Estimating the Elasticity of Intertemporal Substitution Using Mortgage Notches

(with James Cloyne, Ethan Ilzetzki and Henrik Kleven) October 2018. Review of Economic Studies, forthcoming

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, and optimization frictions. We also use our model to characterize the link between the EIS and the reduced form borrowing elasticities often estimated in the literature. This analysis demonstrates that reduced-form elasticities are in general not informative of the underlying structural parameter as the translation between the two is mediated by endogenous variables that can vary widely across borrowers.


Housing Market Responses to Transaction Taxes: Evidence From Notches and Stimulus in the UK

(with Henrik Kleven) Review of Economic Studies, 85 (1), 157-193, 2018

We investigate housing market responses to transaction taxes using administrative data on all property transactions in the UK from 2004-2012 combined with quasi-experimental variation from tax notches and tax stimulus. We present two main findings. First, transaction taxes are highly distortionary across a range of margins, causing large distortions to the price, volume and timing of property transactions. Second, temporary transaction tax cuts are an enormously effective form of fiscal stimulus. A temporary elimination of a 1% transaction tax increased housing market activity by 20% in the short run (due to both timing and extensive responses) and less than half of the stimulus effect was reversed after the tax was reintroduced (due to re-timing). Because of the complementarities between moving house and consumer spending, these stimulus effects translate into extra spending per dollar of tax cut equal to about 1. We interpret our empirical findings in the context of a housing model with downpayment constraints in which leverage amplifies the effects of transaction taxes.


Production vs Revenue EfficiencyWith Limited Tax Capacity: Theory and Evidence From Pakistan

(with Anne Brockmeyer, Henrik Kleven, Johannes Spinnewijn and Mazhar Waseem) Journal of Political Economy, 123 (6), 1311-1355, 2015

To fight evasion, many developing countries resort to production-inefficient tax policies. This includes minimum tax schemes whereby firms are taxed on either profits or turnover, depending on which tax liability is larger. Such schemes create non-standard kink points, which allow for eliciting evasion responses to switches between profit and turnover taxes using a bunching approach. Using administrative tax records on corporations in Pakistan, we estimate that turnover taxes reduce evasion by up to 60-70% of corporate income. Incorporating this in a calibrated optimal tax model, we find that switching from profit to turnover taxation increases revenue by 74% without reducing aggregate profits, despite the production inefficiency that it introduces.

Working Papers

Individuals and Organizations as Sources of State Effectiveness

(with Jonas Hjort and David Szakonyi) December 2018

Policymakers do not implement states’ policies-bureaucrats do. How important are bureaucrats in determining the productivity of the state enterprise? To what extent do the tradeoffs between different policies-and hence optimal policy design-depend on the effectiveness of the bureaucracy tasked with implementation? We investigate these questions in the context of public procurement. Using data on 16 million purchases in Russia during 2011–2016, we first show that over 40 percent of the variation in quality-adjusted prices paid-our measure of performance-is due to the individual bureaucrats and organizations that manage procurement processes. Our estimates imply that ineffective bureaucracies massively reduce public sector output: moving the least effective quartile of procurers to 75th percentile effectiveness would save the Russian government USD 13 billion each year. To explore the implications of bureaucratic effectiveness for policy design, we analyze Russia’s adoption of a ubiquitous procurement policy-bid preferences for domestic suppliers. Using a generalized difference-in-differences strategy, we estimate the impact of the policy separately for procurers of different effectiveness. Consistent with a simple endogenous-entry auction model, we find that bid preferences save the government 17.5 percent when implemented by the least effective quartile of bureaucrats, but only 0.7 percent when implemented by the most effective quartile. Overall, our results demonstrate that the often overlooked bureaucratic apparatus is critical for state effectiveness, which helps to explain why many policies work well only in some settings; and that policy designed with bureaucratic context in mind can partially offset the cost of bureaucratic ineffectiveness.


The Role of Firms in Workers’ Earnings Responses to Taxes: Evidence From Pakistan

May 2014

This paper exploits employee-employer matched administrative tax data on firms and salaried workers in Pakistan to explore the underappreciated role of firms in determining how workers’ taxable earnings respond to taxation. I present evidence on three ways in which firms affect workers’ earnings responses. First, third-party reporting of salaries by employers makes underreporting taxable income more costly for workers and reduces evasion of the income tax. Second, firms’ equilibrium salary-hours offers respond endogenously to the presence of adjustment costs in the labour market by tailoring offers to aggregate worker preferences. Third, workers learn about the tax schedule from firms’ salary offers, making them more responsive to taxation both contemporaneously (by 130%) and in subsequent years (by 100%). However, while third-party reporting makes misreporting more costly, it does not eliminate it in a low tax-capacity setting: 19% of workers still underreport their salaries, leading to a loss of about 5% of tax revenue, and indicating high returns to investments in improving enforcement capacity. The large role played by firms in determining workers’ earnings implies that firms need to play a central role in our analysis of income taxation in lower income countries.


Optimal Income Taxation with Career Effects of Work Effort

(with Henrik Kleven) February 2013. Revise and Resubmit, American Economic Journal: Economic Policy

The literature on optimal income taxation assumes that wage rates are generated exogenously by innate ability and therefore do not respond to behavior and taxation. This is in stark contrast to a large empirical literature documenting a strong effect of current work effort on future wage rates. We extend the canonical Mirrleesian optimal tax framework to incorporate such career effects and provide analytical characterizations that depend on estimable entities. Besides the standard static earnings elasticity with respect to the marginal tax rate, the optimal tax schedule also depends on the elasticity of future wages with respect to current work effort. We explore the empirical magnitude of this “career elasticity” in a meta-analysis of the literature on the returns to work experience and tenure, concluding that a reasonable value for this elasticity lies between 0.2 and 0.4. Calibrating the model to US micro data (under reasonable values of the career elasticity), we present numerical simulations of optimal nonlinear tax schedules that depend on per-period earnings and potentially on age. In the case of age-independent taxation, the presence of career effects make the tax schedule substantially less progressive than in standard models with exogenous wage rates. In the case of age-dependent taxation, career effects create a strong argument for lower taxes on the old, opposite the recommendation in the recent literature on age-dependent taxation. This result reflects both a career incentive effect and an equity effect, where the latter effect arises because increasing earnings over the career path for each ability level imply that, conditional on earnings, age and ability are negatively correlated.


Selected Work in Progress

Incentives and the Allocation of Authority in Organizations: A Field Experiment with Bureaucrats

(with Oriana Bandiera, Adnan Khan and Andrea Prat)

Research Question: How can governments motivare bureaucrats to perform better? We study the impacts of two potential strategies for improving bureaucratic performance, and how they interact. The first is a familiar financial incentive scheme that rewards bureaucrats who achieve the best value for money in procurement. The second strategy provides bureaucrats with greater discretion over how and when they spend, freeing them from some of the pervasive red tape involved in procurement. A third group of bureaucrats received both interventions.



Greener on the Other Side? Spatial Discontinuities in Property Tax Rates and their Effects on Tax Morale

(with François Gerard, Evan Kresch, Joana Naritomi and Laura Zoratto)

Research Question: Do perceptions of unfairness and inequality in property tax liabilities contribute to delinquency? We study the urban property tax in Manaus, Brazil, one of the city’s main revenue sources. Households’ tax liability depends on which sector of the city they live in, but this can lead neighbors on opposite sides of a street, but who are in different sectors, to owe wildly different taxes, which is widely perceived as unfair. Combining administrative data on tax liabilities, payments and property transfers; reforms to the tax and liabilities in the different sectors, and an experiment informing households of the tax liabilities of other sectors, we study whether perceived unfairness affects tax payments.