nep-pbe New Economics Papers
on Public Economics
Issue of 2006‒09‒03
eighteen papers chosen by
Peren Arin
Massey University

  1. Modern Macroeconomics in Practice: How Theory is Shaping Policy By Patrick Kehoe; Varadarajan V. Chari
  2. The Theory of Optimal Taxation: What is the Policy Relevance? By Peter Birch Sørensen
  3. Can Capital Income Taxes Survive? And Should They? By Peter Birch Sørensen
  4. Privatization in Africa: What has Happened? What is to be Done? By John Nellis
  5. Privatization in Latin America By John Nellis
  6. Measuring Tax Efficiency By Raimondos-Møller, Pascalis; Woodland, Alan D.
  7. The Incentive to Declare Taxes and Tax Revenue: The Lottery Receipt Experiment in China By Junmin Wan
  8. Taxation and systematic risk under decreasing returns to scale By Lund, Diderik
  9. Social security, income taxation and poverty distribution By MALDONADO, Darío
  10. Public Investment, Economic Performance and Budgetary Consolidation: VAR Evidence for the 12 Euro Countries By Alfredo M. Pereira; Maria de Fátima Pinho
  11. Externalities and Fundamental Nonconvexities : A Reconciliation of Approaches to General Equilibrium Externality Modelling and Implications for Decentralization By Murty, Sushama
  12. Value Added Tax Treatment of Financial Services: A Developing Country Perspective By Pierre-Pascal Gendron
  13. The Illusion of Sustainability By Michael Kremer; Edward Miguel
  14. Social Security and Intergenerational Redistribution By Bhattacharya, Joydeep; Reed, Robert
  15. Valuation, leverage and the cost of capital in the case of depreciable assets By Lund, Diderik
  16. Economic Policy and Wage Differentials in Latin America By Jere R. Behrman; Nancy Birdsall; Miguel Székely
  17. How Will Declining Rates of Marriage Reshape Eligibility for Social Security? By Madonna Harrington Meyer; Douglas A. Wolf; Christine L. Himes
  18. Monotonicity and Nash Implementation in Matching Markets with Contracts By Haake Claus-Jochen; Klaus Bettina

  1. By: Patrick Kehoe; Varadarajan V. Chari
    Abstract: Theoretical advances in macroeconomics made in the last three decades have had a major influence on macroeconomic policy analysis. Moreover, over the last several decades, the United States and other countries have undertaken a variety of policy changes that are precisely what macroeconomic theory of the last 30 years suggests. The three key developments that have shaped macroeconomic policy analysis are the Lucas critique of policy evaluation due to Robert Lucas, the time inconsistency critique of discre-tionary policy due to Finn Kydland and Edward Prescott, and the development of quantitative dynamic stochastic general equilibrium models following Finn Kydland and Edward Prescott.
    JEL: E21 E4 E43 E5 E52 E58 E6 E62 E65 H2 H25 H3
    Date: 2006–08
  2. By: Peter Birch Sørensen (Department of Economics, University of Copenhagen)
    Abstract: 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.
    Keywords: optimal taxation; uniform taxation; tax neutrality
    JEL: H21 H25
    Date: 2006–08
  3. By: Peter Birch Sørensen (Department of Economics, University of Copenhagen)
    Abstract: The paper surveys some main results in the theory of capital income taxation in the open economy; reviews recent trends in international taxation, and discusses alternative blueprints for fundamental capital income tax reform from the perspective of an open economy faced with growing mobility of capital income tax bases.
    Date: 2006–08
  4. By: John Nellis
    Abstract: Sub-Saharan African states urgently need expanded and more dynamic private sectors, more efficient and effective infrastructure/utility provision, and increased investment from both domestic and foreign sources. Privatization is one way to address these problems. But African states have generally been slow and reluctant privatizers; a good percentage of industrial/manufacturing and most infrastructure still remains in state hands. Given prevailing public hostility towards privatization, and widespread institutional weaknesses, such caution is defensible, but nonetheless very costly. The long-run and difficult solution is the creation and reinforcement of the institutions that underpin and guide proper market operations. In the interim, African governments and donors have little choice but to continue to experiment with the use of externally supplied substitutes for gaps in local regulatory and legal systems.
    Keywords: Sub-Saharan Africa, privatization, investment
    JEL: K23 O55 L33 L50 L60 F21
  5. By: John Nellis
    Abstract: In Latin America, privatization started earlier and spread farther and more rapidly than in almost any other part of the world. More, and larger, firms were sold, and more proceeds were raised. Despite positive microeconomic results, privatization is highly and increasingly unpopular in the region. The core social criticism is that privatization contributes to growing poverty and inequality levels in Latin America—and circumstantial evidence supports the claim. But recent and rigorous studies dilute or counter the negative views, concluding that privatization has contributed only slightly to rising unemployment and in equality, and either reduces poverty or has no effect on it. Still, while privatization may be winning the economic battle it is losing the political war: The benefits are spread widely, small for each affected consumer or taxpayer, and occur (or accrue) in the medium-term. In contrast, the costs are large for those concerned, who tend to be visible, vocal, urban and organized, a potent political combination.
    Keywords: Latin America, privatization, poverty, inequality
    JEL: O54 D21 I32 D63
  6. By: Raimondos-Møller, Pascalis (Department of Economics, Copenhagen Business School); Woodland, Alan D. (Department of Economics, Copenhagen Business School)
    Abstract: This paper introduces an index of tax optimality that measures the distance of some current tax structure from the optimal tax structure in the presence of public goods. In doing so, we derive a [0, 1] number that reveals immediately how far the current tax configuration is from the optimal one and, thereby, the degree of efficiency of a tax system. We call this number the Tax Optimality Index. We show how the basic method can be altered in order to derive a revenue equivalent uniform tax, which measures the size of the public sector. A numerical example is used to illustrate the method developed.
    Keywords: Tax optimality index; excess burden; distance function
    JEL: H21 H41
    Date: 2006–08–30
  7. By: Junmin Wan (Osaka University)
    Abstract: We examine the validity of a new system of taxation called lottery receipts in China theoretically and empirically. Tax collection is difficult as the government difficultly monitors the actual economic dealings. To bring out the private information on transaction known only to a seller and a buyer, the government has set up a lottery receipt system which has been tried out in many areas. If the net revenue from a lottery receipt is invested in pure public goods, the lottery receipt will been purchased even if the consumer has expected quasi-linear utility. By issuing a lottery receipt, the government may prevent tax evasion caused by conspiracies between consumers and firms and collect tax effectively. Estimation is performed based on panel data for different periods from a total of 37 districts in Beijing and Tianjin during 1998-2003. The lottery receipt experiment has significantly raised the business tax, the growths of business tax and total tax revenues.
    Keywords: tax evasion, business tax, lottery receipt experiment, random trend (growth) model
    JEL: H26 D81 D82
    Date: 2006–09
  8. By: Lund, Diderik (Department of Economics, Copenhagen Business School)
    Abstract: Lund (2002a) showed in a CAPM-type model how tax depreciation schedules affect required expected returns after taxes. Even without leverage higher tax rates implied lower betas when tax deductions were risk free. Here they are risky, and marginal investment is taxed together with inframarginal in an analytical model of decreasing returns. With imperfect loss offset tax claims are analogous to call options. The beta of equity is still decreasing in the tax rate, but increasing in the underlying volatility. The results are important if market data are used to infer required expected returns, and in discussions of tax design.
    Keywords: Corporate tax; depreciation; imperfect loss offset; decreasing returns; cost of capital; uncertainty
    JEL: F23 G31 H25
    Date: 2006–06–02
  9. By: MALDONADO, Darío
    Abstract: In this paper I consider the normative arguments that justify a public social security system as a redistributive device when goverment is concerned with individual utility and poverty. Redistribution can be done using social security, income taxation or both. The main objective of this paper is to show how the consideration of a planner that cares about poverty and utility increases the desirability of social with respect to the case when the planner only cares about utility.
    Date: 2006–01–01
  10. By: Alfredo M. Pereira (Department of Economics, College of William and Mary); Maria de Fátima Pinho (Instituto Superior de Contabilidade e Administração)
    Abstract: In a period of heightened concern about fiscal consolidation in the euro area a politically expedient way of controlling the public budget is to cut public investment. A critical question, however, is whether or not political expediency comes at a cost, in terms of both long-term economic performance and future budgetary contention efforts. First, common wisdom suggests that public investments have positive effects on economic performance although the empirical evidence is less clear. Second, it is conceivable that public investment has such strong effects on output, that over time it generates enough additional tax revenues to pay for itself. Obviously, it is equally plausible that the effects on output although positive are not strong enough for the public investment to pay for itself. In this paper we investigate these issues empirically for the twelve countries in the euro area using a vector auto-regressive approach. We conclude that the euro countries can be gathered in four groups according to the nature of the economic and budgetary impact of public investment. The first group includes Austria, Belgium, Luxembourg, and Netherlands, where the economic effects are either negative or positive but very small and, therefore, cuts will be harmless for the economy and effective from a budgetary perspective. The second group includes Finland, Portugal, and Spain, where public investment does not pay for itself and, therefore, cuts are an effective tool of budgetary consolidation although they are harmful for the economy. The third group includes France, Greece, and Ireland where public investment just pays for itself and therefore cuts are not an effective way of achieving long-term budgetary consolidation and are harmful for the economy. Finally, the fourth group includes Germany and Italy, where public investment more than pays for itself and, therefore, cuts are not only harmful for the economy but also counterproductive from a budgetary perspective.
    Keywords: public investment, economic performance, budgetary consolidation, euro area
    JEL: C32 E62 H54
    Date: 2006–08–23
  11. By: Murty, Sushama (Department of Economics, University of Warwick)
    Abstract: By distinguishing between producible and nonproducible public goods, we are able to propose a general equilibrium model with externalities that distinguishes between and encompasses both the Starrett [1972] and Boyd and Conley [1997] type external effects. We show that while nonconvexities remain fundamental whenever the Starrett type external effects are present, these are not caused by the type discussed in Boyd and Conley. Secondly, we find that the notion of a “public competitive equilibrium” for public goods found in Foley [1967, 1970] allows a decentralized mechanism, based on both price and quantity signals, for economies with externalities, which is able to restore the equivalence between equilibrium and efficiency even in the presence of nonconvexities. This is in contrast to equilibrium notions based purely on price signals such as the Pigouvian taxes
    Keywords: externalities ; fundamental nonconvexities ; Clarke’s normal and tangent cones ; public goods
    JEL: D62 D50 H41
    Date: 2006
  12. By: Pierre-Pascal Gendron (International Tax Program, Rotman School of Management, University of Toronto)
    Abstract: How to tax financial services is in many ways the key ‘frontier’ issue for VAT in developed countries. No convincing conceptually correct and practical solution for capturing the bulk of financial services under the VAT has yet been developed anywhere. Developing and transitional countries face constraints that make the taxation of financial services an even more formidable challenge. Since even developed economies with sophisticated financial institutions and markets and capable tax administrations have opted with few exceptions to exempt such activities, it is not surprising that exemption also rules in almost all developing and transitional countries. Surprisingly, however, it may not be that difficult to collect at least some VAT on financial services even in such countries. This paper examines the current VAT treatment of financial services, as well as its rationales and economic effects. It then outlines alternatives to that treatment, focusing on developing and transitional economies and their tax policy constraints. Finally, the paper outlines best practices for tax reform and then proposes an alternative to the exemption system in the form of a hybrid system to capture VAT revenues in developing and transitional economies.
    Keywords: value added tax, financial services, developing and transitional countries
    JEL: H24 O23
    Date: 2006–08
  13. By: Michael Kremer; Edward Miguel
    Abstract: The history of foreign development assistance is one of movement away from addressing immediate needs to a focus on the underlying causes of poverty. A recent manifestation is the move towards “sustainability,” which stresses community mobilization, education, and cost-recovery. This stands in contrast to the traditional economic analysis of development projects, with its focus on providing public goods and correcting externalities. We examine evidence from randomized evaluations on strategies for combating intestinal worms, which affect one in four people worldwide. Providing medicine to treat worms was extremely cost effective, although medicine must be provided twice per year indefinitely to keep children worm-free. An effort to promote sustainability by educating Kenyan schoolchildren on worm prevention was ineffective, and a “mobilization” intervention from psychology failed to boost de-worming drug take-up. Take-up was highly sensitive to drug cost: a small increase in cost led to an 80percent reduction in take-up (relative to free treatment). The results suggest that, in the context we examine, the pursuit of sustainability may be an illusion, and that in the short-run, at least, external subsidies will remain necessary.
    Keywords: foreign development assistance, poverty, sustainability, public good, externality, subsidy
    JEL: O15 H23 H41 H31 F35 I32 I12 I18
  14. By: Bhattacharya, Joydeep; Reed, Robert
    Abstract: Many countries around the world have large public pension programs with significant cross-cohort redistribution. This paper provides a rationale for such programs in a lifecycle framework with search and matching frictions in the labor market. In the model, public pension programs alter the age composition of the labor force by inducing the jobless elderly to retire. This improves the allocation of workers to jobs, raises firm entry and may also improve welfare. By requiring a long history of labor market attachment as a precondition to receiving benefits, these programs raise the future value of current employment for the young. This redistributes bargaining strength and income from the young to the old.
    Keywords: Search, labor market efficiency, unemployment, lifecycle, pensions
    JEL: E0
    Date: 2006–08–23
  15. By: Lund, Diderik (Department of Economics, Copenhagen Business School)
    Abstract: Levy and Arditti (1973) introduced depreciable assets into the Modigliani and Miller (1958) model, and analyzed the implications for the cost of capital. Assuming that the firm reinvests indefinitely to maintain a constant expected cash flow, they found that depreciation increases the cost of capital before and after tax. Most of their assumptions are maintained. However, commitment to perpetual reinvestment is in most cases not a reasonable assumption. Without it, depreciation decreases the cost of capital before and after tax. The effect of depreciation is less in absolute value than in Levy and Arditti, but not insignificant.
    Keywords: Cost of capital; depreciation; corporate taxes
    JEL: G31 H25
    Date: 2006–08–22
  16. By: Jere R. Behrman; Nancy Birdsall; Miguel Székely
    Abstract: This paper applies a new approach to the estimation of the impact of policy, both the levels and the changes, on wage differentials using a new high-quality data set on wage differentials by schooling level for 18 Latin American countries for the period 1977-1998. The results indicate that liberalizing policy changes overall have had a short-run disequalizing effect of expanding wage differentials, although this effect tends to fade away over time. This disequalizing effect is due to the strong impact of domestic financial market reform, capital account liberalization and tax reform. On the other hand, privatization contributed to narrowing wage differentials and trade openness had no significant effect on wage differentials. Technological progress, rather than trade flows, appears to be a channel through which policy changes are affecting inequality.
    Keywords: Latin America, wages, market reform, tax reform, technological change
    JEL: O33 J31 O57 H20 G10 L33
  17. By: Madonna Harrington Meyer (Center for Policy Research, Maxwell School, and SU Gerontology Center, Syracuse University, 426 Eggers Hall, Syracuse, NY 13244-1020); Douglas A. Wolf (Center for Policy Research, Maxwell School of Syracuse University, 426 Eggers Hall, Syracuse, NY 13244-1020); Christine L. Himes (Center for Policy Research, Maxwell School of Syracuse University, 426 Eggers Hall, Syracuse, NY 13244-1020)
    Abstract: For most older people in the United States, Social Security is the major source of income: nine out of ten people age 65 or older receive benefits, which represent an average of 41 percent of their income. Largely as a result of Social Security, poverty rates for the elderly are at an all-time low, just 10 percent. But pockets of poverty persist: older unmarried persons, blacks, and Hispanics experience poverty rates in excess of 20 percent, and over 40 percent of all older single black women live in poverty. People quality for Social Security based either on their work record or their marital status. Most older women receive noncontributory Social Security spouse of widow benefits on the basis of their marital history. For these women, marital status is more important than employment status in shaping old-age financial security. However, the trend to marry and stay married has declined over time in the United States, particularly among black women. This, we hypothesize, means that fewer women will qualify for spouse and widow benefits in coming decades. As a result, Social Security benefits will shrink among the very population that currently reports higher poverty rates, older single women, particularly black women. In this policy brief, we ask: Compared to earlier cohorts, what proportion of white, black, and Hispanic women born in the 1940s, 1950s, and 1960s will enter old age without a marriage that qualifies them for Social Security spouse and widow benefits? We find that the proportion who will reach age 62 without a qualifying marriage, and thus be ineligible for Social Security spouse and widow benefits, is increasing modestly for whites and Hispanics but dramatically for African Americans. Most of these women will be eligible for retired worker benefits under Social Security, but those benefits are not likely to be as large as the benefits they would have received as spouses and widows, had they been eligible. We then discuss a range of policy alternatives, including the possibility of a minimum benefit.
    Keywords: Social Security, spousal benefits, widow benefits, poverty, elderly, social welfare, income security.
    JEL: I38 J14 J15 J16 J26
    Date: 2006–07
  18. By: Haake Claus-Jochen; Klaus Bettina (METEOR)
    Abstract: We consider general two-sided matching markets, so-called matching with contracts markets as introduced by Hatfield and Milgrom (2005), and analyze (Maskin) monotonic and Nash implementable solutions. We show that for matching with contracts markets the stable correspondence is monotonic and implementable (Theorems 1 and 3). Furthermore, any solution that is Pareto efficient, individually rational, and monotonic is a supersolution of the stable correspondence (Theore m 2). In other words, the stable correspondence is the minimal solution that is Pareto efficient, individually rational, and implementable.
    Keywords: microeconomics ;
    Date: 2006

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