Three Essays in the Public Economics of Perception and Belief

Abstract

My dissertation studies three cases in which the perception of current policy or beliefs about future policy shaped economic decisions. Issues of attention and beliefs about the future can have tremendous importance both because agent actions reveal what they believe about the future, such as in the first and third chapters, or because misperception change how agents are affected by policy, such as in the second chapter.

The first chapter measures the effect of the 2017 Tax Cuts and Jobs Act on share prices of publicly traded firms, finding that the most profitable firms, and those in concentrated industries, benefited the most. The tax bill significantly reduced corporate tax rates, thereby increasing share prices, particularly at the top. Among firms with the highest profit rates, more than 80 percent rose in value on news of the tax reform, whereas among less profitable firms, fewer than 60 percent appreciated. By every measure, stock market gains coincident with the tax bill were concentrated among firms with greater market power. This pattern is consistent with economic rents being important components of the values of large U.S. corporations.

The second chapter of my dissertation looks at how to measure welfare in a world where tax policy might be misperceived by agents. Recent developments in behavioral public economics have shown that heterogeneous biases prevent point identification of deadweight loss. The second chapter replicates this result for an arbitrary (closed) consumption set, whereas previous results on heterogeneous attention focused on binary choice. It finds that one can bound the efficiency costs of taxation based on aggregate features of demand. When individuals have linear demand functions, the bounds for deadweight loss are easy to calculate from linear regressions.

While the first chapter of my dissertation looks at the effects of expected policy, the third and last chapter looks at higher-order moments. Forecasts of the consequences of tax changes usually assume that economic actors expect these changes are permanent, despite the inevitable political uncertainty that could lead to future reversals or further changes. This reasoning extends to when a firm's tax burden is correlated to the success of its ventures. The third chapter shows how a firm's belief about how government policy is correlated with the input's marginal product distorts its risk profile, leading it to change its input decision. Generally speaking, input use will be discouraged if the firm faces high taxes precisely when the input is more productive. The last chapter shows that in a world of policy uncertainty this holds under an arbitrary tax system, and in particular it holds even if inputs can be perfectly deducted from the firm's taxable income. Whenever the covariance between policy and payoff is zero, the model replicates the classical result that the deductibility of input expenses leaves the decision undistorted. The third chapter uses this theoretical relationship in an empirical model of asset pricing to infer what investors believe about how future government policy correlates with their risky investments in different firms in the stock market.

Each chapter’s analysis can be read on its own, but the unifying theme is that in each case issues of perception and belief were central in either identifying current beliefs about the world, or in understanding the real impact of economic policy on agent welfare.