The Impact of Tax Regimes on the Development of Private Pension Funds: Reflections on the Capital Market

Private pension funds have been major institutional investors in most countries of the Western hemisphere. The countries providing fiscal incentives and tax shelter to pension savings are also those having large pension fund assets in the economy. In these countries, privately managed, fully or partially funded pension funds play a market-maker role in the capital market, take place in the demand side of the privatization process, help to the mobilisation of work force in business circles, and ease the burden of demographic change on the budget, in addition to their basic function of providing retirement benefits in old age. Taxation regime of retirement savings shapes the dimensions, functions, legal infrastructure and the investment areas of private pension funds. Taxation can also be a useful tool in the development of the domestic financial markets, the promotion of financial innovations and instruments, and establishment of fundamentals of market economy, where necessary. This paper aims to show that inappropriate taxation of private pension savings will restrict not only the accumulation of funds but also the possible positive effects of those funds on the capital market, as well as other sections of the economy. It is also suggested in that, private pension funds can reach such scales sufficient to perform these expected functions, by providing tax exemption to contributions, tax-free environment to investment returns and by taxing only the benefits. Finally, countries suffering from improper functioning of a PAYG type social security system, and planning to design funded private pensions as a “voluntary” second pillar, should give ultimate priority to the taxation aspect of this reform.