Public economics.

The NBER's Program on Public Economics met in Cambridge on October 30-31. Program Director James M. Poterba of MIT organized this agenda:

Maria Cancian, University of Wisconsin, Madison, and Arik Levinson, NBER and Georgetown University, "Labor Supply and Participation Effects of the Earned Income Tax Credit: Evidence from the National Survey of American's Families and Wisconsin's Supplemental Benefit for Families with Three Children" Discussant: John Karl Scholz, NBER and University of Wisconsin

Antonio Rangel, NBER and Stanford University, and B. Douglas Bernheim, NBER and Stanford University, "Emotions, Cognition, and Savings: Theory and Policy" Discussant: Sendhil Mullainathan, NBER and MIT

Zoran Ivkovic, University of Illinois; James M. Poterba; and Scott Weisbenner, NBER and University of Illinois, "Tax-Motivated Trading By Individual Investors" Discussant." Aleh Tsyvinsky, NBER and University of California, Los Angeles

Christopher House, University of Michigan, and Matthew D. Shapiro, NBER and University of Michigan, "Phased in Tax Cuts and Economic Activity" Discussant: Alan J. Auerbach, NBER and University of California, Berkeley

Henrik J. Kleven and Claus T. Kreiner, University of Copenhagen; Herwig Immervoll, University of Cambridge; and Emmanuel Saez, NBER and University of California, Berkeley, "Welfare Reform in European Countries: A Micro-Simulated Analysis" Discussant: Jorn-Steffen Pischke, NBER and London School of Economics

Shinichi Nishiyama, Congressional Budget Office, and Kent Smetters, NBER and University of Pennsylvania, "Consumption Taxes and Economic Efficiency in a Stochastic OLG Economy" Discussant: Kenneth L. Judd, NBER and Stanford University

Cancian and Levinson examine the labor market consequences of the Earned Income Tax Credit (EITC), comparing labor market behavior of eligible parents in Wisconsin, which supplements the federal EITC for families with three children, to that of similar parents in states that do not supplement the federal EITC. Most previous studies have relied on changes in the EITC over time, or on EITC eligibility differences for families with and without children, or have extrapolated from measured labor supply responses to other tax and benefit programs. In contrast, this cross-state comparison examines a larger difference in EITC benefits among families with two or three children.

Bernheim and Rangel construct a new, simple model of savings in which individuals can make mistakes. They use the model to study the impact on savings and welfare of changes in the environment, institutions, and policy. The authors show that this alternative formulation leads to conclusions that are at odds with some of the pre suppositions of the previous literature. In particular, even though individuals make mistakes involving overconsumption, the authors show that one cannot presuppose that there is under-saving. Paradoxically, in this model individuals aware of their self-control problem can end up oversaving. Further, one cannot presuppose that welfare-improving policies increase savings. In fact, for plausible ranges of parameters, welfare increasing changes in the environment, institutions, and policies can decrease savings.

Ivkovic, Poterba, and Weisbenner use a large database, containing nearly 100,000 large individual stock purchases, to study the factors that affect the realization of capital gains and losses. These factors include the holding period, the calendar month, and the accrued gain or loss since the time of purchase. A particularly appealing feature of the dataset is the ability to compare investors' realizations in their taxable and tax-deferred accounts. The authors reach four conclusions. First, for large stock purchases, there is a strong lock-in effect for capital gains in taxable accounts after the stock has been held for a few months. Second, there is evidence of trading behavior that is consistent with year-end tax-loss selling. In taxable accounts in December, and especially in the last week of December, investors are more likely to sell losers than winners. The pattern for other months is the opposite. The December selling effect is particularly strong for stocks that qualify for short-term loss treatment. Further, tax-loss selling is greater for investors who have realized gains during the year and when the overall market has risen during the about-to-end calendar year. The demand for loss offsets is likely to be high in these settings. Third, the authors find that wash sale rules affect trading decisions in December, but they do not find similar evidence for other months. The probability that a stock will be repurchased within 30 days, if sold at a loss in December, is substantially lower than the probability of such a repurchase following sales in other months. This is consistent with wash-sale rules affecting tax-motivated trading. There is no evidence that wash sale rules affect trading behavior in months other than December, or that they, distort trading decisions in taxable versus tax-deferred accounts. Finally, using a simulation to test whether following simple tax-avoidance strategies would have significantly boosted investors' aftertax returns, the authors find that simple rules that accelerate the realization of tax losses could substantially improve aftertax returns for many investors.

Phased-in tax changes are a common feature of tax legislation. House and Shapiro use a dynamic general equilibrium model to quantify the effects of delaying tax cuts. According to their analysis, the phased-in tax cuts of the 2001 tax bill substantially reduced employment, output, and investment during the phase-in period relative to alternative policies with immediate, but more modest tax cuts. The rules and accounting procedures used by Congress for formulating tax policy have a significant impact in shaping the details of tax policy and they led to the phase-ins, sunsets, and temporary tax changes in both the 2001 and 2003 tax bills.

Immervoll, Kleven, Kreiner, and Saez estimate the welfare and distributional impact of two types of welfare reforms in each of the 15 countries in the European Union. The reforms are revenue neutral and financed by an overall and uniform increase in marginal tax rates on earnings. The first reform distributes the extra taxes evenly to everybody (traditional welfare), while the second reform distributes tax proceeds (uniformly) only to workers (earnings credit). The authors build a simple model of labor supply encompassing responses to taxes and transfers along the intensive and extensive margin. They then use the model to describe current welfare and tax systems in all 15 European countries and use calibrated labor supply elasticities along the intensive and extensive margins to analyze the effects of the two welfare reforms. They precisely quantify the equality-efficiency tradeoff for a range of elasticity parameters. In most countries, because of the large existing welfare programs with high phasing-out rates, the uniform redistribution policy is, in general, undesirable unless the redistributive tastes of the government are extreme. However, redistribution to workers is desirable in a very wide set of cases. The authors discuss the practical policy implications for European welfare policy.

Nishiyama and Smetters examine fundamental tax reform in a heterogeneous overlapping-generations (OLG) model in which agents face idiosyncratic earnings shocks and uncertain life spans. Following Auerbach and Kotlikoff (1987), the authors use a Lump Sum Redistribution Authority to rigorously examine efficiency gains over the transition path. They replace progressive income tax with a flat consumption tax (for example, a value-added tax, or a national retail sales tax). If shocks are insurable (that is, no risk), this reform improves (interim) efficiency, a result consistent with the previous literature. But if, more realistically, shocks are uninsurable, then this reform reduces efficiency, even though national wealth and output increase over the entire transition path. This efficiency loss, in large part, stems from reduced intragenerational risk sharing that was provided by the progressive tax system.