Papke, Petersen, and Poterba (1993) survey pension plan administrators, and conclude that 401(k)s tended to replace other pension saving plans.

5. Further evidence from household survey data

The issue of whether tax preferences affect saving behavior is examined below using data from the 1983 and 1989 Survey of Consumer Finances (SCF), which provides detailed information on assets, liabilities, and demographic characteristics of U.S. families. The approach adopted in this paper is different from those the studies cited above for two main reasons. First, the analysis below focuses on the panel component of the SCF--in other words, the same individuals are sampled in the 1983 and 1989 data. This avoids the problems of heterogeneity in comparing different cross-sections over time. 1/ Second, a proxy for the relative after-tax rate of return on tax-assisted saving plans is included in the empirical analysis below in order to directly test the effect of tax assistance for retirement saving.

The tabulation below illustrates some of the characteristics of the data set. For example, the IRA deduction limit appears not to have been a major factor in determining contributions. For example, over one third of those holding IRAs contributed $2,000 or more--the maximum deductible amount. Moreover, the average of positive IRA contributions was over $13,000 and roughly 60 percent of those who made positive contributions had incomes in excess of $50,000--i.e., they could not deduct contributions. 1/ The number of IRA account holders rose from 502 to 635 over the 1983-89 period. The average net retirement from IRAs was just under $14,000, slightly larger than the average contribution. A smaller number of survey respondents participated in 401(k) plans. Interestingly, though, the proportion of contributors to withdrawers was roughly the same as for IRAs, and the relative size of withdrawals and contributions also was roughly the same.

Characteristics of Contributors to IRAs and to Other Tax-Assisted Saving Plans 2/
IRAsOther Tax-Assisted

Saving Plans
Total sample1,4451,445
Number of positive balances635297
Of which: Contributing ≥ $2,000246
Income > $50,000188
Income > $100,000136
Number of positive contributions512301
(Average contribution)$13,286$4,493
Of which: Income > $50,000309
Number of negative contributions179165
(Average withdrawal)$13,934$4,455
Of which: Income > $50,000113

a. An analysis of tax-assisted saving

In this section two hypotheses are examined: (i) whether the tax treatment of pension saving affects the distribution of saving between tax-assisted and other assets and (ii) whether the tax treatment of pension saving affects the total amount of saving. The methodology is to estimate equations explaining saving as function of variables usually thought to affect private saving behavior, and to test whether a proxy for the tax advantage of IRAs and 401(k)s is a significant determinant of saving behavior.

The variables included in the saving equations are those suggested by standard life-cycle models of consumption and saving. In particular, the saving demand equation for asset i is specified as follows:

It would be expected that households’ willingness to save initially rises with age in order to build assets sufficient to fund post-retirement consumption. Similarly, saving would be expected to decline following retirement, and possibly turn negative, as households fund consumption with a lower level of income. In order to account for this possibility, age is included in the regression equations as a quadratic. Similarly, standard life-cycle considerations would suggest that increases in income and wealth would tend to increase saving.

However, it is less clear how the choice between tax-assisted and other forms of saving would be affected by changes in these variables. For example, the discussion in the previous section suggested that the advantage of being able to defer taxes increases with time. Therefore, it might be expected that the young would be more interested in utilizing tax-assisted saving vehicles. Conversely, however, the young might be more concerned about the penalties associated with withdrawing funds from IRAs and 401(k)s. Similarly, while an increase in income and wealth would tend to increase total saving, the effect on the distribution between saving vehicles is not clear. 1/ One possibility is that higher income households would be less concerned about maintaining saving in relatively liquid assets, and so would be more inclined to take advantage of IRAs and 401(k)s.

The variable τ measures the household’s marginal tax rate. The marginal tax rate is assumed to serve as a proxy for the relative yield of tax-assisted pension saving versus saving in other instruments on the assumption that their before-tax rates of return are equal. This variable was constructed by calculating an estimate of taxable income (by subtracting personal deductions and interest payments from household income) and then using the 1989 and 1983 tax tables to infer the appropriate tax rate (see the Appendix for details). 2/

A number of dummy variables also were included. A dummy variable was included for households whose income exceeded $50,000 and that participated in an employee retirement plan. This was intended to account for the fact that households with income in excess of this amount are unable to utilize the IRA deduction. Since the tax advantage of contributions to IRAs is less for these higher income households (holding the marginal tax rate constant), the dummy variable would be expected to affect saving in IRAs and 401(k)s negatively.

Dummy variables for the number of persons in the household and the number of children not at home were included to serve as a proxy for educational and other household expenses. A dummy variable measuring the level of educational attainment proxied for the degree of financial sophistication. Finally, a dummy variable for participation in a defined benefit pension plan also was included; households with a defined benefit plan could be expected to be less concerned with taking advantage of other forms of pension saving.

Table VIII-1 contains the results of an OLS regressions explaining the level of tax-assisted pension saving--IRAs and 401(k)s--and saving in the form of liquid assets. 1/ Two sets of results are reported. In the first set the full sample was used, in the second set individuals with nonpension savings or dissavings of more than $100,000 were excluded to control for the fact that the survey oversamples high income individuals (this is the approach taken by Gale and Scholz (1994)).

Table VIII-1.United States: Saving Equations 1/
Dependent Variable


Saving of

Liquid Assets
Age squared-31.08-11.72-42.151.55
Net equity-6.95-6.54-77.39-6.30
Children not at home-890.68-1,583.27-17,523.80-143.48
Marginal tax rate6.56-284.98-1,199.5420.06
Income threshold dummy13,527.1017,077.4832,265.102,148.86
Pension dummy1,776.286,411.8912,914.20535.75

T-statistics in parentheses; constant term is not reported. The wealth and income variables were defined in thousands of dollars, and the marginal tax rate was defined as a percentage. Columns 1 and 2 exclude households without IRA and 401(k) assets. Columns 2 and 4 are equations that exclude households whose estimated liquid asset accumulation or decumulation was greater than $100,000.

T-statistics in parentheses; constant term is not reported. The wealth and income variables were defined in thousands of dollars, and the marginal tax rate was defined as a percentage. Columns 1 and 2 exclude households without IRA and 401(k) assets. Columns 2 and 4 are equations that exclude households whose estimated liquid asset accumulation or decumulation was greater than $100,000.

The results indicate that both pension saving and saving in the form of liquid assets tend to rise with wealth. However, only pension saving appeared to be a positive function of income; liquid asset accumulation was not significantly related to income. The coefficients for the age variables were significantly different from zero in only the unrestricted pension saving equation. In all cases, however, the point estimates of the coefficients accorded with the expected life cycle profile. Saving tends to increase until late middle-age, and then tends to fall. For example, in the unrestricted equations saving rises with age until age 54 for pension assets and age 61 for liquid assets. 2/ In the restricted equations--i.e., excluding wealthy households--the estimated age at which saving was maximized was later: age 61 for tax-assisted saving and age 75 for liquid assets. The number of children away from home was negatively related to liquid asset saving in the unrestricted equation, possibly indicating the effect of post-secondary education expenses on saving.

The results did not appear to suggest that tax considerations had a significant effect on saving behavior; the coefficients on the proxies for the tax advantage of IRAs and 401(k)s were generally insignificantly different from zero. 1/ The one exception was the coefficient for the income threshold dummy in the equations for tax-assisted pension saving. This coefficient was large and positive, indicating that high income households tended to increase their IRA and 401(k) contributions. The positive effect of the threshold dummy was unexpected. Since households above the threshold would not be able to take advantage of the IRA deduction, they would be expected to save less in the form of tax-assisted saving vehicles.

Similar regressions were estimated using the saving rate as a dependent variable; the results are presented in Table VIII-2. In this case, the sample was restricted to those with positive IRA and 401(k) balances, so as to avoid biasing the results toward rejecting the hypothesis that tax considerations were important. The results were similar to those reported in Table VIII-1, in that wealth and income (entered in logs) were significant determinants of the saving rates, while the age variables appeared to be significant only in the case of the tax-assisted saving rate. The log of wealth entered positively in the equation for the tax-assisted saving rate and negatively in the equation for the liquid-asset saving rate, and the estimated coefficients were almost exactly offsetting. This suggested that as wealth increases, savers substitute tax-assisted saving for other forms of saving, suggesting perhaps that households with higher wealth are less concerned with the illiquidity of tax-assisted saving vehicles.

Table VIII-2.United States: Saving Rate Equations 1/
Dependent Variable


Saving of Liquid Assets
Log of wealth0.068-0.094-0.024
Log of income-0.0590.1690.121
Age squared-0.00017----
Log of net equity-0.010-0.005-0.016
Children not at home-0.019-0.013-0.030
Marginal tax rate0.1640.454--
Income threshold dummy0.002-0.069--
Pension dummy0.0820.2730.321
Tax-assisted saving rate-----1.016

T-statistics in parentheses; constant term is not reported.

T-statistics in parentheses; constant term is not reported.

Conversely, the estimated equations suggested that the tax-assisted saving rate declined with an increase in income, while the liquid asset rate rose with income. The fact that the sum of the coefficients was greater than zero accorded with the prior belief that high-income households tend to save a higher proportion of income. However, it was not clear why the tax-assisted saving rate would be negatively related to income, unless the proxies for the tax advantage--the marginal tax rate and the threshold dummy--were misspecified. This conjecture was refuted by the fact that neither the marginal tax rate nor the threshold dummy were significant determinants of the saving rate.

An important drawback to the above analysis is that tax variables--the marginal tax rate and the threshold dummy--may not accurately describe the relative return on IRAs and 401(k)s. In order to address this issue, an alternate specification of the saving rate equations was considered. In particular, the hypothesis that tax-assisted saving acted as a substitute for other forms of saving was tested directly by estimating the following equation:

In this case, the saving rate for liquid assets (Slqa) is a function of age, income and wealth. However, it is also assumed to be a function of the saving rate for tax-assisted assets (Staa) rather than the proxies for the relative return on those assets. In this way, the effect of changes in the relative return on tax-assisted saving is tested directly. If the tax advantage of IRAs/401(k)s increases and results in an increase in Staa, the coefficient on this variable in the Slqa equation will indicate the extent to which total saving rises. If the coefficient is minus one, the offset is complete. A coefficient that is negative but less than one in absolute value would suggest that the offset is less than full and total saving rises in response to an increase in tax preferences. 1/

The results of estimating this alternate specification for the saving rate for liquid assets are reported in the third column of Table VIII-2. The results are consistent with the previous regressions in that, given a level of the tax-assisted saving rate, an increase in wealth has no effect on the liquid-asset saving rate, while an increase in income would increase the rate. The age variables do not appear as significant determinants of the saving rate, while (somewhat curiously) the existence of a defined benefit pension plan tends to increase the saving rate. Most notably, the pension saving rate is a significant variable explaining the liquid asset rate, and the coefficient is insignificant from negative unity.

In sum, these results would seem to support the results reported by Gale and Scholz (1994) and Engen, Gale, and Scholz (1995) who argue that the tax treatment of IRAs and 401(k)s had a limited effects on total saving. In order to address the issue of substitutability among saving vehicles more directly, the determinants of asset shares in 1989 are examined in the sections below.

b. An analysis of 1989 asset shares

The ratios of tax-assisted pension assets, nonpension liquid assets, and net equity in housing to total net wealth were calculated and related to the variables that were used as explanatory variables in the analysis of saving presented in the previous section. The equations explaining the liquid asset and net housing equity shares were estimated using OLS. However, since a number of households did not hold tax-assisted pension assets in 1989 this equation was estimated using both OLS and TOBIT. 1/

The results are presented in Table VIII-3. They indicate that the share of wealth invested in tax-assisted pension assets tends to decline with an increase in wealth, suggesting a lesser need to tie assets up in relatively illiquid saving.

Table VIII-3.United States: 1989 Asset Share Equations 1/
Dependent Variable
Independent VariableTax-Assisted AssetsLiquid AssetsHousing Equity
83 pension dummy0.343------
Age squared-0.0003-0.000080.0001-0.0000
Income threshold dummy-0.209-0.0450.058-0.013
Household size-0.021-0.012-0.0390.051
Children not at home--0.002-0.0200.018
Education grade0.0270.011-0.0001-0.010
Pension dummy0.3330.138-0.099-0.039
Marginal tax rate0.7830.2780.382-0.659

T-statistics in parentheses; estimate of constant term not reported. Tax-assisted asset equation was estimated using TOBIT and OLS; other equations estimated using OLS. Sample was restricted to those with nonzero income and wealth in 1983. Wealth and income were expressed in million of dollars.

T-statistics in parentheses; estimate of constant term not reported. Tax-assisted asset equation was estimated using TOBIT and OLS; other equations estimated using OLS. Sample was restricted to those with nonzero income and wealth in 1983. Wealth and income were expressed in million of dollars.

The effect of taxes on the pension-asset share is as expected. In the equation estimated using TOBIT, an increase in the marginal tax rate tends to cause an increase in the share of tax-assisted assets, while the effect of income in excess of the IRA threshold is to reduce the share. The tax variables are less significant in the OLS estimate of the equation for the tax-assisted asset share.

The marginal tax rate also is not a significant determinant of the liquid asset ratio, but appears to be negatively related to the net housing equity ratio. Indeed, in the housing equity equation the coefficient is roughly the same size (in absolute value) as the coefficient in the pension saving equation. This suggests that the tax preference causes households to substitute away from investment in housing equity toward tax-assisted pension assets, perhaps by increasing their mortgage debt (thereby lowering their net equity) in order to take advantage of the tax-deductibility of mortgage interest.

6. Conclusion

Concern about the decline in the U.S. private saving rate in recent years has contributed to calls for increased tax incentives for saving. Most recently, both the Administration and the Congress have proposed an expansion of the IRA system. However, there is limited evidence that suggests that existing tax incentives have had a large effect on household saving. Also, the econometric studies that support the view that household saving has been increased also suggest that the increase has been relatively small and barely larger than the reduction in public saving that would result. This issue was reconsidered above using household survey data.

The results suggest that the tax advantages of IRA and 401(k)s have not significantly increased household saving and that reductions in liquid savings have fully offset any increase in tax-assisted saving. Examination of the determinants of the distribution of wealth between tax-assisted and other assets suggest, however, that tax considerations have affected the allocation of household portfolios. In particular, households have tended to bolster their tax-assisted pension assets at the expense of net housing equity.

A number of caveats should be noted, however. First, the analysis of saving flows and rates relied on estimates of household saving calculated by comparing the change in asset stocks and assuming constant contribution rates and interest rates over the 1983-89 period. Also, it was implicitly assumed that the tax regime was unchanged over the period. These assumptions clearly did not hold, which introduces some uncertainty regarding the results. Second, the evidence that U.S. tax assistance for pension saving has not had a significant effect on saving behavior may be partly a reflection of the relatively modest scope of these programs. The IRA and 401(k) contribution limits are relatively low. If these limits are binding on most households that have discretionary funds available for saving, it would be difficult to discern whether the tax advantage has had a large effect. By the same token, these results do not provide an indication of the likely effect of the more fundamental reforms of the tax system that are being contemplated by the Congress.


    AttanasioOrazio P. and Thomas C.DeLeireIRA’s and Household Saving Revisited: Some New Evidence,NBER Working Paper No. 4900 (October1994).

    BurmanLeonardJosephCordes and LarryOzanneIRAs and National Saving,National Tax Journal Vol. 43 No. 3 (September1990) pp. 25983.

    CarrollChris and Lawrence H.SummersWhy Have Private Saving Rates in the United States and Canada Diverged?Journal of Monetary Economics Vol. 20 No. 2 (September1987) pp. 24979.

    EngenEric M.William G.Gale and John KarlScholzDo Saving Incentives Work?Brookings Papers on Economic Activity 1: 1995 pp. 85151.

    FeenbergDaniel and JonathanSkinnerSources of IRA Savings, inLawrence H.Summers (ed.) Tax Policy and the Economy (Cambridge: MIT Press1989).

    FriendIrwin and JoelHasbouckSaving and After-Tax Rates of Return,Review of Economics and Statistics Vol. 65 No. 4 (November1983) pp. 537543.

    GaleWilliam G. and John KarlScholzIRAs and Household Saving,American Economic Review (December1994) pp. 123360.

    GravelleJane G.Individual Retirement Accounts (IRAs) and Related ProposalsCRS Report for Congress No. 95-420 (March1995).

    PapkeLeslie E.MitchellPetersen and James M.PoterbaDid 401(k) Plans Replace Other Employer Provided Pensions?,NBER Working Paper No. 4501 (October1993).

    PoterbaJames M.Steven F.Venti and David A.WiseDo 401(k) Contributions Crowd out Other Personal Saving?NBER Working Paper No. 4391 (June1993).

    SkinnerJonathan and DanielFeenbergThe Impact of the 1986 Tax Reform on Personal Saving,” inJ.Slemrod (ed.) Do Taxes Matter? The Impact of the Tax Reform Act of 1986 (Cambridge: MIT Press1990) pp. 5079.

    United StatesInternal Revenue Service Individual Income Tax Returnsvarious issues (Washington: U.S. Government Printing Office1993 and 1989).

    VentiSteven F. and David A.WiseThe Saving Effect of Tax-Deferred Retirement Accounts: Evidence from SIPP,” inB. DouglasBernheim and John B.Shoven (eds.) National Saving and Economic Performance (Chicago: University of Chicago Press1991).

    VentiSteven F. and David A.WiseThe Wealth of Cohorts and the Changing Assets of Older Americans,NBER Working Paper No. 4600 (1993).


Calculation of saving data

The Survey of Consumer Finances reports asset and liability totals for various categories. However, saving flows are not reported. In order to infer an average level of annual saving the following relationship between assets and contributions is used:

where Ax89 is the asset balance in 1989 and Cx88 is the contribution to the asset balance in 1988. Solving for the average contribution C, assuming that contributions are equal in every year we find:

The rates of return on used to calculate contributions to various assets are the same as those used by Gale and Scholz (1994).

Calculation of marginal tax rates

The marginal tax rates were calculated by comparing households’ taxable income against the tax rate schedules for 1983 and 1989, respectively. 1/ Taxable income was proxied by household adjusted gross income (as reported in the survey) less deductions for interest payments and personal exemptions. For the purpose of determining the filing status of survey respondents (and which tax rate schedule to use), those who reported only a single resident were treated as “single taxpayers,” unmarried taxpayers who reported more than one household resident were treated as “unmarried heads of households,” and married household respondents were treated as “married filing joint returns.”

In 1989, interest deductions were assumed to equal interest paid on reported mortgage debt plus 20 percent of interest on reported credit card and other debt. 2/ As survey data was only available on the amount of debt outstanding, rather than on interest payments, the interest rates on mortgage and credit card debt was assumed to be 12 percent and 16 percent, respectively. Personal exemptions in 1989 were based on filing status, and the same criteria described above were used.

The same procedure was used Co calculate the deductions in 1983. However, account was taken of the fact that in 1983 the full amount of mortgage, credit card, and other debt was deductible, and that personal exemptions were not dependent on taxpayers’ filing status.

Prepared by Alun Thomas and Christopher Towe. The assistance of Arthur Kennickell of the Board of Governors of the Federal Reserve in providing the data set is gratefully acknowledged.

The sum of employee and employer contributions to 401(k) and other defined contribution plans cannot exceed the lesser of 25 percent of salary or $30,000. Tax rules increase the stringency of these limits for high-income individuals.

1991 survey data reported by the U.S. Department of Labor suggests that firms on average matched about 43 percent of employee contributions.

IRAs were first introduced in 1974 (with a limit of $1,500 or 15 percent of income) for employees without employer-sponsored pension plans. The Economic Recovery Act of 1981 removed restrictions on access to IRAs and raised the contribution limit to $2,000. The current restrictions on IRA contributions were introduced in 1986.

This presentation is based on Poterba et al (1993).

For example, in SM/94/223 (pp. 77-88) the (semi) interest elasticity of personal and corporate saving is estimated to be only 0.02--i.e., a 1 percentage point increase in the rate of interest would result in a 0.02 percent increase in aggregate private saving (national accounts definition). See also Friend and Hasbrouck (1983) for a discussion of the empirical behavior of saving.

For example, if saving is defined to include purchases of durable goods.

These results have been criticized for adopting a functional form that is not consistent with any underlying utility function and does not allow individual attributes such as age and asset holdings to have first-order effects on saving.

The SCF survey was conducted every three years from 1983 to 1992. Beginning in 1989 a cross-section survey was added to the panel survey that was conducted in 1983, 1986, and 1989. The survey is based on a dual-frame design. An area-probability sample is carried out to provide adequate population coverage of assets and liabilities and is supplemented with a list of names from the Income Division of the Internal Revenue Service to improve the precision of estimates of assets and liabilities held more narrowly by wealthy households.

The average contributions were estimated by comparing asset stocks in 1983 and 1989 and subtracting an estimate of net investment income, so the figures are subject to a degree of uncertainty.

Data for 1981 except for contribution data, which are based on estimates of average contributions during the 1983-89 period.

Note that in this case wealth is defined as the sum of net financial assets (including housing equity) and so is not intended to serve as a proxy for permanent income.

The tax rate was calculated using the individual income tax formulas for 1983 and 1989, and assumed that the household takes advantage of mortgage interest, other interest, dependency and standard deductions; deductions for state and local taxes, moving expenses, and unreimbursed employee expenses were ignored, as were the effect of state and local income taxes.

Liquid assets are defined as the sum of checking and saving account assets, mutual funds, stocks, bonds and the cash value of life insurance minus loans and credit card debt. The survey only provides data on asset stocks and therefore it is necessary to impute saving flows by making some assumptions about average contributions. This paper follows the approach adopted by Gale and Scholz (1994) and assumes that both contributions and withdrawals are assumed to be equal in each year. See the Appendix for details.

To see this note that the effect of age in the unrestricted tax-assisted saving equation is 3,362 age - 31 age2 (i.e., using the estimated coefficients). Thus, the effect of age is maximized when age = 3,362/2(31) = 54.

While the possibility of collinearity between the income variable and the marginal tax rate was a concern, the correlation between these two variables was found to be relatively low (0.21).

This can be expressed more formally as follows. Suppose that the demand for saving in the form of liquid assets and tax-assisted assets is a function of the marginal tax rate τ and other variables X (i.e, income, wealth, age, etc.). Then the demand functions are Slqa = -ατ + βX and Staa - γτ + ΛX, respectively. Solving the Staa equation for τ, and substituting it into the equation explaining Slqa yields slqa = -α/γStaa + (β-λ/γ)X. If the estimated coefficient on Staa is minus one, then α = γ and the effect of a change in τ on total saving is zero. If the estimated coefficient is greater than minus one, then α < γ, and the effect of an increase in τ is to increase saving. Note, that this substitution may result in a simultaneity bias if saving is measured with an error.

TOBIT provides a maximum likelihood estimate of a regression equation when the dependent variable is truncated at zero. The estimator assumes that the desired level of the dependent variable is unobserved when its actual value is zero.

The source was Individual Income Tax Returns 1983 and Individual Income Tax Returns 1989, published by Department of the Treasury, Internal Revenue Service.

In 1989, only 20 percent of nonmortgage debt was deductible.

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