Michael Troege

R&D COMPETITION AND ENDOGENOUS SPILLOVERS

The paper examines firms’ choices between innovation and imitation in duopoly. We show that in the unique equilibrium asymmetric firms choose the same level of expenditure on imitation and the same ratio of innovative cost reduction to output. We evaluate the marginal contribution of innovation and imitation expenditure by small and large firms to consumer surplus and welfare, and discuss the desirability of differentiated R&D subsidies on innovation and imitation in terms of R&D tax rebates.

On Taxation Pass-Through for a Monopoly Firm

This paper investigates the pass-through of an excise tax imposed on a monopoly firm with constant marginal cost. The optimal price increases as tax increases for any demand function. Tax pass-through is globally under or in excess of 100% according as the direct demand function is log-concave or log-convex. The analysis relies on supermodular optimization and delivers conclusions based on minimal sufficient assumptions in a simple, broadly accessible and self-contained framework. Further results allow for mixed conditions that provide precise and local determination of pass-through. Several illustrative examples are given. Policy conclusions relating to the relative wisdom of taxing high versus low cost monopoly firms are drawn from the results.

From Basel to bailouts: forty years of international attempts to bolster bank safety

This article reinterprets the origin and evolution of the Basel Accords. We argue that the Basel I paradigm was very different from the regulatory approaches that had been applied successfully in most European countries since the Second World War. Banking systems relied on a multitude of tools including entry restrictions, liquidity rules, reserve requirements, deposit rate ceilings, lending and investment restrictions, combined with hands-on supervision and discretional interventions. By focusing exclusively on capital adequacy and credit risk, Basel I shifted attention in a very different and somewhat unexpected direction. The Basel regulations are often understood as a reaction to the bank failures of the 1970s and 1980s, but in fact their capital adequacy rules would not have prevented these failures. Indeed, even today, several of these risks are still not addressed by Basel updates, suggesting that the original and current proposals have a rather different raison d’Aatre, placating political constituencies and banking interests.

Degradation of the Financial System Due to the Structure of Corporate Taxation

Regulators have sought since the 2008 financial crisis to further strengthen the financial system. Yet a core source of weakness and a powerful additional instrument for strengthening the financial system persists unchanged and absent from the regulatory agenda — namely the relentless impact of the corporate tax on the choice between risky debt and safer equity. The tax penalty for equity and the concomitant boost for debt undermines the capital adequacy efforts that have been central to the post-crisis reform agenda. Yet this result is not inevitable.By repurposing tax tools used elsewhere in the world, we show how the safety-undermining impact of the current corporate tax can be ended or even reversed. The best trade-off of goals and practical potential is, first, to reduce the corporate income tax burden on bank equity levels above the required minimum, by according an imputed deduction for the cost of equity capital above the regulatory-required amount. This tax benefit can then, second, be made revenue-neutral to the finances by offsetting it, such as by decreasing the tax deductibility of the riskiest classes of financial system liabilities. That offsetting tax rate can, we show, be quite low, because the financial system’s debt base is wide while its equity base is narrow. Standard bank regulation is command-and-control style. Regulators order what banks can and cannot do; banks resist, lobby to reverse and undermine the commands, find transactional alternatives, and distort their behavior when approaching regulatory constraints. Regulators cannot in many areas know as much as the regulated; with a tax instrument, they do not need to know as much. Existing cross-country and cross-state data show the tremendous potential from this reform to incentivize more safely capitalized banks. The magnitude of the safety benefit should rival the size of all the post-crisis regulation to date. Thus the main thesis we bring forward is not a small or technical claim but a call for a major shift in regulatory style.It is time to change how we tax banks.

DEMAND EXPANSION AND ELASTICITY IMPROVEMENT AS COMPLEMENTARY MARKETING GOALS

Consider a marketing division of a monopoly that faces two marketing options: market enlargement and elasticity improvement. These options are conceived in terms of the target of the firms advertising campaigns: potential new consumers versus existing consumers. Using a CES demand function in a simple model, we show that the two activities are complementary, so that for some cost configurations, the firm will find it profitable to jointly implement the two options together when either option alone would result in a loss. The same joint implementation conclusion also holds for consumer surplus, and hence a fortiori also under a social welfare objective.

Containing Systemic Risk by Taxing Banks Properly

Regulators have sought since the 2008 financial crisis to further strengthen the financial system. Yet a core source of weakness and a powerful additional instrument for strengthening the financial system persists unchanged and absent from the regulatory agenda — namely the relentless impact of the corporate tax on the choice between risky debt and safer equity. The tax penalty for equity and the concomitant boost for debt undermines the capital adequacy efforts that have been central to the post-crisis reform agenda. Yet this result is not inevitable.By repurposing tax tools used elsewhere in the world, we show how the safety-undermining impact of the current corporate tax can be ended or even reversed. The best trade-off of goals and practical potential is, first, to reduce the corporate income tax burden on bank equity levels above the required minimum, by according an imputed deduction for the cost of equity capital above the regulatory-required amount. This tax benefit can then, second, be made revenue-neutral to the finances by offsetting it, such as by decreasing the tax deductibility of the riskiest classes of financial system liabilities. That offsetting tax rate can, we show, be quite low, because the financial system’s debt base is wide while its equity base is narrow. Standard bank regulation is command-and-control style. Regulators order what banks can and cannot do; banks resist, lobby to reverse and undermine the commands, find transactional alternatives, and distort their behavior when approaching regulatory constraints. Regulators cannot in many areas know as much as the regulated; with a tax instrument, they do not need to know as much. Existing cross-country and cross-state data show the tremendous potential from this reform to incentivize more safely capitalized banks. The magnitude of the safety benefit should rival the size of all the post-crisis regulation to date. Thus the main thesis we bring forward is not a small or technical claim but a call for a major shift in regulatory style.It is time to change how we tax banks.

Systemic Financial Degradation Due to the Structure of Corporate Taxation

Regulators have sought since the 2008 financial crisis to further strengthen the financial system. Yet a core source of weakness and a powerful additional instrument for strengthening the financial system persists unchanged and absent from the regulatory agenda — namely the relentless impact of the corporate tax on the choice between risky debt and safer equity. The tax penalty for equity and the concomitant boost for debt undermines the capital adequacy efforts that have been central to the post-crisis reform agenda. Yet this result is not inevitable.By repurposing tax tools used elsewhere in the world, we show how the safety-undermining impact of the current corporate tax can be ended or even reversed. The best trade-off of goals and practical potential is, first, to reduce the corporate income tax burden on bank equity levels above the required minimum, by according an imputed deduction for the cost of equity capital above the regulatory-required amount. This tax benefit can then, second, be made revenue-neutral to the finances by offsetting it, such as by decreasing the tax deductibility of the riskiest classes of financial system liabilities. That offsetting tax rate can, we show, be quite low, because the financial system’s debt base is wide while its equity base is narrow. Standard bank regulation is command-and-control style. Regulators order what banks can and cannot do; banks resist, lobby to reverse and undermine the commands, find transactional alternatives, and distort their behavior when approaching regulatory constraints. Regulators cannot in many areas know as much as the regulated; with a tax instrument, they do not need to know as much. Existing cross-country and cross-state data show the tremendous potential from this reform to incentivize more safely capitalized banks. The magnitude of the safety benefit should rival the size of all the post-crisis regulation to date. Thus the main thesis we bring forward is not a small or technical claim but a call for a major shift in regulatory style.It is time to change how we tax banks.

Free Trade vs. Autarky in an Asymmetric Cournot World

The paper first demonstrates that in a simple asymmetric n-country world with Cournot competition, constant returns and linear demand, free trade can reduce world welfare as well as total output and consumer surplus. We then derive precise conditions for free trade to raise a country’s welfare, consumer surplus, profits etc. and demonstrate how these conditions are linked in a clear order. We also show that free trade always raises the sum of social welfare and consumer surplus in every country. Finally, we show that with symmetric costs or free entry and exit, there are always global gains from free trade.

A Comment on 'The Loss from Trade Under International Cournot Oligopoly with Cost Asymmetry' by Dong and Yuan (2010)

This note corrects some oversights in Dong and Yuan (2010). We show, in particular, that their condition for intra-industry trade to reduce global welfare can never be satisfied. Using a new example, we demonstrate that, nevertheless, their fundamental insight remains correct: Under Cournot competition, trade can reduce global welfare when firms and countries are asymmetric.

Sharing Firm-Specific Information: Incentives and Welfare Effects

The paper derives clear-cut and robust conclusions on the effects of sharing firm-specific information in general linear oligopoly. In Cournot (Bertrand) oligopoly, revealing (concealing) firm-specific cost information is the dominant strategy for each firm. In both competition modes firms have incentives to share firm-specific demand information. Sharing firm-specific cost information always hurts consumers but is socially beneficial in Cournot oligopoly and socially harmful in Bertrand oligopoly. Sharing firm-specific demand information also hurts consumers but increases welfare. Contrary to most existing results these findings are independent of distributional assumptions on costs and signals and hold for general asymmetric oligopoly with any mixture of substitute, complementary and independent goods.