Second-best Setting Research Articles

A second-best argument for low optimal tariffs on intermediate inputs

We derive a new formula for the optimal uniform tariff in a small-country, heterogeneous-firm model with roundabout production and a nontraded good. Tariffs are applied on imported intermediate inputs. First-best policy requires that markups on domestic intermediate inputs are offset by subsidies. In a second-best setting where such subsidies are not used, roundabout production and the monopoly distortion in the traded sector create strong incentives to lower the optimal tariff on imported inputs. In a quantitative version of our two-sector small open economy, we find that the optimal tariff is lowered under nearly all parameter values considered, and can be negative.

Public Health Federalism?

Abstract This paper develops a general equilibrium model of competitive jurisdictional choice that provides insights into what is being coined 'public health federalism'. Using a standard neoclassical model of production combined with a utility maximization hypothesis, jurisdictions choose both tax rates and a level of local public health quality. Incorporating the joint determination of both tax decisions and the choice of public health standards can give rise to some interesting interrelationships between local tax revenues and public health considerations. Additionally, the model is extended to address the fiscal realities of sub-state jurisdictions in the United States. Beleaguered in a second-best setting, devolved efficiency becomes a target difficult to hit. We show that when jurisdictions rely on taxing mobile factors and mobile factor productivity is enhanced by relaxing public health mitigation, jurisdictions will choose lower levels of public health quality. JEL classification numbers: H73, I18, R13. Keywords: Federalism, Decentralized authority, COVID - 19, Public health mandates.

Public Health Federalism?

Abstract This paper develops a general equilibrium model of competitive jurisdictional choice that provides insights into what is being coined 'public health federalism'. Using a standard neoclassical model of production combined with a utility maximization hypothesis, jurisdictions choose both tax rates and a level of local public health quality. Incorporating the joint determination of both tax decisions and the choice of public health standards can give rise to some interesting interrelationships between local tax revenues and public health considerations. Additionally, the model is extended to address the fiscal realities of sub-state jurisdictions in the United States. Beleaguered in a second-best setting, devolved efficiency becomes a target difficult to hit. We show that when jurisdictions rely on taxing mobile factors and mobile factor productivity is enhanced by relaxing public health mitigation, jurisdictions will choose lower levels of public health quality. JEL classification numbers: H73, I18, R13. Keywords: Federalism, Decentralized authority, COVID - 19, Public health mandates.

Optimal design of sin taxes in the presence of nontaxable sin goods.

Sin good consumption entails health damage, which is in general not fully perceived by individuals, what results in its overconsumption. One way to tackle this problem is to tax these unhealthy goods. However, not all the individual choices that affect health status can be easily observed and effectively taxed by the government. This paper considers a setting where individuals can consume two types of sin goods that differ in their observability (taxability) by the government. As a benchmark, the first-best taxes for the observable and non-observable sin good are derived, considering homogeneous individuals. In the second-best setting, where observability on sin good consumption is limited, the rule for the taxable sin good is shown to depend on the degree of complementarity or substitutability with the unobservable sin good. Finally, redistributional considerations are incorporated by extending the analysis to a setting where individuals differ in their wealth and in their degree of misperception of the health damage caused by sin good consumption. Policy implications are illustrated considering physical inactivity and illicit drugs as examples of non-taxable sin goods, while alcohol, tobacco, fat and sugar account for the taxable sin goods.

Should Fishing Quotas Be Measured in Terms of Numbers?

Whereas rights-based catch regulations such as individual transferable quotas (ITQs) are gaining traction as the key management instrument in many fisheries, most fisheries are additionally regulated by gear restrictions, minimum landing sizes, and similar measures that intend to protect young fish from being caught. Here we study the incentives to fish selectively in a second-best setting, where the regulator issues quotas of different types and fishers choose the size of the fish they catch. We find that if quotas are specified in terms of the number of fish, rather than biomass or weight, fishers have substantial incentives to target larger fish. Thus juvenile fish are protected without need for gear restrictions. We develop the economic principles in an analytical model and quantify results for empirical examples. We find that steady-state profits under second-best deregulated number quota management are only 0.1%–2.1% below the first-best optimum.

A Second-Best Argument for Low Optimal Tariffs

We derive a new formula for the optimal uniform tariff in a small-country, heterogeneous-firm model with roundabout production and a nontraded good. Tariffs are applied on imported intermediate inputs. First-best policy requires that markups on domestic intermediate inputs are offset by subsidies. In a second-best setting where such subsidies are not used, the double- marginalization of domestic markups creates a strong incentive to lower the optimal tariff on imported inputs. In a 186-country quantitative model, the median optimal tariff is 10%, and negative for five countries, as compared to 27% in manufacturing from the one-sector, optimal tariff formula without roundabout production.

Workplace parking policies in an agglomeration: An illustration for Barcelona

This paper studies the role of workplace parking policies and illustrates it for the Barcelona agglomeration. We adapt the Brueckner and Franco (2018) analytical model for Western European cities by adding agglomeration externalities, public transport congestion and underground parking. Workers can choose to locate in the city centre or in the suburbs. Commuting to the city centre requires either commuting by car and parking or public transport. Two policies to address inefficiencies of employer-paid parking are compared: employee-paid parking and a workplace parking levy. It is shown how employee-paid parking generates additional agglomeration economies, while a workplace parking levy may have opposite effects. The numerical illustration for Barcelona indicates that the welfare effects of workplace parking policies in a second-best setting are dominated by agglomeration effects. These are three times larger than the welfare changes in the transport and land use markets.

Having it all, for all: Child-care subsidies and income distribution reconciled

We study the design of child-care policies when redistribution matters. Traditional mothers provide some informal child care, whereas career mothers purchase full time formal care. The sorting of women across career paths is endogenous and shaped by a social norm about gender roles in the family. Via this social norm traditional mothers’ informal child care imposes an externality on career mothers, so that the market outcome is inefficient. Informal care is too large and the group of career mothers is too small so that inefficiency and gender inequality go hand in hand.In a first-best world redistribution across couples and efficiency are separable. Redistribution is performed via lump-sum transfers and taxes which are designed to equalize utilities across all couples. The efficient allocation of child care is obtained by subsidizing formal care at a Pigouvian rate.However, in a second-best setting, a trade-off between efficiency and redistribution emerges. The optimal uniform subsidy is lower than the “Pigouvian” level. Conversely,under a nonlinear policy the first-best “Pigouvian” rule for the (marginal) subsidy on informal care is reestablished. While the share of high career mothers continues to be distorted downward for incentive reasons, this policy is effective in reconciling the objectives of reducing the child care related inefficiency and achieving a more equal income distribution across couples. Our results continue to hold when the norm is defined within the mothers’ social group, rather than being based on the entire population.

When Tariffs Disturb Global Supply Chains

We study unanticipated tariffs on imports of intermediate goods in a setting with firm-to-firm supply relationships. Firms that produce differentiated products conduct costly searches for potential input suppliers and negotiate bilateral prices with those that pass a reservation level of match productivity. Global supply chains are formed in anticipation of free trade. Once they are in place, the home government surprises with an input tariff. This can lead to renegotiation with initial suppliers or new search for replacements. We identify circumstances in which renegotiation generates improvement or deterioration in the terms of trade. The welfare implications of a tariff are ambiguous in this second-best setting, but plausible parameter values suggest a welfare loss that rises rapidly at high tariff rates.

A Case For Simpler Gain Bifurcation for Real Estate Developers

This Article examines the judicially sanctioned bifurcation of real estate developers’ gain. The Article recognizes that even though some commentators oppose granting favorable tax treatment to capital gains, the law most likely will not change. With that in mind, the Article examines the all-or-nothing approach of characterizing gain from the sale of real estate as either capital gain or ordinary income. The Article rejects the all-or-nothing approach of characterizing income under the current statutory system. Instead, it embraces gain bifurcation in the second-best setting that taxes capital gains and ordinary income differently. Illustrating the policy justification for gain bifurcation and judicially sanctioned bifurcation structures, the Article recommends that lawmakers should more fully embrace gain bifurcation for real estate developers by creating a simple statutory election for bifurcating gain that would enhance equity, accuracy, and transparency of gain bifurcation. Although the Article limits its analysis to real estate developers, the idea of gain bifurcation, once improved in this area, could be a catalyst for exploring bifurcation in other areas.

To build or not to build? Capital stocks and climate policy∗

We investigate (i) the impact of emission reduction policy on investment in polluting infrastructure, such as coal-fired power stations and (ii) optimal subsidies for “clean” alternatives with “learning” spillovers. We build a general theoretical model, and embed it in a fully calibrated integrated assessment model. Because emission reduction policy reduces investments in polluting assets, short-term emission reductions are enhanced—our “irreversibility effect”. Thus, “stranded assets” in this fuel-using sector have distinctive properties. We also provide a simple formula for how the optimal subsidy to deployment of a “clean” sector depends on its rate of “learning-by-doing” and on its socially-optimal growth. So, if the sector should grow faster for other reasons, its optimal subsidy is increased, showing that its optimal growth rate is faster still—our “acceleration effect”. Our calibrations show that, to limit global climate change to 2○C warming, investments in coal-fired power stations must end very soon. Considering second-best settings, we show that carbon taxes achieve stringent policy targets more efficiently, but subsidies to the “clean” sector deliver higher welfare, and are more efficient, when policy targets are more mild.

Talent, equality of opportunity and optimal non-linear income tax

We adopt a philosophical perspective of equality of opportunity and address the issue of whether outcome inequalities are legitimate when they come from differences in talent. We propose a cumulative definition of talent. In a dynamic setting, talent is a by-product of past-effort, current effort and innate talent, which becomes a residual as time goes by. It implies that talent can change from the status of a circumstance when people are young to an almost responsibility variable when people are getting older. We plug this definition of talent into the Mirrlees model of optimal non-linear income tax and we show that the conflict between the principle of compensation and the principle of natural reward boils down to the optimal income tax with Rawlsian weights in the second-best setting.

Having it All, for All: Child-Care Subsidies and Income Distribution Reconciled

This paper studies the design of child-care policies when redistribution matters. Traditional mothers provide some informal child care, whereas career mothers purchase full time formal care in the market. The sorting of women across career paths is endogenous and shaped by a social norm about gender roles in the family. Via this social norm traditional mothersinformal child care imposes an externality on career mothers, so that the market outcome is inefficient. Informal care is too large and the group of career mothers is too small so that inefficiency and gender inequality go hand in hand. In a first-best, full information word redistribution across couples and efficiency are separable. Redistribution is performed via lump-sum transfers and taxes which are designed to equalize utilities across all couples. The efficient allocation of child care is obtained by subsidizing formal care at a Pigouvian rate. However, in a second-best settings, we show that a trade-off between the reduction of gender inequality and redistributive considerations emerge. The optimal uniform subsidy is lower than the Pigouvianlevel. Under a nonlinear policy the first-best Pigouvianrule for the (marginal) subsidy on informal care is reestablished. While the share of high career mothers continues to be distorted downward for incentive reasons, this policy is effective in reconciling the objectives of reducing the child care related gender inequalities and achieving a more equal income distribution across couples.

Optimal Environmental Policy for a Polluting Monopoly with Abatement Costs: Taxes Versus Standards

In this paper, we characterize the optimal environmental policy for a polluting monopoly that devotes resources to abatement activities when damages are caused by a stock pollutant. With this aim, we calculate the stagewise feedback Stackelberg equilibrium of a (differential) policy game where the regulator is the leader and the monopolist is the follower. Our analysis shows that the first-best policy consists of applying a Pigouvian tax and a subsidy on production equal to the difference between the price and the marginal revenue. However, for a stock pollutant, the Pigouvian tax is not equal to the marginal damages but is given by the difference between the social and private valuation of the pollution stock. On the other hand, if a second-best emission tax is used, the tax is lower than the Pigouvian tax and the difference decreases with the price elasticity of the demand. Finally, we find that taxes and standards are equivalent in a second-best setting. In the second part of the paper, we solve a linear-quadratic differential game and we obtain that the first-best tax increases with the pollution stock whereas the subsidy decreases. Moreover, the tax is negative for low values of the pollution stock, i.e., for low values of the pollution stock, we obtain that the social valuation of the stock is lower than the private valuation. Furthermore, when a second-best policy is applied, the steady-state pollution stock is lower than the steady-state pollution stock associated with the efficient outcome.

To Build or Not to Build? Capital Stocks and Climate Policy

We investigate how irreversibility in “dirty” and “clean” capital stocks affects optimal climate policy, from both theoretical and numerical perspectives. An increasing carbon tax will reduce investments in assets that pollute, and so reduce emissions in the short term: our “irreversibility effect”. As such the “Green Paradox” has a converse if we focus on demand side capital stock effects. We also show that the optimal subsidy increases with the deployment rate: our “acceleration effect”. Considering second-best settings, we show that, although carbon taxes achieve stringent targets more efficiently, in fact renewable subsidies deliver higher welfare when policy is more mild.

To Build or Not to Build? Capital Stocks and Climate Policy

We investigate how in dirty and clean capital stocks affects optimal climate policy, from both theoretical and numerical perspectives. An increasing carbon tax will reduce investments in assets that pollute, and so reduce emissions in the short term: our irreversibility effect. As such the Green Paradox has a converse if we focus on demand side capital stock effects. We also show that the optimal subsidy increases with the deployment rate: our acceleration effect. Considering second-best settings, we show that, although carbon taxes achieve stringent targets more efficiently, in fact renewable subsidies deliver higher welfare when policy is more mild.

The Social Costs of Environmental Goods Provision: A Cautionary Guide to the Revealed-Preference Approach

AbstractEmpirically estimated behavioral models have emerged as the preferred approach to revealing the social opportunity costs of pollution abatement in many areas of environmental economics. This paper identifies conceptual issues in the implementation of the revealed-preference approach to nonpoint-source pollution and provides methods to overcome them. We focus on the common second-best setting where emissions are not measurable at the source and pollution reduction is incentivized indirectly through payments tied to practice adoption. First, we show through simulation that in discrete choice models estimated on microdata, the use of predicted opportunity costs provides an erroneous estimate of underlying abatement costs. We then focus on two metrics commonly used to represent the marginal social costs of abatement actions, namely, average and marginal program expenditures incurred by the regulating agency. We show theoretically and empirically that these metrics generally fail to reveal underlying s...

Environmental rail charges in Europe: a review

ABSTRACTEuropean legislation implies the use of marginal social cost pricing in rail access charges levied on rail operators. Thus, they may include specific environmental charges to internalise the impacts of rail transport. However, when applying these principles in practice, several difficulties call for second-best settings adapted to the particularities of the rail market. In this context, few European railway administrations are already implementing rail access charges with an environmental dimension. This paper reviews the literature on the issue and assesses the current European experience in noise and air pollution rail charges. For this purpose, an analytical framework is built on the definition of four basic dimensions: charging approach, allocation of abatement efforts, degree of differentiation and intermodal approach. The qualitative examination of the existing systems suggests that the level of environmental surcharges can be generally increased given the low substitutability between rail and road and that the range of abatement possibilities should be enlarged by further differentiating charges. It is also found that the pricing scope should be adapted to achieve particular cost-efficient allocations of abatement efforts among rail operators and upstream agents. Finally, further research requirements for a quantitative assessment are defined.

Long-term care and births timing,

Due to the aging process, the provision of long-term care (LTC) to the dependent elderly has become a major challenge of our epoch. But our societies are also characterized, since the 1970s, by a postponement of births, which, by raising the intergenerational age gap, can affect the provision of LTC by children. In order to examine the impact of those demographic trends on the optimal policy, we develop a four-period OLG model where individuals, who receive children's informal LTC at the old age, must choose, when being young, how to allocate births along their life cycle. It is shown that, in line with empirical evidence, early children provide more LTC to their elderly parents than do late children, because they face a lower opportunity cost of providing LTC. When comparing the laissez-faire with the long-run social optimum, it appears that individuals have, at the laissez-faire, too few early births, and too many late births. We then study, in first-best and second-best settings, how the social optimum can be decentralized by encouraging early births, in such a way as to reduce the social burden of LTC provision.

Assessing Benefits of Slum Upgrading Programs in Second Best Settings

Slum upgrading programs are being used by national and city governments in many countries to improve the welfare of households living in slum and squatter settlements. These programs typically include a combination of improvements in neighborhood infrastructure, land tenure, and building quality. In this paper, the authors develop a dynamic general equilibrium model to compare the effectiveness of alternative slum upgrading instruments in a second-best setting with distortions in the land and credit markets. They numerically test the model using data from three Brazilian cities and find that the performance of in situ slum upgrading depends on the severity of land and credit market distortions and how complementary policy initiatives are being implemented to correct for these problems. Pre-existing land supply and credit market distortions reduce the benefit-cost ratios across interventions, and change the rank ordering of preferred interventions. In the light of these findings, it appears that partial equilibrium analysis used in typical cost-benefit work overstates the stream of net benefits from upgrading interventions and may in fact propose a misleading sequence of interventions.