Optimization Frictions Research Articles

THE IMPACT OF ELIGIBILITY FOR MEDICAID VERSUS SUBSIDIZED PRIVATE HEALTH INSURANCE ON MEDICAL SPENDING, SELF-REPORTED HEALTH, AND PUBLIC PROGRAM PARTICIPATION.

We use a regression discontinuity design to understand the impact of a sharp change in eligibility for Medicaid versus subsidized marketplace insurance at 138 percent of the federal poverty line on coverage, medical spending, health status, and other public program participation. We find a 5.5 percentage point shift from Medicaid to private insurance, with no net change in coverage. The shift increases individual health spending by $341 or 2 percent of income, with larger increases at higher points in the spending distribution. Two-thirds of the increase is from premiums and one-thirdfrom out-of-pocket medical spending. Self-rated health and other public program participation appear unchanged. We find no evidence of bunching below the eligibility threshold, which suggests either that individuals are willing to pay more for private insurance or that optimization frictions are high.

Income Responses to the Affordable Care Act: Evidence from a Premium Tax Credit Notch

We examine responses to the ACA subsidy for Marketplace health insurance in the first year of subsidy availability. Drawing on federal tax data and focusing on a notch in the schedule where eligibility is lost, we document that taxpayers lowered their income to remain eligible for the subsidy. The observed bunching is modest relative to the size of the notch, which, consistent with larger responses we detect in additional analyses among certain subgroups, is likely explained by significant optimization frictions. Finally, we find suggestive evidence that increased deductions drive some of the response, while reduced labor supply also plays a role.

Water the flowers you want to grow? Evidence on private recognition and donor loyalty

We study donor loyalty in the context of church membership in Germany. Church members have to make substantial payments to their church but can opt out at any time. In a large-scale field experiment, we examine how private recognition for past payments affects church members’ loyalty. We find that recognizing past payments reduces opt-outs, but the response is temporary. The effect of recognition on retention is most pronounced among members in the bottom quartile of baseline payments to the church. Consistent with optimization frictions prior to the experiment, we observe a spike in opt-outs after treatment for particularly costly memberships.

Labor Supply Responses to Learning the Tax and Benefit Schedule

While optimization frictions have been shown to attenuate earnings responses to financial incentives, less is understood about the individual factors shaping the response. The main contribution of this paper is to separately quantify the role of learning the tax and benefit schedule versus other kinds of frictions. A unique combination of notches in the tax and benefit schedule and an information policy in a Norwegian welfare reform facilitate our study. The presence of notches allows us to measure overall frictions. Quasi-random assignment of a letter targeting misperceptions about the slope and locations of benefit phase-out regions allows us to pin down the role of information. Our analysis delivers two main findings. First, about 50% do not behave as predicted by standard labor supply models, and optimization frictions are particularly prevalent when financial incentives change. Without adjusting for these overall frictions, estimated elasticities would be attenuated by at least 70%. Second, the observed elasticity among those who receive the information letter is at least twice as large as among the non-informed, suggesting governments can partly offset the attenuation with information policy. Our calculations suggest misperceptions of the tax and benefit schedule account for two-thirds of the attenuation in earnings responses to financial work incentives. The findings have important implications for the effectiveness of tax and transfer policy.

Water the Flowers You Want to Grow? Evidence on Private Recognition and Donor Loyalty

We study donor loyalty in the context of church membership in Germany. Church members have to make substantial payments to their church but can opt out at any time. In a large-scale field experiment, we examine how private recognition for past payments affects church members' loyalty. We find that recognizing past payments in a letter significantly reduces opt-outs. This effect is driven by members in the bottom quartile of baseline payments to the church. Consistent with optimization frictions prior to the experiment, we observe a spike in opt-outs immediately after treatment for particularly costly memberships.

Betting on the House: Subjective Expectations and Market Choices

Home price expectations play a central role in macroeconomics and finance. However, there is little direct evidence on how these expectations affect market choices. We provide the first experimental evidence based on a large-scale, high-stakes field experiment in the United States. We provided information by mail to 57,910 homeowners who recently listed their homes on the market. Collectively, these homes were worth $34 billion dollars. We randomized the information contained in the mailing to create non-deceptive, exogenous variation in the subjects’ home price expectations. We then used rich administrative data to measure the effects of these information shocks on the subject’s market choices. We find that, consistent with economic theory, higher home price expectations caused the subjects to delay selling their homes. These effects are statistically highly significant, economically large in magnitude, and robust to a number of sharp checks. Our results indicate that market choices are highly elastic to expectations: a 1 percentage point increase in home price expectations reduced the probability of selling within six months by 2.45 percentage points. Moreover, we provide evidence that this behavioral elasticity would be even higher if it were not for the presence of optimization frictions. Institutional subscribers to the NBER working paper series, and residents of developing countries may download this paper without additional charge at www.nber.org.

Social networks and tax avoidance: evidence from a well-defined Norwegian tax shelter

In 2005, over 8% of Norwegian shareholders transferred their shares to new (legal) tax shelters intended to defer taxation of capital gains and dividends that would otherwise be taxable in the aftermath of a reform implemented in 2006. Using detailed administrative data, we identify family networks and describe how take-up of tax avoidance progresses within a network. A feature of the reform was that the eligibility to set up a tax shelter changed discontinuously with individual shareholding of a firm and we use this fact to estimate the causal effect of availability of tax avoidance for a taxpayer on tax avoidance by others in the network. We find that eligibility in a social network increases the likelihood that others will take-up. This suggests that taxpayers affect each other’s decisions about tax avoidance, highlighting the importance of accounting for social interactions in understanding enforcement and tax avoidance behavior, and providing a concrete example of optimization frictions in the context of behavioral responses to taxation.

Expenditure response to health insurance policies: Evidence from kinks in rural China

This paper utilizes administrative data to analyze expenditure responses to the health insurance policy in rural China, and clear visual evidence of bunching is observed at the kink point. A static response model with optimization frictions estimates that a complete elimination of the reimbursement would cause the total expenditure per visit to decrease by 34.5%, and approximately one-third of the studied population makes decisions with errors. Heterogeneous expenditure responses and optimization frictions are observed across demographic groups. Cost-benefit and counterfactual analyses indicate that the current policy generates the greatest welfare gains.

Estimating the Elasticity of Intertemporal Substitution Using Mortgage Notches

Using a novel source of quasi-experimental variation in interest rates, we develop a new approach to estimating the Elasticity of Intertemporal Substitution (EIS). In the UK, the mortgage interest rate features discrete jumps -- notches -- at thresholds for the loan-to-value (LTV) ratio. These notches generate large bunching below the critical LTV thresholds and missing mass above them. We develop a dynamic model that links these empirical moments to the underlying structural EIS. The average EIS is small, around 0.1, and quite homogeneous in the population. This finding is robust to structural assumptions and can allow for uncertainty, a wide range of risk preferences, portfolio reallocation, liquidity constraints, present bias, and optimization frictions. Our findings have implications for the numerous calibration studies that rely on larger values of the EIS.

Prion disease and cerebroespinal fluid markers: A case report

This paper utilizes administrative data to analyze expenditure responses to the health insurance policy in rural China, and clear visual evidence of bunching is observed at the kink point. A static response model with optimization frictions estimates that a complete elimination of the reimbursement would cause the total expenditure per visit to decrease by 34.5%, and approximately one-third of the studied population makes decisions with errors. Heterogeneous expenditure responses and optimization frictions are observed across demographic groups. Cost-benefit and counterfactual analyses indicate that the current policy generates the greatest welfare gains.

Take-Up and Targeting: Experimental Evidence from SNAP

Abstract We develop a framework for welfare analysis of interventions designed to increase take-up of social safety net programs in the presence of potential behavioral biases. We calibrate the key parameters using a randomized field experiment in which 30,000 elderly individuals not enrolled in—but likely eligible for—the Supplemental Nutrition Assistance Program (SNAP) are either provided with information that they are likely eligible, provided with this information and offered assistance in applying, or are in a “status quo” control group. Only 6% of the control group enrolls in SNAP over the next nine months, compared to 11% of the Information Only group and 18% of the Information Plus Assistance group. The individuals who apply or enroll in response to either intervention have higher net income and are less sick than the average enrollee in the control group. We present evidence consistent with the existence of optimization frictions that are greater for needier individuals, which suggests that the poor targeting properties of the interventions reduce their welfare benefits.

Labor supply and optimization frictions: Evidence from the Danish student labor market

Using Danish administrative data, I investigate the magnitude and nature of optimization frictions in the labor market of Danish students. Danish students face a unique institutional setting that makes it possible to distinguish between different types of frictions and estimate their effect on individual utility. I find that frictions significantly affect observed labor market outcomes. In particular, the empirical evidence points to inattention as the dominant type of friction. In contrast, my findings appear inconsistent with real adjustment costs, price misperception and gradual learning. Overall, optimization frictions reduce the utility of individuals by approximately 2–3% of disposable income.

Labor Supply and Optimization Frictions: Evidence from the Danish Student Labor Market

Using Danish administrative data, I investigate the magnitude and nature of optimization frictions in the labor market of Danish students. Danish students face a unique institutional setting that makes it possible to distinguish between different types of frictions and estimate their effect on individual utility. I find that frictions significantly affect observed labor market outcomes. In particular, the empirical evidence points to inattention as the dominant type of friction. In contrast, my findings appear inconsistent with real adjustment costs, price misperception and gradual learning. Overall, optimization frictions reduce the utility of individuals by approximately 2-3 percent of disposable income.

Take-Up and Targeting: Experimental Evidence from Snap

This paper develops a framework for evaluating the welfare impact of various interventions designed to increase take-up of social safety net programs in the presence of potential behavioral biases. We calibrate the key parameters using a randomized field experiment in which 30,000 elderly individuals not enrolled in – but likely eligible for – the Supplemental Nutrition Assistance Program (SNAP) are either provided with information that they are likely eligible, provided with this information and also offered assistance in applying, or are in a “status quo” control group. Only 6 percent of the control group enrolls in SNAP over the next 9 months, compared to 11 percent of the Information Only group and 18 percent of the Information Plus Assistance group. The individuals who apply or enroll in response to either intervention receive lower benefits and are less sick than the average enrollee in the control group. The results are consistent with the existence of optimization frictions that are greater for needier individuals, suggesting that the poor targeting properties of the interventions reduce their welfare gains.

How Do Individuals Repay Their Debt? The Balance-Matching Heuristic

We study how individuals repay their debt using linked data on multiple credit cards. Repayments are not allocated to the higher interest rate card, which would minimize the cost of borrowing. Moreover, the degree of misallocation is invariant to the economic stakes, which is inconsistent with optimization frictions. Instead, we show that repayments are consistent with a balance-matching heuristic under which the share of repayments on each card is matched to the share of balances on each card. Balance matching captures more than half of the predictable variation in repayments and is highly persistent within individuals over time. (JEL D14, D15, D91, G41)

How Do Individuals Repay Their Debt? The Balance-Matching Heuristic

We study how individuals repay their debt using linked data on multiple credit cards. Repayments are not allocated to the higher interest rate card, which would minimize the cost of borrowing. Moreover, the degree of misallocation is invariant to the economic stakes, which is inconsistent with optimization frictions. Instead, we show that repayments are consistent with a balance-matching heuristic under which the share of repayments on each card is matched to the share of balances on each card. Balance matching captures more than half of the predictable variation in repayments and is highly persistent within individuals over time.

Pensions, Retirement, and the Disutility of Labor: Bunching in Brazil

Elderly workers in developing countries face certain frictions, such as credit constraints, in their retirement decisions that may not be as common among their counterparts in the developed world, and these concerns may lead workers to work more or less than their preferred number of years. In this study, I firstly use regression discontinuity methods to show that a large fraction of urban male heads of households in Brazil (roughly 45%) react contemporaneously to pension eligibility by retiring. Because retirement is not required to receive the pension and because the return to working does not change discontinuously at the eligibility cutoff, workers should not react contemporaneously unless optimization frictions, such as credit constraints, are at work. Secondly, I develop a model of retirement decisions that explores how pensions in the face of credit constraints can influence such decisions, and I discuss applications of this model to determine how the observed behavior in conjunction with the model can be used to make inferences about welfare and labor supply decisions in the face of different pension values.

Inference on sets in finance

We consider the problem of inference on a class of sets describing a collection of admissible models as solutions to a single smooth inequality. Classical and recent examples include the Hansen–Jagannathan sets of admissible stochastic discount factors, Markowitz–Fama mean–variance sets for asset portfolio returns, and the set of structural elasticities in Chetty's (2012) analysis of demand with optimization frictions. The econometric structure of the problem allows us to construct convenient and powerful confidence regions based on the weighted likelihood ratio and weighted Wald statistics. Our statistics differ from existing statistics in that they enforce either exact or first‐order equivariance to transformations of parameters, making them especially appealing in the target applications. We show that the resulting inference procedures are more powerful than the structured projection methods. Last, our framework is also useful for analyzing intersection bounds, namely sets defined as solutions to multiple smooth inequalities, since multiple inequalities can be conservatively approximated by a single smooth inequality. We present two empirical examples showing how the new econometric methods are able to generate sharp economic conclusions. Hansen–Jagannathan bound Markowitz–Fama bounds Chetty bounds mean–variance sets optimization frictions inference confidence set C10 C50

Do Savers Respond to Tax Incentives? The Case of Retirement Savings

This article exploits a large micro-_le tax return data to test whether savers respond to the presence of tax incentives by contributing more in saving accounts that mandate annuitization at retirement. A frictionless model of demand for annuity is first set, which highlights the phenomenon of bunching of savers around tax thresholds when consumers' budget set is kinked. Using French households income tax data, we do not find any bunching, which is consistent either with the absence of behavioral responsiveness to tax incentives or optimization frictions. We investigate the implications of the second hypothesis and propose an alternative test in which discontinuity in marginal rate of return on the two sides of tax thresholds is exploited. We find that the deduction scheme is effective in boosting the demand for annuity of the richest savers whose marginal tax rate is the highest, especially for the oldest savers (aged 45 and above). In most cases, it fails to raise contributions of younger and less wealthy savers.

Bunching and non-bunching at kink points of the Swedish tax schedule

Recent microeconometric studies of taxpayers' responsiveness to taxation have shown that intensive margin labor supply and earnings elasticities typically are modest and sometimes equal to zero. A common view is that long-run responses still might be large if micro-estimates are downward biased owing to optimization frictions. In this paper we estimate the taxable income elasticity at a very large kink point of the Swedish tax schedule using the bunching method. During the period of study the change in the log net-of-tax rate reached a maximum value of 45.6%. Interestingly, we obtain a precise elasticity estimate of zero for wage earners at this large kink. We also conclude by the means of numerical simulations that, even though the kink point we study is very large, income effects are unlikely to bias our estimates. The size of the kink allows us to derive tighter bounds on the long-run elasticity than previous studies. If wage earners on average tolerate 1% of their disposable income in optimization costs, the upper bound on the long-run compensated taxable income elasticity is 0.39.