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Public Economics Program meeting.

The NBER's Program on Public Economics met in Cambridge on April 3 and 4. NBER Research Associates Jeffrey R. Brown and Scott Weisbenner, both of the University of Illinois, organized the meeting. These papers were discussed:

Liran Einav, Stanford University and NBER; Amy Finkelstein, MIT and NBER; and Paul Schrimpf, MIT, "The Welfare Cost of Asymmetric Information: Evidence from the U.K. Annuity Market" (NBER Working Paper No. 13228)

Discussant: Dan Silverman, University of Michigan and NBER

Ran Abramitzky, Stanford University, "The Limits of Equality: Insights from the Israeli Kibbutz"

Discussant: Emmanuel Saez, University of California, Berkeley and NBER

Yuriy Gorodnichenko, University of California, Berkeley and NBER, and Jorge Martinez-Vazquez and Klara Sabirianova Peter, Georgia State University, "Myth and Reality of Flat Tax Reform: Micro Estimates of Tax Evasion Response and Welfare Effects in Russia" (NBER Working Paper No. 13719)

Discussant: Joel B. Slemrod, University of Michigan and NBER

Mark Duggan, University of Maryland and NBER, and Fiona Scott Morton, Yale School of Management and NBER, "The Effects of Medicare Part D on Pharmaceutical Prices and Utilization" (NBER Working Paper No. 13917)

Discussant: Jonathan Gruber, MIT and NBER

Peter A. Diamond, MIT and NBER. and James Banks, University College London, "The Base for Direct Taxation"

Discussant: Alan J. Auerbach, University of California, Berkeley and NBER

Daniel Bergstresser, Harvard University, and Jeffrey Pontiff, Boston College, "Investment Taxation and Portfolio Performance"

Discussant: William Gentry, Williams College

Bruce D. Meyer, University of Chicago and NBER, and James X. Sullivan, University of Notre Dame, "Three Decades of Consumption and Income Poverty"

Discussant: Kathleen M. McGarry, Dartmouth College and NBER

Much of the extensive empirical literature on insurance markets has focused on whether adverse selection can be detected. Once detected, however, there has been little attempt to quantify its importance. Einav and his co-authors start by showing theoretically that the efficiency cost of adverse selection cannot be inferred from reduced-form evidence of how "adversely selected" an insurance market appears to be. Instead, an explicit model of insurance contract choice is required. The authors develop and estimate such a model in the context of the U.K. annuity market. The model allows for private information about risk type (mortality) as well as heterogeneity in preferences over different contract options. The researchers focus on the choice of length of guarantee among individuals who are required to buy annuities. Their results suggest that asymmetric information along the guarantee margin reduces welfare relative to a first-best, symmetric information benchmark by about 127 million [pounds sterling] per year, or about 2 percent of annual premiums. They also find that government mandates, the canonical solution to adverse selection problems, do not necessarily improve on the asymmetric information equilibrium. Depending on the contract mandated, mandates could reduce welfare by as much as 107 million [pounds sterling] annually, or increase it by as much as 127 million [pounds sterling]. Since determining which mandates would be welfare improving is empirically difficult, these findings suggest that achieving welfare gains through mandatory social insurance may be harder in practice than simple theory suggests.

What limits the capacity of society to redistribute and provide insurance? What determines the structure of compensation in organizations striving for income equality? Abramitzky addresses these questions by investigating the economic and sociological forces underlying the persistence of the Israeli kibbutzim, communities based on the principle of income equality. To do this, he exploits newly-assembled data on kibbutzim, and a financial crisis in the late-1980s that affected them differentially. He finds that: 1) productive individuals are the most likely to exit, and a kibbutz's wealth serves as a lock-in device that increases the value of staying; 2) higher wealth reduces exit and supports a high degree of income equality; 3) ideology contributes to income equality. Using a simple model, he shows that these findings are consistent with a view of the kibbutz as providing optimal insurance without commitment to stay, namely when participation is at-will. More generally, these findings contribute to an understanding of how mobility limits redistribution, and to an understanding of the determinants of the sharing rule in other types of organizations, such as professional partnerships, cooperatives and labor-managed firms.

Using micro-level data, Gorodnichenko and his co-authors examine the effects of Russia's 2001 flat rate income tax reform on consumption, income, and tax evasion. They use the gap between household expenditures and reported earnings as a proxy for tax evasion and data from a household panel for 19982004. They find that large and significant changes in tax evasion following the flat tax reform are associated with changes in voluntary compliance and cannot be explained by changes in tax enforcement policies. They also find that the productivity response of taxpayers to the flat tax reform is small relative to the tax evasion response. Finally, they develop a feasible framework for assessing the deadweight loss from personal income tax in the presence of tax evasion. They show that, because of the strong tax evasion response, the efficiency gain from the Russian flat tax reform is at least 30 percent smaller than the gain implied by conventional approaches.

On January 1, 2006 the federal government began providing insurance coverage for Medicare recipients' prescription drug expenditures through a new program known as Medicare Part D. Rather than setting pharmaceutical prices itself, the government contracted with private insurance plans to provide this coverage. Enrollment in Part D was voluntary, with each Medicare recipient allowed to choose from one of the private insurers with a contract to offer coverage in her geographic region. Duggan and Scott Morton evaluate the effect of this program on the price and utilization of pharmaceutical treatments. Theoretically, it is ambiguous whether the expansion in insurance coverage would increase or reduce pharmaceutical prices. Insurance-induced reductions in demand elasticities would predict an increase in pharmaceutical firms' optimal prices. However, Part D plans could potentially negotiate price discounts through their ability to influence the market share of specific treatments. Using data on product-specific prices and quantities sold in each year in the United States, the researchers find that Part D substantially lowered the average price and increased the total utilization of prescription drugs by Medicare recipients. Their results further suggest that the magnitude of these average effects varies across drugs as predicted by economic theory.

Historically, the debate over the appropriate base for annual taxation has been an argument between total (Haig-Simons) income and annual consumption as the best measure of ability to pay and thus the ideal base for taxation. Banks and Diamond argue for an optimal tax approach and focus on the question of how annual capital income should be taxed: not at all; at a flat rate (as in the Nordic dual income tax); by a structure that relates the marginal tax rates on capital and labor incomes to each other (as in the United States); or by taxing all income the same? A succession of papers (following Atkinson-Stiglitz and Chamley and Judd) have shown that under certain conditions the optimal tax schedule should not include taxes on capital. Drawing on both theory and empirical evidence, with particular attention to differences in savings rates and in age-earnings profiles and to uncertainty about future wage rates, they conclude that there should be some role for including capital income as a part of the tax base and they lean toward relating marginal tax rates on capital and labor incomes rather than the Nordic dual tax. They also argue for more use of age-dependent taxes (for example different taxation of earnings for workers of different ages).

Most financial research mistakenly assumes that growth/value and market capitalization portfolios command similar tax burdens. The ability to defer capital gains creates more heterogeneity in aftertax returns than previously recognized. Bergstresser and Pontiff use the 1926 to 2002 Federal Tax code to generate tax-optimized aftertax returns that investors at different income levels would have realized on a set of benchmark portfolios. For an investor at the 95 percent income level, the historical tax cost of holding "Small Minus Big" and "High book-to-market Minus Low" is, respectively, almost 3 and 17 times greater than the cost on the market premium.

Meyer and Sullivan examine poverty in the United States from 1972 through 2005. They investigate how poverty rates and poverty gaps have changed over time, explore how these trends differ across demographic groups, and contrast these trends for several different income and consumption measures of poverty. They document sharp differences, particularly in recent years, between different income poverty measures, and between income and consumption poverty rates and gaps. Moving from the official pretax money income measure to a disposable income measure that incorporates taxes and transfers has a substantial effect on poverty rate changes over the past two decades. Furthermore, consumption poverty rates often indicate large declines, even in recent years when income poverty rates have risen. The patterns are very different across demographic groups, with consumption poverty falling much faster than income poverty for the elderly, but more slowly for married couples with children. Income and consumption measures of deep poverty and of poverty gaps generally have moved sharply and in opposite directions in the last two decades: income deep poverty and poverty gaps are rising, but consumption deep poverty and poverty gaps are falling. Poverty measures that account for the overstatement of inflation in official price indexes indicate sharp declines in poverty, while changes in relative poverty have been fairly small over the past three decades.
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Title Annotation:Program and Working Group Meetings
Publication:NBER Reporter
Date:Mar 22, 2008
Previous Article:International Trade and Investment.
Next Article:Cohort Studies.

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