Subsidies vs. Nudges: Which Policies Increase Saving the Most?

Publication Date: March 2013

Publisher: Center for Retirement Research at Boston College

Author(s): Raj Chetty; John N. Friedman; Soren Leth-Petersen; Torben Heien Nielsen; Tore Olsen

Research Area: Economics

Keywords: retirement savings; tax subsidies; automatic contributions

Type: Report

Coverage: United States Europe

Abstract:

The federal government provides generous tax subsidies for retirement saving in 401(k)s and IRAs. The subsidies are designed to increase household saving and retirement income security, important national goals. The estimated cost, however, exceeds $100 billion a year in lost revenue to the Treasury. Given the nation’s severe budgetary pressures, it is critical to know how effective these subsidies are in raising household saving and whether other approaches would be more cost-effective.

The ability to answer these questions has been limited by inadequate U.S. data on household saving. In particular, it is hard to know whether tax subsidies encourage families to save more, or simply shift money they would otherwise save into tax-advantaged retirement accounts. The same is true for “automatic” saving, such as defaults in 401(k) plans, which increase retirement saving if individuals take no action. While defaults have been shown to increase retirement saving, is this increase offset by reduced saving in taxable accounts or an increase in debt, leav-ing total household saving unchanged?
This brief, based on a recent study, uses high-quality Danish data to address these questions. It assesses the effect of tax subsidies and automatic contributions on retirement saving and total household saving. The Danish retirement system and patterns of retirement saving are similar to those in the United States. The effect of retirement saving policies on total household saving should be similar as well, making the findings relevant to current U.S. policy discussions.

This brief proceeds as follows. The first section introduces the problem of evaluating policies designed to increase retirement saving. The second section describes the data and basic methodology used in the analysis. The third section presents findings on the effect of tax subsidies on retirement saving. The fourth section presents findings on the effect of automatic saving. The fifth section offers an explanation of these findings based on how these policies affect two types of individuals – “active” and “passive” savers. The final section concludes that an expansion of automatic saving could produce much larger increases in household saving, at lower fiscal cost, than current tax subsidies for retirement saving.