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Study Questions Tax Breaks’ Effect on Retirement Savings

Every year, the government spends more than $100 billion on tax breaks to encourage Americans to save more for retirement. But a new study suggests such provisions may have little effect on the amount Americans save.

The finding has particular relevance as Congress looks for ways to raise revenue by reducing tax breaks as part of the year-end budget negotiations.

The researchers — Raj Chetty and John N. Friedman of Harvard, Soren Leth-Petersen and Tore Olsen of the University of Copenhagen, and Torben Heien Nielsen of the Danish National Center for Social Research — looked at Danish data, in part because analogous American numbers are much less detailed.

Although there is no way to know whether the patterns in Denmark and the United States are identical, the two countries have similar pension systems, and the new research fits with previous findings about how Americans save.

The researchers found that every dollar that the Danish government spent on tax breaks increased total savings by about only one cent. In contrast, policies that automatically saved a portion of a worker's income increased total savings by a substantial amount.

William G. Gale, a tax expert at the Brookings Institution, said the new research was remarkable. Automatic savings systems, Mr. Gale said, "have proven remarkably effective in raising 401(k) participation rates and to some extent contribution rates, if done right." But it has not been clear whether people offset those increases by saving less elsewhere, he added.

Glenn Hubbard, the dean of the Columbia Business School and a top Republican economist, said in an e-mail about the new research that he believed low taxes on savings still benefited the economy over the long term. But, he said, saving incentives may be less powerful for the less well-off.

President Obama and Congressional leaders recently started talks to prevent hundreds of billions of dollars of tax increases and spending cuts from taking effect in January. Leaders of both parties say they want to enact policies that would do less damage to the economy in the short term while still reducing the deficit. But their plans differ.

Mr. Obama has said he wants to increase tax revenue by about $1.6 trillion over 10 years, with all new revenue coming from taxes on high-income households. Republicans leaders have signaled that they prefer closer to $800 billion in additional tax revenue, all of it coming from the reduction of tax breaks and faster economic growth, rather than higher tax rates.

The tax breaks for retirement savings are among the largest tax expenditures, along with those for employer-provided health insurance and mortgage interest. About 80 percent of retirement-savings benefits flow to households in the top fifth of earners — those making at least $100,000 — according to the Tax Policy Center in Washington.

In studying the tax data, the Danish and American researchers identified two main types of savers. About 85 percent of Danes were "passive" savers, who tended to be less responsive to government policies and less wealthy. The remaining 15 percent were "active" savers, who were more responsive and richer.

When the government reduced a tax break for retirement savings, passive savers barely changed their behavior. By contrast, automatic savings programs had more impact on them, causing the passive savers to put away more money for retirement, said Mr. Chetty, who recently won a so-called genius grant from the MacArthur Foundation.

Active savers also responded to tax breaks that change — but by shifting money between accounts that come with tax advantages and other accounts, not by changing the amount they put away. The automatic savings programs also had little effect on active savers' overall balances.

The researchers, who have been presenting their findings at academic seminars, said they planned to submit the paper to an academic journal this week.

The researchers conclude that tax breaks do not increase the overall level of savings by much, and do not tend to change the behavior of most workers — particularly the less wealthy, who often need the most help in preparing for retirement.

"The findings reported here call into question whether subsidies are the best policy tool to increase retirement savings," the authors write. "Our findings strengthen recent arguments for using 'nudges' such as automatic payroll deductions or savings defaults to stimulate retirement savings instead of subsidies."

In a typical default program, an employer or government agency automatically directs a portion of workers' earnings to a savings account, although the employees have the option of increasing or decreasing the amount. Most American employers lack a default program, and workers who take no action save nothing.

The biggest question concerning the new study about Denmark is why it deserves attention when dozens of prominent researchers have written hundreds of papers on retirement saving programs and subsidies in this country.

The researchers argue that the answer is in the data. The Danish government keeps much more detailed numbers on retirement accounts and savings patterns. So while there has never been a conclusive answer to the question of whether Washington's tax breaks on retirement savings raise the overall level of saving, the researchers believe they have found the answer in Denmark.

Ultimately, for Washington, the policy implications could be considerable.

The year-end debt talks between Congressional leaders and the White House have the potential to start a larger effort to overhaul the tax code next year, and the $1 trillion a year in breaks in the tax code are expected to come under scrutiny.

The money that the government spends to encourage Americans to save for retirement is money that cannot be spent on deficit reduction, education, health care or other priorities. The study suggests that the money has little effect on the retirement security of lower-income families, either.

On top of that, economists and policy experts have warned about a crisis in retirement security because of the decline in defined-benefit pensions, significant fiscal problems in public retirement programs, the ravages of the recession and the housing bust.

Low-cost policy changes, like requiring employers to put a portion of workers' paychecks into a retirement fund, might help millions of households save for a secure retirement without driving Washington deeper into the red.

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