Government Relief for Risk Associated with Government Action
NBER Working Paper No. 3006 (Also Reprint No. r1768)
A significant source of risk arises from uncertainty concerning future government policy. Government action - - tax reform, deregulation, judicial decisions, budgetary shifts - - produces gains and losses for those who invested under preexisting rules. The effects of government relief - - compensation, grandfathering, phase-ins - - on ex ante incentives and risk bearing are examined in a model in which private insurance is taken into account. It is demonstrated that government relief is inefficient, even when private insurance is subject to moral hazard, because relief shields individuals from some of the effects of their actions.