How costly is it to issue equity when capital gains are taxed?

What is the impact of capital gains tax on share prices? It should be rather high, as stock shares main point is to appreciate. But assessing this is difficult because people find all sorts of ways to avoid this tax, such as taking offsetting losses or exemptions. In addition, capital gains are only taxed when realized.

Harry Huizinga, Johannes Voget and Wolf Wagner find a trick to disentangle this. When there is a cross-border merger or acquisition, any assets subject to capital gains suddenly fall under a different tax jurisdiction as shareholders are located in different countries. As long as the M&A was operated with cash, a change in asset value should reflect the impact of the difference in capital gains taxes. From their database, the authors find that a one percentage point difference in taxes results in a 0.225% reduction in the share price at takeover, and calculating backwards this indicates that the effective tax rate is 31% of the statutory one. This means that the average capital gains tax in the OECD increases equity costs by 5.3%. It is then evident to find that where taxes are higher, takeovers are more likely to be financed by equity, as it does not imply a transfer of tax liability.

Why is barely anyone buying annuities?

I have written before about the fact that so few people take annuities upon their retirement. While several reasons have been proposed, the literature has dealt with them in isolation, which is not very useful.

Svetlana Pashchenko addresses all suggestion in one swoop by using a quantitative life-cycle model with uncertain lifetime and medical expenses, bequest motives and minimum guaranteed consumption. Calibrated to the US, the model determines four equally important factor that prevent annuities from becoming popular: 1) pre-annuitized wealth (pensions), 2) minimum annuity size, 3) illiquid housing wealth, and 4) bequest motives. Pricing of annuities, interestingly, is not a factor. Adverse selection is responsible for making them more expensive than actuarially fair, while it decreases annuity demand for the poor, it increases it for the rich (as they know they will live longer and have cash to buy annuities). Note that 3) is another puzzle to me, as reverse mortgages are also rare, and they would render housing wealth liquid.

Is the CRA responsible for the crisis?

An important component, if not reason, of the last recession has been the run-up in sub-prime mortgages until 2007. There has been much speculation what could have triggered this, for example distorted incentives in the supply of mortgages, poor evaluation of risk, or predatory lending practices. Also mentioned has been the Community Reinvestment Act, which was implemented to reduce discrimination of lending in poorer neighborhoods and, as its title indicates, encourage mortgage holding in these areas. Could the CRA be the big culprit?

Sumit Agarwal, Efraim Benmelech, Nittai Bergman and Amit Seru claim the CRA did lead to more risky lending. This is based on the fact that mortgages given around the time of CRA examinations were 15% more likely to default. That is not that much a surprise as poorer neighborhoods do have riskier mortgage holders and banks had incentives to lend more during those exam periods. The real question is whether the risk was assessed and priced correctly.

The paper is still of interest. It shows that the effect was the strongest among the large banks (those that got bailouts...) and was more important while mortgage securitization was booming. Banks thus are not clean here.

A Reading for the Pigou Club

And also about the Pigou Club, from the NY Times.

Teen sex: are female droping scruples due to the lack of men?

The marriage market unfortunately does not benefit from a mechanism design initiative like for kidney matching. It still is a difficult search with hits and misses. A not insignificant part of the process is the use of sex to attract potential matches. What would economists have to say about this?

Peter Arcidiacomo, Andrew Beauchanp and Marjorie McElroy model this market with a directed search model with male and females of different types and preferences. The search is directed in the sense that individuals look at the type of relationship (sex/no sex), the type of the person and the matching (mating?) probabilities. Clearly, if a gender outnumbers the other, it will go for matches that are high probability even though they are less-preferred. Beyond this, it is difficult to get results, thus they proceed to calibrate the model by using data from high school relationships. They conclude that men value sex more than women (big surprise) and that while some women would not have sex, they still agree to it because they are concerned they could miss on good matches when men are scarce. That could explain high rates of teen pregnancies is some parts of the US population where lots of men are in prison or simply not interesting because of low education compared to the women (the majority of high school drop outs are men).

The puzzling evolution of income inequality

There is good evidence now that income inequality is decreasing in some countries at an unprecedented pace. Income is the outcome of a series of factors, including human capital. So, what is happening with the human capital inequality? And what about countries?

Amparo Castelló-Climent and Rafael Doménech use the latest update of the Barro and Lee dataset on human capital to figure this out. They find that overall, income inequality has not changed in sixty years, but human capital inequality has significantly decreased. This has come through important improvements at the bottom of the distribution. The authors conclude that improvements in literacy are not sufficient to reduce income inequality. I would say that this is even worse. Indeed, the Barro and Lee dataset only counts years of education. But we know that the marginal contribution of an additional year of education decreases over an individual's schooling career. Thus improvements in literacy in developing countries should have had even better results in terms of income. At the aggregate level, the authors show the opposite, though. Puzzling.

How much are your taxes going up?

The Tax Policy Center has a calculator to answer that question.