The consequences of an unknown debt target

Several proposals to reduce U.S. debt reveal large differences in their targets. We examine how an unknown debt target affects economic activity using a real business cycle model in which Bayesian households learn about a state-dependent debt target in an endogenous tax rule. Recent papers use stochastic volatility shocks to study fiscal uncertainty. In our setup, the fiscal rule is time-varying due to unknown changes in the debt target. Households infer the current debt target from a noisy tax rule and jointly estimate the transition probabilities. Three key findings emerge from our analysis: (1) limited information about the debt target amplifies the effect of tax shocks through changes in expected tax rates; (2) the welfare losses are an order of magnitude larger when both the debt target state and transition matrix are unknown than when only the debt target state is unknown to households; (3) an unknown debt target likely reduced the stimulative effect of the ARRA and uncertainty about the sunset provision in the Bush tax cuts may have slowed the recovery and led to welfare losses.     

HOUSEHOLD DEBT AND ATTITUDES TOWARD RISK

We explore the relationship between attitudes toward risk and the level of debt at the household level for a sample of households drawn from the U.S. Panel Study of Income Dynamics (PSID) over the period 1984 to 2007. Using a sequence of questions from the 1996 PSID, we analyze the implications of interpersonal differences in attitudes toward risk for the accumulation of unsecured debt, secured debt, and total debt at the household level. Our empirical findings suggest that attitudes toward risk are an important determinant of the level of debt acquired at the household level with risk aversion being inversely related to the level of debt accumulated by households.     

The 2008 tax rebate and US household debt

Starting in May 2008, the US government disbursed over $100 billion to households in the form of tax rebates. Embedded in the Economic Stimulus Act of 2008, the rollout was aimed at limiting, or possibly reversing, the negative effects of the recession that was just starting. Substantial research concentrated on capturing the impact of the stimulus on consumption behaviour. Prior research suggests that the tax rebate had a small and/or no positive effect. This raises the question: How did individuals spent their tax rebate? Using data from the Survey of Income and Program Participation 2008 panel wave 1 topical module, the data suggest that more than half of the respondents, who received the rebate, used this one-time windfall to pay off debt. Our findings indicate that this effect is more pronounced among low-income individuals, who chose to service their debt burden instead of increasing immediate consumption. The findings point to a stabilizing effect of the tax rebate programme on the financial sector, suggesting that substantial distributional asymmetries exist concerning tax rebate programmes in an economy where a large share of households are indebted.     

债务限额、税收自主权与地方政府隐性债务风险

债务限额管理对隐性债务风险的影响是目前相关研究中的薄弱环节。本文基于全国30个省份2010—2018年的面板数据,运用广义双重差分模型进行了实证研究。研究发现,债务限额没有起到约束隐性债务增长的作用,且债务限额空间减少会加剧隐性债务风险扩张。这一效应在中西部地区尤为明显,而提高税收自主权会减弱债务限额的不利影响。以地方官员集体决策制度（省级党委常委会）衡量的地区异质性分析发现,债务限额对地方隐性债务风险的不利影响在中央下派常委比例高的地区更小。进一步对债务限额进行细分研究发现,地方债置换和新增债券发行对隐性债务风险有不同影响。本文的政策含义是治理地方隐性债务风险需要将债务限额制度、官员行为、财税体制改革结合起来,标本兼治,才能真正实现隐性债务风险化解目标。     

Characteristics of households in the informal sector of an emerging economy

Using the case study of Trinidad and Tobago, we investigate the socio-economic, demographic and attitudinal characteristics of households that participate in the informal sector of an emerging economy and their perception of the risk of detection by tax authorities while doing so. Data are gathered from a cross-sectional field survey covering 570 households. Results using multinomial logit and ordered probit models suggest that households are motivated to participate in the informal sector when members spend little time in formal sector activity, believe that taxes are too high and their incomes are too low, have dependents to support and believe that the resulting tax evasion will go undetected. Their perception of the risk of detection by the tax authority is determined largely by the income they earn in the formal sector and the extent of government bureaucracy prevailing there.     

Corporate Debt,Hybrid Securities,and the Effective Tax Rate

Effective tax rates (ETRs) are useful tools to make comparisons between different tax systems. However, the existing ETR measures are based on rather simplifying assumptions. In particular, they disregard the existence of different kinds of debt and hybrid securities. In this paper, we use contingent‐claim analysis to calculate the ETR. We will therefore deal with both pure debt and two of the most well‐known hybrid securities, that is, convertible and reverse convertible bonds. We will show that effective taxation crucially depends on the characteristics of debt and that the existing measures of ETR can be dramatically biased, since they account neither for default risk nor for the ability to convert debt into equity.     

Investment under Uncertainty, Debt and Taxes

It is common practice in financial derivative valuation to use a discount factor based on the riskless debt rate. But, to what extent is this discount factor appropriate for cash flows emerging in capital budgeting? To answer this question, we introduce a framework for real asset valuation that considers both personal and corporate taxation. We first discuss broad circumstances under which personal taxes do not affect valuation. We show that the appropriate discount rate for equity‐financed flows in a risk‐neutral setting is an equity rate that differs from the riskless debt rate by a tax wedge due to the presence of personal taxation. We extend this result to the valuation of the interest tax shield for exogenous debt policy with default risk. Interest tax shields, which accrue at a net rate corresponding to the difference between the corporate tax rate and a tax rate related to the personal tax rates, can have either positive or negative values. We also provide an illustrative real options application of our valuation approach to the case of an option to delay investment in a project, showing that the application of Black and Scholes formula may be incorrect in presence of personal taxes.     

Optimal Income Taxation with Risky Earnings: A Synthesis

We study optimal nonlinear income taxation when earnings can differ because of both ability and luck, so the income tax has both a redistributive role and an insurance role. A substantial literature on optimal redistribution in the absence of risk has evolved since Mirrlees's original contribution. The literature on the income tax as a social insurance device is more limited. It has largely assumed that households are ex ante identical so unequal earnings are due to risk alone. We provide a general treatment of the optimal income tax under risk when households differ in ability. We characterize optimal marginal tax rates and interpret them in terms of redistribution, insurance, and incentive effects. The case of ex ante identical households and the no‐risk case with heterogeneous abilities come out as special cases.     

Taxes,risk taking,and financial stability

After the global financial crisis, the use of taxes to enhance financial stability received new attention. This paper analyzes the corrective role of taxes in banking and compares two instruments, namely, an allowance for corporate equity (ACE), which mitigates the debt bias in corporate taxation, and a Pigovian tax on bank debt (bank levy). We emphasize financial stability gains driven by lower bank asset risk and develop a principal-agent model, in which risk taking depends on the bank's capital structure and, by extension, on the tax treatment of debt and equity. We find that (i) the ACE unambiguously reduces risk taking, (ii) bank levies reduce risk taking if they are independent of bank performance but may be counterproductive otherwise, and (iii) taxes are especially effective if regulatory capital requirements are constrained to low levels.     

Comments on Articles by Eli Ginzberg and Manley Irwin and Kenneth B. Stanley

Financial institutions engage in financial innovation to increase profits. The resulting increases in consumer debt, however, make low income groups vulnerable to declines in income; households headed by women are particularly vulnerable. Consumers are disadvantaged given the asymmetry between business and consumer choices. Consumers use credit for many reasons including pecuniary emulation and supporting others, support that often falls to women. The paper examines the ratio of debt to financial assets, the ratio of debt to income, the ratio of dept payments to income, and the rate of bankruptcy as indicators of the fragility of household balance sheets.     

On The Distributional Effects Of Reducing Capital Taxes*

This article asks whether household heterogeneity and market incompleteness have quantitatively important implications for the welfare effects of tax changes. We compare a representative‐agent economy to an economy in which households face idiosyncratic uninsurable income risk. The income process is consistent with empirical estimates and implies a realistic wealth distribution. We find that capital tax cuts imply large welfare gains in the representative‐agent economy. However, when households are heterogeneous, substantial redistribution during transition means that only a minority will support capital tax cuts, whereas most households can expect large welfare losses.     

The impact of government debt on the long-run natural real interest rate – a quantitative evaluation

Persistently low natural real interest rates are a problem for monetary policy and financial stability. I analyse to what extent a permanent increase in government debt that is financed by higher taxes could raise the long-run natural real interest rate. As a measurement tool, I use an incomplete markets model with capital and government bonds. Increasing the public debt/GDP ratio by one percentage point raises the real interest rate by between 0.4 and 1.5 basis points, depending on the degree of inequality generated by the model and the tax instrument used to balance the government’s budget constraint. I also show that the interest rate effect of a change in public debt/GDP predicted by the model is significantly smaller than its empirical counterpart for the US, due to the fact that the model understates the empirical fraction of households that are constrained in their consumption decision.     

Optimal Taxation of Risky Human Capital*

In a two‐period life‐cycle model with ex ante homogeneous households, earnings risk, and a general earnings function, we derive the optimal linear labor tax rate and optimal linear education subsidies. The optimal income tax trades off social insurance against incentives to work. Education subsidies are not used for social insurance, but they are only targeted at offsetting the distortions of the labor tax and internalizing a fiscal externality. Both optimal education subsidies and tax rates increase if labor and education are more complementary, because education subsidies indirectly lower labor tax distortions by stimulating labor supply. Optimal education subsidies (taxes) also correct non‐tax distortions arising from missing insurance markets. Education subsidies internalize a positive (negative) fiscal externality if there is underinvestment (overinvestment) in education because of risk. Education policy unambiguously allows for more social insurance if education is a risky activity. However, if education hedges against labor‐market risk, optimal tax rates could be lower than in the case without education subsidies.     

Debt and Currency Crises—Complements or Substitutes?*

Debt and currency crises are closely interlinked through the government's intertemporal budget constraint. The default tax and the inflation/devaluation tax can be considered as alternative means of financing. Our empirical analysis finds that high‐debt countries choose default rather than inflation/devaluation for financing, while a high money stock reduces the probability of debt crises. Further, we find strong evidence that debt and currency crises share common fundamental causes. Finally, there is a Granger causality running from debt crises to currency crises, but only weakly in the other direction.     

S-based taxation under default risk

This article studies the characteristics of a S-based tax system under default risk. In particular we show that its neutrality properties depend on whether debt is protected or unprotected. In the former case, this system is neutral. In the latter case, where default timing is optimally chosen by shareholders, the S-based system is neutral with respect to real decisions only if the firm's and the lender's tax rate are equal. However, the shareholders' decision to default is always distorted.     

Social security and unsecured debt

In this paper, we use a calibrated life-cycle model to explore quantitatively ways of reducing the burden of social security in a world populated by both optimizing and rule-of-thumb consumers. Social security contributions force young households with upward-sloping income profiles to save a sizeable portion of their income for retirement, when their optimal consumption plan would likely have them either saving little or borrowing. We first use household data to document that young households have accumulated social security contributions that are large relative to debt holdings. Then, using a calibrated life-cycle model, we show that both allowing households to use social security wealth to pay off their debt and exempting young households from social security contributions (but in both cases requiring higher contributions later) mitigate many of the inefficiencies of social security from the perspective of life-cycle financial planning. Specifically, in our preferred experiment, which exempts households whose heads are under 30 from making social security contributions, we find that certainty-equivalent consumption increases by 3.4% for optimizing households and by 3.3% for rule-of-thumb households.     

Debt monetization,inflation, and the ‘neutral’ interest rate

The main purpose of this study is to explore the potential expansionary effect stemming from the monetization of debt. We develop a simple macroeconomic model with Keynesian features and four sectors: creditor and debtor households, businesses, and the public sector. We show that such expansionary effect stems mainly from the reduction in the financial cost to servicing the public debt. The efficacy of the channel that operates allegedly through the compression of the risk/term premium on securities is found to be ambiguous. Finally, we show that countries that issue their own currency can avert getting stuck in a structural ‘liquidity trap’ provided their central banks are willing to monetize the debt created by a strong enough fiscal expansion.     

Addiction to debt forgiveness in developing countries: Consequences and who gets picked?

We explore whether the expectation of debt forgiveness discourages developing countries from attaining sustainable fiscal independence through improving their tax effort. While the international financial community advises poor countries to improve revenue mobilization, the same international community routinely bails out poor countries that fail to meet their loan repayment obligations, among other reasons as a result of the low tax effort they exercise. The act of bailing out creates an expectation about receiving debt forgiveness time and again in the future. The key prediction of our theoretical framework is that in the presence of debt forgiveness, countries’ tax efforts will decline and more so the higher the intensity of the bailouts. We test this proposition using data for 55 countries from 1995 to 2015. We find that debt forgiveness is significant in lowering tax effort. In addressing the potential of reverse causality, we also find that the international financial community has been more forgiving to countries that exert lower tax effort. These results, which are robust to various specifications, have significant policy implications for donor and recipient countries.     

What can Islamic financing tell us about macro-prudential policies?

Macro-prudential policies are theoretically effective at mitigating a debt deflation crisis by forcing individuals to internalize their impact on aggregate prices reducing systemic risk caused by pecuniary externalities. To better understand the potential effectiveness of a macro-prudential time varying tax/subsidy on debt/dividends, we empirically estimate the impact of an Islamic financing presence on financial crises. Adherence to Islamic financing principles for a nontrivial portion of a country’s population has similar impacts to a macro-prudential policy in that these limited asset holders are likely to hold less debt or use debt-like instruments rather than conventional debt, driving down their marginal rate of substitution and the price of equity in equilibrium. To empirically estimate the effects of this policy, we interact an Islamic financing variable with debt in an otherwise standard model of financial crises. The results show that this macro-prudential-like policy decreases the likelihood of a banking crisis by 50%. The contribution of the article is twofold. First, we show that an Islamic finance presence encourages precautionary savings like a macro-prudential policy. Second, using an Islamic finance presence to capture macro-prudential potential effects, we find empirically that the likelihood of banking crises are cut roughly by half when such policies are in effect.     

Tax evasion in transition: Outcome of an institutional clash? Testing Feige's conjecture in Albania

A field survey of households was conducted in Tirana, Albania in 2000. A response rate of 89.3% yielded 1.340 valid questionnaires, allowing me to test Feige's (In: Nelson, J.M., Tilley, C., Walker, L. (Eds.), Transforming Post-communist Political Economics. National Academy Press, Washington, DC, p. 21) conjecture that more tax evasion will be observed, when formal and informal institutions clash. Respondents’ attitudes towards formal and informal institutions were obtained by applying factor analysis to their responses to a series of attitudinal questions. The theoretical importance of the interaction between formal and informal institutions in determining tax evasion finds empirical support in the data.