Tax Deferred Savings Plans
Governments around the world operate personal income tax systems but most governments go to considerable lengths to mitigate the distortions caused by the interest tax component of the income tax. A popular antidote is the tax deferred savings plan, TDSP, (e.g., RRSP in Canada or 401(k) in the U.S.; see Poterba (1994a)). It is thought that by deferring income taxes on saving, and the interest income on savings, such plans will move the income tax system closer to the more efficient consumption tax. I argue that whether or not TDSPs in fact move income tax systems away from or closer to a consumption tax depends on whether or not interest on debts incurred to make TDSP contributions is deductible for income tax purposes. If people optimize as assumed in simple life-cycle models then it may be that governments can convert a nonlinear income tax system to a proportional consumption tax system by permitting unlimited TDSPs and disallowing the deductibility of debt interest.
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|Date of revision:||Jan 2002|
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