That is a new paper in International Tax and Public Finance by Florian Buhlmann, Benjamin Elsner, and Andreas Peichl. An important concern about many social insurance programs is that their incentives create “welfare traps,” one of which is a high implicit marginal tax rate if expanding work results in losing welfare benefits (a nice collection of state estimates by Sebastian Leguizamon here).

The Buhlmann et al. investigate piece takes advantage of a couple of important sources of discontinuities and looks for evidence of bunching, i.e. an unusual clustering of observations around an important policy discontinuity. As bunching increases, so does presumably the social cost of offering the program. Here is the abstract:

Welfare programs are important in terms of reducing poverty, although they create incentives for recipients to maximize their income by either reducing their labor supply or manipulating their taxable income. In this paper, we quantify the extent of such behavioral responses for the earned income tax credit (EITC) in the USA. We exploit the fact that US states can set top-up rates, which means that at a given point in time, workers with the same income receive different tax refunds in different states. Using event studies as well as a border pair design, we document that raising the state EITC leads to more bunching of self-employed tax filers at the first kink point of the tax schedule. While we document a strong relationship up until 2007, we find no effect during the Great Recession. These findings point to important behavioral responses to the largest welfare program in the USA.

The authors aren’t able to distinguish whether these are “real” responses (e.g. people working less) versus “reporting” responses (i.e. people manipulating what they report as income to the government). This matters because the policy response should be different for the two response types, and social costs are lower if it is just a reporting response. But the study uses multiple strategies to provide credible evidence that we have cause to investigate further, because something is happening.

 

That is the title of a very interesting new paper appearing in Public Administration Review by Qiushi Wang (Sun Yat-sen University) and Jun Peng  (University of Arizona). The paper focuses on discount rate assumptions used in calculating future returns on pension assets. Increasing the discount rate implies that future liabilities are better funded by present assets, or conversely lowering the discount rate makes the pensions appear more unfunded. Actual future market returns are unknown, and funding the pension is in competition with other funding priorities in the current period, so subjective assumptions of the discount rate are at least as much a political consideration as it is a technocratic judgement.

Wang and Peng look at the public pension boards governing state plans and sets up two dimensions for measuring their “political embeddedness” in the Polanyi tradition. The first dimension they look at is the degree to which state government can directly control the outcome of pension decisions through strong ties to the the board (e.g. the use of political appointees). The second dimension is the degree to which pension decisions are influenced by outside interest groups (e.g. public unions) when ties to government are weak. They motivate a series of variables in this framework and estimate a Cox regression to see which factors jump out as being correlated with discount rate revisions between 2002 and 2014.

There is not an enormous amount of variation in the discount rate over time, so generally effect sizes are rather small. Still, the most consistent result they find among the variables motivated by political theory is the percent of political appointees on the board, who seem to be correlated with downward revisions in the discount rate, forcing the plans to appear less funded than before. The presence of a public sector union or having a more conservative state government, by contrast, did not have any effects. Generally speaking, the governments were less likely to make these revisions while experiencing fiscal stress regardless of who was governing them.

Given that public pensions are generally underfunded, these downward revisions are probably likely to be regarded as a more prudent financial change. It is hard to gerrymander an entire state, so it is not particularly clear why political appointees would be more long-term in their orientation. The authors speculate that politically appointed trustees were more concerned about long term health of the pension funds than trustees elected by plan participants. Generally I think people, maybe academics in particular, tend to underrate partisan appointments if there is an explicitly bipartisan effort. So perhaps states with lots of political appointments are making room on the board for bipartisan appointments where they can check each other’s work and enfranchise political allies to garner the trust necessary in defending technocratic assumptions. This is all to say that Wang and Peng have produced some intriguing data and results that are worth reading and pondering.

For some related literature, I would recommend Friedrich Breyer’s piece in the European Journal of Political Economy which attempts to broadly answer the question of why governments attempt to transfer from young to old, and why these transfers are not 100%.

The newest issue of Public Finance Review is now available, containing five research articles and two replication studies. Here is the table of contents:

How Did the Great Recession Affect Charitable Giving? By Arthur C. Brooks

Hesitating at the Altar: An Update on Taxes and the Timing of Marriage. By Nick Frazier and Margaret McKeehan.

Tax Compliance Costs: Cost Burden and Cost Reliability. By Sebastian Eichfelder and Frank Hechtner.

The Fiscal Effects of Work-Related Tax Expenditures in Europe. By Salvador Barrios, Serena Fatica, Diego Martinez-Lopez, and Gilles Mourre.

The Impact of Ideology on Investment Decisions of a Coalition: A Game Theoretic Analysis. By Ritika Jain and Shubhro Sarkar.

The Fiscal Impacts of Alternative Land Uses: An Empirical Investigation of Cost of Community Services Studies. By Christopher M. Clapp, James Freeland, Keith Ihlanfeldt, and Kevin Willardsen.

Replication of Goolsbee, Lovenheim, and Slemrod’s “Playing with Fire: Cigarettes, Taxes, and Competition from the Internet” (American Economic Journal: Economic Policy, 2010). By Emily Satterthwaite.

A Replication of “Do Voters Affect or Elect Policies? Evidence from the U.S. House” (Quarterly Journal of Economics, 2004). By Patrick Button.

Not about Trump or American elections, but with respect to public finance.

From the perspective of public finance scholarship, much of what I know about Russia comes from numerous studies over the years of their 2001 flat tax reform. The reform replaced a progressively structured system of 12, 20, and 30% with a single rate of 13%. Subsequently, Russia saw a real increase in PIT revenues both in terms of levels (about 20%) and relative to GDP (about 26%). The size of the reform and the greater revenues immediately thereafter were sure to bring it a great deal of attention from both academics and policy makers alike.

Of course, there was much at ideological stake to see a large country cut taxes and see increased revenues. Gaddy and Gales (Brookings) produced a report “demythologizing” the reform for its apparent “supply side” effects, and indeed those magnitudes are implausibly large to be attributable to the tax reform overall. Overall, however, a large country with a history of poor data is unlikely to be a source of high quality evidence on the big questions policy makers want to know. Instead, attention quickly turned to issues in compliance and tax evasion. In a 2005 IMF working paper, Ivanova, Keen, and Klemm took a broad investigation using both micro and macro data. Their conclusion was that there was no strong supply side effect of the reform, but that compliance did improve rather substantially. As you’ll see in a sampling of subsequent research on the reform (see below), I would say the Ivanova et al. findings have largely stood the test of time. To scholars of 2018 familiar with taxable income elasticities, that probably seems like a safe bet conclusion, but at the time most labor supply elasticities were still relatively large (around unity) and we were just on the edge of the improved data and technique literature that would ultimately bring those estimates way down.

• Gorodnichenko, Martinez-Vazquez, and Peter (2009). “Myth and Reality of Flat Tax Reform. Micro Estimates of Tax Evasion Response and Welfare Effects in Russia.” Journal of Political Economy. These authors compare surveys of household expenditure data and reported earnings to develop a measure of tax evasion. This allows them to derive a lower than conventional estimate of deadweight loss that considers tax evasion (i.e. households aren’t sacrificing as much consumption because they can hide their income from taxable authorities).
• Duncan and Peter (2010). “Does Labour Supply Respond to A Flat Tax? Evidence from the Russian Tax Reform.” Economics of Transition. Using micro data, they find real labor supply intensive margin work increases (i.e. hours of work) among men and at the distributional tails for women, as well as increased extensive margin responses (i.e. probability of reporting a job) for both genders. The authors note that these increases are not large enough to produce the aggregate increases in PIT revenues that followed the reform.
• Duncan (2014). “Behavioral Responses and the Distributional Effects of the Russian ‘Flat’ Tax.” Journal of Policy Modeling. The key insight of the model, fit to Russian data for the 2001 tax reform, is that income inequality from income tax data overstates actual income inequality because of tax reform. That is, the inequity of the Russian switch to the flat tax was overstated because high income taxpayers were evading higher rates under the progressive system, and therefore pay more in taxes on the flatter.

 

Suppose that you are an elected executive serving a multiyear term with unilateral control over the annual budget. At the end of your term you have the opportunity for reelection, what would your incentives be for allocating resources across the budget be? The classic view embedded in political economy is that you optimize the budget for electoral advantage, but what does that mean? It might mean that you time the patterns of tax and expenditures in order to coincide with the timing of your next reelection campaign. Perhaps voters have short memories or just dial up their salience of your activities during the campaign season. This might generate what the public choice literature calls “political budget cycles.”

A new paper forthcoming in Public Choice is “Overlapping Political Budget Cycles” by Dirk Foremny (University of Barcelona), Ronny Freier (Technical University of Applied Sciences Wildau), Marc-Daniel Moessinger (ZEW Mannheim), Mustafa Yeter (German Council of Economic Experts) advances this topic with an empirical investigation of political budget cycles in German municipalities between 1992 and 2006 where there exists randomly occurring electoral overlaps between the legislative and executive branches. Here is the abstract:

We advance the literature on political budget cycles by testing for cycles in expenditures for elections to the legislative and the executive branches. Using municipal data, we identify cycles independently for the two branches, evaluate the effects of overlaps, and account for general year effects. We find sizable effects on expenditures before legislative elections and even larger effects before joint elections to the legislature and the office of mayor. In the case of coincident elections, we show that it is important whether the incumbent chief executive seeks reelection. To account for the potential endogeneity of that decision, we apply an IV approach using age and pension eligibility rules.

For those interested in political budget cycles, in two of the last three years the Public Choice Society has given the Elinor & Vincent Ostrom Prize (i.e. best graduate student paper) to a study of the question. One is a metaregression analysis by Pierre Mandon and Antoine Cazals forthcoming in Journal of Economic Survey, the other is a working paper on US gubernatorial elections and government employment by Dodge Cahan. Lastly, the theory of political budget cycles have been successful in motivating instrument variables, with Steve Levitt’s 1997 AER paper on policing being a famous example.

That is the title from new research in Journal of Regional Science by Nadia Greenhalgh-Stanley (Kent State), Shawn Rohlin (Kent State), and Jeff Thompson (Federal Reserve Bank of Boston). Here is the abstract:

We use panel fixed effects estimation with a border approach creating cross‐border county pairs to identify changes in food sales tax rates on employment, payroll, and hiring. Results suggest food sales taxes have a negligible effect on overall employment but adverse effects in the food and beverage stores industry. We find younger workers, who are more likely to work in the food and beverage industry, are more adversely affected when a neighboring state has preferential tax treatment for food. We also determine that omitting food sales tax rates when studying general sales tax effects on employment does not bias estimates.

That last finding is probably not a throw away result, and might turn out to be the most common reason for being cited over the next few years. A constant source of concern in research general sales taxes is both the definition of the tax base (especially the treatment of food) and the other selective sales taxes. This is some evidence that we can relax a bit on those. (Rohlin and Thompson have another article similarly finding that local sales taxes don’t seem to introduce bias either, also good for state sales tax research).

Another reason to check out the paper is if you are interested in attempting a border-discontinuity regression (discussed in section 4).* The opportunity of state border discontinuities is that you presumably have similar local conditions but different state policies. The new potential bias, as the authors point out, is that cross-border flows (like cross-border shopping) can bias the results. In this case, it seems to me the direction of the bias would be against the authors finding their results, so the estimates are probably conservative.

*For the very very interested, I also have a border discontinuity paper with that lays out the math of what type of bias is eliminated and does some other cool things with regard to border matching on this.

PS: Political Science and Politics  (a news and commentary journal that is a companion to American Political Science Review) has a new symposium issue available in firstview on the politics of the Federal Reserve. The symposium is titled “American Oligarchy? The Concealed Politics of the Federal Reserve Bank” and there are six articles to which I’ll hyperlink below. First, a few comments:

• Economists, which have otherwise not focused much on specific bureaucracy and political organizations, by contrast have thrown a lot of heavy hitters at the political independence (or lack thereof) of the Federal Reserve System. Not just in public choice or Austrian economics, but in macroeconomics and game theory. Generally speaking, this is math heavy theoretical models on things like time consistency problems and how to beat expectations of strategic actors.
• Political science and public administration have been much more expansive on the subject of political bureaucracies, particularly ones that contain technocratic experts. The theory is rich and they subsequently invest in lexicon rather than using math to clarify meaning (a generalization). The Federal Reserve has, however, not been a very common target of their interest.
• Therefore, one way in which a interdisciplinary vocabulary could be developed would be to read this symposium and the recent political science scholarship, as well as classics in economics on the subject of Fed independence. This being a political science symposium there are some blind spots in the overview of the coverage of economics and political economics on the Fed, but you nevertheless would undoubtedly gain a usable vocabulary of how to relate ideas across the two disciplines. Also, there are probably intellectual gains from trade in both directions.

Symposium” American Oligarchy? The Concealed Politics of the Federal Reserve Bank

“Clarifying How the Fed is Political” By Rick Valelly

“The Fed, Finance, and Inequality in Comparative Perspective” By Jonas Pontusson

“The Fed’s Political Economy” By Lawrence R. Jacobs and Desmond King

“The Missing Politics of Central Banks” By Christopher Adolph

“The Study of the Federal Reserve and Power in American Politics” By Alexander Hertel-Fernandez

“Why Study Monetary Politics?” By Sarah Binder and Mark Spindel

I’m on vacation this week, I don’t expect to blog much (or at all).

Here are some recent working papers and publications that have otherwise gone unmentioned at PPF:

“Support for contracting-out and public-private partnership: exploring citizens’ perspectives.” Hai (David) Guo and Alfred Tat-Kei Ho. Public Management Review.

“Cost-Benefit and Fiscal Impact Analysis of Ohio Historic Preservation Tax Credit.” By Tatyana Guzman. Journal of Benefit-Cost Analysis.

“The Political Economy of Municipal Pension Funding.”
By Jeffrey Brinkman, Daniele Coen-Pirani and Holger Sieg. American Economic Journal: Macroeconomics.

“Does Fiscal Oversight Matter?” By Désirée I.Christofzik and Sebastian Kessing. Journal of Urban Economics.

“Amenities, Affordability, and Housing Vouchers.” By David S. Bieri and Casey J. Dawkins. Journal of Regional Science.

“Court-Ordered Redistricting and the Law of 1/n.” By Dongwon Lee and Sangwon Park. Public Choice.

“How Sensitive is the Average Taxpayer to Changes in the Tax-Price of Giving.” By Peter Backus and Nicky Grant. International Tax and Public Finance.

“The Impact of Tax and Expenditure Limitations on Municipal Revenue Volatility.” By Tucker Staley, State and Local Government Review.

“Public Debt Stabilization: The Relevance of Policymakers’ Time Horizons.” By Giovanni Di Bartolomeo, Marco Di Pietro, Enrico Saltari, and Willi Semmler. Public Choice.

Given that President Trump has nominated Brett Kavanaugh for the Supreme Court, I thought I would skim over what looks interesting in the literature on judgeship and public finance. Citation followed by brief note on what is in the paper.

• “Judges as Fiscal Activists: Can Constitutional Review Shape Public Finance?” By Jaroslaw Kantorowicz in DANUBE: Law and Economics Review (2013). A panel study of EU countries correlating strength of judicial review with the size of government, contains a thick overview of institutions and constitutional public finance.
• “The Ideological Component of Judging in the Taxation Context.” By Nancy Staudt, Lee Epstein, and Peter Weidenbeck in Washington University Law Review (2006). A law review where the scholars infer the role of politics (partisanship or ideology) in tax cases. They say the previous literature found strong correlations in civil rights cases, but not in economic cases presumably because of the more apolitical nature. Exploring all supreme court cases between 1940 and 2005 that involve interpretation of IRS code, they find no systematic “government” or “taxpayer” bias among judges of either political identity.
• “Taxation, Compensation, and Judicial Independence.” By Jonathan Entin and Erik Jensen in Case Western Reserve Law Review (2005-2006). Another law review, this time an exploratory essay on the limitations of the Compensation Clause (preventing congress from using salary to affect judicial opinion) and describes how this clause has affected taxing power, with specific attention on a 2001 case in which Congress sought to expand OASDI (“social security”) taxes to federal judges.
• “Preferences for School Finance Systems: Voters Versus Judges.” By Colin Campbell and William Fischel in the National Tax Journal (1996). Not about federal supreme court judges, but it documents that one of the most important local public finance reforms in the last 40 years (the centralization of local school finance systems to the state) was at least partially a result of mistaken (so argues Campbell and Fischel) stylized facts about the influence of property rich districts on state legislatures.
• “The Politics of Court Budgeting in the States: Is Judicial Indepdendence Threatened?” by James Douglas and Roger Hartley in Public Administration Review (2003). Surveys state court administrators to uncover the tools state legislatures have over their respective judicial branch. For all that fiscal federalism research emphasizes political independence arising from fiscal independence in geographically overlapping governments, how public finances might undermine the separation of powers seems understudied.