Progressive Income Taxes and the Substitution Effect of RRSPs

Christopher Ragan ()

Canadian Journal of Economics, 1994, vol. 27, issue 1, 43-57

Abstract: Within a progressive income-tax system, Registered Retirement Saving Plans (RRSPs) generate a substitution effect that decreases saving. The key point made here is that when an RRSP is introduced to a system that taxes capital income, the rate of return on marginal saving within the RRSP is driven to equality with the rate of return on non-RRSP saving. Since RRSP contributions redistribute taxable income across periods, they also have the effect of increasing future marginal income-tax rates, which lowers the after-tax return to saving. This result stands in contrast to the conventional view from the public finance literature.

Date: 1994
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