Kenneth Judd

Capital Market Imperfections and Tax Policy Analysis in the Life Cycle Model

Annals of economics and statistics, 1988

One issue often overlooked in dynamic fiscal policy analysis is the importance of assumptions mad... more One issue often overlooked in dynamic fiscal policy analysis is the importance of assumptions made regarding individuals' abilities to use capital markets to transfer income across time. We focus on the impact of borrowing restrictions on consumption functions within the life cycle framework, and address a set of fiscal policy issues. Our principal concerns are two. First, taking into account the effect of borrowing constraints affects the calculation of the efficiency costs of taxation substantially. Second, we address within the life cycle model the importance of precautionary saving in response to capital market imperfections and consequent implications for effects of social insurance programs.

Social Security and Individual Welfare: Precautionary Saving, Borrowing Constraints, and the Payroll Tax

The American Economic Review, 1987

We are grateful to John Shoven, Jonathan Skinner, Lawrence Summers, and the NBER Summer Institute... more We are grateful to John Shoven, Jonathan Skinner, Lawrence Summers, and the NBER Summer Institute Program on Tax Simulation Models for comments, and to Nick Williams for excellent research assistance and helpful discussions. Financial support from the Alfred P. Sloan Foundation is acknowledged. The research reported here is part of the NBER's research program in Taxation and project in Government Budgets. Any opinions expressed are those of the authors and not those of the National Bureau of Economic Research.

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Handbook of Computational Economics, Volume 2: Agent-Based Computational Economics (Handbook of Computational Economics)

North-Holland Publishing Co. eBooks, Jun 1, 2006

This handbook comprises 16 chapters surveying agent-based computational economics research, 6 sho... more This handbook comprises 16 chapters surveying agent-based computational economics research, 6 shorter essays providing personal perspectives, and a "getting started" guide for newcomers to agent-based modeling in the social sciences. Research topics covered include: learning representations for computational agents; agent-based models and human-subject experiments; economic activity on fixed networks; endogenous formation of economic networks; social dynamics and the evolution of norms; heterogenous agent modeling in economics and finance; agent-based computational finance; agent-based models of innovation and technological change; agent-based models of organizations; market design using agent-based models; automated markets and trading agents; agent-based computational methods and models of politics; agent-based tools for exploring the governance of social-ecological systems; and computational laboratories for spatial agent-based modeling. Related work can be accessed at http://www2.econ.iastate.edu/tesfatsi/ace.htm

A Review of Recursive Methods in Economic Dynamics

Journal of Economic Literature, 2016

... u'[h(k)] = I3u'Rh{f[k - h(k)]}l Rj - T){f'[k - h(k)] - 1} + 1D. (6) In David B... more

A Note on Determining Viable Economic States in a Dynamic Model of Taxation

Macroeconomic Dynamics, Apr 23, 2015

Viability theory is the study of dynamical systems that asks "what is the set of initial conditio... more Viability theory is the study of dynamical systems that asks "what is the set of initial conditions that generate evolutions, which obey the laws of motion of a system plus other constraints, for the length of the evolution". We apply viability theory to Judd's (JPE, 1987) dynamic tax model to identify which economic states are viable, in that the application of annually constrained tax-rate adjustments result in non-explosive and non-implosive evolutions of capital, consumption and debt. The set of such states we call the economic viability kernel. We observe, unsurprisingly, that a very high consumption economy lies outside such kernels, at least for annual tax-adjustment levels limited by 20%, and that, generically, the higher the capital, the higher the consumption levels that can be sustained. Furthermore, we notice that the sizes of the kernel slices, for a given taxation level, do not diminish as the tax rate-rate rises, hence high taxation economies are not necessarily more prone to explode, or implode, than their low taxation counterparts. In fact, higher tax rates are necessary to keep many consumption choices viable, when capital approaches the constraint-set boundary. We also see that raising the debt limit increases the viability kernel; however, for the economy to remain viable at the high debt levels, capital has to be maintained large. .

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Equilibrium open interest

Journal of Economic Dynamics and Control, Dec 1, 2010

Open interest in a financial contract describes the total number that are held long at the close ... more Open interest in a financial contract describes the total number that are held long at the close of the exchange; it is a stylized fact that open interest across strikes peaks at-the-money. This paper sets up a two-period model to investigate agents' equilibrium holdings in a portfolio of call options and the resulting curve of open interest across strikes. We document that the shape of the open interest curve in complete markets is very sensitive to assumptions about preferences; in incomplete markets it is in addition to that also very sensitive to distributional assumptions and the strike grid. This is in sharp contrast to the observed robustness of the peak to changes in the underlying security and maturities.

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Social Security and Individual Welfare: Precautionary Saving, LiquidityConstraints, and the Payroll Tax

We are grateful to John Shoven, Jonathan Skinner, Lawrence Summers, and the NBER Summer Institute... more We are grateful to John Shoven, Jonathan Skinner, Lawrence Summers, and the NBER Summer Institute Program on Tax Simulation Models for comments, and to Nick Williams for excellent research assistance and helpful discussions. Financial support from the Alfred P. Sloan Foundation is acknowledged. The research reported here is part of the NBER's research program in Taxation and project in Government Budgets. Any opinions expressed are those of the authors and not those of the National Bureau of Economic Research.

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Liquidity Constraints, Fiscal Policy, and Consumption

Brookings papers on economic activity, 1986

TAX POLICY AND TAX REFORM are important items on the current policy agenda. In evaluating alterna... more TAX POLICY AND TAX REFORM are important items on the current policy agenda. In evaluating alternative tax policies, decisionmakers must consider both their normative and positive impact; in particular, they must examine the effects of competing policies on the overall well-being of the taxpayers and on various indexes of economic activity, in both the short run and long run. Basic to understanding the impact of tax policy is analysis of the relationship between taxation and taxpayers' decisions about consumption, saving, and work effort. Such analysis is especially sensitive to assumptions made regarding individuals' abilities to use capital markets to transfer income across time. By the same token, we think that policy simulation models that ignore "liquidity constraints" result in flawed tax policy analysis. In this paper we analyze the impact of liquidity constraints on consumption functions and use the resulting view of aggregate demand to address two categories of tax and fiscal policy issues. The first issue is developing a tax system that least reduces taxpayer well-being for the amount of lifetime revenue extracted. Recent applications of theoretically based models of individual behavior have facili-We are grateful to John Simpson and Nicolas Williams for excellent research assistance and to Mervyn King, Laurence Kotlikoff, and members of the Brookings Panel and the Faculty Research Seminar at the John F. Kennedy School of Government for helpful comments. Financial support from Northwestern University is acknowledged. 1 2 Brookings Papers on Economic Activity, 1:1986 tated comparisons of the effects of alternative policies. Indeed, much of the present debate over the relative reliance on various tax bases and the optimal degree of progressivity of the income tax has been reflected in studies using policy-simulation models. I These models generally assume that individuals or households maximize well-being over their lifetime, subject only to the restriction that the present value of consumption is no greater than the present value of income. The models then assess how tax policies can alter the rewards to saving and working, thereby distorting intertemporal choices about consumption and work effort. But models with an overall lifetime budget constraint ignore the many restrictions on individuals' ability to shift income in a world of capital market imperfections, restrictions that substantially affect those intertemporal choices.2 Taking into account the effect of liquidity constraints affects the calculation of the welfare costs of taxation substantially; prevailing arguments, based on "perfect market" models, against capital taxation or progressive income taxation and in favor of wage and consumption taxation must be substantially muted and often reversed.3 The second issue that we examine is the importance of liquidity constraints for the debate over the impact of temporary tax cuts financed by debt. We show that liquidity-constraint considerations are quantitatively more important than the frequently discussed "finite-horizon" considerations that focus on how debt shifts the tax burden onto future generations. We also find that when both considerations are incorporated

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The Importance of Asymmetric Tax Policy and Dangers of Aggregation

Journal of Money, Credit and Banking, Jul 20, 2011

Existing tax policies have many complex features that make distinctions across goods, factors, an... more Existing tax policies have many complex features that make distinctions across goods, factors, and financial structures that distort economic allocations. Their importance is ignored when tax policy is summarized by an "effective" tax rate. In fact, the losses due to asymmetries are often larger than the losses due to the level of taxation.

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Which economic states are sustainable under a slightly constrained tax-rate adjustment policy

RePEc: Research Papers in Economics, 2014

Viability theory is the study of dynamical systems that asks what set of initial conditions will ... more Viability theory is the study of dynamical systems that asks what set of initial conditions will generate evolutions which obey the laws of motion of a system and some state constraints, for the length of the evolution. We apply viability theory to Judd's (JPE, 1987) dynamic tax model to identify which economic states today are sustainable under only slightly constrained tax-rate adjustments in the future, when the dynamic budget constraint and consumers' transversality condition at infinity are satisfied. We call the set of such states the economic viability kernel. In broad terms, knowledge of the viability kernel can tell the planner what economic objectives are achievable and assist in the choice of suitable controls to realise them. We observe, unsurprisingly, that a very high consumption economy lies outside such kernels, at least for annual tax-adjustment levels limited by 20%; higher consumption levels can only be sustained when capital is abundant. Furthermore, we notice that the sizes of the kernel slices for a given taxation level do not diminish as the tax rate rises, hence high taxation economies are not necessarily more prone to explode, or implode, than their low taxation counterparts. In fact, higher tax rates are necessary to keep many consumption choices viable, especially when capital approaches the constraint-set boundaries. .

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Exercises in Voodoo Economics

RePEc: Research Papers in Economics, Jun 1, 1983

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The Macroeconomic Effects of Uncertain Fiscal Policy

RePEc: Research Papers in Economics, Dec 1, 1984

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Optimal Consumption Plans and Portfolio Management with Duration- Dependent Returns

RePEc: Research Papers in Economics, Sep 1, 1985

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Mergers and Dynamic Oligopoly

RePEc: Research Papers in Economics, 2000

Static oligopoly theories disagree on whether mergers are profitable. The Cournot model says that... more Static oligopoly theories disagree on whether mergers are profitable. The Cournot model says that many potential mergers would be unprofitable whereas the Bertrand model says that all mergers are profitable. We show that, for economically sensible parameter values, mergers are profitable for merging firms when firms choose both price and output, using inventories to absorb differences between output and sales. Furthermore, substantial cost advantages are necessary for a merger to benefit consumers. The merger predictions of our dynamic model are most similar to predictions of static Bertrand analyses of differentiated products even though our model often behaves like the Cournot model in the long run.

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Effects of Capital Gains Taxation on Life-Cycle Investment and Portfolio Management

Journal of Finance, Jul 1, 1987

We examine the impact of capital income taxation, both accrual forms of taxation and taxation of ... more We examine the impact of capital income taxation, both accrual forms of taxation and taxation of realized capital gains, on total savings and the demand for corporate financial instruments. We find that investors may hold both debt and equity in the face of effective collection of capital gains taxation even in a flat tax system. We also find that the two taxes will have substantially different effects on saving and consumption behavior, making it unlikely that the tax structure can be summarized by any single equivalent accrual tax rate. THIS PAPER EXAMINES THE impact of income taxation on the demand for various corporate financial instruments, focusing on unique features due to taxation of realized capital gains. We take a life-cycle view of investment behavior and examine how accrual and realization taxation jointly affect an individual's allocation of intertemporal resources. We shall consider the impact on his demand for debt and equity, showing that taxation of realized capital gains generates an intrapersonal tax clientele effect: at any one point of time, an individual will strictly prefer either to buy debt or equity, but that choice may be different at different ages. Therefore, many individuals will simultaneously hold both debt and equity. We also find that any attempt to measure the "effective" capital gains tax rate will be difficult and that existing approaches appear flawed since they do not correspond to the pattern of distortions which we find in this explicit model of asset demand and saving. This analysis deviates from earlier work on capital gains taxation in several substantial dimensions. Whereas much of the capital gains taxation literature focuses on how capital gains tax regulations generate arbitrage opportunities in perfect capital markets, the analysis used below essentially assumes effective enforcement of the intent of capital gains taxation. This is desirable since, contrary to the perfect capital market implication, capital gains tax revenues are nontrivial. Therefore, in examining the nature of asset demand and choice, it is reasonable to assume somewhat effective collection of the capital gains tax liabilities. Our analysis will assume completely effective enforcement to highlight the impact of capital gains taxation; it will be clear that several types of leakages will not substantially alter the qualitative conclusions.

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An Agenda for Economic Reform in Korea: International Perspectives

An Agenda for Economic Reform in Korea looks at Korea's economic problems from the perspectiv... more An Agenda for Economic Reform in Korea looks at Korea's economic problems from the perspective of the American experience with economic reforms and sheds new light on the problems of economic reform facing nations all over the world. The authors examine such issues as corporate governance, social welfare, labor relations, and other pressing challenges-and suggest a new vision for the Korean economy.

CIM-EARTH: Community integrated model of economic and resource trajectories for humankind

Climate change is a global problem with local climatic and economic impacts. Mitigation policies ... more Climate change is a global problem with local climatic and economic impacts. Mitigation policies can be applied on large geographic scales, such as a carbon cap-and-trade program for the entire U.S., on medium geographic scales, such as the NOx program for the northeastern U.S., or on smaller scales, such as statewide renewable portfolio standards and local gasoline taxes. To enable study of the environmental benefits, transition costs, capitalization effects, and other consequences of mitigation policies, we are developing dynamic general equilibrium models capable of incorporating important climate impacts. This report describes the economic framework we have developed and the current Community Integrated Model of Economic and Resource Trajectories for Humankind (CIM-EARTH) instance.

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Projection Methods for Saving Aggregate Growth Models

Papers, 1992

Redistributive Taxation in a Perfect Foresight Model

Handbook of Computational Economics, Volume 2: Agent-Based Computational Economics (Handbook of Computational Economics)

This handbook comprises 16 chapters surveying agent-based computational economics research, 6 sho... more This handbook comprises 16 chapters surveying agent-based computational economics research, 6 shorter essays providing personal perspectives, and a "getting started" guide for newcomers to agent-based modeling in the social sciences. Research topics covered include: learning representations for computational agents; agent-based models and human-subject experiments; economic activity on fixed networks; endogenous formation of economic networks; social dynamics and the evolution of norms; heterogenous agent modeling in economics and finance; agent-based computational finance; agent-based models of innovation and technological change; agent-based models of organizations; market design using agent-based models; automated markets and trading agents; agent-based computational methods and models of politics; agent-based tools for exploring the governance of social-ecological systems; and computational laboratories for spatial agent-based modeling. Related work can be accessed at http://www2.econ.iastate.edu/tesfatsi/ace.htm

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