Political Economy

October 17, 2014
Alberto Alesina of Harvard University, Organizer

Ethan Ilzetzki, London School of Economics

A Positive Theory of Tax Reform

The political impediments to reform and the political forces allowing its success are studied in a model where the tax base and the statutory rate are separate instruments of tax policy. Ilzetzki's model predicts that big bang reforms---large changes in the tax code---are politically feasible, while marginal reforms would be rejected. This contrasts with a prominent view that larger reforms face greater political difficulties. Politically feasible tax reform occurs when revenue needs are large, but will nonetheless involve reductions in marginal tax rates. At a "reform moment", political platforms converge and reform may receive unanimous support. The recent history of tax reform in the US and other industrialized countries is discussed and shown to be in line with the model's predictions.

Alberto Alesina, and Francesco Passarelli, Bocconi University

Loss Aversion In Politics

Alesina and Passarelli study how loss aversion affects the political equilibrium in a simple majority voting model. First, the authors show a status quo bias, which leads to path dependence. Second, loss aversion implies a moderating effect on the most extreme voters. Third, in a dynamic setting, the effect of loss aversion diminishes with the length of the planning horizon of voters; however, in the presence of a projection bias, majorities are partially unable to understand how fast they will adapt to a new policy. This makes changes less likely and induces time inconsistency: policy changes are timid at the beginning, while in later periods they are made progressively more radical. Fourth, in a stochastic environment, loss aversion yields a significant distaste for risk, but also a smaller attachment to the status quo. The application of these results to a model of redistribution leads to empirically plausible implications.

Jimmy Charité, Columbia University; Raymond Fisman, Columbia University and NBER; and Ilyana Kuziemko, Princeton University and NBER

Reference Points and Demand for Redistribution: Experimental Evidence

If individuals --- even the wealthy--- are loss-averse relative to their reference point, then redistribution could reduce welfare even in the absence of moral hazard. Charité, Fisman, and Kuziemko test whether this consideration affects the redistributive decisions of individuals acting as social planners. Subjects redistribute exogenous, unequal endowments between two strangers significantly less when the strangers know the initial endowments than when they do not (when in fact the authors observe near complete redistribution). Subjects who are themselves more loss-averse drive this effect. In a separate experiment, respondents choose a tax rate for someone who (due to luck) became rich-five years (one year) ago. Respondents reward the more deeply embedded reference point in the five-year scenario with a lower tax rate. The authors' results offer a new explanation for why voters prefer lower levels of redistribution than standard models predict.

Stelios Michalopoulos and David Weil, Brown University and NBER, and Louis Putterman, Brown University

The Influence of Ancestral Lifeways on Individual Economic Outcomes in Sub-Saharan Africa

A growing literature examines the impact of the historical legacies, including the date of the Neolithic revolution and early political development, on current economic outcomes across countries and regions. In this paper, Michalopoulos, Putterman, and Weil investigate the shadow of history at an even finer scale: individuals. Specifically, the authors explore whether the descendants of agriculturalists are wealthier and better educated than the descendants of groups that practiced other economic life-ways. They match individual level survey data from contemporary Africa (from the DHS) with information on the ancestral ethnicities of respondents. In both rural and urban areas, within ethnic homelands and even within villages, the authors find that descent from pastoralists predicts significantly poorer outcomes. A tentative exploration of the possible channels reveals an inferior treatment of women among those of pastoral ancestry.

Leonardo Bursztyn, University of California, Los Angeles and NBER, and Robert Jensen, University of Pennsylvania and NBER

How Does Peer Pressure Affect Educational Investments?

When academic effort or investment is observable to peers, students may act to avoid social penalties or gain social favor (i.e., "peer pressure") by conforming to prevailing norms. To test this hypothesis, Bursztyn and Jensen conducted an experiment in Los Angeles high schools in which 11th grade students were offered complimentary access to a commercial, online SAT preparatory course from a well-known test company. Sign up sheets differed randomly across students (within classrooms) only in the extent to which they emphasized that the decision to enroll would be kept private from their classmates. The authors find that whether choices are believed to be observable to others has dramatic effects on sign up rates. Further, the effects depend greatly on the setting or prevailing peer group norm. In non-honors classes, the sign up rate was 11 percentage points lower when decisions to enroll were to be public rather than private. But sign up in honors classes was unaffected. Since the differential response in the two types of classes could be driven by differences across students in honors and non-honors classes, to further test for the effects of peer pressure the authors examine students taking the same number of honors classes (e.g., the set of students taking exactly two honors classes). For these students, it is essentially random whether the authors' team arrived and offered them the course during a period in which they were in class with their honors peers or their non-honors peers. When offered the course in their non-honors class, these students were 25 percentage points less likely to sign up if the decision was public. But if they were offered the course in one of their honors classes, they were 25 percentage points more likely to sign up when the decision was public. These results show that students are highly responsive to who their peers are and what the prevailing norm is when they make decisions. These results also allow the authors to isolate peer social concerns from other peer effect mechanisms, since they changed nothing about a student's actual set of peers (or their teachers, classroom or school), only those peers actually present when decisions were made and thus to whom the choice would potentially be revealed.

Daron Acemoglu, MIT and NBER; Tarek Hassan, University of Chicago and NBER; and Amhed Tahoun, London Business School

The Power of the Street: Evidence from Egypt's Arab Spring

During Egypt's Arab Spring, unprecedented popular mobilization and protests broke down Hosni Mubarak's government, and ushered in an era of competition between three groups: elites associated with Mubarak's National Democracy Party (NDP), the military, and the Muslim Brotherhood. Street protests continued to play an important role during this power struggle. Acemoglu, Hassan, and Tahoun show that these street protests are associated with differential stock market returns for firms connected to the three groups. Using daily variation in the number of protesters, we show that more intense protests in Tahrir Square are associated with lower stock market valuations for firms connected to the group currently in power relative to non-connected firms, but have no impact on the relative valuations of firms connected to other powerful groups. Because these results are not driven by changes in formal political institutions or the fall of governments, the authors interpret them as providing evidence that popular mobilization and protests might have a role in restricting the ability of connected firms to capture excess rents under weak institutions. The authors also show that social media played an important role in these protests, though they had no direct effect on rents (or stock market participants' perceptions of rents), and further document that the cohesiveness of the opposition as measured from social media activity determines the effectiveness of protests at limiting rents.

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