Knowledge that Transforms

Prior to the Tax Reform Act of 1986 (TRA 86), interest paid on all types of household debt was deductible from income before the payment of taxes. In 1986, Congress changed the law to phase out the deductibility of interest over a five-year period.' Congress believed deductibility of interest an incentive to invest in durables rather than assets which produce taxable income and, therefore, an incentive to consume rather than save.... By phasing out the present deductibility of personal Congress intended to eliminate from the prior tax law a significant disincentive to (Joint Committee on Taxation [JCT], 1987 p. 263). The other goal of the provision was to raise $9.6 billion per year in tax revenue by 1991. Because Congress determined that encouraging home ownership is an important policy goal, achieved in part by providing a deduction for residential mortgage interest, it chose to retain the residential mortgage interest deduction (JCT, 1987 pp. 263-64). Thus, mortgage interest was fully deductible for interest paid on debt secured by a taxpayer's first or second residence up to his basis in the residence. The Omnibus Budget Reconciliation Act of 1987 (OBRA 87) changed the law so that interest paid was fully deductible on up to $1 million in acquisition debt and $100,000 in home equity debt.2 Debt is categorized as acquisition debt if it is used for the purchase or improvement of a home; home equity debt includes all other debt secured by a home. By keeping the mortgage interest deduction, Congress may have provided a loophole that some taxpayers could exploit. There was no restriction on the use of home equity debt, and taxpayers who owned homes could borrow against their home equity to pay for the same purchases they had previously funded with loans. Homeowners were given an incentive to shuffle their portfolios away from debt into mortgage debt. The widespread introduction of home equity lines of credit in the mid-1980's, which may have been spurred in part by the change in tax law, provided an inexpensive and flexible method for households to make this shift.3 Measuring the extent of portfolio shuffling is important for understanding whether households view mortgage and debt as close substitutes. Clearly the substitution of mortgage debt for debt undermines the goals of Congress to boost saving and increase revenue. Moreover, homeowners already have substantial tax preferences through the lack of taxes on the imputed income from housing and the preferential tax treatment of capital gains on their principal residence. The ability to use deductible mortgage debt to finance purchases provides homeowners another tax advantage relative to renters. Figure 1 plots the percentage change in * Putnam Investments, One Post Office Square, Bos on, MA 02109 (e-mail: [email protected]). This paper was completed while I was on the staff of the Board of Governors of the Federal Reserve System. Financial support from the Stanford Institute for Economic Policy Research and the Lynde and Harry Bradley Foundation is gratefully acknowledged. I would like to thank John Shoven, Orazio Attanasio, John Pencavel, Tim Bresnahan, Anne Royalty, Doug Bernheim, Al Teplin, Craig Furfine, Martha StarrMcCluer, Raphael Bostic, Len Burman, Julia Coronado, two anonymous referees, seminar participants, and the Financial Institutions Research Review Group for helpful comments. The views expressed in this paper are those of the author and do not necessarily reflect the views of Putnam Investments or the Federal Reserve Board or its staff. 1 In this paper, consumer interest refers to interest paid on loans that are not secured by a residence. 2 Under TRA 86, interest paid on qualified educational and medical debt secured by a home was also deductible, even if this debt exceeded the household's basis. This provision was not renewed in OBRA 87. Under OBRA 87, home equity debt also could not exceed the difference between the fair market value of the home and the amount of acquisition debt, even if this difference was less than $100,000. 3 Of course, homeowners can also increase their mortgage debt by taking out a traditional home equity loan, by taking cash out when refinancing their mortgage, or by taking out a larger mortgage when they Durchase a home.

Monetary Instability, the Predictability of Prices, and the Allocation of Investment: An Empirical Investigation Using U.K. Panel Data by Paul Beaudry, Mustafa Caglayan and Fabio Schiantarelli. Published in volume 91, issue 3, pages 648-662 of American Economic Review, June 2001

Between 1973 and 1978, the Indonesian government engaged in one of the largest school construction programs on record. Combining differences across regions in the number of schools constructed with differences across cohorts induced by the timing of the program suggests that each primary school constructed per 1,000 children led to an average increase of 0.12 to 0.19 years of education, as well as a 1.5 to 2.7 percent increase in wages. This implies estimates of economic returns to education ranging from 6.8 to 10.6 percent.

A Test of Game-Theoretic and Behavioral Models of Play in Exchange and Insurance Environments by Cary A. Deck. Published in volume 91, issue 5, pages 1546-1555 of American Economic Review, December 2001

International Trade and Business Cycles: Is Vertical Specialization the Missing Link? by M. Ayhan Kose and Kei-Mu Yi. Published in volume 91, issue 2, pages 371-375 of American Economic Review, May 2001

This paper focuses on pure redistribution among two regional governments. We abstract from mobility of tax bases and externalities in public goods not because they are unimportant, but because they are already well understood. Under conditions of full information, unlimited commitment capacity, and no spillover effects across regions, optimal redistribution is lump sum But these ideal circumstances are seldom met. One of the central results of the paper is that, to cope with asymmetric information, optimal regional redistribution must distort the tax rate chosen by the poor region away from the second best.

Does Buffer-Stock Saving Explain the Smoothness and Excess Sensitivity of Consumption? by Sydney C. Ludvigson and Alexander Michaelides. Published in volume 91, issue 3, pages 631-647 of American Economic Review, June 2001

Economics instruction in U.S. high schools is basically delivered in two ways. About half of high-school students take a required or elective course in economics, according to transcript data. The great majority of these students (about 95 percent) enroll in a regular course that focuses on basic economic concepts with applications. The remaining small percentage of students take a college-oriented course that is often called “honors” or Advanced Placement (AP) economics. Economics instruction for the other half of high-school students, if it is provided at all, is typically delivered in the context of other courses in the high-school curriculum in what is sometimes called the “infusion” or “integrative” approach. These courses would most likely be required courses taught in the social studies, such as U.S. history or American government, or in elective courses taught in business education. This study investigates what high-school students know about basic economics given the different types of economics instruction. The primary focus is on the achievement of students who complete a basic course in high school economics. These results are important because they supply insights into what high school students who have received direct instruction in economics know about the subject. For comparison purposes, the achievement of students who have not taken a formal course in economics will be investigated to identify what they know about economics. The comparison of those students with and without instruction in a separate course in economics gives the best estimate of the importance of direct instruction in economics to the economic understanding of most high-school graduates. In addition, similar comparisons between those students with and without direct instruction in economics will be made for two groups of higher-ability students: those who enroll in honors or AP courses in economics and those who enroll in such courses for other social-studies subjects.

In spring 2000, we conducted a national survey of academic economists to determine how economics is taught in four different types of undergraduate courses (Principles, Intermediate Theory, Statistics and Econometrics, and other upper-division courses) at institutions in the five Carnegie classifications (research, doctoral, master’s, baccalaureate, and associate), as listed in A Classification of Institutions of Higher Education, 1994 Edition. This new survey replicates our 1995 survey (Becker and Watts, 1996). Therefore, we can compare the results from the two surveys to document changes in teaching methods, as well as the related academic issues that were addressed in the background information section of the surveys. A key reason for believing that teaching methods might have changed during this period was the sharp decrease in economics enrollments during the early 1990’s (Becker, 1997; John Siegfried and David K. Round, 2001). As we have documented elsewhere (Becker and Watts, 1998), there is evidence that economists are less likely to use non-lecture teaching methods than instructors in other fields, and that students rate economics instructors somewhat lower than they rate other instructors. Changing teaching methods and increasing the importance of teaching within economics departments, in response to falling enrollments, is therefore a plausible and endogenous response for faculty members and departments concerned about losing resources. Furthermore, there is at least circumstantial evidence that economists are devoting more attention to teaching than in the recent past (Becker, 2000). Since our 1995 survey, several books have been published to illustrate how economists can use a wide range of alternative teaching methods in undergraduate courses (e.g., Becker and Watts, 1998; William Walstad and Philip Saunders, 1998). Other books have appeared focusing on specific teaching methods, such as using classroom experiments, spreadsheet applications, or active-learning and cooperative-learning assignments (e.g., Diane Keenan and Mark H. Maier, 1995; Tod S. Porter and Teresa Riley, 1995; Theodore Bergstrom and John H. Miller, 1997; Denise Hazlett, 1999). Becker (2000) documents the increase in AEA sessions devoted to teaching economics at the annual meetings of the Allied Social Sciences Association during the mid-1990’s. At the 1998–2000 Allied Social Sciences Association (ASSA) meetings the number of sessions devoted to teaching economics ranged from 11 to 14, and presented sessions dealt with such topics as teaching economics in the transition economies (chaired by World Bank chief economist Joseph Stiglitz), a retrospective on Nobel laureate Paul Samuelson’s principles textbook, how faculty advisors can deal with student apprehensiveness about taking economics courses, and teaching business economics (chaired by Nobel laureate Ronald Coase). As recently as the 1996 ASSA meetings in San Francisco there were only six sessions on teaching economics, and at the 1994 meetings in Boston there were only four such sessions. Similarly small numbers of sessions were scheduled through the 1980’s. Here we ask whether any increased emphasis on teaching in economics departments has led to changes in how economics is taught. Do academic economists report that they are now * Becker: Department of Economics, Indiana University, Bloomington, IN 47405 (e-mail: [email protected]), and Adjunct Professor, School of International Business, University of South Australia; Watts: Department of Economics, Purdue University, West Lafayette, IN 47905 (e-mail: [email protected]). We thank Julia K. Huffer, Kevin M. Green, Siddhartha Kapoor, Chatchai Meteveravong, Alexandre Skiba, and Suzanne Becker for help in the mailing, data entry and tabulation, and preparing of this paper. Financial support from the Purdue University Center for International Business Education and Research, University of South Australia School of International Business, and the National Council on Economic Education through its sponsorship of the Journal of Economic Education is gratefully acknowledged.

We evaluate two alternative models of international trade in differentiated products. An increasing returns model where varieties are linked to firms predicts home market effects: increases in a country's share of demand cause disproportionate increases in its share of output. In contrast, a constant returns model with national product differentiation predicts a less than proportionate increase. We examine a panel of U.S. and Canadian manufacturing industries to test the models. Although we find support for either model, depending on whether we estimate based on within or between variation, the preponderance of the evidence supports national product differentiation.