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An economic analysis of the existing taxation of pensions (EET) versus an alternative regime (TEE)

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  • Monique Ebell

    ()

  • Angus Armstrong

    ()

  • Philip Davis

    ()

Abstract

The Government has recently issued a consultation document which raises the possibility of a substantial change in the taxation of pensions. In this paper we assess the economic consequences of changing from the existing EET system (where pension savings and returns are exempt from income tax, but pension income is taxed) to a TEE system (pension savings would be from taxed income but with no further taxation thereafter), making use of two complementary approaches. First, we review the economic and empirical literature, and second we construct a general equilibrium overlapping generations (OLG) model parameterised to UK data and the progressive UK tax system. Both approaches lead to the same outcome: that changing from EET to TEE would lead to a fall in personal savings. Our OLG model also finds that this reduction in savings would have broader macroeconomic consequences including lower aggregate investment, a smaller steady state capital stock, lower productivity and output, lower real wages, lower aggregate consumption, and a higher real interest rate. We compare steady state outcomes for EET to TEE while allowing for pension subsidy rates (i.e. a top-ups on pension savings out of taxed income) of between 10% and 50%. In order for the macroeconomic outcomes under TEE to approach those under EET, a pension subsidy of at least 50% would be required. However, this high rate of TEE subsidy on pension savings would crowd out other forms of government spending as aggregate tax revenues would decline by 3.2%.

Suggested Citation

  • Monique Ebell & Angus Armstrong & Philip Davis, 2015. "An economic analysis of the existing taxation of pensions (EET) versus an alternative regime (TEE)," National Institute of Economic and Social Research (NIESR) Discussion Papers 455, National Institute of Economic and Social Research.
  • Handle: RePEc:nsr:niesrd:455
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    File URL: http://www.niesr.ac.uk/sites/default/files/publications/DP455.pdf
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    References listed on IDEAS

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    1. Katarzyna Romaniuk, 2013. "Pension fund taxation and risk-taking: should we switch from the EET to the TEE regime?," Annals of Finance, Springer, vol. 9(4), pages 573-588, November.
    2. George Kudrna & Alan Woodland, 2012. "Progressive Tax Changes to Private Pensions in a Life-Cycle Framework," Working Papers 201209, ARC Centre of Excellence in Population Ageing Research (CEPAR), Australian School of Business, University of New South Wales.
    3. B. Douglas Bernheim & John Karl Scholz, 1993. "Private Saving and Public Policy," NBER Chapters,in: Tax Policy and the Economy, Volume 7, pages 73-110 National Bureau of Economic Research, Inc.
    4. Orazio P. Attanasio & Thomas DeLeire, 2002. "The Effect Of Individual Retirement Accounts On Household Consumption And National Saving," Economic Journal, Royal Economic Society, vol. 112(6), pages 504-538, July.
    5. Caprio, Gerard, Jr & Demirguc-Kunt, Asli, 1998. "The Role of Long-Term Finance: Theory and Evidence," World Bank Research Observer, World Bank Group, vol. 13(2), pages 171-189, August.
    6. Damiaan H.J. Chen & Roel Beetsma & Eduard Ponds & Ward E. Romp, 2014. "Intergenerational Risk-Sharing through Funded Pensions and Public Debt," CESifo Working Paper Series 4624, CESifo Group Munich.
    7. Guercio, Diane Del & Hawkins, Jennifer, 1999. "The motivation and impact of pension fund activism," Journal of Financial Economics, Elsevier, vol. 52(3), pages 293-340, June.
    8. James M. Poterba & Steven F. Venti & David A. Wise, 1996. "How Retirement Saving Programs Increase Saving," Journal of Economic Perspectives, American Economic Association, vol. 10(4), pages 91-112, Fall.
    9. Walker, Eduardo*Lefort, Fernando, 2002. "Pension reform and capital markets : are there any (hard) links?," Policy Research Working Paper Series 24082, The World Bank.
    10. Whitehouse, Edward, 1999. "The tax treatment of funded pensions," MPRA Paper 14173, University Library of Munich, Germany.
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    Cited by:

    1. Barrios, Salvador & Coda Moscarola, Flavia & Figari, Francesco & Gandullia, Luca, 2018. "Size and distributional pattern of pension-related tax expenditures in European countries," EUROMOD Working Papers EM15/18, EUROMOD at the Institute for Social and Economic Research.
    2. Salvador Barrios & Francesco Figari & Luca Gandullia & Sara Riscado, 2016. "The fiscal and equity impact of tax expenditures in the European Union," JRC Working Papers on Taxation & Structural Reforms 2016-01, Joint Research Centre (Seville site).

    More about this item

    Keywords

    Pension tax relief; private pensions; pension savings; overlapping generations model;

    JEL classification:

    • E21 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth
    • H24 - Public Economics - - Taxation, Subsidies, and Revenue - - - Personal Income and Other Nonbusiness Taxes and Subsidies
    • J32 - Labor and Demographic Economics - - Wages, Compensation, and Labor Costs - - - Nonwage Labor Costs and Benefits; Retirement Plans; Private Pensions

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