The Effect of Tax-Based Savings Incentives on the Self-Employed

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The U.S. individual income tax allows employers to make tax-deferred contributions to qualified pension plans for their employees and, in the case of the self-employed, on their own-behalf. We examine the effect of these tax-based savings incentives on the self-employed. For this purpose we use a panel of sole proprietors constructed from the Statistics of Income (SOI) individual income tax files for 1985, 1989 and 1993. We find that taxes have a substantial effect on both the dichotomous decision to contribute and the amount contributed to tax-deferred retirement savings plan by the self-employed. In general, our estimates suggest a tax price elasticity of contributions around −2.0. This finding is surprisingly robust to a number of alternative specifications.