Knowledge that Transforms

The U.S. federal budget deficits averaged about 1 percent of GNP in the 1960s, about 2 percent of GNP in the 1970s, and then rose to a peak of 5.5 percent of GNP in the four bad years of fiscal 1983 to fiscal 1986. By fiscal 1989, they had fallen back to 2.9 percent of GNP, and under present legislation they are now projected to drop to about 1.5 percent of GNP by 1994. When deficits were at their peak, before the start of the budget bargain for fiscal 1987 (the first budget to show any sizeable deficit reduction), the country passed the GrammRudman-Hollings (GRH) deficit control law. This law has been revised and amended over time, but it is still operating in roughly its initial form. Superficially, the numbers given above suggest that it must be working pretty well. Moreover, in many ways GRH was written to respond to the standard criticisms of deficit constraint legislation: it did not call for abrupt cuts in deficits but rather gradual declines, it was legislative and flexible rather than constitutional and rigid. Yet just as the country is on the verge of finally getting its deficits under control, the legislation is coming under vicious attack, including even that of one of its sponsors, Senator Hollings. Why should such an apparently successful piece of legislation be so widely scorned? In this paper I take on this question. I first illustrate how GRH was intended to operate with a simple indifference curve model, and use this model to see what kinds of changes should have occurred in budget bargains and spending patterns. Then I look for these changes by comparing numbers from the pre-GRH era (1983-86) with those from the post-GRH era (1987-89). I also identify other sources of improvement in budgetary position from the earlier to the later period. This numerical comparison suggests that the direct effects of GRH played a very minor role in the improvement in the U.S. budgetary position, though it seems likely that difficult to evaluate indirect effects were much more significant.

As is widely known, the EEC has gone through some troubling budgetary difficulties in recent years. Disputes have revolved around the growth of agricultural subsidies and about the contributions to be made to the EEC by various member countries; in particular, the U.K. These problems have been brought under control for the short run. However, the implementation of the Single European Act could be greatly complicated, and might falter, if policymakers again became intensely involved in acrimonious budgetary disputes. Maintaining budgetary control for the next several years, and for that matter in the longer term as well, is thus a matter of considerable tactical importance within the context of the overall progress of European economic affairs. In view of the fact that the threat of acute budgetary crisis has receded somewhat, and in view of the prospect of a significant step forward toward more complete economic integration associated with the 1992 initiative, it seems appropriate to give some thought to the budgetary problems that the EEC is likely to confront in the medium term. At a time of enormous political change in Eastern Europe, it is exceptionally hazardous to attempt projections about economic affairs in the EEC. It is easy to visualize scenarios in which significant amounts of resources, whether from the EEC itself or from individual member states, are directed toward promoting economic and other reform in the East, forcing new choices with respect to the commitment of resources by member countries to the EEC. However, to limit the scope of this paper, attention is restricted to developments within the EEC itself. The major trends in the EEC budget are easily delineated, since only a few main initiatives account for the bulk of EEC expenditures. First, agricultural subsidies through the European Agricultural Guidance and Guarantee Fund (EAGGF) have entailed large expenditures. Through the 1980s, these outlays accounted for about two-thirds of EEC expenditures. Another major category of EEC expenditures are for the so-called funds, in particular the European Regional Development Fund (ERDF) and the European Social Fund (ESF). The ERDF funds economic development projects in specially targeted low-income regions. The ESF funds programs that promote the training and employment of workers, especially youth and long-term unemployed persons. These and related expenditures have accounted for about 10-15 percent of expenditures during the 1980s. Altogether, then, agricultural and structural expenditures account for about 85 percent of the total budget. The U.K. has repeatedly protested against what it regards as excessive contributions to the EEC relative to the return that it gets in the form of structural fund outlays, and it has garnered a partial rebate of its contributions to the EEC, equal to two-thirds of the difference between the U.K. VAT contribution and EEC expenditures allocable to the U.K. These rebates account for roughly 5 percent of the EEC budget. As a result of decisions taken in 1988, the outline of the EEC budget for the next sevtDiscussants: Paul Courant, University of Michigan; Rudolph Penner, The Urban Institute; John Yinger, Syracuse University.

Ronald Findlay's analysis of the long-run equilibrium (uniform international growth rates) determinants of the terms of trade, in the context of North-South models of trade and growth, is reconsidered when the North is a Keynesian and a Kaleckian economy. Also examined are the determinants of the terms of trade in long-period equilibrium (uniform profit rates), so that the consequences of capital mobility are accounted for. Two surprising results are noted: first, the long-run terms of trade when the North is a Kaleckian economy will be independent of the North's markup and, second, in the long-period it is theoretically possible for the North to raise its markup, but experience a deterioration in its own terms of trade. Copyright 1990 by American Economic Association.

In a recent article in this Review (Kuhn, 1987), Peter Kuhn seeks to assess the relative importance of statistical and other types of evidence in determining women's perceived level of discrimination. The author's point of departure is what he characterizes as a surprising relationship. He finds a robust, but statistically insignificant, negative correlation between the conventional measure of salary discrimination (statistical in Kuhn's terminology) facing a female worker and the probability that the worker will report discrimination on a confidential survey. In other words, workers facing higher levels of measured salary discrimination are less likely to perceive discrimination. Kuhn explains this finding by hypothesizing the existence of some other evidence (4nonstatistical evidence), which, in addition to the salary differential, leads women to recognize and report sex discrimination in their employment. If the quantity of nonstatistical evidence is low, according to Kuhn, women may not report discrimination even if the statistically measured salary differential is large. Kuhn assumes that the quantity of nonstatistical evidence, which is observed by the worker, but not the researcher, is a function of the worker's observed human capital characteristics. Finally, Kuhn evaluates the effect of the nonstatistical evidence using the worker's observed characteristics as a proxy for the unobserved nonstatistical evidence. According to Kuhn's findings, the unobserved variable is a more important determinant of the worker's decision to report discrimination than is the level of statistically measured wage discrimination. Kuhn uses these results to question the importance of recent Supreme Court decisions allowing statistical measures of discrimination to be admitted into evidence in civil sex discrimination suits. As he concludes that such evidence is not the primary factor influencing workers' reporting behavior, allowing these measures to be presented in court should not lead to a large increase in litigation. In this comment, we argue that Kuhn's result, that workers facing a high level of measured discrimination are less likely to report the discrimination, may be explained by incorporating the quality of information, employers' preferences, and the costs of discrimination into the model. We derive conditions under which the negative correlation between measured and reported salary discrimination may be seen as the result of a rational balancing by employers of the benefits and costs of discrimination. Briefly, employers are more likely to discriminate when employees have less accurate information and the probability of reporting, and hence detection, is low. We also offer statistical evidence from the academic labor market to illustrate this alternative hypothesis.

In an earlier paper (Raymond C. Battalio, John H. Kagel, and Don N. Mac Donald, 1985), we reported Allais-type violations of the independence axiom of expected utility theory with rats choosing over positively valued payoffs (food rewards). This note extends this research, examining animals' choices over losses, testing for (1) standard Allais-type common ratio effect violations of expected utility theory and (2) fanning out of indifference curves for random prospects, tests of Mark J. Machina's (1982, 1987) hypothesis II (hereafter H2), over previously unexplored areas of the unit probability triangle. Results from a parallel series of experiments using human subjects choosing over real losses are also reported. For both rats and people, we find standard Allais-type violations of expected utility theory and a systematic failure of the fanning out hypothesis in the southeast corner of the unit probability triangle, in the case of losses. Thus, the fanning out hypothesis (Machina 1982, 1987) cannot provide a satisfactory explanation for behavioral deviations from expected utility theory.

Sufficient evidence now exists to confirm a strong rising trend in wage inequality in the United States since at least the mid-1970s. Still elusive is a definitive explanation for this tendency. In the pursuit of one, researchers have now begun to turn their attention to two factors: 1) on the supply side, an apparent rapid growth in the rates of return to education; and 2) on the demand side, an acceleration in industrial restructuring, in particular, the shift in employment from goods production to services. In this connection, the decline in unionization and the expanded exposure of the manufacturing sector to international competition have received renewed consideration. This paper contends that it is precisely the increasing returns to schooling in both goods and services in combination with the shift in employment between the two that is responsible for the recent growth in wage dispersion.

A nonparametric analysis of technology, technical change, and productivity is presented in the context of cost minimizing behavior. A number of nonparametric tests concerning the existence and nature of technical change are applied to U.S. and Japanese manufacturing data. Nonparametric measures of technical change are presented. Copyright 1990 by American Economic Association.

The federal income tax has been under attack by the economics profession for more than a decade. The attack comes from two directions: supply-siders who believe that progressive income taxation impairs economic incentives,' and more traditional economists who would substitute a progressive expenditure tax for the income tax.2 At one time, support for the expenditure tax was confined to a few members of our profession, including such distinguished names as John Stuart Mill, Irving Fisher, Nicholas Kaldor, and James Meade. Today, it is fair to say that many, if not most, economists favor the expenditure tax or a flat rate income tax. This group has joined the opponents of progressive taxation in the attack on the income tax. Despite an incessant barrage from both groups, no country in the world is planning to abandon the income tax or is even considering a personal expenditure tax. A wave of tax reform, beginning with the U.S. reform in 1986, has been sweeping the world, aimed at improving the income tax, not at eliminating it. Tax preferences formerly regarded as sacrosanct are being removed and there is a distinct movement toward comprehensive income taxation.3 However, individual income tax rates are being cut, tax progressivity has been declining almost everywhere, and reliance on the income tax has been diminishing. It will come as no surprise to this audience that I approve of the base-broadening feature of the current tax reform movement, but I believe that the reduction in the redistributive effect of the income tax has gone too far. In this paper, I shall show that the progressivity of the U.S. tax system-never very pronounced, except during and immediately after the two world wars-has been declining for more than two decades and that the Tax Reform Act of 1986 reversed this decline, but only slightly. Consequently, we have a long way to go to improve the equity of the tax system. I believe this can be done without punitive tax rates that will hurt economic incentives. I begin with a brief review of recent changes in the U.S. distribution of income and follow this with an analysis of the effect of taxes on the income distribution. I next examine arguments for and against the income tax, with particular emphasis on its effects on economic incentives and its merits when compared with the expenditure tax. I then evaluate the income tax as it emerged from the 1986 tax reform and conclude with tJoseph Pechman passed away on August 19, 1989. His Presidential address was delivered at the onehundred second meeting of the American Economic Association, December 29, 1989, Atlanta, Georgia. *Joseph A. Pechman, Economic Studies Program, The Brookings Institution, 1775 Massachusetts Avenue NW, Washington, DC 20036. I have benefited from the comments and suggestions on an earlier draft of this paper by Henry J. Aaron, Richard Goode, Jane G. Gravelle, Robert W. Hartman, Donald W. Kiefer, Herbert E. Klarman, Robert D. Reischauer, Clifford M. Winston, and H. Peyton Young, but they should not be held responsible for the views expressed in this paper. I am indebted to Richard Kasten for various simulations. I am also grateful to Stephen J. Kastenberg for research assistance and to Diane A. Shugart, Valerie M. Owens, and Sara C. Hufham for secretarial assistance. 'Some of the more extreme supply siders argued that large tax cuts pay for themselves (see, for example, Laffer, 1981), but I believe it is fair to say that this view has been totally discredited. For a more reasonable supply-side view, see the Economic Report of the President 1982. 2See, for example, Michael J. Boskin (1978), David E. Bradford (1980), Charles L. Ballard, Don Fullerton, John Shoven and John Whalley (1985), Paul Courant and Edward Gramlich (1982), Martin Feldstein (1978), Robert Hall and Alvin Rabushka (1985), John Kay and Mervyn King (1983), Charles McLure (1987), Mieszkowski (1980), and Lawrence Summers (1981). It is interesting that the recent popularity of the expenditure tax among economists was stimulated by a tax lawyer, William D. Andrews (1974). 3See Pechman (1988).

One question development economists are especially interested in but so far left unanswered is: how would the societal income distribution be affected by introducing a family-planning program to reduce the reproduction rate of the poor which is usually high in developing countries? The purpose of this paper is to search for analytical answers to this question. We are able to make definite comparisons about some class of inequality measures of the steady-state societal income distributions and these comparisons provide strong theoretical support in favor of the above-mentioned family-planning program. (EXCERPT)