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Jon M. Bakija, Williams College; Adam J. Cole, U.S. Department of the Treasury; and Bradley Heim, Indiana University
Jobs and Income Growth of Top Earners and the Causes of Changing Income Inequality: Evidence from U.S. Tax Return Data
Bakija, Cole, and Heim present summary statistics on the occupations of taxpayers in the top percentile of the national income distribution and fractiles thereof, as well as the patterns of real income growth between 1979 and 2005 for top earners in each occupation, based on information reported on U.S. individual income tax returns. Their data demonstrate that executives, managers, supervisors, and financial professionals account for about 60 percent of the top 0.1 percent of income earners in recent years, and can account for 70 percent of the increase in the share of national income going to the top 0.1 percent of the income distribution between 1979 and 2005. During 1979 to 2005 there was substantial heterogeneity in growth rates of income for top earners across occupations, and significant divergence in incomes within occupations among people in the top 1 percent. The researchers consider the implications for various competing explanations for the substantial changes in income inequality that have occurred in the U.S. in recent times. They then use panel data on U.S. tax returns spanning the years 1987 through 2005 to estimate the elasticity of gross income with respect to net of tax share (that is, one minus the marginal tax rate). The information on occupation allows them to control for other influences on income in a flexible way, using interactions among occupation, position in the income distribution, stock prices, housing prices, and the business cycle. They also allow for income shifting across years in response to anticipated tax changes, for the long run effect of a tax reform to differ from the short run effects, for heterogeneous mean reversion across incomes, and for heterogeneous elasticities across income classes. In a specification that does all this, they estimate a significant elasticity of 0.7 among taxpayers in the top 0.1 percent of the income distribution. Outside of the top 0.1 percent of the income distribution, they find no conclusive evidence of a positive elasticity of income with respect to net of tax shares. They find that the estimate for the top 0.1 percent is not robust to controlling for a spline in lagged income that is very flexible at the upper reaches of the income distribution, suggesting that the method used to allow for income dynamics is very important. Allowing for income shifting across years in response to anticipated tax changes has important consequences for the estimates.
Lisa Schreiber Rosenmerkel, Internal Revenue Service, and Jenny Wahl, Carleton College
Crossing the Bar: Predicting Wealth from Income and Estate Tax Records
Clarifying the connections between income and wealth is essential for ascertaining individual economic status and establishing informed policy. For the very rich, realized income may reveal little about true well-being, because tax liability can drive decisions about form and timing. Fortunately, estate tax records provide a superb additional source of information. Schreiber Rosenmerkel and Wahl have constructed a unique dataset that links several years from U.S. Individual Income Tax Returns (Forms 1040) for persons who died between 1996 and 2002, as well as from the U.S. Estate and Generation Skipping Transfer Tax Return (Form 706) when the decedent's estate size exceeded the filing threshold. The included individuals were members of a panel representing the cohort of tax families (primary and secondary filers and their dependents) that filed Form 1040 in Tax Year 1987. The researchers use the data to: 1) predict the probability of filing a Form 706 from Form 1040 information, 2) estimate individual wealth from Form-1040 data via a Heckman two-step approach that corrects for selection bias, and 3) outline an approach for predicting the amount of total gross estate that will ultimately appear on Forms 706.
Atif R. Mian, University of California, Berkeley and NBER, and Amir Sufi, University of Chicago and NBER
The Effects of Fiscal Stimulus: Evidence from the 2009 "Cash for Clunkers" Program (NBER Working Paper No. 16351)
A key rationale for fiscal stimulus is to boost consumption when aggregate demand is perceived to be inefficiently low. Mian and Sufi examine the ability of the government to increase consumption by evaluating the impact of the 2009 "Cash for Clunkers" program on short- and medium -run auto purchases. The empirical strategy exploits variation across U.S. cities in ex-ante exposure to the program as measured by the number of a clunkers in the city as of the summer of 2008. The researcheres find that the program induced the purchase of an additional 360,000 cars in July and August of 2009. However, almost all of the additional purchases under the program were pulled forward from the very near future; the effect of the program on auto purchases is almost completely reversed by as early as March 2010, only seven months after the program ended. The effect of the program on auto purchases was significantly more short-lived than previously suggested. They also find no evidence of an effect on employment, house prices, or household default rates in cities with higher exposure to the program.
Emmanuel Farhi, Harvard University and NBER, and Ivan Werning, MIT and NBER
Insurance and Taxation over the Life Cycle
Farhi and Werning consider a dynamic Mirrlees economy in a life-cycle context and study the optimal insurance arrangement. Individual productivity evolves as a Markov process and is private information. The researchers use a first-order approach in discrete and continuous time and obtain novel theoretical and numerical results. Their main contribution is a formula describing the dynamics for the labor-income tax rate. When productivity is an AR(1), their formula resembles an AR(1) with a trend where: 1) the auto-regressive coefficient equals that of productivity; 2) the trend term equals the covariance productivity with consumption growth divided by the Frisch elasticity of labor; and 3) the innovations in the tax rate are the negative of consumption growth. The last property implies a form of short-run regressivity. These simulations deliver some novel insights. The average labor tax rises from zero to 46 percent over 40 years, while the average tax on savings falls from 17 percent to zero at retirement. The authors compare the second-best solution to simple, history-independent tax systems, calibrated to mimic these average tax rates, and find that age-dependent taxes capture a sizable fraction of the welfare gains.
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Jesse Cunha, Stanford University, and Giacomo DeGiorgi and Seema Jayachandran, Stanford University and NBER
The Price Effects of Cash versus In-Kind Transfers
Cunha, DeGiorgi, and Jayachandran examine how cash and in-kind transfers into small, partially-closed economies (villages) affect prices. Cash transfers increase the demand for normal goods, causing prices to rise. In-kind transfers generate a similar increase in demand, but they also increase supply (if the goods themselves, rather than vouchers, are provided). Hence, relative to cash transfers, in-kind transfers should lead to lower prices, which shifts surplus from producers to consumers. Prices also should fall for substitutes of the in-kind goods. Analyzing a transfer program for poor households in rural Mexico that randomly assigned villages to receive in-kind food transfers, equivalently-valued cash transfers, or no transfers, the researchers test and find support for these predictions The estimated price effects are quite large: the price decline in in-kind villages increases the program's net transfer by 12 percent for a recipient who is a consumer of food. The price increase in cash villages dissipates 11 percent of the transfer. Also, the pecuniary effects are larger in more remote villages where there is less competition among sellers and the economy is less open.
Jeffrey B. Liebman, Harvard University and NBER, and Neale Mahoney, Stanford University
Do Expiring Budgets Lead to Wasteful Year-End Spending? Evidence from Federal Procurement
Many organizations fund their spending out of a fixed budget that expires at the end of the year. Faced with uncertainty over future spending demands, these organizations have an incentive to build a buffer stock of funds over the front end of the budget cycle. When demand does not materialize, they may rush to spend these funds on lower quality projects at the end of the year. Liebman and Mahoney test these predictions using data on procurement spending by the U.S. federal government. Using data on all federal contracts from 2004 through 2009, they document that spending spikes in all major federal agencies during the 52nd week of the year as the agencies rush to exhaust expiring budget authority. Spending in the last week of the year is 4.9 times higher than the rest-of-the-year weekly average. They examine the relative quality of year-end spending using a newly available dataset that tracks the quality of $130 billion in information technology (I.T.) projects made by federal agencies. Consistent with their model, average project quality falls at the end of the year. Quality scores in the last week of the year are 2.2 to 5.6 times more likely to be below the central value. To explore the impact of allowing agencies to roll unused spending over into subsequent fiscal years, study the I.T. contracts of an agency with special authority to roll over unused funding. They show that there is only a small end-of-year I.T. spending spike in this agency, and that the one major I.T. contract this agency issued in the 52nd week of the year has a quality rating that is well above average.
Damon Jones, University of Chicago and NBER
Inertia and Overwithholding: Explaining the Prevalence of Income Tax Refunds (NBER Working Paper No. 15963)
Over three-quarters of U.S. taxpayers receive income tax refunds, indicating tax prepayments above the level of tax liability. This amounts to a zero interest loan to the government. Previous studies have suggested two main explanations for this behavior: precautionary behavior in light of tax uncertainty and/or a forced savings motive. Jones presents evidence on a third explanation: inertia. He finds that tax filers only partially adjust tax prepayments in response to changes in default withholdings or tax liability. Jones uses three different settings for identification: 1) a 1992 change in default federal withholding; 2) a panel study of child dependents and tax liability; and 3) the expansion of the Earned Income Tax Credit (EITC) during the 1990s. In the first two cases, he finds that individuals offset less than 43 percent of a change to their expected refund after one year, and about 58 percent of this shock after three years. Adjustments in tax prepayments by EITC recipients offset no more than 2 percent of a change in tax liability. Given the evidence on inertia, the design of default withholding rules is no longer a neutral decision made by the social planner, but rather, may affect consumption smoothing, particularly for low-income tax filers.
Syngjoo Choi, University College London; Shachar Kariv, University of California, Berkeley; Wieldand Muller, Tilburg University; and Dan Silverman, University of Michigan and NBER
Who Is (More) Rational?
Revealed preference theory offers a criterion for decisionmaking quality: if decisions are high quality, then there exists a utility function that the choices maximize. Choi, Kariv, Muller, and Silverman conduct a large-scale field experiment that enables them to test for consistency with utility-maximizing behavior and combine the experimental data with the wide range of individual socio-demographic and economic information for the subjects. There is considerable heterogeneity in subjects' consistency scores: high-income and high-education subjects display greater levels of consistency than low-income and low-education subjects; men are more consistent than women; and young subjects are more consistent than older subjects. The researchers also find that consistency with utility maximization is strongly related to wealth differentials: a standard deviation increase in the consistency score is associated with in 15-19 percent more wealth. This is important for understanding the role of decisionmaking quality in determining why households with similar economic and demographic characteristics accumulate radically different amounts of wealth.
Brian Raub, Barry Johnson, and Joseph Newcomb, Internal Revenue Service
Rich or Richer? Comparing Estimates for the Forbes 400 to IRS Data
Three of the major sources of U.S. wealth data are the household estimates derived from the Federal Reserve Board of Governor's Survey of Consumer Finances (SCF); the estimates of personal wealth derived from estate tax returns produced by the Statistics of Income Division (SOI) of the Internal Revenue Service; and Forbes Magazine's estimates for the 400 wealthiest individuals in the United States. The SOI estimates, which are derived from data reported on federal estate tax returns, are limited by the estate tax filing threshold: only a small portion of the wealth distribution, representing the nation's wealthiest individuals, is included. The SCF, on the other hand, does not provide coverage of the topmost segment of the wealth distribution because its sample intentionally excludes individuals with net worth above the threshold represented by the Forbes 400 -- the SOI sample does include this segment of the population. Raub, Johnson, and Newcomb focus on that topmost portion of the wealth distribution that is represented by the Forbes 400 and find that a relatively large share of the nation's wealth is concentrated in this group. In 2007 for example, the Forbes 400 had an estimated collective net worth of almost $1.6 trillion, or about 2.3 percent of the total U.S. household net worth owned by the rest of the U.S. population. In all of the years these researchers examine, the threshold for inclusion in the Forbes estimates was well above the effective estate tax filing threshold. To the extent that data from these three sources prove different, it should provide insight into important estate planning issues. Furthermore, examining to the extent possible the form of wealth held by these top wealth holders may inform the ongoing debate surrounding the effects of the Federal estate tax on the general economy.
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