Public Econ Quizlet 3 Quiz 3, Public Economics Quiz 2, Public Economics: Parts 1 and 2
DWL =?
1/2 * tax rate squared * total expenditure * effective combined elasticity (1/(1/es+1/ed))
• Poverty line
: the federal government's standard for measuring absolute deprivation
Do other developed countries experience the same pattern in inequality?
Answer: Only partly. Similar patterns until the 70s but after that the U.S. experience a much stronger growth in income inequality, even in pre-tax and pre-transfer income.
Why is economic incidence different from statutory incidence?
Because prices typically change as a result of taxes, thus also people who don't remit the tax to the government bear some of the burden through price changes.
Reasons to use in-kind transfers
Commodity egalitarianism / political support by voters ØDiscourages fraud; helps targeting to truly needy ("ordeals") ØPolitical argument: to help producers (if the in-kind program distorts consumption and supply is not perfectly elastic) ØThe in-kind good has a more positive (or less negative externality) than what the person would have bought with cash. I.e., this only works if the in-kind program distorts consumption. E.g.: WIC or training that increases future work opportunities
Why is it sometimes difficult to tell capital gains and labor income apart?
E.g. a house you cannot tell if the gain is from the house prices appreciating or if the people worked on renovating it themselves
How to measureinequality in a single#?
Ginicoefficient: A/(A+B) The Gini coefficient measures inequality. The Gini coefficient is measured by constructing the Lorenz curve, which puts the cumulative populations share (when population is ordered from poorest to richest) on the X-axis and the cumulative income or wealth share on the Y-Axis. The Gini coefficient is the area between the Lorenz curve and the diagonal line drawn in the same graph, divided by the area under the diagonal line.
Why did we do all this stuff with EV, CV, Hicksian(=compensated) demand curves, Slutsky eqn. etc. in Ec21?
In an ordinary (=uncompensated =Marshallian= x(p,y)) demand curve, the quantity demanded reacts to price both because of the income and substitution effect.However, DWL is driven by substitution effectonly.So, need to use a demand curve that onlyreacts due to substitution effect: Hicksian(=compensated) demand: h(p,u)
What are major short comings of the official poverty measure?
It only measures absolute poverty (not relative poverty). ("Does not having a cell phone make you feel poor in 1970? How about in 2018?") does not even measure absolute poverty well: it does not count in-kind benefits it is based on pre-tax income (does not measure taxes or tax rebates) it does not take into account differences in price levels across locations it does take overall inflation over time into account, but uses an inflation measure that measures price increases of different goods than those bought by the poor also should include the cost of earning a living (e.g. two ppl with same wage, one has child and so must pay more for child care than the other)
Rationales for govt intervention for SS?
Market failures: Market failure in annuity market due to asymmetric information Ø Not all individuals save enough due failure to optimize ("internalities" or "myopia") Ø Not all individuals save enough due to the Samaritan's dilemma (which is an externality) Ø The government can produce retirement income more efficiently (SS has lower administrative cost than a private sector system) Redistribution: But can SS redistribute at lower DWL than other ways of redistributing income (say via income taxes)?
• Relative income inequality
Measures share of nation's total income that acrues to the poor relative to the rich
Can we get the higher market rate of return by making SS fully funded?
No problem is that initial gen received benefits but never paid in all future gens are paying for this, one way or another This is the fundamental reason why returns to a PAYG are lower than (riskfree) market returns called the "transition issue"
Which of these factors were most important for causing inequality?
Noah's ranking (not unreasonable, but open to debate) in order of importance, i.e. from not important to very important: ØRace and gender? ØComputers? ØImmigration? ØRepublicans & tax policy? ØThe death of organized labor? ØTrade and exported jobs? ØFailure of educational system to keep up with skill-biased technological change Ø"The very rich" (winner-take-all effects; lobbying, lax corporate governance)
Is Tax Evasion Another Source of Inefficiency?
Only to the extent that people incur real costs from evading (accountants, "not getting interest on cash in the mattress," "second set of financial accounts") or behave differently that they'd do if there were no tax ("not hire employees because it harder to keep evasion secret if you have employees")
How to reduce moral hazard with welfare
Ordeal mechanisms, categorical welfare, increasing outside options
What determines where someone ends up on the income distribution?
Person's ability ØInnate ability ØShocks to ability (sickness; disability) ØSchooling ØThings learned from parents Person's work effort ØEffort in schooling ØEffort in work ØPreferences (on work vs. leisure; choice of occupation) Person's opportunities ØQuality of schooling available ØJob availability ØConnections ØLuck in the job ØAvailability of role models ØInherited wealth ØOther ...
Possible Policy Responses to Inequality and Poverty?
Social insurance programs Taxation ØIncome, wealth (?), inheritances ØEarned income tax credit Means-test programs (TANF, food-stamps, public housing, Medicaid) Education Policies on competition ØAnti-trust regulations (limit market power) ØCorporate governance Policies on labor relations (union rights / regulation) Trade / immigration policy Other ...
Taxes distort along several margins
Taxing one good physical instead of another Working versus not working Consuming today versus consuming in the future Even the location of business activities!
Samaritans dilemma
The expectation of insurance or charity increases the probability of being in the bad state and thus becoming eligible for the transfer
Capitilization of land,who bears the tax?
The owner at the time the tax increase is announced bears the entire burden of current and futureland taxes: future tax is capitalized into land value ØCapitalization happens to to some extent for any tax on the possession of a durable good, but is less than 100% if supply is not completely inelastic
consumption smoothing
The translation of consumption from periods when consumption is high, and thus has low marginal utility, to periods when consumption is low, and thus has high marginal utility.
• What matters more, relative or absolute deprivation?
Two reasons to care about relative income: • First the "minimal" standard of living may be best defined relative to standard of living of others, e.g. minimally acceptable living in 1950s is way different from now • Interesting evidence that the level of inequality in society itself is negatively related to measures of well-being, e.g. one study found tht the mortality rates across nations are highly correlated w/ the degree of income inequality
information asymmetry
a diff in info that is available to sellers and to purchasers in a market
• pooling equilibrium
a market equilibrium in which all types of people buy full insurance even though it is not fairly priced to all individuals
• Precautionary savings model
a model of savings that accounts for the fact that individual savings serve to smooth consumption over future uncertainties, at least partly
annuity payment
a payment that lasts until the recipient's death
SS is financed by?
a payroll tax (FICA); 12.4% payroll tax on earnings up to a cap (split b/w employer and employee) FICA= Federal Insurance Contributions Act
moral hazard
adverse actions taken by indivs or producers in response to insurance against adverse outcomes
actuarially fair premium
an insurance premium that is set equal to the insurer's expected payout
• general equilibrium tax incidence
analysis that considers the effects on related markets of a tax imposed on one market
• partial equilibrium tax incidence
analysis that considers the impact of a tax on a market in isolation
Benefits depend on PIA with adjustments
annual adjustment for inflation adjusted for age of first benefit claiming (EEA vs FBA) if married benefits based on higher on higher of own PIA or 50% of spouse's PIA if widowed: benefits based on higher of own PIA or 100% of late spouse's PIA
Tax incidence
assessing which party(consumers or producers) bears the true burden of a tax
AIME
average indexed monthly earnings indexed by avrg wage and 35 highest years of indexed earnings are used
liquidity constraints
barriers to credit availability that limit the ability of individuals to borrow
Key lessons of the marginal value of insurance coverage
benefit due to consumption smoothing marginal benefits from insurance decreases with insurance coverage
Absolute tax incidence
change a tax rate and leave other taxes/spending unchanged
Substitution effect
change in behavior holding utility constant but relative prices change
income effect
change in behavior when relative prices stay the same but utility changes; does not create DWL
Elasticity
change in quantity due to a change in price
• experience rating
charging a price for insurance that is a function of realized outcomes
What are rationales for govt to get involved in insurance?
efficiency reasons (adverse selection, externalities on others from underinsurance, administrative costs, failure of ppl to make rational decisions), redistrib
risk aversion
extent individuals are willing to bear risk
• Ordeal mechanisms
features of welfare programs that make them unattractive, leading to the self-selection of only the most needy recipients; (e.g. us in-kind benefits)
role of govt for moral hazard?
inevitable effect of insurance due to information asymmetry, not a rationale for government intervention unless somehow(!?) the government can do something about this asymmetry but the private sector cannot
• nominal interest rate
interest rate earned by a given investment
• after-tax price
is the gross price minus the amount of the tax (if producers pay the tax), or plus the amount of the tax (if consumers pay the tax) • in other words it is the price paid by or received by the party that is paying the tax to the government
• current tax incidence
is the incidence of a tax in relation to an individual's current resources
• lifetime tax incidence
is the incidence of a tax in relation to an individual's lifetime resources
benefit reduction rate
is the rate at which welfare benefits are reduced per dollar of other income earned
separating equilibrium
market equilibrium in which different types of people buy different kinds of insurance products designed to reveal their true types • still a market failure, careless are getting would they would get in the model of full info: full coverage, but the careful are not getting their first choice which would be full coverage at a lower actuarially fair price, optimal solution is full coverage for both types with diff prices
insurance premiums
money paid to insurer so that individual will be insured against adverse events
Insure catastrophic events?
more fully (MB curve rotates up with higher size of loss and lower probability of loss)
effect of moral hazard on optimal insurance?
more moral hazard the lower the optimal insurance, moral hazard higher when demand more elastic as the DWL triangle will be larger
caveats of mandated insurance
need to define insurance, need to guarantee access, need to make sure people can "afford" to buy insurance
what determines moral hazard
observability whether adverse event happened, and how easy to change behavior to establish adverse event
role of govt for adverse selection?
offer govt-provided insurance, force people to buy insurance, subsidize insurance
What is optimal insurance?
optimal insurance is partial
SS rate of return =
population growth rate* earnings growth rate *growth rate in SS tax rate
importance of social insurance for consumption smoothing depends on two factors
predictability of event (ppl can self-insure better for predictable events); cost of the event, CS benefits highest for costly events
What do most studies of labor elasticity find?
primary earners much more inelastic than secondary earners supply of labor inelastic in general at 0.1 or 0.2
PIA
primary insurance amount calculated from AIME using a formula
real interest rate equation
r = (1-t)i - pi;
means tested
refers to programs in which eligibility depends on the level of one's current income or assets
Balanced-Budget incidence
specifies what the revenue is spent on and includes the incidence of this spending
Tax burden on demand formula
supply elasticity/ (supply elasticity + demand elasticity) - note it is the absolute value of each
• Taxed on accrual
taxes paid each period on the return earned by an asset in that period
• Taxed on realization
taxes paid on an asset's return only when that asset is sold
Key lesson of marginal cost of insurance coverage
the MC of insurance from moral hazard increases with insurance coverage
risk premium
the amount a person is willing to pay for insurance above and beyond the actuarially fair premium
• Absolute deprivation
the amount of income that the poor have relative to some measure of "minimally acceptable" income
statutory incidence
the burden of a tax borne by the party that sends the check to the government
economic incidence
the burden of taxation measured by the change in the resources available to any economic agent as a result of taxation
a benefit guarantee
the cash welfare benefit for individuals with no other income, which may be reduced as income increases
• intertemporal choice model
the choice about how much to save is really the choice about how to allocate one's consumption over time
capital gain
the difference between an asset's purchase price and its sale price
tax wedge
the difference between what the consumers pay and what the producers receive (net of tax) from a transaction
adverse selection
the fact that insured individuals know more about their risk level than the insurer might cause those most likely to have the adverse outcome to select insurance, leading insurers to lose money if they offer insurance
• intertemporal budget constraint
the measure of the rate at which individuals can trade off consumption in one period for consumption in another
• real interest rate
the nominal interest rate minus the inflation rate: this measures an individual's actual improvement in purchasing power due to savings
• gross price
the price in the market (the price paid by or received by the party not paying the tax to the government)
self-insurance
the private means of smoothing consumption over adverse events, such as thru one's own savings, the labor supply of family members or borrowing from friends
• Basis
the purchase price of an asset for purposes of determining capital gains
• capital income taxation
the taxation of the return from savings
iron triangle
there is no way to change either the benefit reduction rate or the benefit guarantee to simultaneously encourage work, redistribute more income, and lower costs
Why focus on savings and labor responses?
these are the most important types of responses to taxation. Most of the taxes are on labor or capital (=linked to saving) Also: both are cases where income effects are important ->the traditional Ec1 analysis (based on uncompensated demand curves) will lead you astray.
• categorical welfare
welfare programs restricted by some demographic characteristic, such as single motherhood or disability
• cash welfare
welfare programs that provide cash benefits to recipients
Fundamental trade-off between redistribution to the poor and (DWL or moral hazard) cost of work disincentives
ØLow t, requires a low G (for given total expenditures), so low distortions and little redistribution to the poorest. ØFor higher t, higher G possible (for given total expenditures). More redistribution but also more distortion.
Supplemental Security Income (SSI),
• Cash welfare to the aged, blind, or disabled • The job of SSI is to fill holes that are left by incomplete nature of two other major SI programs, SS and DI • Some indiv who have not worked enough in the past may not qualify for benefits under either of those social insurance programs, so they qualify for SSI
Self-control model
• Face conflict b/w impatient short run preferences and patient long-run preferences • Key determinant of savings behavior is the ability of individuals to find ways to commit themselves to save
• 3 sources of leaky bucket
• First source is administrative costs • Second source is because higher income ppl are taxed for the transfers, which lowers returns to work and savings and might cause higher-income people to work less hard or save less • The third source is moral hazard effects on the poor indivs who are potential recipients of these transfers refers to the losses incurred while redistributing income
• Increasing Outside Options:
• Increase outside options so that it is no longer attractive to be on welfare (train welfare recipients so they can earn higher wage) • Training: • Labor market subsidies • Child care and preschool • Child support • Remove welfare "lock"
the Temporary Assistance for Needy Families (TANF)
• Provides supp to low income families with children in which one biological parent is absent • It is means tested and is reduced as the family's income from other sources grow
Nutritional Programs
• Special Supplemental Nutrition Program for Woman, Infants, and Children (WIC) • Provides funds for nutritious food purchases specifically intended to improve fetal development and infant health • School Lunch and Breakfast programs offer free or reduced-price meals to schoolchildren to help the meet federal nutrition standards
Three rules of tax incidence
• Statutory Burden of a tax does not describe who really bears the tax: • The Side of the Market on Which the tax is imposed is Irrelevant to the distribution of the tax burdens: • The fraction of the tax burden born is determined by the relative elasticity of the two parties, with the relatively more elastic party bearing less of the burden and the relatively more inelastic party bearing more of the burden.
Problems with changing poverty line measurement?
• These changes are diff to carry out in practice, how do we measure true value off Medicaid? It is not only the cost of medical reimbursed but also the utility benefit of having consumption smoothed • Second problem is the political ramification of making these changes, poverty levels would go up sharply in the east and west and fall in the south and Midwest
What makes a good targetting mechanism for categorical welfare?
• To features: they are unchangeable (unchangeable characteristic, indivs have no way to change behavior to qualify) • Target those with low earning capacity
• SNAP
• Traditionally provided vouchers that individuals could use to pay for food at participating retailers, have been replaced by debit-card-like systems whereby individuals are issued a card for a certain value of food which id drawn down as they use the card to make purchases
• Public Housing
• Two programs, first is the provision of housing in public housing projects, typically large apartment buildings • The second is the provision of section 8 vouchers which indivs can use to subsidize private rentals from participating landlords