The influence of decision making costs on the effectiveness of tax incentives to save Results from the HMRC/HMT/ESRC Joint Research Programme on Taxation

The influence of decision making costs on the effectiveness of tax

incentives to saveResults from the HMRC/HMT/ESRC Joint Research Programme

on Taxation Analysis

Justin van de Ven ([email protected]), MIAESR & NIESRMartin Weale & Paolo Lucchino, NIESR November, 2013

www.melbourneinstitute.com

Aims of the research

Facilitate use by Whitehall of current best practice methods to analyse savings and employment responses to policy

Advance our understanding of household sector savings decisions

Explore the role of decision costs as influences on responses to tax incentivised savings schemes


Outline

Analysing saving and employment decisions The Lifetime Income Distributional Analysis

(LINDA) Model Empirical analysis The influence of decisions costs on the

effectiveness of ISAs


Analysing saving & employment decisions

• A spectrum of behavioural assumptions

very broad behavioural assumptions

Back-of-an- envelope analysis

detailed statistical analysis

no formal model of behaviour

detailed statistical analysis

formal model of behaviour –

poor approx. of uncertainty

detailed numerical analysis

formal model of behaviour –

uncertainty explicitly considered


LINDA: A model for Whitehall Structural model of household consumption, labour supply,

and investment decisions (van de Ven and Lucchino, 2013) Life-cycle framework

– Motivating observations (Attansio & Webber, 2010)– Resolution of puzzles

Model specifics– Microsimulation of individual households that vary over a range of

characteristics– Decisions modelled at annual intervals from age 20 to 120– Demographics explicit– Hard and soft liquidity constraints– Uncertainty over wages, employment, marital status, investment

returns, and time of death

Modelling effort represents current best practice in the micro-economic analysis of dynamic

decision making at the household level


LINDA: A model for Whitehall

Projects panel data forward and back through time from a population cross-section (WAS)– Policy relevant basis for analysis

Effort has been expended to make the model accessible to non-specialists:– Excel front-end– Summary statistics reported through Excel– Simulated panel data reported in standard

format


LINDA: model methodology• Preferences:

• Budget constraint:

• Evolution of wages:

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ISAji

ISAji dd


LINDA: model methodology

hT

wT

hT-1

wT-1

hT-2

wT-2

h1

w1

time


Using LINDA


Using LINDA


LINDA: Output


LINDA: Output

00.10.20.30.40.50.60.70.80.9

1

20 30 40 50 60 70

prop

n no

t em

ploy

ed

age

single adults

sample statistics simulated statistics


Empirical analysis

The innovative nature of the LINDA model has important advantages for conducting empirical analysis – see Lucchino & van de Ven (2013)

Key findings:– Intertemporal elasticity of substitution at

population averages in region of 0.5.– Allowing for decision costs helps to match the

model to observed rates of participation in ISAs


Empirical analysisUtility price of leisure (A), experience effects (B)

and labour supply

00.10.20.30.40.50.60.70.80.9

1

15 25 35 45 55 65 75

prop

n no

t em

ploy

ed

age

adult couples

sample statistics simulated statistics

A

B

AA


Empirical analysisDiscount factor(A), relative risk aversion (A), preference for bequests (B) and consumption

0

100

200

300

400

500

600

700

15 25 35 45 55 65 75

£(20

06) p

er w

eek

reference person age

geometric mean consumption by age - couples

Sample statistics simulated statistics

A A A

B


Empirical analysisDiscount factor(-A), relative risk aversion (A),

preference for bequests (A) and pension participation

0

0.1

0.2

0.3

0.4

0.5

0.6

0.7

0.8

0.9

15 25 35 45 55 65 75

prop

ortio

n of

cou

ples

reference person age

proportion of couples contributing to private pensions

samplesimulated

A A A


Simulated effectiveness of ISAs

– ISAs do not motivate appreciable increases in household saving, with or without decision costs

– in the absence of decision costs, households are projected to invest heavily through ISAs, but off-set almost all of this saving against other wealth

– decision costs reduce the scale of projected ISA investments, but leave most other effects on population averages qualitatively unchanged

– the form that decision costs are assumed to take has an important influence on determining distributional responses to ISAs

• van de Ven (2013)


Behavioural Results

income ISA investments private pension wealth total wealthqunitile 2006 2026 2046 2006 2026 2046 2006 2026 2046

ISAs not included for analysislowest 0.0 0.0 0.0 2.2 8.4 5.8 8.9 52.9 57.5

3 0.0 0.0 0.0 5.6 81.7 89.7 18.9 170.5 206.4highest 0.0 0.0 0.0 10.8 527.7 921.6 30.5 787.2 1382.3

ISAs included for analysis on the assumption of zero salience costslowest 0.7 44.2 52.8 2.3 9.8 6.9 9.7 57.0 63.0

3 0.6 73.7 72.2 5.7 81.7 91.9 16.5 166.1 195.1highest 1.1 201.0 323.1 10.9 521.2 915.7 30.3 781.9 1446.3

ISAs included for analysis on the assumption of low salience costs variantlowest 0.8 8.6 12.8 2.5 9.1 6.2 9.9 50.2 58.2

3 0.6 15.6 18.0 5.6 81.0 88.8 19.0 170.4 200.6highest 1.1 18.2 37.9 10.7 526.1 919.4 29.6 784.8 1383.7

ISAs included for analysis on the assumption of high salience costs variantlowest 0.8 6.8 8.8 2.5 9.1 6.3 10.1 50.4 58.1

3 0.6 13.2 14.6 5.6 81.2 88.9 19.0 170.6 201.3highest 1.1 16.3 32.8 10.8 525.7 918.7 29.6 784.3 1382.0

Notes: simulated weighted averages of asset values within population subgroups, defined in £000, at 2006 prices

quintile groups identifed within birth cohorts, and with respect to average net income earned over the entire simulated lifetime

hight (low) salience cost variant adjusted to match model to ISA take-up observed for 2006/7 (2007/8) data

Projected savings behaviour of individuals born between 1977 and 1986, by existence of ISAs and decision costs over ISA participation (£000, 2006)


Behavioural Results

year of income salience cost of ISA investmentbirth qunitile no cost low cost* high cost*

lowest -2709 -604 -5281986 2 -3075 -562 -489

to 3 -4193 -505 -4331977 4 -5174 -590 -490

highest -5910 -528 -430Notes: simulated weighted averages of compensating variations within

population subgroups, defined in 2006 prices

quintile groups identifed within birth cohorts, and with respect

to average net income earned over the entire simulated lifetime

*low cost matched to reflect net ISA take-up in 2007/08

*high cost matched to reflect net ISA take-up in 2006/07

Welfare effects of ISAs (£2006)


Directions for further research Adaptation of model framework

– An on-going process Testing alternative empirical specifications and

behavioural hypotheses– Stylised forms to explore intertemporal elasticity

(evidence of time variation?)– Appropriate moments for empirical identification

(novelty of approach)– Form of decision costs?

Applied policy analyses

Documents

The influence of decision making costs on the effectiveness of tax incentives to save Results from the HMRC/HMT/ESRC Joint Research Programme on Taxation