Tax Policies and Saving
A person’s decision on how much of his or her income to spend and how much to save, similar to the decision on the amount of labor to supply is a key individual habit influenced by taxation (Gruber, 685). The government can encourage savings by altering the relative cost of saving. As always, a change in price that comes about as a result of a tax on savings interest will bring about two main effects: When the after-tax interest rate is lower, there will be an increase in consumption because of the activation of the substitution effect. As a result, this will result in a fall in savings. On the other hand, the higher after-tax interest rate will result in an increase in saving and a reduction in consumption. For instance, America’s decision to introduce retirement and lifetime saving accounts in 2003, on which the interest was not to be subjected to taxation, encouraged saving (Gruber, 683). Whenever an individual decided to withdraw, these savings, interest earned, or increases in asset’s values were to be exempted from taxation. The administration’s main objective was to simplify saving incentives to revamp retirement savings by cutting down the taxation of savings of the returns.
On the negative side, determining the suitable interest rate to be used is arguably the biggest disadvantage of using tax policies to encourage savings. In as much a worker’s wage is measurable. It is not easy to determine the most suitable interest rate for savers (Gruber, 690). The type of interest rate that can be deemed as appropriate is dependent on an individual’s saving opportunities, such as tax-subsidized pension and bank accounts. Besides, the interest rates earned on every type of saving naturally change over time, similar to how people make it difficult to get suitable treatments and control groups for determining how savings react to changes in interest rates.