Pension Tax Expenditures. A Costly Christmas Gift … Not From Santa

For people living in Switzerland, December 31 was the last day for 2016 contributions into their Pillar 3a retirement accounts – and hence for taking advantage of the exemption from income tax that these payments benefit from. The scheme is one of many examples from around the world for tax breaks to boost private retirement savings. Many of them, including the Swiss one, should raise concerns.

In a nutshell, the tax treatment of pension plans depends on how taxes (T) and exemptions (E) are distributed along the following three stages: (i) when contributions are made, (ii) when investment income and capital gains accrue, and (iii) upon reception of benefits (i.e. pension income). Whereas individual savings are normally taxed in the first two stages (TTE), pension plans are usually taxed on an EET basis – i.e. the first two stages are tax free (EE), and the third one is treated as taxable income (T). Some schemes in some countries apply different approaches. The TEE structure offered through “Roth Individual Retirement Agreements” in the United States is a case in point.

The recently published OECD Pension Outlook 2016 assesses the impact of preferential tax treatment of retirement savings across the OECD and quantifies the tax advantage – i.e. “… the amount that an individual would save in taxes paid by contributing to a private pension plan [over her lifetime cycle] instead of putting the same amount into an alternative, benchmark saving vehicle” (OECD, 2016).

The report shows that average earners in all OECD countries receive a tax advantage when investing in private pension funds instead of regular savings account – an advantage that can be as high as 37% in Australia, 46% in Hungary, 51% in Israel, and 281% in Mexico[1]. It also highlights that such plans are often regressive. In 20 OECD economies, at least one type of pension plan offers a tax advantage that increases with income.

Pension tax expenditures aim at boosting savings for retirement. Building resilience and ensuring livelihoods for pensioners, as well as reducing the burden on the public sector in the provision of retirement income, are certainly goals worth pursuing. At the same time, these schemes are often opaque[2] and costly. They also raise significant concerns in terms of their effectiveness and distributive impact.

In fact, empirical evidence suggests that tax incentives for private retirement savings are not an effective policy to target their stated objectives. Attanasio et al. (2004) show that most of these schemes are redundant, i.e. the investment would have been undertaken even without them. Chetty et al. (2014) go in the same direction and highlight that the elasticity of savings to tax incentives is considerably low: a dollar spent through such tax schemes increases savings by only one cent. There are many plausible – and possibly complementary explanations – for such low effectiveness. Carnot (2013) points to a substitution effect. The author argues that tax expenditures for pensions are more likely to change the composition of savings rather than increase their overall level.

Empirical evidence also suggests that these schemes are often highly regressive. In the US,“… roughly 70 percent of the tax benefits for employer-based retirement savings and 65 percent of subsidies for individual retirement accounts (IRAs) accrue to the top income quintile, with the fourth quintile picking up much of the rest.”[3]  For the UK, the Resolution Foundation estimates revenue foregone through the country’s pension tax relief to amount to 48 billion GBP[4], and reports that  “… while low earners should be the state’s priority in boosting the adequacy of savings, the benefits of pension tax incentives flow primarily to higher earners. In 2013-14, higher and additional rate taxpayers made up around 8 per cent of the 16+ population, accounted for 30 per cent of pension savers, made 45 per cent of employee pension contributions yet received 63 per cent of tax relief.”[5]

Why are pension tax expenditures so regressive? The reasons are twofold.

First, individuals in higher personal income tax brackets are more likely to have the means to save for retirement, and thus to benefit from tax reliefs for pension contributions.[6] In contrast, poorer households often already struggle to smooth their consumption through a much shorter time span.  For many, saving for retirement is a distant option, if not a mere utopia.

Second, pension tax expenditures are frequently granted as deductions from taxable income. As highlighted by Duflo et al. (2006), this entails that the value of these schemes is negligible for families with low marginal income tax rates, and significantly more valuable as income and thus marginal tax rates go up. Our starting example of Switzerland provides an illustration: A resident of Bern (married, no children, no taxable wealth) with a taxable income of 75,000 CHF who pays 6,000 CHF into her Pillar 3a account reduces her taxes by 1,400 CHF. If her taxable income is 150,000 CHF, everything else equal, the tax benefit goes up to 2,300 CHF.[7]

There may be reasons for such a regressive tilt in the tax system. There may be reasons for providing pension tax expenditures in spite of the research highlighting their limited effectiveness. But there needs to be more scrutiny on what appears to be a costly Christmas present kindly offered…not by Santa, but by the rest of the tax payers.



Attanasio, O., Banks, J. and Wakefield, M. (2004). “Effectiveness of tax incentives to boost (retirement) saving: theoretical motivation and empirical evidence”, IFS Working Paper W04/33, Institute for Fiscal Studies.

Carnot, N. (2013). “The composition of fiscal adjustments: some principles”, Economic Brief Issue 23, Directorate General for Economic and Financial Affairs, European Commission.

Chetty, R., Friedman, J., Leth-Petersen, S., Heien Nielsen, T. and Olsen, T. (2014). “Active vs. passive decisions and crowd-out in retirement savings accounts: Evidence from Denmark”, The Quarterly Journal of Economics, Vol. 129(3), pp. 1141-1219.

Corlett, A. (2015). “Tax expenditures deserve far more scrutiny”, CEP Blog, Council on Economic Policies,

Corlett, A. and Whittaker, M. (2016). “Save it for another day: Pension tax relief and options for reform”, Resolution Foundation,

Duflo, E., Gale, W. Liebman, J., Orszag, P. and Saez, E. (2006). “Saving incentives for low- and middle-income families: evidence from a field experiment with H&R Block”, The Quarterly Journal of Economics, Vol. 121(4), pp. 1311-1346.

Harris, B., Steuerle, C., McKernan, S-M., Quakenbush, C. and Ratcliffe, C. (2014). “Tax subsidies for asset development. An overview and distributional analysis”, Tax Policy Center.

OECD (2016). “OECD Pensions Outlook 2016”, OECD Publishing,

Redonda, A. (2016). “Tax expenditures and sustainability. An overview”, CEP Discussion Note 2016/3, Council on Economic Policies,

Rowena, C., Disney, R. and Emmerson, C. (2012). “Do up-front tax incentives affect private pension saving in the United Kingdom?”, IFS Working Paper W12/05, Institute for Fiscal Studies.

[1] For contributions to “solidarity savings” that are only available to Mexico’s public sector workers.

[2] Transparency concerns are not exclusive to tax expenditures for pensions but rather a common feature for tax incentives in general. See e.g. Corlett (2015) and Redonda (2016).

[3] Harris et al. (2014), p. 1.

[4] As discussed by Corlett and Whittaker (2016), their overall cost estimate of 48 billion GBP includes 13.8 billion GBP of National Insurance contributions (NICs) relief on employer contributions, and does not deduce 13 billion GBP received through the taxation of current pension benefits. Accounting for these two figures would result in a lower bound estimate of 21 billion GBP.

[5] Corlett and Whittaker (2016), p. 3.

[6] See e.g. Rowena et al. (2012).