Fall 2003

Frontiers in Health Policy Research
The History of Corporate Ownership: The Rise and Fall of Great Business Families
Taxation and Saving
Japan Conference

Frontiers in Health Policy Research

The NBER’s seventh annual conference on “Frontiers in Health Policy Research,” organized by David M. Cutler, NBER and Harvard University, and Alan M. Garber, NBER and Stanford University, took place on June 6 in Washington, DC. The program was:

Patricia M. Danzon, NBER and University of Pennsylvania, and Jonathan D. Ketcham, University of California, Berkeley, “Reference Pricing of Pharmaceuticals: Evidence from Germany, the Netherlands, and New Zealand”

Mark V. Pauly, NBER and University of Pennsylvania, “Adverse Selection and the Challenges to Stand-Alone Prescription Drug Insurance”

Wiliam H. Crown and Jonathan Maguire, Medstat; Ernst Berndt, NBER and MIT; and Kenneth E. Haver and Whitney P. Witt, Massachusetts General Hospital, “Benefit Plan Design and Prescription Drug Utilization Among Asthmatics: Do Patient Copayments Matter?”

Jay Bhattacharya, NBER and Stanford University; David M. Cutler; Dana Goldman, Michael Hurd, and Darius Lakdawalla, NBER and Rand Corporation; and Constanjin Panis, Rand Corporation, “Disability Forecasts and Future Medicare Costs”

Nancy Beaulieu, NBER and Harvard University, “Health Plan Conversions: Are they in the Public Interest?”

Danzon and Ketcham describe three prototypical systems of therapeutic reference pricing (RP) for pharmaceuticals — Germany, the Netherlands, and New Zealand — and examine their effects on: the availability of new drugs; manufacturer prices, reimbursement levels, and out-of-pocket surcharges to patients; and market shares of originator and generic products. The results differ across countries in predictable ways, depending on system design and other cost control policies. The most aggressive RP system has severely limited the availability of new drugs, particularly more expensive drugs, disproportionately reduced reimbursement and sales for originator products, and exposed patients to out-of-pocket costs. The authors find little evidence that therapeutic referencing has stimulated competition.

Pauly investigates a possible predictor of adverse selection problems in unsubsidized “stand-alone” prescription drug insurance: the persistence of an individual’s high spending over multiple years. Using MEDSTAT claims data and data from the Medicare survey of Current Beneficiaries, he finds that persistence is much higher for outpatient drug expenses than for other categories of medical expenses. He then uses these estimates to develop a model of adverse selection in competitive insurance markets and to show that this high relative persistence makes it unlikely that unsubsidized drug insurance can be offered for sale, even with premiums partially adjusted for risk, without a probable adverse selection death spiral. This outcome can be avoided if drug coverage is bundled with other coverage, and Pauly briefly discusses the need for comprehensive coverage or generous subsidies if adverse selection is to be avoided in private and Medicare insurance markets.

The ratio of controller-to-reliever medication use has been proposed as one measure of treatment quality for asthma patients. Crown and his co-authors examine the effects of plan-level, mean, out-of-pocket patient copayments for asthma medication, and other features of benefit plan design, on the use of controller medications alone, controller and reliever medications together (combination therapy), and reliever medications alone, relative to no drug treatment. They use claims data for 1995-2000. They find that the controller-reliever ratio rose steadily over 1995-2000, along with out-of-pocket payments for asthma medications. However, after controlling for other variables, plan level mean out-of-pocket copayments were not found to have a statistically significant influence on patient-level asthma treatment patterns. On the other hand, prescribing patterns among providers did influence patient-level treatment patterns; these effects differ somewhat between fee for service versus non-fee for service plans.

The traditional focus of disability research has been on the elderly, with good reason. Chronic disability is much more prevalent among the elderly, and it has more direct impact on the demand for medical care. However, it is also important to understand trends in disability among the young, particularly if these trends diverge from those among the elderly. These trends could have serious implications for future health care spending, since more disability at younger ages almost certainly translates into more disability among tomorrow’s elderly, and disability is a key predictor of health care spending. Using data from the Medicare Current Beneficiary Survey and the National Health Interview Study, Bhattacharya and his co-authors forecast that per capita Medicare costs will decline for the next 15 to 20 years; this is in accordance with recent projections of declining disability among the elderly. However, by 2020, the trend reverses. Per capita costs begin to rise because of growth in disability among the younger elderly. Total costs, which are the product of per capita costs and the total Medicare-eligible elderly population, will then begin to grow at an accelerating rate. Overall, cost forecasts for the elderly that incorporate information about disability among today’s younger generations yield more pessimistic scenarios than those based solely on elderly datasets; this information should be incorporated into official Medicare forecasts.

Over the last decade, managed care companies have been consolidating on a regional and a national scale. More recently, not-for-profit health plans have been converting to for-profit status; frequently, this conversion has occurred as a step toward facilitating a merger or acquisition with a for-profit company. Beaulieu examines certain related health policy issues through the lens of a case study of the proposed conversion of the CareFirst Blue Cross-Blue Shield Company to a for-profit public stock company, and its merger with the Wellpoint Corporation. Company executives and board members argued that CareFirst lacked access to sufficient capital and faced serious threats to its viability as a financially healthy non-profit health care company. They further argued that CareFirst and its beneficiaries would benefit from merger through enhanced economies of scale and product line extensions. Critics of the proposed conversion and merger raised concerns about the adverse impacts on access to care, coverage availability, quality of care, safety net providers, and the cost of health insurance. Analyses demonstrate that CareFirst wields substantial market power in its local market, that it is unlikely to realize cost savings through expanded economies of scale, and that access to capital concerns are largely driven by the perceived need for further expansion through merger and acquisition. Though it is impossible to predict future changes in quality of care for CareFirst, analyses suggest that quality appears to be somewhat lower in for-profit national managed care companies.

These papers will be published by the MIT Press in an annual conference volume. They are also available at "Books in Progress" on the NBER's website under the title Frontiers in Health Policy Research, Volume 7.

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The History of Corporate Ownership: The Rise and Fall of Great Business Families

The NBER held a conference on “The History of Corporate Ownership: The Rise and Fall of Great Business Families” in Alberta, Canada on June 21-22. NBER Research Associate Randall Morck, University of Alberta, organized this program:

Randall Morck; Michael Percy and Gloria Tian, University of Alberta; and Bernard Yeung, New York University, “The Rise and Fall of the Widely Held Firm in Canada”
Discussant: Jordan Siegel, MIT

William N. Goetzmann, NBER and Yale University, and Elisabeth Köll, Case Western Reserve University, “The History of Corporate Ownership in China”
Discussant: Dwight Perkins, Harvard University

Tarun Khanna and Krishna Palepu, Harvard University, “Decision or Serendipity? The Rise of India’s Software Industry”
Discussant: Ashoka Mody, International Monetary Fund

Antoin E. Murphy, Trinity College Dublin, “The History of Corporate Ownership in France”
Discussant: Daniel Raff, NBER and University of Pennsylvania

Caroline Fohlin, California Institute of Technology, “Ownership and Control in German Corporations: A Long-Run Perspective on the Role of Banks”
Discussant: Alexander Dyck, Harvard University

Julian Franks and Stefano Rossi, London Business School, and Colin Mayer, University of Oxford, “The Origination and Evolution of Ownership and Control” Discussant: Barry Eichengreen, NBER and University of California, Berkeley

Alexander Aganin, Cornerstone Research, and Paolo Volpin, London Business School, “The History of Corporate Ownership in Italy”
Discussant: Daniel Wolfenzon, New York University

Randall Morck, and Masao Nakamura, University of British Columbia, “The History of Corporate Ownership in Japan”
Discussant: Sheldon Garon, Princeton University

Peter Högfeldt, Stockholm School of Economics, “The History and Politics of Corporate Ownership in Sweden”
Discussant: Ailsa Röell, Princeton University

Marco Becht, Université Libre de Bruxelles, and J. Bradford DeLong, NBER and University of California, Berkeley, “Why has there been so Little Blockholding in America?”
Discussant: Richard Sylla, NBER and New York University

A long panel of corporate ownership data, stretching back to 1910, shows that the Canadian corporate sector began the century with a predominance of large pyramidal corporate groups controlled by wealthy families or individuals, and relatively few widely held firms. By the middle of the century, widely held firms had become predominant. However, from the 1970s on, there has been a marked resurgence of pyramidal groups controlled by wealthy families and individuals, corresponding to a large decline in the prevalence of widely held firms. Morck, Percy, Tian, and Yeung note that improvements in the general institutional environment and high taxes on inherited income accompany the rise of widely held firms. A sharp abatement in taxes on large states and a rise in the likely returns to political rent seeking accompany the resurgence of pyramidal groups.

Goetzmann and Köll examine the emergence of corporate ownership in China from the final decades of the Qing empire in the late 19th century to the early Republican period in the 1910s and 1920s. By analyzing the actual process of incorporation, the development of the legal and financial environment, and the role of the state, the authors ask whether the “top-down” approach — in which the central government established a legal framework for corporate enterprise based on Western models — and the assumption that it would work as it did for Western firms and markets was a viable approach to the modernization of a financial system traditionally dominated by family businesses and economic state patronage. Using business records from turn-of-the-century Chinese corporations, they find that the government’s “top-down” approach, only insufficiently promoted the system of corporate capitalism. Although China’s first corporate code contained many elements of the modern formula for privatization, it ultimately failed to effectively transform business enterprise. The authors highlight two reasons for the failure. First, the code did not sufficiently shift ownership and control from managers, previously empowered by government patronage, to shareholders. Second, the code was ineffective in stimulating the emergence of an active domestic share market that would induce family-owned firms and entrepreneurial managers to exchange control for access to shareholder capital and the liquidity of an active exchange.

Post-independent India pursued a set of economic policies that generally curbed private sector activity and made Indian industry fragmented and uncompetitive. The one exception to this has been the Indian software industry which began to grow in the 1980s. Today the industry has more than 2500 firms, all in the private sector. The leading Indian software firms are globally competitive, highly profitable, and are growing very rapidly. They are listed on the world’s major stock exchanges, and boast of a large fraction of the world’s leading companies as their customers. Khanna and Palepu trace the history of the development of the Indian software development, and the role played by the private sector product, labor, and financial market intermediaries, and the domestic business groups.

Murphy attempts to show that historical phenomena have had a major impact in the determination of France’s corporate ownership structure. Corporate finance is generated principally from three sources: banks, the capital market, and self-financing. If these are the three furrows leading to corporate investment, then history shows that two of them — the banks and the capital market — were subject to considerable upheaval, rendering them inoperable as channels for corporate finance for a long period in France’s corporate history. Faced with restricted access to the banks and capital markets, business entrepreneurs had to rely on self-financing as a method of growing the business. In turn, self-financing enabled these entrepreneurs and their descendants to retain sizeable shareholdings in the family controlled business. Hence, from an historical perspective, it is not surprising to see French families owning such a large proportion of French corporations. Furthermore, this style of ownership ties in with the French mentality that asset ownership is an intergenerational phenomenon. The objective of holding wealth is to pass on to the next generation assets that have risen in value. There are of course other variables that help to explain the high degree of concentration of corporate ownership by families in France. One of the most important of these is the French approach to the financing of pensions. The absence of funded pension schemes has led to a far lower profile by pension funds and assurance companies in the French stock market: in 1997, pension funds and assurance companies constituted 49 percent of household savings in the United Kingdom and 30 percent in the United States as opposed to 18 percent in France.

Fohlin provides a wide-ranging description of German corporate ownership and governance, both at their roots in the nineteenth century and in more recent experience. Her discussion raises several particularly important points: 1) Corporate governance institutions — executive and supervisory boards — remained quite underdeveloped in Germany until the last quarter of the nineteenth century. Boards were generally small and grew little over the pre-war period. 2) The universal banks were a significant but not overwhelming presence in the ownership and governance of German corporations during this period of rapid heavy industrialization and economic expansion (roughly 1895-1912). Similarly, industrial firms played only a small role in the ownership and governance of other non-financial firms. (Notably, financial firms, especially the large banks, did own shares in other banks and subsidiaries and did sit on the boards of those banks.) 3) Bank involvement in corporate ownership appears to have arisen largely out of the banks’ active involvement with securities issues, particularly of listed firms. Substantial holdings were rare, though earlier universal banks did sometimes unwillingly hold large stakes that they could not sell off for a period of time. 4) Bank involvement in corporate control through interlocking directorates is closely related to firms’ size, sector securities issue, and stock market listing. Control rights appear to have been granted largely via proxy voting for customers who deposited (bearer) shares with the bank. 5) The combination of commercial, investment, and brokerage services within individual banking institutions may have facilitated the networking of bank and firm supervisory boards. 6) Traditional explanations of German bank-firm relationships that focus on banks’ intervention in investment decisions and direct monitoring of debt contracts find little support in the current empirical analysis.

In the first half of the twentieth century, the U.K. capital markets were marked by an absence of investor protection; by the end of the century, there was more extensive protection there than virtually anywhere else in the world. The United Kingdom therefore provides an exceptional laboratory for evaluating how regulation affects the development of securities markets and corporations. Franks, Mayer, and Rossi investigate this issue by tracing the ownership and board composition of firms incorporated around 1900 over the subsequent 100 years and comparing the pattern of ownership and control with a sample incorporated around 1960. The authors find active securities markets at the beginning of the century; firms were able to raise substantial outside equity finance with rapid dispersion of ownership, even in the absence of investor protection. The introduction of investor protection in the second half of the century was not associated with greater dispersion of ownership but with more trading in share blocks. The authors offer an explanation as to how U.K. capital markets could flourish in the absence of investor protection.

Aganin and Volpin study the evolution of the stock market, the dynamics of the ownership structure of traded firms, the birth of pyramidal groups, and the growth and decline of families in Italy. They use a unique dataset covering all companies traded on the Milan stock exchange during the twentieth century. The stock market evolved over time according to a non-monotonic pattern: it was relatively more developed at the beginning and at the end than in the middle of the century. Similarly, ownership structure was more diffused in 1947 and in 2000 than in 1987. Moreover, family-controlled groups and pyramids were less common in 1947 and in 2000 than in 1987. These findings are not consistent with the view that stock market development and ownership concentration are a monotonic function of investor protection.

Morck and Nakamura note that Japan’s corporate sector began as zaibatsu family pyramids, was subjected to Soviet-style central planning, was reorganized into widely held firms, and finally organized itself into keiretsu corporate groups. Both zaibatsu and keiretsu were probably rational responses to weak institutions, a talent shortage, abundant private benefits of control, and an environment where political rent seeking earns high returns. Other common justifications for corporate groups are at best of second-order importance. These include economies of scope and scale and internal capital allocation. The latter provides short-term benefits, but undermines the group in the longer term. Once dominant, such groups lobby for institutional reforms that further their dominance. Examples include the suppression of the bond market in postwar Japan, managerial entrenchment in keiretsu firms, and an increasing importance of rent seeking as a source of competitive advantage. This lobbying almost surely did not enhance social welfare.

Högfeldt explains that because of strong Social Democratic political influence since 1932, control of the largest listed firms in Sweden has remained firmly in the hands of a few old families and banks via pyramids and by extensive use of dual-class shares. A combination of wealth, inheritance, and capital gains taxes locked capital into the established firms, while heavy tax subsidization of retained earnings and R and D spending supported growth by stimulating investments, often in very large projects joint with the government. Addition of young fast-growing firms has been very limited, because accumulation of private fortunes based on entrepreneurship and equity financing was disfavored and treated at significant tax disadvantages for ideological reasons. Of the 50 largest listed firms today, 31 were founded before 1914, only eight in the post-war period, and none after 1970. Being both controlling owners and major providers of loans to the largest listed firms, the two leading banks acted more like long-term bondholders than risk-taking capitalists. This fit the Social Democrats’ vision of large-scale capitalist firms run in the interests of the firms’ stakeholders — social firms without owners — particularly well. Taming of capitalism did not mean immediate takeover of private ownership as long as the capitalists invest and the export-oriented corporate sector remains efficient enough to support a growing, tax-financed public sector with strong egalitarian ambitions. Listed firms in effect did not have to disperse ownership and dilute benefits of control in order to raise new capital, as their dependence on equity markets was limited; on average less than 1 percent of investments are financed by new issues. The historical path of persistent social democratic policies generated high growth rates until the 1970s; then the negative effects of a stale, corporatist society controlled by political and economic powers that have been heavily entrenched for decades resulted in stagnation. The lack of economic and social dynamics is manifest in the dominance of very large, old family-controlled firms, and by the over-sized public sector that redistributes incomes, but not property rights, and wealth by encouraging outsiders to create new firms and fortunes.

A hundred years ago, American corporate control looked “normal”: large financial intermediaries and plutocratic families were controlling blockholders in the economy’s large and growing Chandlerian enterprises. By 50 years ago, the United States had become truly exceptional: blockholding had become rare, and managers largely autonomous. Roe (1994) argues that the political ethos of America was too hostile to the exercise of financier power for blockholding intermediaries to survive. La Porta et al. (1999) paint a picture of blockholding around the world as a response to weak protection of minority shareholders, which suggests that American shareholders been able to afford diversification because of the powerful and effective Delaware’s Chancery. Becht and DeLong say that the situation is more complicated. Yes, America’s deep equity markets amplified the benefits of diversification. Yes, the Delaware Chancery protects minority shareholder rights. Yes, there is a powerful Populist-Progressive current in American politics. But key historical accidents played as large a role as the forces adduced by Roe and La Porta et al. in creating this form of American exceptionalism.

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Taxation and Saving

An NBER Conference on Taxation and Saving, organized by James M. Poterba of NBER and MIT, took place on August 1 and 2. The following papers were discussed:

Andrew A. Samwick, NBER and Dartmouth College, “Mutual Fund Choice in 529 Plans: Federal Tax Advantages and Local Monopolies”
Discussant: Len Burman, Urban Institute

Susan Dynarski, NBER and Harvard University, “Who Benefits from the Education Saving Incentives? Income, Educational Expectations, and the Value of the 529 and Coverdell”
Discussant: Jeffrey Brown, NBER and University of Illinois

Gary Engelhardt, Syracuse University, and Brigitte Madrian, NBER and University of Chicago, “Tax-Deferred Saving and Participation in Employee Stock Purchase Plans”
Discussant: Roger H. Gordon, NBER and University of California, San Diego

Austan Goosbee, NBER and University of Chicago, “How Do Tax Rates Affect Executives’ Decisions About Corporate Stock?”
Discussant: William M. Gentry, NBER and Columbia University

Wojciech Kopczuk, NBER and Columbia University, and Emmanuel Saez, NBER and University of California, Berkeley, “Top Wealth Shares in the United States, 1916-2000: Evidence from Estate Tax Returns”
Discussant: Scott Weisbenner, NBER and University of Illinois

David Joulfaian, U.S. Department of the Treasury, and Kathleen M. McGarry, NBER and University of California, Los Angeles, “Estate and Gift Tax Incentives and Inter Vivos Giving”
Discussant: Alan J. Auerbach, NBER and University of California, Berkeley

Daniel R. Feenberg, NBER, and James M. Poterba, “The Alternative Minimum Tax and Effective Marginal Tax Rates”
Discussant: Rosanne Altshuler, Rutgers University

Jagadeesh Gokhale, Federal Reserve Bank of Cleveland, and Laurence J. Kotlikoff, NBER and Boston University, “The Impact on Consumption and Saving of Current and Future Fiscal Policies”
Discussant: Jonathan S. Skinner, NBER and Dartmouth College

James M. Poterba, “Valuing Assets in Retirement Saving Accounts”
Discussant: William Gale, Brookings Institution

The passage of tax reform legislation in 2001 opened up new tax-advantaged opportunities for families to save for college educations through 529 plans. Unlike other tax-advantaged savings accounts, 529 plans must be chartered by states. Several factors, including more favorable state income tax treatment of contributions or withdrawals, suggest the possibility of a “home bias” in which residents of a state tend to invest disproportionately in their own state’s plan. Home bias confers a local monopoly rent on the mutual fund family that manages the 529 plans. Samwick analyzes the extent to which that rent appears in the fee structure and performance characteristics of mutual funds that are made available in 529 plans. While examples can be found of poor offerings in 529 plans, the general result is that mutual fund companies do not systematically offer higher fee, lower performing funds to their captive market than to their retail market.

Dynarski calculates the incentives created by the 529 and Coverdell tax-advantaged savings accounts (ESA) and studies how these incentives vary by income. She finds that the advantages of the 529 and ESA rise sharply with income, for three reasons. First, those with the highest marginal tax rates benefit the most from sheltering income, gaining in both absolute and relative terms. Second, the accounts are risky for families whose children may not attend college, because account holders are penalized if the accounts are not used for schooling. Dynarski calculates the minimum probabilities of college attendance that are required for the 529 and ESA to have expected returns at least as high as alternative saving vehicles. She finds that, for households with incomes below $57,000, these break-even probabilities are higher than the observed rates at which their children go to college. Third, the financial aid system reduces aid disproportionately for those families that hold their assets in the 529 or ESA rather than in conventional saving vehicles. The financial aid “tax” is particularly high for the ESA; for families on the margin of receiving need-based financial aid, ESA returns net of income and aid taxes are negative. Since the highest-income families are not affected by the aid tax, this further intensifies the positive correlation between income and the advantages of the tax-advantaged college savings accounts.

Employee stock purchase plans (ESPPs) are designed to promote employee stock ownership in the firm and to provide another tax-deferred vehicle for capital accumulation, along with traditional pensions and 401(k)s. Englehardt and Madrian analyze the incentives that employees face to participate in an ESPP, and find that 401(k) saving with employer matching contributions dominates ESPP saving for retirement on an after-tax basis for all but the shortest horizons. Then the authors empirically examine ESPP participation using administrative data from 1997-2001 for a large health services company that employs over 30,000 people. The picture that emerges suggests that participation in and contributions to the ESPP are relatively large in magnitude, and the 401(k) and ESPP plans do not compete for the first dollar of employer-based plan saving. Rather, employees tend to exhaust saving opportunities in the 401(k) first, and then to contribute marginal saving to the ESPP. However, employees appear to be backward-looking when forecasting future returns and making company stock purchase commitments. This suggests that employees may not be fully aware of the risk of company stock and the benefits of diversification. Taxes do not seem to be a prime determinant of ESPP participation.

Goolsbee uses data on executive compensation during 1992-2000, matched to information on federal and state marginal tax rates on different types of income, to examine the impact of taxes on executives’ decisions about corporate stock. He shows that lower capital gains taxes correspond to executives significantly increasing their holding of corporate stock. He then illustrates how interactions between ordinary income taxes, capital gains taxes, and corporate income taxes interact in the executives’ decision on whether to exercise their stock options early. When capital gains taxes fall, as in 1997, executives have an incentive to exercise early and to pay taxes on part of the gain at ordinary income rates now in order to get future appreciation of the stock taxed at the lower capital gains rates in the future. The estimates confirm the model, and suggest that executives do have some inside information into the future prospects of the company, because firms whose stocks ends up growing faster are more likely to exercise early. Interestingly, the executives appear to place almost no weight on the corporate tax consequences of their exercise decisions, because the corporate income tax rate facing their companies has no influence on their behavior.

Using estate tax return data, Kopczuk and Saez present new homogeneous series on top wealth shares from 1916 to 2000 in the United States. Top wealth shares were very high at the beginning of the period but have been hit sharply by the Great Depression, the New Deal, and World War II shocks. Those shocks have had permanent effects. Following a decline in the 1970s, top wealth shares recovered in the early 1980s, but they are still much lower in 2000 than in the early decades of the century. Most of the changes the authors document are concentrated among the very top wealth holders, with much smaller movements for groups below the top 0.1 percent. Consistent with the Survey of Consumer Finances results, top wealth shares estimated from estate tax returns display no significant increase since 1995. Evidence from the Forbes 400 richest Americans suggests that only the super-rich have experienced significant gains relative to the average over the last decade. The most plausible explanations for the facts have been the development of progressive income and estate taxation, which has dramatically impaired the ability of large wealth holders to maintain their fortunes, and the democratization of stock ownership, which now spreads stock market gains and losses much more widely than in the past.

A very small but growing body of the literature has examined the pattern of lifetime gifts. Some of these studies relied on cross-sectional survey and administrative records; others have employed aggregate time-series data on gifts. However, little is known about the pattern of giving during the life cycle. For instance, two questions have yet to be explored: how gifts are allocated over life and how frequently gifts are made. This may be determined by wealth and age, but taxes also may play an important role. To address these questions, and to explore the role of taxes, Joulfaian and McGarry use two datasets. The first consists of several waves of the HRS/AHEAD survey, and the second uses longitudinal data on gifts from gift tax returns that are linked to estate tax returns. The administrative records are particularly useful in studying giving patterns of the wealthy, but not in the case of the less wealthy, where the survey data has a comparative advantage. The findings suggest that much of the giving takes place late in life. While these findings also suggest that taxes are an important consideration in the timing of transfers of the rich, this timing is not universally consistent with a tax minimization strategy.

Feenberg and Poterba examine the impact of the Alternative Minimum Tax on the weighted average marginal tax rates that apply to various components of taxable income. They also consider the impact of various AMT reform proposals on the number of AMT taxpayers and the total revenue collected from the AMT over the next decade. Using the NBER TAXSIM model to project federal personal income tax liabilities and AMT liabilities between 2003 and 2013, the authors’ projections show that modest increases in the AMT exclusion level have substantial effects on the number of AMT taxpayers. Further, indexing the AMT parameters would reduce the number of households with AMT liability from 36 million to 14 million in 2010. The presence of the AMT has only a modest impact on the average marginal tax rates on most income flows because some AMT taxpayers face higher marginal tax rates and others lower tax rates as a result of the tax.

Gokhale and Kotlikoff investigate the potential impact of alternative fiscal policies on current consumption and saving. Their analysis uses households drawn from the Federal Reserve’s 1995 Survey of Consumer Finances. This dataset provides detailed information on household earnings, assets, housing, demographics, and retirement plans. The policies the authors consider are: tax hikes, tax cuts, Social Security benefit cuts, and the elimination of tax-deferred saving. The results are influenced by the fact that a significant minority of their sample is liquidity-constrained, and thus more responsive to current than to future policy changes, no matter how long their duration. The results also are very sensitive to the particular policy being enacted. Income tax changes, for example, have little effect on the consumption/saving of low-income households for the simple reason that their income tax liabilities are relatively small. And, Social Security benefit cuts have only minor effects on the young, because they will occur so far in the future, and because the young generally are liquidity constrained. One the other hand, eliminating tax-deferred saving will have no effect on current retirees, but greatly influences the spending of the young, since such a policy would relax their liquidity constraints. Each of the policies considered has a quite sizeable effect on the current consumption and saving behavior of a substantial subset of this sample, though.

Assets in retirement saving plans have become an important component of net worth for many households. While many studies compare household balances in tax-deferred retirement accounts such as 401(k) plans with the amount held in other financial assets outside these accounts, these different asset components are not directly comparable. Taxes, and in some cases penalties, are due when assets are withdrawn from retirement saving plans. These factors can make assets inside retirement accounts less valuable than assets outside these accounts, particularly for those who are considering withdrawing assets from the tax-deferred accounts in the near future. For younger households who do not plan to withdraw tax deferred assets for many years, there is a countervailing factor — the opportunity for tax-free compound returns in retirement accounts — that can make assets in such accounts more valuable than similar assets outside such accounts. For a long-horizon retirement saver, a dollar inside a tax-deferred retirement saving account may be more valuable than a dollar outside such an account, even though the payouts of principal from the retirement account will be taxed at the time of distribution while the principal outside such accounts is untaxed. Poterba illustrates the potential differences in the value of assets inside and outside tax-deferred accounts. He draws on a range of data sources to calibrate the value of the tax burden, and the benefit of compound growth, for assets held in retirement accounts, and describes the differences in relative valuation for households of different ages.

These papers will be published in a forthcoming issue of the National Tax Journal. They will also be available at “Books in Progress” on the NBER’s website.

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Japan Conference

The NBER, Centre for Economic Policy Research (CEPR), Center for International Reseach on the Japanese Economy (CIRJE), and European Institute of Japanese Studies (EIJS) jointly organized a conference on the Japanese economy in Tokyo on September 19-20. The co-chairs of the meeting were: Magnus Blomstrom, NBER and Stockholm School of Economics; Jennifer Corbett, Australian National Union; Fumio Hayashi, NBER and the University of Tokyo; Anil K Kashyap, NBER and the Graduate School of Business, University of Chicago; and David Weinstein, NBER and Columbia University. The following papers were discussed:

Alan J. Auerbach and Maurice Obstfeld, NBER and University of California, Berkeley, “The Case for Open-Market Purchases in a Liquidity Trap”
Discussant: Susanto Basu, NBER and University of Michigan

Gunter Coenen and Volker Wieland, European Central Bank, “The Zero-Interest-Rate Bound and the Role of the Exchange Rate for Monetary Policy in Japan”
Discussant: David Gruen, Australian Department of the Treasury

I. Serdar Dinc, University of Michigan, and Patrick M. McGuire, Bank for International Settlements, “Did Investors Regard Real Estate as ‘Safe’ during the ‘Japanese Bubble’ in the 1980s?”
Discussant: Kenneth J. Singleton, NBER and Stanford University

Ricardo J. Caballero, NBER and MIT; Takeo Hoshi, NBER and University of California, San Diego; and Anil K Kashyap, “Zombie Lending and Depressed Restructuring in Japan”
Discussant: Chang-Tai Hsieh, NBER and Princeton University

Robert Dekle, University of Southern California, and Kenneth Kletzer, University of California, Santa Cruz, “The Japanese Banking Crisis and Economic Growth: Theoretical and Empirical Implications of Deposit Guarantees and Weak Financial Regulation”
Discussant: David Smith, Federal Reserve Board

Tetsuji Okazaki, University of Tokyo, and Michiru Sawada, Hitotsubashi University, “Bank Merger Movement and Evolution of Financial System: Experiences in Prewar Japan”
Discussant: Takeo Hoshi

Yoshiro Miwa, University of Tokyo, and J. Mark Ramseyer, Harvard University, “Who Appoints Them, What Do They Do? Evidence on Outside Directors from Japan”
Discussant: Randall Morck, NBER and University of Alberta

Gauti Eggertsson, International Monetary Fund, and Michael Woodford, NBER and Princeton University, “Optimal Monetary Policy in a Liquidity Trap”
Discussant: Kazuo Ueda, Bank of Japan

The prevalent thinking about liquidity traps suggests that the perfect substitutability of money and bonds at a zero short-term nominal interest rate renders open market operations ineffective for achieving macroeconomic stabilization goals. Auerbach and Obstfeld show that even if this were the case, there would remain a powerful argument for large-scale open market operations as a fiscal policy tool. This same reasoning implies that open market operations will be beneficial for stabilization as well, even when the economy is expected to remain mired in a liquidity trap for some time. Thus, the microeconomic fiscal benefits of open market operations in a liquidity trap go hand in hand with standard macroeconomic objectives. Motivated by Japan’s recent economic experience, the authors use a dynamic general-equilibrium model to assess the welfare impact of open market operations for an economy in Japan’s predicament. They argue that Japan can achieve a substantial welfare improvement through large open market purchases of domestic government debt.

Coenen and Wieland study the role of the exchange rate in conducting monetary policy in an economy with near-zero nominal interest rates as Japan has experienced since the mid-1990s. This analysis is based on an estimated model of Japan, the United States, and the euro area with rational expectations and nominal rigidities. Te authors first provide a quantitative analysis of the impact of the zero bound on the effectiveness of interest rate policy in Japan in terms of stabilizing output and inflation. Then they evaluate three concrete proposals that focus on depreciation of the currency as a way to ameliorate the effect of the zero bound and to evade a potential liquidity trap. Finally, they investigate the international consequences of these proposals.

It is well known that Japanese banks increased their exposure to land assets and the real estate sector in the latter half of the 1980s, and that this became a primary factor in the non-performing loan problem that emerged in the 1990s. What is less clear, however, is whether this increased exposure was the result of active risk taking, and whether banks and other market participants regarded land and real estate assets as “risky” while real estate prices were increasing dramatically. To address this issue, Dinc and McGuire rely on real estate data contained in corporate balance sheets to estimate the market sentiment toward land assets during 1985-9. They find that the systemic risk of manufacturing companies increased with their real estate holdings but not with other balance sheet assets. This indicates that market participants regarded real estate holdings as riskier than the main operations of manufacturing companies during the “bubble period,” even if they may not have foreseen the subsequent crash in real estate prices.

Caballero, Hoshi, and Kashyap propose a bank-based explanation for the decade-long Japanese slowdown. They start with the well-known observation that most large Japanese banks would be out of business if regulators forced them to recognize all their loan losses immediately. Because of this, the banks keep many “zombie firms” alive by “evergreening” their loans: rolling over loans that they know will not be collected. Thus, the normal competitive outcome, whereby the zombies would shed workers and lose market share, is being thwarted. The authors highlight the restructuring implications of this zombie problem: the counterpart of the congestion created by the zombies is a reduction of the profits for potential new and more productive entrants, which discourages their entry. In this context, even solvent banks see no particularly good lending opportunities in Japan. Essentially Japan has reached the situation of having bankrupt banks lend to bankrupt firms, and in this scenario the private sector struggles. The authors confirm their key predictions that zombie-dominated industries exhibit more depressed job creation, lower productivity, and greater excess capacity.

Dekle and Kletzer use an endogeneous growth model with financial intermediation to show how government policies towards the financial sector can lead to banking crises and persistent growth slumps. The model shows how government deposit guarantees and regulatory forbearance can lead to permanent declines in the growth rate of the economy. The effects of inadequate prudential supervision on asset price dynamics under perfect foresight also are derived in the model. The policies that are used in the analysis are based on essential features of Japanese financial regulation. The implications of the model then are compared to the experience of the Japanese economy and financial system during the 1990s. The authors find that the dynamics predicted by their model are generally consistent with the recent behavior of economic aggregates, asset prices, and the banking system for Japan. One policy implication of the model is that the impact on future economic growth depends on the length of time the government fails to enforce loan-loss reserving by banks.

Okazaki and Sawada examine the effects of bank consolidations on the financial system, using data on the Japanese banking industry before the Second World War, when the first bank merger movement occurred and deposit insurance did not exist. The focus of their analysis is governance structure and the performance of banks. The authors find that consolidations had the effect of excluding an unfavorable interlocking directorate between banks and their related firms, especially in the case of absorbing consolidations. The authors also confirm that consolidations had a positive effect on deposit growth, but not on bank profitability.

Miwa and Ramseyer assemble data on the 1,000 largest exchange-listed Japanese firms from 1986-94 and explore which firms tend to appoint outsiders to their boards. They find that appointments are decidedly non-random. Firms appoint directors from the banking industry when they borrow heavily, when the firm has fewer mortgageable assets, or when the firm itself is in the service and finance industry. Firms appoint retired government bureaucrats when they are in construction and sell a large fraction of their output to government agencies. And, firms appoint other retired business executives when they have a dominant parent corporation or when they are in the construction industry and sell heavily to the private sector. The authors then ask whether firms with more outside directors outperform those with fewer. They find that they do not. Instead, as the logic of market competition predicts, board composition seems endogenous. Given that the composition does not change from the thriving 1980s to the depressed 1990s, optimal board structure seems not to depend on the macroeconomic environment.

Eggertsson and Woodford consider the consequences for monetary policy of the zero floor for nominal interest rates. The zero bound can be a significant constraint on the ability of a central bank to combat deflation. The authors show, in the context of an intertemporal equilibrium model, that open market operations, even “unconventional” ones, are not effective if they do not change expectations about the future conduct of policy. Nonetheless, a credible commitment to the right sort of history-dependent policy can largely mitigate the distortions created by the zero bound. In this model, optimal policy involves a commitment to adjust interest rates so as to achieve a time-varying price-level target when it is consistent with the zero bound. The authors also discuss ways in which other central bank actions, while irrelevant apart from their effects on expectations, may help to make a central bank’s commitment to its target credible. They also consider implications for the policy options currently available for overcoming deflation in Japan.

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