nep-pbe New Economics Papers
on Public Economics
Issue of 2007‒05‒26
twenty-two papers chosen by
Peren Arin
Massey University

  1. The Role of Immigration in Sustaining the Social Security System: A Political Economy Approach By Razin, Assaf; Sand, Edith
  2. Productivity and Taxes as Drivers of FDI By Razin, Assaf; Sadka, Efraim
  3. When the Joneses’ Consumption Hurts: Optimal Income Taxation and Public Good Provision in an OLG Model By Aronsson, Thomas
  4. Distortionary Tax Instruments and Implementable Monetary Policy By Zagaglia, Paolo
  5. Removing the Disincentives in Social Security for Long Careers By Gopi Shah Goda; John B. Shoven; Sita Nataraj Slavov
  6. Cyclical Bias in Government Spending: Evidence from New EU Member Countries By Jan Zápal
  7. Analyzing a Flat Income Tax in the Netherlands By Bas Jacobs; Ruud A. de Mooij; Kees Folmer
  8. To React or Not? Fiscal Policy, Volatility and Welfare in the EU-3 By Jim Malley; Apostolis Philippopoulos; Ulrich Woitek
  9. Let's make the tax system more lovable By Paunić, Alida
  10. Macroeconomic Policy in a Heterogeneous Monetary Union By Oliver Grimm; Stefan Ried
  11. Tax Potential vs. Tax Effort: A Cross-Country Analysis of Armenia's Stubbornly Low Tax Collection By David A. Grigorian; Hamid Reza Davoodi
  12. Optimality conditions and comparative static properties of non-linear income taxes revisited By Laurent Simula
  13. Economic Policy in Health Care: Sickness Absence and Pharmaceutical Cost By Granlund, David
  14. Pension Reform and Macroeconomic Stability in Latin America By Jorge Roldos
  15. Investment and Subsidies in Indian Agriculture By Raghbendra Jha
  16. The Impact of School Choice on Pupil Achievement, Segregation and Costs: Swedish Evidence By Anders Böhlmark; Mikael Lindahl
  17. Old Curses, New Approaches? Fiscal Benchmarks for Oil-Producing Countries in Sub-Saharan Africa By Jan-Peter Olters
  18. On the Distributional Effect of Carbon Tax in Developing Countries: The Case of Indonesia By Arief Anshory Yusuf; Budy P. Resosudarmo
  19. Population ageing, household portfolios and financial asset returns: A survey of the literature By Marianna Brunetti
  21. Endogenous (Re-)Distributive Policies and Economic Growth: A Comparative Static Analysis By Günther Rehme
  22. The Public-Private Sector Wage Differential for Full-Time Male Employees in Britain: A Preliminary Analysis By Monojit Chatterji; Karen Mumford

  1. By: Razin, Assaf; Sand, Edith
    Abstract: In the political debate people express the idea that immigrants are good because they can help pay for the old. The paper explores this idea in a dynamic political-economy setup. We characterize sub-game perfect Markov equilibria where immigration policy and pay-as-you-go (PAYG) social security system are jointly determined through a majority voting process. The main feature of the model is that immigrants are desirable for the sustainability of the social security system, because the political system is able to manipulate the ratio of old to young and thereby the coalition which supports future high social security benefits. We demonstrate that the older is the native born population the more likely is that the immigration policy is liberalized; which in turn has a positive effect on the sustainability of the social security system.
    Keywords: demographic stretegic voting; overlapping generations; social security sustainability
    JEL: E1 H3 P1
    Date: 2007–05
  2. By: Razin, Assaf; Sadka, Efraim
    Abstract: We study the role of productivity and corporate taxation as driving forces of FDI among OECD countries in the presence of threshold barriers, which generate two margins for FDI decisions. Some simulations, based on the estimation results, suggest that there are marked differences in the sensitivity of FDI flows from the U.S. to productivity and taxes in OECD countries. Data on FDI flows are drawn from the International Direct Investment dataset (Source OECD), covering the bilateral FDI flows among 18 OECD countries over the period 1987 to 2003.The sensitivity of these flows to productivity in the U.K. is positive and high, relative to other EU countries and Japan. Similarly, the sensitivity of these flows to taxes in the U.K is negative and high, relative to other EU countries and Japan.
    Keywords: corporate taxation; Foreign direct investment; productivity; selection and flow equations
    JEL: F2 F3 H2
    Date: 2007–05
  3. By: Aronsson, Thomas (Department of Economics, Umeå University)
    Abstract: This paper considers a two-type, self-selection, overlapping generations model with nonlinear labor income and capital income taxation and public good provision, when people care about their relative consumption compared to others. In each case, the standard optimality expressions are modified by terms that reflect the extent to which people care about relative consumption. The modified tax formulas imply substantially higher marginal labor income tax rates than in the conventional case, under plausible assumptions and available empirical estimates regarding comparison consumption concerns. The extent to which the public good provision rule should be modified is shown to depend critically on the preference elicitation format. The effects of positionality on the marginal capital income tax rates are ambiguous.
    Keywords: Optimal taxation; redistribution; public goods; relative consumption; status; positional goods
    JEL: D62 H21 H23 H41
    Date: 2007–05–16
  4. By: Zagaglia, Paolo (Dept. of Economics, Stockholm University)
    Abstract: I introduce distortionary taxes on consumption, labor and capital income into a New Keynesian model with Calvo pricing and nominal bonds. I study the relation between tax instruments and optimal monetary policy by computing simple rules for monetary and fiscal policy when one tax instrument at a time varies, while the other two are fixed at their steady-state level. The optimal rules maximize the second-order approximation to intertemporal utility. Three results emerge: (a) when prices are sticky, perfect inflation stabilization is optimal independently from the tax instrument adopted; (b) the optimal degree of responsiveness of monetary policy to output varies depending on which tax instrument induces fluctuations in the average tax rate; (c) when prices are flexible, fiscal rules that prescribe unexpected variations in the price level to support debt changes are always welfare-maximizing.
    Keywords: Nominal rigidities; distortionary taxation; monetary-policy rules
    JEL: E52 E61 E63
    Date: 2007–05–21
  5. By: Gopi Shah Goda; John B. Shoven; Sita Nataraj Slavov
    Abstract: Implicit taxes in Social Security, which measure Social Security contributions net of benefits accrued as a percentage of earnings, tend to increase over the life cycle. In this paper, we examine the effects of three potential policy changes on implicit Social Security tax rates: extending the number of years used in the Social Security formula from 35 to 40; allowing individuals who have worked more than 40 years to be exempt from payroll taxes; and distinguishing between lifetime low-income earners and high-income earners who work short careers. These three changes can be achieved in a benefit- and revenue-neutral manner, and create a pattern of implicit tax rates that are much less distortionary over the life cycle, eliminating the high implicit tax rates faced by many elderly workers. The effects of these policies on progressivity and women are also examined.
    JEL: H5 J2
    Date: 2007–05
  6. By: Jan Zápal (Institute of Economic Studies, Faculty of Social Sciences, Charles University, Prague, Czech Republic; Economics Department, London School of Economics, University of London)
    Abstract: This paper focuses on dynamics of government spending over the business cycle. The literature on this topic has yet mainly focused on the issue of anti- or pro- cyclicality of fiscal policy. Only recently some researchers brought up a notion that response of fiscal policy might display great deal of asymmetry with respect to economic upturns and downturns. This is known as cyclical bias which arises when government expenditure increases more in cyclical downturns than it decreases in cyclical upturns, or vice versa. Empirical estimates of the sign and degree of cyclical bias show strong evidence in favour of the hypothesis that fiscal authorities do react with a great deal of asymmetry. Among other things, the presence of cyclical bias in government spending has been proposed as an explanation or mechanism which lies behind its unprecedented increase in most OECD countries over the last several decades. The aim of this paper is to show that a similar asymmetry of government spending dynamics can also be found in fiscal data of new EU member countries. We estimate the sign and degree of cyclical bias and compare it to estimates from other countries. Finally, we tackle the question of whether there is any statistically significant influence of political economy variables on the estimated degree of asymmetry.
    Keywords: Cyclical Bias; New EU member states; Fiscal policy
    JEL: E32 E62 H30 H50
    Date: 2007–05
  7. By: Bas Jacobs (Universiteit van Amsterdam, Tilburg University, CentER, Netspar, and CESifo); Ruud A. de Mooij (CPB Netherlands Bureau for Economic Policy Analysis, Erasmus Universiteit Rotterdam, Netspar, and CESifo); Kees Folmer (CPB Netherlands Bureau for Economic Policy Analysis)
    Abstract: A flat tax rate on income has gained popularity in European countries. This paper assesses the attractiveness of such a flat tax in achieving redistributive objectives with the least cost to labour market performance. We do so by using a detailed applied general equilibrium model for the Netherlands. The model is empirically grounded in the data and encompasses decisions on hours worked, labour force participation, skill formation, wage bargaining between unions and firms, matching frictions, and a wide variety of institutional details. The simulations suggest that the replacement of the current tax system in the Netherlands by a flat rate will harm labour market performance if aggregate income inequality is contained. This finding bolsters the notion that a linear tax is less efficient than a non-linear tax to obtain redistributive goals.
    Keywords: Flat tax; Labour market; General equilibrium; Equity; Optimal taxation
    JEL: D3 D5 H2
    Date: 2007–03–21
  8. By: Jim Malley; Apostolis Philippopoulos; Ulrich Woitek
    Abstract: This paper develops a dynamic stochastic general equilibrium model to examine the quantitative macroeconomic implications of countercyclical fiscal policy for France, Germany and the UK. The model incorporates real wage rigidity which is the particular market failure justifying policy intervention. We subject the model to productivity shocks and use either government consumption or investment to react to the output gap or the public debt-to-output ratio. If the object of fiscal policy is purely to stabilize output or debt volatility, then our results suggest substantial reductions can be obtained, especially with respect to output. In stark contrast, however, a formal general equilibrium welfare assessment of the volatility implications of these alternative instrument/target combinations reveals the welfare gains from active policy, measured as a share of consumption, to be very modest.
  9. By: Paunić, Alida
    Abstract: Making the taxes acceptable to large number of people by allocating their obligation to the chosen project is the main subject of this paper. In this way a greater objectivity, transparency and local goals are set in according to the preferences of the tax contributors. State Investment office prevents the rule of invisible hand of market by allocation part of tax money to the less developed regions reducing difference between them.
    Keywords: tax; principal agent problem; welfare
    JEL: D61 H00 D72
    Date: 2007–05
  10. By: Oliver Grimm; Stefan Ried
    Abstract: We use a two-country model with a central bank maximizing union-wide welfare and two fiscal authorities minimizing comparable, but slightly different country-wide losses. We analyze the rivalry between the three authorities in seven static games. Comparing a homogeneous with a heterogeneous monetary union, we find welfare losses to be significantly larger in the heterogeneous union. The best-performing scenarios are cooperation between all authorities and monetary leadership. Cooperation between the fiscal authorities is harmful to both the whole union’s and the country-specific welfare.
    Keywords: monetary union, heterogeneities, policy game, simultaneous policy, sequential policy, coordination, discretionary policies.
    JEL: E52 E61 F42
    Date: 2007–05
  11. By: David A. Grigorian; Hamid Reza Davoodi
    Abstract: Despite recording double digit growth since 2000, Armenia's tax-to-GDP ratio has been fairly stable at about 14½ percent. This paper catalogues a range of factors that may account for Armenia's stubbornly for tax collection by benchmarking Armenia's tax-to-GDP against some comparator countries and conducting an extensive econometric study of the main determinants of tax collection. We find empirical support for the hypothesis that the persistence of Armenia's low tax-GDP ratio can be traced to persistence of weak institutions and a large shadow economy. The gap between the potential and actual tax collection in Armenia could be as high as 6½ percent of GDP. We conclude with some policy recommendations that, if adopted, can boost revenue buoyancy.
    Date: 2007–05–03
  12. By: Laurent Simula
    Abstract: Optimality conditions and comparative static properties of the optimal Mirrleesian nonlinear income tax are obtained for a finite population and quasilinear-in-consumption preferences. Contrary to Weymark (1987) who considers quasilinear-in-leisure preferences, the linearity with respect to gross income, which is observed by the government and used asa tax base, is lost. A reduced-form optimal income tax problem is derived, in which consumption levels are obtained as functions of gross incomes. The contribution of this new reduced form is twofold. First, the optimal allocation can be characterized geometrically in a simple way. Second, comparative static results with respect to individual productivities are easy to obtain.
    Date: 2007
  13. By: Granlund, David (Department of Economics, Umeå University)
    Abstract: This thesis consists of a summary and four papers. The first two concerns health care and sickness absence, and the last two pharmaceutical costs and prices. <p> Paper [I] presents an economic federation model which resembles the situation in, for example, Sweden. In the model the state governments provide health care, the federal government provides a sickness benefit and both levels tax labor income. The results show that the states can have either an incentive to under- or over-provide health care. The federal government can, by introducing an intergovernmental transfer, induce the state governments to provide the socially optimal amount of health care. <p> In Paper [II] the effect of aggregated public health care expenditure on absence from work due to sickness or disability was estimated. The analysis was based on data from a panel of the Swedish municipalities for the period 1993-2004. Public health care expenditure was found to have no statistically significant effect on absence and the standard errors were small enough to rule out all but a minimal effect. The result held when separate estimations were conducted for women and men, and for absence due to sickness and disability. <p> The purpose of Paper [III] was to study the effects of the introduction of fixed pharmaceutical budgets for two health centers in Västerbotten, Sweden. Estimation results using propensity score matching methods show that there are no systematic differences for either price or quantity per prescription between health centers using fixed and open-ended budgets. The analysis was based on individual prescription data from the two health centers and a control group both before and after the introduction of fixed budgets. <p> In Paper [IV] the introduction of the Swedish substitution reform in October 2002 was used as a natural experiment to examine the effects of increased consumer information on pharmaceutical prices. Using monthly data on individual pharmaceutical prices, the average reduction of prices due to the reform was estimated to four percent for both brand name and generic pharmaceuticals during the first four years after the reform. The results also show that the price adjustment was not instant.
    Keywords: vertical fiscal externalities; sickness absence; sickness benefits; health care expenditure; fixed budgets; pharmaceuticals; cost containment; dynamic panel data models; endogeneity; propensity score matching
    JEL: D80 D83 H21 H42 H51 H77 I11 I12 I18 J22 L65
    Date: 2007–05–16
  14. By: Jorge Roldos
    Abstract: This paper reviews macroeconomic aspects of pension reforms in Latin America, focusing on financial market stability and fiscal sustainability. Concentration of pension fund portfolios in government bonds remains high, and the lack of new investment alternatives has distorted asset prices. Countries have gradually liberalized investments abroad, but remain wary of the impact on foreign currency markets. The fiscal costs of the transition to funded systems have been higher than expected, and have contributed to high debt levels. The paper highlights the importance of coordinating changes in portfolio limits with debt management policies and measures to develop securities markets.
    Date: 2007–05–04
  15. By: Raghbendra Jha
    Abstract: One of the principal elements of the economic reforms program initiated in 1991 was to reduce the fiscal deficit of the central government which, at that time, faced a solvency crisis. This reduction was at least partially achieved by reducing transfers to state governments. As a result, state government budgets faced crises and agriculture, being largely a state subject, was denied adequate investment. This paper reviews the performance of Indian agriculture, particularly in the post-reform period. It attributes this lacklustre performance to the stagnation of agricultural investment whereas there has been a contemporaneous rise in agricultural subsidies. Thus while current operations are being subsidised to some extent resource for augmentation of productive capacity in agriculture are dwindling.
    Date: 2007
  16. By: Anders Böhlmark (SOFI, Stockholm University); Mikael Lindahl (SOFI, Stockholm University and IZA)
    Abstract: This paper evaluates school choice at the compulsory-school level by assessing a reform implemented in Sweden in 1992, which opened up for publicly funded but privately operated schools. In many local school markets, this reform led to a significant increase in the quantity of such schools as well as in the share of pupils attending them. We estimate the impact of this increase in private enrolment on the average achievement of all pupils using withinmunicipality variation over time, and controlling for differential pre-reform municipality trends. We find that an increase in the private-school share by 10 percentage points increases average pupil achievement by almost 1 percentile rank point. We show that this total effect can be interpreted as the sum of a private-school attendance effect and a competition effect. The former effect, which is identified using variation in school choice among siblings, is found to be only a small part of the total effect. This suggests that the main part of the achievement effect is due to more competition in the school sector, forcing schools to improve their quality. We use grade point average as outcome variable. A comparison with test data suggests that our results are not driven by differential grade-setting standards in private and public schools. We further find that more competition from private schools increases school costs. There is also some evidence of sorting of pupils along socioeconomic and ethnic lines.
    Keywords: school-choice reform, private-school competition, pupil achievement, segregation
    JEL: I22 I28 H40
    Date: 2007–05
  17. By: Jan-Peter Olters
    Abstract: Buoyant oil prices have allowed oil-producing countries in sub-Saharan Africa (SSA OPCs) to increase oil exports and fiscal revenues, providing them with resources necessary to address the pressing social needs. To preclude another boom-bust cycle, this paper advocates the definition of a fiscal benchmark anchored in sustainability grounds, following Leigh- Olters (2006). The difference between current primary deficits and those that could be maintained after oil reserves are exhausted represent an indication of the degree to which fiscal positions will have to be adjusted-either gradually, while the overall balances remain in surplus, or abruptly, once oil revenues begin to dwindle.
    Date: 2007–05–04
  18. By: Arief Anshory Yusuf (Department of Economics, Padjadjaran University); Budy P. Resosudarmo (Australian National University)
    Abstract: This paper analyses the distributional impact of carbon tax in Indonesia, one of the largest carbon emitter developing countries. Using a Computable General Equilibrium (CGE) model with disaggregated households, the result suggests that in contrast to most studies from industrialised countries, the introduction of carbon tax in Indonesia is not necessarily regressive. Its structural change and resource reallocation effect, following the carbon tax, is in favor of factors endowed more proportionately by rural, and lower income households. In addition, the expenditure of lower income households, especially in rural area, are less sensitive to the prices of energy-related commodities. Revenue-recycling through uniform reduction in commodity tax rate may reduce the adverse aggregate output effect, whereas uniform lumpsum transfers may enhance the progressivity. This study demonstrates an example, that encouraging developing countries to reduce carbon emission, may not only increase the efficiency of carbon abatement globally, but also have desirable distributional implication in the developing countries themselves.
    Keywords: Carbon Tax, Climate Change, Distribution, CGE, Indonesia
    JEL: D30 D58 Q40 Q48 Q54 Q56 Q58
    Date: 2007–05
  19. By: Marianna Brunetti
    Abstract: Population ageing is a recognised phenomenon affecting many countries in the world including most EU ones, Japan and US. The financial implications of this phenomenon can be manifold and some recent literature has focused in particular on the possible consequences of ageing on household portfolios and on main financial asset returns ones. Overall, the extant literature on household portfolios reports a significant effect of age on asset allocation, thereby providing evidence in favour of the standard life-cycle hypothesis. On the other hand, empirical results on the link between demographics and financial asset prices/returns are less uniform. The aim of this paper is to systematize the extant literature on these issues and to provide an overview of the main results reported so far, trying to evaluate whether the different conclusions reached depend on the approach taken in the empirical exercises rather than on the actual differences, in terms of demographic dynamics, public pension systems and financial markets, of the realities considered.
    Keywords: population ageing; household portfolios; financial asset returns
    JEL: D14 D91 G11 J1
    Date: 2007–05
    Abstract: In this paper we evaluate whether government intervention through the public funding of business angel networks is warranted. Based on a regional study of four BANs, we find that these subsidies reach their goals in terms of contribution to economic development and reducing financing and information problems entrepreneurial companies face. However, they are partly based on the wrong assumptions as these companies are not (yet) value creating. Therefore, we advise caution in using the market failure argument as grounds for government intervention in the informal risk capital market.
    Keywords: risk capital; business angels; policy; economic development; market failure
    JEL: G24 H71 M13 R58
    Date: 2007–03
  21. By: Günther Rehme (Institut für Volkswirtschaftslehre (Department of Economics), Technische Universität Darmstadt (Darmstadt University of Technology))
    Abstract: This paper analyzes the interplay of growth, (re-)distribution and policies when the latter are set exogenously or when the latter depend on economically important fundamentals. A redistribution policy generally causes lower growth, but less so when there is technological progress. The model implies that high (endogenous) tax rates may not necessarily imply low growth. The paper shows that the longrun cross-country relationship between growth and endogenous policy is generally not clear-cut. But this relies on conditions that can be used for identification in empirical research. The paper also argues that workers benefit more from technical progress than capital owners, even though inequality might and growth would rise.
    Keywords: Growth, Distribution, Endogenous Policy
    JEL: O4 D3 H2
    Date: 2007–05
  22. By: Monojit Chatterji (University of Dundee); Karen Mumford (University of York and IZA)
    Abstract: Relative employment conditions have changed across the public and private sectors in Britain over the last decade with the former becoming a more attractive earnings option. Using new linked employee-employer data for Britain in 2004, this paper shows that, on average, full-time male public sector employees earn 11.7 log wage points more than their private sector counterparts. Decomposition analysis reveals that the majority of this pay premium is associated with public sector employees having individual characteristics associated with higher pay and to their working in higher paid occupations. Whilst there is some evidence of workplace segregation in the private sector, there is little indication that rates of return vary across the earnings distribution for either public or private sector employees. It no longer appears to be the case that the public sector provides a refuge for the low skilled at the expense of the highly educated. Furthermore, working conditions appear more uniform in the public sector and, unlike the private sector, there is no significant penalty associated with ethnic background.
    Keywords: public sector earnings, male, earnings-gap, interquantile, segregation
    JEL: J3 J7
    Date: 2007–05

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