Findings

Paying the Bills

Kevin Lewis

November 17, 2009

"So picture this: month after month of headlines juxtaposing soaring U.S. trade deficits and Chinese trade surpluses with the suffering of unemployed American workers. If I were the Chinese government, I'd be really worried about that prospect. Unfortunately, the Chinese don't seem to get it: rather than face up to the need to change their currency policy, they've taken to lecturing the United States, telling us to raise interest rates and curb fiscal deficits - that is, to make our unemployment problem even worse. And I'm not sure the Obama administration gets it, either. The administration's statements on Chinese currency policy seem pro forma, lacking any sense of urgency." ["World Out of Balance," Paul Krugman, The New York Times, November 15, 2009]

----------------------

"I think that if we're looking for more money, we ought to look to guys like me. I mean, I am still paying a lower rate on dividends and capital gains than my cleaning lady is, in terms of her payroll tax just to start with. And so, I just think that we've gotten so far out of whack in terms of who's been prosperous in recent years. And most of the economy -- most people have been left behind, you know. So, we learned that a rising tide lifts all yachts." [Warren Buffett, on The Charlie Rose Show, November 13, 2009]

----------------------

"I think those among my conservative and libertarian friends who think spending cuts of that magnitude - in the trillions of dollars per year going forward - are feasible are simply delusional, living in a dream world. Therefore, higher taxes will be the default position when the crunch comes." [Bruce Bartlett, New York Times Q&A, October 28, 2009]

----------------------

Possible Macroeconomic Consequences of Large Future Federal Government Deficits

Ray Fair
Yale Working Paper, September 2009

Abstract:
This paper uses a macroeconometric model of the U.S. economy to analyze possible macroeconomic consequences of the large future federal government deficits. The analysis has the advantage of accounting for the endogeneity of the deficit. The results are bleak. Assuming no large tax increases or spending cuts and no bad dollar and stock market shocks, the debt/GDP ratio rises substantially through 2020. These estimates are in line with other estimates. If the dollar depreciates in response to the deficits, inflation increases but the effect on the debt/GDP ratio is modest. It does not appear that the United States can inflate its way out of its deficit problem. If in addition U.S. stock prices fall, this makes matters worse by lowering output. Large personal tax increases or transfer payment decreases solve the deficit problem, but at a cost of considerable lost output over a decade. The Fed's ability to offset these losses is modest according to the model. Introducing a national sales tax is more contractionary than is increasing personal income taxes or decreasing transfer payments.

----------------------

Large Changes in Fiscal Policy: Taxes Versus Spending

Alberto Alesina & Silvia Ardagna
NBER Working Paper, October 2009

Abstract:
We examine the evidence on episodes of large stances in fiscal policy, both in cases of fiscal stimuli and in that of fiscal adjustments in OECD countries from 1970 to 2007. Fiscal stimuli based upon tax cuts are more likely to increase growth than those based upon spending increases. As for fiscal adjustments, those based upon spending cuts and no tax increases are more likely to reduce deficits and debt over GDP ratios than those based upon tax increases. In addition, adjustments on the spending side rather than on the tax side are less likely to create recessions. We confirm these results with simple regression analysis.

----------------------

Redistributive Politics and Market Efficiency: An Experimental Study

Jens Großer & Ernesto Reuben
Columbia University Working Paper, November 2009

Abstract:
We study the interaction between competitive markets that produce large but unequally distributed welfare gains and elections through which the poor majority can redistribute income away from the rich minority. In our simple laboratory democracy, subjects first earn their income by trading in a double auction market and thereafter vote on redistributive policies in two-candidate elections. In addition, in one of the treatments subjects can attempt to influence the candidates' policy choices by transferring money to them. We observe very high levels of redistribution - even when transfers to candidates are possible - with little effect on market efficiency. Overall, the experimental results are explained by our equilibrium predictions.

----------------------

Redistributive Taxation and Personal Bankruptcy in U.S. States

Charles Grant & Winfried Koeniger
Journal of Law and Economics, August 2009, Pages 445-467

Abstract:
Personal bankruptcy regulation and redistributive taxes and transfers vary considerably across U.S. states and over time. Our hypothesis is that both policies are imperfect substitutes in insuring consumption of risk‐averse agents in incomplete markets. Exploiting data variation over time for 18 U.S. states for the period 1980-2003, we find considerable support for this hypothesis: redistributive taxation and bankruptcy exemptions are negatively correlated, and both policies are associated with more equal consumption growth.

----------------------

A quantitative assessment of the decline in the U.S. current account

Kaiji Chen, Ayşe İmrohoroğlu & Selahattin İmrohoroğlu
Journal of Monetary Economics, forthcoming

Abstract:
Low frequency changes in the U.S. current account can be understood in terms of the influence of differences in productivity growth rates across time and across countries using standard growth theory. In particular, the secular decline is primarily driven by the increase in the U.S. TFP growth rate relative to its trading partners. Differences in population growth rates or fiscal policy have no significant effects on the low frequency changes in the U.S. current account.

----------------------

Does Fiscal Stimulus Cause Too Much Debt?

Laurence Seidman & Kenneth Lewis
Business Economics, October 2009, Pages 201-205

Abstract:
This study distinguishes between temporary fiscal stimulus to combat a recession and two other debt-raising policies: financial bailouts and spending on Medicare, Medicaid, and Social Security. Two striking conclusions emerge from our simulations of the impact of a temporary fiscal stimulus on the economy. First, the fiscal stimulus effectively mitigates the recession. Second, debt as a percentage of GDP is only slightly greater with the fiscal stimulus than it would be without the stimulus.

----------------------

What the Stock Market Decline Means for the Financial Security and Retirement Choices of the Near-Retirement Population

Alan Gustman, Thomas Steinmeier & Nahid Tabatabai
NBER Working Paper, October 2009

Abstract:
This paper investigates the effect of the current recession on the near-retirement age population. Data from the Health and Retirement Study suggest that those approaching retirement age (early boomers ages 53 to 58 in 2006) have only 15.2 percent of their wealth in stocks, held directly or in defined contribution plans or IRAs. Their vulnerability to a stock market decline is limited by the high value of their Social Security wealth, which represents over a quarter of the total household wealth of the early boomers. In addition, their defined contribution plans remain immature, so their defined benefit plans represent sixty five percent of their pension wealth. Simulations with a structural retirement model suggest the stock market decline will lead the early boomers to postpone their retirement by only 1.5 months on average. Health and Retirement Study data also show that those approaching retirement are not likely to be greatly or immediately affected by the decline in housing prices. We end with a discussion of important difficulties facing those who would use labor market policies to increase the employment of older workers.

----------------------

A Diet COLA for Social Security? Not Really

Andrew Biggs
American Enterprise Institute Working Paper, October 2009

Abstract:
Due to falling prices, Social Security will make no cost-of-living adjustment (COLA) to retirement benefits in 2010. Retirees, who feel their benefits are too low and believe the prices they pay are rising, are up in arms. Newspaper headlines announce, "Millions face shrinking Social Security payments," and seniors' groups are already pressuring Congress to pass an ad hoc COLA this year. But most retirees do not know that "no COLA" can actually translate into big benefit increases. When falling prices coincide with stable benefits, purchasing power increases. Moreover, Medicare premium increases are limited in years in which no COLA is paid. Combined, the typical retiree will be better off by almost $725 this year. Paying a COLA this year is unnecessary and would boost the long-term Social Security deficit.

----------------------

A paycheck half-empty or half-full? Framing, fairness and progressive taxation

Stian Reimers
Judgment and Decision Making, October 2009, Pages 461-466

Abstract:
Taxation policy is driven by many factors, including public opinion, but little research has examined the strength and stability of the public's taxation preferences. This paper demonstrates one way in which preferences for progressiveness depend on the framing of the question asked. Participants indicated how they would share a fixed tax burden between two individuals who earned different amounts of money, either by adjusting the amount of tax paid by the two individuals, or by adjusting the amount of post-tax income retained. The units in which tax was described - amount of money or percentage tax rate - were manipulated orthogonally. There was a strong metric effect: Participants favored progressiveness more when tax was described as a percentage rather than amount. However, there was also a clear interaction: for amounts, participants favored progressiveness significantly more when considering post-tax money retained rather than tax paid; for percentages, no such effect was found.

----------------------

State Finance in Times of Crisis

Brian Galle & Jonathan Klick
University of Pennsylvania Working Paper, September 2009

Abstract:
As recent events illustrate, state finances are pro-cyclical: during recessions, state revenues crash, worsening the effects of economic downturns. This problem is well-known, yet persistent. We argue here that, in light of predictable federalism and political economy dynamics, states will be unable to change this situation on their own. Additionally, we note that many possible federal remedies may result in worse problems, such as creating moral hazard that would induce states to take on excessively risky policy, both fiscal and otherwise. Thus, we argue that policy makers should consider so-called 'automatic' stabilizers, such as are found in the federal tax system. We present an argument from micro-economic foundations suggesting that the federal Alternative Minimum Tax has potentially salutary - and heretofore unrecognized - effects that counteract pathologies of state budgets over the business cycle. Namely, as incomes grow and the AMT hits more state residents, state spending becomes more expensive in flush times as the federal tax subsidy for state and local taxes is reduced. Conversely, when state fiscal health deteriorates, the federal tax subsidy grows as fewer state residents fall under the AMT, boosting taxpayer support for state spending. This stabilizing mechanism has the potential to overcome problems state politicians face committing to saving during boom times and spending during bust times. We present empirical evidence suggesting that the AMT does indeed provide some degree of fiscal stabilization in accordance with micro-theory. We provide policy suggestions regarding how the AMT could be modified to leverage this stabilization effect. Calls to 'reform' the Alternative Minimum Tax pre-date the recent economic downturn. AMT reform has appeared in many congressional stimulus proposals, but significant cut-backs are unlikely as federal deficits are projected to grow for the foreseeable future. Our argument here implies that any AMT reform effort should consider whether the AMT's stabilizer function could be replaced by any other viable mechanism.

----------------------

Watch What I Do, Not What I Say: The Unintended Consequences of the Homeland Investment Act

Dhammika Dharmapala, Fritz Foley & Kristin Forbes
MIT Working Paper, June 2009

Abstract:
This paper analyzes the impact on firm behavior of the Homeland Investment Act of 2004, which provided a one-time tax holiday for the repatriation of foreign earnings by U.S. multinationals. The analysis controls for endogeneity and omitted variable bias by using instruments that identify the firms likely to receive the largest tax benefits from the holiday. Repatriations did not lead to an increase in domestic investment, employment or R&D - even for the firms that lobbied for the tax holiday stating these intentions and for firms that appeared to be financially constrained. Instead, a $1 increase in repatriations was associated with an increase of almost $1 in payouts to shareholders. These results suggest that the domestic operations of U.S. multinationals were not financially constrained and that these firms were reasonably well-governed. The results have important implications for understanding the impact of U.S. corporate tax policy on multinational firms.

----------------------

Using Financial Accounting Data to Examine the Effect of Foreign Operations Located in Tax Havens and Other Countries on U.S. Multinational Firms' Tax Rates

Scott Dyreng & Bradley Lindsey
Journal of Accounting Research, December 2009, Pages 1283-1316

Abstract:
This paper investigates the effect tax havens and other foreign jurisdictions have on the income tax rates of multinational firms based in the United States. We develop a new regression methodology using financial accounting data to estimate the average worldwide, federal, and foreign tax rates on worldwide, federal, and foreign pretax book income for a large sample of U.S. firms with and without tax haven operations. We find that on average U.S. firms that disclosed material operations in at least one tax haven country have a worldwide tax burden on worldwide income that is approximately 1.5 percentage points lower than firms without operations in at least one tax haven country. Our results also show that U.S. firms face a 4.4% current federal tax rate on foreign income whether or not they have tax haven operations. Finally, we find that U.S. firms with operations in some tax haven countries have higher federal tax rates on foreign income than other firms. This result suggests that in some cases, tax haven operations may increase U.S. tax collections at the expense of foreign country tax collections.


Insight

from the

Archives

A weekly newsletter with free essays from past issues of National Affairs and The Public Interest that shed light on the week's pressing issues.

advertisement

Sign-in to your National Affairs subscriber account.


Already a subscriber? Activate your account.


subscribe

Unlimited access to intelligent essays on the nation’s affairs.

SUBSCRIBE
Subscribe to National Affairs.