Tax Expenditures as Part of a Broad Strategy to Influence

Saving

May 19, 2009

William Gale

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Four ways to stimulate saving

• Mandates (e.g., Social Security)

• Incentives (AKA “tax expenditures”)

• Information (e.g., SS statement)

• Choice architecture (e.g., auto 401(k))

• Not an either/or choice. The approaches could be substitutes or complements.

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The alternatives differ along several dimensions

• Effects on saving

• Fiscal costs

• Economic distortions

• Distributional effects

• Administrative complexity

• Scalability

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They also differ in how they aim to encourage saving

• Change outcomes directly (mandates, defaults) • Change external constraints (incentives)• Change people’s thinking and attitudes

(information)

• So…what should saving policy “do”? • Through which channels should saving policy

aim to operate?

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Consider two types of consumers

• Neoclassical consumer – full information– fully rational– perfect implementer of plans

• Human – imperfect information– less than fully rational– imperfect implementer of plans

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Policy for neoclassical consumers

• Mandates will be offset (if not too big)

• Default settings will have no impact

• No need to provide information

• The only way to affect saving is through incentives

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Incentives for Neoclassical Consumers

• May be needed, since saving levels may be optimal privately, but not socially (due to an income tax, SS, Medicare, etc.)

• May be regressive

• May be expensive

• May not stimulate much net new saving

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Policy for Humans• Mandates and default settings have real effects

– Gets people into accounts or gets them benefits, but does not equip them to manage these outcomes

• Incentives can have real effects– Same caveats as for neoclassical consumers, AND – The incentives need to be understood

• Information is the potential solution to both of the problems above – Can leverage the impact of other policies – Is due to consumers who are affected by other policies– Is a complement to, not a substitute, for other interventions– is likely to be less expensive than incentives– is likely to be progressive

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Bottom Line

• Current tax incentives for saving – Are expensive– Are regressive – Are of questionable value in raising saving

• Could be leveraged much better – With design changes – Coupled with information and default settings

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For example

• Savers credit – Is poorly utilized and so does not serve its purpose

• But the following combination could work quite well– Revamp the credit as a refundable, fixed rate

matching contribution into the account – Expand automatic enrollment in 401(k)s and IRAs– Educate workers on the value of saving and how to

manage assets

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Example, continued

• Auto enrollment gets people into the system

• The incentive makes saving more rewarding

• The information equips people to deal with the account balances they generate, thus enhancing the value of the incentive.

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Conclusion

• Incentives as just one component of saving policy– Redesign the incentives – Couple with intelligent defaults and

information

• Would leverage the benefits and reduce the costs of incentives

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One more thing

• The US currently spends $200 billion per year on saving preferences.

• Could we use 1 percent of that to design experiments to see which combinations of defaults, information, and incentives work best?