Do Private Pensions Increase National Saving?

This paper discusses how private pension programs differ from public social security in their likely impact on aggregate saving. Although private pensions are likely to reduce direct saving by employees, this should be offset by the combination of companies' partial funding and the shareholders response to unfunded liabilities. In contrast to several earlier empirical studies that implied that social security does depress national saving, the current time series evidence suggests that the growth of private pensions has not had an adverse effect on saving and may have increased saving by a small amount.

Adjusting Depreciation in an Inflationary Economy: Indexing versus Acceleration

With the existing "historic cost" method of depreciation, higher inflation rates reduce the real value of future depreciation deductions and therefore raise the real net cost of investment. The calculations in this paper show that this rise in the net cost can be quite substantial at recent inflation rates; e.g., the real net cost of an equipment investment with a 13 year tax life is raised 21 percent by an 8 percent expected inflation rate if the firm uses a 4 percent real discount rate. The effects of inflation on the net cost of investment can be completely eliminated by indexing depreciation. A more accelerated depreciation schedule can also lower the net cost of investment and make that net cost less sensitive to the rate of inflation. The current paper examines a particular acceleration proposal and finds that, for moderate rates of inflation and real discount rates, the acceleration proposal and full indexation are quite similar. For low rates of inflation, high discount rates, or very long-lived investments, the acceleration proposal causes greater reductions in net cost than would result from complete indexing. Conversely, for high rates of inflation, low discount rates, or very short-lived investments, the acceleration method fails to offset the adverse effects of inflation. Since the acceleration and indexation methods have quite similar effects under existing economic conditions, the choice between them requires balancing the administrative simplicity and other possible advantages of acceleration against the automatic protection that indexation offers against the risk of significant changes from the recent inflation rates and discount rates.

The Effect of Social Security on Private Savings: The Time Series Evidence

This paper reviews the studies by Robert Barro, Michael Darby, and Alicia Munnell, as well as my own earlier time-series study and presents new estimates using the revised national income-account data. The basic estimates of each of the four studies point to an economically substantial effect that is very unlikely to have been observed by chance alone. Although including variables like the Government surplus (Barro) or a measure of real money balance (Darby) can lower the estimated coefficient of the social security wealth variable, this paper explains their inappropriateness in the aggregate consumption function. Use of new data on national income and its components from the Department of Commerce improves my earlier estimates and shows that the unemployment variable does not belong in the consumption function once the level of income and its rate of change are included.

U.S. Budget Deficits and the European Economies: Resolving the Political Economy Puzzle

This paper, prepared for the annual meetings of the American Economic Association, discusses how the increases in the U.S. budget deficits since 1980 have affected the economies of Western Europe. The analysis emphasizes that U.S. deficits have not only affected these economies directly but have also induced them to adopt more restrictive monetary and fiscal policies than they would otherwise have chosen. This induced shift in domestic policies is the primary reason why European governments have pressed for a reduction in the U.S. budget deficits despite the favorable impact of those deficits on European trade surpluses.

The European Central Bank and the Euro: The First Year

The creation of the euro and the European Central Bank is a remarkable and unprecedented event in economic and political history: creating a supranational central bank and leaving eleven countries without national currencies of their own. The experience of the first year confirms that one size fits all' monetary policy is not suitable for Europe because cyclical and inflation conditions vary substantially among countries. Labor market policies during this first year will increase this problem in the future and may lead to more trade protectionism. The paper explores reasons why cyclical unemployment, structural unemployment, and inflation may all be higher in the future as a result of the single currency. Although some advocate the euro despite its economic problems because of its assumed favorable effects on European political cohesiveness, the paper argues that it is more likely to lead to political conflict within Europe and with the Unites States.

Self-Protection for Emerging Market Economies

International economic crises will continue to occur in the future as they have for centuries past. The rapid spread of the 1997 crisis in Asia and of the 1982 crisis in Latin America showed how shifts in market perceptions can suddenly bring trouble to countries even when there has been no change in objective conditions. More recently, the sharp jump in emerging market interest rates after Russia's August 1998 default underlined the vulnerability of all emerging market economies to increases in investors' aversion to risk. Emerging market countries that want to avoid the devastating effects of such crises must protect themselves. They cannot depend on the International Monetary Fund or other international organizations nor expect that a new global financial architecture' will make the world economy less dangerous. Taking steps to protect themselves requires more than avoiding those bad policies that make a currency crisis inevitable. The process of contagion makes even the virtuous vulnerable to currency runs. Liquidity is the key to self-protection. A country that has substantial international liquidity -- large foreign exchange reserves and a ready source of foreign currency loans -- is less likely to be the object of a currency attack. Substantial liquidity also permits a country that is attacked from within or without to defend itself better and to make more orderly adjustments. The challenge is to find ways to increase liquidity at reasonable cost.

Inflation and the Stock Market

This paper discusses a crucial cause of the failure of share prices to rise during a decade of substantial inflation. Indeed, the share value per dollar of pretax earnings actually fell from 10.82 in 1967 to 6.65 in 1976. The analysis here indicates that this inverse relation between higher inflation and lower share prices during the past decade was not due to chance or to other unrelated economic events. On the contrary, an important adverse effect of increased inflation on share prices results from basic features of the current U.S. tax laws, particularly historic cost depreciation and the taxation of nominal capital gains.

The Effect of Marginal Tax Rates on Taxable Income: A Panel Study of the1986 Tax Reform Act

This paper reports new estimates of the sensitivity of taxable income to changes in tax rates based on a comparison of the tax returns of the same individual taxpayers before and after the 1986 tax reform. This comparison is done by using a panel of more than 4000 individual tax returns created by the Treasury that matches tax returns for the same taxpayers in different years. The analysis emphasizes that the response of taxable income is much more general than the response of traditional measures of labor supply and is likely to be much more sensitive to tax rates. The evidence shows a substantial response of taxable income to changes in marginal tax rates. The differences-of-differences calculations imply an elasticity of taxable income with respect to the marginal net-of-tax rate that is at least one and could be substantially higher. There is a brief discussion and simulation analysis of the implications of these estimates for the likely impact of the 1993 tax rate increases on tax revenues. Even the lowest estimated elasticity implies that the tax rate changes enacted in 1993 will lead to little additional personal income tax revenue.