nep-pbe New Economics Papers
on Public Economics
Issue of 2006‒10‒21
23 papers chosen by
Peren Arin
Massey University

  1. Fiscal Policy and Macroeconomic Uncertainty in Developing Countries: The Tale of the Tormented Insurer By Enrique G. Mendoza; P. Marcelo Oviedo
  2. Tax Incentives and Household Portfolios: A Panel Data Analysis By Sule Alan; Søren Leth-Petersen
  3. Collectively Incentive Compatible Tax Systems By Felix Bierbrauer
  4. Distortionary Taxation and the Free-Rider Problem By Felix Bierbrauer
  5. Fiscal sustainability indicators and policy design in the face of ageing By Geert Langenus
  6. The Provision and Pricing of Excludable Public Goods: Ramsey-Boiteux Pricing versus Bundling By Martin Hellwig
  7. The optimal tax treatment of housing capital in the neoclassical growth model By Eerola , Essi; Määttänen , Niku
  8. Optimal budget deficits and immigration By Karin Mayr
  9. Optimal Redistribution With Productive Social Services By Luciano Greco
  10. The effects of aging population on the sustainability of fiscal policy By Puhakka , Mikko
  11. Informative Voting and the Samuelson Rule By Felix Bierbrauer; Marco Sahm
  12. Federal Tax Policy Towards Energy By Gilbert E. Metcalf
  13. Do fiscal variables affect fiscal expectations? Experiments with real world and lab data By Oliver Kirchkamp; Michele Bernasconi; Paolo Paruolo
  14. Labour taxation and shock propagation in a New Keynesian model with search frictions By Vanhala, Juuso
  15. The Threat of Capital Drain: A Rationale for Public Banks? By Hendrik Hakenes; Isabel Schnabel
  16. Fiscal policy in the 1920s and 1930s How much different it is from the post war period's policies? By Virén , Matti
  17. Ex Interim Voting in Public Good Provision By Sven Fischer; Andreas Nicklisch
  18. Evaluating Pension Portability Reforms: The Tax Reform Act of 1986 as a Natural Experiment By Vincenzo Andrietti; Vincent A. Hildebrand
  19. Fiscal Sustainability in a New Keynesian Model By Campbell Leith and Simon Wren-Lewis
  20. Government size and output volatility: is there a relationship? By Virén , Matti
  21. The effect of a transaction tax on exchange rate volatility By Lanne , Markku; Vesala , Timo
  22. The Effects of the Size of the Public Sector on Fertility By Mikko Puhakka; Matti Viren
  23. Political Economy of Electricity Subsidy: Evidence from Punjab By Jain, Varinder

  1. By: Enrique G. Mendoza; P. Marcelo Oviedo
    Abstract: Governments in emerging markets often behave like a "tormented insurer," trying to use non-state-contingent debt instruments to avoid cuts in payments to private agents despite large fluctuations in public revenues. In the data, average public debt-GDP ratios decline as the variability of revenues increases, primary balances and current expenditures follow cyclical patterns sharply at odds with the countercyclical patterns of industrial countries, and the cyclical variability of public expenditures exceeds that of private expenditures by a wide margin. This paper proposes a model of a small open economy with incomplete markets that can rationalize this behavior. In the model a fiscal authority makes optimal expenditure and debt plans given shocks to output and revenues, and private agents make optimal consumption and asset accumulation plans. Quantitative analysis of the model calibrated to Mexico yields a negative relationship between average public debt and revenue variability similar to the one observed in the data. The model mimics Mexico's GDP correlations of government purchases and the primary balance. The ratio of public-to-private expenditures fluctuates widely and the implied welfare costs dwarf conventional estimates of negligible benefits of risk sharing and consumption smoothing.
    JEL: E62 F34 H63
    Date: 2006–10
  2. By: Sule Alan (Department of Economics, York University); Søren Leth-Petersen (Akf - Institute of Local Government Studies, Denmark)
    Abstract: This paper investigates the responsiveness of household portfolios to tax incentives by exploiting a substantial tax reform that altered after-tax returns and cost of debt for a large number of households. An extraordinary panel data set that covers two years before and after the reform is used for the analysis. Our empirical findings suggest that households reshuffle their balance sheets in the case of a partial deductibility phase-out. In particular, heavily taxed,interest-bearing assets are used to pay off mortgage debt. Furthermore, we find that taxes have a significant impact on the structure of household portfolios even after controlling for unobserved heterogeneity.
    Keywords: household portfolios; taxation; panel data; natural experiment
    JEL: G11 H31
    Date: 2006–10
  3. By: Felix Bierbrauer (Max Planck Institute for Research on Collective Goods, Bonn)
    Abstract: This paper assumes that individuals possess private information both about their abilities and about their valuation of a public good. Individuals can undertake collective actions on order to manipulate the tax system and the decision on public good provision. Consequently, an implementable scheme of taxation has to be collectively incentive compatible. If preferences are additively separable, then an implementable tax systems has the following properties: (i) tax payments do not depend on public goods preferences and (ii) there is no scope for a collective manipulation of public goods preferences. For a quasilinear economy, the optimal tax system is explicitly characterized.
    Keywords: Optimal Taxation, Public Good Provision, Revelation of Preferences, Information Aggregation
    JEL: D71 D82 H21 H41
    Date: 2006–09
  4. By: Felix Bierbrauer (Max Planck Institute for Research on Collective Goods, Bonn)
    Abstract: This paper derives a version of the Samuelson rule, which takes not only the marginal costs of public funds into account but also the desirability of preference revelation. Under a linear income tax more able individuals suffer from a larger utility loss if taxes are raised to cover the cost of public good provision. This implies that these individuals are tempted to understate their valuation of the public good. Likewise, less productive individuals are inclined to exaggerate their valuation. These incentive concerns require the use of excessive taxes. They ensure a truthful revelation of preferences for the public good. Under an optimal utilitarian tax constitution, individuals are not granted influence on public good provision if the taxes needed to induce informative behavior are prohibitively high.
    Keywords: Public Good Provision, Revelation of Preferences, Distortionary Taxation, Two-dimensional Heterogeneity
    JEL: D71 D82 H21 H41
    Date: 2006–03
  5. By: Geert Langenus (National Bank of Belgium, Research Department)
    Abstract: Mainly due to increasing concerns about the potential impact of population ageing the sustainability of public finances has become one of the key issues in fiscal assessments. This paper briefly reviews the different theoretical benchmarks and empirical tests for sustainability and assesses the sustainability of public finances in euro area countries on the basis of the latest projections of the Ageing Working Group of the EU Economic Policy Committee. Two alternative operational indicators for fiscal sustainability are proposed and appropriate policy options to restore fiscal sustainability are explored for three individual euro area countries. Pre-funding strategies that create the budgetary room that is needed to finance ageing costs in advance require important consolidation efforts for most euro area countries and can imply aiming at significant budgetary surpluses in the coming years for some. However, a simplified technical exercise assessing the evolution of the fiscal burden of the average worker shows that such strategies generally imply a more even distribution of the fiscal burden across generations than more gradual adjustment strategies.
    Keywords: population ageing, fiscal sustainability, medium-term objectives for fiscal policy
    JEL: H55 H60
    Date: 2006–10
  6. By: Martin Hellwig (Max Planck Institute for Research on Collective Goods, Bonn)
    Abstract: This paper studies the relation between Bayesian mechanism design and the Ramsey-Boiteux approach to the provision and pricing of excludable public goods. For a large economy with private information about individual preferences, the two approaches are shown to be equivalent if and only if, in addition to incentive compatibility and participation constraints, the .nal allocation of private-good consumption and admission tickets to public goods a condition of renegotiation proofness. Without this condition, a mechanism involving mixed bundling, i.e. combination tickets at a discount, is superior.
    Keywords: Mechanism Design, Excludable Public Goods, Ramsey-Boiteux Pricing, Renegotiation Proofness, Bundling
    JEL: D61 H21 H41 H42
    Date: 2006–09
  7. By: Eerola , Essi (RUESG, University of Helsinki); Määttänen , Niku (The Research Institute of the Finnish Economy and CEBR)
    Abstract: In a dynamic setting, housing is both an asset and a consumption good. But should it be taxed like other forms of consumption or like other forms of saving? We consider the optimal taxation of the imputed rent from owner housing within a version of the neoclassical growth model. We find that the optimal tax rate on the imputed rent is quite sensitive to the constraints imposed on the other available tax rates. In general, it is not optimal to tax the imputed rent at the same rate as the business capital income.
    Keywords: housing; capital taxation; optimal taxation
    JEL: E21 H21
    Date: 2005–07–11
  8. By: Karin Mayr (Department of Economics, Johannes Kepler University Linz, Austria)
    Abstract: The paper shows that immigration can create an incentive for deficit-spending among natives. If immigrants use up some given share of public funds net of debt service, a policy of running budget deficits becomes optimal. The optimal budget deficits are higher, the higher the share of net public funds spent exogenously on immigrants. We take the share of immigrants in the total population as a proxy for exogenous spending on immigrants and estimate its effect on budget deficits for 20 OECD countries during 1980--1995. We find the effect to be significant and positive, suggesting that exogenous spending was increasing during that time.
    Keywords: optimal budget deficits, immigration, tax-smoothing
    JEL: H62 H63 F22
    Date: 2006–10
  9. By: Luciano Greco (University of Padua)
    Abstract: We analyze the optimality of alternative mechanisms of public provision of private goods affecting the productive capacity of households (e.g. education, health-care) rather than directly their welfare. Opting out mechanisms - often considered a tool to focus social expenditure - are proven to be welfare improving under the assumption that the provided good is not a substitute of households' exogenous productive capacity (say, inherited wealth). Conversely, when publicly provided goods are substitute of inherited productive capacity, topping up mechanisms prove more efficient.
    Keywords: In-kind transfers, public provision of private goods, opting out, topping up
    JEL: H42 H21
    Date: 2006–10
  10. By: Puhakka , Mikko (Department of Economics, University of Oulu)
    Abstract: We study the effects of aging population on the sustainability of fiscal policy in overlapping generations models with government debt and a pay-as-you-go pension system. The smaller the population growth rate, the lower the maximum sustainable level of deficits. When the utility function is of a specific form, an increase in the payroll tax rate and the replacement rate decreases the level of maximum sustainable deficits; except in the case when pension depends on the wage level prevailing during the working period. The ratio of the deficits in two economies with different population growth rates is characterized with numerical examples.
    Keywords: aging; pensions; overlapping generations; fiscal policy
    JEL: E21 E32
    Date: 2005–10–11
  11. By: Felix Bierbrauer (Max Planck Institute for Research on Collective Goods, Bonn); Marco Sahm (Lehrstuhl fuer Finanzwissenschaft, Munich, Germany.)
    Abstract: We study the classical free-rider problem in public goods provision in a large economy with uncertainty about the average valuation of the public good. Individual preferences over public goods are shaped by a skill and a taste parameter. We use a mechanism design approach to solve for the optimal utilitarian provision rule. The relevant incentive constraints for information aggregation ensure that individuals be-have as if they were engaging in informative voting over the level of public good provision. It is shown that the use of information by an optimal provision rule is inversely related to the polarization of preferences which results from the properties of the skill distribution.
    Keywords: information aggregation, informative voting, public goods, two-dimensional heterogeneity
    JEL: H41 D71 D72 D82
    Date: 2006–08
  12. By: Gilbert E. Metcalf
    Abstract: On Aug. 8, 2005, President Bush signed the Energy Policy Act of 2005 (PL 109- 58). This was the first major piece of energy legislation enacted since 1992 following five years of Congressional efforts to pass energy legislation. Among other things, the law contains tax incentives worth over $14 billion between 2005 and 2015. These incentives represent both pre-existing initiatives that the law extends as well as new initiatives. In this paper I survey federal tax energy policy focusing both on programs that affect energy supply and demand. I briefly discuss the distributional and incentive impacts of many of these incentives. In particular, I make a rough calculation of the impact of tax incentives for domestic oil production on world oil supply and prices and find that the incentives for domestic production have negligible impact on world supply or prices despite the United States being the third largest oil producing country in the world. Finally, I present results from a model of electricity pricing to assess the impact of the federal tax incentives directed at electricity generation. I find that nuclear power and renewable electricity sources benefit substantially from accelerated depreciation and that the production and investment tax credits make clean coal technologies cost competitive with pulverized coal and wind and biomass cost competitive with natural gas.
    JEL: H20 Q48
    Date: 2006
  13. By: Oliver Kirchkamp; Michele Bernasconi; Paolo Paruolo
    Abstract: We generate observable expectations about fiscal variables through laboratory experiments using real world data from several European countries as stimuli. We compare a VAR model of expectations for data which is presented in a fiscal frame with one for neutrally presented data. We find that participants understand the meaning of the fiscal variables, but also that their ability to perceive the correct characteristics of fiscal policy is limited. We tie the VAR analysis to specific models of forming expectations. We find that agents’ expectations are neither consistent with rational nor with purely adaptive expectations but, instead, follow an augmented-adaptive scheme
    Keywords: Experiments, fiscal policy, expectations, causality, cointegration, panel data.
    JEL: C91 D89 E62 H31
    Date: 2006–06
  14. By: Vanhala, Juuso (Bank of Finland Research)
    Abstract: This paper studies the implications of labour taxation in determining the sensitivity of an economy to macroeconomic shocks. We construct a New Keynesian business cycle model with matching frictions of the labour market, where sluggish employment adjustment implies a key role for labour markets in de-termining shock propagation. We consider three policy instruments to analyze the steady state and dy-namic effects of tax reforms: the marginal tax rate and replacement ratio amplify shock responses whereas employment subsidies weaken them. The tax instruments affect the degree to which the wage absorbs shocks. We show that the relative effects of the tax instruments and thus the effects of tax pro-gression are sensitive to the initial degree of tax progression in the economy. Increasing tax progression when taxation is initially progressive is harmful for steady state employment and output, and amplifies the sensitivity of macroeconomic variables to shocks. When taxation is initially proportional, increasing progression is beneficial for output and employment and dampens shock responses of macroeconomic variables.
    Keywords: matching; income taxation; business cycles
    JEL: E24 E32 J64
    Date: 2006–06–12
  15. By: Hendrik Hakenes (Max Planck Institute for Research on Collective Goods, Bonn); Isabel Schnabel (Max Planck Institute for Research on Collective Goods, Bonn)
    Abstract: This paper yields a rationale for why subsidized public banks may be desirable from a regional perspective in a financially integrated economy. We present a model with credit rationing and heterogeneous regions in which public banks prevent a capital drain from poorer to richer regions by subsidizing local depositors, for example, through a public guarantee. Under some conditions, cooperative banks can perform the same function without any subsidization; however, they may be crowded out by public banks. We also discuss the impact of the political structure on the emergence of public banks in a political-economy setting and the role of interregional mobility.
    Keywords: Public banks, cooperative banks, capital drain, credit rationing, financial integration, privatization
    JEL: G21 F36 H11 L33
    Date: 2006–04
  16. By: Virén , Matti (Bank of Finland and University of Turku)
    Abstract: This paper deals with the fiscal behaviour of governments in the 1920s and 1930s. The intention is to see whether there were the same features in government behaviour as in the post-World War II era. In par-ticular, attention is paid to asymmetric fiscal policies, ie the question of whether government deficits react differently to income growth and inflation during depressions and booms. The analysis is carried out us-ing data primarily from the League of Nations. The data come from 32 countries and covers the period 1925–1938. Estimation results suggest the in pre-war period deficits were much less sensitive to output and did not show as many asymmetric features as in post-war period. Otherwise, the same regularities apply to the empirical results. In particular, this is true with the disciplinary role of government debt in terms of budget deficits.
    Keywords: fiscal policy; deficit; asymmetric behaviour
    JEL: E62 H62
    Date: 2005–07–11
  17. By: Sven Fischer (Max Planck Institute of Economics, Jena); Andreas Nicklisch (Max Planck Institute for Research on Collective Goods, Bonn)
    Abstract: We report the results of an experimental study that compares voting mechanisms in the provision of public goods. Subjects can freely decide how much they want to contribute. Whether the public good is finally provided is decided by a referendum under full information about all contributions. If provision is rejected, contributions are reduced by a fee and reimbursed. We compare unanimity with majority voting and both to the baseline of cheap talk. Contributions are highest under unanimity. Yet, results concerning overall efficiency are mixed. When provision occurs, only unanimity enhances efficiency. Overall, however, unanimity leads to too many rejections.
    Keywords: Experimental economics, learning, minimal social situation, myopia
    JEL: D83 D84
    Date: 2006–09
  18. By: Vincenzo Andrietti; Vincent A. Hildebrand
    Abstract: This paper uses the Tax Reform Act of 1986 as a natural experiment to evaluate the job mobility response of prime-aged US employees participating in employer sponsored defined benefit pension plans to a reduction in the vesting period for pension rights accrual. We apply difference-in-differences methods using data from the Survey of Income and Program Participation to estimate the treatment impact of this policy change. We find that on average the reform had no significant effects on voluntary job mobility of the treated group. Our findings are robust to the use of different control groups and difference-in-differences estimators.
    Keywords: Labour mobility, employer-provided pension plans, vesting, program evaluation, propensity score matching
    JEL: J24 J44 J62 J63 J68
    Date: 2006–09
  19. By: Campbell Leith and Simon Wren-Lewis
    Abstract: Most recent work deriving optimal monetary policy utilising New Neo-Classical Synthesis (NNCS) models abstract from the impact of monetary policy on the government’s finances, by assuming the existence of lump sum taxes. In this paper, we assume that the government does not have access to such taxes to satisfy its intertemporal budget constraint in the face of shocks. We then consider optimal monetary and fiscal policies under discretion and commitment in the face of technology, preference and cost-push shocks. We find that the optimal precommitment policy implies a random walk in the steady-state level of debt, generalising earlier results that involved only a single fiscal instrument. We also find that the time-inconsistency in the optimal precommitment policy is such that governments are tempted, given inflationary expectations, to utilise their monetary and fiscal instruments in the initial period to change the ultimate debt burden they need to service. We show that this temptation is only eliminated if following shocks, the new steady-state debt is equal to the original (efficient) debt level. This implies that under a discretionary policy the random walk result is overturned: debt will always be returned to this initial steady-state even although there is no explicit debt target in the government’s objective function. Analytically and in a series of numerical simulations we show which instrument is used to stabilise the debt depends crucially on the degree of nominal inertia and the size of the debt-stock. We also show that the welfare consequences of introducing debt are negligible for precommitment policies, but can be significant for discretionary policy.
    JEL: E60
  20. By: Virén , Matti (University of Turku and Bank of Finland)
    Abstract: This paper provides some further tests for the proposition that a larger public sector leads to smaller out-put volatility. Both Gali and Fatas & Mihov have provided some evidence which appears to support this proposition. Their evidence is, however, based on a relatively small sample of countries. In this study, we go beyond the OECD sample and focus on a much larger World Bank data set covering up to 208 countries for the period 1960–2002. We also seek to utilise some time series aspects of the material by using pooled cross-section time series data. Tests with different models and measures clearly indicate that the original results are not very robust and the relationship between government size and output volatility is either nonexistent or very weak at best.
    Keywords: government; fiscal policy; automatic stabilisers
    JEL: E32 E62 H30
    Date: 2005–05–11
  21. By: Lanne , Markku (Economics Department, European University Institute); Vesala , Timo (RUESG/Department of Economics, University of Helsinki)
    Abstract: We argue that a transaction tax is likely to amplify, not dampen, volatility in the foreign exchange mar-kets. Our argument stems from the decentralised trading practice and the presumable discrepancy be-tween ‘informed’ and ‘uninformed’ traders’ valuations. Since informed traders’ valuations are likely to be less dispersed, a transaction tax penalises informed trades disproportionately, leading to increased volatil-ity. Empirical support for this prediction is found by investigating the effect of transaction costs on the volatility of DEM/USD and JPY/USD returns. High-frequency data are used and an increase in transac-tion costs is found to have a significant positive effect on volatility.
    Keywords: transaction tax; exchange rates; volatility
    JEL: F31 F42 G15 G28
    Date: 2006–10–10
  22. By: Mikko Puhakka (Department of Economics, University of Oulu); Matti Viren (Department of Economics, University of Turku)
    Abstract: We construct a simple exchange economy overlapping generations model in which there are along with a public social security various private insurance schemes to explore fertility and the effects of various variables on it. In the private system parents can invest in children and benefit from their support (care and income support) in the old age. An introduction of the public system will lower the incentive to have children, i.e. the fertility will be lower. This is an important negative externality of public pension system. We test some of the model's basic implications using long historical panel data from 11 countries for the period 1750-1995. In addition, two other data sets, the WDI (World Bank) and MZES (Manheim University) are used to reinforce the empirical results that are obtained with historical data. These analyses show that, opposite to common beliefs, there is a positive relationship between ageing and fertility if we control for the key determinants of fertility (size of the public sector, level of income, education and infant mortality). By contrast there is a strong negative relationship between the size of the public sector and fertility. The same is true in terms of income and education while the fertility effect of infant mortality is clearly positive.
    Keywords: fertility, pensions, overlapping generations
    JEL: E21 E32
    Date: 2006–10
  23. By: Jain, Varinder
    Abstract: The electricity subsidy distribution pattern needs to be scrutinised to assess whether the policy benefits small producers, a normative argument often made while granting any input subsidy. In Punjab, this policy is found to ignore equity considerations while granting non-discriminatory electricity subsidies to the agricultural sector. This study highlights the existence of disparities in the flow of electricity subsidy between the advanced and backward regions. While the medium and large farmers reap the major benefits of the subsidy, the poor small farmers, especially in the backward areas, remain excluded due to their non-possession of electricity connections. In a nutshell, this paper questions the justification for introducing such a policy and puts forward the case for user charges based on open access to electricity.
    Keywords: Political economy; Electricity Subsidy; Agriculture
    JEL: P26 H23
    Date: 2006–09–23

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