Implicit Subsidy Research Articles

The Environmental Bias of Trade Policy*

AbstractThis article describes a new fact, then analyzes its causes and consequences: in most countries, import tariffs and nontariff barriers are substantially lower on dirty than on clean industries, where an industry’s “dirtiness” is defined as its carbon dioxide (CO2) emissions per dollar of output. This difference in trade policy creates a global implicit subsidy to CO2 emissions in internationally traded goods and contributes to climate change. This global implicit subsidy to CO2 emissions totals several hundred billion dollars annually. The greater protection of downstream industries, which are relatively clean, substantially accounts for this pattern. The downstream pattern can be explained by theories where industries lobby for low tariffs on their inputs but final consumers are poorly organized. A quantitative general equilibrium model suggests that if countries applied similar trade policies to clean and dirty goods, global CO2 emissions would decrease and global real income would change little.

The Forced Safety Effect: How Higher Capital Requirements Can Increase Bank Lending

ABSTRACTGovernment guarantees generate an implicit subsidy for banks. A capital requirement reduces this subsidy, through a simple liability composition effect. However, the guarantees also make a bank undervalue loans that generates surplus in states of the world in which it defaults. Raising the capital requirement makes the bank safer, which alleviates this problem. We refer to this mechanism, which we argue is empirically relevant, as the forced safety effect.

A $19-Billion Blind Spot: State Pension Spending

In this brief, we examine an important but obscure form of state spending on K–12 education—state subsidies of school district pension costs. In 2018, this exceeded $19 billion across 23 states. To put that amount into perspective, 2018 federal spending on Title I programs was $15.8 billion. This revenue stream is often ignored in analyses of state aid for K–12 and its distribution across districts. Until recently, accounting standards did not require pension plans to report these implicit subsidies to the school districts, so they did not typically know the size of their subsidy. In some important cases, it was missing from state totals for education aid. In the first comprehensive tabulation of these data, we show that this subsidy can be as much as $2,400 per pupil, as it is in Connecticut. In Illinois, it comprises an additional 56% of state spending on K–12 on top of all formula and categorical aid.

Allocating Subsidies for Private Investments to Maximize Jobs Impacts

Governments often aim to influence the amount and sectoral allocation of private investments through explicit or implicit subsidies. The rules used to select projects to benefit from subsidies may vary, depending on the policy objective. This paper develops a general framework to allocate subsidies to private investments in the presence of jobs-linked externalities (JLEs). JLEs emerge when wages exceed the opportunity cost of labor (labor externalities), or when there are social gains from creating better jobs for some classes of worker, such as women or youth (social externalities). Like all externalities, JLEs create a gap between private and social rates of return. Investments can be socially profitable (once the corresponding JLEs are internalized) but the private returns may be too low for the firm to go ahead. JLEs help to explain why many developing countries see insufficient investment in projects that would reallocate labor towards better jobs. The concept of JLEs is well established in economic literature, but there is a need for better operational approaches to address them. Like other externalities, JLEs can be corrected using a variety of possible subsidies (such as: grants, subsidized infrastructure, credit, training, technical assistance and tax exemptions). But doing this efficiently and at scale this requires mechanisms to (a) estimate the value of the externality and (b) discover the amount of subsidy needed to trigger the private investment. This paper shows that the optimal way to allocate subsidies to offset JLEs is through a competitive bidding process which selects projects based on the estimated amount of JLEs per dollar of subsidy. The bidding process provides an incentive to investors to reveal the subsidy needed for a project to become privately viable. We show that the proposed approach maximizes the jobs impacts of a given amount of fiscal resources that has been allotted to support better jobs outcomes

Longer School Schedules, Childcare and the Quality of Mothers’ Employment: Evidence from School Reform in Chile

Ample empirical evidence has shown that access to childcare for preschool children increases mothers’ labor-force participation and employment. By estimating the causal effect of a school schedule reform in Chile, we investigated whether increased childcare for primary school children improved the quality of the jobs that mothers found. Combining plausibly exogenous temporal and spatial variations in school schedules with a panel of mothers’ employment between 2002 and 2015, we estimated a fixed-effects model that controlled for unobserved heterogeneity. We found a positive effect of access to full-day schools on several measures of the quality of mothers’ jobs, which were correlated to working full-time. We also found small, positive effects on the quality of fathers’ jobs. Our evidence suggests that the mechanism driving the effect was the effect of the reform’s implicit subsidy to the cost of childcare on the opportunity cost of mothers’ time. We also found that less-educated mothers benefited most from the reform. Childcare can increase household welfare by improving parents’ jobs and, thus, can play a role in reducing inequality.

Do the Basel III capital reforms reduce the implicit subsidy of systemically important banks? Australian evidence

This study examines whether systemically important banks realise an implicit subsidy when raising wholesale debt funding and evaluates the effectiveness of the Basel III capital reforms in reducing the subsidy. Our estimations suggest that, before the reforms, systemically important banks realise a subsidy of around 27–32 basis points when they raise senior unsecured borrowings and that, after the reforms are implemented, the subsidy is reduced by approximately one-half. We find evidence that the default protection provided by a stronger capital base substitutes for the protection provided by implicit government guarantees in lifting investor confidence in a systemically important bank.

Stopping and Reversing Climate Change

This article discusses quantitatively how to stop and reverse climate change. To stop climate change, we must transition from burning fossil fuels to using clean energy resources that do not involve the emission of CO2. We discuss the advantages and disadvantages of renewable energy sources, such as wind, water, and solar, relative to nuclear fission and the continued burning of fossil fuels, coupled to CO2 capture and sequestration of the flue gas. A plot of the energy per unit mass, e, against the energy per unit volume, e, shows many orders of magnitude difference between changes in the mechanical state of ordinary matter versus chemical reactions versus nuclear transformations. These differences raise an apparent paradox concerning how the price of electricity can be roughly competitive for the commercial technologies based on the very different fuel types. Explicit and implicit subsidies for politically favored fuels give a partial explanation, but the turbines that turn flowing fluids into flowing electricity account for most of the result.

A Financial Performance Comparison of Czech Credit Unions and European Cooperative Banks

This paper empirically assesses the financial performance of Czech credit unions in relation to other European cooperative banks in terms of their profitability and stability. We created a unique dataset of 283 cooperative banks from 15 European countries in the period 2006-2013. Using the system GMM and alternative panel data methods, we reveal worse performance of Czech credit unions in terms of both profitability and stability compared to their European peers. We also argue that big credit unions in the Czech Republic have assumed a non-sustainable business model depending on excessive risk taking while enjoying implicit subsidy via deposit insurance. In conclusion, we argue that under recent capital management policies, big Czech credit unions will likely face serious financial problems in coming years.

Measuring the effects of price controls using mixed complementarity models

Government involvement in managing domestic prices of energy and other commodities is a major issue in emerging economies. We examine one aspect of the problem, price controls, when governments set or cap prices. We show how a Mixed Complementarity Problem (MCP) formulation can be used to model and assess the impacts of price controls in multi-sector economic-equilibrium models. Both the gains from deregulation and the consequences of imposing new or altering existing regulations can thus be measured. We present three distinct models that capture different price-control situations: firms have to meet demand and receive an implicit subsidy, demand rationing occurs due to an associated price control constraint, and subsidies limit demand rationing. We present an approach to measuring the effects on the equilibrium in the first case and the levels of disequilibrium induced by price controls in the other cases. We also show how to determine the most efficient allocation program when a government engages in rationing. We illustrate the cases described by these models using markets that have or had price controls.

The Accrual Anomaly in the Corporate Bond Market : Korean Evidence

Almost all prior studies on the Korean accrual anomaly focus on the stock market. In contrast to prior studies, our study examines whether or not the accrual anomaly exists in the Korean corporate bond market. Using the corporate bond data traded in the Korean market from 2000 to 2011, we find supporting evidence of the accrual anomaly in the Korean corporate bond market using three approaches: (1) hedge portfolio return test, (2) the Fama-French five factor (three equity market factors plus two bond market factors) time series regression test, and (3) the Fama-MacBeth cross sectional test. Next, we examine whether the unique Korean corporate governance system, chaebol, affects the magnitude of the accrual mispricing in the corporate bond market and find evidence that the accrual anomaly exists only for bonds issued by non-chaebol firms. This finding indicates that bond investors’ expectation about explicit or implicit subsidy from chaebol-affiliated subsidiaries dampens accrual mispricing of a chaebol firm. Taken together, our results suggest that investors in the Korean corporate bond market fixate on earnings, in particular, for non-chaebol firms.

Is Size Everything?

We examine sources of systemic risk (threshold size, complexity, and interconnectedness) with factors constructed from equity returns of large financial firms, after accounting for standard risk factors. From the factor loadings and factor returns, we estimate the implicit government subsidy for each systemic risk measure, and find that, from 1963 to 2006, only our big-versus-huge threshold size factor, TSIZE, implies a positive implicit subsidy on average. Further, pre-2007 TSIZE-implied subsidies predict the Federal Reserve’s liquidity facility loans and the Treasury’s TARP loans during the crisis, both in the time series and the cross section. TSIZE-implied subsidies increase around the bailout of Continental Illinois in 1984 and the Gramm-Leach-Bliley Act of 1999, as well as around changes in Fitch Support Ratings indicating higher probability of government support. Since 2007, however, the relative share of TSIZE-implied subsidies falls, especially after Lehman’s failure, whereas complexity and interconnectedness-implied subsidies are substantial, resulting in an almost sevenfold increase in total implicit subsidies. The results, which survive a variety of robustness checks, indicate that the market’s perception of the sources of systemic risk changes over time.

Investment and Neutrality of Capital Income Taxation: Testing the King-Fullerton Framework

The King-Fullerton (1984) approach to the measurement of effective marginal rates of taxation on capital income has been applied extensively. The empirical literature confirms that the dispersion of effective tax rates, both within each country and among countries, is wide. However, no test has been proposed of the impact on investment of these findings. The paper tests the conjecture proposed by King and Fullerton that standard deviation of effective tax wedges and investment or growth are inversely correlated. We find that international evidence does not support the conjecture: while investment and tax wedges are negatively correlated, as expected, the standard deviation of tax wedges seems to be positively correlated to investment. We propose the following interpretation of this result: a substantial part of the variance of effective marginal rates is explained by an implicit subsidy to equipment investment, and this policy may be justified by De Long-Summers (1992) results or by the view that this type of investment have more impact on growth than other types (such as buildings and inventories). In some cases, also a partial deduction of interest rates may be rational when capital markets are rationed. Thus, it may be simplistic and misleading to use King- Fullerton statistics as yardsticks for tax reforms leading to uniformity of effective marginal tax rates.

Wealth Taxation, Non-Listed Firms, and the Risk of Entrepreneurial Investment

How to incorporate hard-to-value assets into the wealth tax? We analyze the effect of an optimal wealth tax on risk-taking behavior and welfare when investors do not only have the standard portfolio choice with a well-diversified market portfolio, but can alternatively choose to invest all their wealth into a non-diversifiable, indivisible project. The latter is interpreted as entrepreneurial investment into a small, nonlisted firm for which the actual value is hard to measure and non-verifiable. For such firms, real-world wealth tax systems base the wealth tax on deterministic book values. We show that this tax treatment does not distort the choice of projects if the tax is set optimally with an imputed interest rate on book values, actually larger than the risk-free market rate of return. The market equilibrium and a proportional tax on the market portfolio will ensure an efficient risk allocation between private and public consumption and across projects. Failing to apply an imputed inflation of book values, instead, gives rise to an implicit subsidy on entrepreneurial activity and distorts investment. Our findings also have implications for taxation of hard-to-value assets under capital-gains and inheritance taxation.

Unilaterally removing implicit subsidies for maritime fuels

Many academics and policymakers agree that implicit tax subsidies for maritime fuels — which are currently granted around the world — are inefficient, but that their abolishment requires a unanimous international agreement. Such an agreement is deemed indispensable because any unilateral action would be impossible due to massive tax competition in this industry, competitiveness effects and the legal limits on regulating an industry operating mostly in international waters, thus outside of any state’s jurisdiction. However, an international agreement to solve these problems has proven impossible to reach, thus resulting in the conservation of the status quo. To break this deadlock, we propose a mechanism whereby a small coalition of countries, to start with, can abolish these implicit tax subsidies even in the absence of an international agreement. This incentive-compatible scheme solves the above-mentioned issues. The mechanism is furthermore designed to avoid locking in a sub-global scheme. Instead, it has the potential to contribute to unlocking the gridlock in negotiations over a global agreement on this matter.

The Deterrence Case for Comprehensive Automaker Enterprise Liability

This paper explores the potential deterrence advantages of shifting to a comprehensive automaker enterprise liability regime. Under such a system, automakers would be responsible for the economic harms resulting from automobile accidents, irrespective of the type of vehicle (whether fully driverless vehicles, partially automated, or fully human-driven). The paper argues that such a regime would simplify the existing auto tort/compensation system by replacing all of automaker liability law (including auto product defect claims) and driver liability law (as well as existing auto no-fault regimes) with a single enterprise liability system under which all auto-accident victims could seek recovery. It could also have the following deterrence benefits: it would encourage automakers to design and manufacturer safer vehicles; it would incentivize automakers to provide better warnings and instructions with their vehicles; it would result in automobile prices that better reflect the actual costs of driving, leading to a more socially efficient level of auto production; it would induce automakers to coordinate with auto insurers to improve the efficiency of driver care and activity levels; and, finally, it would provide an implicit subsidy for the development and sale of driverless vehicles and automated driving technology generally, funded by an implicit enterprise liability tax on less safe vehicles.

Double Whammy: Implicit Subsidies and the Great Financial Crisis

This paper concerns itself with the joint effect of implicit subsidies that are built into the US housing-finance system and financial safety net. These subsidies are implicit because they are channeled through the regulatory, supervisory, and tax systems in hard-to-observe ways. In the last two economic booms, the stealthy way banks have pursued these subsidies allowed hidden leverage and arcane loss exposures to build up to a disastrous degree. When lenders' safety-net support was finally tested by creditor runs, the struggle to reallocate losses and loss exposures away from the banks that had concealed them pushed the world's financial system into open crisis. Post-crisis regulatory reforms seem to have blunted the force of these subsidies, but the instruments assigned to this task are too weak to work for long. With the connivance of regulators, US megabanks are already re-establishing their ability to use dividends and stock buybacks to rebuild their leverage back to dangerous levels. Meantime a number of European megabanks (exemplified by Deutsche Bank) have remained in a zombie or near-zombie condition throughout the last decade. In the coming years, these banks' perilous condition and the possibility of extending safety-net coverage to support subsidized loans for bankrupt students, pension funds, and state and local entities could easily trigger another crisis. Besides trying to avoid future crises and directing bailouts when a crisis occurs, top regulators seem to believe that an important part of their job is to convince taxpayers that the next crash can be contained within the financial sector and won’t be allowed to hurt ordinary citizens in the ways that previous crises have. This paper seeks to convince readers that, until the law begins to hold individual bankers civilly and criminally responsible for using the safety net to enrich themselves by recklessly putting their banks' survival at risk, these rosy claims are bullsh*t.

Getting Life Expectancy Estimates Right for Pension Policy: Period Versus Cohort Approach

In many policy areas it is essential to use the best estimates of life expectancy, but such estimates are vital to most areas of pension policy – from indexed access age and the calculation of initial benefits to the financial sustainability of pension schemes and the operation of their balancing mechanism. This paper presents the conceptual differences between static period and dynamic cohort mortality tables, estimates the differences in life expectancy between both tables using data from Portugal and Spain, and compares official estimates of both life expectancy estimates for Australia, the United Kingdom, and the United States for 1981, 2010 and 2060. This comparison reveals major differences between period and cohort life expectancy in and between countries and across years. Using measures of period instead of cohort life expectancy creates an implicit subsidy for individuals of 30 percent or more, with potentially stark consequences on the financial sustainability of pension schemes. These and other implications for pension policy are explored and next steps suggested.

¿A quiénes y cuánto subsidia el régimen pensional de prima media en Colombia? Análisis paramétrico y lecciones de política

En este artículo se discuten los subsidios pensionales otorgados por Colpensiones (operador del Régimen de Prima Media en Colombia). Se presentan los resultados obtenidos a partir de simulaciones que parten de las reglas vigentes del sistema pensional y la aplicación de supuestos actuariales comúnmente aceptados, encontrando que bajo estos paradigmas, todas las pensiones otorgadas por Colpensiones estarían subsidiadas. Por otra parte, cuando en los ejercicios de simulación se asumen rentabilidades similares a las que el Régimen de Capitalización Individual (RAIS) otorga a sus afiliados a través de los fondos privados, desaparecen los subsidios de las pensiones más altas. Asimismo, se muestra que se pueden alcanzar iguales resultados implementando algunos ajustes paramétricos razonables, todo lo que da pie a una discusión sobre la política que regula el sistema pensional

Economy-wide effects of international and Russia's climate policies

The objectives of this paper are to analyse the economy-wide effects of international climate policy on the Russian economy as well as the effects of Russia's climate policy on European economies. Our analysis is based on a general equilibrium model that includes inertias, such as imperfect sectoral labour mobility and vintage capital, and has a detailed depiction of the power generation sector. We found that international climate policy could reduce Russia's private welfare by 1.8% annually due to lower revenues from exports of fossil fuels. At the sectoral level, Russia could gain a comparative advantage in producing energy-intensive commodities and hence Russia's producers of those commodities increase their production and export supplies. This could result in a carbon leakage in Russia. Eliminating implicit subsidies on domestic consumption of gas and petroleum products could reduce Russia's private welfare loss by 0.6% points and eliminate the carbon leakage. Nevertheless, eliminating implicit subsidies on gas and petroleum products might not be sufficient to achieve the pledged emission reductions by 2030. Moreover, this leads to an undesirable increase in coal consumption and therefore, some additional climate policy such as a carbon tax or an emission trading system might be required. We also found that Russia's climate policy could have positive but moderate effects on the European economies; in particular, countries such as Lithuania, Slovakia, and Hungary benefit due to decreased export prices for gas, crude oil, and petroleum products from Russia.

Distributional effects of higher natural gas prices in Russia

This paper analyses the distributional effects of eliminating the implicit subsidy on natural gas consumption in Russia. The analysis is based on a computable general equilibrium model with multiple households and a detailed power generation sector. It is found that using additional government revenues from higher domestic gas prices to increase the income of low- and middle-income households could improve the welfare of these households and alleviate income inequality in Russia, e.g., total private consumption of the poorest decile could increase by 3%. Nevertheless, the most efficient revenue-recycling policy would be to invest in the energy efficiency of buildings, which have the largest energy savings potential in Russia. In the long term, investing in the energy efficiency of buildings could reduce greenhouse gas emissions by 240 million tonnes of CO2 equivalent per year and increase the welfare of low- and middle-income households, e.g., total private consumption of the poorest decile increases by 1%. It is also found that increasing the regulated domestic gas price could lead to windfall profits for non-Gazprom producers. Hence, to increase government revenues, the gas-price reform could be supplemented by an increase in the capital income tax in the gas sector.