Knowledge that Transforms

During recent years much attention has been given to the role of bequests in explaining various aspects of economic behavior. For example, authors have studied the impact of bequests on physical wealth accumulation (Laurence Kotlikoff and Lawrence Summers, 1981), the interest elasticity of savings (Owen Evans, 1983), tax reform (Laurence Seidman, 1984), and the distribution of wealth (Alan Blinder, 1976a). More recently, economists have begun to distinguish between human and physical bequests (Gary Becker and Nigel Tomes, 1986). Acknowledging the presence of bequest in human form is important in analyzing each of the issues mentioned above. Outlays on children affect the shape of the family's labor supply and expenditure profiles, upon which the level of aggregate savings crucially depends. If these outlays are interest-sensitive substitutes for physical bequests, they will also influence the interest elasticity of savings. In the area of tax reform, the neutrality of the consumption tax depends on the ability of the government to identify human capital bequests from general consumption (Raymond Batina, 1987). If this is not possible, the portfolio-choice of investment in human versus physical capital may be distorted at the margin. Finally, the unequal transmission of wealth across generations may be explained by the lack of physical bequests and the inefficiently low levels of human bequests made by wealthconstrained households (Becker and Tomes, 1986). To distinguish clearly the behavior of constrained households from unconstrained households, who make sizeable physical bequests, both types of bequests must be recognized.' This paper introduces a model that makes explicit examination of these issues possible. It extends Lord's (1989) multiperiod model of life-cycle savings and adult human capital investment by adding altruistically motivated human and physical bequests.2 The model is calibrated using microeconomic data on earnings, time and goods expenditures on children's human capital, and physical bequests. We then use the model to examine the contribution of bequests to wealth accumulation and the level of savings. This topic is the source of an important but yet unresolved debate between Franco Modigliani (1988) and Kotlikoff (1988). Kotlikoff maintains that U.S. wealth accumulation is primarily the consequence of bequests, as opposed to life-cycle savings for retirement. One type of evidence cited by Kotlikoff comes from simulation results demonstrating the failure of realistically calibrated life-cycle models to generate sufficiently high saving rates and wealth:income ratios (Alan Auerbach and Kotlikoff, 1987). We show, however, that if a pure life-cycle

The desirability of switching from an income tax base to a wage or consumption tax base hinges critically on the potential efficiency gains from doing so. The overlapping-generations life-cycle model developed by Lawrence Summers (1981) cannot easily be used to answer this question. Because individuals of different ages alive at the time of the tax substitution differ in their shares of income, consumption, wages, and savings propensities, steady-state welfare changes include redistribution of taxes and factor incomes. The effects of redistribution on the calculation can be controlled for by tracing the transition. In another paper, Summers (1980) used myopic expectations (individuals assume that current prices will prevail) and solved the economy's equilibrium for 100 years. Gains and losses were discounted and summed. Alan Auerbach, Laurence Kotlikoff, and Jonathan Skinner (1983), hereafter referred to as AKS, employed a perfect-foresight model. They used lumpsum payments to keep the utility of those alive at the time of the tax change fixed and allowed equal equivalent variations to all future generations.1 A perfect-foresight model requires simultaneous solution of many years of equilibria (150 years in the AKS model). Although these techniques eliminate distributional elements, such models are so costly to construct, modify, and use that the study of relative efficiency of alternative tax regimes is now greatly hampered by computational complexity. This study has two major contributions. First, it introduces a much simpler method of separating the efficiency and redistributional components of steady-state gains. Rather than tracing the transition, it uses a system of transfers which ensures that changes in welfare in the steady state do not arise from redistribution of income to or from transitional generations. While this approach does not allow calculation of the transition, its application to the AKS model suggests that very little information about the magnitude of efficiency effects is lost by forgoing the tracing of the transition. For estimating the relative efficiency of income, consumption, and wage taxation, or the extent to which assumptions drive the results, this approach greatly simplifies the researcher's task.2 This simplification becomes increasingly valuable as more detail is introduced into models, which could involve thousands of equations using an approach that traces the transition. Secondly, my calculations suggest that switching tax bases may not be worthwhile. This result differs from the results of Summers (1981) and Auerbach and Kotlikoff (1987), which strongly suggest that the consumption tax is always superior on efficiency grounds. Using a 0.25 intertemporal substitution elasticity and a Cobb-Douglas production function, the steady-state wel*Congressional Research Service, Library of Congress, Washington, DC 20540. I thank Christophe Chamley, Don Fullerton, Yolanda Henderson, Don Kiefer, Larry Kotlikoff, Jonathan Skinner, Tom Woodward, Dennis Zimmerman, and three anonymous referees for helpful comments and discussions. The views in this paper do not necessarily represent those of the Congressional Research Service or the Library of Congress. 1The AKS model is confined to one good. Charles Ballard (1984, 1989), Lawrence Goulder (1985), and Ballard and Goulder (1987) develop multisector models. 2The suggestion of a method for separating efficiency from redistribution is not intended to imply that there is no value to tracing the transition. Tracing the transition can provide information about intergenerational redistribution in an uncompensated change and insights into the realism of the model.

In recent years, a number of proposals have been advanced for the limitation of carbon emissions. Some have argued that such limits would be costless, but our analysis suggests that there is no free lunch. (See our forthcoming paper.) We have attempted to estimate the costs but not the global benefits of slowing down climate change through carbon limitations. All computations were performed in parallel for five geopolitical regions. Except for oil trade, these regions were treated independently-as though there were no opportunity for international trade in carbon rights. For stimulating ideas on the politics and economics of negotiating an agreement on greenhouse gas emission permits, see M. Grubb (1989). Whatever rule is adopted for the allocation of carbon emission rights, there are likely to be significant interregional differences in the value of these rights. International trade will be needed if economic efficiency is to be achieved. In the absence of such trade, there are likely to be significant distortions in the comparative advantage of individual locations for the production of tradeable basic materials such as primary metals. These distortions could lead to counterproductive regulations and new forms of nontariff barriers to trade. This paper is intended to quantify the potential for international trade in carbon emission rights.

The theory of auctions has developed extensively since Robert B. Wilson's (1977) seminal paper. Due to the complexity of equilibrium strategies, however, empirical researchers have been slow to incorporate and test the most basic theoretical precepts.' Typical empirical studies estimate ad hoc bidding models, with no attempt to ascertain whether the implied behaviors are theoretically plausible. The recent paper by Stuart E. Thiel (1988) attempts to bridge this gap. Thiel obtains closed-form equilibrium bidding functions that are theoretically motivated and linear in parameters, and which facilitate empirical estimation and testing. If widely applicable, Thiel's empirical approach would constitute a major methodological breakthrough. Unfortunately, Thiel's approach applies only in special cases that are of limited practical interest. Linear bidding strategies emerge only under circumstances that are unlikely in the real world. The limited range of Thiel's approach may not be apparent to casual readers of his paper. Even when linear strategies do exist, they are not unique under the special assumptions of Thiel's model. For each Nash equilibrium in linear strategies, there exists a related family of nonlinear strategies. Thus, further justification must be found for basing empirical research on the linear specification. We also note a significant error in Thiel's work. The symmetric strategies he derives on the basis of order statistics do not constitute a Nash equilibrium. We derive proper expressions for the symmetric Nash strategies and discuss a specification error in Thiel's regression analysis that would account for the mixed results obtained in his application to the highway-construction industry.

Since the early 1970's, both academic researchers and policymakers have devoted considerable attention to the macroeconomic effects of wage indexation. However, these two groups have focused on different effects. Starting with Jo Anna Gray (1976) and Stanley Fischer (1977a), formal models emphasize the role of indexation in stabilizing or destabilizing output. In contrast, informal policy discussions usually focus on the allegation that indexation is inflationary (e.g., Arthur Okun, 1971; Mario Simonsen, 1983; Eliana Cardoso and Rudiger Dornbusch, 1987). To reduce this gap, this paper presents a model of the effects of indexation on inflation and asks whether indexation raises economic welfare when these effects are taken into account. Until recently it was difficult to formalize the argument that indexation is inflationary, because economists lacked models of the sources of inflation. This paper applies the insight of Robert Barro and David Gordon (1983a) that, with discretionary policy, the employment gains from surprise inflation tempt the monetary authority to create positive trend inflation. As stressed by Fischer and Lawrence Summers (1989), policies that reduce the costs of inflation, such as indexation, cause Barro-Gordon policymakers to choose higher inflation. Indeed, inflation can rise so much that welfare falls despite greater protection against inflation. This effect is appealing because it captures the common argument that indexation weakens policymakers' will to fight inflation.1 This is not the end of the story, however, because wage indexation has a second effect: it reduces the employment effects of surprise inflation. That is, unlike most policies to reduce the costs of inflation, such as indexation of interest rates, wage indexation steepens the Phillips curve. In the BarroGordon model, a steeper Phillips curve reduces the temptation to inflate and hence reduces equilibrium inflation. Since indexation has one inflationary effect (lower costs of inflation) and one anti-inflationary effect (a steeper Phillips curve), the net effect appears ambiguous. Even if the net effect on inflation is determined, the welfare effect may remain unclear: if inflation rises, the welfare loss might or might not be outweighed by the lower cost of a given amount of inflation.2 These ambiguities cannot be resolved with the Barro-Gordon model alone, because the Phillips curve and the effect of inflation on welfare are ad hoc. It is plausible that indexation affects these relations, but the relative strengths of the effects are unclear. Resolving the ambiguities requires a more structural model in which the effects of indexation are derived, rather than assumed. This paper studies such a model; specifically, we use a model of staggered wagesetting based on Gray (1976), Fischer (1977a, b), and John Taylor (1980). The degree of indexation is an explicit parameter, and so we can derive its net effects on inflation and welfare. Section I of this paper presents our basic model and derives equilibrium inflation in

From the Santa Monica Freeway to the New Jersey Turnpike, drivers are unhappy about the cost of automobile insurance and are asking government to do something about it. California voters approved Proposition 103 in 1988; it requires that all rates be approved by the state insurance commissioner, attempts to reduce rates by 20 percent, and dramatically limits the criteria that can be used to rate drivers for premium purposes. New Jersey enacted an insurance reform law that seeks to charge insurers for a deficit-burdened state underwriting pool and prohibits the use of age, sex, and marital status in rating drivers for premiums. Other states enacting or considering significant rate rollbacks or reform since 1988 include Arizona, Florida, Michigan, Nevada, and Pennsylvania. This article describes the current consequences of similar policies adopted in Massachusetts more than a decade ago. The experience suggests that recent moves by other states in the same direction will ultimately prove quite expensive as the proportion of high-cost drivers increases and as insurers lose the incentive to write policies and control costs. The trend away from insurance premiums based on expected cost also reduces incentive effects for drivers, since insurance premiums provide a link between tort judgments and consumer decisions.

planning ; economic development ; production