PA 652 Final Exam

Tiebout Assumptions

1. No externalities 2. Perfectly mobile individuals 3. Perfect information about everything. Know all the tax rates in every town. 4. Need a large number of towns to match every individual's preferences 5. Costs of public services are constant 6. Public services are financed by taxes 7. Communities enact exclusionary zoning laws that prohibit certain uses of land. - If all these hold, people will vote with their feet and move to whatever town they get the most benefit from. Taxes are simply a user fee as with a private good.

DWL and Elasticity

DWL increases if elasticity of demand is larger. Large elasticity means larger response to tax changes and more dead weight loss. Less you change your behavior, less tax incidence and less DWL

Substitution Effect

Substitution effect on a taxed good is always negative. It's the change in marginal rate of substitution (MRS) in response to taxes. You can never levy a tax that makes a consumer want to substitute towards that good. - Before tax MRS = Px/Py - Tax Levied on good X MRS = Px+tax/Py

Insurance is actuarially fair when

premiums = the expected payout during the same time period. - Expected value of you getting sick/not getting sick - If you will lose 30,000 in income if you get sick (10% chance) 30,000 (.10)+ 0 (.90) = 3,000 <- fair premium. - If the insurer insures 10 people he covers his costs of taking care of the one sick person

Without taxes

r is the interest rate; it is the opportunity cost of devoting $1 to investment rather than putting it into the bank or another investment. δ is the true depreciation rate of an asset. This is the cost associated with using an asset and having it decline in value as a result. MB = MC MPk = r + δ

With taxes and depreciation

z = the present value of depreciation allowances as - A firm receives a tax benefit of τz from its investment. - Furthermore, the government may provide an investment tax credit of α. Hence the cost of investing $1 is no longer (r +δ), but instead (r +δ)(1-τz-α)

Social Indifference Curve

- Social indifference curves - these show how SOCIETY (not an individual) is willing to trade off one person's utility for another. - The slope of the social indifference curve tells us how much you will trade off utils of one person for utils of another person. In perfect utilitarian world slope of the indifference curve = 1 - We want to find the point where the social indifference curve is tangent to the utility possibility frontier.

Elenor Ostrom

- Solved the tragedy of the commons. Says that common goods will be over depleted if not regulated. - A social optimum can be achieved without regulation if: - The resource has denied boundaries (land vs. ocean) - Resource dependence: There is a perceptible threat of resource depletion and it must be difficult to nd substitutes - Presence of a community: small and stable populations with thick social networks / norms - Appropriate community-based rules and procedures in place with proper incentives and punishments

Economic vs Statutory Incidence

- Statutory Incidence: Who the law says will bear the burden of the tax - Economic Incidence: Who exactly bears the burden tax increase, regardless of what the law says - Almost never the case where the statutory incidence = economic incidence. - Corporations are made up of people. These people will pass on the tax burden throughout the whole organization through lower wages for example

How do you regulate externalities?

- Subsidize the positive externalities and tax the negative externalities

Corporate Tax Will:

1) Lower benefit of investing in machines (benefits are taxed by the government) 2) Corporate taxation also reduces the cost of investment by permitting firms to deduct the cost of interest expenses and depreciation allowances associated with investment. - Net effect depends on the magnitude of each of these

Add new state and local government workers to the pool of covered workers (i.e., they pay payroll taxes now and receive benefits when they are old).

Broadening the tax base to include these workers would yield a net increase to the system. Current Social Security participants would, over their lifetimes, pay in more than they would withdraw. Therefore, increasing the number of workers covered would provide a net increase to the cash flow in the system. The new workers would stand to lose from this system relative to a plan in which they had their own retirement accounts (because with Social Security they would pay in more than they receive), but the Social Security system would benefit. This new rule might induce some to exit these jobs, but since most workers are covered by the system, they would have little choice as to where else to work to avoid this tax.

Deferrals

Business taxpayers generally are entitled to defer U.S. taxation of foreign income until the income is brought back to the U.S. Hence if you earn $100 in Singapore, pay $17 in Singapore taxes, and reinvest the remaining $83 in Singapore (or, for that matter, India, Italy, or any other foreign country), then you do not yet owe U.S. taxes. As a result, there is a strong incentive for firms with lightly taxed foreign income to delay returning their foreign profits to the United States.

Welfare Payments

E = Household labor earnings G=Welfare grant to household (if earnings are 0) b=benefit reduction rate (0-1_ B=total benefit B=G-(b*E) 0=G-bE bE=G benefit reduction rate will = 0 when earnings = G/B *see graphs for for welfare distorts work

To determine the right amount of a certain public good to provide, the government of West Essex decides to survey its residents about how much they value the good. It will then finance the public good provision by taxes on residents. Describe a tax system that would lead residents to underreport their valuations. Describe an alternative system that could lead residents to over- report their valuations.

If the taxes are based on reported valuations, residents have an incentive to reduce their stated valuation of the good so that they can pay lower taxes and free ride on the public good. If taxes can be levied on nonresidents—e.g., a "commuter" tax—then individuals will tend to overstate their valuations. Alternatively, a tax on only the wealthiest members of West Essex (e.g., a highly progressive income tax) might lead to over-reporting, since the majority of individuals will bear very little of the cost of additional public goods provision.

Graphing Tax Incidence

If you take away the new tax curves but keep the points on the original curve (including new tax) the pictures are identical. You don't need to shift orignal demand of supply curve. Need to find the distance between demand and supply curce that = the amount of the tax.

Ramsey Rule (benefit to cost ratio)

MBx=MCx aka MRx=MDWLx MBy=MCy aka MRy=MDWLy - Set equal to each other and cross multiply - Result is (MRx/MDWLx)=(MRy/MDWLy) - This result is the per $ cost to receive some benefit. It's a benefit to cost ratio - These are now relative numbers that are normalized to each other. You can simply tax the larger one to get "more bang for your buck" If (MRx/MDWLx)<(MRy/MDWLy) then you should tax good y. If MRy/MDWLy = 3 that means for every $1 of additional DWL you get $3 in benefit

Matt is an employee at a large university, where he pays $120 per month in insurance premiums and his employer pays $300 per month. He finds that if he quits his job, the same quality of insurance would cost him $600 per month. Why is there a difference in the premium?

Matt's university employer presented a large pool of people to the insurance company. Insurance companies will insure a large pool of customers for less money than they will insure individuals for two reasons. First, the employees of such a large employer are unlikely to be any less healthy, on average, than any other group of people with the same distribution of age and gender. Since people are unlikely to select university employment based on their likelihood to use health insurance, the insurance company avoids the problem of adverse selection. Second, the law of large numbers predicts that the incidence of a large health insurance claim in this large population would be about what you would statistically expect in the population as a whole. Individuals or small groups, on the other hand, don't give insurance companies this risk-pooling advantage, and individuals who seek health insurance may be doing so because of adverse selection—that is, because they know they are in poorer-than-average health. As a result, the insurance company must charge Matt a higher premium if he quits.

Niche

Maximize the best off. Max (Ua, Ub) - Either give person A everything. Or person B everything. Doesn't matter as long as one person is maximized.

Reduce benefits for beneficiaries with high asset levels (wealth).

Means-testing by considering asset levels would increase the redistributive nature of Social Security but would induce some perverse behavior. People might be able to increase their benefits by hiding assets by setting up trusts or other entities, for example. They might also change the timing of selling some of their assets to retain Social Security benefits, which distorts resource mobility, an efficiency concern. In addition, further reducing benefits for the wealthy—perhaps removing them entirely—will reduce support among the most politically-powerful group. While this plan may appear to benefit the less wealthy at the expense of the wealthy elderly, it seems vulnerable to loopholes, evasive behavior, and the collapse of political coalitions.

Implications of Tiebout

More communities in property tax equilibrium than with head tax one for each demand/house price combination Incentive for low-priced, high-demand households to move to high-priced jurisdictions This is why we needed the exclusionary zoning assumption Prices of low-end houses are higher in high-service communities Capitalization

European Social Security

Responses to this question will obviously depend on the countries chosen. There are fairly wide variations in the ages at which retirees become eligible for benefits in different countries. Retirement age is lowest in Portugal, where the early retirement age is 55 for men and women. Many Eastern European countries, such as Ukraine, Belarus, Russia, and Serbia, also have low ages of eligibility. These countries should see relatively low rates of retirement prior to the local age of eligibility, because eligibility occurs at relatively young ages. In contrast, Iceland and Norway have the highest age of eligibility, 67. Holding health status equal across countries, countries in which eligibility occurs at older ages should experience higher rates of retirement prior to eligibility. It is difficult to generalize given the different currencies and complex structures of individual countries' rules. However, most countries generally provide an amount equal to a percent of average working wage.

Samuelson Rule

Says MRSRaphael D,apple +MRSBill D,apple = MRTD,apple - Key, everyone consumes the same amount of public good. We cannot discriminate and give someone more national defense.

Public Housing

Section 8 vouchers. Construction paid for by the government, provided at lower than market costs. Forces you to consume a fixed quantity of housing. You have to get the unit that the government gives you. You have no alternatives. If you want some other amount of housing (more square feet) you have to go to the private market. *See graphs for budget constraint distortion

Tradgedy of the Commons

Shared resources are often over depleted. People will overuse them because it is rational and in their best interest. - Need national regulators to help police the use of these common goods - Happens despite the fact that depletion of the resource is detrimental to the long-term interests of the individual

Ramsey Rule (Uniform Taxation/Equity)

Taxing uniformly is bad because you can always substitute towards leisure. - Food, non-food, and leisure: Food is inelastic. Higher tax rates than non-food. Makes effective tax rate on food higher for poor people because it makes up more of their budget. - If we were to add equity into this model, a utilitarian may want a lower tax rate on inelastic goods if low income households consume a higher fraction of their budget on those products.

Worldwide Averaging

Taxpayers are entitled to add together all of their foreign income and foreign taxes in calculating the foreign tax credit limit. Suppose the same company earns $100 in Japan and $100 in Singapore. It pays taxes of $40 to Japan and $17 to Singapore. The company owes the U.S. taxes of $70 on its foreign income. [35% of $200 = $70.] The company can claim a credit of $57 for foreign taxes paid, since you add together all foreign taxes paid and all foreign income in calculating the limit. (The adding together of income and taxes earned in different countries is known as worldwide averaging.) In this case, the company's foreign taxes do not exceed the limit, so all the foreign taxes can be claimed as a credit against its U.S. tax obligation. The company has a net U.S. tax liability of $13.

Rawlsian vs. Utilitarian: Which one is more consistant with a government that redistributes from the rich to the poor

The Rawlsian social welfare function is consistent with redistribution from the rich to the poor whenever utility is increasing in wealth (or income). The utilitarian social welfare function can also be consistent with a government that redistributes from the rich to the poor, for example, if utility depends only on wealth and exhibits diminishing marginal utility. However, the Rawlsian social welfare function depends entirely on the least-well-off, so it will generally prescribe more redistribution than the utilitarian social welfare function.

Rhode and Strumpf found that while mobility costs have steadily fallen, the differences in public good provision across communities have fallen as well. Does Tiebout sorting explain this homogenization of public good provision, or must other factors have played a larger role? Explain.

The Tiebout model does not predict homogeneity across communities; in fact, the Tiebout model allows for substantial variance across communities, predicting homogeneity only within each separate community. There may be some towns with very high levels of public good provision and some towns in which very little is publicly provided. Reduced mobility costs would enhance this kind of sorting. Other factors, such as increased mobility itself (as costs have fallen), may have increased homogeneity generally in the population. As people move more and are exposed to more national media, regional or cultural differences in attitudes and preferences might diminish.

What does the Tiebout model predict should happen to the similarity of residents within a community as the costs of moving fall?

The Tiebout model predicts that communities will become more homogeneous with increased mobility. Moving costs are a barrier to complete sorting in Tiebout's model; when those costs fall, people are expected to more easily move to locations where the residents have the same preferences for public goods.

Why do externalities arise?

The absense of property rights. - Incomplete market because the market can't assign property rights? Where are the source of these damages? How can you pinpoint who is polluting the air?

The fact that such a large fraction of U.S. health care costs is spent on people in their last six months of life has led many people to call the American health care system "wasteful." Why might this be an overgeneralization?

The argument is implicit in saying that spending on the last six months of life is wasteful is simple: it seems silly to spend huge sums of money on people who are dying anyway. However, it is crucial to note that doctors may not have known that the patients were dying when they treated them—they may not, in fact, be throwing money at a "sinking ship." An example is useful. Suppose that there is only one type of care ever needed: a $10,000 treatment for people with potentially fatal diseases that could kill them within six months. Suppose that this treatment has a 50% success rate: half of those who are treated live and half die. In this example, a full 50% of all medical costs are spent on treatment for people who die within the next six months. This is clearly not wasteful: the treatment had a 50% success rate, and the appearance of "waste" comes from focusing only on the unsuccessful treatments. Of course unsuccessful treatments look wasteful—but nobody knows in advance which will be successful, so the treatment itself is not.

Obamacare Mandate

Imposes mandate for individuals to have health insurance (like auto insurance) - Penalized 2.5% of household income if you don't have insurance for a certain amount of time. - Purpose of the mandate is combating adverse selection. Getting healthier people into the insurance market and driving down premiums. - Other provisions include: Dependent coverage (can stay on parents plan till 26). Creates exchanges where small businesses and individuals can go to purchase health care plans. 3) Expanded Medicaid to cover individuals up to 133% of the poverty level

Marginal Social Cost

Is the marginal cost to the producers plus the costs associated with production of that good that is imposed on others (marginal damage) MSC = MPC + MD - MPC (marginal private cost) = the cost of assembling the product. The market's marginal cost of the next unit of production. Cost of firm production. - MD (marginal damage). Unrelated to the product. Cost to others from production

Is the rapidly expanding share of total GDP of the health sector in the United States necessarily evidence of wasteful health care spending? Why or why not?

It is almost impossible to meaningfully compare the cost of medical care today with the cost of care in the past because the service being delivered is so different. Spending has increased dramatically, but much of the spending increase has funded medical advances that have extended life expectancies, reduced suffering, and enhanced people's quality of life. Diseases that were once death sentences are now curable, and conditions that required lengthy hospital stays and painful treatment are now treated on an outpatient basis with much less discomfort. From an economic perspective, better treatment and faster recovery times mean less productivity loss due to illness or injury. Certainly there is some waste in the provision of health care, but there have been enormous advances. Perhaps it is worth tolerating some waste to achieve the advances.

The U.S. federal government definition of poverty is the same in all communities around the country. Is this appropriate? Why or why not?

It is not appropriate to define the poverty line by the same dollar amount in all communities. The cost of living varies substantially across communities, across states, and among rural, suburban, and urban dwellers. One of the biggest contributors to this variance is the price of housing. Because housing (either rental or owned) tends to be such a large component of a family's budget, the disparity in prices means that very different amounts of money are needed to adequately support a family depending on where that family lives.

Why Do We Have Social Security?

It's an answer to the adverse selection problem in the annuities market. Insurance against living too long. Money for the future to sustain current consumption. Risk averse person will like to invest in an annuity. Consumption will remain relatively constant. But asymetric information about how long a person should live exists. People who die early will subsidize people who live longer.

Externality

A cost or benefit that occurs where an activity of one entity directly affects the welfare of another in a manner not reflected in the pricing system.

Utilitarian

Utilitarian: maximizes the sum of utilities of all individuals in society such that W = αUA + βUB - For a utilitarian social welfare function this is the ratio of the weights given to each person. - If α = β then a one unit increase in happiness of person A is equal to a unit unit increase to person B - The weights may be different if society values one person more than another person.

Formula for Tax Incidence: What percentage of a tax is borne by consumer? Producer?

(Pcons-P*/tax)/(Prod-P*/tax) Consumer Incidence: (Es/Es-Ed) Producer Incidence: (Ed/Ed-Es) - Person with the smaller elasticity will bear more of the incidence. - If |εD| > εS , then the price increase is borne more by producers, but if |εD| < εS , the price increase is borne more by consumers.

Depreciation

(Purchase Price-Salvage Value)/Useful Life = Depreciation <- what you deduct from tax liability each year. - Present value of the depreciation deductions over the useful life 10,000 + 10,000/(1+.10)^2+.....10,000/(1+.10)^10 - Divide all that ^ by 100,000 (10,000 x 10 years) to get the discounted value of depreciation deductions per $1 - The less the useful life, the more the discounted value of depreciation deductions per $1. Larger because the corporation can depreciate faster. - As a general matter, the more quickly someone is allowed to take depreciation allowances, the stronger is the incentive to invest. Why? The time value of money. - A tax deduction today is worth more than a tax deduction next year, because getting the deduction today reduces today's taxes at the cost of increasing tomorrow's taxes.

Equation of the line (consumption for 2 periods) with no taxes

*Assuming I2=0 C2=(1+r)I1 -(1+r)C1 - (1+r)I1=Vertical Intercept - (1+r)= slope - Savings = I1-C1* C2* = (1+r)Savings (I1-C1). Equal to whatever you don't consume in the first period discounted to present value. - Rate of return in the absence of taxes = (1+r)

When insurance isn't actuarially fair

*See notes for graph - As long as an individual is not risk loving or risk neutral, the individual will always pay more for insurance than their expected losses. - Risk aversion: this is a preference for paying more than the actuarially fair premium in order to guarantee against a big loss. The more curved the utility function, the more risk averse an individual is. The more risk averse, the higher the premium, the individual is willing to pay. The exact amount is the risk premium (the amount above the actuarially fair premium that an individual is willing to pay in order to insure against a loss.)

Tiebout Equilibrium

*see examples for head tax / property tax - In a tiebout equilibrium no one has any incentive to move. Sorting is perfect based on preferences for spending. But within the community there is diversity of income. - Sort into the town that fits your preferences for public spending and taxes - Everyone in a community has the same preferences. Within each community, sum of marginal benefits = marginal cost

Tiebout Equilibrium with property tax

*see notes for calculations Results in people with higher taxes than received benefits moving to a new town. - Everyone picks a new town where a tax rate = benefits received based on their property values. - Everyone is sorted perfectly based on their preferences - Taxes will be different in each community - What keeps low income invidivuals from moving into a low tax town and free-ride the extra benefit? Exclusionary zoning laws. You can say only houses that are at least 500k can live here. Prohibits low income families from moving and keeps the tiebout equilibrium

Demand for public goods

*see notes for graphs - The private goods market delivers an equilibrium where it must be the case that the price Bill pays = price Raphael pays. Pfigs=MBbill=MBraphael. Condition only holds for private goods. Does not hold for public goods. - In the public goods market MBbill+MBraphael = Pdefense = MCdefense - The thing that is different between the public and private market is that we are fixing the number of units and figuring out willingness to pay for both people. What is the marginal benefit of the next unit of the public good? - At market equilibrium, Bill & Raphael both have 10 missiles, but Bill's MB is $6 and Raphael's is $12. Output is the same for both but each MB is different. - KEY POINT: Public goods will be supplied up to the point where the SUM of the MB's = MC = Price of the good. - Consumers have different benefits, but they consume the same fixed amount

Intra-Generational Redistribution

*see slides for formula*

Public Goods Game

- *See notes for chart - Both players maximize their happiness by giving $0. Both giving zero is Nash equilibrium - Nash Equilibrium: Each player plays the strategy that maximizes their happiness, taken the other player's strategy. Nash equilibrium is the cell where no individual has any incentive to deviate and make them worse off. There is no incentive to deviate but it is the worse option for the social planner.

Area of DWL (w/o horizontal supply curve)

- 1/2(Tax)(Change in Q) - (1/2)(t^2)(Es*Ed/Es+Ed)(Q/P) - Note, that holding one elasticity constant, if the other elasticity increases, the DWL will also increase.

Suppose that the government currently provides everyone with a guaranteed income of $12,000 per year, but this benefit level is reduced by $1 for each $1 of work income. The government is considering changing this policy such that the benefit level is reduced by $1 for every $2 of work income. What effect would this policy have on work effort? Explain your answer.

- A dollar-for-dollar reduction in benefits is essentially a 100% tax rate, surely a substantial deterrent to working for many people. No worker who values leisure would ever take a job earning less than $12,000, since his effective wage is zero in that range. Similarly, it is unlikely that a worker would ever choose to earn slightly more than $12,000 since it would require substantial effort but increase his take-home pay to only slightly above the government guarantee. Hence, the government guarantee and the $1 for $1 benefit reduction system will lead to many potential workers choosing to supply no work effort. The new system will encourage these workers to increase their work effort by effectively reducing their tax rate by 50%. - The policy change will discourage the work effort of other workers. For workers who earned between $12,000 and $24,000 under the $1 for $1 reduction system, for example, the policy change will have two effects, both of which tend to reduce their effort. First, there is an income effect: these workers used to receive no support from the government, since the benefit reduction phased out at $12,000 in earned income. After the policy change, the benefit reduction doesn't phase out until $24,000. Hence, these workers begin to receive some government support after the policy change, increasing their total income. Since they value leisure, this income effect will lead them to reduce their work effort. Furthermore, because they now find themselves in the phase-out region, their effective tax rate increases to 50% (from 0%) under the policy change. This substitution effect also leads them to reduce their work effort. - Furthermore, workers who earned slightly more than $24,000 before the policy change may also be induced to reduce—but never to increase—their work effort: the slower phase-out makes earning amounts between $12,000 and $24,000 more appealing. For example, a worker earning $25,000 under the old system could reduce pretax earnings to $23,000 and would now receive $500 in government support, making the reduction in work effort more appealing.

Tax Credits

- A tax credit for charitable giving that does not depend on income. (subtracted from your tax liability. Not your taxable income) The argument is that people need bigger price changes to be incentivized to give to charity. - Savings: Affects savings because it affects return on investment. Tax system discourages savings. What if we just taxed wage income? No distortion to savings behavior.

Welfare Programs

- AFDC (Aid to Families with Dependent Children) Existed from great depression to Clinton. Cash transfers for anyone who had income level below a certain level. - TANF (temporary assistance for needy families): Welfare reform by Clinton. The program that exists today. Indefinite benefits are temporary for households that qualify. No entitlement. Limit of 5 years. Requires work. State has a policy of 50% of single parent and 90% of two parents households if they are not working. - Block grants to states. States can offer benefit reduction rate. States decide how much to reduce benefits as income for recipients increases.

Single Payer Plans

- Abandon the private market. Have one payor of health insurance. Government provides insurance. Doesn't necessarily mean care. Basically means Medicare (or some default option) for everyone. Health care is basically zero for the single payor plan system often leading to rationing health care services. - Comparing Single Payor: 1) Healthcare costs are rising. Seems like a way to curtail costs. Government can negotiate better prices with doctors/hospitals. Does it reduce costs? Evidence to suggest it lowers costs by 50%. Lower administrative costs and more healthy people in the market. But choice is very, very restrictive. People value choice and that would be taken away.

The problem of adverse selection in insurance markets means that it is generally a bad deal for companies to offer insurance at the same price for all potential customers. Why then do we observe some insurance companies (such as those selling "trip insurance" that refunds money to people who purchase trips that they are unable to take) do exactly this?

- Adverse selection results from information asymmetry. In some markets, though, the insured has no better information about his or her risk exposure than does the insurer. If the event that would precipitate an insurance claim is completely unknown to and out of the control of the insured (for example, the outbreak of war in the destination country), then adverse selection will not operate, and insurers will charge a single premium to all customers. - Another reason for single-premium markets is that it is sometimes not worth it to an insurance company to collect the information necessary to tailor premiums to different risk groups. Auto insurance covers drivers over long periods of time, and the probability of a claim during any one period may be fairly high for some drivers. It is worth the time to find out who those drivers are likely to be. Trip insurance, on the other hand, covers a very short period of time with a low risk of a claim being made. A complicated schedule of risk categories may not pay off for the insurance company. Perhaps insurance companies set the premium high enough to cover the traveler who knows she is at a high risk for cancellation, realizing that they can't profitably serve the low-risk population.

Giving to charity (the cost of giving $1)

- If you take the standard deduction: MC is always $1. MB is diminishing. The first dollar means more than the next. - But with itemized deductions (assume 30% tax rate), for every $1 given, you get $.30 back in tax deductions. It only costs you $.70 to give $1. - The tax system believes higher incentives are needed for wealthy people to give to charity. A poorer person only gets $.1 back for donating $1. Wealthier person gets more back. - We are giving people more in subsidies than the charities actually receive.

What is likely to happen to the overall labor supply if the EITC compensation rate increases from 30% to 50% for each dollar earned? What about if the rate of education in the EITC phase-out period increases

- An increase in the EITC compensation rate is likely to increase labor supply. The higher compensation rate makes leisure relatively more expensive for workers, so the substitution effect leads workers to supply more labor. Offsetting this, the higher compensation rate makes workers richer, leading them to consume more leisure and supply less labor. Since the EITC applies only to low-income workers, however, the substitution effect is likely to dominate. - An increase in the rate of reduction of benefits under the EITC might reduce labor supply among some workers because it increases the effective marginal tax rate on earned income. Leisure becomes less expensive, so secondary workers in particular might find it less worthwhile to work relative to staying home.

Tax Salience

- Are people fully aware of taxes? - When taxes are not salient, the incidence on producers is given by the formula ∂t = θ εD εS −εD - Using regression analysis too complex for this class, Chetty et al estimate θ to be 0.35. - This means that relative to the standard incidence formula, the incidence on producers is attenuated by 65% when sales taxes are not directly posted on prices. Intuition: people do not notice tax increase much, so firms can pass most of the tax increase on to the consumer.

Lindahl Auction

- Auctioning off a fraction of the public good that you are paying. - Sraphael + Sbill = 1. S = share of the public good. - Results in unanimous consent. - Also impossible with 300 million people in the country - Key result: in a Lindahl equilibrium, each individual votes for the same quantity of the public good to be provided. Individuals who value the public good more will pay more Recall, ecient provision of the public good requires the sum of the MRS' to equal the MRT

A corporation will invest until

- Corporate taxation reduces the return to investment to only (1−τ) times the return earned, and reduces the cost of investment to only (1−τz −α) times the pretax cost. - What pretax rate of return must $1 of capital earn in order to be worthwhile? $1 of capital needs to earn what? MPK(1−t) = (r +δ)(1−τz −α) MPK = (r+δ)(1−τz−α)/(1−τ) <- the return a machine must generate The lower is z, the more an investment has to earn in order to be worthwhile to the investor. Also, if z < 1, the higher is τ, the more an investment has to earn to be worthwhile.

If supply curve is horizontal

- DWL = (1/2 t^2*Ed*Q/P) - DWL increases squared of the tax t^2. If tax increases from $1 to $2 expect DWL to be 4x as large with double the tax

Effective tax rate

- Differs from stated tax rate = Taxes Paid/Actual Income - Actual income before deductions, income shifting, capital gains, etc.

What is left out of the Ramsey Rule

- Distribution. Commodity taxes can be regressive under this rule. - Administrative and compliance costs: uniform taxes are probably cheaper to administer. - Presence of other taxes (e.g., income taxes, taxes on factors). - Availability of information: how to obtain these elasticities? - Evasion. There was no role for drawing lines between commodities and that firms may create new goods in response --No externalities

Why does the government get involved with welfare?

- Does not have to do with market inefficiencies/failures, but fairness/equity grounds require government intervention.

Elasticity of Demand

- Elasticity: % change in quantity when price changes by 1% - The more inelastic (closer to 0), the steeper the demand curve. Less sensitive to price change. Meaning that large price change results in very little quantity changed relatively. - The more elastic (closer to 1), the flatter the demand curve. More sensitive to price change. Meaning that a smaller relative price change results in a larger relative change in quantity. - Elasticity of Demand = %Change in Quantity Demanded/%Change in Price

Tax avoidance vs Evasion

- Evasion = illegal. Fraudulent. Don't report wage income to tax authority. Failure to pay what is owed. - Avoidance: Legal things you can do to reduce your tax liability. Error/ignorance keep you from knowing all your deductions. More deductions than you would have gotten otherwise. Delaying bonuses, shifting income across classifications, change timing of certain behaviors (death, kids, etc.) Some are more creative than others at this. - The difference between evasion and avoidance is not always clear, as shown by differences in opinion among IRS auditors. Two auditors can review the same tax return and one can determine it to be compliant while the other finds evasion.

Foregin Tax Credits

- Example 1: Suppose an American firm earns $100 in Singapore, where its tax rate is 17%. The firm pays $17 to Singapore, and ALSO owes $35 to the U.S. [Recall the U.S. tax rate is 35%.] The firm receives a credit of $17 against its U.S. taxes. Hence its net U.S. tax obligation on its Singapore income is just $18. [35-17 = 18.] With a foreign tax credit system, taxpayers subject to a 35% home tax rate wind up paying a 35% tax rate on income earned anywhere in the world. - Example 2: Suppose you earn $100 in Japan, which has a 40% tax rate. You pay $40 to Japan, and owe $35 to the United States. You are entitled to claim a credit of $35 for Japanese taxes paid, but NOT $40. Hence the foreign tax credit in this case wipes out your U.S. tax liability on Japanese income, but the U.S. government will not give you money back for taxes you paid to Japan. Firms facing foreign tax rates that exceed the home country tax rate are said to have excess foreign tax credits.

Think of an example of a free rider problem in your hometown. Can you think of a way for your local government to overcome this problem?

- Examples of free rider problems could include litter in public parks, holiday lighting or fireworks displays, public television and radio, and parent volunteer groups in schools. - Admission fees can pay for clean-up and events at public facilities, schools could require all parents to serve on at least one school committee or provide some reward system for parents who volunteer, and taxes could be used to subsidize local public television and radio stations.

Why do people buy insurance

- Expected value is the same for being insured and being uninsured. But the reason people buy insurance is because they look not at EV but expected utility of differing levels of income. - EU = (1−p)U(M)+pU(M −L) where M = income; L = loss of being sick; p = probability of becoming sick - People will buy insurance as long as actual utility >expected utility

Describe the advantages of using a value-added tax instead of a sales tax

- In theory, the two tax systems are equivalent: it doesn't matter if the tax is levied all at once when final goods are sold to consumers, as it is under a sales tax system, or incrementally on the value added at each stage of production, as it is under a VAT. - In practice, however, there are two principal advantages of the VAT. - First, if the system is used to raise a large amount of revenue, a sales tax can provide much larger incentives to evade the tax than can a VAT. Because a sales tax is concentrated on sellers of final goods, they have a big incentive to exchange the good "under the table" for cash, fail to record the transaction, and avoid paying the tax. The VAT reduces the incentive by levying a tax on a smaller portion of the final sale price of the good. (Furthermore, it makes under-the-table transactions harder to hide, since sales of goods to retailers are recorded by their supplier.) - Second, the VAT avoids the "cascade" problem. The problem arises because it is not always easy to distinguish between "final goods" and "intermediate goods." In a pinch, a restaurant might purchase some of its ingredients at a local supermarket, for example. The supermarket treats the transaction as the sale of a final good and pays tax on the transaction, even though it is really an intermediate good. (This tax can be avoided with proper accounting, but in a pinch it might not actually be avoided.) The VAT system treats all sales the same way, regardless of whether the goods sold are ultimately final goods or intermediate goods. It therefore avoids this problem.

Income Tax Distortion

- Income tax changes behavior on work, savings, investments, capital gains, etc. It changes behavior on all of these things not just how much you work. How much you save as well. Also distorts things that are subsidized (buying a house, getting married, donating to charity) in order to reduce their liability.

How does the IRS deal with a tax system that has a lot of room for evasion?

- Information Reporting: W-2, 1099, 1098, banks, tuition, student loan information - Withholding: Interest free-loan to the IRS. Reduces tax evasion because you cannot hide your wage income. Some people argue it allows the government to be bigger because you don't realize how much you are paying in taxes if you get a rebate. Makes tax collection easier - Audits/Fines

Marginal v average tax rates

- Marginal tax rate: tax on next dollar - Average tax rate = Taxes paid/total income

Describe the dimensions along which moral hazard can exist. Can you think of ways in which the government can reduce the prevalence of moral hazard along each dimension?

- Moral hazard exists because the presence of insurance can provide an incentive for people to change their behavior. Insurance makes riskier behavior less costly, both before and after the loss-inducing event occurs. There are three general pathways to moral hazard. - The first is that insured people may be less careful and will not take all possible precautions to guard against a loss; since they have insurance to cover a loss, they will be less cautious. - The second pathway involves the insured's response once a loss has occurred: because repairs or remedies are covered by insurance, there is little incentive to take steps to economize on repairs or to choose less-expensive remedies. -The third pathway involves the provider's response to the insured's loss. The provider of collision repair, medical care, or fire cleanup, for example, knows that the purchaser is not as concerned about saving money as he would be if it were coming out of his own pocket; therefore, the provider has some incentive to either provide more service than is necessary or to inflate the charges of the services provided. - To combat moral hazard along the first dimension, the government could more actively screen claims, denying those for which the insured was at least partly responsible. It could also raise premiums for individuals who have already filed claims, making each claim more expensive in terms of future premiums. The second dimension of moral hazard could be reduced by setting fixed payment amounts or limits on services offered for a list of loss-inducing events. If a broken windshield only nets $x from the insurance company, the insured has an incentive to find a shop that will repair it for less than x and pocket the rest. The third dimension could be reduced by restricting providers to a list of acceptable responses to each event. Tests, procedures, or services not on the list would not be covered by insurance.

Government Intervention

- Notice that government intervention to x moral hazard is not possible. Governments will also lower the price and result in moral hazard. - Thus, justication for government intervention must be made on the previous asymmetric information grounds. - Markets fall apart as low-risk individuals leave the market. Equity concerns arise from price discrimination in the market

Consider two consumption tax systems: (a) one in which all goods are taxed at the same rate and (b) one in which the "necessities" are not taxed and "luxuries" are taxed at a higher rate. Compare the equity and efficiency of these two systems.

- Optimal tax theory would argue in favor of plan (a). This plan is a broad-based tax that is difficult to avoid, so it will not distort behavior significantly. Furthermore, given the tax's broad base, the rate can be relatively low to raise the same amount of revenue. Plan (b) violates most tenets of efficient taxation: it does not tax goods for which demand is inelastic (necessities), even though the Ramsey Rule indicates that taxes on necessities will generate the least deadweight loss. Plan (b) does tax luxuries, for which demand is likely to be elastic. Thus, this tax will distort behavior and generate substantial deadweight loss. Plan (a) is clearly more efficient. - However, plan (a) is regressive: poorer taxpayers will spend a higher percentage of their income on taxes than will wealthier taxpayers. That is because poorer taxpayers cannot afford to save or invest large portions of their income; they spend it on the goods they need. By consuming most of their income, poorer taxpayers are subjecting a high proportion of their income to the consumption tax. Plan (b) is not as regressive, because the kinds of goods that lower-income taxpayers purchase are not taxed but the kinds of goods purchased by higher-income taxpayers are taxed. Plan (b) is clearly more equitable.

Medicare Parts A, B, C, D

- Part A: Hospital insurance. Deductible of 1,024 for 60 days of hospital care. 61-90 pays 256 per day. After 90 days all expenses paid by individual. Also covers 100 nursing home days at $128/day deductible. Paid for by payroll tax - Part B: Supplemental Medical Insurance. Medical services outside of hospital care. Monthly premiums of $96.40. This is optional but you must opt out. you are automatically enrolled - Part C: Also optional. Above and beyond what is provided by part B. The default is that you are opted out. - Part D: Covers perscription drug coverage. Premium of $384/year with fixed deductible at $275. $275-$2,000 you pay 25% of the cost 2,500-5,000 you pay all the cost.

What lessons does the Massachusetts universal health care reform provide for national health care reform? Why is the experience in Massachusetts an imperfect guide to national health care reform? Can the Massachusetts experience help to resolve the three most contentious political issues in the national health care debate?

- Part of the reason Congress has been looking at Massachusetts as a model for national health care reform is that reform in Massachusetts has been successful at achieving its goal of (near) universal coverage. Reform in Massachusetts had several advantages relative to national-level reform, however: It was starting from a lower uninsurance rate (9% in the state versus 18% nationally); Massachusetts is a relatively wealthy state, so fewer subsidies were needed to achieve full coverage than would be needed nationally; and it had a large funding source available—its uncompensated care pool. - The three most contentious political issues in the national health care debate have been financing, the public option, and long-term cost control. As mentioned above, Massachusetts had fewer issues relative to funding a national-level reform—and, in spite of this, funding has still been an issue in Massachusetts. Massachusetts did not offer a public option in its reform, but the relative success of the "Connector" program suggests that using similar exchanges might be a workable alternative to a public option. Massachusetts did not explicitly address long-term cost control, so it is not particularly helpful in guiding the debate on this issue.

Transfer Pricing

- Parts produced in Lithuania (15% tax) - Parts sent to France for assembly (33% tax) - Sent to retailer in Portugal (25% tax) - Corporation will have incentive to move profits to Lithuania. Firms taxable income in Lithuania - Taxable income in Lithuania = PLxQL-deductible costs. - Taxable income in France = PFXQF-(PLXQL) - Firm will have incentive to make PL as large as possible Move French profits into Lithuania and decreases taxable income in France. - No one can verify what price was paid because the transaction is between related parties. Firms pretend that these are some sort of monopoly on this product. Firms says "this is the best stuff. it mustbe sold for x amount"

Social Security

- Planned savings for retiring. People don't often act rationally. People want to spend money now than saving it. US created social security to address these two issues. Founded through a payroll tax (15%). Income taxed below 100k. Half of social security is paid for by you and half by your employer, but you are bearing incidence through lower wages. Now it's a pay as you go basis. Your money is paying for current recipients benefits. Excess funds over benefits go into a social security trust fund that the government has borrowed from to help pay its deficit. - Who is eligible? Full retirement age is 67. Can start collecting at 62 but your benefits will be lower forever. Have to have been paying into the system for 10 year. - Calculated using the average monthly earnings for highest 35 years of your career. - *See slides for formula

Rand Health Experiment

- RAND randomly assigned 2000 families to different insurance plans where the price of services varied. Specfically, coinsurance rates were 0, 25, 50, or 95 % accross the plans. The cap on out of pocket expenditures also varied between 5 and 15% of family income. - In the presence of truly random assignment, differences in health consumption will be attributed to health insurance plan differences. Random assignment implies that on average other characteristics of people will be the same across all the plans. - The result was an elasticity of 0.20. This suggests that DWL from moral hazard can be potentially large. - The study found that consuming more medical services resulted in only very small medical improvements. - Here, criticism of the study requires you attack it for being non-random. Random experiments are the gold standard in economics.

Ramsey Rule

- Raise the tax on good x until MBx (benefit of additional good i.e. additional revenue) = MCx (cost of additional good i.e. additional DWL) - Raise tax on good y until MBy=MCy

The doughnut hole

- Recall that a more efficient health plan minimizes deadweight loss by encouraging individuals to realize the price of the care. - Thus, usually we want plans to feature relatively high deductibles with full coverage for very large risks. - The donut hole in Part D is the exact opposite. It has a low deductible and generous initial benets after which it stops paying for a large amount. - No economic rational for this.

Medicaid

- Recipients of welfare programs Children in low-income two parent families Children and pregnant women in low-income families below 133% of the poverty line - However, to receive Medicaid, you must make a conscious choice and enroll! Enrollment rates are low. - States do most of the provision of insurance with respect to Medicaid, but the federal government funds it. - The federal government provides states with a certain percentage of matching funds to cover costs. Matching funds are higher for states with more poor people. (Range between 50% to 83% federal matches). - However, minimum benefits include hospital and physician visits, prenatal care, and vaccines.

Rent Control

- Restrict the price of certain units in a certain area. - Standard rent control: generates a shortage of housing. This shortage of housing reduces social welfare (total surplus) And it transfers surplus to those tenants who get to keep their house from landlords and from tenants who are displaced. - Results in a shortage. It lowers prices, but demand is now >supply. - Cost of renting to tenants is now lower and some landlords won't rent anymore. It's not even clear whether or not a poor person will get a rent controlled unit.

Self-employed

- Self-employed individuals are not subject to withholding or information reporting - Evasion rates are often highest among the self-employed - Broader lesson: evasion will more likely happen on components of income that are not known to the IRS.

Senator Snead, making the case for universal, free health care, argues that people are not price sensitive to health care costs; when they need to go to the doctor, they go, regardless of the cost. Evaluate this argument in light of the empirical evidence on the price sensitivity of health care demand.

- Senator Snead is incorrect in his claim that demand for health care is completely inelastic. The RAND Health Insurance Experiment conducted in the mid-1970s used a controlled experiment design in which people faced different levels of copayments. Those who had lower copays and thus lower out-of-pocket costs for medical care tended to use more medical care than those whose copays were higher. - Furthermore, more doctor visits were not associated with better health outcomes. If the results of the study generalize well to nationally-provided free universal health care, then universal, free health care would not necessarily improve health outcomes relative to a program that covered only catastrophic adverse health events, but it would increase usage.

Value Added Tax (VAT)

- Taxes all stages of production but allows for deductions based on previous stages of deduction. - VAT Base: Sales - purchases from other businesses - Paid by all businesses including BTB sales (not just on BTC sales) - Has a self-enforcing feature that leaves a paper trail that is easily able to be audited - Also includes services (which may be taxed in a RST, but are not in the USA) - Fairness? Acts as a good proxy for a measure of well-being. Consumption more closely equals ability to pay or well-being. Much more than income or sales tax. - VAT is fairly regressive. Low income households spend relatively more amounts of their income than high income households becuause everything is taxed, only substitution effect is away from leisure.

Earned Income Tax Credit

- The EITC is a credit that rewards positive labor earning for low-income individuals. - To reduce the possible distortion of the ETC, it is phased in and out. - Nonethless over certain portions of the budget set the EITC generates DWL because of subsitition effects. Over other portions it is a pure income effect. - *see graph for EITC

Increasing the tax rate by 20% in all brackets

- The direct effect of the tax rate increase. The direct effect of a tax rate increase is to raise more revenue. - The effects of the tax rate increase on personal income An increase in income tax rates will tend to decrease personal income by reducing the return to working and by reducing the return to saving. As a result, tax revenues may decline: even though the rate is higher, the base on which it is calculated would be expected to decrease. - The effects of the tax rate increase on tax evasion or tax avoidance A higher tax rate will encourage taxpayers to seek ways of lowering the amount of tax they pay, through taking advantage of legal avoidance techniques such as sheltering income, through engaging in transactions that generate more deductions, or through illegal tax evasion. Increased evasion and avoidance will reduce tax revenues.

The U.S. Bureau of the Census reports trends over time in health insurance coverage by race and sex. Which racial or ethnic group has seen the largest increase in its rate of health insurance coverage from 1987 to 2012? Is this increase largely coming from increases in the rates of government-provided insurance, employer-provided insurance, or privately purchased insurance?

- The general trend in insurance coverage from 1987 to 2012 was that of an overall decline in the percent of people covered. The composition of coverage also changed, with an increase in the percent of people covered by government-provided insurance and a decrease in the percent covered by employer-provided plans. African Americans and Hispanic Americans experienced a modest (< 2%) increase in coverage, while coverage for white and Asian Americans fell modestly. - Over that time period, the percentage covered by private insurance fell among all racial and ethnic groups. The fall in private coverage—and a corresponding increase in government coverage—was most significant among white and Hispanic Americans.

Prior to the Affordable Care Act, many privately purchased health insurance plans had stringent "preexisting conditions" exclusions, which denied coverage to insured persons for any health conditions that were known at the time of enrollment. How did these exclusions reflect a market failure in the insurance market?

- The market failure that led to "preexisting conditions" clauses is adverse selection caused by informational asymmetry. Privately purchased plans, in contrast to group plans, are particularly susceptible to adverse selection. In a plan with just one purchaser, there is no law-of-large-numbers effect to drive claims to their statistical expected value, and the event that triggers the purchase of insurance is the decision of a person to buy it, not a person's employment. When there was no purchase mandate, that decision could easily have been motivated by a desire to obtain coverage because the insured knew that an adverse health event was likely. The decision to work for a particular employer was less likely to be motivated by the adverse selection component. Potential insured have much better information about his or her health status than do the insurers. - In the pre-ACA world, an insurance company could not have known for sure whether a private purchaser was a high risk, so it needed to protect itself from loss by including a preexisting condition clause. This strategy reduced the informational asymmetry. The ACA made pre-existing condition clauses illegal. Even if it hadn't, the ACA's purchase mandate would have made pre-existing condition clauses less necessary: when everyone is required to buy insurance, whether healthy or not, insurance companies have less reason to worry that a potential insured is only looking for insurance because they know an adverse event is likely.

Why does the Tiebout model solve the problems with preference revelation that are present with Lindahl pricing?

- The problems with preference revelation with Lindahl pricing arise from the fact that an individual who reports lower preferences for a public good lowers the provision of that public good by only a small amount (since the total provision is averaged across all members of the community) but lowers his taxes by a large amount (since his taxes are based on his reported preferences). - In other words, individuals have an incentive to free ride on the provision of others. In the Tiebout model, everyone in each jurisdiction ends up with the same preferences, and the Lindahl prices can therefore be set equal for each resident. This means that taxes are no longer specific to an individual's report. When an individual reports lower preferences for the public good, he lowers the provision by a small amount, but he also lowers his taxes by a small amount (and lowers everyone else's taxes by the same amount). This removes the incentive to free ride and solves the problems with preference revelation.

US Retail Sales Tax

- The retail sales tax is the tax on commodities in the United States - Levied only on business to consumer sales - - Business to business sales are exempt if the good purchased is an intermediate good. - Focuses on retail. Services usually aren't taxed. - Food is exempt in attempts to make it less regressive.

Consider the major changes in the welfare system that occurred in the 1996 welfare reform, described in section 17.5. Which of these changes are likely to reduce the number of people on welfare? Which of these changes are likely to increase the number of people on welfare?

- Under the current reforms, states receive block grants from the federal government to help finance their welfare programs, allowing states to save money if they spend less in benefits: reducing benefits does not reduce the amount of federal money they receive. Since one way to reduce benefits paid is to move people off the program, this funding mechanism may encourage states to reduce their welfare population. - Time limits will also, almost by definition, reduce the number of people in the program. Once a person has exhausted her eligibility, she will be removed from the program, which reduces the number of beneficiaries. It is not clear, however, what happens to people when they lose eligibility this way as opposed to becoming ineligible because they were successful in finding a job. - Work or education and training requirements may reduce the number of beneficiaries for two reasons. First, effective training and work experience will allow participants to move into better-paying jobs so that they do not need to be in the program. Second, requiring work or school may deter some people from taking advantage of the program because they may not want to meet these requirements. On the other hand, if training programs or related services, such as subsidized child care, are seen as additional benefits, some people may seek eligibility in order to obtain them, thus increasing the welfare rolls. - Some of the provisions of the reform are directly aimed at discouraging unwed motherhood, including requirements that teenagers stay in school and that mothers name the fathers of their children, and capping benefits so that additional children do not increase benefits. This reform seems less likely to reduce the number of welfare beneficiaries. Rates of single parenthood are increasing across age, race, and income levels, not just among poor teenagers. If this phenomenon is a real cultural shift, then welfare reform seems to be a very weak tool for stopping it. Furthermore, some women become single mothers because they lose a spouse or must leave an abusive one. Reforms that are tied to preserving these families will fail.

Food Stamps

- Voucher given to you for the purchase of good. Run by the state. Only eligible to be used on food. Worth less to you than cash would be. Why does this government program exist then? Government is paternalistic, they want you to be healthier (not buying beer, cigarettes) - 27 million people at a cost of 30.4 billion. - In-kind transfer: Benefits require compulsory spending on a particular good such as food stamps. *see graphs for budget constraint distortion due to food stamps

Marginal Product of Capital

- What is the return on the next dollar invested in buying a machine Marginal Product of Capital = MB aka MPk (investment in capital) - MB= (Change in output/change in capital) - Without corporate tax, the firm will keep all of MB *See notes for graphs/formulas*

Moral Hazard

- When an individual obtains insurance, they will engage in different behaviors than they would if they did not own insurance. This is moral hazard. You will eat more junk food, exercise less, and engage in risky behavior because you know your losses will be fully compensated. In addition to this type of moral hazard, you will also go to the doctor more often because once you have paid your premium the cost of a doctors visit is often not observed. - Government program will distort the behavior of individuals. People will become riskier because they have insurance. *See notes for intertemporal budget constraint

Prospective v Retrospective Medicare Payments

- When created in 1965 Medicare Part A reimbursed providers using a method of retrospective payments. - No incentive to keep costs low because costs paid after care provided and billed. - In 1983 switched to prospective payment systems. Requires the hospital to classify a patient (upon admittance) into one of 500 diagnosis related groups. Payment for each diagnosis is fixed based on the estimated cost of treating the diagnosis (adjustments are made for hospitals in high cost areas). - If the hospital incurs less costs than they are paid, they keep the difference. If they incur more, then they are not compensated for these. Some initial evidence of this working as hospital stays declined in length. - With regard to Part B< the government basically imposes price controls on doctors. This is why some doctors do not take Medicare, but in doing so they give up a large market.

Equation of the line in the presence of taxes

- r is being reduced. (1+r(1-t)) = C2 now = (1+r(1-t))I1-(1+r(1-t))C1 - C1* moves to Ct and savings is reduced because of the taxes.

Should state and local government be involved in the economy

1. No. They don't have any power to influence the money supply or interest rates, international trade/commerce, enact keynesian fiscal policy. 2. Redistribution: No. Progressive taxes will cause people to move. Becomes easier to as you get to lower levels of government. It's hard to switch countries but very easy to move cities/states 3. Services: Yes. Services can be provided better locally than nationally. Education for example

Social Security Reform

1. Raise taxes: A 3.2% increase will make system solvent forever. 1.7% increase makes solvent for 75 years 2. Eliminate the payroll tax ceiling: Tax all income at current 15% rate. Equivalent to a 2.19% tax increase but is borne entirely by wealthy (over 100k) 3. Eliminate COLA: Benefits are reduced by CPI. Reducing COLA by 1% is equivalent to 1.43% tax increase. Slowly erodes effectiveness and diminishes purchasing power. 4. Raise the Retirement Age: Set the age to 67. If you increase it by 1 month for 2 years thereafter until it reaches 68. Equivalent to a .46% increase in payroll tax 5. Change Benefits: Use top 38 years rather than 35 (.31% payroll tax equivalent). Use CPI to adjust wages when calculating AIME (average monthly earnings) rather than wage inflation 6. Privatize the System: Earmarked account with certain restrictions administered by the government. Riskier because some people may gamble away their savings in riskier investments. EAsiest option to implement praactically.

Policy will become more progressive when:

1. The policy makers view of the social wellfare places more emphasis on equality 2. People have more inelastic responses to that policy - Policy maker's job is to see how responsive people are and develop policy in that light. No scientific basis for what the welfare function should be. Not the job of the policy analyst to decide.

Public Good

A good that satisfies 1) Non-rivalry 2) Non-excludability - Non-rival: You consuming the good does not prevent me from consuming the good - Non-excludable: It is impossible to prevent anyone from consuming the good if they want to. - Private goods (excludable, rival) - Common good (non-excludable, rival) - Club good (excludable, non-rival) - Public good (non-excludable, non-rival)

Senator Deal proposes to offer a choice to future retirees: if you retire before age 70, the benefits are calculated on the last 35 years of income; if you retire at age 73, however, you receive benefits calculated on only the last 15 years of income. Which option are high-income workers likely to choose? Low-income workers? Why?

A high-income worker may not benefit by much if he delays retirement until age 73, and he would lose three years of benefits. He is likely to choose the earlier retirement age. Assuming no major work interruptions, which is perhaps a more reasonable assumption for a high-wage earner than a low-wage earner, his benefits will be calculated based on his wage since he was in his mid-thirties. These are likely to be fairly-high-earning years, as they begin a decade after a person would have completed his education. Because of the regressive nature of benefit calculations, the higher wages of the last 15 years would yield a low marginal benefit. High-wage earners are also better able to save for retirement in other ways, so they may be able to afford retiring three years earlier. Low-wage earners will be more likely to delay retirement until age 73. They would lose three years of benefits, but their benefits, once they do retire, will be higher if their income is higher in the last 15 years of work. This option will be particularly attractive if these workers had some low- or zero-earning years over the course of their working lives. In addition, calculated benefits are a higher percent of average monthly wage for these workers, so they stand to lose less by working more years. - On the other hand, high-wage workers tend to have greater life expectancy, and so they stand to gain more from benefits calculated on a higher base. Low-wage workers may not live long enough to make waiting to age 73 worthwhile.

Property Tax

A property owner's tax bill depends on Assessment of property by assessor (Assessment is some % of actual value) Tax levies by local governments Real tax rate (percentage of property value) is t = (tax bill assessed value /assessed value actual value) * (Assessed Value / Actual Value) Tax liability is the millage rate times the assessed value divided by 1000. The millage rate is the tax payment that is due per thousand dollars of property value

Asymmetric Information

A situation in which one party has more (or better) information than another party. This is a key market failure that will cause the insurance market to break down. Buyer inherently has more information about their health status or how risky they are. Buyer has incentives to withhold information (lower premiums) - The insurance company wants a good mix of safe people to help sunsidize the risky people - Key point: remember, if individuals are risk adverse, they are willing to pay a risk premium. Thus, whether the market falls apart will depend on how many mildly risk averse people are in the market and how high the premiums need to be.

Pigouvian Tax: What is the optimal tax to reduce MD of an externality?

A tax levied on each unity of output in an amount that is equal to the magnitude of the marginal damage at the efficient level of output. - Tax should exactly equal MSC-MPC=MD. Social planner will set a tax = MD (MSC-MPC) at exactly Q* units.

The government of Kapitalia changes its tax code to allow for more accelerated depreciation of assets. Would you expect firms to substitute production methods away from capital and toward labor, away from labor and toward capital, or neither? Explain.

Accelerated depreciation reduces the cost of investing in capital because the value of the tax deduction is available sooner. If capital and labor are substitutes, the reduced after-tax cost of capital will induce a firm to substitute the cheaper input, capital, for labor. However, if capital and labor are complements, as in a fixed-proportion technology firm, cheaper capital will cause an increase in both capital and labor.

Deductible

Amount you need to spend before insurance kicks in. Fixed amount within a year before they can receive compensation

Suppose the Social Security payroll tax was increased today to 16.4% to solve the 75-year fiscal imbalance in the program. Explain the effect of this change on the value of the Social Security program for people of different ages, earning levels, and sexes.

An increase in the payroll tax would reduce the value of Social Security for younger workers relative to older workers. Older workers would benefit from having a more secure plan, and they wouldn't have to pay in at the higher rate for very long. Younger workers would have to pay the higher rate over many more years, and their benefit calculation would not increase (because the increase in taxes is meant to keep the current system solvent, not to increase benefits). The very-highest-earning workers would not be harmed as much as lower-earning workers because the payroll tax is not imposed on earnings above $118,500 (currently); however, their payroll tax burden would increase. Women generally benefit more from Social Security because they live longer than men. They are also more likely than men to have interrupted their careers to raise their families, so they tend to pay in less. They are also more likely to receive benefits as a surviving spouse. All these factors would continue to exist with a higher tax rate. The higher tax rate would be borne by the employed, not by those who receive benefits because of their survivor spouse status. And anyone receiving benefits and no longer working (and who expects to live for a while linger) would benefit without facing any of the costs of the higher tax rate.

In which way could smoking exert a positive externality on others?

As described in the text, the reduction in expected lifetimes can deliver a positive externality. If smokers tend to die soon after their retirement, they will collect less in Social Security payments, leaving more money for nonsmokers. In addition, if smokers pay into group retirement plans that do not differentiate smoking behavior, then their reduced time of withdrawal from the plans will subsidize the longer-lived nonsmokers.

Moral Hazard in healthcare

Behavior changes due to insurance. Riskier/unhealthier behavior. Induces you to consume more healthcare than you otherwise would. - In addition to this type of moral hazard, you will also go to the doctor more often because once you have paid your premium the cost of a doctors visit is often not observed. Maybe you know your copay, but do you actually know the price being billed to your insurer? And what if you actually had to pay it? Deductible and copay mitigate this eect, but its still a drop in the bucket relative to the actual price.

Means tested programs

Benefits of the program go to someone with financial resources below a certain level (Medicaid, EITC are two examples)

How can government encourage eployers to provide insurance?

By not taxing fringe benefits provided by employer. If an employer gives $5,000 in benefits, that it worth more to the employee than a $5,000 salary increase because of the income tax.

Free-Rider Problem

Can the private market give us this same result? No because of the free-rider problem. The incentive for public goods is to free-ride. You say that you value something less than you actually do. The pricing mechanism no longer works. You don't know how much everyone is willing to pay. - People are trying to minimize liability and hoping everyone else contributes. You want to contribute less but consume all the goods. Private market will under- provide public goods because people will under report their marginal benefit. - Free-riding isn't irrational. It's just a result of people trying to maximize utility.

Medicare

Coverage: - 65 or older. Cannot receive until your 65th birthday - Eligibility rules are uniform across states - Eligible if the person or person's spouse has paid payroll taxes for at least ten years. - Implies about 37 million participants. Note: Medicare is government financing of health care. It is not government provision of health care. Most health care is privately provided in the US as opposed to Britain (which owns hospitals, etc.) - Why a program for the elderly? Most do not have employer provided retiree coverage. And they are likely to be high risk to insurance companies.

Because the free market (competitive) equilibrium maximizes social efficiency, why would the government ever intervene in an economy?

Efficiency is not the only goal of government policy. Equity concerns induce government to intervene to help people living in poverty, even when there are efficiency losses. In economic terms, a society that willingly redistributes resources has determined that it is willing to pay for or give up some efficiency in exchange for the benefit of living in a society that cares for those who have fewer resources. Social welfare functions that reflect this willingness to pay for equity or preference for equity may be maximized when the government intervenes to redistribute resources.

The UI payroll tax is said to be partially experience-rated because the tax rate on earnings is higher for firms with a history of laying off workers. What is the rationale for making the payroll tax rate a function of a firm's layoff history?

Experience rating forces firms to bear some of the cost of laying off workers. In the absence of experience rating, firms would have an incentive to layoff and then rehire workers with greater frequency. Frequent layoffs and rehires without experience rating allows employees to benefit at no cost to the firm. To discourage firms from taking advantage of this implicit subsidy, experience rating increases their insurance premiums when layoffs occur. This disciplines firms to hire only when the long-term prognosis of success is good and to keep workers employed during seasonal, or other temporary, slack times.

Copayment

Fixed amount that is paid by the buyer per medical visit or use of medical services

Reducing corporate tax rates is often considered as a policy tool to enhance investment. How could the presence of tax loopholes diminish the relationship between corporate tax rates and corporate investment?

For corporate investment to be causally related to tax rates, it must be related to the effective tax rate actually paid, not statutory tax rates. When firms use loopholes to shelter some income from taxation or to overstate deductions or take them sooner rather than later, the effective tax rate is already lower than the stated rate. Reducing stated tax rates may not have a very large effect on actual behavior if firms are already avoiding tax liability through creative use of loopholes. Suppose the stated corporate tax rates were lowered but some tax advantages, or loopholes, were phased out. In this case, reducing stated tax rates might not reduce effective tax rates at all and might have no effect on investment or even have an effect that is in the opposite direction of the one intended.

Planner's Problem (Utilitarian)

For example, in the utilitarian case, the goal of the planners is to maximize W = αUA(cA) + βUB(cB) subject to cA + cB = E where c is the consumption level of apples of each agent and E is the world endowment of apples. - Slope = W-Ub - cA/cB=consumption of A,B - Want to maximize subject to the constraint that we want to eat all 300 apples. Equal care to both person A and B - Slope of the possibility frontier = marginal utility of person a/marginal utility of person b - The only time they are equal is when they consume the same amount. The only time they have the same slope is when they have the same consumption. Social planner will set spending and taxes so that everyone has the same taxes. - See graphs

Gradually increase the normal retirement age (NRA) from 65 to 70 (under current laws, the NRA will gradually rise to 67 by 2022; the proposal is to speed up this process so that the NRA will be 70 by 2022).

Gradually increasing the normal retirement age will save the fund money by reducing the number of years during which retirees can collect. People who need to retire earlier for health or physical limitation reasons will be adversely affected. If they are able to, they may attempt to find less physically demanding work or they may increase private savings in order to be able to afford to retire earlier.

Adverse Selection in healthcare

Healthy people drop out of the market because of information asymetry. Higher premiums than the actuarially fair price. This makes healthy people drop out of the market making premiums even higher.

You observe that states with higher income tax rates also tend to have higher rates of employer-provided health insurance. Is this a good test of the effects of tax policy on the demand for employer-provided health insurance? Explain.

Higher income tax rates do make employer-provided health insurance more attractive, because the higher the tax rate, the greater the value of spending a dollar on an untaxed benefit. However, state income taxes may be correlated with other factors that are also correlated with employer-provided health insurance. For example, it may be that state income taxes are higher in states that are more urbanized and thus have more large employers. Larger companies, with more employees, can provide health coverage for a lower cost than can small companies because bigger companies can spread the risk of an expensive loss over more people. A better way to test this correlation would use difference-in-difference: look at whether firms change their health insurance offerings when tax laws change and then, if firms do change, compare the change with what happens at the same time in states where the laws have not changed.

What are the political and economic ramifications of investing a large part of the Social Security trust fund in the stock market, as has been recently proposed?

Historically, stock market returns have been higher than the return on government bonds, so investing savings in the stock market might seem like a good idea. At the same time, stocks do carry greater risks, at least somewhat (or completely, depending on who you believe!) offsetting this benefit. There are several possible economic ramifications of this policy. For example, it is possible that investing in stocks instead of government bonds would shift excess savings from the government to private firms. This would potentially be a boon for the economy, leading to higher investment and more rapid growth. The political ramifications are potentially more pernicious. The Social Security trust fund is large, and investing it in stocks would make the government a major shareholder of many corporations. If politicians had active control of which companies to invest in, this could lead to several kinds of abuses, including politicians using promises of investment (or threats of noninvestment) to exert control over private companies.

Tiebout

How do we decide how much we spend on education? - Response to the Samuelson public goods rule. Local governments can compete with each other for services they provide and the price it will be provided at. - Local public good - imperfect public good - crowding out may cause rivalry. Benefits confined to a small geographical area. - Governments compete for residents. People will pick services and tax structures they want

Laffer Curve

How do we lower taxes and get more revenue? Distortions are so large that lowering taxes will result in more spending and government can tax the extra productivity. -Pick a tax rate that implies marginal revenue = 0 Intuition: in this simple model, keep raising taxes as long as it outweighs the effect of the behavioral response of labor on revenue - As we raise taxes initially, revenues increase, Taxes beyond T* will result in revenues decreasing. - T* = 1/(1+aELabor) a = how does the income distribution look. Laffer estimates 1.5 ELabor = elasticity of labor. Laffer estimates [.1,.45] - For income of the top 1% of the distribution laffer says around 30% most other economists say ELabor is more like 60-75%

Suppose that you had information about the amount of private savings during the years before and after the introduction of the Social Security program. How might you carry out a difference-in- difference analysis of the introduction of the Social Security program on private savings?

How to apply differences-in-differences to examine private savings would depend on the nature of the data. If one had data on only aggregate private savings, one could evaluate the effects of introducing Social Security by comparing changes in the U.S. savings rate (the difference between savings before and savings after Social Security was introduced) to changes in, say, the Canadian savings rate. In particular, one would compute the difference in the U.S. and Canadian savings rates before and after the Social Security system was introduced and then take the difference between these two differences. The validity of this estimate would rely on there being no major contemporaneous changes that affected one country but not the other. Better data would be on individual levels of private savings. Then one could use the fact that some individuals (for example, certain government employees) were and still are outside the Social Security system. One could thus compute the difference in savings rates before and after the introduction of Social Security for individuals (say, of a given age and income level) affected by Social Security. One could then compute a similar difference for similar individuals not affected by Social Security. The difference between these differences would provide an estimate of the change in private savings that was due to the introduction of Social Security.

What should the tax on cigarettes be?

If cigarettes are inelastically demanded (addition), we should have tax, but it is regressive tax with poor distributional qualities because of the types of people who consume cigarettes. Should also tax high in addition to inelasticity because of the negative externality.

Key assumption: Exclusionary Zoning Laws

In the Tiebout equilibrium individuals sort based on their demand for services and taxes. You can imagine that income is correlated with this demand In communities with a high preference for services, incomes will be high and therefore, property values will be high. Thus, lots of services can be financed with a low tax rate because the tax base is large What happens? Low-income individuals could move to this town and pay a very low-tax rate and get more than they would demand in services .As this happens, the tax base shrinks and the tax rate rises But, there is also perfect mobility, so then all the rich individuals will move to another town and this cannot be an equilibrium . Thus this restriction acts as a constraint on mobility for some individuals in some towns and yields the Pareto ecient outcome.

Increase the number of years used to calculate benefits from 35 to 40.

Increasing the number of years used to calculate benefits could lower benefits, because more low- or zero-earning years would be included in a retiree's average wage. To avoid this reduction in benefits, workers might choose to delay retirement so that they had 40 high-earning years included in the calculation. Workers who spent time out of the workforce to raise children or suffer through long unemployment spells might be most vulnerable, as they would have had fewer full-time working years by the time they reach retirement age. Similarly, workers who delayed the start of their careers to pursue bachelors and graduate degrees also have to delay retirement to avoid inclusion of zero-wage or low-wage years.

Housing Vouchers

Like a food stamp because funds can only be spent on housing. *see graphs - Could increase demand, increasing prices and negating some of the benefit. Might not lead to people living in higher quality housing than they otherwise would.

Unemployment Insurance

Like health insurance/annuities, adverse selection, moral hazard, death spiral all apply. The people the insurers are left with are the ones who will likely be unemployed in the future. - Provides you income at the replacement rate (about 50% of your old income) with a cap. Comes from a portion of the payroll tax. Paid by employers only. Cap is a minimum of $7,000 but states can increase that amount. Payroll tax is experience rated. Meaning higher risk firms that fire more people pay more in tax to the government. Higher risk = more people liekly to be unemployed. This creates incentives for firms not to lay off people. - Incentives to workers: Might be a temporary work disincentives (wait to find next job). You'll have guaranteed income without working for it at all. How quickly/hard will you look for a job if this is the case? You can only be eligible for 26 weeks.

Is Utilitarianism feasible in a world with taxes and wellfare distribution?

Likely not - If the utility possibility frontier favors person B, a utilitarian will want to give more to person A to equal distribution. - But if you redistribute, person B may want to work less, becoming less efficient. Decreasing the total size of the pie. - Utility functions aren't identical and there is not fixed income in society

Dead Weight Loss

Loss of social welfare above and beyond the tax revenues that are collected. Taxes will harm more than the revenue that is generated. Amount of apples less that you buy because the tax makes you buy less.

With Taxes

MB = MC MPk x (1-t) = r + δ

What is tax is levied on 2 goods equally?

No substitution effect if you tax two goods at the same rate. Tax doesn't distort anything. No DWL.

Poverty

Not the same thing as income inequality. Absolute deprivation of a particular household. Not relative deprivation - Poverty line: In US set at $23,050/4 person household. Constructed by someone creating a basket of necessities and seeing how much income is needed to buy that basket. But the basket was established a long time ago and has not changed (may not look like a basket of necessities we would purchase today). Prices for goods in the basket are national prices. Local price changes aren't captured in the poverty line. Just based on cash income. Doesn't take noncash into consideration. - Causes of poverty: 1)Macroeconomic shocks 2)Demographic changes (increase in single parent households) 3)Changes in public policy

Suppose you find evidence that workers who are high school dropout are more likely to retire at age 62 than are college-educated workers. You conclude that the dropout workers do so because they are more liquidity-constrained than are other workers. Can you think of alternative explanations for this finding?

One possible explanation is that less-well-educated workers are more likely to have jobs that are relatively more physically demanding and particularly difficult to continue after age 62. Even if they can continue to work, the physical wear and tear of demanding jobs may make it particularly unpleasant to work later in life. Another possible explanation is that these workers have already had their 35 best years: they began working at a younger age than college-educated workers and their upward mobility is constrained, so they will be unlikely to have high salaries later in life. Finally, higher education is correlated with better health; less-well- educated workers may retire fairly early if they anticipate having a reduced life expectancy.

Corporate Tax

Only a tax on corporations. Subchapter C corporation. Not a tax on all business. Small business, limited liability, proprietorship, these don't pay corporate tax. - Flat 35% rate across all levels of taxable income. - Corporate Tax Base: Resources Firm Obtains - Allowable Deductions - Revenue: # of units sold x price of sale. How much cash is coming in - Deductions: Salaries/wages (W*L), value of depreciation of capitol, intermediate inputs (price of inputs x quantity), interest payments made on loans - Does not include paying out dividends (taxed at the corporate level and at the individual income level)

There is evidence that workplace smoking bans substantially reduce overall rates of smoking, particularly for people with longer workweeks. Why should workplace smoking bans be particularly influential in affecting the behavior of people who work long hours?

People who cannot smoke at work have an externally imposed control on their behavior. Longer hours means this "commitment device" has more bite: people have to wait even longer for their smokes. Making it through a 9-hour day without a smoke might be just the impetus needed to get people to quit; six hours without a cigarette might not be long enough to have an impact.

Coinsurance

Percentage of the cost of a medical visit or service that is paid by the buyer

Why is unemployment insurance needed?

Private markets can fail to provide adequate amounts of insurance in the presence of moral hazard and adverse selection. Likely that people with insurance will have higher risks and that people would le claims even if it was the fault of the worker.

One disadvantage to a national health insurance system such as Canada's is "queuing"—people often need to wait long periods of time to receive desired treatments. What elements of a national health insurance system could lead to this situation?

Queuing is most likely to occur as a rationing device when demand for services outstrips supply. Markets correct these shortages by allowing prices to rise, encouraging entry by new suppliers or increased provision by existing suppliers. A national health system that capped expenditures and allowed only a fixed percentage increase in payments each year would not encourage entry of new providers, so the shortage would persist. Fixed-budget health insurance systems are also less able to introduce new techniques and products: First, the capital needed for research and development may not be available, and second, there is no reward for taking the risk inherent in research and development. In the United States, a company that successfully introduces a new drug or procedure can profit; in a nationalized system, the profit motive is eliminated. If these advances made medical care more efficient, the failure to provide them would result in longer wait times than would otherwise occur.

Think about the rival and excludable properties of public goods. To what degree is radio broadcasting a public good? To what degree is a highway a public good?

Radio broadcasting is nonrival: airwaves can be consumed (listened to) simultaneously by many consumers with no deterioration in sound quality. Perhaps radio signals can be made excludable by the use of scramblers, much like the ones used for pay-per-view TV. Anyone who has driven during rush hour knows that highways are subject to congestion. At these times, highways are rival: additional cars reduce the utility everyone receives from driving. Highways can also be excludable through the use of tolls. In practice, however, most highways are not excludable: any (licensed) driver is allowed to use them.

Why does the government mandate individuals to purchase their own insurance in some cases—such as automobile liability insurance—but directly provide insurance to people in other situations—such as health insurance?

Redistributional concerns can argue in favor of mandates for some types of insurance and direct public provision (social insurance) for others. To see why, note that firms tend to charge higher premiums to individuals they can identify as having higher risks of accidents. In providing social insurance, the government can effectively pool different risk types together so that high-risk and low-risk individuals pay the same "premiums" (taxes) for social insurance. Hence, social insurance can make high- risk individuals better off than they would be with a mandate; similarly, it can make low-risk individuals worse off. This sort of redistribution may be more desirable in some contexts than others. In health insurance, for example, "high-risk" individuals are the people unlucky enough to be sick or injured. Redistributing toward these individuals may be normatively desirable. In contrast, the "high-risk" individuals in auto insurance markets are the reckless drivers. It may seem less desirable to redistribute away from the safe drivers toward the reckless ones. This provides a reason to use social insurance for health insurance but mandates for auto insurance. - Another potential reason to use social insurance instead of mandates is the administrative cost differences between private provision and direct public provision. Larger differences (in favor of public provision) argue in favor of using social insurance instead of mandates. It may be that differences in administrative costs are quite large for medical insurance (hence direct provision) and small for auto insurance (hence mandates).

Suppose the government of Orwellia decides to genetically test all individuals for the risk of major illness, and reports the results of these tests to potential insurers when people apply for individual health insurance coverage. Will healthy people find working for large firms more, less, or equally attractive than before this testing program began? How about unhealthy people? Explain.

Since insurers will now observe the outcome of a test, they will presumably charge more for sicker applicants and less for healthier ones. This will make it cheaper for healthy people to buy private health insurance and it will make it more expensive for unhealthy people. Large firms tend to offer health insurance more frequently than small firms—this is one advantage to working at a large firm. Healthy people who can now buy private insurance more cheaply will find the relative benefits of working at a large firm reduced, and will be less likely to work there. For unhealthy people, just the opposite will occur: they will find working at large firms relatively more appealing. Note that this shift in worker types is likely to increase the cost for a large firm to buy health insurance.

Can activity generate positive and negative externalities at the same time?

Sometimes externalities are in the eye (or nose or ear) of the beholder. If you like the music your roommate plays, you can free ride when he or she is playing music, enjoying a positive externality. Your other roommate, though, who hates that kind of music, would experience a negative externality. Sometimes a positive externality becomes too much of a good thing. During the holiday season, some people construct elaborate displays that everyone can enjoy just by driving by them. But if too many people drive by every night, traffic congestion becomes a problem for those living in the neighborhood: for them, the holiday display creates a negative externality.

Obamacare Mandate as a tax

The payment that is triggered for not purchasing health care looks like a tax even though Congress did everything to make sure it was not called a tax. According to the Court: Its collection is administered by the IRS It is reported when paying income taxes It does not apply to individuals who are not required to le income tax returns because their income is too low It is calculated as a function of taxable income, dependents, and ling status It produces revenue for the government, which the court (quite expansively!) noted is the essential feature of any tax

Many towns and cities on the northeast and west coasts have passed bans on smoking in restaurants and bars in the past decade. What is the economic rationale behind these bans? Would there be similar rationales for banning smoking in automobiles? Apartment buildings? Houses?

The economic rationale for these bans is that smoking causes externalities, in particular through the health effects of secondhand smoke. The secondhand smoke externality does not apply in private automobiles, homes, or apartments. But there may be other externalities associated with smoking in these settings. Smoking while driving may increase the risk of an accident, which would potentially injure other drivers, passengers, or pedestrians. Smoking in an apartment building may increase the risk of a fire, which would injure other residents in the building. Smoking in a private house also poses the risk of a fire, but if houses are sufficiently far apart, this may not impose significant externalities.

When Wisconsin had lower drinking ages than its neighboring states, it experienced higher levels of alcohol-related crashes in its border counties than in other counties in its interior. What does this finding imply for the spillover effects of the policies of one state (or country) on other jurisdictions?

The evidence from Wisconsin suggests that people from nearby states who were old enough to drink in Wisconsin but not in their own state were driving to Wisconsin to drink. In this particular case, the older drinking ages in nearby states was imposing a negative externality on Wisconsin. (Of course, Wisconsin's lower drinking age may have been imposing a negative externality on nearby states as well.)

Summary of public goods

The government can't provide the optimal amount because they don't know the social optimal. They can guess to more and more efficiency and eliminate free-riders, but won't ever get to the socially optimal amount

We add the demands of private goods horizontally but add the demands of public goods vertically when determining the associated marginal benefit to society. Why do we do this, and why are the procedures different for public and private goods?

The horizontal summation of private goods adds up the individual quantities demanded by each consumer, which is done because each consumer uses up the quantity he or she purchases. Furthermore, in most models, each consumer faces the same price. The vertical summation for public goods adds up each consumer's willingness to pay for each additional unit. Because the good is public, each consumer gets to consume each unit (that is, they share the same Q). This sum therefore gives the total social valuation of each additional unit—society's demand curve.

Marginal Social Benefit

The marginal benefit to the consumer minus any costs associated with its consumption that are imposed on others MSB = MPB + MD - MPB = value of smoking the next cigarette. The individual willingness to pay for the next unit of the good. Benefit to the individual - MD: value of utility change of person who is damaged by smoking. Damage (or benefit) to others

Different states have different corporate tax rates. How could you use this to study the elasticity of corporate investment with respect to corporate tax rates? What would be the problems with this approach?

The natural approach suggested by this variation would be to compare how corporate investment varied across states with different tax rates. It would be important to control for firms' characteristics in this approach, since investment rates vary across industries and firms for reasons unrelated to the tax rates. Even if this were done, there would be potential problems with the estimation procedure. Suppose—as expected—you found that states with higher taxes have lower investment rates. This is still not enough to show that the lower investment rates were caused by the higher taxes. You would have to rule out other possible explanations. Suppose, for example, that the reason some states have high tax rates is that they face a major statewide recession and need to raise revenue to meet their constitutional balanced budget requirements. The recession would also dampen investment, so you would see lower investment levels in states with high tax rates even if the lower investment rates were not caused by the high tax rates.

Groves Clark Mechanism Design

The public good can be provided eciently if the government tells you: - To report your willingness to pay for the public good - Promises to use the information to provide the Pareto ecient quantity of the public good and to assign each individual a tax - The tax will be designed such that for every incremental increase in the public good, the change in the tax bill will be the incremental cost of the public good minus the value that everyone else places on the increase - Your answer doesn't increase or decrease your own tax liability. Will get more honest answers - Change in Taxes = Incremental cost of the public good - value of good (to everyone else) for incremental increase. Bill's Tax Change = MC - MB Raphael - Bill's tax increase does not depend on what he tells the government. Bill has no incentive to lie. This will result in less missiles and Bill is worse off. The truth comes when the cost doesn't depend on their answer - This doesn't actually work. People don't trust government, it's a hard mechanism to understand, and it's hard to figure out everyone's marginal benefit. Not practically implementable. Too much information to collect.

The Coase Theorem

The social optimal will be produced if 1) the cost of parties bargaining is negligible 2) The owners of resources can identify the source of damages 3) There is legal mechanism to prevent damages. - Why does the Coase Theorem fail? (pollution for example) Pollution effects millions of people; getting together to negotiate likely has high costs. Individuals are unlikely to be able to say which firm is infringing on their right to clean air. Likely unable to determine the proportion of damages each individual should receive

Ramsey Rule (Inverse Elasticity Rule)

Tx/Ty = (1/EDx)/(1/EDy) - Set the tax inversely related to the elasticity of demand of a good. Large elasticities means small tax changes (because you are more responsive to price changes). Small elasticity = Large Tax Rates. The government wants to raise the most revenue through the least amount of DWL by taxing the thing that you respond least to. - Generates less DWL at a higher rate - Ramsey rule: taxes are inversely proportional to elasticities of demand. - If EDx>EDy, then Tx<Ty - If EDx<EDy, then Tx>Ty - If EDx=EDy, then Tx=Ty. The only time you should tax things the same amount is if their elasticities are the same

Incentives for US Firms

US Firms receive higher tax rates. Do they have incentives to locate money in low tax places? Yes. Firms might want to create subsidiaries in low-tax countries to balance out high tax subsidiaries - How to solve this? Do away with deferrals and worldwide averaging. - US firms are at a competitive disadvantage. US firms earn less after tax than other firms. Discourages firms from incorporating in America - American firms have incentives to invest in low-tax foreign locations IF they have excess foreign tax credits or can benet from deferral. But American firms have much smaller incentives to invest in low-tax foreign locations than do Canadian, German, Dutch, British, Japanese,... firms. As a result, American firms are likely to lose out to foreign competitors in bidding for assets in low-tax foreign markets, particularly if the returns would be heavily taxed by the U.S.

Destination/Origin Principle

US RST levied on destination principle. You pay taxes based on where you use the item. Not where you buy the item. Legally speaking. - In practice, it is more of the origin principle. You pay tax based on where you buy it. - Why the destination principle? Keeps people from crossing state lines to avoid a tax, and also smooths out who gets sales tax revenue (places with lots of retail stores, malls, shopping centers would get more revenue)

Caffeine is a highly addictive drug found in coffee, tea, and some sodas. Unlike cigarettes, however, there have been very few calls to tax it, to regulate its consumption, or limit its use in public places. Why the difference? Can you think of any economic arguments for regulating (or taxing) it's use?

Unlike cigarettes, caffeine does not cause any obvious externalities (e.g., secondhand smoke). If we believe Becker and Murphy's rational addiction model, then addictiveness does not provide a motivation for regulating a good—only externalities do. On the other hand, if people have self-control problems, then "internalities" could potentially provide a motivation for taxing or otherwise regulating caffeine. This is particularly true for children, who tend to be short-sighted and may not fully appreciate the long-term consequences of caffeine addiction. This might be a reason to regulate in schools the sales of sodas containing caffeine, for example.

Utility Possibility Frontier

Utility possibility frontier: maximum feasible amount of utility for one person given the utility of the other individual - All utlity combinations if you distribute x amount of good y - Slope: Change in Marginal Utility of person A / change in utility of person B - As income falls possibility frontier shifts in (able to buy less) - Like a production or consumption possibility frontier, however, its in utils. - It is bowed out because of diminishing marginal utility. - It is drawn for a fixed endowment of income that is split between multiple people. - The Pareto optimum is the set of outcomes that corresponds to the utility combinations that are on the frontier.

Rawlsian

Want to maximize the happiness of the worst off. Maximize the lowest utility. Takes away utility until it reaches the next closest person. Up until the worst off is no longer the worst off. Eventually, results in perfect equality. - Indifference curve is L shaped - W = min(UA, UB) - Social indifference curve will be tangenet to the utility possibility frontier. Same outcome as the utilitarian.

Question that the Ramsey Rule tries to answer

What pattern of commodity taxes raises the required revenue while causing the minimal amount of inefficiency/distortion in the economy? - What is the optimal pattern of tax rates to levy on two different commodities - Without taxes MRS = (Px/Py) - With taxes MRS = (Px(1-tax rate))/(py(1-taxrate)) - But equal tax rates won't work unless you can also tax leisure. - Ramsey Rule says uniform taxation of commodities is NOT optimal when you cannot tax leisure.

Insurance Premium

What the buyer pays to the provider in exchange for a promise of payment by the provider in the event of an adverse health shock

In the midwestern United States, where winds tend to blow from west to east, states tend to approve new polluting industries more easily near their eastern borders than in other parts of the state. Why do you think this is true?

When a state approves new polluting industries, it imposes an externality on neighboring "downwind" states. It is unlikely that downwind states have figured out a way to make upwind states fully internalize their externalities. States are therefore unlikely to fully take into account the costs they impose on other states by locating their polluting plants near their eastern borders. On the other hand, they will tend to take into account the pollution costs they would impose on themselves by locating their plants farther west. Hence, the private cost of installing plants in the eastern part of the states will tend to be smaller than the private cost of installing plants in the western part, and they are therefore more likely to approve new polluting industries near their eastern borders.

Adverse Selection/Death Spiral

When premiums are high, healthy people drop out of the market, and the group is relatively more risky which causes premiums to increase even more to pay for the relatively riskier group. The uninformed side of the market is then left with the group of people they didn't want in the first place. Called adverse selection. Makes mandates needed to keep healthy people in the market. Could discriminate and charge more for the risky people but that raises some equity conerns for the older, riskier, unhealthier people. Adverse selection + equity concerns leads to government intervention in the insurance market. - Adverse selection alone does not necessitate government intervention because the private market could just price discriminate.

What negative externalities arise when an individual does not have health insurance?

When someone does not have insurance, costs are imposed on those who do in several ways. First, many diseases are contagious. If contagious diseases go untreated because the infected person lacks insurance and thus cannot afford treatment, they will spread to the rest of the population. Second, emergency treatment is not denied to people who cannot afford to pay; therefore, uninsured people will go to hospitals and receive care. The cost of providing the care is borne by the insured patients. Third, uninsured care is often given in a hospital emergency room rather than a doctor's office. The resource costs of providing care in a hospital setting are much higher than in a doctor's office, so the care the uninsured do receive is more costly than the care they would have received if they had insurance. Inefficiently used hospital resources impose a social cost.

Explain why take-up rates—the fraction of eligible individuals who enroll in the program—are so much higher for Medicare than for Medicaid.

While Medicaid coverage is considerably more generous than Medicare coverage, there are several reasons that take-up rates are modest for Medicaid and nearly universal for Medicare. First, Medicaid is considered a welfare program designed to help the needy, so there is a stigma attached to it. Medicare is universal, so there is no such stigma. Second, while Medicaid offers generous benefits to enrollees, it has relatively low doctor reimbursement rates, so many doctors do not take Medicaid patients. People who wish to choose their doctor and be ensured of easy access to care may prefer not to go on Medicaid. These problems are much less severe with Medicare. Third, once a person is eligible for Medicare, he or she is eligible forever. In contrast, eligibility for Medicaid can be transitory, and some individuals who know they are likely to lose their eligibility shortly—say, when they find a new job—may not find it worth the hassle of signing up. Finally, Social Security retirement beneficiaries automatically get Medicare Parts A and B, without having to fill out enrollment paperwork; only a few states have anything resembling auto- enrollment for Medicaid.

Tax Incidence

Who is going to bear the burden of the tax policy? Study of effects of tax policies on prices and distribution of utilities What happens to market prices when a tax is introduced or changed?

Does employer provision help adverse selection pool?

Yes. It increases the size of the risk pool. But employers who have more generous plans are left with sicker people. Sick people might actively choose jobs that include more generous plans. Sorting within the job market itself.