The Impact of Risk-Based Premiums on FDIC-Insured Institutions

This paper examines the effect of a series of announcements leading to the approval of risk-based deposit insurance premiums on returns to stockholders of commercial banks. Utilizing risk-weighted capital ratios and measures of overall risk, we group banks according to one of the nine-tier insurance categories subsequently defined by the FDIC. During the period in which the new insurance system was considered and approved, we found that stockholders of well-capitalized, healthy banks experienced wealth changes significantly different from those experienced by less than well-capitalized, less than healthy banks. Although many argued the premium range in the initial insurance schedule was insufficient, the results show that this initial risk-basing marked an important change in the relative burdens imposed by FDIC insurance.     

Company Tax Structure and Company Tax Incidence

This paper reviews conflicting theories of company tax incidence impliedby the alternative new and traditional views of dividends andexamines their contrasting policy implications. Whereas, under thetraditional view, closer integration of the corporate and personalincome tax systems is suggested, an alternative policy orientationemphasizing the non-distorting features of the classical system is impliedby the new view. Even if the traditional view is accepted, theimplications for design and reform of the company tax vary widely underalternative specifications of domestic and international tax policy objectives. Schedular alternatives to global income taxation are alsoconsidered.     

Performance Evaluation and Corporate Income Taxes in a Sequential Delegation Setting

We consider a setting where a firm delegates an investment decision and, subsequently, a sales decision to a privately informed manager. For both decisions corporate income taxes have real effects. We show that compensating the manager based on pre-tax residual income can ensure after-tax NPV-maximization (goal congruence) for each decision problem in isolation. However, this metric fails if both decisions are nontrivial, since it requires asset-specific hurdle rates and hence precludes asset aggregation. After-tax residual income metrics (e.g., EVA) allow the firm to consistently apply its after-tax cost of capital as the hurdle rate to its aggregate asset base. We show that existing tax depreciation schedules may explain why firms in practice use more accelerated depreciation schedules than those suggested by previous studies. Our findings also rationalize the widespread use of dirty surplus accounting for windfall gains and losses for managerial retention purposes.     

The impact of tax on foreign direct investment: Empirical evidence and the implications for tax integration schemes

We estimate the impact of taxation on foreign direct investment (FDI) flows, using data on flows between seven countries for 1984 through 1989, and a sophisticated measure of the cost of capital. We find that the choice between domestic investment and total outward FDI is not significantly affected by taxation but that taxation does affect the location of outward FDI. These results are used to examine the impact of tax integration systems. Giving a tax credit to foreign shareholders may induce a large increase in inward FDI from exemption countries but not from partial-credit countries. For the United States, the total effect would be small.     

Environmental Taxes, International Capital Mobility and Inefficient Tax Systems: Tax Burden vs. Tax Shifting

This paper deals with the so-called double dividend of an environmental tax reform. In a model with only labor and a polluting input as factors of production, we find that society faces a trade-off between internalizing environmental externalities and raising revenues in the least distortionary way. However, if capital enters the production structure, an ecological tax reform may render the tax structure more efficient from a non-environmental point of view, thereby raising not only environmental quality but also private incomes.     

Tax Competition, Income Differentials and Local Public Services

This paper examines strategic tax setting between fiscal authorities in the presence of mobile workers who locate across these jurisdictions in response to differing tax structures and congestable local public amenities. We find that the nature of the tax setting outcomes depend crucially on the proximity between cities. For distant cities with the same size populations, the pressure on tax rates of a more mobile workforce depends on the whether mobile workers are net beneficiaries or net contributors. If mobile workers are either high or low income earners, cities lower tax rates. If mobile workers are middle income earners, cities raise tax rates. For close or neighbouring cities, workers locate in one of the cities and tax rates and local public amenities are dispersed.     

Balance Sheets, the Transfer Problem, and Financial Crises

In a world of high capital mobility, the threat of speculative attack becomes a central issue of macroeconomicpolicy. While first-generation and second-generation models of speculative attacks both have considerablerelevance to particular financial crises of the 1990s, a third-generation model is needed to make sense of thenumber and nature of the emerging market crises of 1997-98. Most of the recent attempts to produce such amodel have argued that the core of the problem lies in the banking system. This paper sketches another candidatefor third-generation crisis modeling—one that emphasizes two facts that have been omitted from formal modelsto date: the role of companies' balance sheets in determining their ability to invest, and that of capital flows inaffecting the real exchange rate.     

A New Approach to Group Structure, Burden Sharing, and the Equilibrium Provision of Public Goods

In the received model of the voluntary provision of a pure public good, the usual practice is to proceed from assumptions about the group characteristics to inferences about an implied outcome. The approach advocated in this paper reverses the traditional direction. Assuming a Nash equilibrium, we ask how to characterize the diverse set of group characteristics which will support it. Approaching the problem from this angle we define three crucial characteristics of a group-equilibrium: consumer's free rider inducing supply, zero contribution-inducing wealth and voluntary surplus tribute which is the amount by which a person's actual income exceeds his/her zero-contribution inducing wealth. Defining these indicators we show how they form the foundation of a complete mapping between the distribution of individual characteristics of a group, and equilibrium public good supply. Certain questions such as the interaction between size of the group and heterogeneity of incomes and tastes not yet adequately addressed are shown to yield easily to this approach.     

Optimal Consumption Taxes and Social Security Under Tax Measurement Problems and Uncertainty

A representative individual lives for two periods; works when young and depends on savings and a government operated social security system when old—the returns on both sources of income, when old, are random. Due to administrative problems the returns to savings are observed with some measurement error. Two alternative consumption tax systems are considered; the Registered Asset Treatment (RAT) and the Non-Registered Asset Treatment (NRAT). The advantage of the RAT is that it can perform a social insurance role while the disadvantage is that it imposes measurement error risk. Correlation between the random return on saving and its measurement error can provide a risk-hedging role that can be further strengthened by the RAT version. The NRAT version neither provides social insurance nor imposes measurement error risk. Both tax systems hedge against the uncertainties in the social security system. The taxpayer engages in precautionary saving in response to future uncertainty.     

Horizontal Inequity and Vertical Redistribution

Inequality of post-tax income among pre-tax equals is evaluated andaggregated to form a global index of horizontal inequity in the income tax.The vertical action of the tax is captured by its inequality effect on averagebetween groups of pre-tax equals. Putting the two together, horizontalinequity measures loss of vertical performance. The identification problem,which has previously been thought insuperable, is addressed by a procedurevalidating the banding of income units into close equals groups. Thehorizontal and vertical effects of a major Spanish income tax reform areevaluated. Lines for future investigation are suggested.     

Economic Effects of the 2003 Partial Integration Proposal in the United States

On January 7, 2003, President George W. Bush proposed a significant change in capital income taxation in the United States. In the context of a jobs and growth package, the President proposed to reduce substantially the double taxation of corporate-source income by eliminating investor-level taxes on dividends paid from earnings on which corporate tax had been paid. In addition, the Presidents proposal would have reduced the tax on retained earnings by allowing a basis adjustment for accumulated previously taxed retained earnings. Taken together, these proposals would have moved the U.S. income tax much closer to an integrated tax system along the lines outlined by the Treasury Department in President George H.W. Bushs administration a decade earlier.Putting together the impacts of the Presidents proposal on economic activity through greater capital accumulation and improved calculation, I estimate that the proposal, if it had been enacted in its original form, would yield a permanent increase of 0.48 percent in the U.S. economys potential output. This estimated gain does not include any gains made possible by improved corporate financial policy.At the time of the integration proposal, the author was Chairman of the Council of Economic Advisers.     

Conduit Entities: Implications of Indirect Tax-Efficient Financing Structures for Real Investment

As well known, companies shift income from high to low tax jurisdictions. Typically, profit shifting is achieved by direct financing structures whereby companies use debt finance in the high tax entity and equity finance in the low tax entity. However, certain tax policies can lead to indirect financing structures whereby a conduit entity provides an opportunity to achieve at least two deductions for interest expenses for an investment made in the host country. The effect of direct and indirect financing structures on real investment is compared.     

When Capital Follows Profitability: Non-linear Residual Income Dynamics

Economic reasoning suggests that capital follows profitability. This study introduces into residual income valuation capital follows profitability investment dynamics whereby capital investments are guided by the profitability of underlying investment opportunities. These investment dynamics predict convex versus linear relations between future and current residual income, with slope and convexity dependent on investment opportunity. We test these predictions against the linear information dynamics (LID) proposed by Ohlson (1995) and Feltham and Ohlson (1996), with supportive results. These findings point the way to further development of links between firm value and the economics of value creation.     

“Investor sentiment” and the closed-end fund puzzle: A 7 percent solution

Lee, Shleifer, and Thaler (1991) argue that the irrational noise trader model of DeLong, Shleifer, Summers, and Waldmann (1990) ... is consistent with the published evidence on closed-end fund prices. ... However, Lee, Shleifer, and Thaler provide no indication of how much of the variability of a closed-end fund's discounts and premiums is due to such investor sentiment. Using the signal extraction technique of French and Roll (1986) to measure noise, this article estimates that on average only 7 percent of the variance of a standardized measure of weekly changes in discounts and premiums can be attributed to noise-trading activity. Investor sentiment, therefore, seems to account for very little of a closed-end fund's discount and premium variability over time.     

The Information Content of Bank Examinations

We identify three types of information from bank examinations—auditing information from verifying the honesty and accuracy of the bank's books, regulatory discipline information about the treatment of the bank by regulators, and private information about bank condition. We estimate these information effects by comparing the cumulative abnormal market returns associated with examinations in which the CAMEL rating remained unchanged, improved, and worsened. All three information effects are found to be greater for banks entering the examination process with unsatisfactory ratings from prior examinations. The only consistently strong effect found is that examination downgrades appear to reveal unfavorable private information about bank condition. The evidence also suggests that the information may reach the market in part through loan quality data released in quarterly financial statements.     

The origin principle and the welfare gains from indirect tax harmonization

This paper establishes a parallelism between indirect tax harmonization when taxes are levied according to the destination principle and its counterpart when taxes are imposed on an origin basis. Using a simple two-country model of international trade it is argued that, under normal circumstances, indirect tax harmonization under the origin principle, considered as a movement of domestic taxes toward an appropriately designed average tax structure, is potentially Pareto improving. It is also shown that if the initial position is a Nash equilibrium, there are exceptional situations under which the above-mentioned reform may generate an actual Pareto improvement, so that both countries improve their welfare without any need for a compensating international transfer.     

Do mortgage rates vary based on household default characteristics? Evidence on rate sorting and credit rationing

Credit screening models suggest that lenders vary loan rates and debt ceilings across applicants on the basis of credit risk. We argue that regulatory constraints such as Fair Lending Laws may preclude rate sorting while increasing lender use of debt ceilings to adjust for applicant credit risk. Using household data from the 1983 SCF, we find that mortgage rates do not vary with applicant credit risk whereas related studies find that debt ceilings vary with borrower risk attributes. Together, these findings support arguments that regulatory constraints reduce rate sorting while increasing the use of non-price terms in the mortgage contract.     

An economic assessment of rent controls: The Ontario experience

Rent controls have existed in Ontario since 1975. Although controls have undergone numerous changes, the basic approach has remained a modified cost-pass-through system with provision for the elimination of financial loss and for a return of new capital expenditures, and, prior to 1986, an exemption for new construction. This paper analyzes the economic consequences of the first twelve years of controls. The major effects have been to reduce rents on pre-1976 units but to increase rents on newly constructed post-1975 units, to reduce new construction, to accelerate deterioration and conversion of the existing rental stock, to generate a severe rental housing shortage, to create an environment for key money, to inefficiently and inequitably redistribute income, and to significantly exacerbate government budgetary deficits by reducing tax revenues and inducing increased government housing expenditures.     

Analyst Following and Equity Offerings Subsequent to Initial Public Offerings

Analyst forecast information is collected for firms following their IPOs and is used in an examination of subsequent seasoned equity offerings (SEOs). Consistent with information asymmetry arguments, the analysis indicates that a larger percentage of firms conducting SEOs within three years of the IPO are covered by financial analysts than those without SEOs, and that analyst coverage is a significant predictor of subsequent SEOs. In addition, the results indicate that long-term earnings growth forecasts are larger for firms with subsequent SEOs, but growth forecasts decline significantly following the SEOs. Further, SEO abnormal returns exhibit a significant negative relationship with earnings growth forecasts. These results are consistent with windows of opportunity arguments since they suggest that SEOs are timed to coincide with the peak of earnings growth expectations, but that market participants compensate by reacting more negatively to offerings by firms with high growth forecasts.     

Corporate Real Estate and Stock Market Performance

An interesting question in corporate real estate literature is whether real estate can improve the stock market performance of property-intensive non-real estate firms. Using a data set comprising 75 non-real estate corporations that own at least 20 percent properties, this paper empirically assesses and compares the pair-wise return, total risk, systematic risk and Jensen abnormal return performance of composite (with real estate) and hypothetical business (without real estate) firms. We employed Morgan Stanley Capital International world equity index instead of a local market index to provide some insights into the performance of the local market relative to the global market during the 1997–2001 volatile periods experienced by many Asian countries. Our results suggest the inclusion of real estate in a corporate portfolio appears to be associated with lower return, higher total risk, higher systematic risk and poorer abnormal return performance. It is therefore likely that non-real estate firms own properties for other reasons in addition to seeking improvement in their stock market performance. Further research is needed to explore the main factors contributing to corporate real estate ownership by non-real estate firms.