Project team : Professor Richard Disney (PI), IFS and University of Nottingham

© Institute for Fiscal Studies

Household responses to complex tax incentivesHMRC/HMT/ESRC Project: Code: RES 194-23-0013Project duration: Jan 1, 2011 to Dec 31, 2011

Project team:

Professor Richard Disney (PI), IFS and

University of Nottingham

Carl Emmerson, IFS

Rowena Crawford, IFS

Dr Johannes Abeler, University of

Nottingham and University of Oxford


Motivation• Overall: The extent to which individuals, and households,

respond to complex decision-making environments.• Up-front financial incentives are an often used policy

lever to encourage retirement saving. Is this an effective method?

• We focus on tax reliefs:– Tax relief on own income given at marginal tax rate (mtr) –

should be more attractive to high earners.– Tax relief on partner’s income given at marginal tax rate –

might induce households with differential mtrs to adjust joint saving.

– Has the introduction of the New Tax Credits boosted private pension coverage?

• Arguably, these ‘tax planning’ incentives differ in their transparency and in their complexity.

• Pattern of responses using econometric methods + experiment.

What are the ‘upfront incentives to save’ I?• Individual contributions to pensions are exempt from

income tax, therefore £1 of pension contribution ‘costs’ £(1-MTR)– Basic rate taxpayers: 78p (1999 to 2007), 80p (2008

onwards)– Higher rate taxpayers: 60p


£0 £10,000 £20,000 £30,000 £40,000 £50,000 £60,000 £70,0000%

10%

20%

30%

40%

50%

60%

70%

Gross annual income net of any pension contribution

Rate

at w

hich

relie

f give

n

What are the ‘upfront incentives to save’ II?• Contributions to pensions are also deducted from income

before assessment for means-tested tax credits, therefore £1 of pension contribution ‘costs’ £(1-EMTR)– For basic rate income taxpayers on WTC/CTC first taper:

41p– For higher rate income taxpayers on CTC second taper: 53p


£0 £10,000 £20,000 £30,000 £40,000 £50,000 £60,000 £70,0000%

10%

20%

30%

40%

50%

60%

70%

Gross annual income net of any pension contribution

Rate

at w

hich

relie

f give

n

Up-front income tax and tax credit relief on individual pension contributions, one-earner

family with two children aged below 65

Empirical strategy• Consider the discontinuity at the higher rate threshold

(HRT)– At the HRT the cost of £1 pension saving falls from 78p to

60p• Other than the tax difference those ‘just’ above the HRT

and those ‘just’ below the threshold should be ‘the same’

• Therefore compare the pension saving behaviour of:1. Those with income just above and just below the higher

rate threshold• Expect those just above the HRT to be more likely to engage in

pension saving than those just below2. Married individuals below the HRT who have a partner just

above the HRT, with married individuals below the HRT who have a partner just below the HRT• Expect those below the HRT with a partner just above the HRT

to be less likely to engage in retirement saving that those with a partner just below the HRT© Institute for Fiscal Studies

Data: Family Resources Survey• FRS is a cross sectional survey that records detailed

income information for a large sample of the GB/UK population

• Pooled 9 years of FRS: 1999 to 2008• All nominal values (income, thresholds etc) uprated to

2007 prices using RPI• Analysis restricted to employees age 22-59• ‘Just’ below/above is defined as within [£10k / £5k / £2k]• Looking at current pension membership: individuals only

counted as being a member of a pension if they contributed in the last 12 months


1) HRT individual analysis – non parametric method

• Regression discontinuity design, comparing those - ‘just’ above the HRT with those ‘just’ below, for different thresholds.


-10k t

o -9.5

k-90

00-80

00-70

00-60

00-50

00-40

00-30

00-20

00-10

00

0 to 5

0010

0020

0030

0040

0050

0060

0070

0080

0090

000.680.700.720.740.760.780.800.820.84

Distance from higher rate threshold (£, 2007 prices)

Prop

ortio

n co

ntrib

utin

g to

a

pens

ion

1) HRT individual analysis – parametric method • Regression discontinuity design, comparing those ‘just’

above the HRT with those ‘just’ below• Run regressions of pension membership on whether

above the HRT, controlling for:

– Individual characteristics include: age, age2, sex, marital status, education, hours, partner’s age difference, education, hours, other household income

– Three thresholds, ± £2000, £5000, £10,000


Distance from

HRT

Distance from HRT2

Individual characteristic

s*Model A Model B Model C Model D

1) HRT individual analysis – parametric results (1/3)

• Some evidence that hitting the HRT has a small positive effect on pension membership (greater probability of pension membership when incentives greater)


h = £10k h = £5k h = £2kModel A 0.014

(0.008) 0.026**

(0.012)0.020

(0.018)Model B 0.026**

(0.012)0.019

(0.018)0.022

(0.028)Model C 0.013

(0.008) 0.028**

(0.011)0.023

(0.018)Model D 0.026**

(0.012)0.019

(0.017)0.021

(0.027)

Sample 41,129 19,627 7,851

Note: Coefficients are in bold, standard errors are in parentheses

1) HRT individual analysis – parametric results (2/3)

• Check results by testing some placebo thresholds


Test threshold: Model C Model D Sample size

HRT-£10k (h = £10k) -0.006(0.007)

-0.001(0.010)

75,591

HRT+£10k (h = £10k) -0.002(0.012)

0.010(0.018)

19,664

HRT-£5k (h = £5k) 0.000(0.010)

0.001(0.015)

27,818

HRT+£5k (h = £5k) 0.010(0.014)

0.009(0.021)

13,276

HRT-£2k (h = £2k) 0.011(0.017)

0.002(0.026)

9,076

HRT+£2k (h = £2k) -0.023(0.020)

-0.046(0.030)

6,617

1) HRT individual analysis – results (3/3)• Run the model separately for subgroups to look at

heterogeneous effects• Robust results:


Coefficient Standard Error Sample sizeMen

0.032** (0.015) 27,629Women

0.014 (0.020) 13,466

Aged 22 – 39 0.037* (0.020) 17,796

Aged 40 – 59 0.019 (0.015) 23,299

Low education 0.011 (0.022) 15,024

Mid education 0.065** (0.026) 9,364

High education 0.016 (0.017) 16,707

Notes:

Results are reported for model D with h=£10k. Similar results are produced from model C with h=£5k.

Education is defined as: low = left FT education at or before age 16, mid = left FT education above age 16 but less than age 19, high = left FT education

at or above age 19

1) HRT individual analysis – pension types• Might expect effect to differ by pension type• ‘Employer pension’ probably includes group personal

pensions and group stakeholder pensions (only separately distinguished 2006 onwards)

• ‘Personal pension’ includes personal and stakeholder pensions


No personal pension Personal pension

No employer pension 43.6% 9.2%Employer pension 44.9% 2.3%

1) HRT individual analysis – ‘personal pensions’


-10k t

o -9.5

k-85

00-70

00-55

00-40

00-25

00-10

00 500

2000

3500

5000

6500

8000

9500

to 10

000

0.000.020.040.060.080.100.120.140.16


Prop

ortio

n co

ntrib

utin

g to

a

pers

onal

or s

take

hold

er p

ensio

n

Regression analysis confirms no significant effect

1) HRT individual analysis – ‘employer pensions’


-10k t

o -9.5

k-85

00-70

00-55

00-40

00-25

00-10

00 500

2000

3500

5000

6500

8000

9500

to 10

000

0.56

0.60

0.64

0.68

0.72

0.76


Prop

ortio

n co

ntrib

utin

g to

an

empl

oyer

pen

sion

Regression analysis confirms the significant effect

2) HRT couples analysis• If spouses both have an income below the HRT, both

get tax relief on pension saving at same rate (~22%)• If one spouse has an income above the HRT, he/she

gets tax relief on pension saving at 40%– If saving is done jointly in a tax efficient manner, pension

saving should be done by the individual with the higher marginal tax rate

• Compare the pension saving behaviour of spouses, one of whom has an income just above and one of whom has an income just below the threshold, with those where both have an income below the threshold

• Expect those below the HRT with a partner just above the HRT to be less likely to engage in retirement saving that those with a partner just below the HRT


2) HRT couples analysis - method• Further restrict sample to married individuals earning

below HRT• Regression discontinuity design, comparing those whose

spouse is ‘just’ above the HRT with those whose spouse is ‘just’ below


2) Discontinuity in pension membership?


-10k t

o -9.5

k-85

00-70

00-55

00-40

00-25

00-10

00 500

2000

3500

5000

6500

8000

9500

to 10

000

0.540.580.620.660.700.74

Partner’s distance from higher rate threshold (£, 2007 prices)

Prop

ortio

n co

ntrib

utin

g to

a

pens

ion

2) HRT couples analysis - method• Further restrict sample to married individuals earning

below HRT• Regression discontinuity design, comparing those whose

spouse is ‘just’ above the HRT with those whose spouse is ‘just’ below

• Run regressions of pension membership on whether partner is above the HRT, controlling for:


Partner’s

distance from

HRT

Partner’s

distance from HRT2

Individual characteristic

s*

Model A Model B Model C Model D

* Individual characteristics include: age, age2

, sex, marital status, education, hours, partner’s age difference,

education, hours, other household income

2) HRT couples analysis – results (1/2)• Inconclusive evidence on whether pension membership

is affected by partner hitting the HRT


h = £10k h = £5k h = £2kModel A 0.010

(0.015)-0.020(0.021)

-0.038(0.032)

Model B -0.000(0.022)

-0.050 (0.030)

-0.060(0.048)

Model C 0.010(0.014)

-0.020(0.019)

-0.031(0.031)

Model D -0.030(0.021)

-0.040(0.029)

-0.050(0.046)

Sample 18,806 9,045 3,555

Note: Coefficients are in bold, standard errors are in parentheses

1) HRT couples analysis – ‘personal pensions’


-10k t

o -9.5

k-85

00-70

00-55

00-40

00-25

00-10

00 500

2000

3500

5000

6500

8000

9500

to 10

000

0.000.020.040.060.080.100.120.140.16


Prop

ortio

n co

ntrib

utin

g to

a

pers

onal

or s

take

hold

er p

ensio

n

1) HRT couples analysis – ‘employer pensions’


-10k t

o -9.5

k-85

00-70

00-55

00-40

00-25

00-10

00 500

2000

3500

5000

6500

8000

9500

to 10

000

0.460.510.560.610.660.710.76


Prop

ortio

n co

ntrib

utin

g to

an

empl

oyer

pen

sion

2) HRT couples analysis – results (2/2)• Evidence (that pension membership is affected by

partner hitting the HRT) is not any stronger for particular subgroups

• Evidence is not any stronger by pension type• Could be that standard errors are too large to pick up an

effect (individuals in sample are much more heterogeneous, sample sizes much smaller)

• Could be that there is no effect (separation risk? additional complexity in understanding incentives?)

• May expect more evident effect if look at levels of contributions made


Conclusions so far• Hitting the higher rate threshold is associated with

around a 3ppt increase in the probability of contributing to a pension– Stronger effect for men, those aged 22-39, and those with

mid levels of education (left school after age 16 but before age 19)

– Effect seems to come from contributions to ‘employer pensions’ rather than ‘personal pensions’

• Not clear that partner hitting the higher rate threshold is associated with a change in the probability of an individual contributing to a pension


What’s next...


• Consider levels of contributions rather than just whether contribute?

• Using the FRS: compare the pension saving behaviour of:3. Those affected by the tax credit taper, who experience a

much higher effective rate of tax relief, with those just above the taper who only get basic rate relief

• Using the BHPS: examine changes in income that take individuals across higher rate threshold and their probability of engaging in pension saving

• Sister project: a laboratory experiment to investigate individual saving decisions in the presence of different types of incentives

Documents

Project team : Professor Richard Disney (PI), IFS and University of Nottingham