Governments incentivize retirement saving by allowing individuals to contribute to tax-advantaged accounts where the returns to financial assets receive special tax treatment. In accounts with "back-loaded" taxation, the individual contributes pretax money and pays taxes when the money is withdrawn. In accounts with "front-loaded" taxation, the individual contributes aftertax money and pays no future taxes. Under some simplifying assumptions, a standard benchmark result is that both the individual and the government are indifferent between the two types of accounts. We add investment management fees to the benchmark model and show that the neutrality result breaks down. Assuming fees are fixed as a percent of assets under management (AUM), we show that individuals are still indifferent to the timing of taxation but the government is not. Under back-loaded taxation, the government implicitly owns a share of all retirement accounts and is effectively paying investment fees on this share, something it avoids under front-loaded taxation. We estimate this to cost the government $15 billion per year, representing a subsidy to the asset management industry. We then ask whether this result holds in general equilibrium, where fees as a percent of AUM are allowed to vary. The answer depends both on the nature of the cost function for asset management services, and on the nature of market competition, but we find that the result will in general continue to hold: back-loaded taxation is more expensive for the government and produces a larger asset-management industry. Finally, we use the general equilibrium model to examine welfare implications. In a rough calibration of the model, we find that this increase in the size of the asset management industry reduces consumer welfare.
Landoni, Mattia, and Stephen Zeldes. "Should the Government Be Paying Investment Fees on $3 Trillion of Tax-Deferred Retirement Assets?" Columbia Business School, October 11, 2017.
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