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Taxes on Savings
Jonathan Gruber
Public Finance and Public Policy
Introduction
Does the existing structure of income
Introduction
This lesson proceeds as follows:
Figure 1
C2
Y(1+r)
Y(1+r(1-))
C2
slo
pe
slop
=-
e=
( 1+
r)
-(1+
r(1-
))
S(1+r)
BC2
C1
BC1
Y
C1
taxation of savings.
Figure 2
C2
C2
Substitution effect
is larger
Income effect
is larger
Or rise.
C2
C2
C2*
C2*
BC2
BC1
BC2
C1
C1 C1 *
S
BC1
C1 * C1
S
C1
Table 1
Inflation
Constant real
rate
Tax rate
Inflatio
on
Saving
The
nominal
rate
n
interest
s
will
0%
likely
0%adjust for
100
inflation,
however.
0%
50%
100
With
taxes
on
With
10%
inflation
Interes
After-tax
nominal
returns,
and
at 10%
return,
Nominal earning resource
the real
returns is
rate
s
negative!
zero.
Price
of
skittle
s
Bags
of
skittle
s
10%
$10
$110
$1.00
110
10%
$10
$105
$1.00
105
10%
0%
100
10%
$10
$110
$1.10
100
10%
50%
100
10%
$10
$105
$1.10
95.5
10%
0%
100
21%
$21
$121
$1.10
110
10%
50%
100
21%
$21
$110.5
$1.10
100.5
ALTERNATIVE MODELS OF
SAVINGS
Precautionary saving models
The precautionary saving model is a
l
Social
insurance
and
a
c
i
r
i
ce
p
n
Em vide
personal savings
E
There are a number of studies in support of
the precautionary model. They show that
greater uncertainty leads to higher savings,
and that social insurance programs that lower
income uncertainty lead to lower savings.
Chou, et al. (2003) find that the introduction
of National Health Insurance in Taiwan led to
a decrease in savings among affected workers.
Gruber and Yelowitz (1999) find that Medicaid
expansions in the U.S. lowered the need for
precautionary savings.
commitment devices.
following characteristics:
Individuals avoid paying income tax on
their contributions.
Earnings accumulate at the before-tax
rate of return.
Withdrawals are taxed as ordinary
income, not the lower capital gains tax
rate.
Table 2
Earning
Tax on
Initial
s With an
earning
IRA (ordeposi
t
401k),sthe
Regula
r
( =25%)
investment
accrues
$100
$25
$75
at the before-tax
rate of return.
IRA
$100
$100
Interest
Taxes paid
Total amount
withdrawn
$7.50
$1.88
=0.25x($7.5
0)
$80.62
=$75+$7.50-$1.88
$10
$27.50
=0.25x($11
0)
$82.50
=$100+$10$27.50
This
tax subsidy
earned
upon
leads to greater
withdrawal
(r=10%)
overall wealth.
Figure 3
C2
Y(1+r(1-))
Y(1+r(1-))
C2
slo
pe
slop
=( 1+
r(1
-
))
e=
-(1+
r(1
B
C
))
S(1+r(1-))
The
BC2
C1
BC3 = BC1
Y
C1
Figure 4
C2
D
slope = -(1+r(1-))
Y(1+r(1-))
Y
$3,000
C1
Y(1+r(1-))
B
?
For athe
lownet
saver,
theis
Thus,
effect
income and
ambiguous
for low
substitution
effects go
savers.
in opposite directions.
A
C1 g
Y
1,000
C1
Y(1+r(1-))
C1W C2W
$4,000
$5,000
C1
n
o
i
t
a
c
pli
p
A
l
The impact of tax incentives
a
c
i
ir nce
p
Em vide for savings on savings behavior
E
Empirical work examining the impact of IRAs and
l
The impact of tax incentives
a
c
i
ir nce
p
Em vide for savings on savings behavior
E
Engelhardt (1996) studies the Canadian
Registered Home Ownership Savings Plan.
Unlike the programs in the U.S., this created
quasi-experimental variation because:
Evidence
Alternative Models of Savings
Tax Incentives for Retirement Savings