Taxation and savings: a survey

The choice of how much of society’s income to consume today and how much to save for future consumption is among the most important economic decisions. It can have implications not only for the well-being of the households taking the decisions, but also for the rate at which the economy invests and grows, and therefore the well-being of future generations. The way in which savings decisions are taken is a matter of ongoing research in the literature, involving such important and unresolved issues as the degree of foresight and rationality of households, the extent to which capital markets are complete and wellfunctioning, the importance of life-cycle versus bequest versus precautionary motives for saving, and more generally the weight, if any, that current savers put on the welfare of future generations.

Finite Lifetimes, Borrowing Constraints, and Short-Run Fiscal Policy

Recent developments in public finance in the analysis of dynamic government debt policies have emphasized effects on the distribution of real resources across generations. At the same time, macroeconomists have emphasized the importance of the length of the time horizon over which agents optimize their decisions about consumption for judging the effects of fiscal policy on aggregate demand. Much of the discussion of these issues has focused on whether linkages among generations are sufficient to give consumers infinite horizons. To the extent that horizons are finite, debt burdens can be shifted to future generations, and substitutions of debt for taxes have real effects. This paper argues that, as a matter of quantitative significance, theoretical and empirical emphasis on the importance of finite horizons for the analysis of many fiscal policies is misplaced. Studies of the role of finite horizons in determining the effects of short-run fiscal policies on consumption have been conducted largely under the assumption of perfect capital markets. We show that while the marginal propensity to consume (MPC) out of temporary tax changes is nonzero in finite- horizon models, it is not very large. We demonstrate that the MPC is, however, quite sensitive to the importance of restrictions on borrowing in the economy. The clear implication is that shifting emphasis from the length of the planning horizon to the structure of capital markets is an important step for empirical research.

Liquidity Constraints, Fiscal Policy, and Consumption

macroeconomics, liquidity constraints, fiscal policy, and consumption

Risk, Return and Portfolio Allocation under Alternative Pension Arrangements with Imperfect Financial Markets

This paper uses stochastic simulations on calibrated models to assess the steady state impact of different pension arrangements in an environment where financial markets are less than perfect. Surprisingly little is known about the optimal split between funded and unfunded systems when there are sources of uninsurable risk that are allocated in different ways by different types of pension system and where there are imperfections in financial markets (eg transactions costs or adverse selection) . This paper calculates the expected welfare of agents in different economies where in the steady state the importance of unfunded, state pensions differs. We estimate how the optimal level of unfunded, state pensions depends on rate of return and income risks and also upon the actuarial fairness of annuity contracts. We focus on the case of Japan where aging is rapid and unfunded pensions are currently generous.Pensions; portfolio allocation, demographics; annuities; risk-sharing

A Review of Human Capital Theory: Microeconomics

With the beginning of the new millennium it has become more and more apparent that education and human capital constitute a key element of modern economies. Despite the important role of human capital in modern societies, there are still many unknowns about the process of educational production as well as individual and collective decisions concerning how much and what kind of education to obtain. This literature review aims at providing a better understanding of the process of human capital formation and educational attainment. Although human capital plays an important role in both microeconomics and macroeconomics, we focus on the former branch of literature in order to analyze the individual incentives to acquire skills. This review is divided into six parts each of them representing an important stream of human capital literature. First, we introduce the basic concept of human capital that models individuals as investing in skills in response to the expected returns to education. After this, we investigate the different implications of investments in general and specific human capital and then provide an overview of various empirical studies measuring the rate of return to education. Because educational attainment may also be affected by other factors such as school characteristics or family background, we review the literature on educational production functions and discuss the significance of potential inputs into the process of educational production. Subsequently, we refer to models of human capital accumulation over the life-cycle that manage to replicate the empirical life-cycle patterns with respect to the age-earnings profile of individuals. Finally, we analyze the effects of taxation and education subsidies on the formation of human capital.Human Capital, Return to Education, Education Production Function, Life-Cycle of Earnings, Education Subsidies

Human Capital Investments in Pakistan: Implications of Micro Evidence from Rural Households

A number of cross-country studies suggest that the Pakistani aggregate human capital investments, measured by educational performance, are low relative to other countries of similar per capita income levels. This paper investigates the implications of micro evidence on schooling from rural Pakistan for an understanding of the cases of low human capital investments. The results of school-entrant and dropout regressions using household panel data indicate that the permanent and transitory income movements affect children’s schooling behaviour, indicating credit market imperfections. Hence, the human capital investments in rural Pakistan may be discouraged by poverty, combined with incompletely insured income volatility. Moreover, our analysis points out that there is a distinct gender difference in education.

Quantitative macroeconomics with heterogeneous households

Macroeconomics is evolving from the study of aggregate dynamics to the study of the dynamics of the entire equilibrium distribution of allocations across individual economic actors. This article reviews the quantitative macroeconomic literature that focuses on household heterogeneity, with a special emphasis on the “standard” incomplete markets model. We organize the vast literature according to three themes that are central to understanding how inequality matters for macroeconomics. First, what are the most important sources of individual risk and cross-sectional heterogeneity? Second, what are individuals’ key channels of insurance? Third, how does idiosyncratic risk interact with aggregate risk?Macroeconomics ; Insurance

Human Capital Inequality, Life Expectancy and Economic Growth

This paper provides a theoretical model in which inequality affects per capita income when individuals decide to accumulate human capital depending on their life expectancy. The model assumes that life expectancy depends to a large extent on the environment in which individuals grow up, in particular, on the human capital of their parents. After calibrating the life expectancy function according to the international evidence for cross-section data, our results show the existence of multiple steady states depending on the initial distribution of education. In particular, human capital may converge towards different stable steady states. In accordance with the evidence displayed by many developing countries, the low steady state is a poverty trap in which children are raised in poor families, have a low life expectancy and work as non-educated workers all their lives.life expectancy, iinequality, human capital accumulation

Endogenous borrowing constraints and wealth inequality

This paper studies the evolution of wealth inequality in an economy with endogenous borrowing constraints. In the model economy, agents need to borrow to finance human capital investments but cannot commit to repaying their loans. Creditors can punish defaulters by banishing them permanently from the credit market. In equilibrium, loan default is prevented by imposing a borrowing limit tied to the borrower\u27s inheritance. The heterogeneity in inheritances translates into heterogeneity in the borrowing limits: endogenously, some young borrowers face a zero borrowing limit, some are partly constrained, while others are unconstrained. Depending on the initial distribution of inheritances, it is possible all lineages are attracted to either the zero-borrowing-limit steady state or to the unconstrained-borrowing steady state -- long-run equality. It is also possible some lineages end up at one steady state and the rest at the other -- complete polarization. Interestingly, the wealth dynamics in the model closely resemble that in the seminal work of Galor and Zeira (1993)