The Marriage Market, Inequality and the Progressivity of the Income Tax

August 30, 2019

By Tim Obermeier

This paper studies how the progressivity of the income tax affects intra-household inequality and the marriage market. Tax progressivity increases the after-tax earnings of the lower earning spouse and improves their bargaining position in marriage. This mechanism reduces inequality in consumption and leisure within households. In addition, tax progressivity can change who is single and who marries whom. I study these effects in an equilibrium search and matching model with intra-household bargaining, labor supply and savings. The model is calibrated to data from the Netherlands and used to study a hypothetical reform which increases progressivity by 40% relative to the current system. The reduction of intra-household inequality accounts for 24.77% of the reduction in inequality in private consumption due to the reform, and 11.43% of the reduction in inequality in utility from private and public consumption, leisure and home production. Changes in the composition of couples and singles, due to endogenous marriage and divorce, have small implications for inequality.

This paper is leaving me puzzled. Indeed, the lower earning spouse is usually the one that is less attached to the labor market, and thus is the marginal earner. That income is then the one that faces the higher marginal tax rate under more progressive taxation. The paper seem to to treat the two incomes as simultaneous or even the higher income as being marginal.


Austerity in the Aftermath of the Great Recession

August 28, 2019

By Christopher House, Christian Proebsting and Linda Tesar

Cross-country differences in austerity, defined as government purchases below forecast, account for 75 percent of the observed cross-sectional variation in GDP in advanced economies during 2010-2014. Statistically, austerity is associated with lower GDP, lower inflation and higher net exports. A multi-country DSGE model calibrated to 29 advanced economies generates effects of austerity consistent with the data. Counterfactuals suggest that eliminating austerity would have substantially reduced output losses in Europe. Austerity was so contractionary that debt-to-GDP ratios in some countries increased as a result of endogenous reductions in GDP and tax revenue.

Beyond the very relevant topic, this paper is a nice demonstration that fiscal policy is not a simple accounting exercise: the economy in its entirely is an endogenous object that responds to policy, sometimes in strong ways (like the increase in the debt/GDP ratio mentioned in the abstract).

International Welfare Spillovers of National Pension Schemes

August 24, 2019

By James and Olena Staveley-O’Carroll

We employ a two-country overlapping-generations model to explore the international dimension of household portfolio choices induced by the asymmetric provision of government-run pensions. We study the resulting patterns of risk-sharing and the corresponding welfare effects on both home and foreign agents. Introducing the defined benefits pay-as-you-go system at home increases the welfare of all other agents at the expense of the home workers and improves the degree of intergenerational risk sharing abroad. Conversely, a defined contributions system leads to welfare losses of both home cohorts accompanied by gains abroad, but does increase the extent of intergenerational risk sharing at home.

This papers brings an interesting perspective the welfare analysis of pension schemes: they are excessively home-biased, and thus those who can overcompensate. This can leads to welfare losses. One avenue could be to get rid of that home bias, but good luck with making it happen.

Ramsey Tax Competition with Real Exchange Rate Determination

August 20, 2019

By Paul Gomme

How should governments choose tax rates when they face competition from other jurisdictions? This questions is answered by solving for the Nash equilibrium of the game played between Ramsey planners in a two good, two country open economy macroeconomic model. It is shown, analytically, that the planers do not tax capital income in the long run. Short term results, obtained computationally, reveal that the government of the larger country manages the path of the real exchange rate in order to manipulates its smaller rival’s choice of tax rates. Tax competition does not lead to a “race to the bottom.”

Paper full of insights about international tax competition and “currency manipulation.” It is particularly interesting for tax havens that struggle with the movements (or levels) of their exchange rate.

Rethinking capital regulation: the case for a dividend prudential target

August 16, 2019

By Manuel Muñoz

The paper investigates the effectiveness of dividend-based macroprudential rules in complementing capital requirements to promote bank soundness and sustained lending over the cycle. First, some evidence on bank dividends and earnings in the euro area is presented. When shocks hit their profits, banks adjust retained earnings to smooth dividends. This generates bank equity and credit supply volatility. Then, a DSGE model with key financial frictions and a banking sector is developed to assess the virtues of what shall be called dividend prudential targets. Welfare-maximizing dividend-based macroprudential rules are shown to have important properties: (i) they are effective in smoothing the financial and the business cycle by means of less volatile bank retained earnings, (ii) they induce welfare gains associated to a Basel III-type of capital regulation, (iii) they mainly operate through their cyclical component, ensuring that long-run dividend payouts remain unaffected, (iv) they are flexible enough so as to allow bank managers to optimally deviate from the target (conditional on the payment of a sanction), and (v) they are associated to a sanctions regime that acts as an insurance scheme for the real economy.

This paper suggests an intriguing policy, which is to use taxes and subsidies to prevent excessive retained earnings volatility in banks. Why do banks like to smooth dividends? Is it because they hate to reveal less than stellar results? If so, wouldn’t more volatile dividend create the potential for a run? That would not be good. This trade-off seems to be missing in this paper.

Real consequences of open market operations: the role of limited commitment

August 4, 2019

By Francesco Carli and Pedro Gomis Porqueras

We study how limited commitment in credit markets affects the implementation of open market operations and characterize when they result in real indeterminacies and when they have real effects. To do so, we consider a frictional and incomplete market framework where agents face stochastic trading opportunities and limited commitment in some markets. When limited commitment does not constraint agents’ choices, we find necessary and sufficient conditions for the existence of a unique monetary equilibrium. However, real indeterminacies are possible when buyers face a binding no-default constraint. We also show that when the no-default constraint binds and bonds are not priced fundamentally, open market operations generically have real effects. A sale of government bonds can increase or decrease interest rates, depending on the nature of equilibria. The direction of the interest rate effects critically depend on the size of the liquidity premium on government bonds. Finally, government bonds purchases can be used to rule out real indeterminacies, thus finding another rationale for such policy.

In principle, monetary policy should not matter, only real quantities are relevant. But it does due to the monetary illusion. A few mechanisms for this illusion have been demonstrated, here is another one.