Under the main types of tax-preferred vehicles used to incentivize saving, governments tax savings in the contribution year (TEE-type) or in the withdrawal year (EET-type). The relative returns of the two types depend on effective marginal tax rates in these two years, which in turn depend on earnings dynamics. This paper estimates a model of earnings dynamics on a Canadian longitudinal administrative database containing millions of individuals. The model is then used, together with a tax simulator, to predict returns across income groups. Results suggest that TEE accounts generally yield higher returns, especially for low-income groups. Comparing optimal saving choices predicted by the model with saving choices observed in the data suggests that EET accounts are over-chosen, especially in the province of Quebec. These results have important implications for “nudging” policies being implemented in Quebec, which mandate employers to automatically enrol their employees in EET-type accounts.
Publication Author: Steeve Marchand