The impact of changing skill levels on optimal nonlinear income taxes

The impact of changing an individual's skill level on the solution to a finite population version of the Mirrlees optimal nonlinear income tax problem with quasilinear-in-leisure preferences is investigated. It is shown that it is possible to sign the directions of change in everyone's optimal consumptions and optimal marginal tax rates in response to such a change.     

A policy response to a downside of the integration of economies: An impossibility theorem

Recent research shows that the merger of economies increases aggregate stress. This paper shows that there is no income distribution policy which will ensure that the wellbeing of the individuals belonging to merging economies does not fall below their pre-merger level.     

Optimal nonlinear income taxation with a finite population

In the standard optimal income taxation problem, tax payments depend only on each consumer's own actions. Piketty [J. Econ. Theory 61 (1993) 23-41] shows that, if one individual's tax schedule depends on others’ actions and the government knows the exact ability distribution, it can implement any undistorted allocation as the unique revelation game outcome. If some individuals misreveal their types, Piketty's mechanism may assign infeasible allocations. We require that tax schedules must balance the government budget for every possible vector of revelations. When individuals reveal their type by simple announcements, all undistorted allocations can be still implemented, even with off-equilibrium feasibility constraints.     

Teach a man to fish? Education vs. optimal taxation

Abstract In models of redistribution, differences in human capital are often the relevant source of heterogeneity among individuals. Presumably, the distribution of human capital can be manipulated through education spending. This paper examines the use of education as a redistributive tool when there is a non‐linear tax system in place. The results show that taxation, whether under full or asymmetric information, substantially reduces the redistributive role of education spending in maximizing social welfare. This points to a conflict between the equalization of utility and human capital outcomes.     

Integration, social distress, and policy formation

I study the integration of regions in the form of a merger of populations, which I interpret as a revision of people’s social space and their comparison set; I illustrate the way in which a merger can aggravate social distress; and I consider policy responses. Specifically, I view the merger of populations as a merger of income vectors; I measure social distress by aggregate relative deprivation; I demonstrate that a merger increases aggregate relative deprivation; and I show that a social planner is able to reverse this increase by means of least-cost, post-merger increases in individual incomes, but is unable to counter it by relying exclusively on a self-contained income redistribution that retains individual levels of wellbeing at their pre-merger levels.     

The role of the state in resolving business disputes in China

In this paper, we follow the theoretical framework proposed by Djankov et al. (2003) to investigate the role of the state in resolving business disputes and its impact on enterprise performance. Using a survey of private enterprises in China, we first construct an index to quantify the power of the state vis-à-vis the market in resolving business disputes, and then find that enterprises located in regions where the government has a greater relative power enjoy better performance. Our results suggest that the regulatory state has played a positive role in the economic transition in China.     

On the Effect of Skewness and Kurtosis Misspecification on the Hedging Error

Using a result in Angelini and Herzel (2009a) , we measure, in terms of variance, the cost of hedging a contingent claim when the hedging portfolio is re‐balanced at a discrete set of dates. We analyse the dependence of the variance of the hedging error on the skewness and kurtosis as modeled by a Normal Inverse Gaussian model. We consider two types of strategies, the standard Black–Scholes Delta strategy and the locally variance‐optimal strategy, and we perform some robustness tests. In particular, we investigate the effect of different types of model misspecification on the performance of the hedging, like that of hedging without taking skewness into account. Computations are performed using a Fast Fourier Transform approach.     

Environmental regulation of technically inefficient firms

This paper presents a model in which a technically inefficient firm is responsible for the emissions of pollutants. We derive second-best regulatory schemes (tax and quota) assuming that the firm’s technical efficiency is unknown to the regulator.     

Gross national happiness as an answer to the Easterlin Paradox?

The Easterlin Paradox refers to the fact that happiness data are typically stationary in spite of considerable increases in income. This amounts to a rejection of the hypothesis that current income is the only argument in the utility function. We find that the happiness responses of around 350,000 people living in the OECD between 1975 and 1997 are positively correlated with the level of income, the welfare state and (weakly) with life expectancy; they are negatively correlated with the average number of hours worked, environmental degradation (measured by SOx emissions), crime, openness to trade, inflation and unemployment; all controlling for country and year dummies. These effects separate across groups in a pattern that appears broadly plausible (e.g., the rich suffer environmental degradation more than the poor). Based on actual changes from 1975 to 1997, small contributions to happiness can be attributed to the increase in income in our sample. Interestingly, the actual changes in several of the ‘omitted variables’ such as life expectancy, hours worked, inflation and unemployment also contribute to happiness over this time period since life expectancy has risen and the others have, on average, fallen. Consequently the unexplained trend in happiness is even bigger than would be predicted if income was the only argument in the utility function. In other words, introducing omitted variables worsens the income-without-happiness paradox.     

Optimal taxation with endogenously incomplete debt markets

Empirical analyses of labor tax and public debt processes provide prima facie evidence for imperfect government insurance. This paper considers a model in which the government's inability to commit to future policies or to report truthfully its spending needs renders government debt markets endogenously incomplete. A method for solving for optimal fiscal policy under these constraints is developed. Such policy is found to be intermediate between that implied by the complete insurance (Ramsey) model and a model with exogenously incomplete debt markets. In contrast to optimal Ramsey policy, optimal policy in this model is consistent with a variety of stylized fiscal policy facts such as the high persistence of labor tax rates and debt levels and the positive covariance between government spending and the value of government debt sales.     

On the optimality of optimal income taxation

The Mirrleesian model of income taxation restricts attention to simple allocation mechanism with no strategic interdependence, i.e., the optimal labor supply of any one individual does not depend on the labor supply of others. It has been argued by Piketty (2009) [12] that this restriction is substantial because more sophisticated mechanisms can reach first-best allocations that are out of reach with simple mechanisms. In this paper, we assess the validity of Piketty?s critique in an independent private values model. As a main result, we show that the optimal sophisticated mechanism is a simple mechanism, or, equivalently, a Mirrleesian income tax system.     

Optimal environmental taxation and enforcement policy

We study the optimal environmental taxation and enforcement policy when (i) the regulator does not know the firms’ abatement costs, (ii) penalties for tax evasion are limited, and (iii) monitoring of pollution is costly. We show that the threat of being audited alter the usual firms’ incentives to over-estimate their abatement costs. In particular, depending on the firms’ abatement costs, the optimal policy may involve over or under-deterrence compared to the full information outcome. We then investigate the properties of a pollution standard. We show that this policy comes close to an environmental tax once the economic incentives of the accompanying enforcement policy are considered.     

On the Limitations of Some Current Usages of the Gini Index

This note constructs a simple two class example in which the Gini index is held constant while the size of the rich and poor populations change, in order to illustrate how very different societies can have the same Gini index and produce very similar estimates of standard inequality averse Social Welfare Functions. The rich/poor income ratio can vary by a factor of over 12, and the income share of the top one per cent can vary by a factor of over 16, with exactly the same Gini index. Focussing solely on the Gini index can thus obscure perceptions—e.g. of important market income trends or large changes in the redistributive impact of the tax and transfer system. Hence, analysts should supplement the use of an aggregate summary index of inequality with direct examination of the segments of the income distribution which they think are of greatest importance.     

A note on redistributive fairness and economic reform

To understand reasons for possible failures of ‘good’ economic reforms, we consider an institution which is always successful in making the best public decision from the utilitarian perspective. We show it is bound to introduce inequality if costs of a reform are privately known: the losers can not be always compensated. Thus, if equity is a primary concern, then some reforms with positive aggregate net gain might not be undertaken. If the utilitarian welfare is the only guide for making public decisions, implementing a reform might require the ability to ignore the associated social costs of inequality.     

Nonseparable preferences and optimal social security systems

In this paper, we consider economies in which agents are privately informed about their skills, which evolve stochastically over time. We require agents' preferences to be weakly separable between the lifetime paths of consumption and labor. However, we allow for intertemporal nonseparabilities in preferences like habit formation. In this environment, we derive a generalized version of the Inverse Euler Equation and use it to show that intertemporal wedges characterizing optimal allocations of consumption can be strictly negative. We also show that preference nonseparabilities imply that optimal differentiable asset income taxes are necessarily retrospective in nature. We show that under weak conditions, it is possible to implement a socially optimal allocation using a social security system in which taxes on wealth are linear, and taxes/transfers are history-dependent only at retirement. The average asset income tax in this system is zero.     

The tradeoff between growth and equity in decentralization policy: China's experience

This paper investigates the potential tradeoff between economic growth and regional equity in the design of fiscal decentralization policy in the context of China's experience. We develop a theoretical model of fiscal decentralization, where overall national economic growth and equity in the regional distribution of fiscal resources are the two objectives pursued by the central government. The model is tested using panel data for 1985–98. We find that fiscal decentralization in China has led to economic growth as well as to significant increases in regional inequality.     

Individual risk and Lebesgue extension without aggregate uncertainty

Many economic models include random shocks imposed on a large number (continuum) of economic agents with individual risk. In this context, an exact law of large numbers and its converse is presented in [Y.N. Sun, The exact law of large numbers via Fubini extension and characterization of insurable risks, J. Econ. Theory 126 (2006) 31-69] to characterize the cancellation of individual risk via aggregation. However, it is well known that the Lebesgue unit interval is not suitable for modeling a continuum of agents in the particular setting. The purpose of this paper is to show that an extension of the Lebesgue unit interval does work well as an agent space with various desirable properties associated with individual risk.     

The benefits of central bank's political independence

We consider a two-tier model of monetary policy where the central banker is both subject to the explicit influence of elected political principals through contracts and the implicit influence of interest groups willing to capture monetary policy. We analyze the impact of granting independence to the central banker on the scope for capture and the agency costs of delegating the monetary policy to a central banker. Political independence increases those agency costs but significantly stabilizes the politically induced fluctuations of inflation and improves ex ante social welfare.     

The veil of public ignorance

A theory of cooperative choice under incomplete information is developed in which agents possess private information at the time of contracting and have agreed on a utilitarian “standard of evaluation” governing choices under complete information. The task is to extend this standard to situations of incomplete information. Our first main result generalizes Harsanyi's (J. Polit. Econ. 63 (1955) 309) classical result to situations of incomplete information, assuming that group preferences satisfy Bayesian Coherence and Interim Pareto Dominance. These axioms are mutually compatible if and only if a common prior exists. We argue that this result partly resolves the impossibility of Bayesian preference aggregation under complete information.     

The role of independence in the Green-Lin Diamond-Dybvig model

Green and Lin study a version of the Diamond-Dybvig model with a finite number of agents, independence (independent determination of each agent's type), and sequential service. For special preferences, they show that the ex ante first-best allocation is the unique equilibrium outcome of the model with private information about types. Via a simple argument, it is shown that uniqueness of the truth-telling equilibrium holds for general preferences—and, in particular, for a constrained-efficient allocation whether first-best or not. The crucial assumption is independence.