nep-pbe New Economics Papers
on Public Economics
Issue of 2007‒04‒28
twenty-one papers chosen by
Peren Arin
Massey University

  1. The Power of the Family By Alberto Alesina; Paola Giuliano
  2. Optimal Capital Income Taxation in a Two Sector Economy By Selim, Sheikh
  3. Fiscal Policy Throughout the Cycle: The Colombian Experience By Ignacio Lozano; Jorge Toro
  4. The Future of Social Security By Gonzalez-Eiras, Martin; Niepelt, Dirk
  5. Fiscal system and fiscal relations in the European Union: political restraints and alternative approach to public finance By Hrvoje Šimović
  6. Reading the fine print: how details matter in tax and expenditure limitations By Heather Brome; Darcy Rollins Saas
  7. Choosing the Legal Retirement Age in Presence of Unemployment By Casamatta, Georges; De Paoli, Caroline
  8. Emergence and Persistence of Inefficient States By Daron Agemoglu; Davide Ticchi; Andrea Vindigni
  9. Americans' Dependency on Social Security By Laurence J. Kotlikoff; Ben Marx; Pietro Rizza
  10. The Impact of Fiscal Policy on Labour Supply and Education in an Economy with Household and Market Production By Booth, Alison L; Coles, Melvyn G
  11. Taxes, Wages, and the Labor Supply of Older Americans By Lucie Schmidt; Purvi Sevak
  12. Local Government Finance in Kentucky: Time for Reform? By David Wildasin
  13. Recyclage et externalités environnementales : faut-il subventionner les activités de récupération recyclage ?. By Jean De Beir; Mouez Fodha; Guillaume Girmens
  14. The sustainability of euro area debt: a re-assessment By Peter Wierts
  15. Giving the ageing of the population how can countries afford pay-as-you-go social insurance pensions? By Gugushvili, Alexi
  16. Frames and Games By Jordi Brandts; Christiane Schwieren
  17. Social Security Privatization with Income-Mortality Correlation By Shinichi Nishiyama; Kent Smetters
  18. And Then There Were Four... How Many (and Which) Measures of Active Labour Market Policy Do We Still Need? By Eichhorst, Werner; Zimmermann, Klaus F
  19. Government expenditures on education, health, and infrastructure : a naive look at levels, outcomes, and efficiency By Trujillo,Lourdes; Gonzalez, Marianela; Estache, Antonio
  20. Implicaciones Fiscales y Sectoriales de la Reforma a las Transferencias Territoriales en Colombia By Igancio Lozano; Jorge Ramos; Hernán Rincón
  21. An Economic Theory of Political Institutions: Foreign Intervention and Overseas Investments By Toke A. Aidt and Facundo Albornoz

  1. By: Alberto Alesina; Paola Giuliano
    Abstract: The structure of family relationships influences economic behavior and attitudes. We define our measure of family ties using individual responses from the World Value Survey regarding the role of the family and the love and respect that children need to have for their parents for over 70 countries. We show that strong family ties imply more reliance on the family as an economic unit which provides goods and services and less on the market and on the government for social insurance. With strong family ties home production is higher, labor force participation of women and youngsters, and geographical mobility, lower. Families are larger (higher fertility and higher family size) with strong family ties, which is consistent with the idea of the family as an important economic unit. We present evidence on cross country regressions. To assess causality we look at the behavior of second generation immigrants in the US and we employ a variable based on the grammatical rule of pronoun drop as an instrument for family ties. Our results overall indicate a significant influence of the strength of family ties on economic outcomes.
    JEL: H20 J01
    Date: 2007–04
  2. By: Selim, Sheikh (Cardiff Business School)
    Abstract: We extend the celebrated Chamley-Judd result of zero capital income tax and show that the steady state optimal capital income tax is nonzero, in general. In particular, we find that the optimal plan involves zero capital income tax in investment sector and a nonzero capital income tax in consumption sector. In a two sector neoclassical economy, interdependence of labour and capital margins allows the government to choose an optimal policy that involves nonzero tax on capital income. The distortion created by capital income tax in consumption sector can be undone by setting different rates of labour income taxes. The optimal plan thus involves zero capital income tax in both sectors only if optimal labour income taxes are equal. This may not be the optimal policy if marginal disutility of work is different across sectors and/or the social marginal value of capital is different across sectors. The difference in social marginal value of capital can be undone by setting different labour income taxes across sectors. We also show that if the government faces a constraint of keeping same capital and labour income tax rates across sectors, optimal capital income tax is nonzero.
    Keywords: Optimal taxation; Ramsey problem; Primal approach; Two-sector model
    JEL: C61 E13 E62 H21
    Date: 2007–04
  3. By: Ignacio Lozano; Jorge Toro
    Abstract: This paper reviews the relationship between the business cycle and public finances in Colombia. The evidence shows that cyclical movements in output systematically affect the situation of public finances. Hence, the distinction between the cyclical and permanent (i.e. structural) components of the fiscal balance may allow fiscal authorities to determine the extent to which the fiscal stance in a particular year reflects their discretionary actions. Our findings indicate that the cyclical component of the central government balance in Colombia has in general been fairly small. For instance, during the recession and recovery period 1999-2003, the cyclical component attained, on average, -0,5% of the GDP which explained only 8% of the actual overall deficit. More recently in 2006, the cyclical component amounted to +0,8% of the GDP, equivalent to 17% of the actual fiscal imbalance. Governments are not usually neutral during the business cycle. Ideally, they ought to practice a counter-cyclical fiscal policy to moderate the magnitude of output fluctuations. However, in emerging economies, counter-cyclical fiscal policies are inhibited by domestic and external factors, such as credit restrictions, quality of institutions, fiscal rules, corruption, voracity effect, etc. Using a standard approach we find that fiscal policy in Colombia has been pro-cyclical over the last 45 years or so, with the primary surplus falling (and the deficit rising) as a share of GDP by approximately 1/5th of a percentage point when the output gap improves by one percentage point.
    Keywords: Fiscal Policy, Business Cycle, Stabilization, Deficit, Budget. Classification JEL: E62; E32; E63; H62; H61.
  4. By: Gonzalez-Eiras, Martin; Niepelt, Dirk
    Abstract: We analyze the effect of the projected demographic transition on the political support for social security, and equilibrium outcomes. Embedding a probabilistic-voting setup of electoral competition in the Diamond (1965) OLG model, we find that intergenerational transfers arise in the absence of altruism, commitment, or trigger strategies. Closed-form solutions predict population ageing to lead to higher social security tax rates, a rising share of pensions in GDP, but eventually lower social security benefits per retiree. The response of equilibrium tax rates to demographic shocks reduces old-age consumption risk. Calibrated to match features of the U.S. economy, the model suggests that, in response to the projected demographic transition, social security tax rates will gradually increase to 16 percent; other policies that distort labour supply will become less important; and in contrast with frequently voiced fears, labour supply therefore will rise.
    Keywords: labour supply; Markov perfect equilibrium; probabilistic voting; saving; social security
    JEL: E62 H55
    Date: 2007–04
  5. By: Hrvoje Šimović (Faculty of Economics and Business, University of Zagreb)
    Abstract: Development of the European integration through the European Union (EU) considers not only strengthening integration from the economic aspect (internal market). It also considers the political aspect of the integration i.e. strengthening political integration of member states and their citizens. Political segment of integration considers strengthening of the internal policies of the EU in which fiscal system, i.e. public finances have extremely important role. The EU fiscal system presents reflection of the extremely strong and often confronted interests between the economic and the political integration. These issues are closely related to the second component of the European politic and economic integration, that are the fiscal relations between the EU “central” level and the national “lower” levels which bring the all important decisions in the EU. According to the theory of public finance (fiscal federalism) and the criteria of economic efficiency, fiscal functions (allocation, redistribution, stabilization) and activities are assigned to the different levels of government, as well as certain resources for their financing. On the basis of fiscal functions carried out by national levels in the EU, and the manner of their financing, the EU is a prominently fiscally decentralized complex community. The traditional approach to the fiscal federalism that fiscal authorities are transferred from central to lover levels means that this is a process of decentralization, while in the case of the EU this means centralization of fiscal authorities from the level on national states to the EU as a supra-national level. The main goal of this paper is to analyze fiscal relations in the EU according to basic fiscal functions: allocation, redistribution and stabilization. Methodology would include analysis and comparison of positive EU aspect with normative aspect of public finances in multi-level community. Induction of gained results will confirm thesis that, because of political restraints, development of common (central) system of the EU public finances is based on alternative approaches of harmonization and cooperation.
    Keywords: fiscal system, fiscal relations, fiscal federalism, the European Union
    JEL: H77 H87 F50
    Date: 2007–04–16
  6. By: Heather Brome; Darcy Rollins Saas
    Abstract: At least 30 states, including Connecticut, Maine, Massachusetts, and Rhode Island, operate under “tax and expenditure limitations” (TELs): formula-based budgeting requirements that apply specific limits to expenditures, appropriations, or revenue collections by state or local government. More than a dozen states considered TELs in 2006. Legislation proposing a new TEL to further limit General Fund appropriations in Rhode Island was introduced; Maine citizens will vote on a more restrictive TEL this November. ; Several factors, including a desire for lower taxes and a belief that additional measures are needed to keep government spending in check, drive this interest in TELs. This paper discusses such arguments.
    Keywords: Taxation ; Local finance ; State finance ; Tax and expenditure limitations ; Property tax
    Date: 2006
  7. By: Casamatta, Georges; De Paoli, Caroline
    Abstract: The aim of this paper is to better understand the impact of unemployment on the design of Pay-As-You-Go pension systems, in the context of population aging. We consider a model in which people differ according to age and face in every period a given probability of becoming unemployed. We first determine the optimal pension system, which consists in a payroll tax rate, a pension benefit level and a retirement age and study its comparative statics with respect to a change of the unemployment rate and the length of life. We then characterize the issue-by-issue voting equilibrium and compare it to the optimal pension scheme. It is shown that the median voter in general chooses a retirement age lower than the optimal one as well as a higher payroll tax rate.
    Keywords: retirement age; unemployment
    JEL: H55
    Date: 2007–04
  8. By: Daron Agemoglu; Davide Ticchi; Andrea Vindigni
    Abstract: Inefficiencies in the bureaucratic organization of the state are often viewed as important factors in retarding economic development. Why certain societies choose or end up with such inefficient organizations has received very little attention, however. In this paper, we present a simple theory of the emergence and persistence of inefficient states. The society consists of rich and poor individuals. The rich are initially in power, but expect to transition to democracy, which will choose redistributive policies. Taxation requires the employment of bureaucrats. We show that, under certain circumstances, by choosing an inefficient state structure, the rich may be able to use patronage and capture democratic politics. This enables them to reduce the amount of redistribution and public good provision in democracy. Moreover, the inefficient state creates its own constituency and tends to persist over time. Intuitively, an inefficient state structure creates more rents for bureaucrats than would an efficient state structure. When the poor come to power in democracy, they will reform the structure of the state to make it more efficient so that higher taxes can be collected at lower cost and with lower rents for bureaucrats. Anticipating this, when the society starts out with an inefficient organization of the state, bureaucrats support the rich, who set lower taxes but also provide rents to bureaucrats. We show that in order to generate enough political support, the coalition of the rich and the bureaucrats may not only choose an inefficient organization of the state, but they may further expand the size of bureaucracy so as to gain additional votes. The model shows that an equilibrium with an inefficient state is more likely to arise when there is greater inequality between the rich and the poor, when bureaucratic rents take intermediate values and when individuals are sufficiently forward-looking.
    Keywords: bureaucracy, corruption, democracy, patronage politics, political economy, public goods, redistributive politics.
    JEL: P16 H11 H26 H41
    Date: 2006
  9. By: Laurence J. Kotlikoff (Boston University); Ben Marx (Boston University); Pietro Rizza (Boston University)
    Abstract: According to a recent estimate by Gokhale and Smetters (2005), the present value difference between the U.S. government’s projected future expenditures and its projected future tax receipts exceeds $60 trillion. Closing this enormous fiscal gap requires a variety of different tax increases and expenditure reductions. In this paper we examine how potential Social Security benefit cuts would impact the wellbeing of different American households. Specifically, we examine the living standard impacts of immediate and permanent 30 percent and 100 percent cuts in Social Security benefits. We examine cuts of these magnitudes to illustrate the dependency of the population on Social Security and to help policymakers calibrate the cost to Americans of this form of policy adjustment. The extent of current and future living standard reductions in response to announcements of future Social Security benefit cuts depends on the age of the household, when the cuts are announced, the size of the cuts, and the income of the household. Social Security benefit cuts of 30 percent, if announced when a household is about to retire, can lead to retirement living standard reductions ranging from roughly one tenth to one third depending on the household’s income. These reductions in living standard are substantially reduced if the household learns at younger ages about the benefit cuts and, consequently, has a longer time period over which to adjust.
    Date: 2006–09
  10. By: Booth, Alison L; Coles, Melvyn G
    Abstract: This paper considers optimal educational investment and labour supply with increasing returns to scale in the earnings function In so doing we develop the work of Rosen (1983), who first highlighted the increasing returns argument that arises because private returns to human capital investment are increasing in subsequent utilization rates. We demonstrate that increasing returns generates task specialisation - individuals choose to become either home specialists or work specialists. With heterogeneous workers, we show for certain types, that a tax on labour income leads to large, non-marginal substitution effects; i.e. those with a comparative advantage in home production are driven out of the market sector. Tax deadweight losses are consequently large. Consistent with the theory, our empirical results, using a cross-country panel, find that gender differences in labour supply responses to tax policy can play an important role in explaining differences in aggregate labor supply across countries.
    Keywords: fiscal policy; household production; increasing returns; labour supply
    JEL: H24 J13 J24 J31
    Date: 2007–04
  11. By: Lucie Schmidt (Williams College); Purvi Sevak (Hunter College)
    Abstract: The aging of the U.S. population, combined with an increasing probability that any given older individual will work, means that the importance of older workers to the labor force is rising. One possible solution to the solvency problems facing the Social Security System is increasing the labor supply of older workers. Understanding how policy levers can affect the labor supply of the elderly therefore has become increasingly important. In this paper we use data from the Health and Retirement Study (HRS), linked to state identifiers, to estimate the responsiveness of the labor supply of older workers to features of the tax code, on both the extensive margin of participation and the intensive margin of hours of work. This unique data set allows us to avoid some of the traditional pitfalls associated with the labor supply literature. We find evidence that the labor supply of older workers is responsive to the tax structure. Our results suggest that government policies could play a role in increasing the labor supply of individuals over the age of 65 by changing the returns to work through the tax code.
    Date: 2006–11
  12. By: David Wildasin (Martin School of Public Policy and Administration and Department of Economics, University of Kentucky)
    Abstract: This is a time of increased interest in local government finance in Kentucky, as evidenced by the creation of a Task Force on Local Taxation, established by the General Assembly. The final report of the Task Force offers significant recommendations, including an amendment of the state constitution that would provide the General Assembly with the flexibility to institute new instruments of local government finance. The present paper reviews the status of local government finance in Kentucky and discusses some of the key findings and recommendations of the Task Force. As the Task Force report clearly recognizes, informed analysis of local tax policy in Kentucky is hampered by inadequate data on local government finances. This paper identifies some of these deficiencies and a number of important policy issues that require further policy analysis, particularly if the General Assembly entertains significant reforms of local taxation.
    Date: 2007–04
  13. By: Jean De Beir (EPEE, Université d'Evry-Val-d'Essonne); Mouez Fodha (Centre d'Economie de la Sorbonne); Guillaume Girmens (EPEE, Université d'Evry-Val-d'Essonne)
    Abstract: This paper considers recycling in a general equilibrium model. It is shown that recycling should be subsidized if recycling costs are high, as an incentive to recycle all of the available waste. This tax incentive should vanish if recycling is profitable enough. In this case, recycling should even be taxed, in order to make the competitive equilibrium be an optimal allocation. We conclude also that, if recycling is efficient enough, it allows to internalize environmental externalities. In this case, recycling replaces a tax instrument.
    Keywords: Overlapping generation model, recycling sector, environmental externalities, tax policy.
    JEL: D62 H23 Q53
    Date: 2007–03
  14. By: Peter Wierts
    Abstract: This paper re-assesses findings of the literature that the systematic debt stabilising response in fiscal policy has been sufficiently strong for keeping debt ratios on a sustainable path in Euro area countries. In doing so, it adjusts the standard approach to the specific context of Economic and Monetary Union. Results show that before 1993 policy responses towards net and gross debt are comparable. After 1993, the reaction to net debt weakens while policies react more strongly to the build-up of gross debt according to the definition of the EU fiscal rules. This suggests that financial assets have increasingly been used for managing gross debt ratios while improving net worth has received less priority.
    Keywords: debt; sustainability; EMU; stock flow adjustment
    JEL: E62 H62 H63
    Date: 2007–04
  15. By: Gugushvili, Alexi
    Abstract: The paper examines formation and sustainability of Pay-As-You-Go pension systems within the consequences of the ageing of population. Parametric reforms rather than institutional transformation of Pay-As-You-Go systems into funded pension schemes are advocated. Following the modern theories of family economics and contrary to the mainstream works on the issue, reciprocal causation between pension systems and ageing is stressed. The paper concludes that the World Bank’s first pillar adjustment for maintaining the Pay-As-You-Go schemes achieves its objectives only if it is focused on all elements of the Pay-As-You-Go system.
    Keywords: Pensions; Pay-As-You-Go; Ageing
    JEL: J26 J11 P11 J18 H55
    Date: 2007–03
  16. By: Jordi Brandts; Christiane Schwieren
    Abstract: Decision-makers are sometimes influenced by the way in which choice situations are presented to them or "framed" This can be seen as an important challenge to the social sciences, since strong and pervasive framing effects would make it difficult to study human behavior in a synthetic or theoretic manner. We present results from experiments with dilemma games designed to shed light on the effects of several frame variations. We study, among others, the particular public bad frame used by Andreoni (1995) and two more naturalistic frames involving stories. Our results show that none of the frame manipulations have a significant effect on average behavior, but we do find some effects on extreme behavior. We also find that incentives do matter where frames do not matter.
    Keywords: Framing, Experiments, Public Goods
    JEL: C92 H41
    Date: 2007–03–15
  17. By: Shinichi Nishiyama (Georgia State University); Kent Smetters (The Wharton School)
    Abstract: While privatizing Social Security can improve labor supply incentives, it can also reduce risk sharing. We simulate a 50-percent privatization using an overlapping-generations model where heterogeneous agents with elastic labor supply face idiosyncratic earnings shocks and longevity uncertainty. When wage shocks are insurable, privatization produces about $30,100 of extra resources for each future household after all transitional losses have been paid. When wages are not insurable, privatization reduces efficiency by about $8,100 per future household. We check the robustness of these results to different model specifications as well as policy reforms and arrive at several surprising conclusions. First, privatization performs better in a closed economy, where interest rates decline with capital accumulation, than in an open economy. Second, privatization also performs better when an actuarially-fair private annuity market does not exist. Third, government matching of private contributions on a progressive basis is not very effective at restoring efficiency and can actually harm.
    Date: 2006–11
  18. By: Eichhorst, Werner; Zimmermann, Klaus F
    Abstract: Through the Hartz reforms, German active labour market policy was fundamentally restructured and has since been systematically evaluated. This paper reviews the recent evaluation findings and draws some conclusions for the future setup of active labour market policies in Germany. It argues in favour of a reduced range of active labour market policy schemes focusing on programs with proven positive effects (that are wage subsidies, training, start-up grants and placement vouchers) and calls for a systematic evaluation of all instruments not scrutinized so far.
    Keywords: active labour market policy; evaluation; Germany
    JEL: D61 H43 J68
    Date: 2007–04
  19. By: Trujillo,Lourdes; Gonzalez, Marianela; Estache, Antonio
    Abstract: All interested parties seem to agree that it is important to be able to monitor public sector performance at the sectoral level, but most current work based on multi-country databases does not lend itself to country-specific conclusions. This is due to a large extent to major data limitations both on sectoral expenditures and on sectoral outcomes. This paper discusses the related issues and shows what we can do with the current data inspite of the drastic limitations. The main conclusions of the paper are that any efforts to assess country-specific performances in relative terms are likely to be difficult in view of the data problems. A rough sense of performance across sectors can be estimated for groups of countries, allowing some modest benchmarking exercises. These estimates show that low-income countries generally lag significantly behind higher-income countries. Efficiency has improved during the 1990s in energy and education but has not improved significantly in transport.
    Keywords: Transport Economics Policy & Planning,Public Sector Expenditure Analysis & Management,Inequality,Economic Theory & Research,Poverty Monitoring & An alysis
    Date: 2007–05–01
  20. By: Igancio Lozano; Jorge Ramos; Hernán Rincón
    Abstract: En este documento se analizan las implicaciones fiscales y sectoriales de la reforma a las transferencias territoriales que actualmente se debate en segunda vuelta en el Congreso. La reforma ajusta los montos que el gobierno nacional deberá transferir a las regiones y considera marginalmente la discusión sobre su distribución sectorial y territorial. Las competencias de gasto no se consideran en el proyecto, por lo que el modelo de descentralización fiscal no sufrirá cambios sustanciales. Se concluye, en primer lugar, que el Sistema General de Participaciones establecido en 2001 ayudó a flexibilizar el manejo del presupuesto general de la Nación, y le ha permitido al gobierno nacional hacer ahorros importantes que, infortunadamente, no se han reflejado plenamente en sus resultados fiscales. Con lo aprobado en la primera legislatura, la administración central podría mantener en el mediano plazo su actual postura fiscal y usar los ahorros potenciales para reducir su deuda. En caso de hundirse el proyecto, se compromete la sostenibilidad de sus finanzas. En segundo lugar, las transferencias han permitido avances importantes en materia de cobertura, especialmente en la educación y la salud, aunque no se ha logrado su universalización. Entre tanto, pocos avances se registran en materia de eficiencia y calidad en la prestación de estos servicios. Los pronósticos sectoriales dependen, en buena parte, de los fondos públicos asignados en los próximos años. Con el texto aprobado en la primera legislatura, se logra cobertura plena en el nivel básico de educación y en el régimen subsidiado de salud.
    Keywords: Gobiernos locales, relaciones intergubernamentales, gasto público en salud y educación, bienes públicos Classification JEL: H75; H77; H51; H52;H41.
  21. By: Toke A. Aidt and Facundo Albornoz
    Abstract: The recent literature on endogenous political institutions highlights domestic economic factors, such as recessions, economic growth and inequality, as key determinants of political transitions. We argue that international capital flows and the possibility that foreign governments, in order to protect specific economic interests, might seek influence on the regime choice in other countries are important, yet overlooked, additional determinants of political institutions. Building on Acemoglu and Robinson (2001), we develop a theory of political transitions in economies with access to international capital markets and show that the possibility of foreign intervention significantly affects regime dynamics and the set of sustainable political regimes
    Keywords: Political transitions, democracy, autocracy, foreign investments; foreign government intervention
    JEL: D72 D74 H71 O15 P16
    Date: 2007–03

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