On the Taxation of Private Retirement Wealth

Private retirement plans have become an increasingly important component of house hold wealth in the United States, with nearly two-thirds of Americans having access to employer-sponsored defined contribution plans. These plans have significant tax advantages, as both employee and employer contributions are tax-exempt, while the returns remain untaxed until their withdrawal during retirement. We develop a quantitative life-cycle model that incorporates both private and public pension systems,the life-cycle profile of homeownership, as well as a detailed tax-transfer system. Our model is able to replicate key empirical regularities, such as the observed distribution of private retirement wealth by age and income and the age and income dependence of pickup rates. We show that these subsidies lead to “new†savings in the long run, as they do not crowd out savings in other assets, while there is some crowding out in the short run. At the same time, eliminating these tax advantages leads to a wider tax base in the short run, which allows the government to reduce taxation, generating substantial redistribution towards current generations.