A new look at the Laffer curve

The Laffer curve became fashionable among US Republicans in the 1970s and 1980s, leading to the 1981 tax cut that proved that the US was still on the right side of the curve. But since, tax rates have increased overall, as well as in other countries, where they were higher to start with. So are all these countries still on the good side of the Laffer curve?

Mathias Trabandt and Harald Uhlig study this problem using a neoclassical growth model and new estimates of tax data. And the US is still far from the slippery slope, but not surprisingly closer for capital income tax than for labor income tax. Even for Europe, countries are generally on the right side of the curve. Exceptions: Denmard and Sweden for capital income taxes.

Note that the whole argument here is about the maximization of government revenue. That is usually not the objective. And there are also ways to raise significant revenue while improving a country's welfare, like taxing negative externalities and sins. But at least this paper should put to rest the argument that taxes need to be lowered to raise more revenue.

Stock spams work

We have all received these spam emails touting some obscure stock as the next one to surge. And have you not wondered who would fall victim to such shenanigans and why we still keep getting such emails?

According to Taoufik Bouraoui, these emails actually have an impact in that they increase the volatility of the stock. And under such circumstances, money can be made, unfortunately only for the originator of the spam emails. Unless you are among the very first to get the emails and are able to quickly buy stocks, you are out of luck...

The best political cartoon in years

Why are bad mortgages not renegociated?

As everybody is well aware of, there are plenty of delinquent mortgages in the United States. It is also quite obvious that a home loses substantial value as soon as it is foreclosed, because of homeowner neglect and the fact that it needs to be sold rapidly. Then, why do banks not renegotiate mortgage terms to keep foreclosures from happening. It seems to be in the best interest of banks.

Manuel Adelino, Kristopher Gerardi and Paul Willen wondered about this as well and and a hard look at the data. Specifically, they analyze detailed data on mortgages from Lender Processing Services (LPS). They first reject the standard explanation: whether a mortgage has been securitized or not has no impact on renegotiation.

It turns out that the risk of default after a renegotiation of terms is very high. After all this is why there was renegotiation in the first place. Given the cost of finding new terms, banks simply do not find it worth the trouble. This is similar to the adverse selection problem in insurance. Also, those homeowners who are temporarily in difficulty and will get back on their feet will escape default anyway, and new terms would not change anything.

Why it is foolish to tax outsourced goods

Suppose the production of some good gets outsourced. Outraged, locals ask their government to retaliate, and one obvious policy is to impose a tax on the firms doing this outsourcing. Is this a good policy?

Subhayu Bandyopadhyay, Sugata Marjit and Vivekananda Mukherjee study the case in which this good is an input. Quite obviously, if the incriminated firms are particularly labor-intensive, this tax will actually hurt wages, which plays against the initial intentions. But they show this can hurt local wages even if the sector is capital-intensive if the outsourced good is an intermediate input. The reason is that the final good sector may be labor intensive and the higher costs of inputs hurts it.

Does this actually matter? I have a hard time coming up with a relevant example. One would need to find a country where a capital intensive intermediate good was outsourced and imported to be used in a labor-intensive sector. Usually, one outsources the production of labor-intensive goods, to import them for use in capital-intensive sectors, i.e., the exact opposite of what Bandyopahya, Marjit and Mukerjee have in mind. So why write this paper?

Better incentives for CEOs, and mutual fund managers, too

It is believed that the best way to provide proper incentives to CEOs is to compensate them with option on the stock of the firm they are leading. Options are highly sensitive to the stock's performance, and they are oriented towards the future. Can this be beaten?

Alex Edmans, Xavier Gabaix, Tomasz Sadzik and Yuliy Sannikov claim it is possible with "Dynamic Incentive Accounts." These are essentially escrow accounts that are rebalanced to make sure the equity share is high (and increasing) so as to track firm perfomance also after the CEO has left. Their advantage is that they can be set to follow firm performance further in the future than options can, they cannot be sold like options and they can also track relative poor performance, something options cannot do once they are out of the money (below the exercise price). I am sold. And it should also apply to fund managers. That would work much better than the now oft-criticized bonus system.

Technology shocks and hours: it is the identification, stupid!

There has been an endless debate in macroeconomics about what exogenous variable is supposed to trigger business cycles. While real business cycle models showed some success in matching business cycle features, Jordi Galí used VARs to show that total factor productivity shocks cannot possibly be the right source. It took a few years for the RBC people to recuperate from that blow, but they seem to have found the weak spot in Galí's argument: the data sample is desperately small or it is impossible to go from model to VAR and vice-versa. In other words, the statistical approach is ill-advised.

José-Víctor Ríos-Rull, Frank Schorfheide, Cristina Fuentes-Albero, Raul Santaeulalia-Llopis and Maxym Kryshko now come with yet another argument. The problem is not the econometrics, it is the identification. To be more precise, it all hinges on the labor supply elasticity. And that one is a difficult one, given that macroeconomists and microeconomists do not seem to be able to agree what its ballpark value should be. In particular, they argue that if one uses an elasticity as calibrated in the literature, TFP shocks can explain anything between 1% and 150% of business cycles. However, if this parameter is carefully estimated within a DSGE model using household level data, these shocks explain less than 10%. Will this settle the debate. Surely not. But I am looking forward to more fireworks. I have my popcorn ready.

Low labor market attachment and disability insurance, some expected relationships

Insurance fraud is a constant problem, and we have addressed this in the case of employment insurance before. Now it is the turn of invalidity insurance. We occasionally read stories in the press about gross fraud by healthy people, but what about those at the margin? Of course, they are impossible to measure individually, but maybe something can be measure collectively.

Joshua Angrist, Stacey Chen and Brigham Frandsen look at Vietnam Veterans. The latter benefit from dedicated disability insurance, if they use such a facility more frequently then non-veterans, it must be because of war-related conseuqnces, right? Angrist, Chen and Frandsen use the 2000 census, which has birth date information, to identify who likely went to Vietnam, as birth dates were linked to draft status. It turns out that invalidity declared in the census is no more likely for Vietnam vetarans. Well, allmost all, because those with low skills, who typically have lower employment prospects, report higher invalidity incidence than comparable men who did not go to Vietnam. The authors argue that this cannot be due to a higher incidence of war injuries for low skilled soldiers. So it can only be that they view disability insurance as a good alternative to employment.

Traffic safety, obesity, and ... organ donations

There are times where you really wonder why authors would even think that some variables could be correlated and how they then come up with a story that can explain this statistical relationship coming from seemingly nowhere. The paper by Jose Fernandez and Lisa Stohr is one of these.

To quote their abstract, "this paper uses variation in traffic safety laws and obesity rates to identify substitution patterns between living and cadaveric kidney donors." Despite reading this sentence ten times, I could not make any theoretical sense of it. But reading through the paper, a good story can be made. Tightening traffic safety laws reduces the number of fatalities, and thus the number of cadaveric organ donors. An increase in obesity increases the demand for organs, in particular kidneys. Thus one can instrument for supply and demand using these measures. With this in mind, one can then study how variations in the supply of supply of cadaveric organs (which are of poor value) and demand can motivate living donors to come forward, as they trade off the usefulness of their donation with the personal harm it will inflict upon them. Fernandez and Stohr find that donors respond indeed to cadaveric supply and to the increase in demand due to obesity.

But finding such ways to interpret data is difficult, you need the talents like those of John Donohue and Steven Levitt.

Update: I just came across another paper making essentially the same points, by Randolph Beard, John Jackson, David Kaserman and Hyeongwoo Kim.

Climate change and non-committal governments

As I reported yesterday, gas taxes are the best way to reduce carbon pollution. However, that will only be effective if governments can commit to future gas taxes as well. If they can, investment in energy efficiency will happen in an ... efficient way. If they cannot, energy efficiency is out of the window.

In that case, Alistair and David Ulph study how the policy should be altered. The major consequence is that current governments need to overdo in some way current policy in order to make sure future outcomes are coherent with current wishes. In other words, the potential time inconsistency of public policies makes that current government want to lock in future governments. One way to do this is to invest in green technologies, as obviously the private sector would not do it. This can also be attained with investment credits.

I think this opens a ethical question about current governments deciding for future generations. While it is obvious that you do not want to put future generations in a disadvantage due to current choices, it is less clear that it would be advisable to force the choices of future generations to conform with the preferences of current ones. There is a distinction between solving a commitment problem and forcing the hand of future governments.

Rents differ markedly from user costs in the US

Economic theory tells us that at least in the long run and under perfect competition, marginal revenue should equal marginal cost. With free entry, one should even observe that price equals costs, as profits are driven to zero. So it is puzzling when when one observes persistent deviations from this equality.

Randal Verbrugge notes that this is the case for housing rents in the United States. Now housing is a capital good with fluid markets in the US, so one should see even less deviations. Yet they exist, in part due to large fluctuations in costs. There do not appear to be opportunities for additional profits: transaction costs are high, and fluctuations are impossible to predict. So there are no arbitrage opportunities, even if arbitrage appears to be rather slow.

Gas taxes are still the best option to reduce CO2 emissions

I have advocated numerous times on this blog that high gas taxes are required in order to take into account the various negative externalities of gas consumption. Yet, in the real world, not only are gas taxes low, other means to reducing gas consumption are applied, such as fuel-efficiency standards and special taxes on gas-guzzlers. How do they really compare.

Rüdiger Pethig looks at combinations of the three and finds that gas taxes dominates them all. The reason is that a gas tax is the closest you can get to a CO2 emissions tax. And to reduce the emissions of CO2, nothing beats the price mechanism. The other two means just increase the price of cars, but do not impact the price of gas, and thus the marginal effect of gas consumption: you just end up driving more and consuming only slightly less gas.

And this without even considering that gas taxes can replace labor distorting labor income taxes, while standards provide no revenue.

Are women really more generous?

They is a widespread belief that women are more generous, and this is due to their maternal instincts. Experimental evidence confirms that women are indeed more generous, but has not been able to explain why. An interesting question here is whether by more generous in innate or whether it cost with the social context. This seems difficult to measure, but one could try to devise experiments that can get a hint of an answer.

Anne Boschini, Astri Muren and Mats Persson do the usual dictator games used to study generosity but with a few interesting twists. Instead of asking for demographic information at the start of the experiment, they ask about it after for some people. Or they do not mix genders in the experimental lab. The results are intriguing: women are only more generous when gender is asked before the experiment, or when the participants are of mixed gender. In fact, women are consistently generous, it is the men who change behavior. When they are reminded of their gender, or when women are present, they act tough, even though experiments are conducted anonymously. Pure machism.

More Economics research blogging

There few of us blogging on research in Economics, as most economist bloggers prefer to concentrate on current events, data releases and arguing with each other who started personal attacks. So when some newcomer decides to start with a blog really dedicated to research, this is a welcome addition.

Some NEP editors are starting an experiment with blogging about new papers in their respective fields. According to the post on the RePEc blog, each participating editors will select one paper a week for discussion. Two blogs are already up, Open Macroeconomics and Dynamic General Equilibrium, with hopefully more to come. There are only few comments so far, but they just started. As I hope Economic Logic demonstrates, a blog can be good even without big discussions (although I would obviously prefer it).

At this point, the blogs cater to a niche market, but I can see them develop into a meeting place for people working in those areas, in particular with the proposed weekly posts, which is a pace more appropriate for academics. That may be more successful than my blog, which is more dispersed and has so far five posts a week (I just have so much to say and share...).

If you are curious about other research blogs in Economics, there is a compilation over at Econ Academics. And by the way, NEP is a terrific source of new research in Economics, which I draw heavily on.

Measuring the peace dividend

How costly can a conflict be? While one can measure the expenses poured into a conflict and the physical destruction that ensued, there are important indirect costs that are much harder to get to. Think about the fear, the uncertainty, and the costs of migration. Taking the example of Northern Ireland, Timothy Besley and Hannes Mueller measure violency by conflict related death in eleven regions and look at their impact on house prices, which are supposed to capitalize all costs, and in particular incorporate both immediate suffering and risk as well as the likelihood of future violence. Indeed, a casualty is often a signal about future violence to come, and thus house prices capture also the learning process about conflict violence.

Besley and Mueller model this with a Hamilton regime switching process. Whenever an event occurs, it changes the likelihood that a region is in a violent regime. And this likelihood impacts hose prices. They find that the peace dividend corresponds to about 4-12% in Belfast and 0.8-2.5% over all regions. They also find a migration effect: when violence increases in Belfast, surrounding areas gain, and this effect is even stronger than the learning effect about the region's own violence process. Thus, it looks like every region reacts differently.

Are these effects big? I would say so given that the violence has directly impacted a very small fraction of the population. In fact, the cost of conflict can be even much larger. Indeed, the study only looked at differences across regions in Northern Ireland. There can be substantial costs for the region as a whole, costs that are washed out by trends and fixed effects. For example, the recent housing price boom in the area may have reflected the new peace (along with reduced conflict related expenses by authorities).