NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

NBER Reporter: Summer 2002


Public Economics


    The NBER's Program on Public Economics, directed by James M. Poterba of MIT, met in Cambridge on April 5. The following papers were discussed:

    William M. Gentry, NBER and Columbia University, and David M. Schizer, Columbia University Law School, "Frictions and Tax-Motivated Hedging: An Empirical Exploration of Publicly-Traded Exchangeable Debt"

    Discussant: Mihir A. Desai, NBER and Harvard University

    Susan Dynarski, NBER and Harvard University, "Loans, Liquidity, and the Market for Higher Education"

    Discussant: Charles T. Clotfelter, NBER and Duke University

    B. Douglas Bernheim and Antonio Rangel, NBER and Stanford University, "Addiction, Cognition, and the Visceral Brain"

    Discussant: Botond Koszegi, University of California, Berkeley

    Mark Duggan, NBER and University of Chicago, "Does Contracting Out Improve the Efficiency of Government Programs? Evidence from Medicaid HMOs"

    Discussant: Katherine Baicker, NBER and Dartmouth College

    Alberto Alesina, NBER and Harvard University, Ignazio Angeloni, European Central Bank, and Federico Etro, Harvard University, "Institutional Rules for Federations" (NBER Working Paper No. 8646)

    Discussant: Roger H. Gordon, NBER and University of California, San Diego

    Daniel Bergstresser, MIT, and James M. Poterba, "Asset Allocation and Asset Location Decisions: Evidence from the Survey of Consumer Finances"

    Discussant: Andrew Samwick, NBER and Dartmouth College

    Financial innovation may undermine efforts at taxing capital income; often financial innovations take advantage of the realization-based elements of the tax code. Gentry and Schizer examine one such innovation: publicly traded exchangeable debt issued in the United States between 1992 and 2000. These debt contracts raise cash and allow the issuer to hedge much of the risk of an appreciated position but do not trigger a tax on the capital gain. The authors note that in addition to underwriting fees, typically 3 percent of gross proceeds, financial market frictions create costs of using these securities to avoid taxes. The announcement of these securities is associated with a negative 1.03 percent average abnormal return in the underlying stock. Furthermore, just prior to the execution of the transaction, the underlying stock experiences an abnormal return of negative 2.8 percent. To some extent, the underlying stock rebounds from this later price effect, but the issuer does not participate fully in this rebound because the debt has hedged the issuer from benefiting in the price movements in the underlying stock. In addition to the price effects, the issuance of these debt securities is associated with large abnormal trading volume in the underlying stock, suggestive of arbitrage trading.

    During the 1999-2000 school year, students borrowed $36 billion through the federal loan program, double the volume in 1992-3. Despite the large size and rapid growth of the student loan market, it has been the subject of little economic analysis. Does the availability of government loans affect schooling decisions? Identifying the effect of loans is empirically challenging, because eligibility for federal loans is correlated with observed and unobserved determinants of schooling. Dynarski exploits variation in loan eligibility induced by the Higher Education Amendments of 1992, which removed home equity from the set of assets that are taxed by the federal financial aid formula. She finds that loan eligibility has a positive effect on college attendance. Loan eligibility also appears to shift students toward four-year private colleges.

    Bernheim and Rangel develop a new model of the consumption of addictive substances. The basic premise of their theory is that environmental cues can trigger states that lead the brain to provide an incomplete characterization of the decision problem; this can lead the decisionmaker to make systematic mistakes. Importantly, cues affect behavior because they influence how the brain characterizes the problem, not because they change the underlying preferences. The authors show that their model: can explain the basic stylized facts associated with addiction; has good foundations in neuroscience and psychology; and generates plausible consumption patterns for different substances. They also use the model to study the welfare properties of six drug policies: laissez-faire; taxation; subsidization of treatment programs; criminalization; regulated dispensation; and "behavioral policies" such as education and "shock-based" marketing campaigns.

    State governments contract with health maintenance organizations (HMOs) to coordinate medical care for nearly 20 million Medicaid recipients. Identifying the causal effect of HMO enrollment on government spending and health care quality is difficult if, as is often the case, recipients have the option to enroll in a plan. To estimate the average effect of HMO enrollment, Duggan exploits county-level mandates introduced during the last several years in the state of California requiring most Medicaid recipients to enroll in a managed care plan. His results demonstrate that the resulting switch from fee-for-service to managed care was associated with a substantial increase in government spending but no observable improvement in health outcomes, thus apparently reducing the efficiency of this large government program. The findings cast doubt on the hypothesis that HMO contracting has reduced the strain on government budgets.

    Alesina, Angeloni, and Etro study the organization of federations -- or international unions -- which together decide the provision of certain public goods. The authors individuate as an optimal institutional design a form of fiscal federalism based on decentralization of expenditures and a system of subsidies and transfers between countries. Since this solution can be politically unfeasible, they also study institutional compromises between a centralized federation and a decentralized one. "Flexible unions" and federal mandates in which both the state and federal levels are involved in providing public goods typically are superior to complete centralization and are politically feasible. Finally, the authors study the effects of a qualified majority voting rule in a centralized system: they find that it can be a useful device for correcting a bias toward "excessive" union level activism.

    The rapid growth of assets in self-directed tax-deferred retirement accounts has generated a new set of financial decisions for many households. In addition to deciding which assets to hold, households with substantial assets in both taxable and tax-deferred accounts must decide where to hold their various assets. Bergstresser and Poterba use data from the 1989-98 Surveys of Consumer Finances to assess how many households have enough assets in both taxable and tax-deferred accounts to face significant choices regarding asset location. As of 1998, 45 percent of households had at least some assets in a tax-deferred account, and more than ten million households had at least $25,000 in their taxable as well as their tax-deferred accounts. Many households hold equities in their tax-deferred accounts, but not in their taxable accounts, while also holding taxable bonds in their taxable accounts. This contradicts the general wisdom that one should locate heavily taxed assets in the tax-deferred account. Asset allocation within tax deferred accounts is quite similar to asset allocation in taxable accounts.


 
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