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Household responses to complex tax incentivesHMRC/HMT/ESRC Project: Code: RES 194-23-0013Project duration: Jan 1, 2011 to Dec 31, 2011
Project team:
Professor Richard Disney (PI), IFS and
University of Nottingham
Carl Emmerson, IFS
Rowena Crawford, IFS
Dr Johannes Abeler, University of
Nottingham and University of Oxford
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Motivation
• Overall: The extent to which individuals, and households, respond to complex decision-making environments.
• Up-front financial incentives are an often used policy lever to encourage retirement saving. Is this an effective method?
• We focus on tax reliefs:– Tax relief on own income given at marginal tax rate (mtr) –
should be more attractive to high earners.– Tax relief on partner’s income given at marginal tax rate –
might induce households with differential mtrs to adjust joint saving.
– Has the introduction of the New Tax Credits boosted private pension coverage?
• Arguably, these ‘tax planning’ incentives differ in their transparency and in their complexity.
• Pattern of responses using econometric methods + experiment.
What are the ‘upfront incentives to save’ I?
• Individual contributions to pensions are exempt from income tax, therefore £1 of pension contribution ‘costs’ £(1-MTR)– Basic rate taxpayers: 78p (1999 to 2007), 80p (2008
onwards)– Higher rate taxpayers: 60p
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£0 £10,000 £20,000 £30,000 £40,000 £50,000 £60,000 £70,0000%
10%
20%
30%
40%
50%
60%
70%
Gross annual income net of any pension contribution
Rate
at
whic
h r
elie
f giv
en
What are the ‘upfront incentives to save’ II?• Contributions to pensions are also deducted from income
before assessment for means-tested tax credits, therefore £1 of pension contribution ‘costs’ £(1-EMTR)– For basic rate income taxpayers on WTC/CTC first taper:
41p– For higher rate income taxpayers on CTC second taper: 53p
© Institute for Fiscal Studies
£0 £10,000 £20,000 £30,000 £40,000 £50,000 £60,000 £70,0000%
10%
20%
30%
40%
50%
60%
70%
Gross annual income net of any pension contribution
Rate
at
whic
h r
elie
f giv
en
Up-front income tax and tax credit relief on individual pension contributions, one-earner
family with two children aged below 65
Empirical strategy• Consider the discontinuity at the higher rate threshold
(HRT)– At the HRT the cost of £1 pension saving falls from 78p to
60p
• Other than the tax difference those ‘just’ above the HRT and those ‘just’ below the threshold should be ‘the same’
• Therefore compare the pension saving behaviour of:1. Those with income just above and just below the higher
rate threshold• Expect those just above the HRT to be more likely to engage in
pension saving than those just below
2. Married individuals below the HRT who have a partner just above the HRT, with married individuals below the HRT who have a partner just below the HRT• Expect those below the HRT with a partner just above the HRT
to be less likely to engage in retirement saving that those with a partner just below the HRT© Institute for Fiscal Studies
Data: Family Resources Survey
• FRS is a cross sectional survey that records detailed income information for a large sample of the GB/UK population
• Pooled 9 years of FRS: 1999 to 2008
• All nominal values (income, thresholds etc) uprated to 2007 prices using RPI
• Analysis restricted to employees age 22-59
• ‘Just’ below/above is defined as within [£10k / £5k / £2k]
• Looking at current pension membership: individuals only counted as being a member of a pension if they contributed in the last 12 months
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1) HRT individual analysis – non parametric method
• Regression discontinuity design, comparing those - ‘just’ above the HRT with those ‘just’ below, for different thresholds.
© Institute for Fiscal Studies
-10k
to -9
.5k
-900
0
-800
0
-700
0
-600
0
-500
0
-400
0
-300
0
-200
0
-100
0
0 to
500
1000
2000
3000
4000
5000
6000
7000
8000
9000
0.680.700.720.740.760.780.800.820.84
Distance from higher rate threshold (£, 2007 prices)
Pro
port
ion c
ontr
ibuti
ng t
o a
pensi
on
1) HRT individual analysis – parametric method • Regression discontinuity design, comparing those ‘just’
above the HRT with those ‘just’ below• Run regressions of pension membership on whether
above the HRT, controlling for:
– Individual characteristics include: age, age2, sex, marital status, education, hours, partner’s age difference, education, hours, other household income
– Three thresholds, ± £2000, £5000, £10,000
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Distance from
HRT
Distance from HRT2
Individual characteristic
s*
Model A
Model B
Model C
Model D
1) HRT individual analysis – parametric results (1/3)
• Some evidence that hitting the HRT has a small positive effect on pension membership (greater probability of pension membership when incentives greater)
© Institute for Fiscal Studies
h = £10k h = £5k h = £2kModel A 0.014
(0.008) 0.026**
(0.012)0.020
(0.018)Model B 0.026**
(0.012)0.019
(0.018)0.022
(0.028)Model C 0.013
(0.008) 0.028**
(0.011)0.023
(0.018)Model D 0.026**
(0.012)0.019
(0.017)0.021
(0.027)
Sample 41,129 19,627 7,851
Note: Coefficients are in bold, standard errors are in parentheses
1) HRT individual analysis – parametric results (2/3)
• Check results by testing some placebo thresholds
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Test threshold: Model C Model D Sample size
HRT-£10k (h = £10k) -0.006(0.007)
-0.001(0.010)
75,591
HRT+£10k (h = £10k) -0.002(0.012)
0.010(0.018)
19,664
HRT-£5k (h = £5k) 0.000(0.010)
0.001(0.015)
27,818
HRT+£5k (h = £5k) 0.010(0.014)
0.009(0.021)
13,276
HRT-£2k (h = £2k) 0.011(0.017)
0.002(0.026)
9,076
HRT+£2k (h = £2k) -0.023(0.020)
-0.046(0.030)
6,617
1) HRT individual analysis – results (3/3)
• Run the model separately for subgroups to look at heterogeneous effects
• Robust results:
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Coefficient Standard Error Sample sizeMen
0.032** (0.015) 27,629Women
0.014 (0.020) 13,466
Aged 22 – 39 0.037* (0.020) 17,796
Aged 40 – 59 0.019 (0.015) 23,299
Low education 0.011 (0.022) 15,024
Mid education 0.065** (0.026) 9,364
High education 0.016 (0.017) 16,707
Notes:
Results are reported for model D with h=£10k. Similar results are produced from model C with h=£5k.
Education is defined as: low = left FT education at or before age 16, mid = left FT education above age 16 but less than age 19, high = left FT education
at or above age 19
1) HRT individual analysis – pension types
• Might expect effect to differ by pension type• ‘Employer pension’ probably includes group personal
pensions and group stakeholder pensions (only separately distinguished 2006 onwards)
• ‘Personal pension’ includes personal and stakeholder pensions
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No personal pension Personal pension
No employer pension 43.6% 9.2%
Employer pension 44.9% 2.3%
1) HRT individual analysis – ‘personal pensions’
© Institute for Fiscal Studies
-10k
to -9
.5k
-850
0
-700
0
-550
0
-400
0
-250
0
-100
050
020
0035
0050
0065
0080
00
9500
to 1
0000
0.000.020.040.060.080.100.120.140.16
Distance from higher rate threshold (£, 2007 prices)
Pro
port
ion c
ontr
ibuti
ng t
o a
pers
onal or
stake
hold
er
pensi
on
Regression analysis confirms no significant effect
1) HRT individual analysis – ‘employer pensions’
© Institute for Fiscal Studies
-10k
to -9
.5k
-850
0
-700
0
-550
0
-400
0
-250
0
-100
050
020
0035
0050
0065
0080
00
9500
to 1
0000
0.56
0.60
0.64
0.68
0.72
0.76
Distance from higher rate threshold (£, 2007 prices)
Pro
port
ion c
ontr
ibuti
ng t
o a
n
em
plo
yer
pensi
on
Regression analysis confirms the significant effect
2) HRT couples analysis
• If spouses both have an income below the HRT, both get tax relief on pension saving at same rate (~22%)
• If one spouse has an income above the HRT, he/she gets tax relief on pension saving at 40%– If saving is done jointly in a tax efficient manner, pension
saving should be done by the individual with the higher marginal tax rate
• Compare the pension saving behaviour of spouses, one of whom has an income just above and one of whom has an income just below the threshold, with those where both have an income below the threshold
• Expect those below the HRT with a partner just above the HRT to be less likely to engage in retirement saving that those with a partner just below the HRT
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2) HRT couples analysis - method
• Further restrict sample to married individuals earning below HRT
• Regression discontinuity design, comparing those whose spouse is ‘just’ above the HRT with those whose spouse is ‘just’ below
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2) Discontinuity in pension membership?
© Institute for Fiscal Studies
-10k
to -9
.5k
-850
0
-700
0
-550
0
-400
0
-250
0
-100
050
020
0035
0050
0065
0080
00
9500
to 1
0000
0.54
0.58
0.62
0.66
0.70
0.74
Partner’s distance from higher rate threshold (£, 2007 prices)
Pro
port
ion c
ontr
ibuti
ng t
o a
pensi
on
2) HRT couples analysis - method• Further restrict sample to married individuals earning
below HRT• Regression discontinuity design, comparing those whose
spouse is ‘just’ above the HRT with those whose spouse is ‘just’ below
• Run regressions of pension membership on whether partner is above the HRT, controlling for:
© Institute for Fiscal Studies
Partner’s
distance from
HRT
Partner’s
distance from HRT2
Individual characteristic
s*
Model A
Model B
Model C
Model D * Individual characteristics include: age, age
2, sex, marital status, education, hours, partner’s age difference,
education, hours, other household income
2) HRT couples analysis – results (1/2)
• Inconclusive evidence on whether pension membership is affected by partner hitting the HRT
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h = £10k h = £5k h = £2kModel A 0.010
(0.015)-0.020(0.021)
-0.038(0.032)
Model B -0.000(0.022)
-0.050 (0.030)
-0.060(0.048)
Model C 0.010(0.014)
-0.020(0.019)
-0.031(0.031)
Model D -0.030(0.021)
-0.040(0.029)
-0.050(0.046)
Sample 18,806 9,045 3,555
Note: Coefficients are in bold, standard errors are in parentheses
1) HRT couples analysis – ‘personal pensions’
© Institute for Fiscal Studies
-10k
to -9
.5k
-850
0
-700
0
-550
0
-400
0
-250
0
-100
050
020
0035
0050
0065
0080
00
9500
to 1
0000
0.000.020.040.060.080.100.120.140.16
Partner’s distance from higher rate threshold (£, 2007 prices)
Pro
port
ion c
ontr
ibuti
ng t
o a
pers
onal or
stake
hold
er
pensi
on
1) HRT couples analysis – ‘employer pensions’
© Institute for Fiscal Studies
-10k
to -9
.5k
-850
0
-700
0
-550
0
-400
0
-250
0
-100
050
020
0035
0050
0065
0080
00
9500
to 1
0000
0.46
0.51
0.56
0.61
0.66
0.71
0.76
Partner’s distance from higher rate threshold (£, 2007 prices)
Pro
port
ion c
ontr
ibuti
ng t
o a
n
em
plo
yer
pensi
on
2) HRT couples analysis – results (2/2)
• Evidence (that pension membership is affected by partner hitting the HRT) is not any stronger for particular subgroups
• Evidence is not any stronger by pension type• Could be that standard errors are too large to pick up an
effect (individuals in sample are much more heterogeneous, sample sizes much smaller)
• Could be that there is no effect (separation risk? additional complexity in understanding incentives?)
• May expect more evident effect if look at levels of contributions made
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Conclusions so far
• Hitting the higher rate threshold is associated with around a 3ppt increase in the probability of contributing to a pension– Stronger effect for men, those aged 22-39, and those with
mid levels of education (left school after age 16 but before age 19)
– Effect seems to come from contributions to ‘employer pensions’ rather than ‘personal pensions’
• Not clear that partner hitting the higher rate threshold is associated with a change in the probability of an individual contributing to a pension
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What’s next...
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• Consider levels of contributions rather than just whether contribute?
• Using the FRS: compare the pension saving behaviour of:3. Those affected by the tax credit taper, who experience a
much higher effective rate of tax relief, with those just above the taper who only get basic rate relief
• Using the BHPS: examine changes in income that take individuals across higher rate threshold and their probability of engaging in pension saving
• Sister project: a laboratory experiment to investigate individual saving decisions in the presence of different types of incentives