NBER Reporter: Summer 2001

Public Economics

The NBER's Program on Public Economics, directed by James M. Poterba of MIT, met in Cambridge on April 6. The following four papers were presented and discussed:

Leora Friedberg, NBER and University of Virginia, and Anthony Webb, University of California, San Diego, "The Impact of 401(k) Plans on Retirement"

Discussant: Andrew Samwick, NBER and Dartmouth College

Mark H. Lang and Edward L. Maydew, University of North Carolina, and Douglas A. Schackleford, NBER and University of North Carolina,

"Bringing Down the Other Berlin Wall: Germany's Repeal of the Corporate Capital Gains Tax"

Discussant: William M. Gentry, NBER and Columbia University

Douglas Holtz-Eakin, NBER and Syracuse University, and Donald Marples, Syracuse University, " Distortion Costs of Taxing Wealth Accumulation: Income versus Estate Taxes" (NBER Working Paper No. 8261)

Discussant: William Gale, Brookings Institution

B. Douglas Bernheim and Antonio Rangel, NBER and Stanford University, and Luis Rayo, Stanford University, "A Theory of Legislative Policymaking: Part 1, Basic Institutions"

Discussant: Stephen Coate, NBER and Cornell University

In 1993, nearly 40 million people were covered by a 401(k) plan, up from about 7 million in 1983. Previous research showed that the spread of defined benefit plans with sharp age-related incentives, first discouraging and later encouraging retirement, contributed to the early retirement trend of past decades. Defined contribution plans differ along several dimensions, especially in their smooth rate of pension wealth accrual. Friedberg and Webb use data from the Health and Retirement Study to show that retirement patterns have begun to change as defined contribution plans have spread. Their estimates indicate that the financial incentives in defined benefit pensions lead people to retire almost two years earlier on average, compared to people with defined contribution plans.

Faced with pressure from increased global competition and capital mobility, Germany's government made a surprise announcement in December 1999 that it would repeal the longstanding capital gains tax on sales of corporate cross-holdings. The repeal was hailed as a revolutionary step toward breaking up Germany's complex web of cross-ownership. When the changes become effective in 2002, Germany will move from having one of the most punitive taxes on corporate capital gains to having the smallest among major industrial countries. Lang, Maydew, and Shackleford use Germany as a natural experiment to study the extent to which taxes present a barrier to the efficient acquisition and divestiture of stakes in other firms. In particular, they examine the stock market response by German firms to the announcement that capital gains taxes on inter-company holdings would be eliminated. They find a positive association between a firm's abnormal stock returns and the extent of its cross-holdings, consistent with taxes acting as a barrier to efficient allocation of ownership and investment. However, the reaction is limited to the largest banks and insurers and their extensive minority holdings in industrial firms, suggesting that taxes are not the binding constraint preventing most firms from divesting their cross-holdings.

Holtz-Eakin and Marples develop a framework for computing the deadweight loss of a revenue-neutral switch from an estate tax to a capital income tax. They focus on the potential lifetime behavioral responses in anticipation of paying the estate tax. They conclude that eliminating the estate tax and replacing its revenue with that from a capital income tax likely will enhance economic efficiency. Specifically, they estimate that the mean decrease in deadweight loss is $.018 per dollar of wealth. However, their estimates are based on data that do not contain the "super rich" who are most deeply affected by the estate tax.

Bernheim, Rangel, and Rayo propose and explore a general framework for modeling legislative institutions. Their analysis reveals a surprisingly robust tendency for a natural class of legislative institutions to produce high concentrations of political power. For the simplest institutions they consider, the authors identify surprisingly weak conditions under which the legislator with the last opportunity to make a proposal is effectively a dictator. Moreover, this outcome is more likely to arise when more legislators have opportunities to make proposals. Thus, seemingly democratic (inclusive) reforms can have the perverse effect of further concentrating political power. Super-majority requirements do little to overcome the dictatorial power of the final proposer. When the rules of the legislature permit members to bring deliberations to a close through collective action, the power of the last proposer may evaporate. However, the particular outcome depends on the details of the closure rules. When legislators are not permitted to bundle policy proposals with closure motions, one can obtain almost anything from inaction to a universalistic outcome, depending on the initial status quo.