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Public Sector Economics

Public Sector Economics. Tax Incidence. Private Sector Response to Public Redistribution. price changes partial equilibrium general equilibrium migration altruism insurance markets. Outline of Topics. partial equilibrium excise tax theory elastic agents bear less

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Public Sector Economics

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  1. Public Sector Economics Tax Incidence

  2. Private Sector Response to Public Redistribution • price changes • partial equilibrium • general equilibrium • migration • altruism • insurance markets

  3. Outline of Topics • partial equilibrium • excise tax theory • elastic agents bear less • principle of comprehensive cost • cigarette tax incidence • general equilibrium theory • capital tax incidence • incidence of taxes and spending by • income group • cohort  social security • paternalism

  4. industry cost curve A B+D = borne by demanders C+E = borne by suppliers B D no-tax price E C industry demand F Tax on Demanders after-tax price B+C = government revenue D+E = dwc pre-tax price B/C = depends only on dp/dt

  5. Partial Equilibrium Model • general results • “elastic agents bear less” • doesn’t matter whether the tax is levied on the buyer or seller • special results • only supply and demand elasticities matter • only suppliers and demanders in the taxed market are affected • both suppliers and demanders are harmed by the tax

  6. Incidence in the “Long Run” • “long run” = capital can adjust • if capital is elastically supplied in the long run, than capital will not bear the burden of taxes • theories of the supply of capital • international trade • economic growth theories

  7. Descriptions of Policy Incidence • dimensions of government redistribution • income classes • age/year of birth • factor ownership • occupation • instruments of redistribution • taxes • spending • regulation

  8. Pechman’s Study of Tax Incidence • people distinguished only by their annual income • statutory incidence only • savings and work are fixed • consumption patterns are fixed, and do not vary by income class • variety of assumptions regarding incidence of corporate income, property, and payroll taxes • IIT: 100% on payer • sales and excise: 100% on consumers • payroll tax: 75-100% on workers • property tax: 100% on landholders and/or capital owners • corporate income: variety • MERGE files • start with CPS • for filing population, use Form 1040 income information for “similar” families in the IRS database • CPS necessary because it is a random sample • benchmark: proportional income tax

  9. Pechman’s Study of Tax Incidence: Results • no significant difference from flat tax, except at very top and bottom • results for top and bottom are mild, and vary across incidence models • transfers • appear very progressive in Pechman • but Social Security is a big part of transfers, and is not so progressive w.r.t. lifetime income

  10. Regressive Taxes in Western Europe • Western European countries • known for their generous welfare states • Sometimes known for progressive income taxes • However, income tax is not the only tax especially in Western Europe • Other taxes • payroll taxes, sales taxes, excise taxes, property taxes • often are regressive • Western European taxes are more regressive because they are less income-tax intensive

  11. Calculating the Income Incidence of Social Security • annual cross-sections show the “poor” receive most of the SS expenditures, but do not pay much of taxes • eg., Musgrave et al (1974, Table 6) • generational accounting = focus on age-dimension rather than income dimension • stratify by both income and year of birth • what is the lifetime relation between income and years spent in school? • payroll tax caps • some portion of benefits may be paid from general revenue. Is the general tax system progressive? • payroll tax rates across occupations

  12. Calculating the Income Incidence of Social Security (cont’d) • special treatment of government employees • do they tend to be rich or poor? • is the supply of government employees competitive? • benefit receipt often requires knowledge of eligibility and/or infrastructure • not the same with tax payments • is knowledge correlated with lifetime income? • differential valuation of benefits • legislative exclusions • minorities. eg., Jamaica, Rhodesia, South Africa • nonunion members • agriculture • trend is toward eliminating exclusions

  13. Calculating the Income Incidence of Social Security (cont’d) • progressivity of the annual benefit formula • SS OASDI paid as a life annuity • more life –> more benefits received • what is the relation between lifetime income and mortality? • health benefits paid as reimbursement for medical procedures, etc. • more life –> more benefits received • when alive, more visits to doctor/hospital –> more benefits received • what is the relation between visits and lifetime income? • years-of-participation rules for eligibility; SI incidence • SS crowds out other (more progressive?) public programs

  14. Generational Accounting • date of birth accounts • each cohort’s NPV of taxes - transfers, forward from birth • for a self-financed transfer program with negligible admin costs, sum to PV zero across cohorts (including unborn and deceased cohorts in the sum) • more generally • cohort sum to PV of (past & present) gov. purchases • what is the incidence of these purchases? • can be expressed as: • $ per cohort member • $ per NPV of taxes (Kotlikoff critique) • IRR • remaining lifetime accounts (Kotlikoff) • each cohort’s NPV of taxes & benefits, forward from today • sum across cohorts to debt value + PV of future purchases • based entirely on estimates of future tax & transfer rules

  15. IRR as a measure of Generational Incidence

  16. Generational Accounts Feature Present Values

  17. Generational Accounting – Some Results • large redistribution in the age dimension • from postwar generations to prewar generations (eg., Leimer) • from unborn generations to current generations (Kotlikoff) • old age public pensions are the main mechanism • education spending hardly reverses this • current laws in most, but not all, countries (among those studied) imply redistribution from unborn generations • other (obvious) results • cutting OASDI benefits hurts older generations • raising the sales tax to finance constant OASDI benefits hurts younger generations less than raising the payroll tax • unavoidable legacy

  18. Social Security Reforms • unavoidable legacy: since older cohorts, younger cohorts must do poorly • unless • NPV’s do not sum to zero • ie, combine Social Security with a profitable government enterprise • viable government enterprises? • buying stocks and selling bonds • reducing tax distortions has positive NPV • charging for immigration • what is the connection between the government enterprise and SS? Would the enterprise be profitable without SS? • example: letting SS earn the pretax return = reducing capital taxes

  19. Distortions and Redistribution • are distortions a necessary but unintended byproduct of redistribution? • standard public finance view • but why are “strings attached” to the transfers? • can this apply to “universal” participation programs? • is redistribution a necessary but unintended byproduct of distortion? • paternalism • correcting market failures • producer interests • tax incidence is very different • distinguishing these models • compare magnitude of distortions with magnitude of redistribution • look at take-up rates • are distortions in the direction of luxury or inferior goods? • is the statutory incidence against the poor? • what determines the markets for intervention?

  20. Three Versions of Paternalism • consumption-based paternalism • literal consumption externality/merit good/impure altruism • information-based paternalism • arises from pure altruism • disagreement about the probability of various contingencies • but is force necessary? Why not communicate the information? • strategically-induced paternalism • arises from pure altruism, and the timing of decisions • e.g., Samaritan’s Dilemma, parents relying on their children for elderly support • unfunded mandate enhances efficiency, while helping the Samaritan at the expense of the beneficiary

  21. Strategically-Induced Paternalism • consumption over time: c1 and c2 • superscripts r, p still indicate rich poor • second stage • rich make voluntary transfer to the poor • poor consume the sum of their savings and this transfer • no government at this stage • savings from previous period denoted mr and mp • second stage decision rules are: • assume: the rich are altruistic enough, and/or poor are poor enough –> positive and equal partial derivatives of c2p(mp,mr) in the interval (0,1)

  22. Strategically-Induced Paternalism (cont’d) • first stage • rich and poor separately choose their savings, looking ahead to the effect of their savings on future consumption • government may be regulating, or taxing, at this stage • without government, rich have objective • compare with

  23. Differential Valuation • if paternalism is operative, differential valuation is necessarily an exercise in extrapolation • “structural” approach • build a numerical model of demand • choose utility parameters (or demand elasticities) • calculate compensating variation or consumer surplus • prices from secondary markets • resale of in-kind transfers. but is the existence of a resale market consistent with paternalism? • hedonics. also applicable when differential valuation derives from the public production function (eg., public housing) • contingent valuation

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