Optimal tax policy and expected longevity: a mean and variance utility approach

This paper studies the normative problem of redistribution between agents who can influence their survival probability through private health spending, but who differ in their attitude towards the risks involved in the lotteries of life to be chosen. For that purpose, a two-period model is developed, where agents’ preferences on lotteries of life can be represented by a mean and variance utility function allowing, unlike the expected utility form, some sensitivity to what Allais (Econometrica 21(4), 503–546, 1953) calls the ‘dispersion of psychological values’. It is shown that if agents ignore the impact of health spending on the return of their savings, the decentralization of the first-best utilitarian optimum requires intergroup lump sum transfers and group-specific positive taxes on health spending. Under asymmetric information, a differentiated taxation across agents is still required, but subsidizing health spending may be optimal as a way to solve the incentive problem.     

The welfare comparison of corrective ad valorem and unit taxes under monopolistic competition

The ad valorem versus unit tax debate has traditionally emphasized tax yield. On this criterion, ad valorem taxes outperform unit taxes in terms of welfare for a wide range of imperfect competition settings including Dixit–Stiglitz monopolistic competition. However, in a number of policy fields such as environmental, health, and trade economics, policy makers use taxes to reduce the production/consumption volume in an industry, i.e., to correct an externality rather than to improve tax yield. This paper compares the two tax instruments with respect to equal corrective effect in a Dixit–Stiglitz setting with love of variety, entry, exit, and redistribution of tax revenues. We find that unit taxes lead to more firms in the industry, less output per firm, less tax revenue, but higher welfare compared to ad valorem taxes.      

The role of the corporate income tax as an automatic stabilizer

This paper analyses the effectiveness of the corporate income tax as an automatic stabilizer. It employs a unique firm-level data set of German manufacturers combining financial statements with firm-specific information about credit market restrictions. The results show that approximately 20 per cent of all firms report both positive taxable income and capital market restrictions. Taking account of the income tax rates and the size differences of the firms, we find that demand stabilization through the corporate income tax amounts to about 8 per cent of an initial shock to gross revenues. This stabilization effect varies over the business cycle and tends to increase during cyclical downturns.     

Rent taxation and its intertemporal welfare effects in a small open economy

Previous literature concludes that replacing wage taxation by taxes on a fixed factor or its rents benefits future generations. However, the effects of such steady-state gains on the transition generations have been left open. In this paper, we show that taxation of rents may also increase utility of the current generation provided tax revenues are earmarked to reduce wage taxes. In particular, a shift in the tax mix may yield an intergenerational Pareto-improvement when the initially prevailing tax mix is sufficiently skewed toward wage taxation.     

The welfare loss from differential taxation of sectors in Germany

In the spirit of Harberger, we apply a dynamic computable general equilibrium (CGE) model and estimate the excess burden stemming from the tax-induced distortion in the allocation of capital across the corporate and the non-corporate sectors in Germany. In doing so, we perform a counterfactual analysis and ask how the allocation of capital across sectors would change compared with a sector-neutral tax system which assures an identical effective tax burden on both sectors. Our estimates suggest that the excess burden per-period amounts to approximately 2.2 billion Euros or to about 0.1 per cent of GDP. In present value terms, the excess burden translates to about 89 billion Euros or 4.0 per cent of GDP. In order to identify the impact of the firm’s financial behaviour on the size of the emerging excess burden, we perform several sensitivity analyses with regard to debt financing, external equity financing and debt constraints via agency cost.     

On irregular functionals of SDEs and the Euler scheme

We prove a sharp upper bound for the error $\mathbb {E}|g(X)-g(\hat{X})|^{p}We prove a sharp upper bound for the error in terms of moments of , where X and are random variables and the function g is a function of bounded variation. We apply the results to the approximation of a solution to a stochastic differential equation at time T by the Euler scheme, and show that the approximation of the payoff of the binary option has asymptotically sharp strong convergence rate 1/2. This has consequences for multilevel Monte Carlo methods. The author was supported by the Finnish Graduate School in Stochastics and Statistics, the Ellen and Artturi Nyyss?nen Foundation, and the Academy of Finland, project #110599.     

Tax structure,size of government,and the extension of the voting franchise in Western Europe, 1860–1938

We study the consequences of the extension of the voting franchise for the size of (central) government and for the tax structure in ten western European countries, 1860–1938. The main hypothesis under investigation is that the impact of the franchise extension on the tax structure is conditional on tax collection costs. We find that the share of direct taxes (including the personal income tax) is positively affected by the franchise extension, but only if relative tax collection costs are below a given threshold. We use literacy as a proxy for the cost of levying a broad-based income tax. We also show that the gradual relaxation of income and wealth restrictions on the right to vote contributed to growth in total government spending and taxation.      

Exports,foreign direct investment,and the costs of corporate taxation

This paper develops a model of a monopolistically competitive industry with extensive and intensive investment and shows how these margins respond to changes in average and marginal corporate tax rates. Intensive investment refers to the size of a firm’s capital stock. Extensive investment refers to the firm’s production location and reflects the trade-off between exports and foreign direct investment as alternative modes of foreign market access. The paper derives comparative static effects of the corporate tax and shows how the cost of public funds depends on the measures of effective marginal and average tax rates and on the elasticities of extensive and intensive investment. The paper was presented in 2006 at the German public finance meeting in Giessen; the Institute for Advanced Studies in Vienna; the ESF/CEPR Workshop on Outsourcing, Migration and the European Economy in Rome; the University of St. Gallen; the Graduate Institute for International Studies in Geneva, and in 2007 at the International Monetary Fund in Washington, DC, the CESifo Area Conference in Public Sector Economics in Munich and the 63rd IIPF Congress in Warwick. I appreciate stimulating comments by Michael Devereux and seminar participants and, in particular, by the discussants Andreas Haufler and Nadine Riedl, an anonymous referee and the editor Richard Cornes.     

Neutral taxation of shareholder income? Corporate responses to an announced dividend tax

The introduction of the 2006 Norwegian shareholder income tax was announced in advance, and it increased top marginal tax rates on individual dividend income from zero to 28%. We document strong timing effects on dividend payout on a large panel of non-listed corporations, with a surge of dividends prior to 2006 and a sharp drop after. Mature firms are more likely to pay dividends, and high asset growth increases the probability of retaining all earnings. Intertemporal income shifting through the timing of dividends seems to be a drain on internal equity and cause increases in the corporations’ debt–equity ratios. The debt ratios drop sharply after the implementation of the reform.     

A positive analysis of labor-market institutions and tax reforms

In this paper, we investigate the structure of the “Laffer curve” for taxes on labor and other factors of production, under different institutional frameworks of the labor market. Using a Cobb–Douglas production technology allows us to characterize important properties of the “Laffer curve” in terms of the wage share for a competitive labor market, the monopoly union model, the right-to-manage approach, the insider-dominated union, and efficient Nash bargains simultaneously. In this way, we are able to highlight the menu of factor tax systems, and thus of potential tax reforms available to a government, without perfect knowledge of the mechanism of the labor market. In particular, we show that the employment-maximizing tax system features a constant energy tax, while the energy mini-/maximizing tax system features a constant labor tax. We also illuminate to what extent these results must be modified if we either employ a CES production function, or if we allow for an endogenous reservation wage.     

Efficiency and equity of European education and training policies

This paper reviews empirical evidence, especially from Europe, on how education and training policies can be designed to advance both efficiency and equity. Returns to educational investments tend to decrease over the life cycle. Moreover, they are the highest for disadvantaged children at early stages and for the well-off at late stages of the life cycle. This creates complementarities between efficiency and equity at early stages and trade-offs at late stages. The paper discusses specific policies for efficiency and equity at each educational stage, ranging from early childhood education and schools over vocational and higher education to training and lifelong learning. The available evidence suggests that both efficiency and equity can be enhanced by output-oriented reforms properly designed to each stage, where the state generally sets a regulatory framework that ensures accountability and funding, and uses the forces of choice and competition to deliver best results. Designed this way, education and training systems can advance efficiency and equity at the same time. This paper is an adapted and revised version of the analytical report that accompanied the Communication and Staff Working Paper of the European Commission on “Efficiency and Equity in European Education and Training Systems” (ec.europa.eu/education/policies/2010/back_gen_en.html).     

International income risk-sharing and the global financial crisis of 2008–2009

We examine the impact of the global financial crisis on the degree of international income and consumption risk-sharing among industrial economies using returns on cross-border portfolio holdings (e.g., debt, equity, FDI). We split the returns from the net foreign holdings as receipts (inflows) and payments (outflows) to investigate which of the two sides exhibited the greater resilience for income risk-sharing during the recent crisis. First, we find that debt delivered better risk-sharing than equity, mainly reflecting the deficit deterioration in EMU countries during the post-crisis period. FDI, by contrast, did not correspond to noticeable risk diversification. Second, separating output shocks into positive and negative components reveals that debt holding receipts (equity liability payments) performed better under negative (positive) realizations of the shock variable. Third, the unwinding of capital flows resulted in a sharp fall in income dis-smoothing via the debt liability channel in the new EU countries.     

Is Prescott right? Welfare state policies and the incentives to work, learn, and retire

This paper bolsters Prescott’s (Fed. Reserve Bank Minneap. Q. Rev. 28(1):2–13, 2004) claim that high taxes are responsible for lackluster labor market performance in Continental European countries. We develop a life-cycle model with endogenous skill formation, endogenous labor supply, and endogenous retirement. Labor taxation distorts not only labor supply, but also education and retirement decisions. Actuarially unfair pensions further exacerbate labor tax distortions on retirement. Education subsidies can nevertheless cushion the adverse impact of taxation on skill formation. Feedbacks between education, labor supply, and retirement are important. The model is simulated with realistic behavioral elasticities that are consistent with microeconometric evidence. If, besides labor supply, also learning and retirement are endogenous, the uncompensated (compensated) elasticity of the tax base equals 0.46 (0.85), which is more than twice as large as the standard uncompensated (compensated) labor supply elasticity of 0.18 (0.40). Furthermore, life-cycle interactions between education, working, and retirement are quantitatively important and the interactions raise all behavioral elasticities substantially. For example, the uncompensated labor supply elasticity increases with one-half due to life-cycle interactions (to 0.26). We demonstrate that low European labor supply can be fully explained by taxation without relying on unrealistically high labor supply elasticities. Reducing labor market distortions, cutting benefit levels, lowering tax rates, and making (early) retirement actuarially more fair, therefore, boosts labor supply, delays retirement, and stimulates skill formation. In addition, high education subsidies are needed in large welfare states to offset explicit and implicit tax burdens on human capital investment.      

Accounting information,disclosure, and expected utility: Do investors really abhor uncertainty?

Investors are said to “abhor uncertainty,” but if there were no uncertainty they could earn only the risk‐free rate. A fundamental result in the analytical accounting literature shows that investors buying into a CARA‐normal CAPM market pay lower asset prices, gain higher ex‐ante expected returns, and obtain higher expected utility, when the market payoff has higher variance. New investors obtain similar “welfare” gains from risk under a log/power utility CAPM. These results do not imply that investors “abhor information.” To realize investors' ex‐ante expectations, the subjective probability distributions representing market expectations must be accurate. Greater payoff risk can add to investors' expected utility, but higher ex‐post(realized) utility comes from better information and more accurate ex‐ante expectations. An important implication for accounting is that greater disclosure can have the simultaneous effects of (i) exposing more fully or perceptibly firms' payoff uncertainty, thereby increasing new investors' expected utility, and (ii) improving market estimates of firms' payoff parameters (means, variances, covariances), thereby giving investors a better chance of realizing their expectations. Paradoxically, better information can be valuable to new investors by exposing more fully and more accurately the risk in firms' business operations and results–new investors maximizing expected utility want both more risk and better information.     

An applied analysis of ACE and CBIT reforms in the EU

We assess the quantitative impact of two reforms to corporation tax, which would eliminate the differential treatment of debt and equity: the allowance for corporate equity (ACE) and the comprehensive business income tax (CBIT). We explore the impact of these reforms on various decision margins, using an applied general equilibrium model for the EU calibrated with recent empirical estimates of elasticities. The results suggest that, if governments adjust statutory corporate tax rates to balance their budget, profit shifting and discrete location render CBIT more attractive for most individual European countries. European coordination makes a joint ACE more, and a joint CBIT less efficient. A combination of ACE and CBIT is always welfare improving.     

Do artificial income smoothing and real income smoothing contribute to firm value equivalently?

This paper examines the potential impacts of artificial smoothing (abnormal accruals) and real smoothing (derivatives) on firm value. We find that the value of the firm decreases with the magnitude of abnormal accruals and increases with the level of derivative use. Moreover, the accrual discount is more pronounced in firms with weak investor protection and the hedging premium is greater for poorly governed firms. These results suggest that although managers can engage in real smoothing to improve the informativeness of firms’ earnings and thus reduce agency costs, they might use artificial techniques to cosmetically improve the income stream in order to expropriate minority shareholders. In further support of agency theories, we report that poor corporate governance motivates the use of abnormal accruals and discourages derivative use.     

Does financial reporting above or below operating income matter to firms and investors? The case of investment income in China

We explore a unique regulatory change in China in 2007 that moves investment income in an income statement from below the line of operating income to above the line. We find that, post-regulatory change, firms report high investment income when core earnings (operating income excluding investment income) are low and vice versa. Investment income and core earnings exhibit a significantly negative correlation every year post regulation, in contrast to a significantly positive correlation beforehand. We also find that investors do not fully see through the change. Before the regulation, both core earnings and investment income are positively correlated with contemporaneous stock returns and uncorrelated with future stock returns, suggesting appropriate pricing of the information. However, afterward, the results on core earnings are similar to those in the pre-regulation period, but investment income is negatively correlated with future stock returns, implying that the stock market overreacts to the information in investment income in the contemporaneous year.     

Solvency II: state of play and perspectives

Solvency II is a complex project which will be introduced in different stages for entry into force on 1 January 2013. The economic risk based approach followed in Solvency II will provide the insurance industry with a modern solvency regime that corresponds more closely with the way the industry manages its business. The implementing measures which are to be adopted in the course of 2011 will take account of the results of QIS 5, the last major quantitative impact study. They will be incorporated into a Commission regulation that will be adopted following the new procedure introduced by the Lisbon Treaty. The adoption in 2010 of the new EU supervisory architecture will reinforce the objective of a single EU rulebook for insurance supervision with the creation of EIOPA, a new authority that replaces CEIOPS and that will have important powers, thereby reinforcing the EU component in insurance supervision. Solvency II will have a major impact on insurance products and markets. It is therefore important that insurance and reinsurance undertakings start their preparations now.     

Minimal sufficient conditions for a primal optimizer in nonsmooth utility maximization

We continue the study of utility maximization in the nonsmooth setting and give a counterexample to a conjecture made in Deelstra et al. (Ann. Appl. Probab. 11:1353–1383, 2001) on the optimality of random variables valued in an appropriate subdifferential. We derive minimal sufficient conditions on a random variable for it to be a primal optimizer in the case where the utility function is not strictly concave.     

Trade and domestic tax reforms in the presence of a public good and different neutrality conditions

This paper develops a perfectly competitive general-equilibrium model of a small open economy with production of private traded goods and of a public good which is financed by revenues from trade and domestic taxes. Within this framework we consider the effects on public good provision and on welfare of the following tax reforms: (i) a producer-price-neutral reduction in export taxes and a corresponding increase in production taxes, (ii) a consumer-price-neutral reduction in tariffs and a corresponding increase in consumption taxes, and (iii) a partial tax-revenue-neutral reform in trade and domestic taxes.