"Missed" Behavior

As the nation continues to grapple with fiscal challenges, the subject of so-called “tax expenditures,” (the amount of tax breaks accorded various programs) has attracted a great deal of attention. Critics of the current tax preferences structure for work place retirement plans have questioned the efficacy of those preferences relative to the savings produced.

In that vein, a recent study¹ examined the experience of the Danish pension system to consider the relative impact of government retirement-savings tax preferences on savings behaviors, as well as the impacts on savings patterns of a mandate that required all Danish citizens to contribute 1 percent of their earnings to a retirement savings account from 1998 until 2003.

In explaining their rationale for drawing on the Danish pension experience, the study’s authors described that nation’s pension system as “broadly similar in structure” to that in the United States and other developed countries, in that it has individual accounts, employer-provided pensions, and a government-supported defined benefit (DB) retirement plan. However, while the components are similar, as a recent EBRI Notes article² points out, the Danish retirement system functions differently in several critical aspects.

The Danish Experience

Not surprisingly, the research on Danish workers noted a “sharp increase” in savings rates in 1998 (when the mandate took hold), and sharp reductions in total savings in 2004 (when the mandate lapsed). They also considered worker savings responses when, in 1999, the Danish government reduced the subsidy for contributing to capital pension accounts for individuals in the top income tax bracket, noting that while contributions fell sharply for individuals in the top bracket, they “remained virtually unchanged for individuals just below that bracket.” In other words, the individuals directly affected by changes in the incentives reacted, while those for whom the tax subsidy was unchanged did not.

They also found that the reduction in incentives also had a larger effect on Danish workers who make frequent changes to their pension contributions. In essence, Danish savers who were actively making decisions about their pension contributions were more likely to respond to the change in incentives than other individuals. This group the study authors classified as “active savers,” who, as it turns out, also have significantly higher wealth/income ratios and were more likely to be older than other Danish workers in the study.

Combining all these results, the authors arrive at two top-line conclusions about the saving behavior of Danish workers. First, that only 15 percent of those individuals are “active” savers, that only those active savers respond to tax incentive changes, and then largely only by reallocating savings between their tax-deferred pension accounts and taxable savings accounts. Second, for these active savers, a $1 of tax expenditure by the government on subsidies for retirement savings raises total savings by only about 1 cent, on average. Not surprisingly, these conclusions have drawn the attention of those who question the efficacy of the current retirement savings tax incentives in the U.S. But is this Danish experience relevant to the United States?

For the most part, the U.S. private sector relies on a voluntary retirement system—both on the part of workers to participate and save, and, significantly, on the part of employers to not only sponsor but also encourage participation with education, payroll deduction, and matching contributions. Furthermore, while U.S. employers sponsor these programs to attract and retain workers, they are encouraged to do so by certain tax preferences, conditional on administering the plan in accordance with various “nondiscrimination” standards. However, if the tax-deferred status of pension savings accounts were altered, previous surveys have shown these ties would almost certainly be weakened, if not entirely broken.³

Ultimately, the study of Danish worker savings behaviors was just that, and—as a study of individual savings behaviors in that environment—it has merit. It did not, however, consider the reaction of employers to these kind of changes. Those who would draw lessons from that experience should consider that the “success” of defined contribution work place retirement plans in the United States currently depends on the behavior of TWO parties: workers who voluntarily elect to defer compensation, and employers that choose to sponsor and, in many cases, contribute to them.

Nevin E. Adams, JD

¹ See Chetty, Raj, John N. Friedman, Soren Leth-Petersen, Torben Heien Nielsen, and Tore Olsen, “Active vs. Passive Decisions and Crowd-Out in Retirement Savings Accounts: Evidence from Denmark,” NBER Working Paper # 18565, November 2012, online here.

² See “Tax Preferences and Mandates: Is the Danish Savings Experience Applicable to the United States?”

³ A survey conducted on behalf of The Principal Financial Group in 2011 determined that if workers’ ability to deduct any amount of the 401(k) contribution from taxable income was eliminated, 65 percent of the plan sponsor respondents would have less desire to continue offering their 401(k) plan. A separate survey of plan sponsors by AllianceBernstein that same year found that small plan sponsors were more likely to respond negatively to a proposed change in the deductibility of contributions by employees than larger employers—the impact of the loss of access to plans, and to the matching contributions often associated with those plans, was documented in previous EBRI research. See “Modifying the Federal Tax Treatment of 401(k) Plan Contributions: Projected Impact on Participant Account Balances,” online here.