Greatest (Research) Hits of 2016

Some new insights from the National Bureau of Economic Research on the relationship between taxes and business investment, work incentives, and inequality.

With its indecipherable terms of art, incomprehensible mathematics, and turgid prose, the “publish or perish” world of academia often seems to go out of its way to make its research as inaccessible as humanly possible to the real world of policy making.  But that doesn’t mean scholarly papers don’t have important insights to share.

We subscribe to the National Bureau of Economic Research’s Working Paper listserve, which offers a look at the latest research coming out on all dimensions of tax and fiscal policy.  For every one paper we have occasionally featured in a standalone article in Fiscal Focus, there are probably ten others that have some relevance to key issues being discussed in this state.  So as the year closes, we thought we’d highlight a few of the more interesting findings and conclusions we’ve come across.

On taxes and business investment – Expensing of capital purchases promotes capital investment, at least among smaller firms that can realize immediate cash flow benefits.  Analyzing data from over 120,000 firms, researchers found bonus depreciation raises investment in eligible capital relative to ineligible capital by 16.9%.1  The policy is especially relevant to small firms which respond 95% more than large firms.  But firms only respond to these investment incentives when the policy generates immediate cash flow benefits, not when cash flow comes in the future.

For larger, publically traded firms attention to a different policy area may be in order – the research and development credit.  An examination of how the public corporation in the United States has evolved over the past forty years2 unveiled a remarkable and profound shift in business investment activity as these firms now invest far less in physical assets but much more in R&D.  In 1980 the average public corporation spent almost 7 times more on capital than on R&D.  Today R&D expenditures are 78% higher than capital spending.

On taxes and work incentivesThe interactive effects of the design of income support programs, eligibility thresholds, minimum wage laws, and the tax code remains an important public policy issue.  A study examining marginal tax rates facing low-income families showed enormous variation across families who participate in different combinations of income support programs.3  Families participating in two or more programs face negative or modestly positive marginal tax rates at low earnings levels, but usually face very high rates at higher earnings ranges, often up to 80% and occasionally over 100%.  While the fraction of families in this category is not large, they constitute about one-fifth of single parent families.

But there is another major and rapidly growing demographic hugely affected by these issues.  Another study examined work disincentives facing the elderly, who lose federal and state benefits with higher earnings – with a special emphasis on the clawback of disability benefits resulting from Medicaid and Social Security’s complex earnings tests.4  As they retire, Baby Boomers will face high and in many circumstances extremely high work disincentives.  Researchers found the marginal tax rate associated with a significant increase in senior earnings (e.g. $20,000) due to part time work is dramatically higher than that associated with a relatively small amount (e.g. $1,000) of extra income.  Working harder and longer to maintain living standards in retirement faces headwinds thanks to the “hodgepodge design of our fiscal system.”

On taxes and inequality -- The ultimate test of inequality and fairness is defined by living standards which recognize that unequal distribution of income and wealth can be and is offset by progressive spending policies.  A study examining this issue concluded the progressivity of our national and state spending systems puts a notable dent in income and wealth inequality as measured by lifetime spending.5  The study found the distribution of lifetime spending, while still highly unequal, is considerably more equal than either net wealth or current income.  The results are reflected in “lifetime marginal tax rate” findings that capture the present value of additional lifetime spending per dollar of additional earnings.  Within each age cohort, those with the lowest resources face significantly negative average remaining lifetime tax rates and those with the highest resources face significantly positive average remaining lifetime net tax rates.

The study also concludes that current income is a very poor proxy for lifetime resources and current year net tax rates can provide a highly distorted picture of true fiscal progressivity.  With the upcoming release of Minnesota’s tax incidence study, which focuses exclusively on tax progressivity and all the accompanying fairness issues, this is an important idea to remember.  Minnesota does an exceptional job addressing fairness concerns in its spending policies, and ignoring or discounting that reality for political purposes does a true injustice to the state.

  • 1 “Tax Policy and Heterogeneous Investment Behavior”  NBER Working Paper No. 21876, January, 2016
  • 2 “Is the American Public Corporation in Trouble?” NBER Working Paper  No. 22857, November, 2016
  • 3 “Trends in Cumulative Marginal Tax Rates Facing Low Income Families” NBER Working Paper No. 22782, October, 2016
  • 4 “Is Uncle Sam Inducing the Elderly to Retire” NBER Working Paper No. 22770, October, 2016
  • 5 “U.S. Inequality, Fiscal Progressivity, and Work Disincentives: An Intergenerational Accounting” NBER Working Paper No. 22032, February, 2016