Order Code RL33482
CRS Report for Congress
Received through the CRS Web
Saving Incentives: What May Work, What May Not
June 20, 2006
Thomas L. Hungerford
Specialist in Public Sector Economics
Government and Finance Division
Congressional Research Service ˜ The Library of Congress

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Saving Incentives: What May Work, What May Not
Summary
Saving is the portion of national output that is not consumed and represents
resources that can be used to increase, replace, or improve the nation’s capital stock.
The U.S. net national saving rate reached a post-war peak of 12.4% in 1965 and has
then trended downward since to a low of 0.8% in 2005. Many analysts claim that
saving is too low. Among the Organization for Economic Cooperation and
Development (OECD) countries, the United States has the third lowest saving rate.
Survey evidence suggests that people know why they should save, but many
don’t save, especially lower-income individuals and families. Several reasons have
been offered to explain the declining personal saving rate and the relatively high
proportion of individuals and families that do not save. Economic reasons start from
the premise that individuals and families are rational and make optimal decisions
about consumption and saving throughout the life course. Low saving rates are then
explained by economic disincentives induced by government policy or by life cycle
changes in the propensity to save. Behavioral reasons start from the premise that
individuals and families do not always make optimal decisions regarding
consumption and saving.
The government offers tax incentives to individuals and families to save. The
empirical evidence on the relationship of tax incentives to the saving rate mostly
comes from examinations of traditional individual retirement accounts (IRAs) and
401(k) plans. The reported results are mixed, but generally indicate small effects.
Be that as it may, the tax incentives tend to benefit higher-income individuals and
families to a much greater extent than lower-income individuals and families. The
primary reasons are (1) higher-income individuals are much more likely to save, and
(2) higher-income individuals face higher marginal tax rates and benefit more from
sheltering income from taxation.
Furthermore, the tax revenue loss for these incentives lower public saving by
reducing the budget surplus or increasing the budget deficit. For FY2006, these tax
incentives are estimated to cost the U.S. Treasury $125.6 billion in forgone tax
revenues — almost 40% of the estimated FY2006 budget deficit. The Bush
Administration and the President’s Advisory Panel on Federal Tax Reform have
advocated expanding tax incentives as the primary policy to encourage personal
saving. Research has shown that personal saving has been fairly unresponsive to tax
incentives, however, and such incentives may substantially decrease public saving
(that is, increase the budget deficit). The long-term net effect on national saving and
economic growth is likely negative.
This report contains historical data and will not be updated.

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Contents
Reasons for Saving and Not Saving . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3
Economic Reasons for Low Savings and Saving Rates . . . . . . . . . . . . . . . . . 6
Behavioral Reasons for Low Savings and Saving Rates . . . . . . . . . . . . . . . . 7
Inducements to Save . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9
Tax Incentives . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9
Other Inducements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12
Proposals to Increase Saving . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14
Conclusions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15
List of Figures
Figure 1. Net National Saving Rates, 1946-2005 . . . . . . . . . . . . . . . . . . . . . . . . . 2
Figure 2. Percentage of Households Not Saving By Age and Income Group . . . . 5
List of Tables
Table 1. Reasons for Saving by Age and Income Group . . . . . . . . . . . . . . . . . . . . 4
Table 2. Estimates of Tax Expenditures, 2006-2010 . . . . . . . . . . . . . . . . . . . . . . 10

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Saving Incentives: What May Work, What
May Not
From an individual’s perspective, saving is “money in the bank.” The increases
in wealth that saving represents can be spent in the near future for emergencies or
children’s educational expenses, in the distant future for retirement, or passed down
to heirs.1 From a national perspective, however, saving is income that is not spent
on consumption goods or services. That is, it is the portion of national output that
is not consumed and represents resources that can be used to increase, replace, or
improve the nation’s capital stock.2
Many analysts claim that saving is too low. For example, recent research has
shown that about a quarter of the U.S. population live in households whose assets are
below 25% of the poverty threshold.3 If housing wealth is not included, the
proportion increases to over 40% of the U.S. population. Furthermore, retirement
specialists argue that many people nearing retirement have not accumulated enough
assets to maintain their present living standards after retirement.4
At the national level, analysts caution against a low savings rate. They argue
that high capital investment is a good thing, but if it is not financed by national
saving it has to be financed by borrowing abroad.5 Persistent borrowing from abroad
builds up international liabilities and implies increasing shares of national income
will be sent overseas as interest and dividends. It is difficult to say that the U.S.
national saving rate is too low since there is no universally accepted definition of
what constitutes a low saving rate. But it is noteworthy that among the Organization
1 The term saving refers to the flow of resources not consumed and represents additions to
wealth. Savings is a synonym for wealth.
2 See CRS Report RL30873, Saving in the United States: How Has It Changed and Why Is
It Important? by Brian W. Cashell and Gail Makinen.
3 See Asena Caner and Edward N. Wolff, “Asset Poverty in the United States, 1984-1999:
Evidence from the Panel Study of Income Dynamics,” Review of Income and Wealth, vol.
50, no. 4 (Dec. 2004), pp. 493-518. The authors adopt the definition of “asset poor” as a
household whose “access to ‘wealth-type resources’ is insufficient to enable the household
to meet its ‘basic needs’ for some limited ‘period of time.’” They choose the poverty
threshold as their definition of basic needs and three months as the limited period of time.
4 See, for example, B. Douglas Bernheim and John Karl Scholz, “Private Saving and Public
Policy,” in James M. Poterba, ed., Tax Policy and the Economy, Vol. 7 (Cambridge, MA:
MIT Press, 1993), pp. 73-110; and Alicia H. Munnell, Anthony Webb, and Luke Delorme,
A New National Retirement Risk Index, Center for Retirement Research at Boston College,
Issue Brief no. 48, Jun. 2006.
5 See, for example, Edward Gramlich, “The Importance of Raising National Saving,” speech
at the Benjamin Rush Lecture, Dickinson College, PA, Mar. 2, 2005.

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CRS-2
for Economic Cooperation and Development (OECD) countries, the United States
has the third lowest saving rate.6
The post-World War II trend in the U.S. saving rate (saving as a percentage of
gross domestic product) is shown in Figure 1.7 The net national saving rate (the
heavy solid line) reached a post-war peak of 12.4% in 1965 and has trended
downward since then to a low of 0.8% in 2005.
Figure 1. Net National Saving Rates, 1946-2005
14
Net Saving
12
Net Personal Saving
Net Business Saving
10
Net Public Saving
8
P
D
6
G
t of
4
n
e
rc
2
Pe
0
-2
-4
-6
1946
1950
1954
1958
1962
1966
1970
1974
1978
1982
1986
1990
1994
1998
2002
Year
Source: Department of Commerce, Bureau of Economic Analysis.
There are three components to national saving. The first is personal saving or
the saving by individuals and households (the light solid line in the figure). This is
what people typically think of as saving. The second component is business saving,
which consists of corporate retained earnings (the dashed line). The final component
is public saving, which is federal, state, and local government surpluses (the dotted
line). Public saving can be and often is negative if the government sector is running
a deficit.
The decline in the national saving rate since 1965 has two main sources. First,
the public saving rate fell from 1.4% in 1965 to -4.2% in 1983. Most of this decline
6 Only Iceland and Portugal have lower national saving rates than the United States. See
OECD in Figures, OECD Observer 2005, Supplement 1.
7 The figure shows net saving rather than gross saving. Gross saving includes depreciation
allowances destined to replace existing capital. Net saving represents resources from
forgoing consumption that are available to increase the stock of capital.

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CRS-3
in the public saving rate was due to increasing federal budget deficits. After 1982,
the steady fall in the personal saving rate accounts for much of the decline in the
national saving rate. The fall in the personal saving rate has been attributed to a
combination of factors including the increase in transfer income (which is rarely
saved), an increase in household wealth, and an increase in the proportion of the
population 65 years or older (who tend to spend rather than accumulate savings).8
Each of these could increase consumption relative to income, thus lowering saving.
In response to the perceived low saving rate, the government offers many saving
incentives through the tax system. In addition, many employers offer some
inducements to encourage their employees to save for retirement. This report
examines why individuals and households save or don’t save, and the effectiveness
of the various incentives and inducements in increasing personal and national saving.
Reasons for Saving and Not Saving
John Maynard Keynes argued that there are eight primary reasons or motives
leading individuals to save (that is, to forgo consumption):9
! Precaution motive: “To build up a reserve against unforeseen
contingencies,”
! Foresight motive: “To provide for an anticipated future relation
between the income and the needs of the individual or his family
different from that which exists in the present,”
! Calculation motive: “To enjoy interest and appreciation,”
! Improvement motive: “To enjoy gradually increasing expenditures,”
! Independence motive: “To enjoy a sense of independence and the
power to do things,”
! Enterprise motive: “To secure a masse de manœuvre to carry out
speculative or business projects,”
! Pride (bequest) motive: “To bequeath a fortune,” and
! Avarice motive: “To satisfy pure miserliness.”
Others have added a down payment motive as a ninth reason for saving.10 Recent
survey evidence generally confirms that many of these motives are the main reasons
8 See David W. Wilcox, “Household Spending and Saving: Measurement, Trends, and
Analysis,” Federal Reserve Bulletin, vol. 77, no. 1 (Jan. 1991), pp. 1-17.
9 John Maynard Keynes, The General Theory of Employment, Interest and Money (London:
MacMillan and Co., 1936), pp. 107-108.
10 See Martin Browning and Annamaria Lusardi, “Household Saving: Micro Theories and
Micro Facts,” Journal of Economic Literature, vol. 34, no. 4 (Dec. 1996), pp. 1797-1855.
As an example, qualifying for a mortgage with no private mortgage insurance requires a
down payment of 20%.

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CRS-4
why Americans save (see Table 1). The table reports the response of prime-aged
heads of households grouped by age and income.11
Table 1. Reasons for Saving by Age and Income Group
Ages 25-39
Ages 40-49
Ages 50-59
Bottom
Top
Bottom
Top
Bottom
Top
Half
Half
Half
Half
Half
Half
Retirement
14.5%
31.1%
30.7%
50.4%
38.1%
48.8%
Precautionary
30.1
30.9
29.8
20.0
31.4
23.0
House
12.9
6.3
6.5
1.4
3.4
2.8
Purchases
9.9
5.1
10.7
4.4
9.8
4.6
Education
20.1
19.4
12.4
21.0
6.4
8.2
Other
9.4
6.8
4.6
1.9
4.4
3.8
Can’t Save
3.2
0.4
5.4
1.0
6.6
0.4
Source: CRS tabulation of 2004 Survey of Consumer Finances.
Note: Columns may not sum to 100% due to rounding.
Four major points can be made about these results. First, saving for retirement
is generally the most important reason for saving in nearly every age and income
group. The foresight or retirement motive is stronger for older age groups — the age
groups closer to retirement. Furthermore, families in the upper half of the income
distribution are more likely to cite saving for retirement as their primary reason for
saving than those in the lower half of the income distribution.
Second, saving for the inevitable rainy day (the precaution motive) appears to
be the primary reason for saving among younger families in the lower half of the
income distribution. For the other groups, it is the second most frequently cited
reason for saving. For the older two age groups, those with lower income are more
likely to save for precautionary reasons than those with more income.
Third, within each age group, those in the lower half of the income distribution
are more likely than those in the upper half to cite saving for future purchases of
goods and services such as homes, home repairs, and durable goods as the most
important reason to save. A possible explanation for this disparity by income is
lower-income families may be credit constrained and have to save for purchases
rather than using a credit card.
Lastly, among the youngest families, about one in five report that education is
the most important reason for saving (the improvement motive). For the young
11 Families are divided into the top half or the bottom half of the income distribution based
on total family income.

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CRS-5
families, there is not much difference between the two income groups. Older
families, especially those in the oldest age group, are less likely to report this as an
important reason for saving since their children are generally grown and finished
with their formal education.
The results reported in Table 1 suggest that people know why they should save,
but provides little information on whether or not they do save. Figure 2 shows the
percentage of families in each age and income group who report not saving. There
is relatively little variation across age groups — about 20% of the families do not
save. There are large disparities, however, by income. About 10% of the families
in the upper half of the income distribution report not saving. In contrast, about a
third of the families in the lower half of the income distribution do not save.
Several reasons have been offered for the declining personal saving rate and the
relatively high proportion of individuals and families that do not save. The economic
reasons start from the premise that individuals and families are rational and make
optimal decisions about consumption and saving throughout the life course. Low
saving rates are then explained by economic disincentives induced by government
policy or by life cycle changes in the propensity to save. Behavioral reasons start
from the premise that individuals and families do not always make optimal decisions
regarding consumption and saving.
Figure 2. Percentage of Households Not Saving By Age
and Income Group
40%
35%
30%
25%
t
n
e
Bottom Half
20%
rc
Top Half
Pe
15%
10%
5%
0%
25-39 Years
40-49 Years
50-59 Years
Age Category
Source: CRS analysis of 2004 Survey of Consumer Finances.

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CRS-6
Economic Reasons for Low Savings and Saving Rates
At the aggregate level, some analysts point out that the rising proportion of the
elderly in the U.S. population may explain the declining saving rate. Since the
elderly should dissave (that is, spend their savings) rather than save, the aggregate
saving rate should fall. Research has shown, however, that saving rates do not vary
that much across age groups, and the change in the age distribution in the 1980s was
too small to explain the decline in the aggregate saving rate.12
Although the change in the age distribution of the U.S. population toward a
higher proportion of elderly may not explain the fall in the saving rate, there is
evidence that the elderly now are saving less than past cohorts of elderly. Research
shows that there has been an increase in annuitization of wealth (especially Social
Security and defined benefit pension wealth) which could be due to lessened bequest
and precautionary motives.13 Consequently, consumption by the elderly is higher and
saving is lower. More elderly who are saving less may have had some effect on the
personal saving rate. But this does not explain low saving rates for younger
individuals. Furthermore, this finding may change in the future with the shift from
defined benefit pension plans to defined contribution pension plans (especially
401(k) plans), which do not have to be annuitized at retirement.
Some have argued that social welfare programs (social insurance and public
assistance) have contributed to the decline in saving. Social insurance programs such
as unemployment insurance and Social Security (both for disability and old age) may
have reduced the need for precautionary saving.14 But there have been no large scale
changes in these programs since 1980 that could explain the trend in personal saving.
Furthermore, recent research shows that the precautionary saving motive does not
give rise to much wealth in the economy and probably to relatively little saving.15
A related argument suggests that asset-based, means-tested public assistance
programs such as Temporary Assistance to Needy Families, Supplemental Security
Income, and food stamps discourage saving by families with low expected lifetime
earnings. Proponents of this argument point out that the asset test acts as an implicit
100% tax rate on savings “in the event of an earnings downturn or medical expense
12 See Alan J. Auerbach and Laurence J. Kotlikoff, “Demographics, Fiscal Policy, and U.S.
Saving in the 1980s and Beyond,” in Lawrence H. Summers, ed., Tax Policy and the
Economy, Vol. 4 (Cambridge, MA: MIT Press, 1990), pp. 73-101.
13 See Alan J. Auerbach, Laurence J. Kotlikoff, and David N. Weil, The Increasing
Annuitization of the Elderly — Estimates and Implications for Intergenerational Transfers,
Inequality, and National Saving, National Bureau of Economic Research, Working Paper
no. 4182, Oct. 1992.
14 See Lawrence Summers and Chris Carrol, “Why Is U.S. National Saving So Low?”
Brookings Institution, Brookings Papers on Economic Activity, no. 1, 1987, pp. 607-635.
15 See Erik Hurst, Annamaria Lusardi, Arthur Kennickell, and Francisco Torralba,
Precautionary Savings and the Importance of Business Owners, National Bureau of
Economic Research, Working Paper no. 11731, Nov. 2005.

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CRS-7
large enough to cause the household to seek welfare support.”16 This would prevent
these families from saving for precautionary reasons and for retirement since most
public assistance programs include both regular and retirement savings accounts as
assets subject to the asset limit. This may help explain why lower-income families
have little savings, but does not explain the decline in the personal saving rate since
the mid-1980s because the means-testing rules of these programs have not
substantially changed over the past 25 years. In addition, many low-income families
do not save because after everyday living expenses are covered there is little or no
money left over for saving.
Two financial explanations offered to explain declining saving rates are (1)
capital gains in housing and equities, and (2) the development of financial markets.
The increase in wealth from unrealized capital gains in housing and equities since
1990 allows individuals and families to maintain a target level of wealth (and even
increase the target level) without active saving. The developments and expansion in
credit cards and home equity loans mean families do not have to save as much for
future durable good and home purchases.
Retirement saving has to last throughout the retirement years. Recent evidence
suggests that individuals tend to underestimate how long they will live. Survey
results show that a majority of Americans underestimate the life expectancy “for
someone their own age and gender.”17 Similarly, British men and women
underestimate how long they are likely to live by about five years.18 Consequently,
even if people are saving for retirement, they may be undersaving because they are
saving for a shorter retirement period than what they will actually experience. This
could help explain low levels of savings, but cannot explain the downward trend in
personal saving rates unless there has been a change in Americans’ underestimate of
their life expectancy.
Behavioral Reasons for Low Savings and Saving Rates
In recent years, behavioral models have been developed to explain low savings
and low saving rates, especially for retirement. The traditional economic model of
saving, the life-cycle model, assumes that individuals make rational, far-sighted
decisions. The theory implies that saving rates increase with age and savings
accumulate until retirement when individuals begin to spend down their savings. The
bulk of the empirical evidence, however, tends to not support the life-cycle model.19
16 R. Glenn Hubbard, Jonathan Skinner, and Stephen P. Zeldes, “Precautionary Saving and
Social Insurance,” Journal of Political Economy, vol. 103, no. 2 (1995), p. 393.
17 Society of Actuaries, 2005 Risks and Process of Retirement Survey: Report of Findings,
Mar. 2006, p. 5.
18 Chris O’Brien, Paul Fenn, and Stephen Diacon, How Long Do People Expect to Live?
Results and Implications, Centre for Risk and Insurance Studies, Research Report 2005-1,
June 2005.
19 See, for example, Paul Courant, Edward Gramlich, and John Laitner, “A Dynamic Micro
Estimate of the Life Cycle Model,” in Henry J. Aaron and Gary Burtless, eds., Retirement
(continued...)

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CRS-8
Unlike the traditional economic model for saving, behavioral models stress that
individuals can and do make choices that are unfavorable to themselves. These
models emphasize the role of inertia, the lack of self-control, and the limits of human
intellectual capabilities.
Retirement savings accounts (for example, 401(k) plans and IRAs) require
workers to be proactive and decide to participate, how much to save, and how to
invest the retirement account assets. But through inertia, workers may never make
or at least postpone making these critical decisions. Research shows that changing
the “default” options in 401(k) plans so the workers have to decide not to participate
can substantially increase participation rates in these plans and increase retirement
saving.20 Workers, through inertia, also tend to accept the default contribution rate
and the investment allocation chosen by the plan administrator. Therefore, the
defaults need to be carefully chosen to allow for an adequate return while protecting
the worker’s investment.
Saving takes will power. Individuals have to forgo current consumption in order
to save for future consumption, and they may not have the self-control to forgo
consumption.21 Often individuals develop self-regulatory mechanisms or rules to
control spending such as mental accounting systems. In a mental accounting system
the individual treats money in different accounts as not being fungible, and has a
different propensity to spend money from the different accounts. But equally as often
individuals manipulate or bend their own rules of self-control.22
To make the complex decisions determining the optimal consumption path over
a lifetime requires not only complete information on the economic environment, but
also almost unlimited computing power. Individuals, however, rarely have complete
information, and may not be able to adequately process the information they do have.
To deal with human information processing limitations, individuals often use simple
rules of thumb to make these complex decisions and generally accept alternatives that
are “good enough” rather than optimal.23 Consequently, individuals may make
seemingly short-sighted decisions and save too little.
19 (...continued)
and Economic Behavior (Washington, DC: Brookings Institution, 1986); and B. Douglas
Bernheim, Jonathan Skinner, and Steven Weinberg, “What Accounts for the Variation in
Retirement Wealth Among U.S. Households?” American Economic Review, vol. 91, no. 4
(Sept. 2001.), pp. 832-857.
20 Brigitte C. Madrian and Dennis F. Shea, “The Power of Suggestion: Inertia in 401(k)
Participation and Savings Behavior,” Quarterly Journal of Economics, vol. 116, no. 4 (Nov.
2001), pp. 1149-1187.
21 See, for example, Richard H. Thaler, “Psychology and Savings Policies,” American
Economic Review, vol. 84, no. 2 (May 1994), pp. 186-192.
22 Amar Cheema and Dilip Soman, “Malleable Mental Accounting: The Effect of Flexibility
on the Justification of Attractive Spending and Consumption Decisions,” Journal of
Consumer Psychology, vol. 16, no. 1 (2006), pp. 33-44.
23 See, for example, Herbert A. Simon, The Sciences of the Artificial, 2nd Edition
(Cambridge, MA: MIT Press, 1981).

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CRS-9
Many people nearing retirement age do not plan ahead and have not thought
about retirement and financing their retirement. A recent study found that about a
third of older Americans aged 50 to 61 years have not thought about retirement.
Furthermore, those who have not thought about retirement have significantly lower
net financial wealth than those who have thought about retirement (either a little or
a lot).24
Inducements to Save
The government offers various incentives to individuals, families, and
businesses to save. In addition, businesses offer a variety of inducements to
encourage their employees to save for retirement. The incentives and inducements
are designed to overcome one or more barriers to saving.
Tax Incentives
Tax incentives increase the effective rate of return on savings. Tax-favored
savings plans for individuals and families are classified as either front-loaded or
back-loaded.25 In front-loaded plans, the contributions are tax deferred so the tax
benefits primarily accrue at the time money is contributed to the account. The
earnings grow tax-free until the funds are withdrawn or distributed. At that time,
both the contributions and earnings are taxed. Traditional deductible IRAs and
401(k) plans are examples of a front-loaded savings accounts. In back-loaded plans,
after-tax dollars are contributed to the account, and neither the contributions nor the
earnings are taxed for qualified withdrawals. The Roth IRA is the best known
example of a back-loaded savings account.
Both types of plans will yield a higher after-tax distribution than regular taxable
savings accounts, thus providing an incentive to save in these accounts. As long as
the tax rate is the same at the time of withdrawal as when the funds were contributed,
both front-loaded and back-loaded savings accounts will yield the same after-tax
distribution at retirement. Individuals who save for their children’s education, on the
one hand, often begin saving early in their working career when their earnings are
relatively low, and tend to be in the lower tax brackets. They then withdraw the
funds during their peak earning years when their children attend college.
Consequently, they may be in a higher tax bracket when the monies are distributed
from the savings account. A back-loaded plan may confer greater benefits than a
front-loaded plan in this case. On the other hand, individuals saving for retirement
often are in higher tax brackets during their working years than at retirement. For
these individuals, a front-loaded plan may confer greater benefits. In either case, the
24 Annamaria Lusardi, “Information, Expectations, and Savings for Retirement,” in Henry
J. Aaron, ed., Behavioral Dimensions of Retirement Economics (Washington, DC:
Brookings Institution, 1999).
25 For a discussion of many of the issues with regards to IRAs see CRS Report RL30255,
Individual Retirement Accounts (IRAs): Issues and Proposed Expansion, by Thomas L.
Hungerford and Jane G. Gravelle.

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CRS-10
saving decisions are often made several years before anticipated withdrawals, and it
is difficult to know what tax bracket one will be in so far in advance.
These tax incentives, however, can affect both personal and public saving. The
tax revenue loss for these incentives will lower public saving by reducing the budget
surplus or increasing the budget deficit.26 The reduction in public saving may more
than offset any increase in personal saving induced by the tax incentives. The costs
of front- and back-loaded savings plans are reflected in the federal budget at different
times. For front-loaded plans, the tax expenditures are incurred immediately, and the
revenues from taxing distributions occur in the future. But there are no immediate
tax expenditures for back-loaded savings plans because only after-tax income is
contributed to the account. The costs to the government are reflected in the budget
only when the monies are distributed from the account. Over the long-term, a front-
loaded plan may be less costly to the government than a back-loaded plan, but within
the typical 5- or 10-year budget window, the back-loaded plan will look less
expensive.
The tax expenditures of these tax incentives are not trivial. Table 2 reports the
estimated tax expenditures for the exclusion of contributions and earnings for
employer pension plans such as 401(k) plans, IRAs, and Keogh plans, in addition to
the Saver’s Credit which is discussed below. The Joint Committee on Taxation
estimates that the FY2006 retirement income related tax expenditures will amount
to $125.6 billion, which is equivalent to 37.2% of the Congressional Budget Office’s
estimate of the FY2006 federal budget deficit. By FY2010, these tax expenditures
are estimated to reach $156.7 billion.
Table 2. Estimates of Tax Expenditures, 2006-2010
(billions of dollars)
Fiscal Year
2006
2007
2008
2009
2010
Employer
$104.1
$110.2
$115.2
$120.8
$126.7
Plans
IRAs
11.2
14.0
15.5
16.9
18.4
Keogh
9.4
10.3
10.8
11.3
11.6
Plans
Saver’s
0.9
0.6
-
-
-
Credit
Total
125.6
135.1
141.5
149.0
156.7
Source: U.S. Congress, Joint Committee on Taxation, Estimates of Federal Tax Expenditures For
Fiscal Years 2006-2010, committee print, 109th Congress, 2nd sess., Apr. 25, 2006 (Washington: GPO
2006), p. 40.
26 The cost of tax incentives are measured in terms of tax expenditures, which are estimates
of the revenue losses attributable to provisions of federal tax laws.

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CRS-11
Furthermore, conventional economic theory and empirical analysis do not offer
unambiguous evidence that these tax incentives have increased personal saving.
From a theoretical perspective, the effect of a tax reduction on personal saving is
ambiguous because of offsetting income and substitution effects. The increased rate
of return may cause individuals to substitute future consumption for current
consumption and save more (a substitution effect), but, at the same time, the higher
rate of return allows individuals to save less and still obtain their target amount of
savings (an income effect). The overall consequences for personal savings depends
on the relative magnitude of these two effects. In the case of IRAs, personal savings
may be unaffected because most of the tax benefits are provided to individuals
contributing the maximum amount, which eliminates any substitution effect. Casual
observation suggests that the income effect dominates since the personal saving rate
has fallen since the introduction of IRAs and 401(k) plans. The empirical evidence
on the relationship of tax incentives to the saving rate mostly comes from
examinations of traditional IRAs and 401(k) plans. The reported results are mixed,
but generally indicate small effects.27 Furthermore, Roth IRAs eliminate the
immediate reward to retirement saving because the contributions are not tax
deductible and may thus reduce saving.
In general, many tax incentives to increase saving tend to benefit higher-income
individuals and families to a much greater extent than lower-income individuals and
families. The primary reasons are (1) higher-income individuals are much more
likely to save, and (2) higher-income individuals face higher marginal tax rates and
27 For a more complete discussion of the savings literature, see Jane G. Gravelle, The
Economic Effects of Taxing Capital Income (Cambridge, MA: MIT Press, 1994), p. 27 for
a discussion of the general empirical literature on savings and pp. 193-197 for a discussion
of the empirical studies of IRAs. Subsequent to this survey, a paper by Orazio P. Attanasio
and Thomas C. DeLeire, “The Effect of Individual Retirement Accounts on Household
Consumption and National Savings,” Economic Journal, vol. 112 ( July 2002), pp. 504-538
found little evidence that IRAs increased savings. For additional surveys see the three
articles published in the Journal of Economic Perspectives, vol. 10, no. 3 (Fall 1996): R.
Glenn Hubbard and Jonathan Skinner, “Assessing the Effectiveness of Savings Incentives,”
(pp. 73-90); James M. Poterba, Steven F. Venti and David A. Wise, “How Retirement
Savings Programs Increase Saving,” (pp. 91-113); Eric M. Engen, William G. Gale, and
John Karl Scholz, “The Illusory Effects of Savings Incentives on Saving,” (pp. 113-138).
A working paper by Alun Thomas and Christopher Towe, “U.S. Private Saving and the Tax
Treatment of IRA/401(k)s: A Re-examination Using Household Saving Data,” International
Monetary Fund working paper 96/87 Aug. 1996 found that IRAs did not increase private
household saving. A more recent study by Eric M. Engen and William G. Gale found that
401(k) plans, which are similar to IRAs in important ways, had a negligible to modest effect
on savings. See “The Effects of 401(k) Plans on Household Wealth: Differences Across
Earnings Groups,” National Bureau for Economic Research working paper 8032, Dec. 2000.
See also Douglas H. Joines and James G. Manegold, “IRAs and Savings: Evidence from a
Panel of Taxpayers,” Federal Reserve Bank of Kansas City research working paper 91-05,
Oct. 1991; Daniel J. Benjamin, “Does 401(k) Eligibility Increase Saving? Evidence from
Propensity Score Subclassification,” Journal of Public Economics, vol. 83, no. 5-6 (2003),
pp. 1259-1290; and Orazio P. Attanasio, James Banks, and Matthew Wakefield,
“Effectiveness of Tax Incentives to Boost (Retirement) Savings: Theoretical Motivation and
Empirical Evidence,” OECD Economic Studies No. 39, 2004/2, pp. 145-172, which all
present evidence that retirement saving tax incentives induce very little new saving.

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benefit more from sheltering income from taxation. Furthermore, with regards to
educational savings plans, the penalties for using the educational savings for non-
educational purposes may discourage lower-income families from having these
accounts. Children from lower-income families are less likely to attend college than
other children, thus increasing the likelihood of being penalized for having an
education savings account. These penalties partly explain why parents participating
in Coverdell Education Savings Accounts (ESAs) and 529 plans have substantially
higher income, on average, than other parents.28
The Economic Growth and Tax Relief Reconciliation Act of 2001 (P.L. 107-16)
provided low- and moderate-income individuals a nonrefundable tax credit for
contributions to a qualified retirement plan (the Saver’s Credit), which is set to expire
at the end of 2006.29 The maximum amount of the tax credit is $2,000. The savings
effects of this tax credit have not been fully evaluated yet, but early evidence suggests
that many taxpayers are unable to receive the full benefit because the credit is
nonrefundable.30 In addition, the Saver’s Credit appears to be substantially less
effective in boosting saving among low-income individuals than a simple matching
contribution possibly because of the complexity of the Saver’s Credit and the tax
system in general.31
Other Inducements
There are at least four other inducements that have been used to encourage
savings for specific purposes. First, an initial or supplemental contribution can be
placed in an individual’s savings account. An example is the 1% agency contribution
placed in a federal employee’s Thrift Savings Plan (TSP) account.32 This
contribution is placed in the account whether or not the employee chooses to make
contributions to his or her account. This can encourage individuals to save by
overcoming the inertia to open an account, and it allows individuals to observe the
28 See Susan Dynarski, “Who Benefits from the Education Saving Incentives? Income,
Educational Expectations and the Value of the 529 and Coverdell,” National Tax Journal,
vol. 57, no. 2 (June 2004), pp. 359-383; Sarah Holden, “Saving for College with 529 Plans,”
paper presented the Ninety-fifth Annual Conference on Taxation, Orlando, FL, Nov. 16,
2002; and Jennifer Ma, Education Saving Incentives and Household Saving: Evidence from
the 2000 TIAA-CREF Survey of Participants, National Bureau of Economic Research
Working Paper no. 9505, Feb. 2003.
29 For a description of the Saver’s Credit see William G. Gale, J. Mark Iwry, and Peter
Orszag, The Saver’s Credit: Expanding Retirement Savings for Middle- and Lower-Income
Americans, The Retirement Security Project, Issue Brief no. 2005-2, Mar. 2005.
30 See Gary Koenig and Robert Harvey, “Utilization of the Saver’s Credit: An Analysis of
the First Year,” National Tax Journal, vol. 58, no. 4 (Dec. 2005), pp. 787-806.
31 See Ester Duflo, William Gale, Jeffrey Liebman, Peter Orszag, and Emmanuel Saez,
Saving Incentives for Low- and Middle-Income Families: Evidence from a Field Experiment
with H&R Block, National Bureau of Economic Research, Working Paper no. 11680, Sept.
2005.
32 This applies only to federal employees in the Federal Employee Retirement System
(FERS) system and not to employees in the Civil Service Retirement System (CSRS).

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benefits of saving (for example, interest compounding) without risking their own
money. Once the benefits of saving are experienced, individuals may be more
willing to commit their own funds to the savings account.
Second, matching contributions can be made to an individual’s account. This
is a common practice in many 401(k) pension plans, including the federal Thrift
Saving Plan. In the case of 401(k) pensions, part or all of an employee’s contribution
is matched by the employer. The more the employee contributes, the more the
employer contributes up to a limit. The employer is essentially supplementing the
employee’s salary, but only if the employee saves. Empirical evidence suggests that
small matching contributions (about 10 cents for every dollar saved) will increase
employees’ contributions. But increasing matching contributions past this point may
have no effect on an employee’s contributions or actually reduce his or her
contributions.33 If an employee has a set target for saving, for example, then
increasing the employer’s contribution means that the employee can save less and
still meet his or her saving target. Limited evidence suggests that matching
contributions could significantly increase contributions by low- and moderate-income
families.34
Third, tax-favored savings initially could be used only for a specific purpose,
such as retirement in the case of 401(k) plans, and individuals faced a penalty for
nonqualified uses of the savings. The penalty helps commit individuals to hold the
funds for the desired purpose (such as retirement) rather than use them for current
consumption. But individuals may be reluctant to give up the freedom to use the
funds for other equally important purposes as individuals try to balance saving for
retirement and saving for precautionary reasons. Over time, however, laws and
regulations were changed to allow employees to borrow from their 401(k) plan or to
make penalty-free withdrawals for emergency purposes. In addition to retirement
after age 59½, qualified (that is, penalty-free) distributions can be made from IRAs
for educational expenses, first-time home purchase, and medical expenses. There is
some empirical evidence that pre-retirement access to 401(k) funds increases
participation in and contributions to 401(k) pension plans.35 But allowing pre-
retirement access to 401(k) assets could also lead some to have smaller pension
balances at retirement if the borrowed funds are never repaid or if withdrawn funds
are never replaced.
Fourth, some firms have experimented with changing the default options for
pension plans where participation is voluntary. For example, employees are covered
by a firm’s 401(k) plan only if they actively sign up and enroll in the plan. However,
33 See Leslie E. Papke, “Participation in and Contributions to 401(k) Pension Plans:
Evidence from Plan Data,” Journal of Human Resources, vol. 30, no. 2 (Spring 1995), pp.
311-325.
34 See Ester Duflo, William Gale, Jeffrey Liebman, Peter Orszag, and Emmanuel Saez,
Saving Incentives for Low- and Middle-Income Families: Evidence from a Field Experiment
with H&R Block, National Bureau of Economic Research, Working Paper no. 11680, Sept.
2005.
35 U.S. Government Accountability Office, 401(k) Pension Plans: Loan Provisions Enhance
Participation But May Affect Income Security for Some, GAO/HEHS-98-5, Oct. 1997.

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through inertia many employees do not participate. The default option, therefore,
combines with worker inertia to yield low saving rates and little retirement savings.
Changing the default to automatic enrollment means the employee has to actively opt
out of the pension plan.36 Recent evaluations of some firms that have changed to
automatic enrollment shows that participation is significantly increased though this
simple change. But through inertia, a substantial fraction of the new participants
accept the firm’s default contribution level and investment options for their pension
assets.37
Proposals to Increase Saving
In the FY2007 budget proposal, the Bush Administration proposed to encourage
saving by expanding tax-free saving opportunities. The Administration proposed
creating lifetime savings accounts (LSAs) and Retirement Savings Accounts (RSAs).
Both would have an annual contribution limit of $5,000, regardless of age or income.
The RSA contribution, however, cannot be greater than earnings. The LSA and RSA
would be similar to Roth IRAs in that investment earnings accumulate tax-free.
Funds from the LSA could be withdrawn penalty-free at any time for any purpose,
while RSA distributions would not be taxed or penalized if made after age 58, death,
or disability. The annual contribution limit would be indexed to inflation.
The recent President’s Advisory Panel on Federal Tax Reform proposed the
creation of Save for Family Accounts (SFAs) to replace existing education and
medical savings accounts, and Save for Retirement Accounts (SRAs) to replace
traditional and Roth IRAs. This proposal would allow every taxpayer to contribute
up to $10,000 every year to an SFA and an SRA on an after-tax basis.38 The earnings
would accumulate tax-free in the same way as in the current Roth IRA. Tax-free
withdrawals would be allowed at any time from the SFA for qualified educational
and medical costs, or to purchase a primary residence. In addition, taxpayers would
be able to withdraw up to $1,000 tax-free each year for any purpose. Nonqualified
distributions in excess of the $1,000 limit would be subject to income taxes and a
10% penalty tax, similar to the penalty paid on nonqualified distributions from the
current Roth IRA. Tax-free withdrawals from SRAs would be allowed after age 58,
death, or disability. Nonqualified withdrawals would be subject to the income tax
and a 10% penalty tax.
Both the Bush Administration proposal and the President’s Advisory Panel plan
shift savings incentives from the front-loaded form to the back-loaded form. Most
of the arguments regarding increasing private saving, however, apply to front-loaded
savings plans. Back-loaded plans or Roth IRAs eliminate (1) the immediate reward
36 For a review of IRS rulings regarding automatic enrollment in 401(k) plans, see CRS
Report RS21954, Automatic Enrollment in Section 401(k) Plans, by Patrick Purcell.
37 See Brigitte C. Madrian and Dennis F. Shea, “The Power of Suggestion: Inertia in 401(k)
Participation and Savings Behavior,” Quarterly Journal of Economics, vol. 116, no. 4 (Nov.
2001), pp. 1149-1187.
38 Contributions to the SRA can not exceed earnings.

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to retirement saving (the tax deduction), and (2) the need to save for future tax
liabilities. Consequently, shifting from front-loaded to back-loaded savings
approaches may reduce personal savings. In addition, the long-term revenue loss
from these proposals could be substantial thus leading to a large reduction in public
saving.39 The result of these savings proposals could be a large reduction in national
saving and a reduction in economic growth.
The Administration also proposed the establishment of Individual Development
Accounts (IDAs) for lower-income individuals and families. Eligible individuals and
families could set up IDAs with qualified entities who would then match the first
$500 contributed in a taxable year.40 Contributions would not be tax deductible and
investment earnings would be subject to tax, but the matching contributions and
associated investment earnings would be tax-free. Qualified withdrawals could be
made from IDAs for higher education, first-time home purchase, business start-up,
or qualified rollovers. Withdrawals for other purposes could result in forfeiture of
some or all of the matching contributions and earnings. IDAs could increase
personal saving by stimulating new saving by low- and moderate-income taxpayers.
The matching contributions would reduce public saving but increase personal savings
by the same amount. The overall effect on national saving would, therefore, likely
be positive.
A recent proposal offered by analysts at the Brookings Institution moves away
from reliance on tax incentives to encourage retirement saving.41 The proposal has
several elements designed to remove behavioral barriers to saving. The two major
elements are (1) automatic enrollment in 401(k) plans or in an IRA if the employer
does not sponsor a pension plan, and (2) a 30% government matching contribution.
The government contribution would replace the current tax deduction for retirement
saving contributions. Other elements include allowing participants to borrow from
their retirement account, and removing retirement savings from the asset test for
public assistance eligibility.
Conclusions
Various motives have been identified as to why people save, and survey
evidence suggests that people know why they should save. However, many people
do not save. Many reasons have been offered to explain low saving rates and low
savings. Economic barriers to saving include disincentives induced by government
39 See CRS Report RL32228, Proposed Savings Accounts: Economic and Budgetary Effects,
by Jane G. Gravelle and Maxim Shvedov. The report suggests that the 10-year cost after
2015 of the Administration’s proposal could be in the neighborhood of $300 to $500 billion.
40 Eligibility is limited to U.S. citizens and legal residents between the ages of 18 and 60
years who cannot be claimed as a dependent on another taxpayer’s return, with modified
adjusted gross income less than $20,000 for individuals, $30,000 for heads of household,
and $40,000 for married taxpayers filing a joint return.
41 See William G. Gale, Jonathan Gruber, and Peter R. Orszag, Improving Opportunities and
Incentives for Saving by Middle- and Low-Income Households, Brookings Institution,
Hamilton Project White Paper no. 2006-02, Apr. 2006.

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policies and life-cycle changes in the propensity to save. Behavioral explanations for
low savings stress that individuals can make choices that are unfavorable to
themselves. To overcome these barriers, the government offers a variety of saving
incentives.
Most of the government incentives to save come through the tax system. For
FY2006, these tax incentives are estimated to cost the U.S. Treasury $125.6 billion
in forgone tax revenues — almost 40% of the estimated FY2006 budget deficit. The
tax incentives primarily benefit higher-income families because they (1) are more
likely to save, and (2) face higher marginal tax rates and thus benefit more from
sheltering income from taxation. The tax incentives, however, appear to be relatively
ineffective in inducing new saving — many of the families benefitting from the tax
incentives likely shifted funds from other saving accounts into the tax-preferred
accounts. Consequently, public saving is lower because of the forgone tax revenues
due to the tax incentives while personal saving may be only slightly increased at best.
In designing pro-saving policies, it is important to consider the aggregate effects of
the policies on all components of national savings, both public and private.
The Bush Administration and the President’s Advisory Panel on Federal Tax
Reform have advocated expanding tax incentives as the primary policy to encourage
saving. Personal saving has been shown to be fairly unresponsive to tax incentives,
however, and they may substantially decrease public saving (that is, increase the
budget deficit). The long-term net effect on national saving is likely negative. Other
proposals offered by retirement experts are designed to (1) overcome behavioral
barriers to saving, and (2) redistribute the benefits of government saving incentives
more broadly across the population. These proposals could increase personal saving,
but could also decrease public saving.

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