Savings and Retirement: How does tax-favored retirement saving affect national saving?

One of the most important and controversial aspects of the taxation of retirement saving is its effect on private saving, wealth accumulation, and retirement preparedness. Although traditional pensions and other tax-deferred vehicles such as 401(k) plans and Individual Retirement Accounts (IRAs) clearly make up a sizable share of households’ wealth, both in their preretirement years and during retirement, it is less clear how much of that wealth represents incremental balances, that is, wealth that would not have existed in some other form in the absence of favored tax treatment of retirement saving.

The accounts raise private saving to the extent that they induce households to finance their own contributions through either reductions in consumption or increases in labor supply. Saving incentives do not raise private saving to the extent that households finance their contributions by shifting their existing assets into a tax-favored account, or by shifting current-period saving that would have occurred even in the absence of the incentive, or by increasing their debt. Likewise, there is no increase in private saving to the extent that households respond to employer-provided pensions or contributions by reducing their other saving or increasing their borrowing.

• The earliest research on both traditional defined-benefit pensions and defined-contribution plans appeared to demonstrate very strong effects on private wealth and saving. These efforts, however, were marred by a series of econometric and statistical problems. More recent research, using improved methods, has found significantly smaller impacts of tax-preferred saving vehicles on private saving and wealth, and in some cases has found no net effects on private wealth at all.