The Budgetary Cost and Welfare Effect of Tax-Deferred Retirement Saving Accounts

In this paper, we construct a dynamic general-equilibrium overlapping-generations model with heterogeneous households and analyze the macroeconomic, budgetary, and welfare effects of introducing tax-deferred retirement saving accounts similar to the U.S. 401(k) plans. We solve the model for equilibrium transition path to show both the long-run and short-run effects under several different financing assumptions. If we ignored the budgetary cost, tax-deferred accounts would surely increase capital stock and total output of the economy and make all but current old households better off. However, the benefits of tax-deferred accounts are not free. If we assume transfer payment cuts or marginal tax rate increases to balance the government budget, introducing tax-deferred accounts would more likely hurt households than benefit them. The current and near-future households would likely be worse off more than future households, because the budgetary cost of tax-deferred accounts is much higher in the short run than in the long run. JEL Classification Numbers: