The marginal cost of public funds and the flypaper effect

A lump-sum intergovernmental transfer has a “price effect”, as well as an “income effect”, because it allows the recipient government to reduce its tax rate, which lowers its marginal cost of public funds, while still providing the same level of public service. This reduction in the effective price of providing the public service helps to explain the “flypaper effect”—the empirical observation that a lump-sum grant has a much larger effect on spending than an increase in personal income. Contrary to the assertions of Mieszkowski (Modern Public Finance, 1994) and Hines and Thaler (J. Econ. Perspect. 9:217–226, 1995), a model of a benevolent local government financing its expenditures with a distortionary tax predicts flypaper effects from lump-sum grants that are similar to those observed in many econometric studies.     

Evidence of the invisible: toward a credibility revolution in the empirical analysis of tax evasion and the informal economy

Empirical research about tax evasion and the informal economy has exploded in the past few decades, seeking to shed light on the magnitude and (especially policy) determinants of these phenomena. Quantitative information informs the analysis of policy choices, enables the testing of hypotheses about determinants of this phenomenon, and can help with the accurate construction of national income accounts. Even as empirical analysis has burgeoned, some have expressed doubts about the quality and usefulness of some prominent measures. The fact that high-quality data is elusive is neither surprising nor a coincidence. The defining characteristic of tax evasion and informal economic activity—that they are generally illegal—often renders unreliable standard data collection methods such as surveys. Unlike invisible phenomena in the natural sciences, these invisible social science phenomena are hard to measure because of choices made by individuals. Analysis of tax evasion and the informal economy must proceed even in the absence of the direct observability of key variables, and theory should guide the construction and interpretation of evidence of the “invisible.” In this paper, we address what can be learned using micro or macro data regarding tax evasion and the informal economy under given conditions and assumptions, and critically review some of the most common empirical methods in light of our conclusions. We conclude with an entreaty for researchers in this field to enlist in the “credibility revolution” (Angrist and Pischke in J. Econ. Perspect. 4(2):3–30, 2010) in applied econometrics.     

The capital structure of multinational companies under tax competition

This article studies the relation between debt policies of multinational companies (MNCs) and governments’ tax strategies. In the first part, we show that the ability to shift income from high- to low-tax countries affects MNCs’ financial choices. In the second part we show how MNCs’ financial decisions can affect the tax strategies of two governments competing to attract income.      

Taxpayers' responsiveness to tax rate changes and implications for the cost of taxation in Sweden

Historically, labor supply elasticities have been used to evaluate tax policy and predict tax revenue effects. They are likely to underestimate taxpayers' response to tax rate changes, and hence to underestimate changes in potential tax revenues, however, because they measure only how taxpayers alter hours worked. Taxpayers can also respond to tax rate changes by altering, for instance, their work effort and form of compensation. An alternative measure that accounts for these responses as well as hours worked is the elasticity of taxable income. This paper estimates the elasticity of earned taxable income for Swedish taxpayers using two different approaches and a number of control variables and the 1990/1991 tax reform as a “natural experiment”. The preferred elasticity estimates fall in the range of 0.4–0.5, comparable with recent estimates for the U.S. and larger than most of the labor supply elasticity estimates used to evaluate tax policy in Scandinavia previously, which suggests that deadweight losses are two to three times higher than previously thought. JEL Classification H21 · H24 · H31 · J22     

Poverty traps and intergenerational transfers

In this paper, by adopting an OLG neoclassical growth model, we show that intergenerational transfers may trigger the take off of an economy entrapped into poverty in a twofold way: (1) by eliminating the zero equilibrium, which, under technology with low factor substitutability, is always a “catching” point, so that the economy might start converging to a positive equilibrium. In this case, the appropriate instrument turns out to be a transfer from the old to the young, while there is no room for policies redistributing in the opposite direction (i.e., a pay-as-you-go pension scheme); (2) when the rich equilibrium is unstable—which can be the case under high intertemporal elasticity of substitution of individuals—the introduction of transfers may stabilize such an equilibrium, so that the economy starts converging to it. In the latter case, both policy programs such as pay-as-you-go pension schemes or subsidies to the young may help escaping from poverty. However, we point out that in either circumstance, the “size” of transfers should be sufficiently large (and, as for pensions, not even too large), in order to avoid ineffective and useless burden on the taxpayers without triggering the take off.      

Optimal income taxation and social norms in the labor market

This paper concerns optimal income taxation in a two-type model extended to allow for social interaction and social norms in the labor market. One norm refers to “normal behavior” with respect to work hours (the hours of work norm), whereas another means that “one should earn one’s living by working” (the participation norm). The results show how the hours of work norm gives rise to a corrective motive for using income taxation. We also show how the interaction between the hours of work norm and the private incentive to participate in the labor market (which reflects the participation norm) gives rise to an employment motive for using the income tax.     

Balance,growth and diversity of financial markets

A financial market comprising of a certain number of distinct companies is considered, and the following statement is proved: either a specific agent will surely beat the whole market unconditionally in the long run, or (and this “or” is not exclusive) all the capital of the market will accumulate in one company. Thus, absence of any “free unbounded lunches relative to the total capital” opportunities lead to the most dramatic failure of diversity in the market: one company takes over all other until the end of time. In order to prove this, we introduce the notion of perfectly balanced markets, which is an equilibrium state in which the relative capitalization of each company is a martingale under the physical probability. Then, the weaker notion of balanced markets is discussed where the martingale property of the relative capitalizations holds only approximately, we show how these concepts relate to growth-optimality and efficiency of the market, as well as how we can infer a shadow interest rate that is implied in the economy in the absence of a bank.      

Bank Competition and Financial Stability

Under the traditional “competition-fragility” view, more bank competition erodes market power, decreases profit margins, and results in reduced franchise value that encourages bank risk taking. Under the alternative “competition-stability” view, more market power in the loan market may result in higher bank risk as the higher interest rates charged to loan customers make it harder to repay loans, and exacerbate moral hazard and adverse selection problems. The two strands of the literature need not necessarily yield opposing predictions regarding the effects of competition and market power on stability in banking. Even if market power in the loan market results in riskier loan portfolios, the overall risks of banks need not increase if banks protect their franchise values by increasing their equity capital or engaging in other risk-mitigating techniques. We test these theories by regressing measures of loan risk, bank risk, and bank equity capital on several measures of market power, as well as indicators of the business environment, using data for 8,235 banks in 23 developed nations. Our results suggest that—consistent with the traditional “competition-fragility” view—banks with a higher degree of market power also have less overall risk exposure. The data also provides some support for one element of the “competition-stability” view—that market power increases loan portfolio risk. We show that this risk may be offset in part by higher equity capital ratios.

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.     

Unequal wages for equal utilities

When educational policy is supplemented by a redistributive income tax, and when individuals differ in their ability to benefit from education, the optimal policy is typically rather regressive. Resources are concentrated on the most able individuals in order to get a “cake” as big as possible to share among individuals through income taxation. In this paper, we put forward another reason to push for regressive education. It is not linked to heterogeneity in innate ability but to the property that welfare may be a convex function of an individual’s wage. For simplicity, we assume a linear education technology and a given education budget. To give the equal wage outcome the best chance to emerge, we also assume that individuals have identical learning abilities. Nevertheless, it turns out that in the first-best wage inequality is always preferable to wage equality. Even more surprisingly, this conclusion remains valid in the second-best when the feasible degree of wage differentiation is sufficiently large. This is in spite of the fact that wage equalization would eliminate any need for distortionary income taxation.     

A test of bear market mergerstat control premiums

This paper examines all 340 of the 2001 “bear market” acquisition announcements of U.S. target firms reported by Mergerstat/Shannon Pratt’s Control Premium Study^TM. This paper compares the “Control Premium” reported by Mergerstat/Shannon Pratt’s Control Premium Study^TM to a comparable “Cumulative Abnormal Return”(CAR) calculated using event study methodology. While the average total “Control Premium” reported by Mergerstat differed by only −3.45% from the event study CAR, significant differences presented themselves when the event period was broken down between the day −63 to −1 “runup” period and the day 0 to end “markup” period.      

The theory of optimal taxation: what is the policy relevance?

The paper discusses the implications of optimal tax theory for the debates on uniform commodity taxation and neutral capital income taxation. While strong administrative and political economy arguments in favor of uniform and neutral taxation remain, recent advances in optimal tax theory suggest that the information needed to implement the differentiated taxation prescribed by optimal tax theory may be easier to obtain than previously believed. The paper also points to the strong similarity between optimal commodity tax rules and the rules for optimal source-based capital income taxation.      

Tax credits,income support,and partnership decisions

This paper considers the potential impact of welfare benefits on the partnership status of women in the UK. Using recent policy reforms to identify the response rate, it was found that a ￡100/week welfare benefit “partnership penalty” reduces the probability of a woman having a partner by seven percentage points. The model is also used to explore the potential effects of the recent tax credit reforms on partnership rates; it was found that while the 1999 WFTC reform improved partnership incentives, this effect was effectively undone by the 2003 WTC/CTC reform.      

Tax treatment of dividends and capital gains and the dividend decision under dual income tax

The paper analyses efficiency aspects of a dual income tax system with a higher tax on capital gains than dividends. It argues that apart from the distortions to investments claimed in earlier literature, the system puts even more emphasis in creating incentives for entrepreneurs to participate in tax planning. The paper suggests that the owner of a closely held company can avoid all personal taxes on entrepreneurial income by two tax-planning strategies. The first is the avoidance of distributions, which would be taxed at the tax rate on labour income. These funds would instead be invested in the financial markets. The second strategy is a distribute and call-back policy, converting retained profits into new equity capital. Interestingly, the outcome is that investment in real capital is not distorted in the long-run equilibrium. Empirical evidence using microdata is also provided.      

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.      

Redistribution, production inefficiency and decentralized efficiency

This paper analyzes the role of production distortion in income redistribution in an international trade model. In particular, it examines the role of the Stolper and Samuelson effect on efficient income redistribution. It first shows that production inefficiency can be part of a Pareto-efficient tax system for a small country when there is an asymmetric information problem between the government and individuals. Second, the paper shows that such production inefficiency is not only Pareto-improving for a small country, but is also essential in achieving worldwide tax-constrained Pareto-efficient allocation. These two results suggest important implications for commercial policies. The original version of this paper was circulated in 1996 as No. 391 of the Discussion Paper Series of Research Seminars in International Economics at the University of Michigan (http://www.fordschool.umich.edu/rsie/workingpapers/wp.html), with the title “Tariffs and production subsidies as devices to relax the incentive problem of a progressive income tax system”. Since the distribution of the working paper version, this paper has been cited and used in several papers, such as Guesnerie (2001) and Spector (2001). I hope that this updated version of the paper is useful for researchers.     

Poverty-decreasing indirect tax reforms: Evidence from Tunisia

This paper proposes a methodology to identify revenue-neutral directions for poverty-alleviating tax reforms. The search for such poverty-reducing tax reforms is done “robustly” over broad classes of poverty measures and poverty lines. The methodology, which is illustrated using data from Tunisia, is of significant policy interest given the widespread use of commodity subsidization and taxation in developing and developed countries alike. The results suggest that Tunisian poverty could be decreased robustly by following reform directions that are often at odds with frequently-heard views. They also highlight the importance of stating clearly under which set of ethical criteria the desirability of potential indirect tax reforms is assessed. JEL Code D12 ⋅ D63 ⋅ H53 ⋅ I32 ⋅ I38     

Delinquency and Default in Arms: The Effects of Protected Equity and Loss Aversion

This paper extends the extant literature in understanding the effects of equity and debt on delinquency and default by focusing on a variant of borrower equity where part of equity is “protected”. The CPF scheme in Singapore stipulates that the refund of borrower’s retirement funds utilized for property purchase prior to September 2002 takes priority over loan obligations. A decision to utilize CPF for property purchase actually increases ex post delinquency and default risk as it effectively reduces cash equity commitment. In particular, any erosion in house value that places protected equity at risk translates into potential wealth reduction or financial liability for the borrower. While loss aversion is evident for non-distressed sellers, the effect of equity losses for distressed borrowers is not as clear. Our research suggests that averting losses in committed equity may be a secondary consideration for borrower subject to income shocks, recognizing that delinquency and default are precursors to foreclosure. Interestingly, we find that the borrowers are strongly averse to incurring protected equity-induced wealth loss or financial liability. This study suggests that the first-lien “anomaly” associated with CPF refund may reduce delinquency and default risks for mortgage backed securities.