Showing papers by "Matthew D. Shapiro published in 2008"

Labor Supply: Are the Income and Substitution Effects Both Large or Both Small?

Abstract: Labor supply is unresponsive to permanent changes in wage rates. Thus, income and substitution effects cancel, but are they both close to zero or both large? This paper develops a theory of labor supply where income and substitution effects cancel, taking into account optimization over time, fixed costs of going to work, and interactions of labor supply decisions within the household. The paper then applies this theory to survey evidence on the response of labor supply to a large wealth shock. The evidence implies that the constant marginal utility of wealth (Frisch) elasticity of labor supply is about one.

Imputing Risk Tolerance from Survey Responses

Abstract: Economic theory assigns a central role to risk preferences. This article develops a measure of relative risk tolerance using responses to hypothetical income gambles in the Health and Retirement Study. In contrast to most survey measures that produce an ordinal metric, this article shows how to construct a cardinal proxy for the risk tolerance of each survey respondent. The article also shows how to account for measurement error in estimating this proxy and how to obtain consistent regression estimates despite the measurement error. The risk tolerance proxy is shown to explain differences in asset allocation across households.

Temporary Investment Tax Incentives: Theory with Evidence from Bonus Depreciation

Abstract: Even modest reductions in the after-tax cost of capital purchases provide strong incentives for increased investment. Indeed, for tax subsidies that are temporary, and for capital goods that are very long-lived, the incentive to invest when the after-tax price is temporarily low is essentially infinite. Firms that would have purchased new capital equipment in the future, instead make their purchases during the period of the subsidy. For tax increases, the effects are the opposite. Firms, that would have normally invested now, delay until the tax rate returns to normal. We present a model of the equilibrium effects of temporary investment tax incentives. The model reveals a simple relationship between the shadow price of investment goods and the size of a temporary investment tax incentive. Specifically, for sufficiently long-lived capital goods (goods with very low rates of economic depreciation) and for sufficiently short-lived investment tax subsidies, the shadow value of capital should be nearly unchanged, and thus the pre-tax shadow price of capital goods should fully reflect the magnitude of the tax subsidy. This result holds regardless of the elasticity of investment supply and regardless of the underlying demand for capital. Instead, it relies only on the firm’s ability to arbitrage predictable movements in the after-tax price of long-lived capital over time. Two conclusions immediately follow. First, observ ing price increases following a temporary tax incentive is not evidence that investment supply is relatively inelastic. A temporary investment tax subsidy can substantially affect investment even if it bids up the price of investment sharply. Second, because economic theory dictates that the shadow price of investment moves one-for-one with a temporary tax subsidy, the elasticity of supply can be inferred from quantity data alone. Recent changes in US tax law allow us to use the model and its implications to estimate struc tural parameters that govern the supply of investment. The 2002 and 2003 tax bills provided temporarily accelerated tax depreciation called bonus depreciation for certain types of qualified capital goods. Under the 2002 bill, firms could immediately deduct 30 percent of investment purchases and then depreciate the remaining 70 percent under standard depreciation schedules.

Labor Supply: Are the Income and Substitution Effects Both Large or Both Small?

Abstract: Labor supply is unresponsive to permanent changes in wage rates. Thus, income and substitution effects cancel, but are they both close to zero or both large? This paper develops a theory of labor supply where income and substitution effects cancel, taking into account optimization over time, fixed costs of going to work, and interactions of labor supply decisions within the household. The paper then applies this theory to survey evidence on the response of labor supply to a large wealth shock. The evidence implies that the constant marginal utility of wealth (Frisch) elasticity of labor supply is about one.