Knowledge that Transforms

Worldwide many governments rely on personal income taxation as one of their major sources of tax revenue. Casual empirical evidence suggests that, although most developed countries levy substantial taxes, particularly on higher incomes, there also exist a few countries that are characterized by no or very low income taxation. A distinguishing feature of the countries in the latter group is that they are geographically very small, as can be seen from Table 1, which presents international income tax policies and geographical dimensions of some selected countries. In the present paper, we investigate whether the geography of a country is related to its pattern of taxation. Central to our argument is the ongoing international integration in the last decades. In some cases (e.g., in the European Union) the process has advanced to the point at which all formal constraints to mobility have been abandoned. This development has also greatly improved the mobility of households across states or national borders. In contrast to the mobility of production factors, however, the effects of household mobility (migration) are not confined to budgetary consequences as taxpayers immigrate or emigrate: the inand outflow of citizens also alters policy objectives by changing the composition of the electorate in a jurisdiction. At the same time migration decisions, especially those of wealthy individuals, are based on local tax policies. Consequently, the migration of households determines fiscal policies through the interplay of two basic effects: (1) residential choices determine tax rates through a process in which a jurisdiction's inhabitants select their local policies, and (2) tax and welfare policies in each jurisdiction influence residential decisions. As we argue in this paper, this interdependency of residential and political decisions may provide an explanation for the stylized facts illustrated in Table 1. We consider a simple framework in which households differ in incomes and national tax policies are democratically determined. As a natural implication of their earning characteristics, high-income households ceteris paribus prefer to live in countries with low taxation. For ease of exposition, we refer to those countries as tax h(e)avens, in a slight perturbation of popular nomenclature. Low-income households, in contrast, are more interested in generous public spending than in low income tax rates. Ceteris paribus, they prefer to reside in countries with large welfare programs financed by substantial taxation, which we call tax hells for obvious reasons. Thus, individual preferences imply a self-selection process, which leads to the segregation of households across countries according to income classes.1 If this segregation is, in turn, supported by a national vote for low taxes in countries where high-income earners live and high taxes in countries where lower-income earners live, an equilibrium with tax heavens, populated by wealthy residents, and tax hells, populated by the less affluent, evolves. Yet, the geographical size of countries plays a crucial role in this development: first, it affects the number of a country's inhabitants (the population size). Because households sort *Hansen: Apax Partners & Company, Possartstr. 11, 81679 Miinchen, Germany; Kessler: Department of Economics, University of Bonn, Adenauerallee 24-42, 53113 Bonn, Germany ([email protected]). We thank two anonymous referees, Marcus Berliant, Dennis Epple, Christian Ewerhart, Gerhard Glomm, David Pines, Urs Schweizer, and participants in presentations at the University of Munich, the 1997 SITE meeting (Stanford), the 1997 American Econometric Society Summer Meeting (Pasadena), and the 1996 IIPF Congress (Tel Aviv) for helpful suggestions and discussions. Both authors gratefully acknowledge financial support by the Deutsche Forschungsgemeinschaft, SFB 303 at the University of Bonn. Remaining errors are our own. The views expressed in this paper should not be attributed to Apax Partners & Company. 1 The sorting of individuals by preferences across jurisdictions goes back to the famous contribution of Charles M. Tiebout (1956) on migration as a means to reveal preferences over public goods.

Accounting for individual-level heterogeneity in the response to treatment is a major development in the econometric literature on program evaluation. A substantial body of empirical evidence demonstrates that econometric models fit on individual-level data manifest heterogeneity in treatment effects that is present even after conditioning on observables. An important distinction is the one between evaluation models where participation in the program being evaluated is based, at least in part, on unobserved idiosyncratic responses to treatment and models where participation is not based on unobserved idiosyncratic responses. This is the distinction between selection on unobservables and selection on observables. The validity of entire classes of evaluation estimators hinges on whether or not they allow agents to act on unobserved idiosyncratic responses. In a wide variety of applications, the available evidence suggests that not only are ex post (postenrollment) responses heterogeneous, but that ex ante decisions to participate in programs are based, in part, on these heterogeneous responses (Heckman and Vytlacil, 2000b, 2001).

In Search of Homo Economicus: Behavioral Experiments in 15 Small-Scale Societies by Joseph Henrich, Robert Boyd, Samuel Bowles, Colin Camerer, Ernst Fehr, Herbert Gintis and Richard McElreath. Published in volume 91, issue 2, pages 73-78 of American Economic Review, May 2001

Revealed preference theory assumes that each consumer has demands that are rational, meaning that they arise from the maximization of his or her own utility function. In contrast, econometric or statistical demand models assume that each consumer's demands equal a rational systematic component derived from a common utility function, plus an individual-specific, additive error term. This paper reconciles these differences, by providing necessary and sufficient conditions for rationality of statistical demand models given individual consumer rationality. (JEL D11, D12, C30, C43)

This paper characterizes conditions under which interest-rate feedback rules that set the nominal interest rate as an increasing function of the inflation rate induce aggregate instability by generating multiple equilibria. It shows that these conditions depend not only on the monetary-fiscal regime (as emphasized in the fiscal theory of the price level) but also on the way in which money is assumed to enter preferences and technology. It provides a number of examples in which, contrary to what is commonly believed, active monetary policy gives rise to multiple equilibria and passive monetary policy renders the equilibrium unique. (JEL E52, E31, E63)

Estimating the Knowledge-Capital Model of the Multinational Enterprise by David L. Carr, James R. Markusen and Keith E. Maskus. Published in volume 91, issue 3, pages 693-708 of American Economic Review, June 2001

Research on productivity change in health care has surged in recent years. This interest reflects both policy interest in the value of health care and improving data capabilities and methods for productivity research. Because of the central importance of quality change in health care, this research has directly or indirectly considered not only changes in the costs of producing health services (e.g., the cost of a hospital day), but also changes in the benefits of health services for patient health. Some studies have compared overall changes in population health to changes in aggregate medical expenditures. For example, recent studies by Kevin Murphy and Robert Topel (1999) and William Nordhaus (1999) suggest that the value to current and future generations of Americans of improvements in life expectancy in recent decades has exceeded $2 trillion per year. Accounting for the improvements in ageadjusted functional health that also appear to have occurred in recent decades (e.g., Kenneth Manton et al., 1997) makes the improvement in health even greater. Cutler and Elizabeth Richardson (1999) estimate that, even if only 25 percent of the overall improvement in health is attributable to medical care, then health-care productivity has risen. Yet translating this into health-care productivity calculations leaves many issues unresolved. It is not immediately clear how to determine the share of health improvements that result from medical care. Further, even if overall productivity improvements have been high, it is possible that many changes in health-care productivity have been less valuable. Identifying areas of high and low past and potential future productivity improvements would be helpful for guiding policymakers. For all of these reasons, much of the recent research on health-care productivity has focused on explicit analysis of costs and outcomes for certain common, serious health problems, where other factors can be controlled for and relevant inputs and health outcomes can be measured. In this paper, we review the state of the art of the evidence on health-care productivity. We first summarize a set of recent productivity studies of common conditions that account for a substantial fraction of overall medical spending. These studies also illustrate the range of methods that have been used in disease-level productivity studies. In general, the studies show rather substantial productivity gains in care. We then present new evidence on productivity of treatment for breast cancer, a disease that, at least in its most common forms in adults, many experts believe has seen little improvement in benefits of care over time. Considering cancer allows us to focus on a condition where there is no presumption that medical care has been worthwhile, and where there are a host of complex issues related to case-finding, the timing of diagnoses, and chronic care. We find that the treatment of cancer has had at best small productivity improvements. Outcomes have improved more on a per-case basis than when considering the population as a whole.

In the aftermath of emerging market crises from Russia to Asia and Latin America, there is a quest for better monetary arrangements that are more crisis-proof. Fixed rates are out, flexible rates are in with a policy focus on inflation targeting. But there is, of course, the alternative of abolishing exchange rates all together. This paper revisits the issue of dollarization or currency boards to review what arguments in the debate stand up. The case for flexible exchange rates emphasizes the need for a tool to accomplish relative price adjustment. This paper argues that in an intertemporal perspective most shocks require financing in the capital market rather than adjustment. Moreover, countries frequently do not use their flexible rate to play a cyclical role and, as a result, only a pay a premium for the option to depreciate but do not take advantage of the flexibility; on the contrary, they engineer systematic overvaluation in the context of inflation targeting.

We study a contest with multiple, nonidentical prizes. Participants are privately informed about a parameter (ability) affecting their costs of effort. The contestant with the highest effort wins the first prize, the contestant with the second-highest effort wins the second prize, and so on until all the prizes are allocated. The contest's designer maximizes expected effort. When cost functions are linear or concave in effort, it is optimal to allocate the entire prize sum to a single “first” prize. When cost functions are convex, several positive prizes may be optimal. (JEL D44, J31, D72, D82)

This paper examines the question of whether households adjust savings in response to interest rates in a life-cycle model with precautionary savings, where both motives for saving (retirement and precautionary) are present. While uncertainty may be the most important motive for younger households, eventually, households will start saving for retirement as well. By how much the wealth of the median household at retirement changes after an exogenous permanent increase in the after-tax interest rate is computed. In an estimated life-cycle model with precautionary savings, the elasticity of savings is also very low. However, the results are sensitive to the utility parameters.