Research

Time to Bury the Deadweight Loss: A New Partial-Equilibrium Approach to Approximating the Welfare Effects of Monopoly and Taxes (with Paul Klein)

We analyze the effects of monopoly power and commodity taxation, and provide a new partial-equilibrium formula for the change in surplus resulting from turning a monopolistic into a competitive market, or from changing a commodity tax rate. It differs from the traditional deadweight-loss (DWL) formula by taking into account the opportunity cost of resources. Because the DWL is based on partial-equilibrium analysis, it can only be a good approximation of true welfare losses if the market in question is small compared to the economy as a whole. But the DWL also requires an additional, much stronger assumption: that all other markets are undistorted. In examples with specific functional forms, we show that the DWL may even get the sign of the surplus change wrong when a substantial share of the economy is monopolized and/or subject to commodity taxes. By contrast, our formula provides an accurate approximation even when other markets are distorted.

Innovation-driven growth in a multi-country world (with Paul Klein) (Appendix)

We develop a multi-country model of endogenous growth through innovation with cross-country spillovers. A key feature of our model is that some ideas are globally applicable, while others are of local use only. The main implications of our model are the following. On a balanced growth path (i) all countries integrated into the world economy have a common endogenous rate of productivity growth; (ii) a fully integrated country's size does not affect its productivity, but for partially integrated countries, productivity is increasing in country size; (iii) other characteristics of a country, such as its research effort, determine the level of productivity; (iv) at a global level, there is a scale effect so that productivity growth increases in the size of the world's population, but this effect is concave and not linear. We also study transitional dynamics, and find that our framework may help us understand the apparent fall in research productivity in currently rich countries in recent decades.

Optimal Tax Policy and Endogenous Growth through Innovation (with Paul Klein) (click here for a link to the published article)

Journal of Public Economics, Volume 209, May 2022, 104645

We investigate optimal tax policy in a Romer-style endogenous growth model. We derive formulas for the optimal tax rates on capital, labor, and innovation on a balanced growth path. We compute the balanced growth path and the transition to it with optimal policy for a range of parameter values. We find that capital should be taxed in the short run, but be paid its marginal product in the long run. The returns to innovation and production labour, on the other hand, should always be lower than their marginal products. Whether the resulting taxes on innovative activity should be positive or negative depends on (a) the extent of government spending needs, (b) the importance of innovation externalities and (c) the market power of patent holders. The welfare gains from optimal policy are much larger than in a comparable exogenous growth model.

Dynamic Capital Tax Competition under the Source Principle (with Paul Klein and Miltiadis Makris) (click here for a link to the published article)

American Economic Journal: Macroeconomics, Vol. 14, No. 3, July 2022, pp. 365-410

We explore the short- and long-run implications of tax competition between jurisdictions, where governments can only tax capital at source. We do this in the context of a neoclassical growth model under commitment and capital mobility. We provide a new theoretical perspective on the dynamic capital-tax externalities that emerge in this model. Numerically, we show that the net capital-tax externality is positive in the short run but converges to zero in the long run. We also find that non-cooperative source-based capital taxes are initially positive and slowly decline towards zero. Coordinated capital tax rates are higher than non-cooperative ones in the short run, lower in the medium run, and the same in the long run. This stands in contrast to common beliefs and results from static and two-period models, which have informed policy debates in the European Union and elsewhere.

Dynamic Optimal Fiscal Policy in a Transfer Union (click here for a link to the published article)

Review of Economic Dynamics, Vol. 42, October 2021, pp. 194-238 (click here for the code)

Transfers between regions within a federal or supranational entity are highly prevalent and may yield substantial benefits; however, such transfers are also likely to have an impact on the involved regions' incentives to tax and spend and thereby efficiency. This paper studies theoretically and quantitatively how the taxation of strategically-acting tax authorities affects their optimal fiscal policy in a dynamic model. Fiscal policy is composed of source-based capital taxes, labour taxes, government consumption, productive infrastructure, and bonds. The global capital stock evolves endogenously due to private agents' optimal savings decisions as in a neoclassical growth model. Labour taxes, government consumption, and infrastructure are all declining functions of the share of government revenues which are transferred. Capital taxes are surprisingly increasing in transfers in the short run, but unaffected in the long run. In the short run, capital taxes are too low and infrastructure spending is too high from a global welfare perspective in the absence of transfers, whereas both are at the efficient level in the long run. The dampened capital-tax and infrastructure competition during the transition means that economic efficiency and thus welfare paradoxically increase for low levels of transfers, even though there are no redistributive gains from transfers.

Residence- and source-based capital taxation in open economies with infinitely-lived consumers (with Paul Klein and Miltiadis Makris) (click here for a link to the published article)

Journal of International Economics, Volume 127, November 2020, 103369

In this paper we investigate tax competition in a neoclassical growth model where each country may use both residence- and source-based capital taxes. We show that both types of capital taxes are zero at any interior steady state, just as in a closed economy. For symmetric countries, and even for countries that differ only with respect to size and productivity, we prove analytically and verify numerically that the open-economy policies coincide exactly with the closed-economy policies in all time periods. For countries that are asymmetric in other dimensions, we find that source-based taxes are used to manipulate the intertemporal terms of trade in the short run. Either way, the fiscal externalities of source-based taxes vanish once residence-based taxes are allowed.

Temporary Foreign Workers and Firms: Theory and Canadian Evidence (with Pierre Brochu & Christopher Worswick) (click here for a link to the published article)

Canadian Journal of Economics, Vol. 53, No 3, August 2020, pp. 871-915

Temporary Foreign Worker (TFW) programs have grown considerably in size when uncapped. We develop a simple efficiency-wage model to explain this phenomenon and examine the empirical evidence for it. We then use the model to evaluate the implications of TFW programs for domestic workers. In our framework, firms which have been unable to find domestic workers may hire TFWs at the wage previously advertised to domestic workers. Due to the lower outside option for TFWs than domestic workers, TFWs will exert more effort for the same wage. In equilibrium, lower wage offers are made to domestic workers and unemployment increases when a TFW program is in place. Using Canadian data, we find that, relative to domestic workers, TFWs work longer hours, have lower rates of absenteeism, and are less likely to be laid off, consistent with higher effort in our model. Moreover, for TFWs from home countries with a relatively high outside option, effort is lower than for TFWs from other countries.

Sequential versus Simultaneous Trust (with Maros Servatka and Radovan Vadovic) (click here for a link to the published article)

Journal of Institutional and Theoretical Economics, Vol. 176, No 3, September 2020, pp. 446-472

We theoretically and experimentally examine the implications of trusting behavior arising under sequential and simultaneous designs. In this institutional design problem, player A makes an investment choice, and player B decides whether to share the investment gains with player A. In the sequential design, the level of investment is observable, allowing for more sophisticated strategic behavior by player A than is possible in the simultaneous design. Theoretically, we show that in certain circumstances the simultaneous design may actually result in a more efficient outcome than the sequential design. In our experiment, we compare the two designs not only in terms of outcomes but also in terms of perceived cooperation levels, which represent a proxy for trust in the institution itself. Although the outcomes of the two designs differ in predictable ways, i.e., the investment levels, sharing rates, and efficiency are all significantly higher in the sequential design, we do not find corresponding differences in the perceived cooperation levels. We conjecture that this happens because in the sequential design a substantially higher exposure by player A is necessary to induce cooperation by player B. Our data strongly support this conjecture.

Unemployment and Income-distribution Effects of Economic Growth: A Minimum-Wage Analysis with Optimal Saving (with Richard Brecher) (click here for a link to the published article)

International Journal of Economic Theory, Vol. 16, No 3, September 2020, pp. 243-259

Theoretically and numerically, we analyze the unemployment and income-distribution effects of economic growth, in a model with optimal saving (investment) and a minimum wage for unskilled labor.  Within this three-factor model (including skilled labor), an exogenous rise in the growth rate increases unemployment if capital and unskilled labor are complements (versus substitutes), implying a trade-off between (faster) growth and (lower) unemployment.  We also show how the growth rate affects the skill premium and factor shares of national income, providing little support for Piketty’s (2014) controversial thesis that capital’s share is higher when growth is slower.

A Minimum-Wage Model of Unemployment and Growth: The Case of a Backward-Bending Demand Curve for Labor (with Richard Brecher) (click here for a link to the published article)

International Journal of Economic Theory, Vol. 15, No 3, September 2019, pp. 297-309

We add a minimum wage and hence involuntary unemployment to a conventional two-sector model of a perfectly competitive economy with optimal saving and endogenous growth. Our resulting model highlights the possible case of a backward-bending demand curve for labor, along which a hike in the minimum wage might increase total employment. This possibility provides theoretical support for some controversial empirical studies, which challenge the textbook prediction of an inverse relationship between employment and the minimum wage. Our model also implies that a minimum-wage hike has negative implications for both the growth rate and lifetime utility.

Employment Gains from Minimum-Wage Hikes under Perfect Competition: A Simple General-Equilibrium Analysis (with Richard Brecher) (click here for a link to the published article)

Review of International Economics, Vol. 26, Issue 1, February 2018, pp. 165-170

Contrary to conventional wisdom, higher minimum wages may lead to greater levels of employment under perfect competition.  We demonstrate this possibility in a simple general-equilibrium model with two goods produced by two factors and consumed by two representative households.  Within our model, hiking a minimum wage redistributes income between heterogeneous consumers.  This redistribution may create an excess demand for the labor-intensive good, and hence increase employment to restore equilibrium, despite the fact that every firm becomes less labor intensive.

Merit Pay and Wage Compression with Productivity Differences and Uncertainty (with Gary Charness & Christopher Guo)  (click here for a link to the published article)

Journal of Economic Behavior and Organization 117 (2015), pp. 233-247

This paper experimentally investigates wage setting and effort choices in a multi-worker setting when there is heterogeneity in worker productivity and managers' perception of this productivity is imperfect. Worker ability is assigned via an aptitude test and, in an innovative design, manager uncertainty concerning this ability is related to the manager's own test performance. We propose a merit-pay hypothesis, that higher-ability workers will reduce their effort if they are not paid more than coworkers with lower ability, but not vice versa. Based on a simple model, we also predict that the higher the uncertainty about employee ability levels, the more managers compress wages between perceived high- and low-ability workers. We find strong experimental support for both hypotheses.

Equilibrium Capital Taxation in Open Economies under Commitment (click here for a link to the published article)

European Economic Review 70 (2014), pp. 75-87

This paper analyzes equilibrium capital taxation in open economies with strategic interaction in a neo-classical growth model. Under perfect commitment, I show that non-cooperative capital taxes are zero in the long run for a large open economy, thereby generalizing the result previously established only for the special cases of a closed and a small open economy. This does not represent a race to the bottom, though, since the result is independent of the degree of capital mobility, the number of countries, or a country's size relative to the rest of the world. Moreover, when countries cooperate, they still set capital taxes to zero in the long run. These outcomes are robust to different equilibrium specifications, the inclusion of endogenous government spending, and heterogeneous agents and non-linear labor income taxation. Governments find it optimal to implement the efficient capital allocation in the long run, both in a closed and an open economy; this trumps incentives to tax foreigners' domestic capital holdings by raising capital taxes and attracting capital from abroad by lowering capital taxes.

Unpublished working papers

On the relevance of tax competition when it is optimal to tax capital income in the long run

I analyze international tax competition for strategically competing governments, where the global capital stock is determined endogenously as in a neo-classical growth model. Under perfect commitment, governments optimally tax capital in the long run in the same way for a closed economy as in an open economy. This is independent of relative country size or capital taxes in other countries and is robust to a large set of modeling choices as to why capital is taxed in the first place. In contrast, with an exogenous capital stock, returns on capital are pure rents and a government's ability to capture them is limited through capital flight, triggering a race to the bottom in capital taxes. With an endogenous capital stock, capital is an intermediate good and does not produce any rents, so that capital taxes are not used to raise revenues, but to implement the optimal capital allocation. Even in a non-cooperative game it is thus not individually rational for governments to engage in tax competition in the long run.

Capital Taxation, Intermediate Goods, and Production Efficiency

An important controversy in public finance is whether long-run capital taxes are optimally zero or not, with a broad variety of models supporting each claim. This paper examines the question whether capital is special and if so, what the underlying principle could be that explains both types of results. I show that in a wide class of models capital is provided without distortions, i.e. that the government's intertemporal marginal rate of substitution and transformation are the same in first and second best. The conditions for this to hold are that the government is able to tax all of capital's co-factors of production and that capital does not enter the utility function. When individually rational behavior leads to sub-optimal capital accumulation, then capital taxes are used to implement the optimal allocation, while the generation or loss of tax revenues is incidental. The intuition is that capital is an intermediate good: optimal taxation seeks to raise revenues by taxing endowments and intermediate goods do not have any endowment component.

Financing Constraints, Firm Dynamics, and International Trade (with Stéphane Verani)

This paper studies the impact of financial constraints on exporter dynamics, and the role of financial intermediation in international trade. We propose a two-country general equilibrium model economy in which entrepreneurs and lenders engage in long-term credit relationships. Financial markets are endogenously incomplete because of private information, and financial constraints arise as a consequence of optimal financial contracts. In equilibrium, competitive financial intermediaries actively channel individuals' short-term deposits to fund a diversified portfolio of long-term risky firms. Young and small firms operate below their efficient level, and their financial constraint is relaxed as entrepreneurs’ claim to future cash-flows increases. Consistent with empirical regularities, there is a substantial year-to-year transition in and out of export markets for smaller firms, and new exporters account only for a small share of total exports. Established exporters are less likely to exit export markets, and tend to experience a more stable growth.