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Progressive Income Taxes and the Substitution Effect of RRSPs

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Abstract

Within a progressive income-tax system, Registered Retirement Saving Plans (RRSPs) generate a substitution effect that decreases saving. The key point made here is that when an RRSP is introduced to a system that taxes capital income, the rate of return on marginal saving within the RRSP is driven to equality with the rate of return on non-RRSP saving. Since RRSP contributions redistribute taxable income across periods, they also have the effect of increasing future marginal income-tax rates, which lowers the after-tax return to saving. This result stands in contrast to the conventional view from the public finance literature.

Suggested Citation

  • Christopher Ragan, 1994. "Progressive Income Taxes and the Substitution Effect of RRSPs," Canadian Journal of Economics, Canadian Economics Association, vol. 27(1), pages 43-57, February.
    • Handle: RePEc:cje:issued:v:27:y:1994:i:1:p:43-57
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    Cited by:

    1. Haoming Liu & Jie Zhang, 2008. "Donations in a recursive dynamic model," Canadian Journal of Economics/Revue canadienne d'économique, John Wiley & Sons, vol. 41(2), pages 564-582, May.
    2. Gilles Bérubé & Denise Côté, 2000. "Long-Term Determinants of the Personal Savings Rate: Literature Review and Some Empirical Results for Canada," Staff Working Papers 00-3, Bank of Canada.
    3. Bev Dahlby & Kevin Milligan, 2017. "From theory to practice: Canadian economists contributions to public finance," Canadian Journal of Economics, Canadian Economics Association, vol. 50(5), pages 1324-1347, December.
    4. John B. Burbidge, 2004. "Tax‐deferred savings plans and interest deductibility," Canadian Journal of Economics/Revue canadienne d'économique, John Wiley & Sons, vol. 37(3), pages 757-767, August.
    5. Rydqvist, Kristian & Schwartz, Steven T. & Spizman, Joshua D., 2014. "The tax benefit of income smoothing," Journal of Banking & Finance, Elsevier, vol. 38(C), pages 78-88.
    6. Milligan, Kevin, 2003. "How do contribution limits affect contributions to tax-preferred savings accounts?," Journal of Public Economics, Elsevier, vol. 87(2), pages 253-281, February.
    7. John Burbidge & Deborah Fretz & Michael R. Veall, 1998. "Canadian and American Saving Rates and the Role of RRSPs," Canadian Public Policy, University of Toronto Press, vol. 24(2), pages 259-263, June.
    8. Rydqvist, Kristian & Spizman, Joshua & Schwartz, Steven, 2011. "The Tax Benefit of Income Smoothing," CEPR Discussion Papers 8425, C.E.P.R. Discussion Papers.
    9. Ranjini L. Thaver, 2013. "Integrating The Output And Substitution Effects Of Production Into The Intermediate Microeconomics Textbook," Business Education and Accreditation, The Institute for Business and Finance Research, vol. 5(1), pages 81-90.
    10. Giuseppe Ruggieri & Maxime Fougère, 1997. "The effect of tax-based savings incentives on government revenue," Fiscal Studies, Institute for Fiscal Studies, vol. 18(2), pages 143-159, May.
    11. Hans Fehr & Christian Habermann & Fabian Kindermann, 2008. "Tax-Favored Retirement Accounts: Are they Efficient in Increasing Savings and Growth?," FinanzArchiv: Public Finance Analysis, Mohr Siebeck, Tübingen, vol. 64(2), pages 171-198, June.

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