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Do Tax Incentives Really Push People To Save More?


Economic Trends

DO TAX INCENTIVES REALLY PUSH PEOPLE TO SAVE MORE?

At first glance, the array of tax incentives devised by Congress in recent decades to boost household savings has been a striking success. More than 40 million people now have 401(k) plans, for example. And the annual sums pumped into 401(k)s, individual retirement accounts (IRAs), and the like have soared from just $5.4 billion in 1980 to $66 billion in 1990.

The critical question, however, is whether the plans have induced taxpayers to save more. In a study in Brookings Papers on Economic Activity, economists Eric M. Engen, William G. Gale, and John Karl Scholz note that there's nothing to stop people from reducing their taxes by using past savings or even borrowed funds to make contributions to IRAs, 401(k)s, or other plans. They can also choose to squirrel away the same amount they would have anyhow, while spending the extra cash provided by a lower tax bill.

To find out how people actually behaved, the study looked at two matched groups of savers presumably influenced by tax incentives: 401(k) participants and IRA participants not eligible for 401(k) plans. Because the 1986 tax reform act slashed IRA deductibility while expanding opportunities to save via 401(k)s, the researchers figured that by 1991 the savings of the latter group should have grown a lot more than the IRA group. Instead, they found no real difference in asset growth from 1986 to 1991.

The economists conclude that most of the funds flowing into tax-incentive plans are not new savings but substitutes for other forms of savings. And while some may disagree, their results are bolstered by one salient fact: The personal savings rate, which averaged 7% from 1950 to 1980, has slumped to the 4.5% range--just as contributions to savings incentive plans have taken off.GENE KORETZ


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