Working Paper: NBER ID: w21109
Authors: Louis Kaplow
Abstract: A central justification for social insurance and for other policies aimed at retirement savings is that individuals may fail to make adequate provision during their working years. Much research has focused on myopia and other behavioral limitations. Yet little attention has been devoted to how these infirmities, and government policies to rectify them, influence labor supply. This linkage could be extremely important in light of the large pre-existing distortion due to income and consumption taxation and income-based transfer programs. For example, might myopic individuals, as a first approximation, view payroll taxes and other withholding to fund retirement savings as akin to an income tax, while largely ignoring the distant future retirement benefits that they fund? If so, the distortion of labor supply may be many times higher than otherwise, making savings-promotion policies much more costly than appreciated. Or consider what may be the labor supply implications for an individual who is defaulted into higher savings and, as a consequence, sees concomitantly lower take-home pay. This essay offers a preliminary, conceptual exploration of these questions. In most of the cases considered, savings policies do not act purely like a tax despite individuals’ non-optimizing savings behavior, and in some cases labor supply actually is raised, not lowered, in which event policies that boost savings may be significantly more welfare-enhancing than recognized. Accordingly, there is a compelling need for empirical exploration of the interaction between nonoptimal savings behavior and labor supply.
Keywords: labor supply; myopia; savings policy; social insurance; behavioral economics
JEL Codes: D11; D91; H21; H24; H31; H55; J22; J26
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Forced savings policies (e.g., payroll taxes) (H31) | Labor supply decisions (J22) |
| Myopic individuals perceive payroll taxes as akin to income taxes (H22) | Distortion of labor supply decisions (H31) |
| Defaulted into higher savings (D14) | Decrease in take-home pay (H31) |
| Decrease in take-home pay (H31) | Negative effect on labor supply (J29) |
| Forced savings recognized as beneficial (D14) | Increase in labor supply (J20) |
| Government savings policies (H55) | Complex effects on labor supply (J29) |