nep-pbe New Economics Papers
on Public Economics
Issue of 2005‒07‒18
25 papers chosen by
Kerim Arin
Massey University

  1. Forecasting the Term Structure of Government Bond Yields By Francis X. Diebold; Canlin Li
  2. Understanding the Effects of Government Spending on Consumption By Jordi Galí; J.David López-Salidoz; Javier Vallés
  3. The Basel II Accord: Internal Ratings and Bank Differentiation By Eberhard Feess; Ulrich Hege
  4. On the Optimal Progressivity of the Income Tax Code By Juan Carlos Conesa; Dirk Krueger
  5. Pareto Improving Social Security Reform when Financial Markets are Incomplete!? By Dirk Krueger; Felix Kubler
  7. Latent and actual entrepreneurship in Europe and the US: some recent developments By Roy Thurik; Isabel Grilo
  8. Determinants of entrepreneurial engagement levels in Europe and the US By Roy Thurik; Isabel Grilo
  9. Prioritizing public health expenditures when there is a private alternative By Hoel, Michael
  10. New Keynesian or RBC Transmission? The Effects of Fiscal Policy in Labor Markets By Evi Pappa
  11. The elusive costs and the immaterial gains of fiscal constraints By Fabio Canova; Evi Pappa
  12. On the Use of Racial Profiling as a Law Enforcement Tool By Bunzel, Helle; Marcoul, Philippe
  13. A Note on the Anglo-Saxon and Continental Approaches to Europe: Identical in Spirit, not in Practice By Thierry Warin
  15. The Incidence of a Tax on Pure Rent in a Small Open Economy. By Alberto Petrucci
  16. Correcting Second Home Equity in HRS/AHEAD: the Issues, a Method, and Preliminary Results By Honggao Cao; Thomas Juster
  17. Does Falling Smoking Lead to Rising Obesity? By Jonathan Gruber; Michael Frakes
  18. Political Competition and Economic Performance: Theory and Evidence from the United States By Timothy Besley; Torsten Persson; Daniel Sturm
  19. The Sensitivity of Homeowner Leverage to the Deductibility of Home Mortgage Interest By Patric H. Hendershott; Gwilym Pryce
  20. The State of Village-Level Infrastructures and Public Services in Indonesia During the Economic Crisis By Jesse Darja; Daniel Suryadarma; Asep Suryahadi; Sudarno Sumarto
  21. Redistribution, horizontal inequity and reranking: how to measure them properly By Ivica Urban; Peter J. Lambert
  22. Refundable Tax Credits for Health Insurance: The Sensitivity of Simulated Impacts to Assumed Behavior By David W. Emmons; Eva Madly; Stephen A. Woodbury
  23. Endogenous Timing in a Mixed Triopoly with a Foreign Competitor By Yuanzhu Lu
  24. Market integration for agricultural output markets in Peru: the role of public infrastructure By Javier Escobal; Arturo Vásquez
  25. Unemployment, growth and fiscal policy: new insights on the hysteresis hypothesis By Xabier Raurich; Hector Sala; Valeri Sorolla

  1. By: Francis X. Diebold (University of Pennsylvania, and NBER); Canlin Li (University of California)
    Abstract: Despite powerful advances in yield curve modeling in the last twenty years, comparatively little attention has been paid to the key practical problem of forecasting the yield curve. In this paper we do so. We use neither the no-arbitrage approach, which focuses on accurately fitting the cross section of interest rates at any given time but neglects time-series dynamics, nor the equilibrium approach, which focuses on time-series dynamics (primarily those of the instantaneous rate) but pays comparatively little attention to fitting the entire cross section at any given time and has been shown to forecast poorly. Instead, we use variations on the Nelson-Siegel exponential components framework to model the entire yield curve, period-by-period, as a three-dimensional parameter evolving dynamically. We show that the three time-varying parameters may be interpreted as factors corresponding to level, slope and curvature, and that they may be estimated with high efficiency. We propose and estimate autoregressive models for the factors, and we show that our models are consistent with a variety of stylized facts regarding the yield curve. We use our models to produce term-structure forecasts at both short and long horizons, with encouraging results. In particular, our forecasts appear much more accurate at long horizons than various standard benchmark forecasts.
    Keywords: Term structure, yield curve, factor model, Nelson-Siegel curve
    JEL: G1 E4 C5
    Date: 2004–01–09
  2. By: Jordi Galí (CREI and Universitat Pompeu Fabra); J.David López-Salidoz (Banco de España); Javier Vallés (Banco de España)
    Abstract: Recent evidence on the effect of government spending shocks on consumption cannot be easily reconciled with existing optimizing business cycle models. We extend the standard New Keynesian model to allow for the presence of rule-of-thumb (non-Ricardian) consumers. We show how the interaction of the latter with sticky prices and deficit financing can account for the existing evidence on the effects of government spending.
    Keywords: Rule-of-Thumb Consumers, Fiscal Multiplier, Government Spending, Taylor Rules
    JEL: E32 E62
    Date: 2004–01–23
  3. By: Eberhard Feess (Aachen University (RWTH), Dept. of Economics, Templergraben 64, D-52056 Aachen); Ulrich Hege (HEC School of Management, Department of Finance and Economics, F-78351 Jouy-en-Josas Cedex, France)
    Abstract: The Basel Committee plans to differentiate risk-adjusted capital requirements between banks regulated under the internal ratings based (IRB) approach and banks under the standard approach. We investigate the consequences for the lending capacity and the failure risk of banks in a model with endogenous interest rates. The optimal regulatory response depends on the banks’ inclination to increase their portfolio risk. If IRB-banks are well-capitalized or gain little from taking risks, then they will increase their market share and hold safe portfolios. As risk-taking incentives become more important, the optimal portfolio size of banks adopting intern rating systems will be increasingly constrained, and ultimately they may lose market share relative to banks using the standard approach. The regulator has only limited options to avoid the excessive adoption of internal rating systems.
    Keywords: Basel II Accord, risk-based capital, internal ratings based approach, bank capital, bank competition, risk-taking
    JEL: K13 H41
    Date: 2004–01–25
  4. By: Juan Carlos Conesa (Universitat Pompeu Fabra, CREA and CREB-UB); Dirk Krueger (Department of Business and Economics, Johann Wolfgang Goethe-University Frankfurt am Main, Mertonstr. 17, PF 81, 60054 Frankfurt am Main, Germany; and CFS, CEPR and NBER)
    Abstract: This paper computes the optimal progressivity of the income tax code in a dynamic general equilibrium model with household heterogeneity in which uninsurable labor productivity risk gives rise to a nontrivial income and wealth distribution. A progressive tax system serves as a partial substitute for missing insurance markets and enhances an equal distribution of economic welfare. These beneficial effects of a progressive tax system have to be traded off against the efficiency loss arising from distorting endogenous labor supply and capital accumulation decisions. Using a utilitarian steady state social welfare criterion we find that the optimal US income tax is well approximated by a flat tax rate of 17:2% and a fixed deduction of about $9,400. The steady state welfare gains from a fundamental tax reform towards this tax system are equivalent to 1:7% higher consumption in each state of the world. An explicit computation of the transition path induced by a reform of the current towards the optimal tax system indicates that a majority of the population currently alive (roughly 62%) would experience welfare gains, suggesting that such fundamental income tax reform is not only desirable, but may also be politically feasible.
    Keywords: Progressive Taxation, Optimal Taxation, Flat Taxes, Social Insurance, Transition
    JEL: E62 H21 H24
    Date: 2005–01–10
  5. By: Dirk Krueger (University of Frankfurt); Felix Kubler (University of Mannheim)
    Abstract: This paper studies an overlapping generations model with stochastic production and incomplete markets to assess whether the introduction of an unfunded social security system leads to a Pareto improvement. When returns to capital and wages are imperfectly correlated a system that endows retired households with claims to labor income enhances the sharing of aggregate risk between generations. Our quantitative analysis shows that, abstracting from the capital crowding-out effect, the introduction of social security represents a Pareto improving reform, even when the economy is dynamically effcient. However, the severity of the crowding-out effect in general equilibrium tends to overturn these gains.
    Keywords: Social Security Reform, Aggregate Fluctuations, Intergenerational Risk Sharing, Incomplete Markets.
    JEL: E62 H55 H31 D91 D58
    Date: 2005–01–12
  6. By: Mauricio Avella Gómez
    Abstract: The hypothesis that the internal public debt has played the role of shock absorber in Colombia since 1923 is modelled. 1923 was an important landmark in the history of fiscal and monetary reforms in Colombia during the twentieth century. The econometric results offer a strong support for the hypothesized shock-absorber role of the internal debt.
    Keywords: Deficit, Surplus
    JEL: H62
    Date: 2005–06–30
  7. By: Roy Thurik; Isabel Grilo
    Abstract: This paper uses 2004 survey data from the 15 old EU member states and the US to explain country differences in latent and actual entrepreneurship. Other than demographic variables such as gender, age and education, the set of covariates includes the perception by respondents of administrative complexities, of availability of financial support and of risk tolerance as well as country-specific effects. A comparison is made with results using a similar survey in 2000. While a majority of the surveyed population identifies lack of financial support as an obstacle to starting a new business, the role of this variable in both latent and actual entrepreneurship appears to be even more counterintuitive in 2004 than in 2000: it has no impact on actual entrepreneurship and is positively related to latent entrepreneurship. Administrative complexities, also perceived as an obstacle by a large majority of the population, have the expected negative impact both for latent and actual entrepreneurship in both years. Country-specific effects are important both for latent and actual entrepreneurship and the comparison of 2000 and 2004 results suggests that, once all other factors are controlled for, an improvement in actual entrepreneurship in the EU relative to the US has taken place in the last four years. However, in terms of unweighted averages actual entrepreneurship remained about the same. Latent entrepreneurship dropped while this drop seems to have occurred evenly in the US and the EU member states.
    Keywords: entrepreneurship; latent entrepreneurship; nascent entrepreneurship; determinants; Europe
    JEL: M13 H10 J23 R12
    Date: 2005–07
  8. By: Roy Thurik; Isabel Grilo
    Abstract: Determinants from different streams of literature and spanning different disciplines are used to explain entrepreneurial decisions. A multinomial logit model and survey data from the old 15 EU member states, Norway, Iceland, Liechtenstein and the US are used to establish the effect of demographic and other variables on various entrepreneurial engagement levels. These engagement levels range from "never thought about starting a business" to "thinking about it", "taking steps for starting up", "having a young business", "having an older business" and "no longer being an entrepreneur". Data of two Entrepreneurship Flash Eurobarometer surveys (2002 and 2003) containing over 20,000 observations are used. Other than demographic variables, the set of explanatory variables used includes the perception by respondents of ad-ministrative complexities, of availability of financial support and of risk tolerance, the respondents' prefer-ence for self-employment and country specific effects. The most striking result is that the perception of lack of financial support has no discriminative effect across the various levels of entrepreneurial engagement.
    Keywords: entrepreneurship, determinants, nascent entrepreneurship, multinomial logit, barriers to entry, Europe
    JEL: M13 H10 J23 R12
    Date: 2005–06
  9. By: Hoel, Michael (Dept. of Economics, University of Oslo)
    Abstract: Cost-effectiveness analysis often plays an important role in prioritization among different types of public health expenditures. Cost-effectiveness is defined as the maximal health benefits for given expenditures on health care. With a private health sector as a supplement to the public sector, the socially optimal ranking of treatments to be included in the public health program is changed. The larger are the costs per treatment for a given benefit-cost ratio, the higher priority should the treatment be given. The more heterogeneous preferences for a particular treatment are, the lower priority should this treatment be given. If the health budget does not exceed the socially optimal size, treatments with sufficiently low costs should not be performed by the public health system if there is a private alternative
    Keywords: public health; prioritization; cost-effectiveness analysis
    JEL: H42 H51 I10 I18
    Date: 2005–05–25
  10. By: Evi Pappa
    Abstract: We study the mechanics of transmission of fiscal shocks to labor markets. We characterize a set of robust implications following government consumption, investment and employment shocks in a RBC and a New-Keynesian model and use part of them to identify shocks in the data. In line with the New-Keynesian story, shocks to government consumption and investment increase real wages and employment contemporaneously both in US aggregate and in US state data. The dynamics in response to employment shocks are mixed, but in many cases are inconsistent with the predictions of the RBC model.
  11. By: Fabio Canova; Evi Pappa
    Abstract: We study whether fiscal restrictions affect volatilities and correlations of macrovariables and the probability of excessive debt for a sample of 48 US states. Fiscal constraints are characterized with a number of indicators and volatility and correlations are computed in several ways. The second moments of macroeconomic variables in states with different fiscal constraints are economically and statistically similar. Excessive debt and the mechanism linking budget deficit and excessive debts are independent of whether tight or loose fiscal constraints are in place. Creative budget accounting may account for the results.
  12. By: Bunzel, Helle; Marcoul, Philippe
    Abstract: The “End Racial Profiling Act of 2001” (ERPA) states that “no law enforcement agent or law enforcement agency shall engage in racial profiling” and mandates states to “collect detailed data on stops, searches, seizures, and arrests.” We develop a stylized dynamic model of highway policing to study the long-run consequences of ERPA. In the model, color-neutral police officers receive incentives to arrest criminals, but face a per stop cost which increases when the racial mix of the interdicted differs from the racial composition of the population. Incarceration rates are defined to be racially “fair” if the racial composition of the prison and criminal population is identical. The model predicts that the long-term racial composition of the prison population may not be fair and that ERPA may increase fairness. Ceteris paribus, however, ERPA may lower efficiency (the number of criminals in jail). Finally, we characterize and compare the incentive schemes for crime fighting that a government would optimally set with and without ERPA.
    Date: 2005–07–14
  13. By: Thierry Warin
    Abstract: The purpose of this note is to propose a breakdown of the European concept into different sub-categories, based upon the different stages of the European integration process. In doing so, it is easier to understand the political differences and debate between an allegedly Anglo-Saxon approach and a Continental one. This note challenges the usual definition of the Anglo-Saxon and Continental approaches, and highlights the usual misconceptions and misunderstandings of the European economic goal.
    Keywords: Europe, EMU, EU, Schengen Convention, Anglo-Saxon approach, Continental approach
    JEL: E5 H0
    Date: 2005–07
  14. By: Daniela Mantovani; Fotis Papadopoulos; Holly Sutherland; Panos Tsakloglou
    Abstract: This paper considers the effects on current pensioner incomes of reforms designed to improve the long-term sustainability of public pension systems in the European Union. We use EUROMOD to simulate a set of common illustrative reforms for four countries selected on the basis of their diverse pension systems and patterns of poverty among the elderly: Denmark, Germany, Italy and the UK. The variations in fiscal and distributive effects on the one hand suggest that different paths for reform are necessary in order to achieve common objectives across countries, and on the other provide indications of the appropriate directions for reform in each case.
    Keywords: Pensions; European Union; Microsimulation
    JEL: C81 I30 H55
    Date: 2005–07
  15. By: Alberto Petrucci
    Abstract: This paper analyzes the effects of a land rent tax on capital formation and foreign investment in a life-cycle small open economy with endogenous labor-leisure choices. The consequences of land taxation critically depend on how the tax proceeds are used by the government. A land tax depresses capital formation, crowds out foreign investment and increases national wealth and consumption when the land tax revenues are distributed as lump-sum payments. If the proceeds from land taxation are used to finance unproductive government expenditure, the land tax will be neutral in its effects on the capital stock, nonhuman wealth and labor. When the tax revenues are used to reduce labor taxes, the land rent tax spurs nonhuman wealth accumulation and ambiguously affects the capital stock and labor.
    Keywords: Land Taxation, Labor Supply, Capital Accumulation, Overlapping generations.
    JEL: E21 E62 H22
    Date: 2005–07–12
  16. By: Honggao Cao (University of Michigan); Thomas Juster (University of Michigan)
    Abstract: Second home equity is an important component of both housing equity and net worth for the old population. It has been covered, implicitly or explicitly, across all waves of HRS and AHEAD surveys. But due to a skip-pattern error, not all households with second homes were asked detailed questions about current market value, amount of mortgage, etc... The negative impact of the inconsistent treatment of second home on the estimation of housing equity and net worth is substantial. When the second home information is not collected for all the households who own second homes (as in AHEAD 1995 and HRS 1996), the second home equity measure based on the partial data is likely to suffer from selection bias, rendering vulnerable both measures of total housing equity and total net worth. This paper reports on an imputation method to correct for this bias that we demonstrate and find effective.
    Date: 2004–06
  17. By: Jonathan Gruber; Michael Frakes
    Abstract: The strong negative correlation over time between smoking rates and obesity have led some to suggest that reduced smoking is increasing weight gain in the U.S.. This conclusion is supported by the findings of Chou et al. (2004), who conclude that higher cigarette prices lead to increased body weight. We investigate this issue and find no evidence that reduced smoking leads to weight gain. Using the cigarette tax rather than the cigarette price and controlling for non-linear time effects, we find a negative effect of cigarette taxes on body weight, implying that reduced smoking leads to lower body weights. Yet our results, as well as Chou et al., imply implausibly large effects of smoking on body weight. Thus, we cannot confirm that falling smoking leads in a major way to rising obesity rates in the U.S.
    JEL: H1 I1
    Date: 2005–07
  18. By: Timothy Besley; Torsten Persson; Daniel Sturm
    Abstract: One of the most cherished propositions in economics is that market competition by and large raises consumer welfare. But whether political competition has similarly virtuous consequences is far less discussed. This paper formulates a model to explain why political competition may enhance economic performance and uses the United States as a testing ground for the model's implications. It finds statistically robust evidence that political competition has quantitatively important effects on state income growth, state policies, and the quality of Governors.
    JEL: D72 H11 H70 N12 O11
    Date: 2005–07
  19. By: Patric H. Hendershott; Gwilym Pryce
    Abstract: Mortgage interest tax deductibility is needed to treat debt and equity financing of homes equally. Countries that limit deductibility create a debt tax penalty that presumably leads households to shift from debt toward equity financing. The greater the shift, the less is the tax revenue raised by the limitation and smaller is its negative impact on housing demand. Measuring the financing response to a legislative change is complicated by the fact that lenders restrict mortgage debt to the value of the house (or slightly less) being financed. Taking this restriction into account reduces the estimated financing response by 20 percent (a 32 percent decline in debt vs a 40 percent decline). The estimation is based on 86,000 newly originated UK loans from the late 1990s.
    JEL: H2 H3
    Date: 2005–07
  20. By: Jesse Darja (SMERU Reasearch Centre); Daniel Suryadarma (SMERU Reasearch Centre); Asep Suryahadi (SMERU Reasearch Centre); Sudarno Sumarto (SMERU Reasearch Centre)
    Abstract: Infrastructures play a crucial role in economic development and poverty reduction. The economic crisis in 1997-98 severely curtailed the government’s capacity to maintain existing infrastructures, negatively impacted the prospects for future economic development and poverty reduction in the country. This study provides an overview of the changes in the availability of village-level infrastructures and public services during the economic crisis. The findings indicate that there were mixed trends in the availability of different types of infrastructures and public services. Furthermore, the changes in the availability of certain infrastructures or public services differ across urban and rural areas as well as between Java-Bali and the outer islands. In the era of regional autonomy, it is essential to involve regional governments in infrastructure development planning, management, and maintenance.
    Keywords: economic development, poverty reduction, economic crisis, village-level, infrastructure development, public services, Java-Bali, Indonesia
    JEL: H54 P43 P46
    Date: 2004–06
  21. By: Ivica Urban (Institute of Public Finance, Zagreb, Croatia); Peter J. Lambert (University of Oregon Economics Department)
    Abstract: The decomposition of the redistributive effect of an income tax into vertical, horizontal and reranking contributions according to the model of Aronson, Johnson and Lambert (1994), henceforth AJL, is revisited. When close equals groups are used, rather than the exact equals groups upon which the model is predicated, problems arise. A new measurement system is proposed, in which three distinct forms of reranking are disentangled and the vertical and horizontal contributions are redefined. Other approaches to measuring equity in tax systems are set in context. Findings are applied to Croatian data, and recommendations for users of the AJL methodology are given.
    Keywords: redistributive effect, vertical equity, horizontal inequity, reranking
    JEL: H23
    Date: 2005–07–01
  22. By: David W. Emmons (American Medical Association); Eva Madly (W.E. Upjohn Institute); Stephen A. Woodbury (W.E. Upjohn Institute and Michigan State University)
    Abstract: We replicate and extend a simulation model developed by Jonathan Gruber with the goals of illuminating Gruber's modeling of health insurance coverage under a tax credit and examining the sensitivity of the results to changes in the model's key parameters. The replications suggest that a refundable tax credit of $1,000 for a single individual or $2,000 for a family for private health insurance would reduce the number of uninsured individuals by between 17.5 and 28 percent and require new government expenditures of between $16.6 and $44 billion, of which about $7.4 - $9.7 billion would be for coverage of previously uninsured individuals. These wide simulated ranges highlight the uncertainty inherent in modeling the effects of health insurance tax credits and suggest that progress on the issue of tax credits for health insurance will require improved evidence on the likely take-up rate of a credit.Keywords: Sullivan, TANF, eligibility, vehicle, asset limits
    Keywords: health, insurance, Gruber, tax, credit, Woodbury, Emmons, Upjohn
    JEL: I18 H23
    Date: 2005–07
  23. By: Yuanzhu Lu (National University of Singapore)
    Abstract: Endogenous order of moves is analyzed in a mixed triopoly with one public firm, one domestic private firm and one foreign private firm. The public firm produces most inefficiently, the foreign private firm produces most efficiently, and the efficiency of the domestic private firm is in between. We consider the observable delay game of Hamilton and Slutsky (1990) in the context of a quantity setting mixed triopoly where firms first choose the timing of choosing their quantities before quantity choice and find subgame perfect Nash equilibria (SPNE). The main result is that the public firm chooses to produce in the last period while the domestic private firm chooses to produce in any period except the last one in such a mixed triopoly, provided that efficiency differential between domestic and foreign private firm is not big.
    Keywords: Mixed Oligopoly; Endogenous Timing; Foreign Competitor; Simultaneous; Sequential; Efficiency Differential
    JEL: C72 D43 H42 L13
    Date: 2005–07–12
  24. By: Javier Escobal (Grupo de Análisis para el Desarrollo GRADE); Arturo Vásquez (OSINERG)
    Abstract: This paper shows the impact that investment in infrastructure may have on the efficiency of agricultural products markets. Using daily price series for the most important agricultural crop in Peru (potato), in 10 cities from 1995 to 2001, we show that there is enough evidence to conclude that agricultural markets are spatially integrated. However we also show that there is short term disequilibria that affect the efficiency with which price information is transmitted across markets. A Threshold Cointegration Model is used to asses the speed of adjustment towards the equilibrium, the presence of transaction costs and the probabilities of successful and failed arbitrage between spatially distributed markets. As was expected, the paper shows that distance and geographic differences are important factors affecting spatial integration and efficiency between markets. However, other elements susceptible of government intervention, such as availability of information (access to local media and telecommunications facilities), road density or access to wholesale markets, are key factors for the reduction of transaction costs and the improvement of spatial integration between markets.
    Keywords: Infrastructure, Investment, Rural, Peru
    JEL: R12 D23 H54 Q11 Q13
    Date: 2005–07–13
  25. By: Xabier Raurich (Universitat Girona and Creb, Universitat de Barcelona); Hector Sala (Universitat Autònoma de Barcelona and IZA); Valeri Sorolla (Universitat Autònoma de Barcelona)
    Abstract: We develop a growth model with unemployment due to imperfections in the labor market. In this model, wage inertia and balanced budget rules cause a complementarity between capital and employment capable of explaining the existence of multiple equilibrium paths. Hysteresis is viewed as the result of a selection between these different paths. We use this model to argue that, in contrast to the US, those fiscal policies followed by most of the European countries after the shocks of the 1970’s may have played a central role in generating hysteresis.
    Keywords: unemployment,hysteresis,multiple equilibria,economic growth,fiscal policy
    JEL: E24 E62 O41
    Date: 2005–07

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