Program Meeting: Public Economics

NBER Reporter: Summer 2000

Public Economics

The NBER's Program on Public Economics held its spring meeting in Cambridge on April 13 and 14. Program Director James M. Poterba of MIT organized the following agenda:

John P. Conley, University of Illinois, and Antonio Rangel, NBER and Stanford University, "Intergenerational Spillovers and Decentralization"

Discussant: Dennis N. Epple, NBER and Carnegie Mellon University

Julia Lynn Coronado, Federal Reserve System; Don Fullerton, NBER and University of Texas; and Thomas Glass, Glass & Company, "The Progressivity of Social Security" (NBER Working Paper No. 7520)

Discussant: Jeffrey B. Liebman, NBER and Harvard University

Jonathan Gruber, NBER and MIT, and Michael K. Lettau, Bureau of Labor Statistics, "How Elastic Is the Firm's Demand for Health Insurance?"

Discussant: Douglas Holtz-Eakin, NBER and Syracuse University

David F. Bradford, NBER and Princeton University; Rebecca Schlieckert, BlackRock Financial; and Stephen H. Shore, Harvard University, "The Environmental Kuznets Curve: Exploring a Fresh Specification"

Discussant: Lawrence H. Goulder, NBER and Stanford University

Kenneth L. Judd, NBER and Stanford University, "Is Education as Good as Gold? A Portfolio Theory of Human Capital Investment"

Discussant: Casey Mulligan, NBER and University of Chicago

William M. Gentry and R. Glenn Hubbard, NBER and Columbia University, "Tax Policy and Entrepreneurial Activity"

Discussant: Bruce D. Meyer, NBER and Northwestern University

Todd M. Sinai, NBER and University of Pennsylvania, and Joseph E. Gyourko, University of Pennsylvania, "The Asset Price Incidence of Capital Gains Taxes: Evidence from the Taxpayer Relief Act of 1997 and Publicly Traded Estate Firms"

Discussant: Douglas A. Shackelford, NBER and University of North Carolina, Chapel Hill

Conley and Rangel show that decentralized institutions have an advantage over centralized institutions in the provision of durable public goods (DPGs). The key feature of DPGs is that they generate intergenerational spillovers. Conley and Rangel show, based solely on intergenerational effects, that decentralization does better even with no sorting effects, because all of the agents have the same preferences over public goods. Their results imply that the level of government at which a particular DPG should be allocated depends on the interplay of three forces: intergenerational spillovers, sorting effects, and interjurisdictional externalities. If the intergenerational component is dominant, DPGs should be allocated at the local level. If the interjurisdictional externalities are strong enough, they should be allocated at the central level.

How much does the current social security system really redistribute from rich to poor? Coronado, Fullerton, and Glass proceed to answer the question in seven steps. First, they classify individuals by annual income and use Gini co-efficients, finding that Social Security is highly progressive. Second, they reclassify individuals on the basis of lifetime income and find that Social Security is less progressive. Third, the authors remove the cap on measured earnings and find that Social Security is even less progressive. Fourth, they switch from actual to potential lifetime earnings (the present value of the wage rate times 4,000 hours each year). This measure captures the value of leisure and home production, so that those out of the labor force are less poor, and net payments to them are less progressive. Fifth, the authors assign to each married individual half of the couple's income. The low-wage spouse is then not so poor, and Social Security becomes even less progressive. Sixth, they incorporate mortality probabilities that differ by potential lifetime income. Since the rich live longer and collect benefits longer, Social Security is no longer progressive at all. Finally, Coronado, Fullerton, and Glass increase the discount rate from 2 to 4 percent, which puts relatively more weight on the earlier-but-regressive payroll tax and less weight on the later-but-progressive benefit schedule. The whole Social Security system is then found to be regressive.

Gruber and Lettau investigate the impact of tax subsidies on the firm's decision to offer health insurance and on firm spending on that insurance. They use microdata underlying the Employee Compensation Index, which matches very high-quality compensation data with information on a sample of workers in the firm. Gruber and Lettau find overall that offering insurance is modestly elastic with respect to aftertax prices (elasticity of -0.3), but that insurance spending is highly elastic with respect to tax subsidies (elasticity of -1.3). The elasticity of offering insurance is driven solely by small firms, whose elasticity is -0.7, but spending on insurance is more elastic in large firms. Gruber and Lettau also show how the aggregation of worker preferences determines decisions about providing benefits. In particular, they find evidence of a median voter model of benefits determination, along with some additional influence for the most highly compensated workers in the firm.

Using a new specification, Bradford, Schlieckert, and Shore re-analyze the data on worldwide environmental quality investigated by Gene M. Grossman and Alan B. Krueger in a well-known paper on the environmental Kuznets curve (which postulates an inverse U-shaped relationship between income level and pollution). The new specification enables the authors to draw conclusions from fixed effects estimation. In general, they find support for the environmental Kuznets curve for some pollutants and for its rejection in other cases.

Do we underinvest in education? One way to answer this question is to compare the expected returns to education to the returns on assets of comparable risk. Judd argues that the usual practice of comparing the return to education to equity investments is incorrect. Under optimal contracting, the correct private risk premium for idiosyncratic risk is zero, the same as the social cost of idiosyncratic risk. Combining his results with conventional wisdom indicates that the correct hurdle rate is substantially less than the expected return to equity, perhaps down to that of gold.

Using the Panel Study of Income Dynamics for 1979-92, Gentry and Hubbard incorporate various effects of the income tax system in their empirical estimations of the probability that people will enter self-employment. The level of the marginal tax rate does not affect entry into self-employment in a consistent manner across specifications, but progressive marginal tax rates on the whole discourage entry into self-employment. The effects of the convexity of the tax schedule on entrepreneurial entry are rather large. For example, Gentry and Hubbard estimate that the Omnibus Budget Reconciliation Act of 1993, which raised the top marginal tax rate, lowered the probability of entry into self-employment for upper-middle-class households by about 20 percent.

Sinai and Gyourko examine how asset prices adjusted to the capital gains tax cut in the Taxpayer Relief Act of 1997 (TRA97). By comparing two organizational structures in the real estate industry that differ only in how they should be affected by a change in capital gains tax rates, the authors are able to isolate the effect of the tax cut from industry trends and firm-level heterogeneity. In real estate, the benefit of a capital gains tax deferral accrued mainly to the buyer of an appreciated property; much of the value of the subsidy was capitalized into asset prices. Using share price data, Sinai and Gyourko find that on average real estate firms called "UPREITs," whose tax subsidy was reduced in TRA97, had 14 percent less price appreciation in 1997 relative to 1996 than companies known as "REITs," which had no tax change. Firms that appeared likely to be purchasers of property -- and thus received the benefit from the tax subsidy before it was cut -- were the only ones that had share prices that declined. In addition, those firms did not experience any relative movement in share prices during the previous year when capital gains tax rates did not change. Sinai and Gyourko also find that prices for new acquisitions rose for UPREITs relative to REITs after TRA97.

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