Public Economics and Finance

Critical Research Questions and Findings

Public economics informs every aspect of policymaking. From financial regulatory policy to exchange rates in emerging markets, from income-tax compliance to mortgage finance rates, from healthcare spending to affordable housing, and from the cost of climate-change mitigation to the impact of potential changes in the charitable tax deduction, Price School faculty examine a diverse range of topics on how best to allocate limited public resources and when and how government should intervene to solve societal problems.

What is the optimal tax rate for the top 1 percent of earners?

Professor Richard K. Green and Assistant Professor Mark Phillips differentiate between the statutory burden of a tax and its economic burden. For example, gas prices rise when gas taxes are increased, as costs get passed on to consumers. In the context of income taxes, this implies that increases in tax rates on the wealthy might not be borne entirely by the high earners themselves. Their research suggests that optimal tax rates may be substantially lower than the 70 percent or higher marginal rates proposed by other prominent economists.

How do tax incentives affect charitable contributions?

Examining the charitable deduction’s effect on public charities’ revenue, Assistant Professor Nicolas Duquette’s research found that a 1 percent increase in the tax cost of giving results in a three-fold decline in nonprofit income — rather than the one-for-one tradeoff typically found. He also determined that direct-care organizations serving the most vulnerable populations were more tax-sensitive and would be hit harder by reductions in the charitable deduction than educational and arts institutions.

How does an underfunded tax agency such as the IRS detect tax evaders?

Assistant Professor Mark Phillips found that the amount of evasion detected depends not only on the number of audits conducted, but also on the amount of resources devoted to a given audit and the egregiousness of the taxpayer’s noncompliance itself. He solved for an equilibrium in which the tax agency chooses both whom to audit and at what intensity. To succeed, the tax agency should audit all taxpayers at similar probabilities, but the resources devoted to high-income audits should be sufficiently larger in order to better recover these taxpayers’ higher unpaid liabilities as well as promote more voluntary compliance.

Are people with higher incomes more likely to under-report income?

Assistant Professor Mark Phillips, a former economist in the Internal Revenue Service’s Office of Research, used IRS audit data to investigate the correlation between a taxpayer’s income and his or her propensity to evade taxes. He found that the higher the income, the more likely an individual was to under-report it. However, his research found this was primarily due to the fact that higher-income individuals had more opportunity to evade because they carry a much higher percentage of non-third-party-reported income (i.e., income not reported on a W-2 or 1099). Similarly, higher tax rates correlate with noncompliance, but this is primarily due to the higher rates typically levied upon non-third-party income.

How do financial and housing wealth influence consumer spending?

Professors Raphael Bostic and Gary Painter, and UCLA’s Stuart Gabriel, assembled a unique matched sample of household data from the Survey of Consumer Finance and the Consumer Expenditure Survey to estimate the consumption effects of financial and housing wealth during the recent recession. Their findings indicated relatively large housing wealth effects, some three times larger than the wealth effect of financial assets, which pointed to sizable economy-wide risks associated with retrenchment in house values. Their study was widely covered, including citation by then Federal Reserve Board Chair Alan Greenspan.

How did the Taxpayer Relief Act of 1997 affect homeowner mobility?

Intended to let people trade down in home ownership — for instance to move to a less expensive housing market — without facing tax penalties, the act replaced the one-time capital gain exclusion for people older than 55 with a larger amount that could be protected every two years. Professor Gary Painter analyzed household data to determine if this resulting, repeated ability to exclude periodic capital gains from taxation shortened housing tenure significantly. Despite the act’s targeting of older taxpayers, Painter’s study showed that significant decreases in tenure were pervasive, appearing in all age ranges and in samples of homeowners who traded up as well as down. He found that the act also led to measurable changes in price elasticity of housing turnover.

What impact do financial literacy programs have on choices of mortgage products?

Professor Raphael Bostic’s research demonstrates that increasing financial literacy programs could save borrowers between $500 million and $2 billion a year.

How have the economic crisis of 2008 and the ensuing policy changes altered how the economy operates?

Associate Professor Rodney Ramcharan — former chief of Systemic Financial Institutes and Markets for the Federal Reserve Board — studied the impact of the Fed’s effort to push down the longer-term interest rate and, in particular, whether that fostered investment, added jobs, and helped improve the economy. He found that firms traditionally using longer-term debt were more likely to add jobs in 2012 and 2013, when the policy was in place. He also examined whether mortgage interest-rate cuts were passed through to households, revealing that the reduced interest rates tended to benefit higher-income individuals in more expensive homes. For those underwater in their mortgage, he found they often could not qualify for refinancing and a reduced rate.

What part did financial engineering play in the last real estate boom and the financial crash of 2008?

According to research by Associate Professor Christian Redfearn, financial engineering degree programs started in the 1990s with the idea that people could learn what investments to make simply by studying the patterns in numbers. Moreover, increasingly “sophisticated” models were used to “manage” and price risk. Whatever patterns they perceived by looking backward failed to anticipate changes in real estate markets. The housing bubble burst in 2007, when fundamentals finally exposed these models as inadequate. Lehman Brothers’ failure in fall 2008 became the most infamous case of misunderstanding the natural forces of supply and demand for real estate as something apart from financial engineering.

What is the future of aviation security and its impact on the economy?

In a study for Congressional review, researchers at USC’s Center for Risk and Economic Analysis of Terrorism Events (CREATE) calculated that the reduced screening times from adding one more Transportation Security Administration (TSA) official to each airport would augment the nation’s economy by nearly $62 million.

How will the Affordable Care Act (ACA) affect the nation’s economy in the long term?

The Economic Report of the President cites research by Vice Dean and USC Schaeffer Center Director of Research Neeraj Sood in bolstering its case for the ACA’s benefits to the larger economy. Sood and his colleagues found that rising healthcare costs can be a drag on hiring, calculating that for every 1 percent increase in health insurance premiums provided to a company’s workforce, employment declines by 1.6 percent. Trimming the sails on health insurance premiums, therefore, can be a boost to the economy. Sood found that the ACA will increase job growth by 250,000 to 400,000 jobs a year by the second half of this decade.

What are the effects of temporary fiscal policies on economic efficiency?

Assistant Professor Mark Phillips developed a methodology for estimating the economic efficiency of temporary fiscal policies that reduce taxes or increase subsidies over a limited window of time. Such policies tend to promote new economic activity, with potentially beneficial efficiency consequences, but also induce shifts in the timing of purchases, with potentially negative efficiency consequences. He analyzed two specific policies, the federal government’s Cash for Clunkers program and states’ sales tax holidays, and found that both were harmful to efficiency in net.

How did the institutions of the president and Congress interact with private firms and regulatory agencies to contribute to the 2008 financial meltdown?

Dean Jack Knott found that the United States’ economic governance system failed to counteract the financial markets’ excessive optimism, but rather contributed to and reinforced this development. He determined that political moral hazard weakened the institutional checks and balances in economic regulation and that these developments occurred in a time of significant financial innovation, making it difficult to foresee the risk building in the system.

What role do public agencies play in promoting credible commitment by the government to promote overall economic benefit to society?

Dean Jack Knott and a colleague assessed what role public agencies play in promoting credible commitment by the government to promote overall economic benefit to society. In answering this question, the authors critique the dominant perspective in political science—Principal-Agency Theory. They make the case that the principal-agency approach is suspect from the point of view of Madisonian separation of powers, which assumed that elected officials would be ambitious and self-serving in ways that can do harm to the public good. They offer an alternative approach called Trustee Theory, which is based on the notion that the trustees sometimes can best serve the principals by not being responsive to the principal’s interests, especially when the principals’ pursuit of self interest threatens the public interest in the long run. Examples include the independent regulatory agencies, such as the Federal Reserve, which may sometimes serve the public interest by not being responsive to elected officials self-serving interests.

Richard K. Green

“The culture here rewards relevance. We’re also expected to do work that matters to the world, that goes beyond abstractions. We get our hands dirty.”

Professor Richard K. Green
Director and Chair of the USC Lusk Center for Real Estate
Senior Advisor, U.S. Department of Housing and Urban Development

Price School Impact

Price faculty expertise is sought by such entities as the World Bank, the International Monetary Fund, Fannie Mae, and the Federal Reserve Board, as well as governments and financial institutions around the world.

In addition to faculty whose scholarship focuses on this arena, the vast majority of Price professors are deeply engaged in public economics through studying its impact on policies in health, transportation, housing, immigration, the environment, nonprofits and philanthropic foundations, income inequality, and social justice, to name a few.