Abstract
An important issue in public policy analysis is the potential endogeneity of the policies under study. If policy changes constitute responses on the part of political decision-makers to changes in a variable of interest, then standard analyses that treat policy changes as natural experiments may yield biased estimates of the impact of the policy (Besley and Case 2000). We examine the extent to which such political endogeneity biases conventional fixed effects estimates of behavioral parameters by identifying the elasticities of demand for cigarettes and beer using the timing of state legislative elections as an instrument for changes in state excise taxes. In both cases, we find sizable differences between these estimated demand elasticities and the fixed effect estimates cited in Evans, Ringel, and Stech (1999). We conclude that the use of fixed effects estimators in environments where policy interventions are endogeneously determined may lead to large biases in the estimated effects of the policies. This paper was revised July 2002.
Highlights
A critical, but rarely addressed, issue affecting the empirical analysis of public policies is the potential endogeneity of the policies under study
While we do not claim that the models estimated in this paper necessarily provide the best possible estimates of the parameters in question, we believe that our results do suggest caution in interpreting findings from models that fail to take into account the endogeneity of state policymaking
In 42 of the 49 states, the mean change in beer taxes is greater after election years compared to nonelection years. This result is the opposite of what we found for cigarette taxes, suggesting that a different political dynamic may exist in the case of alcoholic beverages
Summary
A critical, but rarely addressed, issue affecting the empirical analysis of public policies is the potential endogeneity of the policies under study. As discussed in a recent paper by Besley and Case (2000), a majority of studies that analyze the impact of public policies treat variation in state-level policy variables as exogeneous.
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