Taxation and Savings: A Survey

The choice of how much of society's income to consume today and how much to save for future consumption is among the most important economic decisions. It can have implications not only for the well-being of the households taking the decisions, but also for the rate at which the economy invests and grows, and therefore the well-being of future generations. The way in which savings decisions are taken is a matter of ongoing research in the literature, involving such important and unresolved issues as the degree of foresight and rationality of households, the extent to which capital markets are complete and well- functioning, the importance of life-cycle versus bequest versus precautionary motives for saving, and more generally the weight, if any, that current savers put on the welfare of future generations. Taxation is one of many policies that affect the level of savings. Other significant ones include the system of social insurance, especially pensions, but also health and disability insurance, welfare services and education; transfers of various sorts; and debt policy. None the less, the principles by which saving behaviour responds to these various policies are very similar. We begin our survey with a discussion of these principles, first at the household level and then in the aggregate. Then, the effects of taxation are addressed. This is done first from a theoretical perspective, followed by a discussion of some of the main currents in the empirical literature on taxation and savings. Finally, we address some important normative or policy issues that have arisen in the literature, focusing mainly on two issues. One is the optimal tax treatment of savings — 1 Queen's University and Vanderbilt University, respectively.