Tax treatment of owner occupied housing and wealth inequality

We construct a quantitative general equilibrium lifecycle model with housing tenure decisions to investigate the degree to which wealth inequality in the United States is affected by the preferential tax treatment of home-ownership. Favorable tax treatment of owner occupied housing in the form of home mortgage interest and property tax deductibility, and the untaxed nature of imputed rents, provides a financial incentive for home-ownership over renting as well as an incentive to “over-consume” housing since houses are not fungible. Since the favorable tax treatment of housing disproportionately creates tax savings for the upper quantiles of the income distribution, we quantify how it contributes to the heavily right skewed distribution of wealth in the United States using data from the Survey of Consumer Finances. We consider a revenue-neutral government response to the counter factual experiments of removing the current tax structure on housing. Our quantitative analysis shows that, in terms of distributional effects, removing all of the preferential tax treatments results in an aggregate increase in welfare. However, we do not find any reduction in inequality. We also find that while some re-allocation toward financial assets occurs, households primarily increase their consumption when imputed housing rents are taxed and the property tax deduction is removed. Thus housing tax policy may be effective at encouraging more overall saving through housing assets.     

The existence, uniqueness, and optimality of the terminal wealth depletion time in life-cycle models of saving under uncertain lifetime and borrowing constraint

In life-cycle models of saving under uncertain lifetime and borrowing constraint, the consumer's wealth must be depleted before the maximum lifetime. This paper investigates the existence, uniqueness, and optimality of the terminal wealth depletion time. It is proved that the optimal terminal wealth depletion time, if such exists, must be unique. If the equation that determines the optimal terminal wealth depletion has multiple solutions, then the location of the optimal solution will depend on the configuration of the solutions. An optimality test is developed to verify whether a candidate solution for the terminal wealth depletion time is indeed optimal. The paper introduces a method new to economics, the Dubovitskii-Milyutin adjoint equation, to analyze the properties of the optimal control problem.     

Self-insurance vs. self-financing: A welfare analysis of the persistence of shocks

We study the welfare cost of market incompleteness in a generalized Bewley model where idiosyncratic risk takes the form of entrepreneurial productivity shocks. Market incompleteness in our framework has two dimensions. First, in the Bewley tradition, only a limited set of instruments for consumption smoothing is available. Second, entrepreneurs? capital rental is subject to collateral constraints. As is well known, it is harder to self-insure against more persistent shocks, and the welfare cost of missing consumption insurance increases with shock persistence. On the other hand, with collateral constraints, an increase in shock persistence leads to better allocation of production factors through entrepreneurs? self-financing, and the welfare cost of imperfect capital rental markets decreases with shock persistence. The overall welfare cost of market incompleteness can be increasing, decreasing, or even non-monotone in shock persistence, depending on the relative strengths of its two components—the cost of missing insurance and the cost of imperfect capital markets.     

Optimal consumption and the timing of the resolution of uncertainty

As is well-known, consumers want to accumulate precautionary savings in the face of income risks when their marginal utility is convex (prudence). In this paper, we explore the effect of the timing of the resolution of income uncertainty on savings. An agent faces uncertainty about his income at date t+2. What is the effect of being informed that the uncertainty will be resolved at date t+1 on the consumption at date t? We show that the effect is positive, if and only if, marginal utility is convex (prudence), when either the risk free rate is equal to the rate of pure preference for the present, or when the utility function is HARA. The intuition is that an early resolution of uncertainty allows for time-diversifying the risk. It therefore plays a role similar to a reduction of the income risk, whose effect on savings is negative under prudence.     

Over-savings and hyperbolic discounting

Hyperbolic discounting models are widely seen as implying that consumers do not save enough, in accordance with the observed low rates of savings of some households. This paper qualifies this view by showing that hyperbolic consumers may ‘oversave’ in the short run. The result extends to uncertainty on future income and does not depend on whether preferences are present-biased or future-biased. A generalized comparative statics analysis of self-control is introduced, and its relationship to the analysis of uncertainty on discount factors is emphasized.     

Saving rates and portfolio choice with subsistence consumption

We analytically show that a common across rich/poor individuals Stone-Geary utility function with subsistence consumption in the context of a simple two-asset portfolio-choice model is capable of qualitatively and quantitatively explaining: (i) the higher saving rates of the rich, (ii) the higher fraction of personal wealth held in risky assets by the rich, and (iii) the higher volatility of consumption of the wealthier. On the contrary, time-variant “keeping-up-with-the-Joneses” weighted average consumption which plays the role of moving benchmark subsistence consumption gives the same portfolio composition and saving rates across the rich and the poor, failing to reconcile the model with what micro data say.     

Education, segregation and marital sorting: theory and an application to the UK

This paper presents a model of the intergenerational transmission of education and marital sorting. Parents matter both because of their household income and because their human capital determines the distribution of a child's disutility from making an effort to become skilled. We show that an increase in segregation has potentially ambiguous effects on the proportion of individuals that become skilled in the steady state, and hence on marital sorting, the personal and household income distribution, and welfare. We calibrate the steady state of our model to UK statistics. We find that an increase in the correlation of spouses in their years of education will bring about a small increase in the proportion of skilled individuals when the relative supply of skilled individuals is variable at the family level and a decrease when this supply is fixed. Ex-ante utility (of an unborn individual) increases in the first case and decreases in the second. The welfare effect of increased sorting is negative for unskilled individuals and positive for skilled individuals. Increased segregation always leads to an increase in welfare inequality between skilled and unskilled individuals.     

Consumption externalities, production externalities, and efficient capital accumulation under time non-separable preferences

The effects of consumption and production externalities on economic performance under time non-separable preferences are examined both theoretically and numerically. We show that a consumption externality alone has long-run distortionary effects if and only if labor is supplied elastically. With fixed labor supply, it has only transitional distortionary effects. Production externalities always generate long-run distortions, irrespective of labor supply. The optimal tax structure to correct for the distortions is characterized. We compare the implications of this model with those obtained when the consumption externality is contemporaneous. While some of the long-run effects are robust, there are also important qualitative and quantitative differences, particularly along transitional paths.     

Modeling internal commitment mechanisms and self-control: A neuroeconomics approach to consumption–saving decisions

We provide a new model of consumption–saving decisions which explicitly allows for internal commitment mechanisms and self-control. Agents have the ability to invoke either automatic processes that are susceptible to the temptation of ‘over-consuming,’ or alternative control processes which require internal commitment but are immune to such temptations. Standard models in behavioral economics ignore such internal commitment mechanisms. We justify our model by showing that much of its construction is consistent with dynamic choice and cognitive control as they are understood in cognitive neuroscience.The dynamic consumption–saving behavior of an agent in the model is characterized by a simple consumption–saving goal and a cut-off rule for invoking control processes to inhibit automatic processes and implement the goal. We discuss empirical tests of our model with available individual consumption data and we suggest critical tests with brain-imaging and experimental data.     

Income inequality, consumption, and social-status seeking

Using the Chinese Urban Household Survey data between 1997 and 2006, we find that income inequality has a negative (positive) effect on household consumption net of education expenditures (savings) even after we control for household income. We argue that people save to improve their social status when social status is associated with pecuniary and non-pecuniary benefits. Rising income inequality can strengthen the incentives of status-seeking savings by increasing the benefit of improving status, and by enlarging the wealth level required for status upgrading. We also find that the negative effect of income inequality on consumption is stronger for poorer and younger people and that income inequality stimulates more education investment, which are consistent with the status-seeking hypothesis.     

Consumption habits in an overlapping-generations model

This paper introduces consumption habits in the Blanchard (1985) overlapping-generations model. It shows that steady-state capital and consumption are higher if individuals have habits than otherwise. Moreover, “inward habits” lead to higher steady-state capital and consumption compared to “outward habits.”     

Inflation,nominal portfolios,and wealth redistribution in Canada

Abstract This paper quantifies the redistributional effects of inflation in Canada that arise through the revaluation of nominal assets and liabilities. We find that the effects are non‐trivial even for low inflation episodes. The main winners are young, middle‐class households with mortgage debt. The government receives a windfall gain from its long‐term debt. The old, the rich or the middle‐aged, middle‐class lose, largely owing to their holdings of bonds and non‐indexed defined benefit pension assets. Finally, our Canada‐U.S. comparison reveals that the extent of redistributions can be quite different even between countries of similar economic and legal environments.     

Moving costs, nondurable consumption and portfolio choice

The substantial adjustment cost for housing affects nondurable consumption and portfolio allocations, as well as the frequency of housing transactions. A simple theoretical model, roughly calibrated, is used to assess the quantitative impact of adjustment costs on those decisions. The impact on portfolios is found to be significant, suggesting that housing wealth should be useful in empirical studies of portfolio choice. The welfare loss from the transaction cost is also substantial. The effect on nondurable consumption is small, however, so adjustment costs can explain only a small part of the equity premium puzzle.     

Subjective random discounting and intertemporal choice

This paper provides an axiomatic foundation for a particular type of preference shock model called the random discounting representation where a decision maker believes that her discount factors change randomly over time. For this purpose, we formulate an infinite horizon extension of [E. Dekel, B. Lipman, A. Rustichini, Representing preferences with a unique subjective state space, Econometrica 69 (2001) 891-934], and identify the behavior that reduces all subjective uncertainties to those about future discount factors. We also show uniqueness of subjective belief about discount factors. Moreover, a behavioral comparison about preference for flexibility characterizes the condition that one's subjective belief second-order stochastically dominates the other. Finally, the resulting model is applied to a consumption-savings problem.     

Discounting and altruism to future decision-makers

Is discounting of future decision-makers’ consumption utilities consistent with “pure” altruism toward those decision-makers, that is, a concern that they are better off according to their own, likewise forward-looking, preferences? It turns out that the answer is positive for many but not all discount functions used in the economics literature. In particular, “hyperbolic” discounting of the form used by Phelps and Pollak (Rev. Econ. Studies 35 (1968) 201) and Laibson (Quart. J. Econ. 112 (1997) 443) is consistent with exponential altruism towards future generations. More generally, we establish a one-to-one relationship between discount functions and altruism weight systems, and provide sufficient, as well as necessary, conditions for discount functions to be consistent with pure altruism.     

Modes of foreign bank entry and effects on lending rates: Theory and evidence

Policy makers who decide to liberalize foreign bank entry frequently put limitations on the mode of entry. We study how different entry modes affect the lending rates of foreign and domestic banks. In our model, the mode of entry determines whether a foreign bank inherits a customer base. This, in turn, affects how information is distributed between foreign and domestic banks. We show that this distribution of information about incumbent customers leads to stronger competition if foreign entry occurs through a greenfield investment. As a result, domestic bank lending rates are lower after greenfield entry. We find empirical support for this prediction for a sample of banks from 10 Eastern European countries for the period 1995–2003.     

Subjective mortality expectations and consumption and saving behaviours among the elderly

Abstract Life expectancy is an important factor that individuals have to take into account for saving and consumption choices. The life‐cycle model of consumption and saving behaviour predicts that consumption growth should decrease with higher mortality rates. The aim of this study is to test this hypothesis based on data about subjective longevity expectations from the Health and Retirement Study merged with detailed consumption data from two waves of the Consumption and Activities Mail Survey. This study finds that an increase in subjective mortality by 1% corresponds to an annual decrease in consumption of non‐durable goods of around 1.8%.     

An experimental study on individual choice, social welfare, and social preferences

We experimentally study subjects’ compliance with dominance relationships of income distributions in a ranking task. The experiment consisted of four different treatments: Lottery, individual choice, social preferences, and social planner. Our results suggest that people's risk attitudes do not adequately reflect their inequality attitudes. Uninvolved social planners exhibit randomization preferences, while self-interested social planners are generally more inequality averse and try to avoid extreme outcomes.     

Intergenerational mobility and macroeconomic history dependence

A large literature on ‘endogenous inequality’ has argued that persistent differences in macroeconomic performance across countries can be explained by historical inequality, owing to indivisibilities in occupational choice and borrowing constraints. These models are characterized by homogenous agents, a continuum of steady states (SSs) and lack of mobility in every SS. We show that introducing (even a little) heterogeneity in order to generate SS mobility shrinks the SS set dramatically. Mobile SSs are generically locally unique and finite in number. Sufficient conditions for global uniqueness and convergence of competitive equilibrium dynamics are provided.     

Will the consumption externalities' effects in the Ramsey model please stand up?

According to the prior literature, in a Ramsey model, consumption externalities have no impact on steady state behavior, once labor supply is exogenous. In contrast, this paper argues that — in the presence of technical change — consumption externalities always affect steady state behavior, via their impact on the elasticity of marginal utility of consumption.