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Wednesday, November 7, 2012

Cliff notes

 

The design of fiscal adjustments

Alberto Alesina & Silvia Ardagna
NBER Working Paper, September 2012

Abstract:
This paper offers three results. First, in line with the previous literature, we confirm that fiscal adjustments based mostly on the spending side are less likely to be reversed. Second, spending based fiscal adjustments have caused smaller recessions than tax based fiscal adjustments. Finally, certain combinations of policies have made it possible for spending based fiscal adjustments to be associated with growth in the economy even on impact rather than with a recession. Thus, expansionary fiscal adjustments are possible.

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Fiscal Policy in a Depressed Economy

Bradford Delong & Lawrence Summers
Brookings Papers on Economic Activity, Spring 2012, Pages 233-297

Abstract:
In a depressed economy, with short-term nominal interest rates at their zero lower bound, ample cyclical unemployment, and excess capacity, increased government purchases would be neither offset by the monetary authority raising interest rates nor neutralized by supply-side bottlenecks. Then even a small amount of hysteresis - even a small shadow cast on future potential output by the cyclical downturn - means, by simple arithmetic, that expansionary fiscal policy is likely to be self-financing. Even if it is not, it is highly likely to pass the sensible benefit-cost test of raising the present value of future potential output. Thus, at the zero bound, where the central bank cannot or will not but in any event does not perform its full role in stabilization policy, fiscal policy has the stabilization policy mission that others have convincingly argued it lacks in normal times. Whereas many economists have assumed that the path of potential output is invariant to even a deep and prolonged downturn, the available evidence raises a strong fear that hysteresis is indeed a factor. Although nothing in our analysis calls into question the importance of sustainable fiscal policies, it strongly suggests the need for caution regarding the pace of fiscal consolidation.

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Fiscal consolidation strategy

John Cogan et al.
Journal of Economic Dynamics and Control, forthcoming

Abstract:
In the aftermath of the global financial crisis and great recession, many countries face substantial deficits and growing debts. In the United States, federal government outlays as a ratio to GDP rose substantially from about 19.5 percent before the crisis to over 24 percent after the crisis. In this paper we consider a fiscal consolidation strategy that brings the budget to balance by gradually reducing this spending ratio over time to the level that prevailed prior to the crisis. A crucial issue is the impact of such a consolidation strategy on the economy. We use structural macroeconomic models to estimate this impact focusing primarily on a dynamic stochastic general equilibrium model with price and wage rigidities and adjustment costs. We separate out the impact of reductions in government purchases and transfers, and we allow for a reduction in both distortionary taxes and government debt relative to the baseline of no consolidation. According to the model simulations GDP rises in the short run upon announcement and implementation of this fiscal consolidation strategy and remains higher than the baseline in the long run. We explore the role of the mix of expenditure cuts and tax reductions as well as gradualism in achieving this policy outcome. Finally, we conduct sensitivity studies regarding the type of model used and its parameterization.

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What It Takes To Solve The U.S. Government Deficit Problem

Ray Fair
Contemporary Economic Policy, October 2012, Pages 618-628

Abstract:
This paper uses a structural multi-country macroeconometric model to estimate the size of the decrease in transfer payments (or tax expenditures) needed to stabilize the U.S. government debt/gross domestic product (GDP) ratio. It takes into account endogenous effects of changes in fiscal policy on the economy and in turn the effect of changes in the economy on the deficit. A base run is first obtained for the 2013:1-2022:4 period in which there are no major changes in U.S. fiscal policy. This results in an ever increasing debt/GDP ratio. Then transfer payments are decreased by an amount sufficient to stabilize the long-run debt/GDP ratio. The results show that transfer payments need to be decreased by 2% of GDP from the base run, which over the 10 years is $3.2 trillion in 2005 dollars and $4.8 trillion in current dollars. The real output loss is 1.1% of baseline GDP. Monetary policy helps keep the loss down, but it is not powerful enough in the model to eliminate all of the loss. The estimates are robust to a base run with less inflation and to one with less expansion.

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A quantitative analysis of unemployment benefit extensions

Makoto Nakajima
Journal of Monetary Economics, forthcoming

Abstract:
Extensions of unemployment insurance (UI) benefits have been implemented in response to the Great Recession. This paper measures the effect of these extensions on the unemployment rate using a calibrated structural model featuring job search and consumption-saving decisions, skill depreciation, and UI eligibility. The ongoing UI benefit extensions are found to have raised the unemployment rate by 1.4 percentage points, which is about 30 percent of the observed increase since 2007. Moreover, the contribution of the UI benefit extensions to the elevated unemployment rate increased during 2009-2011; while the number of vacancies recovered, the successive extensions kept search intensity down.

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Welfare States and Social Trust

Cheol-Sung Lee
Comparative Political Studies, forthcoming

Abstract:
This article tests the linkage between institutional configuration and social trust, highlighting the role of the welfare states in coordinating interests among different labor market actors. This study initially builds a theoretical framework distinguishing training-supplemented welfare regimes from transfer-based welfare regimes. Evidence from descriptive and multivariate analyses of World Values Survey based on 17 advanced industrial democracies supports my argument that public investment in skill provision prevalent in training-supplemented welfare states leads to higher accumulation of social trust, whereas passive social transfers result in lower social trust. Especially, high investment in public skill provision leads to a decreased gap in social trust between employers and low-skilled workers, as well as among different occupational groups. In addition, the negative effect of passive social transfers on trust is greatly ameliorated when it is jointly configured with high active labor market policies. The findings lend credibility to my claim that specific social policies aiming to upgrade citizens' skill levels provide employees with better prospects for managing life chances (and risks) and therefore building higher social trust.

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The "Thin film of gold": Monetary rules and policy credibility

Niall Ferguson & Moritz Schularick
European Review of Economic History, November 2012, Pages 384-407

Abstract:
We ask whether developing countries reap credibility gains from submitting policy to a strict monetary rule. We look at the gold standard era, 1880-1914, to test whether adoption of a rule-based monetary framework such as the gold standard increased policy credibility, focusing on sixty independent and colonial borrowers in the London market. We challenge the traditional view that gold standard adherence was a credible commitment mechanism rewarded by financial markets with lower borrowing costs. We demonstrate that for the poor periphery - where policy credibility is a particularly acute problem - the market looked behind "the thin film of gold".

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Gold sterilization and the recession of 1937-1938

Douglas Irwin
Financial History Review, forthcoming

Abstract:
The recession of 1937-8 is often cited as illustrating the dangers of withdrawing fiscal and monetary stimulus too early in a weak recovery. Yet our understanding of this severe downturn is incomplete: existing studies find that changes in fiscal policy were small in comparison to the magnitude of the downturn and that higher reserve requirements were not binding on banks. This article focuses on a neglected change in monetary policy, the sterilization of gold inflows during 1937, and finds that it exerted a powerful contractionary force during this period. The transmission of this monetary shock to the real economy appears to have worked through lower asset (equity) prices and higher interest rates.

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Elections, Uncertainty and Irreversible Investment

Brandice Canes-Wrone & Jee-Kwang Park
British Journal of Political Science, forthcoming

Abstract:
This article argues that the policy uncertainty generated by elections encourages private actors to delay investments that entail high costs of reversal, creating pre-election declines in the associated sectors. Moreover, this incentive depends on the competitiveness of the race and the policy differences between the major parties/candidates. These arguments are tested using new survey and housing market data from the United States. The survey analysis assesses whether respondents' perceptions of presidential candidates' policy differences increased the likelihood that they would delay certain purchases and actions. The housing market analysis examines whether elections are associated with a pre-election decline in economic activity, and whether any such decline depends on electoral competitiveness. The results support the predictions and cannot be explained by existing theories.

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The Statistical Behavior of GDP after Financial Crises and Severe Recessions

David Papell & Ruxandra Prodan
B.E. Journal of Macroeconomics, October 2012

Abstract:
Do severe recessions associated with financial crises cause permanent reductions in potential GDP? If the economy eventually returns to its trend, does the return take longer than the return following recessions not associated with financial crises? We develop a statistical methodology appropriate for identifying and analyzing slumps, episodes that combine a contraction and an expansion and end when the economy returns to its trend growth rate. We analyze the Great Depression for the United States, severe and milder financial crises for advanced economies, severe financial crises for emerging markets, and postwar recessions for the United States and other advanced economies. The preponderance of evidence for episodes comparable with the current U.S. slump is that, while potential GDP is eventually restored, the slumps last an average of nine years. If this historical pattern holds, the Great Recession that started in 2007:Q4 will not ultimately affect potential GDP, but the Great Slump is not yet half over.

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Social Insurance: Connecting Theory to Data

Raj Chetty & Amy Finkelstein
NBER Working Paper, October 2012

Abstract:
We survey the literature on social insurance, focusing on recent work that has connected theory to evidence to make quantitative statements about welfare and optimal policy. Our review contains two parts. We first discuss motives for government intervention in private insurance markets, focusing primarily on selection. We review the original theoretical arguments for government intervention in the presence of adverse selection, and describe how recent work has refined and challenged the conclusions drawn from early theoretical models. We then describe empirical work that tests for selection in insurance markets, documents the welfare costs of this selection, and analyzes the welfare consequences of potential public policy interventions. In the second part of the paper, we review work on optimal social insurance policies, which are designed to maximize expected utility taking into account the costs of moral hazard. We discuss formulas for the optimal level of insurance benefits in terms of empirically estimable parameters. We then consider the consequences of relaxing the key assumptions underlying these formulas, e.g. by allowing for fiscal externalities or behavioral biases. We also summarize recent work on other dimensions of optimal policy, including mandated savings accounts and the optimal path of benefits. Finally, we discuss the key challenges that remain in understanding the optimal design of social insurance policies.

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The Spirit of the Welfare State? Adaptation in the Demand for Social Insurance

Martin Ljunge
Journal of Human Capital, September 2012, Pages 187-223

Abstract:
Young generations demand substantially more social insurance than older generations, although program rules have been constant for decades. I postulate a model in which the utility of claiming social insurance benefits depends on older generations' past behavior. The intertemporal mechanism estimated can account for half of the younger generations' higher demand for social insurance benefits. Instrumenting for older generations' behavior using mortality rates reveals an even stronger influence of reference group behavior on individual demand. The analysis suggests that behavioral responses estimated by natural experiments could strongly underestimate the true long-run elasticities relevant for the fiscal sustainability of the welfare state.

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How big (Small?) are Fiscal multipliers?

Ethan Ilzetzki
Journal of Monetary Economics, forthcoming

Abstract:
Contributing to the debate on the macroeconomic effects of fiscal stimuli, we show that the impact of government expenditure shocks depends crucially on key country characteristics, such as the level of development, exchange rate regime, openness to trade, and public indebtedness. Based on a novel quarterly dataset of government expenditure in 44 countries, we find that (i) the output effect of an increase in government consumption is larger in industrial than in developing countries, (ii) the fiscal multiplier is relatively large in economies operating under predetermined exchange rates but is zero in economies operating under flexible exchange rates; (iii) fiscal multipliers in open economies are smaller than in closed economies; (iv) fiscal multipliers in high-debt countries are negative.

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What does Monetary Policy do to Long-term Interest Rates at the Zero Lower Bound?

Jonathan Wright
Economic Journal, November 2012, Pages F447-F466

Abstract:
This article uses a structural VAR with daily data to identify the effects of monetary policy shocks on various longer term interest rates since the federal funds rate has been stuck at the zero lower bound. The VAR is identified using the assumption that monetary policy shocks are heteroskedastic: monetary policy shocks have especially high variance on days of FOMC meetings and certain speeches, while there is otherwise nothing unusual about these days. A complementary high-frequency event-study approach is also used. I find that stimulative monetary policy shocks lower Treasury and corporate bond yields but the effects die off fairly fast.

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Made Poorer by Choice: Worker Outcomes in Social Security vs. Private Retirement Accounts

Javed Ahmed, Brad Barber & Terrance Odean
University of California Working Paper, September 2012

Abstract:
We compare outcomes from currently-promised Social Security benefits to simulated income streams from investing individuals' Social Security taxes in private retirement accounts (PRAs). Based on a representative population of workers, we estimate the effect of allowing choice in stock allocation and stock selection on the probability that a worker receives less than her promised Social Security benefit (an income shortfall). We compare simulated outcomes under two choice scenarios to a baseline in which workers are constrained to invest in a 60/40 stock/bond portfolio invested in low-cost index funds. Allocation choice allows workers to choose a mix of stocks and bonds, which remains fixed until retirement. In the equity choice setting, workers earn the same expected returns but failure to diversify exposes them to idiosyncratic risk. In baseline simulations without allocation or equity choice, 29.8% of workers experience an income shortfall at age 88 and 52.2% of workers have greater than 25% probability of an income shortfall. Relative to this baseline, we present three main findings. First, allocation choice increases the unconditional probability of an income shortfall from 29.8% to 34.4%. Moreover, the percentage of workers facing greater than 25% probability of an income shortfall increases from 52.2% to 66.1%. Low equity allocations for some workers leads to degraded average PRA performance (and increased dispersion) when allocation choice is allowed. Second, equity choice increases the probability of income shortfall from 29.8% to 41.0%, and the percentage of workers facing a greater than 25% chance of an income shortfall increases from 52.2% to 88.4%. With equity choice, degradation in performance arises because of under-diversification in working-year equity investments. Third, low-income workers face much higher risk of income shortfalls due to the regressive nature of Social Security benefits. Without offsetting policy initiatives, the probability of income short-falls from PRAs for the bottom quintile of wage earners is 48.8% at age 88 when choice is constrained, 54.7% when allocation choice is allowed, and 59.0% with equity choice. The corresponding probabilities for the top quintile of wage earners are 12.7%, 15.9%, and 23.8%. All workers in the bottom quintile of wage earners face greater than 25% probability of an income shortfall regardless of the choice scenario. Our results emphasize the importance of limiting investment choice in PRAs and highlight the disproportionate impact of decision risk on retirement outcomes for low-income workers.

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The Revenue Demands of Public Employee Pension Promises

Robert Novy-Marx & Joshua Rauh
NBER Working Paper, October 2012

Abstract:
We calculate increases in contributions required to achieve full funding of state and local pension systems in the U.S. over 30 years. Without policy changes, contributions would have to increase by 2.5 times, reaching 14.1% of the total own-revenue generated by state and local governments. This represents a tax increase of $1,385 per household per year, around half of which goes to pay down legacy liabilities while half funds the cost of new promises. We examine sensitivity to asset return assumptions, wage correlations, the treatment of workers not currently in Social Security, and endogenous geographical shifts in the tax base.

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Well-intended policies

Francisco Buera, Benjamin Moll & Yongseok Shin
Review of Economic Dynamics, forthcoming

Abstract:
Market failures provide a rationale for policy intervention. But policies are often hard to alter once in place. We argue that this inertia can result in well-intended policies having sizable negative long-run effects on aggregate output and productivity. In our theory, financial frictions provide a rationale for providing subsidized credit to productive entrepreneurs to alleviate the credit constraints they face. In the short run, such targeted subsidies have the intended effect and raise aggregate output and productivity. In the long run, however, individual productivities mean-revert while individual-specific subsidies remain fixed. As a result, entry into entrepreneurship is distorted: The subsidies prop up entrepreneurs that were formerly productive but are now unproductive, while impeding the entry of newly productive individuals. Therefore aggregate output and productivity are depressed. Our theory provides an explanation for two empirical observations on developing countries: idiosyncratic distortions that disproportionately affect productive establishments, and temporary growth miracles followed by growth failures.

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Investment, Accounting, and the Salience of the Corporate Income Tax

Jesse Edgerton
NBER Working Paper, October 2012

Abstract:
This paper develops and tests the hypothesis that accounting rules mitigate the effect of tax policy on firm investment decisions by obscuring the timing of tax payments. I model a firm that maximizes a discounted weighted average of after-tax cash flows and accounting profits. I estimate the weight placed on accounting profits by comparing the effectiveness of tax incentives that do and do not affect them. Investment tax credits, which do affect accounting profits, have larger effects on investment than accelerated depreciation, which does not. This difference in estimated effects is not obviously driven by discounting, cash flow effects, or measurement error. Results thus suggest that accelerated depreciation provisions are less effective than they otherwise would be and that the corporate income tax could create smaller distortions to investment decisions than we would otherwise estimate.

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Investment and Capital Constraints: Repatriations Under the American Jobs Creation Act

Michael Faulkender & Mitchell Petersen
Review of Financial Studies, November 2012, Pages 3351-3388

Abstract:
The American Jobs Creation Act (AJCA) significantly lowered U.S. firms' tax cost when accessing their unrepatriated foreign earnings. Using this temporary shock to the cost of internal financing, we examine the role of capital constraints in firms' investment decisions. Controlling for the capacity to repatriate foreign earnings under the AJCA, we find that a majority of the funds repatriated by capital-constrained firms were allocated to approved domestic investment. Although unconstrained firms account for a majority of repatriated funds, no increase in investment resulted. Contrary to other examinations of the AJCA, we find little change in leverage and equity payouts.

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Why Do Citizens Discount the Future? Public Opinion and the Timing of Policy Consequences

Alan Jacobs & Scott Matthews
British Journal of Political Science, October 2012, Pages 903-935

Abstract:
It is widely assumed that citizens are myopic, weighing policies' short-term consequences more heavily than long-term outcomes. Yet no study of public opinion has directly examined whether or why the timing of future policy consequences shapes citizens' policy attitudes. This article reports the results of an experiment designed to test for the presence and mechanisms of time-discounting in the mass public. The analysis yields evidence of significant discounting of delayed policy benefits and indicates that citizens' policy bias towards the present derives in large part from uncertainty about the long term: uncertainty about both long-run processes of policy causation and long-term political commitments. There is, in contrast, little evidence that positive time-preferences (impatience) or consumption-smoothing are significant sources of myopic policy attitudes.

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The Effect of Tax Rates and Tax Bases on Corporate Tax Revenues: Estimates with New Measures of the Corporate Tax Base

Laura Kawano & Joel Slemrod
NBER Working Paper, October 2012

Abstract:
Several recent analyses have suggested that the revenue-maximizing corporate tax rate resides in the low-30's. We challenge this result by re-examining this relationship using a new compilation of changes in corporate tax base definitions for OECD countries between 1980 and 2004. By considering tax base changes in addition to tax rate changes, we can address the estimation bias that applies to tax rates absent their consideration. We find that the relationship between corporate tax rates and corporate tax revenues is tenuous. The large behavioral response to corporate tax rates implied in the literature does not obtain when accounting for persistent differences in tax policy and business environments across countries.

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The Macroeconomic Effects of Large-scale Asset Purchase Programmes

Han Chen, Vasco Cúrdia & Andrea Ferrero
Economic Journal, November 2012, Pages F289-F315

Abstract:
We simulate the Federal Reserve second Large-Scale Asset Purchase programme in a DSGE model with bond market segmentation estimated on US data. GDP growth increases by less than a third of a percentage point and inflation barely changes relative to the absence of intervention. The key reasons behind our findings are small estimates for both the elasticity of the risk premium to the quantity of long-term debt and the degree of financial market segmentation. Without the commitment to keep the nominal interest rate at its lower bound for an extended period, the effects of asset purchase programmes would be even smaller.

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The Impact of Tax Incentives on the Economic Activity of Entrepreneurs

Jarkko Harju & Tuomas Kosonen
NBER Working Paper, October 2012

Abstract:
Based on existing evidence, we know little about how the taxation of small business owners affects their economic activity. This paper studies the effect of two Finnish tax reforms, in 1997 and 1998, on the effort decisions of the owners of small businesses utilizing both theoretical model and empirical data. The reforms reduced the income tax rates of small business owners and applied only to unincorporated firms, leaving corporations out. We use a difference-in-differences strategy to estimate the causal impact of tax incentives on the economic activity of small businesses. The results imply that lighter taxation leads to an increase in the turnover of firms that we interpret as an increase in effort exerted by their owners.

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Overcoming Fiscal Gridlock: Institutions and Budget Bargaining

Carl Klarner, Justin Phillips & Matt Muckler
Journal of Politics, October 2012, Pages 992-1009

Abstract:
We argue that the costs of bargaining failure are important determinants of legislative delay and gridlock. When these costs are high, elected officials have a greater incentive to reach legislative bargains, even if doing so means compromising on their policy objectives. We develop and evaluate this claim in the context of state budgeting, treating late budgets as examples of fiscal gridlock. Specifically, we argue that budgetary gridlock imposes political and private costs on lawmakers, the magnitudes of which are shaped by institutions and features of the political environment. Our expectations are tested and confirmed using an original dataset of the timing of budget adoption for all states over a 46-year period. Though our investigation is set in the context of the states, we show that differences in the costs of bargaining failure can also account for variation in the patterns of budgetary delay across levels of government and (to a lesser extent) variation in fiscal gridlock within the federal government.

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Recent Marginal Labor Income Tax Rate Changes by Skill and Marital Status

Casey Mulligan
NBER Working Paper, September 2012

Abstract:
This paper calculates monthly time series for the overall safety net's statutory marginal labor income tax rate as a function of skill and marital status. Marginal tax rates increased significantly for all groups between 2007 and 2009, and dramatically so for unmarried household heads. The relationship between incentive changes and skill varies by marital status. Unemployment insurance and related expansions contribute to the patterns by skill while food stamp expansions contribute to the patterns by marital status. Remarkably, group changes in hours worked per capita line up with the statutory measures of incentive changes.

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How Major Local Taxes Affect Private Employment: An Empirical Analysis of Northeastern Illinois Municipalities

Yonghong Wu
Economic Development Quarterly, November 2012, Pages 351-360

Abstract:
This empirical research focuses on three major local taxes - property tax, sales tax, and telecommunications tax - to examine their impacts on local economic development in the six-county Chicago metropolitan area. The statistical results indicate that these three major local taxes have significant negative effects on business employment. The study implies that it may be counterproductive for local governments to raise tax levels in order to address some immediate revenue shortfalls in the aftermath of the recent economic recession.

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Impact of State-Level Tax and Expenditure Limits (TELs) on Government Revenues and Aid to Local Governments

Sharon Kioko & Christine Martell
Public Finance Review, November 2012, Pages 736-766

Abstract:
This article investigates the impact of state-level tax and expenditure limits (TELs) on state government revenues and aid to local governments. Using an instrumental variable approach to control for endogeneity, the authors find that the general fund TELs (i.e., revenue and expenditure limits) have led to substantial increases in tax and nontax revenues. States with procedural limits (i.e., those with voter approval and/or legislative supermajority requirements votes) have significantly lower tax revenues. For states with these procedural limits, their ability to impose new or higher taxes is limited by the rules for passing such legislation. This study also finds that states with general fund TELs have higher levels of aid to local governments, while those with procedural TELs have lower levels of aid. Local government property tax limits do not have any impact on taxing authority of states and have only marginal impacts on the state-aid programs.

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Defined Benefit Pension Plan Distribution Decisions by Public Sector Employees

Robert Clark, Melinda Morrill & David Vanderweide
NBER Working Paper, October 2012

Abstract:
Studies examining pension distribution choices have found that the tendency of private-sector workers is to select lump sum distributions instead of life annuities. In the public sector, defined benefit pensions usually offer lump sum distributions equal to employee contributions, not the present value of the annuity. Using administrative data from the North Carolina state and local government retirement systems, we find that over two-thirds of public sector workers under age 50 separating prior to retirement from public plans in North Carolina left their accounts open and did not request a cash distribution from the pension system within one year of separation. Furthermore, the evidence suggests many separating workers, particularly those with short tenure, may be forgoing important benefits due to lack of knowledge, understanding, or accessibility of benefits. In contrast to prior research in the private sector, we find no evidence of a bias toward cash distributions for public employees in North Carolina.

By KEVIN LEWIS | 09:00:00 AM