© Institute for Fiscal Studies Household responses to complex tax incentives HMRC/HMT/ESRC Project: Code: RES Project 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

© Institute for Fiscal Studies 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 © Institute for Fiscal Studies

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 © Institute for Fiscal Studies 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 below 2.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 ‘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 © Institute for Fiscal Studies

1) HRT individual analysis – non parametric method Regression discontinuity design, comparing those - ‘just’ above the HRT with those ‘just’ below, for different thresholds. © Institute for Fiscal Studies

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, age 2, sex, marital status, education, hours, partner’s age difference, education, hours, other household income –Three thresholds, ± £2000, £5000, £10,000 © Institute for Fiscal Studies Distance from HRT Distance from HRT 2 Individual characteristics* 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) © Institute for Fiscal Studies h = £10kh = £5kh = £2k Model A (0.008) 0.026** (0.012) (0.018) Model B 0.026** (0.012) (0.018) (0.028) Model C (0.008) 0.028** (0.011) (0.018) Model D 0.026** (0.012) (0.017) (0.027) Sample41,12919,6277,851 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 © Institute for Fiscal Studies Test threshold: Model CModel DSample size HRT-£10k (h = £10k) (0.007) (0.010) 75,591 HRT+£10k (h = £10k) (0.012) (0.018) 19,664 HRT-£5k (h = £5k)0.000 (0.010) (0.015) 27,818 HRT+£5k (h = £5k)0.010 (0.014) (0.021) 13,276 HRT-£2k (h = £2k)0.011 (0.017) (0.026) 9,076 HRT+£2k (h = £2k) (0.020) (0.030) 6,617

1) HRT individual analysis – results (3/3) Run the model separately for subgroups to look at heterogeneous effects Robust results: © Institute for Fiscal Studies CoefficientStandard ErrorSample size Men 0.032**(0.015)27,629 Women 0.014(0.020)13,466 Aged 22 – *(0.020)17,796 Aged 40 – (0.015)23,299 Low education0.011(0.022)15,024 Mid education 0.065**(0.026)9,364 High education0.016(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 © Institute for Fiscal Studies No personal pensionPersonal pension No employer pension 43.6%9.2% Employer pension 44.9%2.3%

1) HRT individual analysis – ‘personal pensions’ © Institute for Fiscal Studies Regression analysis confirms no significant effect

1) HRT individual analysis – ‘employer pensions’ © Institute for Fiscal Studies 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 © Institute for Fiscal Studies

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 © Institute for Fiscal Studies

2) Discontinuity in pension membership? © Institute for Fiscal Studies

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: © Institute for Fiscal Studies Partner’s distance from HRT Partner’s distance from HRT 2 Individual characteristics* Model A  Model B  Model C  Model D * Individual characteristics include: age, age 2, 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 © Institute for Fiscal Studies h = £10kh = £5kh = £2k Model A (0.015) (0.021) (0.032) Model B (0.022) (0.030) (0.048) Model C (0.014) (0.019) (0.031) Model D (0.021) (0.029) (0.046) Sample18,8069,0453,555 Note: Coefficients are in bold, standard errors are in parentheses

1) HRT couples analysis – ‘personal pensions’ © Institute for Fiscal Studies

1) HRT couples analysis – ‘employer pensions’ © Institute for Fiscal Studies

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 © Institute for Fiscal Studies

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 © Institute for Fiscal Studies

What’s next... © Institute for Fiscal Studies 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