Whi ehouse, Edwa d
A icle
The ax ea men o unded pensions
Schmolle s Jah buch – Zei sch i ü Wi scha s- und Sozialwissenscha en. Jou nal o Applied
Social Science S udies
P o ided in Coope a ion wi h:
Duncke & Humblo , Be lin
Sugges ed Ci a ion: Whi ehouse, Edwa d (2000) : The ax ea men o unded pensions, Schmolle s
Jah buch – Zei sch i ü Wi scha s- und Sozialwissenscha en. Jou nal o Applied Social Science
S udies, ISSN 1865-5742, Duncke & Humblo , Be lin, Vol. 120, Iss. 3, pp. 415-443,
h ps://doi.o g/10.3790/schm.120.3.415
This Ve sion is a ailable a :
h ps://hdl.handle.ne /10419/291964
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Schmolle s Jah buch 120 (2000), 415-443
Duncke
&
Humblo , Be lin
The ax ea men o unded pensions
By Edwa d Whi ehouse1
Abs ac
The ax ea men o pensions is a c i ical policy choice in he ansi ion om a
public sec o , pay-as-you-go sys em o one in which all o pa o pensions a e p o-
ided h ough indi idual, p i a ely managed pension accoun s. A gene ous ax ea -
men will p omo e pension sa ing bu may be cos ly in e ms o e enues o gone and
encou age ax a oidance. The dis ibu ional consequences may also be undesi able i
highe income indi iduals a e be e able o ake ad an age o ax elie s.
In coun ies wi h ma u e unded pension sys ems - such as he Ne he lands, Swi -
ze land, he Uni ed Kingdom and he Uni ed S a es - pension unds a e wo h an
a e age o 85 pe cen o GDP. P i a e pensions accoun o a majo pa o p i a e-
sec o sa ings lows, a e an impo an supplie o capi al o indus y and play a la ge
and g owing ole in p o iding e i emen incomes. These igu es alone mean ha i is
i al o gi e he ax ea men o pensions ca e ul conside a ion.
Zusammen assung
Beim Übe gang on umlage inanzie en Ren en zu kapi algedeck en Ren en is die
s eue liche Behandlung de Ren en eine zen ale Poli ik a iable. Eine s eue liche Be-
o zugung kapi algedeck e Al e s o so ge kann die Spa quo e e höhen, üh je-
doch auch zu s a egische S eue e meidung und S eue aus ällen. Da übe hinaus
können auch die Ve eilungswi kungen une wünsch sein, wenn o allem Pe sonen
mi höhe em Einkommen S eue o eile ausnü zen können. Wenn kapi algedeck e
Ren en einen g oßen Teil de Al e s o so ge ausmachen und - wie beispielsweise in
den Niede landen, de Schweiz, G oßb i annien und den Ve einig en S aa en on
Ame ika das Ve mögen de Pensions onds e wa 85 % des B u osozialp oduk s aus-
machen - soll e de s eue lichen Behandlung kapi algedeck e Ren en besonde es
Augenme k geschenk we den. Im Au sa z geschieh dies mi Hil e eines in e na io-
nalen Ve gleichs.
JEL-Classi ica ion: H 24, H 55
1 Thanks a e due o Da id Lindeman and Robe Palacios o he Wo ld Bank, An-
d ew Dilno and Richa d Disney o he Ins i u e o Fiscal S udies in London, Willem
Adema and Ma k Pea son o he OECD in Pa is and Paul Johnson o he Financial
Se ices Au ho i y in London o hei help and ad ice. The usual disclaime applies,
and he pape is a pe sonal iew.
Schmolle s Jah buch 120 (2000) 3
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416 Edwa d Whi ehouse
This pape is s uc u ed as ollows. The i s sec ion conside s a numbe
o di e en possible ways o axing pensions. Sec ion 2 p o ides a desc ip-
i e o e iew o he ax ea men o pensions in a ange o coun ies. Sec-
ion 3 ex ends he analysis o compu e a summa y measu e o he gene osi y
o ax incen i es, he ma ginal e ec i e ax a e on pension sa ing. Sec ion
4 conside s he link be ween he axa ion o pension unds and he ax
ea men o he unde lying asse s, pa icula ly equi ies and bonds, in
which hey in es . Sec ion 5 examines he deduc ibili y o con ibu ions.
Sec ion 6 looks a he impo ance o pension unds and associa ed ax in-
cen i es in agg ega e. Sec ion 7 assesses he objec i es o axing pensions,
he op ions and he a gumen s while sec ion 8 concludes.
1. Possible pensions axa ion égimes
Th ee ansac ions cons i u e he p ocess o sa ing ia a unded pension
scheme, each o which p o ides an occasion a which axa ion is possible:
• when money is con ibu ed o he und, no mally by employe s and em-
ployees;
• when in es men income and capi al gains acc ue o he und; and
• when e i ed scheme membe s ecei e bene i s.
I pensions a e pay-as-you-go inanced (i.e., ou o cu en con ibu ions)
hen he second poin a which axa ion may occu is los .
Gi en h ee poin s a which i is possible o le y ax, he e a e eigh basic
ax combina ions. The e a e examples o many o hese in p ac ice, bu some
a e mo e common and cha ac e ise heo e ical ideals o he ax sys em.
Table 1 illus a es ou hypo he ical égimes.2 The Table shows he ne
pension esul ing om a con ibu ion o 100 made i e yea s be o e e i e-
men . A p opo ional ax o 25 pe cen and a a e o e u n on in es men
o 10 pe cen pe annum a e assumed. The e ec o in la ion is igno ed o
he momen .
The i s égime exemp s con ibu ions om ax, does no ax und in-
come, bu does ax he pension in paymen . This can be e med an exemp ,
exemp , axable (EET) sys em. The second in ol es sa ing ou o axed in-
come, no ax on he und's in es men e u n and ax- ee wi hd awal o
pension bene i s, i.e., a TEE sys em. In his simple amewo k wi h a la
ax a e, hese wo sys ems a e equi alen in e ec . They bo h con e a pos -
2 The able igno es ex eme cases whe e pensions a e axed a all h ee possible
poin s o a none o hem, and whe e ei he in es men e u ns alone a e axed o
alone a e exemp . These mo e unusual égimes a e discussed below.
Schmolle s Jah buch 120 (2000) 3
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The ax ea men o unded pensions 417
ax a e o e u n o sa ing equal o he p e- ax a e o e u n. They a e neu-
al be ween consump ion now and consump ion in e i emen . Faced wi h
ei he égime, an indi idual ea ning 100 now can consume now, paying 25
in ax and buying goods wo h 75, o hey can sa e, allowing consump ion
o 120.79 in i e yea s. Bu 120.79 is simply he amoun a ailable o con-
sump ion now, inc eased a a 10 pe cen a e o compound in e es , i.e.
75x(l.l)5. This also means hese égimes a e equi able in hei ea men o
di e en indi iduals: people who sa e o u u e consump ion pay he same
ax as hose who consume now. Finally, he wo sys ems also deli e he
same ne p esen alue o e enues o he go e nmen . Howe e , he iming
is di e en : e enues a e de e ed un il e i emen unde EET, bu ecei ed
immedia ely unde TEE.
Table 1
Al e na i e pensions axa ion égimes
EET TEE TTE ETT
Con ibu ion 100 100 100 100
Tax -25 25 -
Fund 100 75 75 100
Ne in es men e u n 61.05 45.79 32.67 43.56
Fund a e i emen 161.05 120.79 107.67 143.56
Tax on pension 40.26 - - 35.89
Ne pension 120.79 120.79 107.67 107.67
Ne p esen alue o ax 25 33.14 25 33.14
No e: Assumes 10 pe cen annual eal e u n, 25 pe cen ax a e and i e-yea in es men
e m.
In p ac ice, he EET and TEE sys ems may no ha e he same e ec be-
cause o he poin a which he ax exemp ion occu s. I an indi idual pays
a di e en ma ginal income ax a e while in wo k om he ax a e paid in
e i emen , hen p e- and pos - ax a es o e u n will no longe be equal-
ised. The indi idual will bene i mo e om a égime g an ing ax elie
when his o he ma ginal a e is highe .
The las wo sys ems in ol e axa ion a wo poin s. Unde he hi d é-
gime, sa ings a e made ou o axed income, income ea ned by he und is
hen axed bu bene i s ecei ed a e exemp ed (TTE). The ax exemp ion in
he las sys em occu s a he poin o con ibu ion, while und income and
bene i s a e axable (ETT).
The e ec s o hese wo sys ems a e he same in his simple model. How-
e e , he pos - ax a e o e u n is now below he p e- ax a e (7.5 pe cen
a he han 10 pe cen : 107.67 = 75x(1.075)5). These wo sys ems esul in a
Schmolle s Jah buch 120 (2000) 3
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418 Edwa d Whi ehouse
disincen i e o sa ing, because consump ion now is wo h mo e han con-
sump ion in he u u e.
The EET and TEE égimes a e equi alen o he 'expendi u e ax' o he
public inance li e a u e3, while he ETT and TTE sys ems co espond o a
'comp ehensi e income ax'. The o igin o hese names is clea . The i s wo
égimes ax only consump ion (o expendi u e) and a he same a e
whe he consump ion is unde aken now o in he u u e. In con as , he
las wo sys ems ax all acc uals o income, whe he om ea nings o in-
es men s, i espec i e o whe he hey a e sa ed o consumed.
These wo benchma k ax sys ems a e di e en ways o in e p e ing ' is-
cal neu ali y' wi h espec o sa ings. Equalising p e- and pos - ax a es o
e u n is neu al be ween p esen and u u e consump ion. A comp ehensi e
income ax is neu al be ween consump ion and sa ing, ea ing sa ings in
exac ly he same way as any o he o m o consump ion. Howe e , sa ings
a e no a commodi y like any o he good o se ice. They a e a means o u-
u e consump ion, and his is pa icula ly ob ious whe e sa ing o e i e-
men is conce ned. Neu ali y be ween consump ion now and consump ion
in e i emen is he ele an concep o axing pensions, and ha is he
o m o neu ali y achie ed by he expendi u e ax.4,5
2. An in e na ional compa ison o he ax ea men o pensions
Ha ing examined he axa ion o pensions in heo y, his sec ion compa es
pensions axa ion in p ac ice in a ange o coun ies.6
Table 2 summa ises he ax ea men o pensions in OECD coun ies a
h ee s ages iden i ied in he p e ious sec ion: when con ibu ions a e
made, in es men e u ns acc ue and when he pension is paid ou .7
3 The EET sys em is he classical example o an expendi u e ax. The TEE sys em
is o en called he 'p e-paid expendi u e ax'.
4 On hese issues, see Kaldo (1955), Ca e Commission (1966), Meade Commi ee
(1978), Pechman (1980), Uni ed S a es T easu y (1977, 1984), And ews (1974) and IFS
Capi al Taxes G oup (1995).
5 Un o una ely, op imal ax heo y gi es li le guidance on he app op ia e ax
ea men o sa ings. The heo y shows ha he c oss-elas ici y o labou supply wi h
espec o he in e es a e is a cen al a iable in an in e empo al model, bu he e
is no empi ical ag eemen on he magni ude o his a iable. The only i m conclusion
is ha nei he a capi al ax a e o ze o ( he expendi u e ax) no a capi al ax a e
equal o he ax on labou ea nings ( he comp ehensi e income ax) is op imal.
6 See also Dilno (1992, 1996a), Johnson (1993) and Whi ehouse (1996) o in e -
na ional compa isons o pensions ax incen i es.
7 The Table e e s o indi idual pension sa ings accoun s. Employe -based plans
a e signi ican in a numbe o coun ies and hei ax ea men is usually simila o
pe sonal pensions. Excep ions a e Aus alia and Po ugal -whe e employe con ibu-
Schmolle s Jah buch 120 (2000) 3
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The ax ea men o unded pensions 419
The i s column ela es o he pe sonal income ax eà men o con ibu-
ions made ou o ea ned income. In mos coun ies - excep ions include
Aus alia, Iceland and Japan - con ibu ions o a pension a e made ou o
p e- ax income o a ac a ax eba e. The ex en o his deduc ibili y is
limi ed in mos coun ies.
The nex h ee columns ela e o he ea men o in es men e u ns. In
mos coun ies, income acc uing in he pension und accumula es ax- ee,
al hough Aus alia and Sweden apply a special ax a e (15 and 10 pe cen
espec i ely) o pension und in es men e u ns ha is lowe han ma ginal
income ax a es. Denma k axes only eal in es men e u ns, in line wi h
he 'pu e' comp ehensi e income ax.
The inal wo columns o Table 2 co e axa ion o he pension in pay-
men . The ax ea men o wi hd awals om he und, ei he as an annui y
o a lump sum, a ies conside ably. All coun ies ba New Zealand ex ac
some ax a his poin , al hough he e a e o en ax concessions a ailable.
Aus alia, I eland, Japan and he Uni ed Kingdom, o example, allow wi h-
d awal o a ax- ee lump sum o be om he und. In mos coun ies, wi h-
d awals om he und be o e e i emen age a e no pe missible, al hough
in some, such as Aus ia and he Uni ed S a es, his is possible subjec o a
ax penal y.
Table 3 shows ax ea men in a ange o coun ies, mos o which ha e
ecen ly mo ed, o a e p oposing o mo e, owa ds a unded pension sys em.
In he majo i y o La in Ame ican coun ies, he ax ea men is o he a-
di ional expendi u e ax kind (EET). The only excep ion is Pe u, which has
a p e-paid expendi u e ax (TEE). Hunga y and Poland ha e bo h adop ed
he expendi u e ax o hei new manda o y pension unds. Poland ope -
a es a p e-paid expendi u e ax égime o olun a y pension con ibu ions.
Hunga y gi es a much mo e gene ous ea men : exemp ing in es men e-
u ns and pensions in paymen as well as gi ing a ax c edi on con ibu-
ions which exceeds e en he highes ax a e (see he box in he nex sec-
ion). The Czech Republic axes i s olun a y unds in a simila way, ma ch-
ing con ibu ions up o a limi .
ions a e ully deduc ible, bu employee con ibu ions only pa ially deduc ible - and
Ge many and he Uni ed S a es - whe e employe con ibu ions a e deduc ible bu
employee con ibu ions a e axed.
Schmolle s Jah buch 120 (2000) 3
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Schmolle s
Jah buch
120 (2000) 3
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The ax ea men o unded pensions 429
Assuming 50 pe cen o p o i s we e paid as di idends, he e ec i e ax
a e on domes ic equi y in es men was 0.5x0.31 + 0.5x(0.31-0.2), o 21 pe
cen . Domes ic equi ies comp ise 52 pe cen o pension unds' po olios,
wi h o e seas equi ies making up a u he 23 pe cen . Assuming ha o he
coun ies' co po a e income ax a e is also 31 pe cen , hen he e ec i e
ax a e on pension unds unde his sys em would be 0.52x0.21 +
0.23x0.31, o 18.1 pe cen .
The ax c edi o equi ies owned by companies and pension unds was
abolished in he 1997 budge by he incoming New Labou go e nmen . The
sys em is now classi ied as one o 'pa ial sha eholde elie ' (OECD, 1991).
So al hough pensions unds emain exemp om ax on hei di idends,
he e is no longe any allowance made o axes paid a he company le el.
The ne ax e enues in his simple example a e now 24.8 (31 % o 80). This
inc eases he e ec i e ax a e on domes ic equi ies om 21 o 31 pe cen .
The o e all e ec i e ax a e on pension unds, wi h a o al o 76 pe cen
in es ed in equi ies, is he e o e 0.76x0.31, o 23.6 pe cen . As his is a li le
highe han he s anda d a e o income ax (23 pe cen ), he ue ax é-
gime o s anda d- a e axpaye s is ETT a he han EET.
One likely impac o his e o m is o encou age companies o swi ch om
equi y o deb inance, ei he om loans o bond issues. The e ec o his is
illus a ed in he inal column o Table 5, which shows wha would happen
i he company doubled hei deb bu kep hei e ained ea nings cons an .
Deb in e es paymen s inc ease om 20 o 40 and e ained p o i s emain
27.6, lea ing 13.9 o he di idend. Howe e , ne ax eceip s all o 18.6,
and so he ne e u n o pension und in es o s (as bond and sha eholde s)
inc eases. The e is al eady e idence o companies o ganising hei inances
o educe hei ax paymen s in his way.
5. Dis ibu ional issues and es ic ions on pension con ibu ions
Table 2 showed ha mos coun ies es ic he ex en o which pension
con ibu ions can be deduc ed om he pe sonal income ax. This is no -
mally o ci cumsc ibe ax a oidance o because o dis ibu ional conce ns.
Highe -income indi iduals a e be e able o make pension con ibu ions,
and ecei e a la ge ax ad an age because o he deduc ibili y o con ibu-
ions agains highe a es o income ax.
Limi s on deduc ibili y can ake a numbe o o ms:
• absolu e limi s on he amoun o con ibu ions
(e.g.
Aus alia, Ge many)
• limi s on he p opo ion o con ibu ions ha can be deduc ed
{e.g.
Aus-
ia, Finland)
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430 Edwa d Whi ehouse
• limi s on he p opo ion o income on which con ibu ions can be made
{e.g.
Uni ed Kingdom)
• limi s on he deduc ibili y o con ibu ions a highe a es o income ax
Table 5 in es iga es he las o hese u he using he simple amewo k
o Table 1. The i s ou columns look a an indi idual who pays a highe
ax a e, assumed o be 40 pe cen , du ing bo h hei wo king li e and e-
i emen .
The i s column shows he s anda d expendi u e- ax ea men . Since
con ibu ions a e deduc ible a he highe a e, he esul up o e i emen is
he same as o he s anda d a e axpaye in Table 1. A e e i emen , how-
e e , 40 pe cen ax is payable, so he ne pension is jus 96.63. Again, he
ax is neu al o e he iming o consump ion: he indi idual can consume
60 now o 96.63 = 60x(l.l)5. Again, he classical expendi u e ax has he
same e ec as he p e-paid expendi u e ax, shown in he second column.
The deduc ibili y o pension con ibu ions is es ic ed o he s anda d
a e o ax - assumed o be 25 pe cen - in he hi d column. Pa ial deduc -
ibili y means he g oss con ibu ion o 100 is educed by 15 ( he di e ence
be ween he highe and s anda d a es). The esul is a lowe pension -
82.14 o 15 pe cen lowe - han he un es ic ed expendi u e ax. Howe e ,
al hough he pension is 14 lowe , he ne p esen alue o ax eceip s is only
nine highe . The pa ial axa ion o con ibu ions means he e is less o ax
when he pension is paid.
The ou h column shows a comp ehensi e income ax a a 40 pe cen
a e. This shows ha es ic ing he deduc ibili y o con ibu ions is close o
in oducing a comp ehensi e income ax. Mo eo e , he a gumen s o and
agains his ea men can also be applied o he a gumen ha con ibu-
ions should no be deduc ible a highe a es o income ax.
The inal ou columns show a simila analysis o a pe son who pays he
highe a e o ax when con ibu ions a e paid and in es men e u ns ac-
c ue, bu pays he s anda d a e o ax du ing e i emen . Column i e shows
ha he classical expendi u e- ax ea men deli e s he same pension and
ax eceip s as o people who pay he s anda d a e o ax du ing hei
wo king li e (compa e Table 1). Bu he p e-paid expendi u e ax aises mo e
e enue han he classical ax om people who a e highe - a e axpaye s
when wo king and s anda d- a e axpaye s when hey d aw hei pension.
Again, es ic ing he deduc ibili y o con ibu ions o he basic a e (col-
umn se en) educes he pension compa ed wi h un es ic ed deduc ibili y.
I also aises he ax ake, bu he ini ial gain om es ic ed deduc ibili y
is o se by he loss om he lowe e enues on he lowe pension. The ne
e ec is again close o he comp ehensi e income ax (column eigh ).
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The ax ea men o unded pensions 431
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432 Edwa d Whi ehouse
6. Measu ing he e enue cos o pensions axa ion incen i es
The concep o a ' ax expendi u e' was de eloped in ecogni ion o he
ac he ax sys em can be used o achie e simila goals o public spending
p og ammes, bu accoun ing o he cos s and bene i s o ax measu es is o -
en less igo ous and egula han o di ec expendi u e. A ax expendi u e
is said o exis when he ax sys em de ia es om some benchma k ax sys-
em. In gene al, his no m includes he ax a e s uc u e, accoun ing con-
en ions, adminis a i e p o isions and p o isions ela ing o in e na ional
iscal obliga ions. De ining a ax expendi u e in p ac ice can be di icul :
some ax measu es may no be eadily classi ied as pa o he benchma k o
an excep ion o i .14 Tax expendi u es a e usually calcula ed using he so-
called ' e enue o gone' me hod, which compu es he ax ha would ha e
been payable ce e is pa ibus i he ax concession we e emo ed, and eco-
nomic beha iou emained unchanged. Fou een OECD coun ies now p o-
duce ax-expendi u e epo s.
Wi h h ee occasions a which hey migh be axed, pensions o e a b oad
ange o possible benchma ks, a subse o which we e p esen ed in Table 1.
Coun ies' me hods o calcula ing ax expendi u es o pensions di e , and
a numbe o coun ies (including Belgium, Canada and he Uni ed King-
dom) ha e ecen ly changed hei me hods o epo ing ax expendi u es o
pensions. In Aus alia, Canada, Spain and he Uni ed S a es, he comp e-
hensi e income ax - wi h pension bene i s ax- ee and con ibu ions and
in es men e u ns axed - is used as he benchma k. Usually, howe e ,
he e is no in la ion adjus men , so nominal a he han eal e u ns a e
axed. In he Uni ed Kingdom, he ac ual ax ea men is compa ed wi h a
so-called 'unapp o ed' scheme, whe e con ibu ions and in es men e u ns
a e axed bu he wi hd awal o he pension as a lump sum is ax- ee. This
is equi alen o he comp ehensi e income ax ea men (i.e., TTE). O he
coun ies (such as he Ne he lands) do no epo ax expendi u es o pen-
sions a all, o ( o example, Ge many) choose a benchma k e y much clo-
se o he ac ual sys em.
The esul s a e highly sensi i e o he choice o benchma k. The di e ence
in he esul s be ween measu ing he cos agains he comp ehensi e income
ax and he expendi u e ax can be seen om he ela i e posi ions o he
wo lines in Figu es 1 and 2. The baseline agains which he ac ual ea -
men is compa ed is be ween 25 and 50 pe cen highe (depending on he
coun y's ax sys em) in he comp ehensi e income ax case. Dilno and
Johnson (1993a,b) a gue ha , since an expendi u e ax is he mos app op i-
a e ax ea men o pensions, ax expendi u es should be calcula ed
14 See OECD (1984, 1995) and Su ey (1975) o a de ailed discussion.
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The ax
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Schmolle s Jah buch 120 (2000) 3
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434 Edwa d Whi ehouse
agains his no m. A second a gumen o using an expendi u e ax as
benchma k is ha in esponse o he aboli ion o pension ax incen i es,
sa ings would low o simila ly iscally p i ileged asse s. Taking accoun o
beha iou al esponses, he ex a e enue aised om abolishing pensions
ax incen i es would be small. Dilno and Johnson ound ha he Uni ed
Kingdom ax expendi u e on pensions was jus £lbn when measu ed in his
way, compa ed wi h a ound £7bn epo ed in o icial igu es a he ime o
hei s udy.
Table 6 shows ax expendi u es ela ing o pensions epo ed by OECD
go e nmen s in na ional cu encies and as a pe cen age o o al ax eceip s.
Compa ed wi h a comp ehensi e income ax base, o e 3 pe cen o income
ax e enues a e o gone in Aus alia, Canada, he Uni ed Kingdom and he
Uni ed S a es. In Canada and he Uni ed Kingdom, pensions a e he la ges
i em in ax expendi u e accoun s; in he Uni ed S a es, hey a e he second
la ges , a e heal h insu ance. These ax expendi u es a e also la ge when
compa ed wi h di ec public spending. In he Uni ed Kingdom, o example,
he o al epo ed in he ax expendi u e accoun s o 1996-97 was o e
£10bn compa ed wi h £30bn spen on s a e pensions.
Howe e , because o he use o di e en benchma ks in compu ing e en-
ues o gone, many o hese igu es a e no s ic ly compa able be ween coun-
ies. No , because o beha iou al esponses, a e hey an accu a e indica ion
o he e enues ha he emo al o ax elie s o pensions would aise.
7. Objec i es o he ax sys em
The i s sec ion o he pape a gued ha he expendi u e ax was he
mos app op ia e ea men o pension sa ings because i is neu al in he
alloca ion o consump ion be ween he wo king li e and e i emen . The e
a e u he easons, including ones o equi y and simplici y, o hinking
ha an expendi u e ax migh o e he bes way o axing pensions.
Fi s , iden i ying in es men e u ns, especially hose in he o m o un-
ealised capi al gains, can be di icul . Taxing gains on ealisa ion a he
han as hey a e acc ued causes di e en p oblems.15
15 De ined-bene i plans (whe e he alue o he pension bene i is ela ed o some
measu e o ea nings and yea s o scheme membe ship) aise u he adminis a i e
di icul ies. A any poin du ing scheme membe ship, he alue o he pension de-
pends on wo u u e, unce ain a iables - he o al du a ion o membe ship and u-
u e ea nings - and so he alue o und and in es men e u ns canno be alloca ed
o indi iduals. When ma ginal income ax a es a y (as in any p og essi e ax sys-
em), i is no possible o ind he app op ia e ax a e o apply o he pension und,
unless some a bi a y a e is used. This also applies o con ibu ions o he und: in a
de ined bene i plan, hese bea no ela ion o he pension bene i being acc ued, and
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The ax ea men o unded pensions 435
Secondly, as he ma ginal e ec i e ax a es in Figu e 3 showed, he com-
p ehensi e income ax has di icul y dealing wi h in la ion. Taxing in es -
men e u ns o en means ha nominal e u ns a e axed, meaning he pos -
ax eal e u n alls s ill u he below he p e- ax eal e u n. I , o exam-
ple, he eal in e es a e we e 2.5 pe cen , and in la ion 7.5 pe cen , hen
he TTE and ETT sys ems wi hou in la ion adjus men would esul in he
ne pension showing no eal e u n. The 7.5 pe cen pos - ax nominal
e u n is only jus enough o compensa e o in la ion. A highe le el o in-
la ion would deli e nega i e eal e u ns. Many OECD coun ies do ax
ce ain asse s his way, such as o dina y in e es -bea ing deposi s (see
OECD 1994, Table 4.1). By con as , he expendi u e ax, by a oiding axing
in es men e u ns, main ains equal p e- and pos - ax eal e u ns wha -
e e he mix o in la ion and eal e u ns in he nominal in e es a e.
Howe e , a comp ehensi e income ax aises mo e e enue a a gi en ax
a e: he discoun ed o al ax ake is 25 unde he expendi u e ax and 33
unde he comp ehensi e income ax in he example gi en in Table 1. The
b oade ax base o comp ehensi e income allows a lowe ax a e o collec
he same e enues. A 20.5 pe cen a e in he simple model would aise he
same e enues as an expendi u e ax wi h a 25 pe cen a e. This could
ha e impo an economic e ec s h ough labou -supply incen i es and he
incen i e o wo k in he 'black' o 'shadow' economy.16 Bu i s ill means
sa ings choices a e dis o ed. An indi idual could choose o consume 79.5
now o sa e o e i emen and consume 116.5 hen. Bu ha is equi alen o
jus 72.3 a wo king age (o , equi alen ly, he neu al consump ion in e i e-
men would be 128).
An expendi u e ax may also a ec po olio choice. Since pensions a e
axed on wi hd awal unde he classical expendi u e ax (EET), he go e n-
men becomes a co-in es o , sha ing in any en s, bu also pa icipa ing in
any losses. This may encou age a iskie choice o po olio.17
A second concep o iscal neu ali y wi h espec o sa ings decisions is
neu ali y be ween di e en ypes o sa ings ins umen s.18 I one sa ings
employe con ibu ions a e ypically made as some pe cen age o he agg ega e pay-
oll (Disney and Whi ehouse, 1994, 1996).
16 Howe e , dynamic models o he economy sugges ha wage ea ne s bene i
om he lowe axa ion o capi al unde an expendi u e ax. The economy's capi al
s ock is highe , inc easing p oduc i i y and wages.
17 O cou se, his may be co ec i e i in es o s su e om myopic isk o loss
a e sion.
18 Hamil on and Whalley (1985) ind ha his ype o neu ali y is ex emely im-
po an . They ind ha bo h a comp ehensi e income ax and expendi u e ax which
ea all sa ings equally domina e a hyb id sys em wi h an expendi u e ax ea men
o housing and a comp ehensi e income ax ea men o e e y hing else. The e-
duced p ice dis o ion be ween asse s domina es he e ec o educed dis o ion o
in e empo al choice. See also Hamil on (1987).
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436 Edwa d Whi ehouse
medium is axed mo e ligh ly han o he s a e, hen i will end o a ac
unds a hei expense. Economic ine iciency esul s as decisions a e dis-
o ed compa ed wi h hose ha would be made in a ax- ee en i onmen .
In many coun ies, sa ing o e i emen is ea ed a ou ably compa ed
wi h o he sa ings media. A numbe o a gumen s ha e been p oposed o
suppo his ela i ely gene ous ea men :
• he s a e should ensu e ha people main ain a s anda d o li ing in e i e-
men app oaching he le el when hey we e o wo king age;
• by encou aging indi idual p o ision o e i emen , he cos o social se-
cu i y bene i s may be educed, pa icula ly when means- es ed bene i s
a e an impo an sou ce o e i emen income; and
• he s a e should inc ease long- e m sa ings o add o he le el and / o s a-
bili y o capi al a ailable o in es men .
The i s a gumen is a pa e nalis one; he s a e gi es incen i es o sa e
o e i emen ( ela i e bo h o cu en and o u u e, p e- e i emen con-
sump ion) because in he absence o incen i es, indi iduals will ail o make
'su icien ' p o ision.19 The e a e a numbe o easons why, i s his a io-
nale may no be alid and, secondly, why he ax sys em is no a good way o
achie ing i . I is ha d o de ine 'su iciency' o e i emen income beyond
an adequa e minimum. O e ing ax incen i es o e i emen sa ing may
no ensu e ha e e yone achie es a minimum s anda d; some will s ill ail
o p o ide whe eas o he s may e en o e -p o ide.20 O he means o ensu -
ing ha e i emen li ing s anda ds app oach he le el du ing wo king li e
may be mo e e ec i e and, pe haps, less dis o iona y: o example, he
s a e can adjus he le el o compulso y p i a e pension con ibu ions ( he
'second pilla ').
The second a gumen is one o 'mo al haza d' - indi iduals will no p o-
ide o hemsel es i hey know he s a e will gi e hem an adequa e in-
come anyway. Pensions a e pa ly - e.g. in he Uni ed Kingdom - o wholly -
e.g. in Aus alia - means- es ed in a numbe o coun ies. This means- es -
ing p oduces a subs an ial disincen i e o sa e o e i emen , especially o
people wi h low incomes. Again, howe e , i does no ollow ha a aching
iscal p i ileges o pensions is an e ec i e way o minimising he cos o he
s a e, compa ed, o example, wi h manda ing a ce ain le el o con ibu-
ions. The educ ion in cu en e enues ha esul s om he ax incen i e
adds o his a gumen .
19 Diamond (1977) and Samuelson (1987).
20 O he indi iduals may be 'o e -annui ised', i.e. hold mo e o hei weal h in he
o m o annui ies (which canno be bequea hed) han hey would wish in he absence
o ax p i ileges.
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The ax ea men o unded pensions 437
Tax incen i es o pensions appea o inc ease pension sa ings. Examples
include he 'success' o egis e ed e i emen sa ings plans, RRSPs, in Cana-
da, pe sonal pensions in he Uni ed Kingdom, and indi idual e i emen
accoun s, IRAs, in he Uni ed S a es.21 Whe he his esul s, howe e , om
a subs i u ion o pensions o o he sa ings media o om an inc ease in
o e all sa ings is di icul o asce ain. I people ha e a ixed a ge o
e i emen sa ings, a new ax incen i e o pensions could induce hem o
educe cu en sa ings, since hei le el o e i emen income would emain
he same. Tax incen i es cos he go e nmen by educing e enues, cu ing
public sec o sa ing. E en i household sa ings inc ease, he o e all e ec
on na ional sa ing is unce ain.
The empi ical e idence on he e ec o ax incen i es on sa ings is incon-
clusi e. Alan Blinde commen ed,
.. he e is ze o e idence ha ax incen i es ha enhance he a e o e u n on sa -
ing ac ually boos he na ional sa ing a e. None. No e idence. Economis s now ac-
cep ha as a consensus iew'.22
Many empi ical s udies o household sa ing, pa icula ly o IRAs in he
Uni ed S a es, ha e ound a posi i e e ec 23, al hough o he s a e scep ical.24
The OECD (1994a) s udy o axa ion and sa ings concludes i s su ey o e i-
dence in a numbe o coun ies,
'The e is no clea e idence ha he le el o axa ion, along wi h o he ac o s
a ec ing he a e o e u n, does gene ally a ec he le el o sa ing'.25
Gi en he inconclusi e na u e o his li e a u e, i does no seem wise o
sugges ha a desi e o inc ease economy-wide sa ing ei he is o should be
a majo objec i e o he axa ion o pensions. Changing he composi ion o
sa ing owa ds long- e m e i emen sa ings migh a imes, howe e , be a
use ul policy ool.
Ha ing es ablished he desi abili y o expendi u e ax ea men o pen-
sions and o a 'le el playing ield' o di e en ypes o sa ing, he inal pol-
icy choice is be ween he classical expendi u e ax (EET) and he p e-paid
expendi u e ax (TEE).
The p e-paid expendi u e ax has much o ecommend i . Fi s , by b ing-
ing he e enues om pension axa ion o wa d compa ed wi h he de e ed
21 See Ca oll and Summe s (1987) on RRSPs, Disney and Whi ehouse (1992a,b) on
pe sonal pensions, and Ven i and Wise (1986,1987) and G a elle (1989,1991) on IRAs.
22 In e iew in Challenge, Sep embe -Oc obe 1992 quo ed by Gyl ason (1993).
23 See, o example, Hubba d (1984), Ven i and Wise (1987), Feenbe g and Skinne
(1989) and Po e ba, Ven i and Wise (1996).
24 Fo example, G a elle (1989, 1991), Munnell (1986) and Engen, Gale and Scholz
(1994).
25 OECD (1994a), p. 189. See also Robson (1995) and Boadway and Wilasdin (1994)
o a discussion.
Schmolle s Jah buch 120 (2000) 3
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438 Edwa d Whi ehouse
axa ion in he classical expendi u e ax, i alle ia es he ansi ional pen-
sion de ici when mo ing om a pay-as-you-go o a unded sys em. The ou -
going Conse a i e go e nmen in he Uni ed Kingdom p oposed such a
scheme in 1997.26 C oa ia has also adop ed he p e-paid expendi u e ax.
Secondly, i limi s ax a oidance and e asion by ensu ing he go e nmen
collec s he money up- on . I also ensu es e enues can be collec ed om
o eign wo ke s o people who in end o emig a e on e i emen . Thi dly, i
will aise mo e e enues om people who a e highe - a e axpaye s du ing
hei wo king li e bu pay ax a he s anda d a e du ing e i emen .27
Howe e , he p e-paid expendi u e ax has wo majo d awbacks. Fi s ,
al hough he ax incen i e may be equi alen o a classical expendi u e ax,
psychology sugges s ha he up- on ax elie is pe cei ed as mo e alu-
able. Financial-se ices companies also ind up- on elie s a be e selling
poin .28 Secondly, he p e-paid expendi u e ax subjec s unded pensions o
'policy isk'. A u u e go e nmen may no eel bound by commi men s o
p e ious go e nmen s no o ax pensions in paymen o in es men e u ns,
and may iew pension unds as an easy e enue a ge . This is likely o un-
de mine he a ac i eness o unded pensions o po en ial in es o s.
8. Conclusions
The expendi u e- ax sys em axes pensions once: ei he when con ibu-
ions a e made o when bene i s a e wi hd awn. I is he bes way o axing
pensions, because i does no dis o he decision whe he o consume now
o sa e and consume in he u u e, unlike he comp ehensi e income ax.
Mo eo e , i is also easy o adminis e and he ax bu den does no a y a -
bi a ily wi h in la ion. A mo e gene ous ea men han he expendi u e
ax is no jus i ied, nei he by he impac on na ional sa ing no he e ec
on public pension and social-assis ance liabili ies.
Mos coun ies ax pensions using a sys em close o he expendi u e ax.
The p e-paid e sion o he ax, which exemp s bene i s, collec s mo e e -
enue up- on . Howe e , i may no be c edible i consume s suspec he go -
e nmen migh e en ually ax bene i s when hey a e paid. Finally, in he
con ex o he design and implemen a ion o a pension e o m, i is impo an
o ake he cos o ax elie s, measu ed by ax expendi u es, in o accoun .
26 This is he so-called 'basic-pension-plus' scheme. See Whi ehouse (1998), sec ion
VI, Depa men o Social Secu i y (1997) and Whi ehouse and Wol (1997).
27 The e ec can be seen by compa ing he i s and ou h columns in Table 6. The
TEE ea men would s ill p oduce a ne pension o 96.63 i he axpaye we e a high-
e - a e axpaye while in wo k and s anda d- a e axpaye in e i emen .
28 See Thale (1994).
Schmolle s Jah buch 120 (2000) 3
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