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Spring 2019

Using Big Data to Solve Economic and Social Problems Professor Raj Chetty Head Section Leader: Gregory Bruich, Ph.D. Spring 2019. Behavioral Public Economics. Traditional economic approach assumes that all individuals are fully aware of taxes that they pay and optimize perfectly in response

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Spring 2019

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  1. Using Big Data to Solve Economic and Social Problems Professor Raj Chetty Head Section Leader: Gregory Bruich, Ph.D. Spring 2019

  2. Behavioral Public Economics • Traditional economic approach assumes that all individuals are fully aware of taxes that they pay and optimize perfectly in response • Is this true in practice? • Do you know your marginal income tax rate? • Do you think about it when choosing a job? When deciding how much to save for retirement?

  3. Federal Income Tax Rates for a Single Earner with 2 Children in 2006 60 51% 46% 45% 40% 40 35% 33% 38% 30% 31% 28% 21% 20 Marginal Tax Rate (%) 0% 0 -20 -25% -40% -40 $0 $50K $100K $150K $200K Pre-Tax Earnings Source: NBER Taxsim marginal tax rate calculator

  4. Number of Pages of Instructions that Come with Form 1040 (Basic Individual Tax Form) Source: Gruber 2016

  5. Behavioral Public Economics Example 1: Sales Taxes • Begin by considering one of the simplest taxes: sales taxes on purchases in grocery stores • Chetty, Looney, Kroft (2009) test whether consumers are aware of and respond “rationally” to these simple taxes • Sales taxes not included in posted prices in the U.S. • Test whether this affects response to sales taxes using an experiment in a grocery store in Northern California

  6. Original Tag Experimental Tag Source: Chetty, Looney, Kroft (2009)

  7. CONTROL STORES Control Categories Treated Categories Period Difference Baseline 30.57 27.94 -2.63 (0.24) (0.30) (0.32) Experiment 30.76 28.19 -2.57 (0.72) (1.06) (1.09) DD = 0.06 Difference 0.19 0.25 CS over time (0.64) (0.92) (0.90) Effect of Posting Tax-Inclusive Prices: Mean Quantity Sold TREATMENT STORE Period Control Categories Treated Categories Difference Baseline 26.48 25.17 -1.31 (0.22) (0.37) (0.43) Experiment 27.32 23.87 -3.45 (0.87) (1.02) (0.64) DD = -2.14 Difference 0.84 -1.30 TS over time (0.75) (0.92) (0.64) -2.20 DDD Estimate (0.58) Source: Chetty, Looney, Kroft (2009)

  8. -.05 -.1 Effects of Changes in State Beer Excise Taxes on Changes in Beer Consumption .1 .05 0 Change in Log Per Capita Beer Consumption -.02 -.015 -.01 -.005 0 .005 .01 .015 .02 Change in Log(1+Beer Excise Rate) Source: Chetty, Looney, Kroft (2009)

  9. Effects of Changes in State Sales Taxes on Changes in Beer Consumption .1 .05 0 Change in Log Per Capita Beer Consumption -.05 -.1 -.02 -.015 -.01 -.005 0 .005 .01 .015 .02 Change in Log(1+Sales Tax Rate) Source: Chetty, Looney, Kroft (2009)

  10. Behavioral Public Economics Example 2: Income Taxation • Next, turn to the Earned Income Tax Credit: largest cash transfer anti-poverty program in the U.S. • $70 billion spent per year, partly with goal of increasing work among low-income families • Is the EITC successful in achieving this goal? • Chetty, Friedman, and Saez (2013) study this question, focusing on importance of knowledge and information about EITC

  11. 2008 Federal EITC Schedule for a Single Filer with Children $5K $4K $3K EITC Credit $2K $1K $0K $0 $10K $20K $30K $40K Total Earnings (Real 2010 $) One Child Two or More Children

  12. Income Distributions for Individuals with Children in 2008 5% 4% 3% Percent of Tax Filers 2% 1% 0% $0 $10K $20K $30K $40K Total Earnings (Real 2010 $) One Child Two Children

  13. Earnings Distribution Around EITC-Maximizing Threshold in Texas 5% 4% 3% Percent of Filers 2% 1% 0% -$10K $0K $10K $20K Income Relative to 1st Kink

  14. Earnings Distribution Around EITC-Maximizing Threshold in Kansas 5% 4% 3% Percent of Filers 2% 1% 0% -$10K $0K $10K $20K Income Relative to 1st Kink

  15. Fraction of Tax Filers Who Report Income that Maximizes EITC Refund in 1996 > 4.1 % 1.5 % 0 %

  16. Fraction of Tax Filers Who Report Income that Maximizes EITC Refund in 1999 > 4.1 % 1.5 % 0 %

  17. Fraction of Tax Filers Who Report Income that Maximizes EITC Refund in 2002 > 4.1 % 1.5 % 0 %

  18. Fraction of Tax Filers Who Report Income that Maximizes EITC Refund in 2005 > 4.1 % 1.5 % 0 %

  19. Fraction of Tax Filers Who Report Income that Maximizes EITC Refund in 2008 > 4.1 % 1.5 % 0 %

  20. Is the Spatial Variation Driven by Differences in Knowledge About the EITC? • Is the spatial variation in EITC response driven by differences in knowledge or other factors, such as differences in tax compliance? • Knowledge explanation makes a very specific prediction: asymmetric impact of moving • Moving to a higher-bunching neighborhood should increase responsiveness to EITC as people learn • But moving to a lower-bunching area should not affect responsiveness

  21. Event Study of Sharp Bunching Around Moves 5% 4% 3% Sharp Bunching Rate at First EITC Threshold 2% 1% 0% -4 -2 0 2 4 Event Year Movers to Lowest Bunching Decile Movers to Middle Bunching Decile Movers to Highest Bunching Decile

  22. Change in EITC Refunds vs. Change in Sharp Bunching for Movers 120 100 β = 59.7 (5.7) Change in EITC Refund ($) 80 60 β = 6.0 (6.2) p-value for diff. in slopes: p < 0.0001 40 -1% -0.5% 0% 0.5% 1% Change in ZIP-3 Sharp Bunching

  23. Reporting vs. Real Responses • Audit studies reveal that sharp bunching at EITC refund maximizing threshold is partly due to misreporting of self-employment income • To isolate real work responses, focus on wage earnings reported on W-2 firms directly by employers

  24. Income Distribution For Single Wage Earners with One Child 3.5% $4K 3% $3K 2.5% 2% EITC Amount ($) Percent of Wage-Earners $2K 1.5% 1% $1K 0.5% 0% $0K $0K $5K $10K $15K $20K $25K $30K $35K W-2 Wage Earnings

  25. Income Distribution For Single Wage Earners with One Child Is the EITC having an effect on this distribution? 3.5% $4K 3% $3K 2.5% 2% EITC Amount ($) Percent of Wage-Earners $2K 1.5% 1% $1K 0.5% 0% $0K $0K $5K $10K $15K $20K $25K $30K $35K W-2 Wage Earnings

  26. Income Distribution For Single Wage Earners with One Child High vs. Low Bunching Areas 3.5% $4K 3% $3K 2.5% 2% EITC Amount ($) Percent of Wage-Earners $2K 1.5% 1% $1K 0.5% 0% $0K $0K $5K $10K $15K $20K $25K $30K $35K W-2 Wage Earnings Lowest Bunching Decile Highest Bunching Decile

  27. Earnings Distribution in the Year Before First Child Birth for Wage Earners 6% 4% Percent of Individuals 2% 0% $10K $20K $30K $40K $0K Wage Earnings Lowest Sharp Bunching Decile Middle Sharp Bunching Decile Highest Sharp Bunching Decile

  28. Earnings Distribution in the Year of First Child Birth for Wage Earners 6% 4% Percent of Individuals 2% 0% $10K $20K $30K $40K $0K Wage Earnings Lowest Sharp Bunching Decile Middle Sharp Bunching Decile Highest Sharp Bunching Decile

  29. Implications for Design of Earned Income Tax Credit • EITC has significant impacts on labor supply of low-income families with kids • But knowledge about the program plays a big role in determining its impacts • If we want to amplify impacts of EITC on labor supply, may be more effective to increase awareness (or include in pre-tax wage) than change credit amount

  30. Behavioral Public Economics Example 3: Retirement Savings • Widespread concern that many families are not saving enough for retirement • U.S. government effectively spends $100 billion on programs to increasing saving for retirement • Subsidies for retirement savings accounts such as IRAs and 401(k)s • Is this an effective way to increase retirement saving? • Are there other policy instruments that may be more effective? • Insights from behavioral economics has shifted policy approaches to increasing saving significantly in the past 15 years

  31. The Power of Defaults • Madrian and Shea (2001) analyze impacts of employer defaults on individuals' 401(k) retirement account contributions • Defaults just change whether employees opt-in or opt-out of retirement saving • Do not change actual incentives to save, so should have no impact under traditional economic model

  32. Effects of Automatic Enrollment on 401(k) Participation Source: Madrian and Shea (2001)

  33. Effects of Automatic Enrollment on Distribution of 401(k) Contribution Rates Source: Madrian and Shea (2001)

  34. Crowdout in Retirement Savings Accounts • Do defaults increase total savings or just lead to shifting of assets from non-retirement to retirement accounts? • Impacts of defaults on total saving not obvious despite Madrian and Shea evidence • Even inattentive individuals still have to satisfy budget constraint by cutting consumption or savings in non-retirement accounts • Chetty et al. (2014) analyze this question using third-party reported data on all financial wealth for population of Denmark

  35. Impacts of Defaults in Denmark • Employers make pension contributions on workers behalf automatically • Contributions vary substantially across employers • Research design: event study when workers switch firms • Retirement savings rate can change sharply when workers switch firms • Do workers offset these changes in their own private savings?

  36. Event Study around Switches to Firm with >3% Increase in Employer Pension Rate 12 Δ Employer Pensions = 5.64 8 Contribution or Taxable Saving Rate (% of income) 4 0 -4 -2 0 2 4 Year Relative to Firm Switch Employer Pensions

  37. Event Study around Switches to Firm with >3% Increase in Employer Pension Rate 12 Δ Employer Pensions = 5.64 Δ Individual Pensions = -0.56 8 Contribution or Taxable Saving Rate (% of income) 4 0 -4 -2 0 2 4 Year Relative to Firm Switch Individual Pensions Employer Pensions

  38. Event Study around Switches to Firm with >3% Increase in Employer Pension Rate 12 Δ Employer Pensions = 5.64 Δ Taxable Savings = 0.02 8 Contribution or Taxable Saving Rate (% of income) 4 0 -4 -2 0 2 4 Year Relative to Firm Switch Taxable Saving Employer Pensions

  39. Impacts of Retirement Savings Subsidies • Next, compare these effects to impacts of standard tax incentives for retirement saving • Denmark subsidizes individual’s contributions to retirement accounts, analogous to 401(k)’s in the U.S. • Reform in 1999 in Denmark lowered subsidy for saving in pension accounts by 12 cents per DKr for individuals in top income tax bracket • Ask two questions analogous to those above: • How did this reform affect contributions to pension accounts? • How much money was shifted to other non-retirement accounts?

  40. Impact of 1999 Pension Subsidy Reduction On Pension Contributions 15000 10000 Capital Pension Contribution (DKr) 5000 0 -75000 -50000 -25000 0 25000 50000 75000 Income Relative to Top Tax Cutoff (DKr) 1996 1999

  41. Impact of 1999 Pension Subsidy Reduction On Pension Contributions 15000 10000 Capital Pension Contribution (DKr) 5000 0 -75000 -50000 -25000 0 25000 50000 75000 Income Relative to Top Tax Cutoff (DKr) 1996 1997 1999

  42. Impact of 1999 Pension Subsidy Reduction On Pension Contributions 15000 10000 Capital Pension Contribution (DKr) 5000 0 -75000 -50000 -25000 0 25000 50000 75000 Income Relative to Top Tax Cutoff (DKr) 1996 1997 1998 1999

  43. Impact of 1999 Pension Subsidy Reduction On Pension Contributions 15000 10000 Capital Pension Contribution (DKr) 5000 0 -75000 -50000 -25000 0 25000 50000 75000 Income Relative to Top Tax Cutoff (DKr) 1996 1997 1998 1999

  44. Impact of 1999 Pension Subsidy Reduction On Pension Contributions 15000 10000 Capital Pension Contribution (DKr) 5000 0 -75000 -50000 -25000 0 25000 50000 75000 Income Relative to Top Tax Cutoff (DKr) 1996 1997 1998 1999 2000

  45. 15000 10000 5000 0 -75000 -50000 -25000 0 25000 50000 75000 Income Relative to Top Tax Cutoff (DKr) 1996 1997 1998 1999 2000 2001 Impact of 1999 Pension Subsidy Reduction On Pension Contributions Capital Pension Contribution (DKr)

  46. .02 .01 0 -.01 -.02 1996 1997 1998 1999 2000 2001 Change in Marginal Propensity to Save in Retirement vs. Non-Retirement  Accounts at Top Tax Cutoff by Year Difference in MPS Above vs. Below Top Tax Cutoff Year Retirement Accounts

  47. .02 .01 0 -.01 -.02 1996 1997 1998 1999 2000 2001 Change in Marginal Propensity to Save in Retirement vs. Non-Retirement  Accounts at Top Tax Cutoff by Year Difference in MPS Above vs. Below Top Tax Cutoff Year Retirement Accounts Taxable Savings Accounts

  48. Active vs. Passive Savers • 15% of people account for entire reduction in pension contributions following reform (“active savers”) • But these people simply shift money from retirement account to other accounts, with essentially no net change in total saving • 85% of people do not respond to incentives at all (“passive savers”) • These people are heavily influenced by defaults and increase total saving in response

  49. Heterogeneity in Responses to Subsidies by Educational Attainment 20 15 % Who Stop Contributing to Capital Pensions in 1999 10 5 0 No College College Economics Education

  50. Implications for Retirement Savings Policies • Tax incentives for retirement saving have little impact on total savings because they simply induce active savers to switch accounts • $1 of expenditures by government on retirement savings incentives generates only 1 cent of additional saving • Automatic contributions/defaults have much larger impacts because they influence the behavior of passive savers • Behavioral economics perspective calls for shift toward automatic enrollment plans and reductions in existing 401(k)-style incentives

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