Applied Public Economics PDF

Applied Public Economics 1. Introduction and Motivation Michael Gerfin Maximilian von Ehrlich University of Bern Spring 2024 Course Outline 1 Introduction and Motivation 2 Tax incidence 3 Efficiency costs of taxation 4 Optimal taxation 5 Empirical Welfare Analysis 6 International taxation 7 Taxation...

Applied Public Economics 1. Introduction and Motivation Michael Gerfin Maximilian von Ehrlich University of Bern Spring 2024 Course Outline 1 Introduction and Motivation 2 Tax incidence 3 Efficiency costs of taxation 4 Optimal taxation 5 Empirical Welfare Analysis 6 International taxation 7 Taxation of Savings and Wealth 8 Public goods 2 / 49 Contents of first lecture 1. Introduction 2. Role of the Government 3. Applied Public Economics 4. Behavioral Public Economics 5. Eliciting the people’s view 3 / 49 Introduction What is Public Economics? Study of the role of the government in the economy Government is instrumental in many aspects of economic life 1 Government in charge of huge regulatory structure 2 Taxes: governments in advanced economies collect 35-50% of National Income in taxes 3 Expenditures: taxes fund public goods (infrastructure, defense) and welfare state (retirement benefits, health care, income support) We pool a large share of our incomes through government 4 / 49 Introduction Size of Public Sector 5 / 49 Introduction Size of Public Sector 6 / 49 Introduction A Bigger Picture View Of Government Sometimes, economics takes a narrow minded view of individual behavior: purely selfish and rational interacting through markets This view sets limits to fully understand public economics Social interactions are critical for humans we naturally cooperate at many levels: families, communities, nations, global treaties Humans reveal their social nature from the size and design of their “governments” (informal and formal) Replacing social institutions by markets does not always work 7 / 49 Introduction 3 Questions 1 When should the government intervene in the economy? 2 What is the effect of those interventions on economic outcomes? 3 Why do governments choose to intervene in the way that they do? 8 / 49 Role of the Government 1. Introduction 2. Role of the Government 3. Applied Public Economics 4. Behavioral Public Economics 5. Eliciting the people’s view 9 / 49 Role of the Government Q1: When should government intervene in the economy? 1 Market Failures Market economy sometimes fails to deliver an outcome that is efficient Then government intervention may improve the situation 2 Redistribution Market economy generates substantial inequality in economic resources across individuals Inequality is an issue because we are “social beings” People willing to pool their resources (through government taxes and transfers) to help reduce inequality 10 / 49 Role of the Government Market Failures Imperfect competition: (example: monopoly) → requires regulation (typically studied in Industrial Organization) Imperfect/Asymmetric Information: (example: health insurance markets) Healthy people drop out of private market → unraveling Mandated coverage could make everyone better off Externalities: (example: greenhouse carbon emissions) markets incomplete due to lack of prices (e.g. pollution) require interventions (such as corrective taxation) Individual failures People do not behave as “fully rational individuals” example: myopic people may not save enough for retirement intervention by forcing to save via social security paternalistic? 11 / 49 Role of the Government Inequality and Redistribution Even when the private market outcome is efficient, it may not have good distributional properties 2nd Welfare Theorem: Any Pareto efficient outcome can be reached by 1 2 Suitable redistribution of initial endowments (individualized lump-sum taxes based on indiv. characteristics and not behavior) Then letting markets work freely In general, redistribution of initial endowments is not feasible Government can redistribute income through tax and transfer system (distortionary) Then redistribution creates an equity-efficiency trade-off 12 / 49 Role of the Government Q2: What Are the Effects of Alternative Interventions? 1 Direct effects effects of government interventions that would be predicted if individuals did not change their behavior in response to the interventions relatively easy to compute 2 Indirect Effects effects of government interventions that arise only because individuals change their behavior in response to the interventions (sometimes called unintended effects) empirical public economics analysis tries to estimate indirect effects to inform the policy debate Example: increasing top income tax rates mechanically raises tax revenue but top earners might find ways to avoid taxes, reducing tax revenue relative to mechanical calculation 13 / 49 Role of the Government Q3: Why Do Governments Intervene in the Way They Do? 1 Political Economy theory of how the political process produces decisions that affect individuals and the economy example: how the level of taxes and spending is set through voting and voters’ preferences 2 Public choice sub-field of political economy from a libertarian perspective that focuses on government failures situations where the government does not act in the benefit of society (e.g., government captured by special interests or a self-perpetuating bureaucracy) This question is not addressed in this course 14 / 49 Role of the Government Normative vs. Positive Public Economics 1 Normative analysis: what should the government do if we can choose optimal policy? how high should taxes be? should health insurance be mandated? 2 Positive analysis: what are the observed effects of government programs and interventions? do higher taxes reduce labor supply? does mandatory health insurance increase health care spending? Positive economics is a required first step before we can complete normative economics Positive analysis is primarily empirical, and normative analysis is primarily theoretical 15 / 49 Role of the Government Methodology Public economics is at the frontier of a methodological transformation in applied microeconomics Data-driven approach to answering important policy questions Combines a broad set of skills: applied theory, applied econometrics, simulation methods Useful skill set for many applied fields in economics Applied Public Economics is not feasible without a good knowledge of modern econometric tools 16 / 49 Applied Public Economics 1. Introduction 2. Role of the Government 3. Applied Public Economics 4. Behavioral Public Economics 5. Eliciting the people’s view 17 / 49 Applied Public Economics Connecting Theory to Data Modern public economics tightly integrates theory with empirical evidence to derive quantitative predictions what is the optimal income tax rate? what is the optimal unemployment benefit level? Traditional approach: theoretical models and numerical simulations but: theory often makes weak predictions: e.g. optimal tax rate between 0 and 100% numerical simulations rely on strong assumptions Recent work derives robust formulas that can be implemented using well-identified empirical estimators difference-in-differences, IV, regression discontinuity Students interested in these approaches are encouraged to take the course Causal Analysis also offered this semester 18 / 49 Applied Public Economics Connecting Theory to Data Curry et al. (2020), Technology and Big Data Are Changing Economics:Mining Text to Track Methods, AEA Papers & Proceedings, forthcoming 19 / 49 Applied Public Economics Connecting Theory to Data Curry et al. (2020), Technology and Big Data Are Changing Economics:Mining Text to Track Methods, AEA Papers & Proceedings, forthcoming 20 / 49 Applied Public Economics Data types used in economic research Curry et al. (2020), Technology and Big Data Are Changing Economics:Mining Text to Track Methods, AEA Papers & Proceedings, forthcoming 21 / 49 Applied Public Economics “Big Data” Compelling implementation of quasi-experimental methods requires a lot of data Recent availability of very large datasets has transformed research in applied microeconomics government data: tax records, Medicare corporate data: retailer data (scanner data), health insurance companies, Facebook unstructured data: Twitter, newspapers, Swisscom 22 / 49 Applied Public Economics What are the benefits of Big Data? 1 Higher quality information: virtually no missing data or attrition 2 Longitudinal tracking over long periods Very large sample sizes 3 Can develop new research designs Can zoom in to subgroups 4 Ability to measure new variables (e.g. non-market inter- actions, networks, emotions) 23 / 49 Behavioral Public Economics 1. Introduction 2. Role of the Government 3. Applied Public Economics 4. Behavioral Public Economics 5. Eliciting the people’s view 24 / 49 Behavioral Public Economics What is behavioral economics? In the last years, a large body of research has incorporated insights from psychology – such as loss aversion, present bias, and inattention – into economic models Still, the neoclassical model remains the benchmark for most economic applications The debate about behavioral economics is often framed as a question about the foundational assumptions of neoclassical economics Are individuals rational? Do they optimize in market settings? Potentially fruitful to approach the debate on behavioral economics from a more pragmatic, policy-oriented perspective 25 / 49 Behavioral Public Economics Policy-oriented behavioral public economics The pragmatic approach starts from a policy question and incorporates behavioral factors to improve empirical predictions and policy decisions The implications of behavioral economics for public policy can be classified into three domains Each of these domains has a intellectual tradition in economics → from a pragmatic perspective, behavioral economics is a natural progression of neoclassical economic methods 26 / 49 Behavioral Public Economics Domain 1: New policy tools Insights from psychology offer new tools that expand the set of outcomes that can be achieved through policy changing default options framing incentives as losses instead of gains 27 / 49 Behavioral Public Economics Domain 2: Better predictions about the effects of policies Incorporating behavioral features such as inertia or inattention into neoclassical models can yield better predictions about the effects of economic incentives such as retirement savings subsidies or income tax policies These behavioral features can help econometricians develop new counterfactuals to identify policy impacts 28 / 49 Behavioral Public Economics Domain 3: New welfare implications Behavioral biases may generate a gap between welfare from a policy maker’s perspective, which depends on an agent’s experienced utility (his actual well-being), and the agent’s decision utility (the objective the agent maximizes when making choices) Accounting for these gaps between decision and experienced utilities improves predictions about the welfare consequences of policies The difference between the policy maker’s and agent’s objectives in behavioral models parallels non-welfarist approaches to optimal policy 29 / 49 Behavioral Public Economics Example : Chetty et al (2014) Denmark has two types of tax-deferred savings accounts capital pensions paid out as a lump sum upon retirement annuity pensions paid out as annuities In 1999, the tax deduction for contributing to capital pension accounts was reduced from 59% to 45% for individuals in the top income tax bracket (≈ DKr 250k) Chetty et al. (2014) analyze how this change affected payments to the capital pension Control group: individuals in the lower income brackets 41 million observations on the savings of all Danish citizens from 1995-2009 Source: Chetty, R., J. Friedman, S. Leth-Peterson, T. Nielsen, and T. Olsen (2014), Active vs. Passive Decisions and Crowd-out in Retirement Savings Accounts: Evidence from Denmark, QJE 30 / 49 Behavioral Public Economics Chetty et al (2014): results The greenish lines refer to periods before the reform, the reddish lines to periods after the reform. Incomes below 250k DKr. are the control group, which shows no change over time. Savings behavior of treatment group strongly changes after reform. 31 / 49 Behavioral Public Economics Chetty et al (2014) The estimated effect is driven by the 19%, who stopped to pay into the capital pension (left spikes). The other 81% did not react to the reform. About half of the reduction in capital pension contributions was offset by increased contributions to annuity pension accounts, the rest was almost entirely offset by increased saving in taxable accounts 32 / 49 Behavioral Public Economics Chetty et al. (2014) Lessons from this analysis: Responses that appear to be consistent with optimization in the aggregate may mask significant deviations from optimization at the individual level any optimizing agent at an interior optimum should change capital pension contributions by some non-zero amount when the subsidy is reduced Standard policy tools suggested by neoclassical theory are not very successful in increasing savings rates they induce only a small group of individuals to respond these individuals simply shift assets between accounts 33 / 49 Eliciting the people’s view 1. Introduction 2. Role of the Government 3. Applied Public Economics 4. Behavioral Public Economics 5. Eliciting the people’s view 34 / 49 Eliciting the people’s view Large-scale online surveys and experiments New strand of research using large-scale online surveys and experiments to understand how people think how they form their perceptions, beliefs, and attitudes how their views on economic and social policies emerge Examples Kuziemko et al (2015), “How Elastic are Preferences for Redistribution: Evidence from Randomized Survey Experiments”, American Economic Review) Stantcheva (2021), “Understanding Tax Policy: How do people Reason?”, QJE Alesina et al (2021), “Immigration and Redistribution”, Review Of Economic Studies Ferrario & Stantcheva (2022), “Eliciting People’s First-Order Concerns: Text Analysis of Open-Ended Survey Questions”, AER P&P 35 / 49 Eliciting the people’s view Understanding Tax Policy: How do people reason? Elements of survey Background Socioeconomic Questions: apart from typical (age, income) highest level of education achieved, main source of news, and political orientation political orientation: classify themselves in terms of their views on economic policy, ranging from “very conservative” to “very liberal”; what they consider their political affiliation to be (Republican/Democrat/Independent/Other/Nonaffiliated) Knowledge: level of the top federal taxes, the threshold for the top income tax bracket, the top tax rates in the 1950s, the share of households paying no income tax, the average tax rate for the median household or the top household, the share of total income that goes to the top 1%, or the occupational composition of the top 1% of earners 36 / 49 Eliciting the people’s view Understanding Tax Policy: How do people reason? Elements of survey Information Treatment: randomly chosen subsample of respondents was shown one of three versions of an instructional video that provided information about the policy (see following slides) Reasoning about taxes: respondents are asked to think in more detail about how tax policy works. What behavioral responses, efficiency effects, and effects on the broader economy will it trigger? What are the distributional consequences for different groups? What fairness concerns do people have? Example: in the income tax module, respondents are asked to what extent they believe people will engage in the following behaviors if their taxes were to increase: save less, work less, stop working altogether, evade taxes, and so on; whether taxing away the income of different groups is fair or unfair. 37 / 49 Eliciting the people’s view Understanding Tax Policy: How do people reason? Elements of survey Policy Views: Respondents were asked about their views on the current tax systems (Is it fair?) and for opinions regarding policy actions (increasing tax to fund specific programs) Views of Government: respondents expressed their views about the role and capacity of the government to deal with the issue at hand (e.g. to what extent they think the government has the tools and ability to reduce income inequality) and their general attitudes toward government (e.g. trust) 38 / 49 Eliciting the people’s view Redistribution Treatment Stantcheva (2021), Understanding Tax Policy: How Do People Reason?, QJE 39 / 49 Eliciting the people’s view Efficiency Treatment Stantcheva (2021), Understanding Tax Policy: How Do People Reason?,QJE 40 / 49 Eliciting the people’s view Economist Treatment Stantcheva (2021), Understanding Tax Policy: How Do People Reason?,QJE 41 / 49 Eliciting the people’s view Main Considerations About Income Tax Stantcheva (2021), Understanding Tax Policy: How Do People Reason?,QJE 42 / 49 Eliciting the people’s view Perceived Behavioral Responses Stantcheva (2021), Understanding Tax Policy: How Do People Reason?, QJE 43 / 49 Eliciting the people’s view Perceived Efficiency Costs Stantcheva (2021), Understanding Tax Policy: How Do People Reason?, QJE 44 / 49 Eliciting the people’s view Social Preferences Stantcheva (2021), Understanding Tax Policy: How Do People Reason?, QJE 45 / 49 Eliciting the people’s view Support for Increasing Taxes Depends on Goal Stantcheva (2021), Understanding Tax Policy: How Do People Reason?, QJE 46 / 49 Eliciting the people’s view Construction Of Policy Index Goal: policy index that increases when respondents support more progressive taxes and are more favorable to government intervention to reduce inequality Apply unsupervised, clustering machine learning algorithm based on latent Dirichlet allocation Algorithm identifies probability distributions over answers and assigns them to respondent “profiles” based on their frequency Income tax policy index: combines variables on whether the respondent thinks that progressive taxation is an important tool to reduce inequality, whether they support increasing taxes on higher-income to expand programs targeted to low incomes or to increase investments, and whether they believe that the government should have responsibility in reducing income inequality between the rich and the poor. Stantcheva (2021), Understanding Tax Policy: How Do People Reason?, QJE 47 / 49 Eliciting the people’s view Decomposing Tax Policy Views Stantcheva (2021), Understanding Tax Policy: How Do People Reason?, QJE 48 / 49 Eliciting the people’s view Impact of Information Treatments Stantcheva (2021), Understanding Tax Policy: How Do People Reason?,QJE 49 / 49