Optimal policy and the coexistence of markets and governments

This thesis explores three aspects of the coexistence of governments and markets from an optimal policy point of view. In chapter 1, I study how the presence of financial markets shapes the government's ability to redistribute. Individuals do not, constrain consumption to equal their net-of- tax income every period, but instead use markets to allocate their resources over time. This restricts the set of policy instruments available to the government. At the same time, however, markets enable agents to enter long-term consumption commitments. Changing these contracts is costly. These potential default costs mitigate the government's ex-post incentives to renege on the promised tax schedule, and therefore provide a coninitment device for the government. In that sense, financial markets may facilitate rather than hinder redistribution. In chapter 2, I present a rationale for corporate income taxes to discriminate between debt and equity financing. For risk-averse entrepreneurs, equity generates more surplus than debt, because it provides financing and insurance. A government seeking to extract surplus from entrepreneurs would naturally tax equity-generated income more than debt-generated income. Moreover, in the presence of private information, the government can use taxes to discriminate between different types of entrepreneurs. This degree of freedom allows a manipulation of the relevant incentive constraints, and an increase in overall efficiency. The optimal non-linear tax schedule to achieve the desired discrimination is isomorphic to one that taxes debt-generated income at a lower rate than equity-generated income. In chapter 3, I explore how fast people adapt to institutional change. I study the differential reaction of former East and West Germans to a series of health care reforms. Along with the decrease in coverage under the public health insurance, former East Germans were significantly less likely to sign complementary insurance contracts in the private market. I show that the differential uptake rates of additional insurance are consistent with a model in which agents learn over time that institutions have changed and they are now responsible for optimizing their coverage. Thus, I provide evidence for the existence of a substantial transition period in the individual adaptation to new institutions.

Department dc:contributor.department

Massachusetts Institute of Technology. Dept. of Economics.

Grantor dc:publisher

Massachusetts Institute of Technology

Year dc:date.issued

2011

Author dc:creator

• Simon, Jenny, Ph. D. Massachusetts Institute of Technology

Advisor dc:contributor.advisor

• Daron Acemoglu and Iván Werning.

• Economics.

Statement dc:rights

• M.I.T. theses are protected by copyright. They may be viewed from this source for any purpose, but reproduction or distribution in any format is prohibited without written permission. See provided URL for inquiries about permission.

Licence dc:rights.uri

• http://dspace.mit.edu/handle/1721.1/7582

Language dc:language.iso

eng

Handle dc:identifier.uri

http://hdl.handle.net/1721.1/69478

OAI identifier oai:identifier

oai:dspace.mit.edu:1721.1/69478