Tax Reform and Automatic Stabilization

A fundamental property of a progressive income tax is that it provides implicit collective insurance against idiosyncratic shocks to income by dampening the variability of disposable income and consumption. The Economic Recovery Tax Act of 1981 (ERTA) and the Tax Reform Act of 1986 (TRA86) greatly reduced the number of marginal tax brackets and the maximum marginal rate, which limits the ability of households to stabilize consumption in the face of transitory fluctuations in taxable income. We examine the effect of the federal income tax reforms of the 1980s on the associated degree of automatic stabilization of consumption. The empirical framework derives from the consumption insurance literature where the ideal outcome is spatially equal changes in households' marginal utilities of consumption. Because evidence for U.S. households rejects complete consumption insurance we begin with a model of partial consumption insurance, which we use to identify how the degree of partial insurance has changed since ERTA and TRA86. Our data come from interview years 1980-1991 in the Panel Study of Income Dynamics. Although in some cases the tax reforms of the 1980s actually increased the automatic stabilization inherent in a progressive income tax (especially when the Social Security payroll tax and the Earned Income Tax Credit are included), our overall outcome is that ERTA and TRA86 reduced consumption stability by about 50 percent. More recent tax reforms, most notably increased EITC generosity, have restored or enhanced consumption insurance.

Income Transfers and Assets of the Poor

Compared with nonpoor households, many poor households accumulate little wealth over their lifetimes. This rich-poor wealth gap may be due to different abilities to accumulate assets, possibly because the poor face a lifetime of lower incomes and higher income uncertainty. Alternatively, the wealth gap might be due to different responses to economic incentives to accumulate, such as transfer-program policies. In this paper, I use data from the Panel Study of Income Dynamics and a correlated random-effects estimator to estimate the wealth-disincentive effects of both transfer-program income and policies in a buffer-stock model of asset accumulation. With the estimated parameters, I decompose the rich-poor wealth gap into the fraction attributable to ability-to-accumulate differences and the fraction attributable to differences in responses to asset-accumulation incentives. The results suggest that welfare income and policies discourage accumulation of liquid assets, but do not reduce net wealth. However, the wealth decomposition indicates that at least 75 percent of the rich-poor wealth gap emanates from ability differences. This suggests that the disincentives created by transfer programs have a small impact on the overall asset position of the poor.

Welfare Reform and Food Stamp Caseload Dynamics

We use state-level panel data for federal fiscal years 1980–1998 to estimate the impacts of welfare reform and the business cycle on food stamp caseloads. The model we employ is a dynamic function of past caseloads, economic factors, AFDC and Food Stamp Program policies, political factors, AFDC caseload levels, and unobserved fixed and trending heterogeneity. Our results suggest that the robust economy has substantially influenced the recent decline in food stamp caseloads, but that the estimated aggregate effect of welfare reform is modest—we attribute around 45 percent of 1994–1998 decline to the macroeconomy and about 5 percent to welfare reform. We do find substantial heterogeneity in the impact of AFDC waiver policies. States with JOBS sanctions policies but not family cap or earnings disregard waivers can expect a larger long-run decline in caseloads than those states with all three policies. In addition, we do find some evidence, albeit weaker, that states with waivers for unemployed able-bodied adults without dependents can expect higher caseload levels than states without the waivers and that the Electronic Benefits Transfer program is leading to food stamp caseload declines. An important finding of this study is that modeling food stamp caseload dynamics has implications for the estimated effects of policy changes and economic factors—when dynamic models are employed, we observe substantially reduced welfare-reform effects but significantly increased effects of the macroeconomy on food stamp caseloads. These results are robust to models that permit the simultaneous determination of AFDC and food stamp caseloads.

Policy Relevant Heterogeneity in the Value of Statistical Life: New Evidence from Panel Data Quantile Regressions

We examine differences in the value of statistical life (VSL) across potential wage levels in panel data using quantile regressions with intercept heterogeneity. Latent heterogeneity is econometrically important and affects the estimated VSL. Our findings indicate that a reasonable average cost per expected life saved cut-off for health and safety regulations is $7 million to$8 million per life saved, but the VSL varies considerably across the labor force. Our results reconcile the previous discrepancies between hedonic VSL estimates and the values implied by theories linked to the coefficient of relative risk aversion. Because the VSL varies elastically with income, regulatory agencies should regularly update the VSL used in benefit assessments, increasing the VSL proportionally with changes in income over time.panel data, quantile regression, VSL, value of statistical life, fixed effects, PSID, fatality risk, CFOI

Explicit Versus Implicit Income

By supplementing income explicitly through payments or implicitly through taxes collected, income-based taxes and transfers make disposable income less variable. Because disposable income determines consumption, policies that smooth disposable income also create welfare improving consumption insurance. With data from the Panel Study of Income Dynamics we find that annual consumption variation is reduced by almost 20 percent due to explicit and implicit income smoothing. Consumption insurance is as important economically as private health or automobile insurance. Although taxes have become an increasingly important source of consumption insurance, the 2001 income-tax reform legislation should have little effect on implicit consumption insurance

The Importance of Sample Attrition in Life Cycle Labor Supply Estimation

We examine the importance of possible non-random attrition to an econometric model of life cycle labor supply including joint nonlinear taxation of wage and interest incomes and latent heterogeneity. We use a Wald test comparing attriters to nonattriters and variable addition testing based on formal models of attrition. Results from the Panel Study of Income Dynamics are that non-random panel attrition is of little concern for prime-aged male labor supply estimation because the effect of attrition is absorbed into the fixed effects. Attrition is less econometrically influential than research design decisions typically taken for granted; the wage measure or instrument set has a much greater impact on the estimated labor supply function of prime-aged men than how one includes panel attrition

Tax Reform and Automatic Stabilization

A fundamental property of a progressive income tax is that it provides implicit insurance against shocks to income by dampening the variability of disposable income and consumption. The Economic Recovery Tax Act of 1981 (ERTA) in combination with the Tax Reform Act of 1986 (TRA86) greatly reduced the number of marginal tax brackets and the maximum marginal rate, which limits the stabilizing effect of the tax system on household consumption when pre-tax income fluctuates. We examine the effect of the federal income tax reforms of the 1980s on the associated degree of automatic stabilization of consumption. The empirical framework derives from the consumption insurance literature, where the ideal outcome is spatially equal changes in households’ marginal utilities of consumption, and permits partial insurance, which we use to identify how the degree of consumption insurance has changed since ERTA and TRA86. Our data come from interview years 1980–1991 in the anel Study of Income Dynamics. We find that in certain cases the tax reforms of the 1980s actually increased the automatic stabilization inherent in the United States income tax. Overall, ERTA and TRA86 reduced consumption stability by about 50 percent. More recent tax reforms, most notably increased EITC generosity, have restored or enhanced consumption insurance. A welfare analysis indicates that the cost of moving to the post-TRA86 system is sizable for relatively risk averse households facing large income risk, but is much more modest for the typical household

How Unobservable Productivity Biases the Value of a Statistical Life

A prominent theoretical controversy in the compensating differentials literature concerns unobservable individual productivity. Competing models yield opposite predictions depending on whether the unobservable productivity is safety-related skill or productivity generally. Using five panel waves and several new measures of worker fatality risks, first-difference estimates imply that omitting individual heterogeneity leads to overestimates of the value of statistical life, consistent with the latent safety-related skill interpretation. Risk measures with less measurement error raise the value of statistical life, the net effect being that estimates from the static model range from $5.3 million to$6.7 million, with dynamic model estimates somewhat higher.

Accounting for the Decline in AFDC Caseloads: Welfare Reform or Economic Growth?

Nationwide, AFDC caseloads have decreased by about 18 percent since March 1994, while some states, such as Wisconsin, Indiana, and Oregon, have seen declines of 40 percent or more. Two factors are frequently suggested as possible causes: state-level experiments with welfare reform and strong economic growth. In this paper, we use state-level monthly panel data from 1987 to 1996 to assess the importance of each of these factors by estimating a model of AFDC caseloads as a dynamic function of time-dependent state welfare reform variables (welfare waivers) and economic variables such as per capita employment. Our results from the dynamic model suggest that the decline in per capita AFDC caseloads is attributable largely to the economic growth of states and not to waivers from federal welfare policies. In the 26 states experiencing at least a 20 percent decline in per capita AFDC caseloads between 1993 and 1996, we attribute 78 percent of the decline to business-cycle factors and 6 percent to welfare waivers.

Policy Relevant Heterogeneity in the Value of Statistical Life: New Evidence from Panel Data Quantile Regressions

We examine differences in the value of statistical life (VSL) across potential wage levels in panel data using quantile regressions with intercept heterogeneity. Latent heterogeneity is econometrically important and affects the estimated VSL. Our findings indicate that a reasonable average cost per expected life saved cut-off for health and safety regulations is $7 million to$8 million per life saved, but the VSL varies considerably across the labor force. Our results reconcile the previous discrepancies between hedonic VSL estimates and the values implied by theories linked to the coefficient of relative risk aversion. Because the VSL varies elastically with income, regulatory agencies should regularly update the VSL used in benefit assessments, increasing the VSL proportionally with changes in income over time