Public Economics Lectures Part 1: Introduction

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Econometric Problem 3: Selection into Labor Force Consider model with fixed costs of working, where some individuals choose not to work Wages are unobserved for non-labor force participants Thus, OLS regression on workers only includes observations with l i > 0 This can bias OLS estimates: low wage earners must have very high unobserved propensity to work to find it worthwhile Requires a selection correction (e.g. Heckit, Tobit, or ML estimation) See Killingsworth and Heckman (1986) for implementation Current approach: use panel data to distinguish entry/exit from intensive-margin changes Public Economics Lectures ()Part 5: Income Taxation and Labor Supply 12 / 217
Extensive vs. Intensive Margin Related issue: want to understand effect of taxes on labor force participation decision With fixed costs of work, individuals may jump from non-participation to part time or full time work (non-convex budget set) This can be handled using a discrete choice model: P = φ(α + ε log(1 − τ) − ηy) where P ∈ {0, 1} is an indicator for whether the individual works Function φ typically specified as logit, probit, or linear prob model Note: here it is critical to have tax variation; regression cannot be run with wage variation Public Economics Lectures ()Part 5: Income Taxation and Labor Supply 13 / 217
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Public Economics Lectures Part 1: I
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Motivation 1: Practical Relevance I
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Motivation 2: Academic Interest Pub
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Methodological Themes 1 Micro-based
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Federal Government Revenue and Expe
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Federal Revenues (% of total revenu
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Federal Spending (% of total spendi
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Government Intervention in the Econ
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First Role for Government: Improve
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First Welfare Theorem Private marke
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Failure 2: Asymmetric Information a
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Individual Failures Recent addition
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Why Limit Government Intervention?
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Three Types of Questions in Public
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Public Economics Lectures Part 2: I
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References on Tax Incidence Kotliko
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Economic vs. Statutory Incidence Eq
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Overview of Literature Ideally, we
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Partial Equilibrium Model: Setup Tw
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Partial Equilibrium Model: Supply P
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Tax Levied on Producers Price S+t $
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Perfectly Inelastic Demand Price D
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Formula for Tax Incidence Implicitl
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Tax Incidence with Salience Effects
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Chetty et al.: Empirical Framework
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Chetty et al.: Strategy 1 Experimen
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TABLE 1 Evaluation of Tags: Classro
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Period Effect of Posting TaxInclu
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Period Effect of Posting TaxInclu
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Chetty et al.: Strategy 2 Compare e
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Per Capita Beer Consumption and Sta
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Evaluating Empirical Studies Consid
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Cigarette Taxation: Background Ciga
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Evans, Ringel, and Stech (1999) Exp
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Public Economics Lectures () Part 2
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Triple Difference Some studies use
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Fixed Effects Include time and stat
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Evans, Ringel, and Stech (1999) Imp
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Evans, Ringel, and Stech: Incidence
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Evans, Ringel, and Stech: Demand El
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Evans, Ringel, and Stech: Long Run
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Hastings and Washington 2008 Questi
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Rothstein 2008 How does EITC affect
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Rothstein: Empirical Strategy Two m
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DFL Reweighting Widely used method
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Rothstein: Results Basic DFL compar
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Rothstein: Results Ultimately uses
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Extensions of Basic Partial Equilib
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Extensions of Basic Partial Equilib
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Harberger 1962 Two Sector Model 1 F
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Harberger Model: Effect of Tax Incr
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Harberger Model: Main Effects 2. Ou
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Harberger Model: Main Effects 3. Su
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Computable General Equilibrium Mode
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Criticism of CGE Models Findings ve
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Open Economy Application: Framework
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Open Economy Application: Empirics
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Feldstein and Horioka 1980 Second s
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Open Economy Applications: Empirics
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Capitalization and the Asset Price
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Empirical Applications 1 [Cutler 19
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Cutler 1988 First, compute excess r
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Cutler: Results Cutler finds ˆb =
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Linden and Rockoff: Results Find ho
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Excess Returns Around Drug Approval
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Distribution of Excess Returns arou
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Mandated Benefits We have focused u
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Mandated Benefits: Simple Model Lab
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Mandated Benefit Wage Rate S w 1 B
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Mandated Benefits: Incidence Formul
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Gruber 1994 Studies state mandates
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Acemoglu and Angrist 2001 Look at e
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Acemoglu and Angrist 2001 Acemoglu
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Public Economics Lectures Part 3: E
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Definition Incidence analysis: effe
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Effi ciency Cost: Introduction Gove
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Partial Equilibrium Model: Setup Tw
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Price Excess Burden of Taxation S $
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Effi ciency Cost: Marshallian Surpl
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EB Increases with Square of Tax Rat
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P P 3 P 2 P 1 S+t 1 +t 2 S+t 1 E B
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Tax Policy Implications With many g
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General Model: Demand and Indirect
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Path Dependence Problem Initial pri
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Consumer Surplus: Conceptual Proble
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Compensating and Equivalent Variati
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Equivalent Variation Measures utili
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Effi ciency Cost Formulas with Inco
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Compensating vs. Equivalent Variati
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Marshallian Surplus p h(V(p 1 ,Z))
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Excess Burden Deadweight burden: ch
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p h(V(p 1 ,Z)) ~ h(V(p 0 ,Z)) p 1 M
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Implementable Excess Burden Formula
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Harberger Formula Without pre-exist
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Goulder and Williams 2003 Show that
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Goulder and Williams Formula Obtain
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Goulder and Williams Results Calibr
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Harberger vs. Hausman Approach Unde
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Primitives Sufficient Stats. Welfar
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Heterogeneity Benefit of suff stat
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Discrete Choice Model Recast as pla
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Effi ciency Cost: Applications 1 [I
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Feldstein Model: Setup Government l
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Taxable Income Formula Simplicity o
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Excess Burden with Transfer Costs L
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Gorodnichenko, Martinez-Vazquez, an
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Poterba 1992 Estimates effi ciency
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Porterba: Results Tax reforms in 19
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Price and Tax Elasticities By Year
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Welfare Analysis in Behavioral Mode
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Behavioral Welfare Economics: Two A
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Behavioral Welfare Economics: Two A
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Bernheim and Rangel 2009: Choice Se
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Bernheim and Rangel 2009: Compensat
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Bernheim and Rangel 2009: Refinemen
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Welfare Analysis with Salience Effe
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Welfare Analysis with Salience Effe
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Preference Recovery Assumptions A1
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Excess Burden with No Income Effect
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Effi ciency Cost with Income Effect
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Directions for Further Work on Beha
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Outline 1 Commodity Taxation I: Ram
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Second Welfare Theorem Starting poi
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Four Central Results in Optimal Tax
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Ramsey Model: Key Assumptions 1 Lum
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Ramsey Model: Consumer Behavior Lag
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Ramsey Model: Government’s Proble
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Ramsey Formula: Perturbation Argume
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Ramsey Formula: Compensated Elastic
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Special Case 1: Inverse Elasticity
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Special Case 2: Uniform Taxation Th
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Diamond 1975: Many-Person Model H i
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Diamond: Many-Person Optimal Tax Fo
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Diamond: Optimal Transfer In this m
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Lipsey and Lancaster (1956): Theory
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Diamond and Mirrlees Model Two good
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Consumer’s Offer Curve Public Eco
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Production Set with Revenue Require
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Second Best: Optimal Distortionary
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Diamond and Mirrlees: General Model
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Proof of Production Effi ciency Res
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Policy Consequences: Public Sector
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Policy Consequences: No Taxation of
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Policy Consequences: No Taxation of
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Diamond and Mirrlees: Optimal Tax R
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Diamond and Mirrlees Result: Limita
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Key Concepts for Taxes/Transfers Le
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Optimal Income Tax with No Behavior
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Mirrlees 1971: Incorporating Behavi
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Mirrlees: Subsequent Work Mirrlees
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Revenue-Maximizing Tax Rate: Laffer
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Optimal Top Income Tax Rate { } dM
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Optimal Top Income Tax Rate In US t
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Connection to Revenue Maximizing Ta
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General Non-Linear Income Tax Optim
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Numerical Simulations of Optimal Ta
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Numerical Simulations Use formula e
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Commodity vs. Income Taxation Now c
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Atkinson and Stiglitz: Commodity Ta
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Page 359 and 360: Atkinson-Stiglitz: Intuition With s
Page 361 and 362: Atkinson-Stiglitz: Implications for
Page 363 and 364: Chamley-Judd: Capital Taxation Judd
Page 365 and 366: Taxation and Savings: Evidence Key
Page 367 and 368: Public Economics Lectures () Part 4
Page 369 and 370: Optimal Transfer Programs Several t
Page 371 and 372: Optimal Transfers: Mirrless Model M
Page 373 and 374: Saez 2002: Participation Model Mode
Page 379 and 380: Saez 2002: Optimal Tax Formula Smal
Page 387 and 388: Mankiw and Weinzierl 2009 Tagging w
Page 389 and 390: Nichols and Zeckhauser 1982: In-Kin
Page 391 and 392: Soup Kitchen without Wait: Cash Tra
Page 393 and 394: Income Taxation as Insurance (Varia
Page 395 and 396: Varian Model: Private Insurance Var
Page 397 and 398: Public Economics Lectures Part 5: I
Page 399 and 400: References Surveys in labor economi
Page 401 and 402: Baseline Labor-Leisure Choice Model
Page 403 and 404: Labor Supply Behavior First order c
Page 405 and 406: Econometric Problem 1: Unobserved H
Page 407: Measurement Error and Division Bias
Page 411 and 412: Progressive Taxes and Labor Supply
Page 413 and 414: Example 1: Progressive Income Tax P
Page 415 and 416: Example 3: Social Security Payroll
Page 417 and 418: Progressive Taxes and Labor Supply
Page 419 and 420: Non-Linear Budget Set Estimation: V
Page 421 and 422: Likelihood Function: Located at the
Page 423 and 424: Hausman (1981) Application Hausman
Page 425 and 426: Saez 2009: Bunching at Kinks Saez o
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Page 429 and 430: Earnings Density and the EITC: Wage
Page 431 and 432: Taxable Income Density, 1960-1969:
Page 433 and 434: Friedberg 2000: Social Security Ear
Page 435 and 436: Friedberg: Estimates Estimates elas
Page 439 and 440: Why not more bunching at kinks? 1 T
Page 443 and 444: Chetty et al. 2009: Model Firms pos
Page 445 and 446: Cost of Bunching at Bracket Cutoff
Page 447 and 448: Marginal Tax Rates in Denmark in 19
Page 449 and 450: All Wage Earners: Top Tax Bracket C
Page 451 and 452: Married Women Frequency 0 10000 200
Page 453 and 454: Married Female Professionals with A
Page 455 and 456: Married Women, 1994 Frequency 0 100
Page 457 and 458: Married Women, 1996 Frequency 0 100
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Married Women, 1998 Frequency 0 100
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Married Women, 2000 Frequency 0 100
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Married Women at the Middle Tax: 10
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Married Women at the Middle Tax: 8%
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Distribution of Individuals’Deduc
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Teachers Wage Income: 1998 Frequenc
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Wage Earnings: Teachers with Deduct
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Distribution of Modes in Occupation
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SelfEmployed: Distribution around
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Estimates of Hours and Participatio
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Public Economics Lectures ()Part 5:
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Problems with Experimental Design E
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Instrumental Variable Methods Anoth
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Mroz 1987: Setup and Results Uses b
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Eissa 1995: Caveats Does the common
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Bianchi, Gudmundsson, and Zoega 200
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Bianchi, Gudmundsson, and Zoega 200
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Overall Costs of Anti Poverty Progr
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Monthly Welfare Case Loads: 1963-20
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Behavioral Responses to the EITC 1
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Eissa and Liebman 1996 Study labor
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Eissa and Liebman: Results Find a s
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Meyer and Rosenbaum 2001 Analyze th
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Eissa and Hoynes 2004 EITC based on
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Meyer and Sullivan 2004 Examine the
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Relative Consumption: single women
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Meyer and Sullivan: Results Materia
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Changing Elasticities: Blau and Kah
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Intertemporal Models and the MaCurd
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Life Cycle Model: Time Separability
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Dynamic Life Cycle Model: Frisch El
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Frisch vs. Compensated vs. Uncompen
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Card Critique of ITLS models Critiq
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Blundell, Duncan, and Meghir 1998 C
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Blundell, Duncan, and Meghir: Resul
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Farber 2005: Division Bias Argues t
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Manoli and Weber 2009 Use variation
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Distribution of Tenure at Retiremen
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US Income Taxation: Trends The bigg
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Bottom 99% Tax Units 40% $40,000 35
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Feldstein 1995 First study of taxab
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Feldstein: Results Feldstein obtain
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Feldstein: Econometric Criticisms S
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18% 16% Wages SCorp. Partner. Sol
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Gruber and Saez 2002 First study to
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Gruber and Saez: Results Find an el
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Imbens et al. 2001: Income Effects
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Taxable Income Literature: Summary
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Prescott 2004 Uses data on hours wo
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Davis and Henrekson 2005 Run regres
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Optimization Frictions Many frictio
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Setup Consider a static demand mode
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Optimization Frictions Define agent
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Construction of Choice Set 151 150
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Identification with Optimization Fr
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Identification with Optimization Fr
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Calculation of Bounds on Structural
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) Lower Bound on Structural Elastic
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Application to Taxation and Labor S
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4.0 Bounds on IntensiveMargin Lab
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4.0 3.5 Bounds on IntensiveMargin
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Chetty and Saez 2009: Experimental
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Year 2 Earnings Distributions: 1 De
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Year 2 Wage Earnings Distributions:
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Labor Supply Elasticities: Implicat
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Chetty: Formula for Risk Aversion L
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u c ,u l w 0 u c (w 0 l,l) Case A:
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Chetty 2006: Results Labor supply e
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Outline 1 Motivations for Social In
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Growth of Social Insurance in the U
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Unemployment Benefit Systems in Dev
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Useful Background Reading 1 Institu
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Adverse Selection as a Motivation f
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Rothschild-Stiglitz: Key Assumption
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Rothschild-Stiglitz: Equilibrium De
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Rothschild-Stiglitz: Second Best So
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Adverse Selection: Empirical Eviden
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Aggregate Shocks as a Motivation fo
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Unemployment Insurance Start with U
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Replacement Rate Common measure of
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Baily-Chetty model Canonical analys
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Baily-Chetty model: Setup Static mo
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Baily-Chetty model: First Best Prob
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Baily-Chetty model: Second Best Pro
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Two Approaches to Optimal Social In
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Envelope Condition Why can ∂e ∂
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Suffi cient Statistic Approach to K
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Baily-Chetty model: Second Best Sol
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Baily-Chetty Consumption-Based Form
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Empirical Estimates: Duration Elast
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Hazard Models Define hazard rate h
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Meyer 1990 Meyer includes log UI be
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Consumption Smoothing Benefits of U
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Consumption Smoothing Benefits of U
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Calibrating the Model b ∗ Results
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Homeowners’Consumption around Une
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Commitments and Risk Aversion How d
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Commitments Model: Implications for
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Chetty 2008: Moral Hazard vs. Liqui
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Chetty 2008: Job Search Technology
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Chetty 2008: Value Functions Value
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Chetty 2008: Moral Hazard vs. Liqui
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Chetty 2008: Formula for Optimal UI
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Moral Hazard vs. Liquidity: Evidenc
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Figure 3a Effect of UI Benefits on
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Figure 3c Effect of UI Benefits on
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log UI ben 0.527 (0.267) TABLE 2
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Figure 5 Effect of Severance Pay on
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Figure 6b Effect of Severance Pay o
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Chetty 2008: Implications for Optim
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Figure 3 Frequency of Layoffs by Jo
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Figure 4 Selection on Observables M
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TABLE 3a Effects of Severance Pay a
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Shimer and Werning 2007: Reservatio
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Figure 5a Effect of Severance Pay o
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Figure 10b Effect of Severance Pay
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Effect of Extended Benefits on Subs
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Spike at Benefit Exhaustion Most st
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Job Finding vs. Unemployment Exit H
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Effect of Benefit Expiration on Haz
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Experience Rating in Washington, 20
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Feldstein 1978: Empirical Results F
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UI Savings Accounts Alternative to
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Feldstein and Altman 2007 Calculati
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Black, Smith, Berger, and Noel 2003
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Black, Smith, Berger, and Noel 2003
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Dynamics: Path of UI Benefits Class
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Workers Compensation Insurance agai
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Theory of Workers’Compensation Fo
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Effects of Benefits on Injuries Pot
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Effect on Equilibrium Wage Workers
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Disability Insurance See Bound et.
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Two Views on the Rise in DI Trend h
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Theory of Disability Insurance Key
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Empirical Evidence: Bound-Parsons D
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Empirical Evidence: Bound-Parsons D
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Gruber 2000 Exploits differential l
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Autor and Duggan 2003 Focus on inte
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Employment Shocks and DI Applicatio
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Employment Shocks and DI Applicatio
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Health Insurance Arrow (1963): semi
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Health Care Spending in OECD Nation
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Americans’Source of Health Insura
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Growing Health Expenditures: Key Fa
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Market Failures and Government Inte
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Measuring Health Before discussing
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Optimal Govt. Intervention in Healt
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Feldstein 1973 x = non-medical cons
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Feldstein 1973: First Best Solution
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Price of each visit $200 A B S=MC $
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Finkelstein 2006 Impact of Medicare
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Ellis and McGuire 1986 Previous ana
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Ellis and McGuire: Compensation Sch
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Ellis and McGuire: Optimal Payment
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Ellis and McGuire: Optimal Payment
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Ellis and McGuire Model: Limitation
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Crowdout of Private Insurance So fa
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Currie and Gruber 1995: Benefits of
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Public Economics Lectures Part 7: P
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Public vs. Private Goods Private go
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Public Good Person 1’s Consumptio
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Public Goods Model: Setup Economy w
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First Best if G is Private To ident
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First Best if G is a Pure Public Go
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Samuelson (1954) Rule Condition for
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Model of Private Provision: Setup P
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Lindahl Equilibrium How to achieve
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Lindahl Equilibria: Key Properties
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Voting Model: Setup Suppose that pu
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Arrow (1951) and Single-Peaked Pref
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Median Voter Theorem With single-pe
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Median Voter Choice: Effi ciency In
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Optimal Second Best Provision of PG
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Bergstrom, Blume, and Varian (1986)
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Bergstrom-Blume-Varian Model: Crowd
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BBV Model: Additional Results 1 Tot
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Empirical Evidence on Crowd-Out Two
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Hungerman 2005 Studies crowdout of
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Hungerman 2005 Estimates imply that
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Andreoni and Payne 2003 OLS still y
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Andreoni and Payne 2003 $1000 incre
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Andreoni 1988 Isaac, McCue, and Plo
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Andreoni 1993 Uses lab experiment t
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Andreoni 1993 Public good levels ar
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Financing PGs with Distortionary Ta
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PGs with Distortionary Taxes: Setup
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PGs with Distortionary Taxes: 1st B
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PGs with Distortionary Taxes: 2nd B
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Kreiner and Verdelin 2009 Consider
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Subsidies for Charity: Setup Warm-g
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Optimal Subsidies for Charity Resul
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Optimal Subsidies for Charity (Saez
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Empirical Evidence Existing studies
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Externalities: Outline 1 Definition
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Externalities: Main Questions 1 The
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Model of Externalities: Equilibrium
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Model of Externalities: Deadweight
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Remedies for Externalities 1 Coasia
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Coasian Solution: Limitations 1 Cos
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Price Pigouvian Tax SMC=PMC+MD S=PM
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Permits: Cap-and-Trade Cap total am
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Weitzman 1974: Market for Pollution
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Weitzman Model: Policy without Unce
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MB steep, Quantity regulation Publi
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Quantity Regulation Price Regulatio
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MB Flat, Quantity Regulation Public
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Quantity regulation Price Regulatio
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Optimal Second-Best Taxation with E
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Sandmo 1975: Setup Individual maxim
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Sandmo 1975: Additivity Result Main
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Double Dividend Debate Claim: gas t
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Externalities: Empirical Measuremen
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Brookshire et al. 1982 Infer willin
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Chay and Greenstone 2005 Conclusion
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Diamond and Hausman 1994 Describe p
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Becker and Murphy 1988 Show that ad
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Bernheim and Rangel 2004 Model of
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Public Economics Lectures Part 1: Introduction

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