Findings

Where the Money Is

Kevin Lewis

December 08, 2011

Using inflation to erode the US public debt

Joshua Aizenman & Nancy Marion
Journal of Macroeconomics, December 2011, Pages 524-541

Abstract:
Projections indicate the US Federal debt held by the public may exceed 70-100% of GDP within 10 years. In many respects, the temptation to inflate away some of this debt burden is similar to that at the end of World War II. In 1946, the debt ratio was 108.6%. Inflation reduced this ratio by more than a third within a decade. Yet there are some important differences - shorter debt maturities today reduce the temptation to inflate, while the larger share of debt held by foreigners increases it. This paper lays out an analytical framework for determining the impact of a large nominal debt overhang on the temptation to inflate. It suggests that when economic growth is stalled, the US debt overhang may induce an increase in inflation of about 5% for several years that could significantly reduce the debt ratio.

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Baseball Salaries and Income Taxes: The "Home Field Advantage" of Income Taxes on Free Agent Salaries

James Alm, William Kaempfer & Edward Batte Sennoga
Journal of Sports Economics, forthcoming

Abstract:
In this article, the authors examine the impact on the salaries of free agents in Major League Baseball (MLB) of differences in state and local individual income taxes between major league cities, in an attempt to see if income taxes affect player salaries. This basic specification suggests that each percentage point of an income tax raises free agent salaries by $21,000 to $24,000; other estimates indicate even larger impacts. These findings suggest that the existence of this additional salary demand means that low-tax cities (e.g., Florida, Texas, and Washington) have a "home field advantage" in the baseball free agent market.

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You owe it to yourself: Boosting retirement saving with a responsibility-based appeal

Christopher Bryan & Hal Hershfield
Journal of Experimental Psychology: General, forthcoming

Abstract:
Americans are not saving enough for retirement. Previous research suggests that this is due, in part, to people's tendency to think of the future self as more like another person than like the present self, making saving feel like giving money away rather than like investing in oneself. Using objective employer saving data, a field experiment capitalized on this phenomenon to increase saving. It compared the effectiveness of a novel message - one appealing to people's sense of "social" responsibility to their future selves - with a more traditional appeal to people's sense of rational self-interest. The social-responsibility-to-the-future-self message resulted in larger increases in saving than the self-interest message, but only to the extent that people felt a strong "social" connection to their future selves. These results broaden our understanding of the psychology of moral responsibility and refine our understanding of the role of future-self continuity in fostering intertemporal patience. They further demonstrate how understanding conceptions of the self over time can suggest solutions to important and challenging policy problems.

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Optimal Taxation of Top Labor Incomes: A Tale of Three Elasticities

Thomas Piketty, Emmanuel Saez & Stefanie Stantcheva
NBER Working Paper, November 2011

Abstract:
This paper analyzes the problem of optimal taxation of top labor incomes. We develop a model where top incomes respond to marginal tax rates through three channels: (1) the standard supply-side channel through reduced economic activity, (2) the tax avoidance channel, (3) the compensation bargaining channel through efforts in influencing own pay setting. We derive the optimal top tax rate formula as a function of the three elasticities corresponding to those three channels of responses. The first elasticity (supply side) is the sole real factor limiting optimal top tax rates. The optimal tax system should be designed to minimize the second elasticity (avoidance) through tax enforcement and tax neutrality across income forms, in which case the second elasticity becomes irrelevant. The optimal top tax rate increases with the third elasticity (bargaining) as bargaining efforts are zero-sum in aggregate. We then analyze top income and top tax rate data in 18 OECD countries. There is a strong correlation between cuts in top tax rates and increases in top 1% income shares since 1975, implying that the overall elasticity is large. But top income share increases have not translated into higher economic growth, consistent with the zero-sum bargaining model. This suggests that the first elasticity is modest in size and that the overall effect comes mostly from the third elasticity. Consequently, socially optimal top tax rates might possibly be much higher than what is commonly assumed.

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U.S. State Governments Are Not Leviathans: Evidence from the Economic Freedom Index

Noel Campbell & David Mitchell
Social Science Quarterly, December 2011, Pages 1057-1073

Objective: Does increasing a political party's power lead to Leviathan state governments? The evidence is mixed. We use the Economic Freedom of North America (EFNA) Index to measure governmental activity to study the impact of political parties on government outcomes.

Methods: We employ instrumental-variable, panel data methods to regress states' EFNA scores on median voter and differentiated-party variables.

Results: Party effects are negligible, but a simple median voter explanation emerges.

Conclusion: As political power is consolidated in either party, economic freedom increases. This is consistent with a model wherein the median voter has effective agency control with positive monitoring costs and prefers a particular level of so-called economic freedom. These results are inconsistent with Leviathan models of state legislatures.

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The Case for a Progressive Tax: From Basic Research to Policy Recommendations

Peter Diamond & Emmanuel Saez
Journal of Economic Perspectives, Fall 2011, Pages 165-190

Abstract:
This paper presents the case for tax progressivity based on recent results in optimal tax theory. We consider the optimal progressivity of earnings taxation and whether capital income should be taxed. We critically discuss the academic research on these topics and when and how the results can be used for policy recommendations. We argue that a result from basic research is relevant for policy only if 1) it is based on economic mechanisms that are empirically relevant and first order to the problem, 2) it is reasonably robust to changes in the modeling assumptions, and 3) the policy prescription is implementable (i.e, is socially acceptable and not too complex). We obtain three policy recommendations from basic research that satisfy these criteria reasonably well. First, very high earners should be subject to high and rising marginal tax rates on earnings. Second, low-income families should be encouraged to work with earnings subsidies, which should then be phased-out with high implicit marginal tax rates. Third, capital income should be taxed. We explain why the famous zero marginal tax rate result for the top earner in the Mirrlees model and the zero capital income tax rate results of Chamley and Judd, and Atkinson and Stiglitz are not policy relevant in our view.

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Gold Sterilization and the Recession of 1937-38

Douglas Irwin
NBER Working Paper, November 2011

Abstract:
The Recession of 1937-38 is often cited as illustrating the dangers of withdrawing fiscal and monetary stimulus too early in a weak recovery. Yet our understanding of this severe downturn is incomplete: existing studies find that changes in fiscal policy were small in comparison to the magnitude of the downturn and that higher reserve requirements were not binding on banks. This paper focuses on a neglected change in monetary policy, the sterilization of gold inflows during 1937, and finds that it exerted a powerful contractionary force during this period. The transmission of this monetary shock to the real economy appears to have worked through lower asset (equity) prices and higher interest rates.

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Should the U.S. National School Lunch Program continue its in-kind food benefit? A school district-level analysis of funding efficiency and equity

Cora Peterson & Julian Le Grand
Applied Economic Perspectives and Policy, Winter 2011, Pages 566-583

Abstract:
For over 65 years, the U.S. Department of Agriculture has purchased commodity foods for the National School Lunch Program (NSLP) in an effort to support both schools and food producers. Based on data from 339 Minnesota school districts from 2001-2008, this research examined whether the NSLP's in-kind food program is an efficient and equitable way to fund school food services. Multivariate models suggested that the program is inefficient, though offered limited insight into district-level factors that affected utilization of commodity funding, and therefore offered less clear conclusions about equity. It was estimated that districts obtained just $0.60 in commodity food value given a $1 increase in available commodity funding over the years observed, and that the commodity program's system of "reconciled" and "rollover" funding accounted for much of this discrepancy. Based on these results, it is recommended that a cash benefit replace the NSLP's current in-kind food benefit for schools.

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The Unemployment Puzzle of Corporate Taxation

Horst Feldmann
Public Finance Review, November 2011, Pages 743-769

Abstract:
Using annual data on nineteen industrial countries for the period 1979-2005 and a large number of controls, this article is the first to empirically study the impact of corporate taxes on the unemployment rate. In contrast to previous empirical research on the labor demand, investment and growth effects of corporate taxation, which consistently finds adverse effects, the regression results suggest that higher corporate taxes may have a favorable impact, lowering the unemployment rate. The magnitude of the estimated effect is substantial. The results of this study are robust to both endogeneity and numerous variations in specification.

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Anticipating the Great Depression? Gustav Cassel's Analysis of the Interwar Gold Standard

Douglas Irwin
NBER Working Paper, November 2011

Abstract:
The intellectual response to the Great Depression is often portrayed as a battle between the ideas of Friedrich Hayek and John Maynard Keynes. Yet both the Austrian and the Keynesian interpretations of the Depression were incomplete. Austrians could explain how a country might get into a depression (bust following an investment boom) but not how to get out of one (liquidation). Keynesians could explain how a country might get out of a depression (government spending on public works) but not how it got into one (animal spirits). By contrast, the monetary approach of economists such as Gustav Cassel has been ignored. As early as 1920, Cassel warned that mismanagement of the gold standard could lead to a severe depression. Cassel not only explained how this could occur, but his explanation anticipates the way that scholars today describe how the Great Depression actually occurred. Unlike Keynes or Hayek, Cassel explained both how a country could get into a depression (deflation due to tight monetary policies) and how it could get out of one (monetary expansion).

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Did Technology Shocks Drive the Great Depression? Explaining Cyclical Productivity Movements in U.S. Manufacturing, 1919-1939

Robert Inklaar, Herman De Jong & Reitze Gouma
Journal of Economic History, December 2011, Pages 827-858

Abstract:
Technology shocks and declining productivity have been advanced as important factors driving the Great Depression in the United States, based on real business cycle theory. We estimate an improved measure of technology for interwar manufacturing, using data from the U.S. census reports. There is clear evidence of increasing returns to scale and we find no statistical proof that technology shocks led to changes in hours worked or other inputs. This contradicts a key prediction of real business cycle theory. We find that increasing returns to scale are not due to market power but to labor and capital hoarding.

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Budget Slack, Institutions, and Transparency

Shanna Rose & Daniel Smith
Public Administration Review, forthcoming

Abstract:
Economic theory suggests that it is optimal for governments to use precautionary saving as a countercyclical tool. However, the availability of surplus funds often triggers political pressure for tax cuts and spending increases. Mechanisms for alleviating that pressure include limiting the transparency of slack resources and limiting politicians' discretion to use slack resources for purposes other than stabilization. This article investigates the extent to which these two mechanisms are substitutes. In particular, the authors examine whether the widespread adoption of budget stabilization funds (BSFs) in the U.S. states over the past several decades has been accompanied by a decline in conservative revenue forecast bias. Using panel data from 47 states over a 22-year period, they find that the adoption of a BSF reduces revenue underestimation by approximately two-thirds; however, the size of the effect depends in part on how much a state saves in the BSF and the rules governing BSF deposits and withdrawals. The results suggest that BSFs have the unintended effect of increasing fiscal transparency.

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Do Tax Reforms Affect Firm Performance and Executive Remuneration? Evidence from a Compressed Wage Environment

Harald Dale-Olsen
Economica, forthcoming

Abstract:
The agency framework predicts a strong positive relationship between executive effort, pay and firm performance. We study how changes in Norwegian payroll tax legislation and earnings tax (which influence CEOs' return on effort), affect firm performance and executive earnings for over 11,800 firms. Both reduced payroll tax and reduced marginal earnings tax increase firm performance measured by firms' operating margins. In the latter case total pay increases, but contingent on the return on firm performance, the fixed wage drops. The sensitivity of the remuneration scheme to the earnings tax depends on CEO productivity and effort costs.


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