Annuities, Credits and Deductions: An Experimental Test of the Relative Strength of Economic Incentives

Abstract

Does the type of tax incentive matter in terms of encouraging behavior? Social policies often use tax incentives to encourage behavior, but little research has been conducted on how the structure or type of tax incentive might influence behavior. Using experimental methods, we test the effects of incentives structured as tax deductions and credits with respect to the policy problem of how best to encourage people to purchase annuities at retirement. We hypothesize that tax credits may be more effective than tax deductions at increasing the rate at which individuals would engage in socially desirable behavior, because credits appear to have immediate value. Adult subjects played a financial decision-making game in which they were offered different incentives to purchase annuities. We found that incentives in the form of tax credits not only encouraged more annuity purchases relative to actuarially equivalent deductions, but also relative to deductions that were greater in value than the credit-based tax incentives.