Fiscal and Monetary Policy
Preventing a National Debt Explosion
Martin Feldstein
NBER Working Paper, October 2010
Abstract:
The projected path of the U.S. national debt is the major challenge facing American economic policy. Without changes in tax and spending rules, the national debt will rise from 62 percent of GDP now to more than 100 percent of GDP by the end of the decade and nearly twice that level within 25 years. This paper discusses three strategies that, taken together, could reverse this trend and reduce the ratio of debt to GDP to less than 50 percent. The first strategy, which focuses on the current decade, would reduce the Administration's proposed spending increases and tax reductions that would otherwise add $3.8 trillion to the national debt in 2020. The second strategy would augment the tax-financed benefits for Social Security, Medicare and Medicaid with investment based accounts would permit the higher future spending on health care and pensions with a relatively small increase in saving for such accounts. The third strategy focuses on "tax expenditures," the special features of the tax law that reduce revenue in order to achieve effects that might otherwise be done by explicit outlays. Tax expenditures now result in an annual total revenue loss of about $1 trillion; reducing them could permanently reduce future deficits without increasing marginal tax rates or reducing the rewards for saving, investment, and risk taking. The paper concludes with a discussion of how the high debt to GDP ratio after World War II was reversed and how the last four presidents ended their terms with small primary deficits or primary budget surpluses.
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Dimensions, Issues, and Bills: Appropriations Voting on the House Floor
Michael Crespin & David Rohde
Journal of Politics, October 2010, Pages 976-989
Abstract:
One of the fundamental findings in the congressional literature is that one or sometimes two dimensions can successfully describe roll-call voting. In this paper we investigate if we can reach the same conclusions about low dimensionality when we divide the roll-call agenda into subsets of relatively homogeneous subject matter. We are primarily interested in the degree to which the same ordering of representatives is yielded across these different groups of votes. To conduct our analysis we focus on all roll calls on the 13 annual appropriations bills across eight congresses. When we concentrate on these smaller issue areas, we find that voting is multidimensional and members do not vote in a consistent ideological fashion across all issue areas.
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Macroeconomics after the Crisis: Time to Deal with the Pretense-of-Knowledge Syndrome
Ricardo Caballero
NBER Working Paper, October 2010
Abstract:
In this paper I argue that the current core of macroeconomics - by which I mainly mean the so-called dynamic stochastic general equilibrium approach - has become so mesmerized with its own internal logic that it has began to confuse the precision it has achieved about its own world with the precision that it has about the real one. This is dangerous for both methodological and policy reasons. On the methodology front, macroeconomic research has been in "fine-tuning" mode within the local-maximum of the dynamic stochastic general equilibrium world, when we should be in "broad-exploration" mode. We are too far from absolute truth to be so specialized and to make the kind of confident quantitative claims that often emerge from the core. On the policy front, this confused precision creates the illusion that a minor adjustment in the standard policy framework will prevent future crises, and by doing so it leaves us overly exposed to the new and unexpected.
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Allan Meltzer
Journal of Monetary Economics, forthcoming
Abstract:
In the standard policy model, a policymaker optimizes the welfare of a representative agent. In practice, policies are chosen in a political process by agents elected by voters. Drawing on evidence from my two-volume History of the Federal Reserve, the paper reports many examples of decisions influenced by political pressures. The History shows that the meaning of the independence of the Federal Reserve changed over time reflecting political influences.
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Policy Options for State Pension Systems and Their Impact on Plan Liabilities
Joshua Rauh & Robert Novy-Marx
NBER Working Paper, October 2010
Abstract:
We calculate the present value of state pension liabilities under existing policies, and separately under policy changes that would affect pension payouts including cost of living adjustments (COLAs), retirement ages, and buyout schedules for early retirement. Liabilities if plans were frozen as of June 2009 would be $3.2 trillion if capitalized using taxable municipal curves, which credit states for a possibility of default in the same states of the world as general obligation debt, and $4.4 trillion using the Treasury curve. Under the typical actuarial method of recognizing future service and wage increases, liabilities are $3.6 trillion and $5.2 trillion using municipal curves and Treasury curves respectively. Compared to $1.8 trillion in pension fund assets, the baseline level of unfunded liabilities is therefore around $3 trillion under Treasury rates. A one percentage point reduction in COLAs would reduce total liabilities by 9‐11%, implementing actuarially fair early retirement could reduce them by 2‐5%, and raising the retirement age by one year would reduce them by 2‐4%. Even relatively dramatic policy changes, such as the elimination of COLAs or the implementation of Social Security retirement age parameters, would leave liabilities around $1.5 trillion more than plan assets under Treasury discounting. This suggests that taxpayers will bear the lion's share of the costs associated with the legacy liabilities of state DB pension plans.
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Deciding to Provide: Local Decisions on Providing Social Welfare
Michael Craw
American Journal of Political Science, October 2010, Pages 906-920
Abstract:
Fiscal federalism predicts local governments will avoid social welfare expenditures, owing to capital mobility across local jurisdictions. Yet Census of Governments data consistently show that many local governments provide one or more social welfare functions, and moreover many jurisdictions provide these functions without federal or state intergovernmental support. This article finds evidence that, while local expenditures are largely driven by fiscal capacity and federal and state assistance, local decisions on providing social welfare functions and participating in intergovernmental revenues are primarily affected by degree of capital mobility and by local political factors. Consequently, local governments exercise much greater autonomy over social welfare policymaking than fiscal federalism suggests.
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How Big (Small?) are Fiscal Multipliers?
Ethan Ilzetzki, Enrique Mendoza & Carlos Végh
NBER Working Paper, October 2010
Abstract:
We contribute to the intense debate on the real effects of fiscal stimuli by showing that the impact of government expenditure shocks depends crucially on key country characteristics, such as the level of development, exchange rate regime, openness to trade, and public indebtedness. Based on a novel quarterly dataset of government expenditure in 44 countries, we find that (i) the output effect of an increase in government consumption is larger in industrial than in developing countries, (ii) the fiscal multiplier is relatively large in economies operating under predetermined exchange rate but zero in economies operating under flexible exchange rates; (iii) fiscal multipliers in open economies are lower than in closed economies and (iv) fiscal multipliers in high-debt countries are also zero.
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The elusive costs of sovereign defaults
Eduardo Levy Yeyati & Ugo Panizza
Journal of Development Economics, January 2011, Pages 95-105
Abstract:
The evidence supporting the presence of output losses associated with sovereign defaults is based on annual observations and suffers from measurement and identification problems. This paper examines the impact of default on growth using quarterly data and finds that output contractions precede defaults and that output starts growing after the quarter in which the default took place. This indicates that default episodes mark the beginning of the economic recovery and that the negative effects of a default on output are likely to be driven by the anticipation of default, independently of whether or not the country ultimately decides to validate it.
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Are we taxing ourselves?: How deliberation and experience shape voting on taxes
Rupert Sausgruber & Jean-Robert Tyran
Journal of Public Economics, forthcoming
Abstract:
We let consumers vote on tax regimes in experimental markets. We test if taxes on sellers are more popular than taxes on consumers, i.e. on voters themselves, even if taxes on sellers are inefficiently high. Taxes on sellers are more popular if voters underestimate the extent of tax shifting in the market. We show that inexperienced voters are prone to such a tax-shifting bias, that experience is an effective de-biasing mechanism, but that pre-vote deliberation about tax regimes makes initially held opinions more extreme rather than correct. Our results suggest that voting on taxes is prone to bias and that easy-to-interpret facts are needed to de-bias voters.
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Making Savers Winners: An Overview of Prize-Linked Savings Products
Melissa Schettini Kearney, Peter Tufano, Jonathan Guryan & Erik Hurst
NBER Working Paper, October 2010
Abstract:
For over three centuries and throughout the globe, people have enthusiastically bought savings products that incorporate lottery elements. In lieu of paying traditional interest to all investors proportional to their balances, these Prize Linked Savings (PLS) accounts distribute periodic sizeable payments to some investors using a lottery-like drawing where an investor's chances of winning are proportional to one's account balances. This paper describes these products, provides examples of their use, argues for their potential popularity in the United States - especially to low and moderate income non-savers - and discusses the laws and regulations in the United States that largely prohibit their issuance.
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Vertical Diffusion and the Policy-Making Process: The Politics of Embryonic Stem Cell Research
Andrew Karch
Political Research Quarterly, forthcoming
Abstract:
This article examines the influence of national government activity on the politics of embryonic stem cell research in the American states. Its analysis of bill introduction patterns between 1999 and 2008 suggests that President Bush's nationally televised address on stem cell research and the debate over the Stem Cell Research Enhancement Act increased the probability that officials in a state would introduce stem-cell-related legislation in a given year. National activity also seemed to increase the number of bills that legislators introduced. These results illustrate how political forces can increase the salience of public policies and thereby serve as diffusion mechanisms during the agenda-setting process.
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Transparency and Accountability: Empirical Results for U.S. States
James Alt & Robert Lowry
Journal of Theoretical Politics, October 2010, Pages 379-406
Abstract:
Recent formal models of accountability allow us to make different conditional predictions about how transparency affects voters' willingness to re-elect incumbents and acceptance of higher taxes. We review two models and investigate empirical implications derived from or related to them, using panel data from 1972-2000 for U.S. state budget process transparency, gubernatorial elections, and tax increases in a small structural model. We do not find that budget transparency has a direct effect on incumbent retention, but we do find clear evidence that increased transparency dampens the negative effect of tax increases on retention of incumbent governors. Independent of this, we also find that increased transparency leads to greater fiscal scale. We suggest some possible directions for future models based on our results.
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Flat income taxation, redistribution and labour market performance
Bas Jacobs, Ruud de Mooij & Kees Folmer
Applied Economics, October 2010, Pages 3209-3220
Abstract:
A flat tax rate on labour income has gained popularity in European countries. This article assesses the attractiveness of such a flat tax in achieving redistributive objectives with the smallest distortions to employment. We do so by using a detailed applied general equilibrium model for the Netherlands. The model is empirically grounded in the data and encompasses decisions on hours worked, labour force participation, skill formation, wage bargaining between unions and firms and a wide variety of institutional details. The simulations suggest that the replacement of the current tax system in the Netherlands by a flat rate will harm labour market performance if aggregate income inequality is contained. Only flat tax reforms that reduce redistribution will raise employment. This finding bolsters the notions from optimal tax literature regarding the equity-efficiency trade off and the superiority of nonlinear taxes to obtain redistributive goals in an efficient way.
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Tomer Blumkin & Efraim Sadka
International Tax and Public Finance, October 2010, Pages 501-517
Abstract:
We re-examine a key result in the optimal UI literature that benefits should decline over time. We show that when the population is heterogeneous, Pareto-efficiency may call for multiple payment schedules, some with benefits that fall over time and some with benefits that rise over time.
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Majority Rule versus Supermajority Rules: Their Effects on Narrow and Broad Taxes
Jac Heckelman & Keith Dougherty
Public Finance Review, November 2010, Pages 738-761
Abstract:
Buchanan and Tullock argue that larger supermajority rules reduce tyranny of the majority but should have no effect on the passage of mutually advantageous policies. The authors test this argument by separately analyzing the effect of supermajority requirements on taxes that are targeted toward narrow groups (more redistributive) and taxes targeted toward a broader base (less redistributive), in a panel of fifty states from 1970 to 2008. Regression analysis reveals an inverse relationship between narrow taxes and the size of the majority rule requirement and no relationship between broad taxes and the size of the majority requirement - consistent with the claim of Buchanan and Tullock. The authors also find that Democratic controlled governments have significantly higher tax rates on narrow taxes than Republican controlled governments. The reverse is found for broad taxes, but the result is not as strong.
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Human capital and optimal positive taxation of capital income
Bas Jacobs & Lans Bovenberg
International Tax and Public Finance, October 2010, Pages 451-478
Abstract:
This paper analyzes optimal linear and non-linear taxes on capital and labor incomes in a life-cycle model of human capital investment, financial savings, and labor supply with heterogenous individuals. A dual income tax with a positive marginal tax rate on not only labor income but also capital income is optimal. The positive tax on capital income serves to alleviate the distortions of the labor tax on human capital accumulation. The optimal marginal tax rate on capital income is lower than that on labor income if savings are elastic compared to investment in human capital, substitution between verifiable and non-verifiable inputs in human capital formation is difficult, and most investments in human capital are verifiable so that education subsidies can directly reduce the tax wedge on learning. Numerical calculations suggest that the optimal marginal tax rate on capital income is substantial.
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U.S. Monetary and Fiscal Policy in the 1930s
Price Fishback
NBER Working Paper, October 2010
Abstract:
The paper provides a survey of fiscal and monetary policies during the 1930s under the Hoover and Roosevelt Administrations and how they influenced the policies during the recent Great Recession. The discussion of the causal impacts of monetary policy focuses on papers written in the last decade and the findings of scholars using dynamic structural general equilibrium modeling. The discussion of fiscal policy shows why economists do not see the New Deal as a Keynesian stimulus, describes the significant shift toward excise taxation during the 1930s, and surveys estimates of the impact of federal spending on local economies. The paper concludes with discussion of the lessons for the present from 1930s monetary and fiscal policy.