Leth-Petersen and Heien Nielsen in The Quarterly Journal of Economics
Do retirement savings policies - subsidies or mandates - raise total wealth accumulation and help preparing people for retirement?
In this paper, a joint University of Copenhagen and Harvard project co-authored with Raj Chetty, John Friedman and Tore Olsen, we revisit this classic question fundamental for understanding the effects of savings policies and for designing pension systems. Using 41 million observations on savings for the Danish population, we show that the impacts of retirement savings policies on wealth accumulation depend crucially on whether the policy promotes active or passive choices. Subsidies given as tax deductions for contributions to private retirement accounts rely upon individuals to take an action to raise savings. They primarily induce individuals to shift assets from taxable accounts to retirement accounts and are therefore costly. We estimate that each $1 of government expenditure on subsidies increases total saving by only 1 cent. In contrast, policies that rely on mandates and do not require individual action, e.g. automatic employer contributions to retirement accounts, not only raise retirement contributions but also total wealth accumulation substantially. We estimate that 15% of the population is "active savers" who respond to tax subsidies in accordance with a neoclassical model of savings choices by shifting assets across accounts. 85% of individuals are "passive savers" who are unresponsive to subsidies. Instead, these agents turn out to be influenced extensively by automatic contributions made on their behalf. Active savers tend to be wealthier and more financially sophisticated. We conclude that automatic contributions are more effective at increasing savings rates than subsidies for three reasons: (1) subsidies induce relatively few individuals to respond, (2) they generate substantial crowd-out among those responding, and (3) they do not increase the savings of passive individuals, who are least prepared for retirement.