Erick M. Elder

The Role of Budget Stabilization Funds in Smoothing Government Expenditures over the Business Cycle

The economic downturn that began in 2001 resulted in sizable budget shortfalls and arguably the worst fiscal conditions for state governments in decades. The use of savings to stabilize cyclical fluctuations in the budget has been institutionalized in most states in the form of budget stabilization funds. In this article, the authors explore how state expenditure volatility is affected by the existence, size, and structure of stabilization funds using multiple measures of expenditure cyclicality over the period from 1969 to 1999. The results indicate that while most states have not witnessed a reduction in expenditure volatility over the business cycle, states with rule-bound stabilization funds experience significantly less expenditure volatility from utilizing a budget stabilization fund. In fact, the authors find that state expenditures are approximately 20 percent less volatile following the adoption of a rule-bound budget stabilization fund.

Political Effects on Pension Underfunding

Pension underfunding in the public sector has received considerable attention recently and is often cited as the next looming crisis. The majority of recent research has focused on appropriately measuring the underfunding. In this paper, we employ a political economy framework to show that increases in partisan polarization and electoral uncertainty lead to greater underfunding. Using an unbalanced panel of individual pension plans, we find robust empirical evidence that higher legislative turnover rates, more electoral competition, and term limits all lead to more pension underfunding. The political environments of state and local governments play a pivotal role in pension underfunding.

Dynamic Fiscal Policy with Regime-Duration Uncertainty: The Tax-Cut Case

This essay incorporates the uncertainty agents face regarding the duration of the governmental deficit policies into the life-cycle model developed by Auerbach and Kotlikoff (1987) . I assume that agents have a probability measure over the possible durations of current deficit policies. They make their savings decisions based upon these expectations, which are updated only after observing the governments action each period. In this setup the transition period is more interesting to policy evaluation as compared to the perfect foresight version of the model. Results suggest that individual expectations and the actual fiscal policy implemented interact to determine the effect deficit policies have on capital formation.

Consumer switching costs and private information

We consider a standard model of consumer switching costs with demand uncertainty where firms observe private information about demand. Given this private information, each firm forms beliefs over different demand realizations as well as beliefs over the other firms information. The main result here is that in the first period, if firms observe information suggesting that future demand is likely to be high, they will price aggressively, sacrificing current profits for higher market share and the expectation of higher future profits.

Social Security reform: the effect of investing in equities

Abstract Several proposals have been developed to reform the Social Security System to ensure that it is fully funded. The investment of a portion of Social Security funds in equities has often been proposed as a means to avoid increasing payroll taxes. This paper develops a general equilibrium model to demonstrate that investing Social Security funds in equities will decrease the return on equities and increase interest rates on bonds, which also leads to an increase in general income taxes. Thus, investing Social Security funds in equities simply shifts a potential increase in payroll taxes to an increase in income taxes.

Teacher Pension Workshop: Connecting Evidence-Based Research to Pension Reform: Campaigning For Retirement: State Teacher Union Campaign Contributions and Pension Generosity

Despite rhetoric that public sector unions are partially responsible for the health of state and local pension systems, little concrete evidence exists regarding the role unions play in influencing the generosity of their retirement benefits. Using a panel of state teacher pension plans, we find credible robust evidence linking stronger teachers’ unions to more generous benefits. For an average teacher in a strong union state compared to a teacher in a weak union state, our results imply that the differential in the present value of benefits earned each year paid by the plan sponsor is

A simple approach to balancing government budgets over the business cycle

2,400 per member.

Implications of Social Security Reform on Interest Rates: Theory and Evidence

Despite the renewed interest in fiscal rules to constrain government deficits and debt, most rules provide no guidelines for reaching fiscal objectives in practice. This note demonstrates how to construct simple and transparent savings-rate rules that could aid policymakers if balancing the budget over the business cycle is a goal.

Revenue Cycles and the Distribution of Shortfalls in U.S. States: Implications for an "Optimal" Rainy Day Fund

This article investigates the potential effect that Social Security reform may have on bond and equity returns. We specifically focus on the effect of proposals to shift a portion of the investment of the U.S. Social Security Trust Fund to the equities market. Models are developed to demonstrate the relationship between returns and both the relative size of the Social Security Trust Fund and the portfolio allocation of the Trust Fund. Using these two models, we then show that interest rates will increase from either a decrease in the size of the Social Security Trust Fund or a shifting in the investment mix from bonds to equities. We derive an adjustment factor that relates the magnitude of change in interest rates from either source and use this adjustment factor in conjunction with estimates of the relationship between government debt and interest rates to forecast the potential effect on interest rates from shifting part of the Trust Fund to the equity market. The estimates herein suggest that investing some of the Social Security funds in equities is not a painless cure-all for the Social Security system and may even have some adverse effects in terms of income transfers from American taxpayers to foreign bondholders.