7. a. Suppose Greg deposits the €10,000 in his SSS. At 5% interest, the €10,000 bonus is worth €10,000(1.05) in one year, €10,000(1.05)(1.05) = €10,000(1.05) 2 in two years, up to five years when it is worth €10,000(1.05) 5 = €12,763. After Greg withdraws he must pay 30% in taxes, leaving him with 0.7€12,763 = €8934 after taxes. If Greg does not use the SSS, he will have to pay a 30% tax on the bonus in the year that he receives it, leaving him €7,000 to invest. He must also pay 30% of his interest income in taxes each year, so that the actual interest he will receive will be 70% of 5%, or 3.5% after taxes. In five years his investment will be worth €7,000(1.035) 5 = €8314. He owes no further taxes on withdrawal. On net, Greg ends up with €8934 after taxes if he deposits his bonus in his SSS, and €8314 if he does not. So the SSS is a good deal for Greg. b. The SSS effectively increases the interest rate that Greg can earn on his saving. A higher interest rate increases the reward to saving (which tends to increase saving) but also makes it easier to achieve a given savings target (which tends to reduce saving). Empirically, a higher real return seems to increase saving modestly, suggesting that on this count, the availability of SSSs has a positive (if small) effect on saving. From a psychological perspective, the fact that funds cannot be withdrawn from an SSS prior to retirement (except at substantial penalty) may make it easier for people to exert self-control. On this count also, SSSs tend to raise saving.
- Fall '19
- Macroeconomics, Fisher equation