Tax Policy and the Economy

September 14, 2017
Robert A. Moffitt of Johns Hopkins University, Organizer

Alex Rees-Jones, University of Pennsylvania and NBER, and Dmitry Taubinsky, University of California at Berkeley and NBER

Taxing Humans: Normative Implications of Biased Responses to Taxes

A growing body of evidence suggests that psychological biases can lead different implementations of otherwise equivalent tax incentives to result in meaningfully different behaviors. Rees-Jones and Taubinsky argue that in the presence of such failures of "implementation invariance," decoupling the question of optimal feasible allocations from the tax system used to induce them -- the "mechanism design approach" to taxation--cannot be the right approach to analyzing optimal tax systems. After reviewing the diverse psychologies that lead to failures of implementation invariance, the researchers illustrate their argument by formally deriving three basic lessons that arise in the presence of these biases. First, the mechanism design approach neither estimates nor bounds the welfare computed under psychologically realistic assumptions about individuals' responses to the tax instruments used in practice. Second, the optimal allocations from abstract mechanisms may not be implementable with tax policies, and vice-versa. Third, the integration of these biases may mitigate the importance of informational asymmetries, resulting in optimal tax formulas more closely approximated by classical Ramsey results. Authors conclude by proposing that a "behavioral" extension of the "sufficient statistics" approach is a more fruitful way forward in the presence of such psychological biases.

James Andreoni, University of California at San Diego and NBER

The Benefits and Costs of Donor Advised Funds

Donor Advised Funds (DAFs) are becoming a major source of charitable donations in the US, responsible for 1 in 10 dollars donated to charity in 2015. In 2016 Fidelity Charitable became the largest charity in the US, passing the United Way and Salvation Army. Paradoxically, most people have never heard of them. This leads Andreoni to ask, whom do DAFs serve? Why and how are they valuable to those who use them? What is the cost of DAFs to the US Treasury, and what are the benefits of DAFs to the taxpaying public? Could DAFs possibly create more in new charity than they create in additional reductions of tax revenue?

Andrew Samwick, Dartmouth College and NBER

Means-Testing Federal Health Entitlement Benefits (NBER Retirement Research Center Paper No. NB 12-16)

In recent years, federal legislation has linked the price paid for health insurance benefits to measures of current income. Under the Patient Protection and Affordable Care Act of 2010, individuals and families with income as high as 400% of the federal poverty level are eligible for subsidies that limit their health insurance premiums to no more than 9.5% of their income. Under the Medicare Modernization Act of 2003, higher-income beneficiaries face income-related premiums over three times the standard premium for Part B coverage. For workers at or near retirement age, means-testing based on current income provides an incentive for early retirement, dissaving, and income manipulation, raising concerns about the efficiency of such means-testing. Further, current income is subject to short-term fluctuations, making it a noisy predictor of ability to pay. Using the Health and Retirement Study and linked Social Security earnings histories, it is shown that a measure of lifetime income compares favorably to current income as a basis for means-testing. Samwick offers less short-term variation in premiums while improving incentives for pre-retirement work and saving.

Jeffrey Clemens, University of California at San Diego and NBER, and Benedic N. Ippolito, American Enterprise Institute

Implications of Medicaid Financing Reform for State Government Budgets

Clemens and Ippolito analyze potential reforms to Medicaid financing through the lens of fiscal federalism. Because substantial dollars are at stake, both the economic and political sides of intergovernmental transfers have high relevance in this setting. The researchers show that changes in Medicaid financing formulas can shift amounts exceeding several hundred dollars per capita from "winning" states to "losing" states. In some cases, these amounts exceed 10 percent of states' own-source revenues. States' balanced budget requirements imply that such changes would, if not phased in gradually, require significant budgetary adjustment over short time horizons. The researchers next show that alternative Medicaid financing structures have significant implications for states' exposure to budgetary stress during recessions. During the Great Recession, an acyclical block grant structure would have increased states' shortfalls by 2-3.5 percent of own-source revenues relative to either an explicitly counter-cyclical block grant or the current matching system. Finally, Clemens and Ippolito assess the implications of several financing structures for the extent to which they subsidize states' decisions on both the "extensive" and "intensive" margins of coverage generosity over the short and long term.

Bruce D. Meyer, University of Chicago and NBER, and Wallace K.C. Mok, Chinese University of Hong Kong

Disability, Taxes, Transfers and the Economic Well-Being of Women

Meyer and Mok study the economic situation of disabled women and the role that taxes and transfers play in improving their economic circumstances, using 1968-2015 data from the Panel Study of Income Dynamics. The researchers begin by documenting the trends in point-in-time disability rates of women as well as estimating the prevalence of disability over a woman's lifetime. The researchers find that women are more likely than men to have experienced a disability through their mid-40s, but are less likely to have experienced a serious disability prior to retirement. The onset of disability for women is found to be associated with a fall in labor supply, family income and consumption. The fall varies with the degree of disability but tends to be smaller than that of disabled men, particularly for family income and consumption. Transfers, particularly Disability Insurance and SSI play a large role in cushioning the fall in income for disabled women. However, while the relative decline in income is smaller for women than men, a larger share of disabled women have very low absolute levels of income and consumption. Approximately half of the most disabled women receive SNAP benefits, pointing to the greater relative importance of means-tested benefits rather than social insurance for this group.

Caroline M. Hoxby, Stanford University and NBER

Online Postsecondary Education and the Higher Education Tax Benefits:
An Analysis with Implications for Tax Administration

Online postsecondary education is growing rapidly and increasingly dominates the use of the tax benefits for higher education: the American Opportunity Tax Credit, the Lifelong Learning Credit, and the Deduction for Tuition and Fees. Because online education does not closely resemble "brick-and-mortar" residential college education aimed at 18 to 23 year olds, it presents new challenges and opportunities for administering the tax benefits for higher education. In this paper, Hoxby combines tax data with administrative data from the U.S. Department of Education for cross-validation, to study compliance, and to gain an understanding of how online schools and students use tax benefits for higher education. Hoxby also analyzes take-up of the tax benefits and how they affect earnings. The findings suggest several practical implications for the administration of the tax benefits, including form revisions, federal data coordination, and novel uses of earnings data to target compliance reviews.

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