Public Economics

April 2-3, 2009
Raj Chetty and Amy Finkelstein, Organizers

Peter Diamond, MIT and NBER (Joint with Johannes Spinnewijn)
Capital Income Taxes with Heterogeneous Discount Rates

With heterogeneity in both skills and preferences for the future, the Atkinson-Stiglitz result -- that savings should not be taxed with optimal taxation of earnings -- does not hold. Empirical evidence shows that, on average, people with higher skills save at higher rates. Saez (2002) suggests that with such positive correlation, taxing savings can increase welfare. Diamond and Spinnewijn analyze this issue in a model with less than perfect correlation between ability and preference for the future. To have multiple types at the same earnings level, the number of types of jobs in the economy is restricted. Key to the analysis is that types who value future consumption less are more tempted to switch to the low earning job. The researchers show that introducing both a small savings tax on the high earners and a small savings subsidy on the low earners increase welfare, regardless of the correlation between ability and preferences for the future. However, a uniform savings tax, as in the Nordic dual income tax, increases welfare only if that correlation is sufficiently high.

Benjamin Olken, MIT and NBER,Monica Singhal, Harvard University and NBER
Informal Taxation

Informal cash and in-kind payments are an important yet frequently overlooked source of local public finance in many developing countries. Olken and Singhal use microdata from ten developing countries to establish stylized facts on the magnitude, form, and distributional implications of this type of informal taxation. They find that informal taxation is prevalent in a wide range of countries, particularly in rural areas, and includes substantial payments in the form of labor. The wealthy pay more in informal taxes in absolute terms but less in percentage terms, and the informal tax system as a whole appears more regressive than the formal tax system. Failing to take informal taxation into account results in underestimates of the tax burdens faced by households and the level of revenue decentralization in developing countries. The authors propose a simple model of information and enforcement constraints that parsimoniously explains the patterns observed in the data.

Raj Chetty, UC, Berkeley and NBER
Bounds on Elasticities with Optimization Frictions:An Application to Taxation and Labor Supply

Chetty studies the identification of price elasticities in an environment where agents face optimization frictions, such as adjustment costs, or inattention. He shows that even when one is uncertain about how such frictions enter the agents’ decision problem, one can obtain simple bounds on the price elasticity of interest. Agents are permitted to deviate arbitrarily from the optimal choice as long as the utility cost of doing so lies below an exogenously specified threshold. Chetty derives analytical bounds on price elasticities that are a function of the observed response to a price change, the degree of optimization frictions, and the size of the price change. He applies these bounds to the literature on labor supply and taxation, allowing for optimization frictions of up to 1 percent of consumption. Permitting such small frictions can reconcile several disparate findings in this literature. Pooling elasticity estimates from several studies yields approximate bounds on the taxable income elasticity of (0:47; 0:54).

Laurence Kotlikoff, Boston University and NBER (Joint with Alexander Blocker and Stephen Ross)
The True Cost of Social Security

Implicit government obligations represent the lion’s share of government liabilities in the United States and many other countries. Yet these liabilities are rarely measured, let alone properly adjusted for their risk. Blocker, Kotlikoff, and Ross show, by example, how modern asset pricing can be used to value implicit fiscal debts taking into account their risk properties. The example is the U.S. Social Security system’s net liability to working-age Americans. Marking this debt to market makes a big difference; its market value is 23 percent larger than the Social Security trustees’ valuation method suggests.

Kevin Milligan, University of British Columbia and NBER (Joint with Mark Stabile)
Do Child Tax Benefits Affect the Well Being of Children? Evidence From Canadian Child Benefits

A vast literature has examined the impact of family income on the health and development outcomes of children. One channel through which increased income may operate is an improvement in a family’s ability to provide food, shelter, clothing, books, and other expenditure-related inputs to a child’s development. In addition to this channel, many scholars have investigated the relationship between income and the psychological wellbeing of the family. By reducing stress and conflict, more income helps to foster an environment more conducive to healthy child development. Milligan and Stabile exploit changes in child benefits in Canada to study these questions. Importantly, their approach allows them to make stronger causal inferences than has been possible with the existing, mostly correlational, evidence. Using variation in child benefits across province, time, and family type, they study outcomes spanning test scores, mental health, physical health, and deprivation measures. The findings suggest that child benefit programs in Canada had significant positive effects on test scores, as has been featured in the existing literature. However, they also find that several measures of both child and maternal mental health and well-being show marked improvement with higher child benefits. They further find strong and interesting differences in the effects of benefits by sex of the child: benefits have stronger effects on educational outcomes and physical health for boys and on mental health outcomes for girls. These results also provide some support for the hypothesis that income transfers operate through measures of family emotional well-being.

Edward Miguel, UC, Berkeley and NBER (Joint with Marco Manacorda and Andrea Vigorito)
Government Transfers and Political Support

Manacorda, Miguel, and Vigorito estimate the impact of a large anti-poverty program -- the Uruguayan PANES -- on political support for the government that implemented it. The program consisted mainly of a monthly cash transfer for a period of roughly two and half years. Using the discontinuity in program assignment based on a pre-treatment score, the researchers find that beneficiary households are 21 to 28 percentage points more likely to favor the current government (relative to the previous government). Impacts on political support are larger among poorer households and for those near the center of the political spectrum, consistent with the probabilistic voting model in political economy. Effects persist after the cash transfer program ends. The authors estimate that the annual cost of increasing government political support by 1 percentage point is roughly 0.9 percent of annual government social expenditures.

Jonathan Gruber, MIT and NBER (Joint with Jason Abaluck)
Choice Inconsistencies Among the Elderly: Evidence from Plan Choice in the Medicare Part D Program

The Medicare Part D Prescription Drug Plan represents the most significant privatization of the delivery of a public insurance benefit in recent history, with dozens of private insurers offering a wide range of products with varying prices and product features. The typical elder had a choice of roughly 40 stand-alone drug plans. Gruber and Abaluck evaluate the choices of elders across this wide array of Part D options using a unique dataset of prescription drug claims matched to information on the characteristics of choice sets. They first document that the vast majority of elders are choosing plans that are not on the “efficient portfolio” of plan choice, in the sense that an alternative plan offers better risk protection at a lower cost. They then estimate several discrete choice models to document three dimensions along which elders are making choices that are inconsistent with optimization under full information: elders place much more weight on plan premiums than they do on expected out-of-pocket costs; they place almost no value on variance-reducing aspects of plans; and, they value plan financial characteristics beyond any impacts on their own financial expenses or risk. These findings are robust to a variety of specifications and econometric approaches. The authors develop an "adjusted" revealed preference approach that combines data from consumer choices with ex ante restrictions on preferences, and find that in a partial equilibrium setting, restricting the choice set to the three lowest average cost options likely would have raised welfare for elders under the program.

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