Active vs. Passive Decisions and Crowd-Out in
Retirement Savings Accounts:
Evidence from Denmark
Raj Chetty
John N. Friedman
Harvard University and NBER
and
Soren Leth-Petersen
Torben Nielsen
University of Copenhagen and SFI
14th Annual Joint Conference of the Retirement Research Consortium
August 2-3, 2012
Washington, D.C.
This research was supported by the Danish Council for Independent Research and by the U.S. Social
Security Administration (SSA) through grant #10-M-98363-1-02 to the National Bureau of Economic
Research as part of the SSA Retirement Research Consortium (RRC). The findings and conclusions
expressed are solely those of the authors and do not represent the views of SSA, any agency of the Federal
Government, or the NBER. We thank Tore Olsen, Brigitte Madrian, and James Poterba for helpful
comments and discussion. Jessica Laird, Sarah Griffis, and Heather Sarsons provided excellent research
assistance.
Abstract: Most developed countries use an array of policies to increase
retirement savings, including tax-deferred savings accounts, mandatory savings
plans, defined benefit pensions, and defined contribution savings accounts. Firms
also use defaults and match-rates to encourage saving among workers. While
many studies have analyzed the impacts of such policies on savings within
retirement accounts, much less is known about the impacts on total retirement
savings (i.e., crowd-out). When assessing the effectiveness of these policies, the
central question is whether they successfully induce people to raise the total
amount saved, or instead simply encourage workers to shift money from one
account to another. For instance, a firm that successfully raises pension
contributions among its workers may have no affect on their total savings if the
workers simply save less in their private stock portfolios.
In this paper, we measure the effect of savings policies on total savings. We show
that a key determinant of this broader effect is whether policies induce active or passive
changes in savings behavior. Our main result is that policies that rely upon individuals to
actively respond in order to raise savings -- such as tax subsidies for retirement savings -have smaller impacts on total savings than policies that raise savings passively -- such as
defaults or mandatory savings requirements. A secondary result is that policies that raise
savings passively are especially effective at raising the savings of individuals saving less
for retirement to begin with.
We study the impacts of savings policies on individuals' total savings using
Danish income tax records. These data provide administrative information on the value
of assets and liabilities including stocks, bonds, bank accounts, credit card debt,
mortgages, and other secured debt for all Danish citizens from 1994-2008. The Danish
data have two advantages over datasets used in prior work. First, they offer considerably
more precise information for a larger sample of individuals. The state-of-the-art study in
this literature (Gelber 2011) uses 835 observations from the Survey of Income and
Program Participation. Our analysis sample includes approximately 45 million
observations. Second, Denmark experienced a series of sharp, targeted reforms that
provide an ideal opportunity to study the impacts of retirement savings policies on
savings behavior. These features of the data yield much more precise estimates of the
impacts of saving policies on total savings than prior work, allowing us to uncover how
different types of policies vary in their success at increasing total retirement savings.
1 First, we analyze the impacts of savings mandates. These policies generate
passive changes in retirement savings, since the policy automatically increases pension
contributions without any action by the worker. A growing literature suggests that
policies such as mandates or default settings can powerfully affect the amount that
workers contribute to their pension plan, even though workers are free to undo the policy
if they choose. But this does not imply that such policies improve total savings. For
instance, higher pension contributions may cause individuals to run down their bank
accounts and run up credit card debt, leaving total savings unchanged.
We analyze a Danish government policy introduced in 1998 that required all
Danish citizens to contribute 1% of their gross earnings to a pension account that would
be managed by the government. This mandatory savings plan continued, with some
modifications to its design, until 2003, when it was terminated. Because the plan
contribution was proportional to income, individuals earning higher incomes were forced
to contribute larger absolute amounts to the account. As in the previous literature, we
find that this mandate had large effects on total pension contributions.
In order to study the effect of this policy on total savings, we exploit two
strategies. First, we analyze those around the income threshold for eligibility. In 1998,
individuals earning less than 34,500 Danish kroner were not subject to the program. As a
result, individuals who earned just above the threshold were forced to save 1% more than
those just below. We then find that individuals just above the threshold save
considerably more than those just below. Second, in order to more precisely estimate the
impacts of savings mandates on total savings, we examine the savings decisions of
individuals who switch between firms and, as a result, experience large increases in
employer pension contributions. Since the workers could offset these increases in
employer pensions by reducing private savings, they function much like mandates. Here
too, we estimate that a large share of increases in employer-sponsored pension savings
passes through to total savings. Combining these results, we conclude that approximately
90% of the direct impact of savings mandates remains in total savings.
Second, we study tax subsidies for retirement savings. In contrast to mandates
and defaults, tax subsidies generate active changes in retirement savings, since workers
must themselves increase pension contributions in response to the incentive. Existing
2 research on pension policies suggests that only a small fraction of workers respond to
such incentives, but among this group the increase in pension contributions is very large.
Once again, this does not imply that total savings have increased, since workers may
actively shift savings from bank accounts or stock portfolios into tax-deferred accounts in
response to the incentives.
In 1999, the Danish government reduced the tax subsidy for contributing to
capital pension retirement savings accounts -- analogous to 401(k)'s -- by approximately
15 cents per dollar for individuals in the top income tax bracket. Individuals below the
top income tax bracket were unaffected by the reform. This reform allows us to identify
the impacts of changes in the tax subsidy on savings, by comparing the responses of
affected individuals just above the top tax bracket to unaffected individuals just below it.
As in the previous literature, we find that a small fraction of individuals responded
sharply to the policy change, and as a result capital pension contributions fell sharply for
individuals in the top income tax bracket but remained virtually unchanged for
individuals just below that bracket.
We find that the impacts of this reform on total savings are very limited. Most of
this reduction in capital pension contributions is offset by increases in contributions to
other types of retirement savings accounts and increases in non-retirement savings. We
find that active savers follow a "pecking order" model of savings in that they substitute
for capital pensions first using other retirement savings accounts and then using taxable
accounts that are poorer substitutes. Because they must be attentive to the tax subsidy to
response in the first place, they do not increase pension contributions in isolation but
rather rebalance their savings across all accounts. On net, we estimate that only 10% of
the reduction in capital pension savings due to the elimination of the tax subsidy remains
in total savings.
These results suggest that savings mandates and tax subsidies for savings affect
two very different groups of people. Mandates affect the majority of savers who do not
pay close attention to savings policies. Tax subsidies, on the other hand, affect those few
savers who do pay attention. Our final results show that these two groups are not
randomly scattered throughout the population but are in fact two quite different types of
people. "Active" savers who respond to tax subsidies and undo savings mandates are
3 wealthier, more likely to be college educated, and contribute more to their pension
accounts each year to begin with. Therefore savings mandates, which affect less
educated and less wealthy savers who do not pay attention, may better target individuals
who are at risk of undersaving for retirement.
The main lesson of these results is that policies such as tax subsidies that rely on
active changes by attentive individuals may be less effective in increasing total savings
than policies like mandates that shift individuals' behavior passively. As with any
empirical study of this form, our estimates apply to the specific Danish institutional
context that we study. It is plausible that the specific estimates we obtain would differ in
other countries, e.g. those with less generous pension systems such as the U.S.
Nevertheless, these results raise important questions about the development of savings
policy in the U.S.
Over the last 25 years, savings policies in the United States have focused
increasingly on tax-deferred accounts such as 401(k) plans and defined-contribution
pensions. These tax subsidies cost the federal government $125 billion in 2010. These
large subsidies were intended to increase personal savings, but since price subsidies rely
on active decisions, our findings suggest instead that tax-deferred accounts may be
ineffective at increasing total savings. Much of the increase in savings in tax-deferred
accounts over the past 25 years, therefore, may have come directly out of other accounts
rather than from reduced consumption.
A number of questions remain open for future research. Our study finds sharp
differences in the short-term effects of the savings policies studied. These policies may
not have as starkly different effects in the long-term, however. Another fertile area for
future work is characterizing how savings policies differ in their impacts on individuals'
overall welfare. Although mandated savings policies may be most effective at increasing
total savings, they also cause inattentive workers to misperceive how much they are
saving, and how much wealth they have. Believing themselves to be poorer than they
actually are, individuals alter their consumption; the effect on their overall welfare
depends on how the benefits of their additional savings balance with the benefits or
harms of their changed consumption decisions. Additionally, policies that forcibly
increase savings are only of interest when many individuals are below the level of
4 savings that is socially optimal; future research might attempt to estimate the social value
created by each additional dollar saved.
Given the policy objective of raising the savings of individuals who would
otherwise save too little for retirement, our work suggests that policies which raise
savings passively are preferable to those which rely on active responses. The
effectiveness of tax subsidies at raising savings levels is limited by three important
factors. First, only individuals who are attentively optimizing their savings portfolio will
actively respond to the changed incentive. Second, these attentive individuals are
generally aware of the substitution possibilities between their savings accounts, and
respond by shifting money across their accounts rather than raising the overall amount
they save. Finally, the attentive individuals affected by the subsidy are those who are
saving more for retirement to begin with -- the benefits of the subsidy are therefore
missed by those who need it most. In contrast, policies which change individuals'
savings behavior passively, such as mandatory savings requirements, have a much larger
impact on total savings levels, and their impact is also better targeted at individuals with
low initial retirement savings. We therefore find that policies which passively raise
savings will likely be more effective, better targeted, and achieve the objective of raising
total savings at a lower cost.
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