Faculty Bibliography
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In our 1994 article in this Journal, we demonstrated that legal rules should not be adjusted to disfavor the rich and favor the poor in order to redistribute income, because the income tax and transfer system is a more efficient means of redistribution. In this article, we revisit our argument and others that favor relying on the income tax system to redistribute income, and we then focus on qualifications to our argument that we previously offered. In particular, we elaborate on a qualification that is the subject of Chris Sanchirico's article in this issue of the Journal and explain why it has only a tangential bearing on the question whether legal rules should favor the poor and why it is of doubtful practical importance.
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Louis Kaplow, Horizontal Equity: New Measures, Unclear Principles (NBER Working Paper No. w7649, Apr. 2000).
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Alan Auerbach and Kevin Hassett offer a new measure of horizontal equity (HE) that is designed to overcome deficiencies in prior indexes. There is, however, a fundamental problem that their effort shares with their predecessors' attempts: the underlying rationale for pursuing HE at the expense of individuals' well-being is never stated. Moreover, as discussed here, it appears that no plausible rationale can be given because the essence of HE involves giving weight to morally arbitrary factors. Indeed, pursuing HE may even conflict with the Pareto principle. On reflection, it seems that the appeal of HE is specious: HE does not possess intrinsic value, but rather is a rough proxy concept that may signal various ways in which unequal treatment of individuals can lead to a loss in social welfare. Unfortunately, HE indexes are not very useful even with regard to HE's proxy role.
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Our thesis is that the assessment of a legal policy should depend exclusively on its effects on human welfare, that is, on the well-being of individuals. In particular, no independent evaluative weight should be accorded to notions of fairness, such as corrective justice in tort and desert in punishment. (Concerns about the distribution of income are not, however, subject to our critique.) When the choice of legal rules is influenced by notions of fairness, individuals are often made worse off. Indeed, if the prescriptions of any notion of fairness are followed, it is always possible that everyone will be made worse off. Moreover, when we examine notions of fairness and the literature that advances them, we are unable to identify reasons that, on reflection, justify giving weight to these notions at the expense of individuals' well-being. Nevertheless, notions of fairness are widely felt to be appealing. We suggest that this appeal can largely be explained by three factors: notions of fairness often correspond to social norms that usefully regulate everyday life; notions of fairness may serve as proxy devices for achieving instrumental objectives; and individuals may have a taste for satisfaction of the notions. However, we explain that none of these factors warrants employing notions of fairness as independent evaluative principles in the assessment of legal policy. We develop these arguments through consideration of specific conceptions of fairness that are employed in major areas of law: tort, contract, legal procedure, and law enforcement. We also discuss the implications of our analysis for our primary audience, legal academics and other legal policy analysts, and also for government officials, notably legislators, regulators, and judges.
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Most legal academics and policy makers believe that notions of fairness should be accorded positive weight in evaluating legal policies. We explain, however, that ascribing importance to any notion of fairness (other than one concerned solely with the distribution of income) will sometimes lead to a conflict with the Pareto principle. That is, to endorse a notion of fairness is to endorse the view that it can be desirable to adopt a legal rule that will reduce the well-being of every person in society.
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The public at large, many policymakers, and some economists hold views of social welfare that attach some importance to factors other than individuals' utilities. This note shows that any such non-individualistic notion of social welfare conflicts with the Pareto principle.
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Louis Kaplow, Transfer Motives and Tax Policy (Nat'l Bureau Econ. Res., Working Paper No. w6340, Mar. 1999).
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This paper considers the optimal tax treatment of voluntary transfers to individuals in a" framework that integrates redistributive income taxation and estate and gift taxation. Under this" formulation, redistributive considerations become secondary. The optimal tax treatment of" transfers depends upon the differences between expenditures on transfers and ordinary personal" consumption. It turns out that some types of transfers confer a sort of positive externality on" donees, some create tax revenue externalities, and some affect donors' and donees' marginal" utilities of income in a manner relevant to the optimal taxation problem. Different types of" transfers have qualitatively different effects.
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This is a survey of the field of economic analysis of law, focusing on the work of economists. The survey covers the three central areas of civil law liability for accidents (tort law), property law, and contracts as well as the litigation process and public enforcement of law.
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Measurements of the distortionary cost of labor income taxation generally assume that there are no other distortions. Browning (1994)identifies many pre-existing distortions, argues that such distortions reduce wages below the social value of labor's marginal product, and concludes that the marginal welfare cost of labor income taxation is substantially higher than suggested by previous estimates. The primary type of distortion Browning analyzes, however, has no direct effect on the marginal distortionary cost of labor income taxation.
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The complexity of the income tax is an unending source of complaint, and compliance costs are estimated to be very large. Yet most recognize that some degree of complexity is necessary if income is to be measured accurately. This article presents a framework for analyzing the value of greater accuracy in income taxation. Formulations for both distributive and incentive benefits of accuracy are offered. In addition, the article takes into account that compliance costs and the effects of complex provisions are endogenous, determined in significant part by taxpayers' information acquisition efforts. The article addresses whether taxpayers have excessive or inadequate incentives to acquire information about taxable income and to challenge tax assessments.
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In a recent article, I demonstrated that, under standard simplifying assumptions, it is possible to finance a public good in a manner such that a Pareto improvement results whenever the simple cost-benefit test is satisfied -- that is, without any adjustment for the "marginal cost of funds." In particular, the method of finance involves adjusting the income tax so that the combined incidence of the tax adjustment and the public good is distribution neutral. One implication of this result is that, if the public good is financed in some other manner, the difference in outcome will be purely redistributive, so that any change in distortionary costs will be accompanied by an opposing change in redistributive benefits. I also showed how this analysis is applicable to determining the optimal level of environmental taxes. Edgar Browning and Liqun Liu have written a critique of my article. It does not, however, disagree with any of these claims. Instead, their argument focuses on how one should interpret the term "distortion." It should not be surprising, however, that under any interpretation of the term -- including their preferred one -- my conclusions about how policy analysis should be conducted continue to be correct.
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Many features of public legal systems and private schemes of dispute resolution influence the accuracy of legal outcomes, including rules of procedure and evidence, appeals, regulation of lawyers' conduct, and some aspects of substantive law. An economic inquiry into this subject is concerned with the trade-off between accuracy and cost. Much of the effort involves careful specification of the value of accuracy and cost. Much of the effort involves careful specification of the value of accuracy, which until recently has been largely taken for granted. It turns out that the benefits from greater accuracy vary greatly by context. Accordingly, the discussion separately considers problems of determining liability, assessing damages, and establishing future rights and obligations.
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In Israel, as in a number of other economies, a few large banks have historically played a major role in the nonfinancial sector. At the end of 1995, the Israeli government appointed the Brodet Committee to examine bank investments in nonfinancial corporations. The Israeli Knesset subsequently adopted the committee's recommendations and imposed major limitations on the role of banks in the nonfinancial sector. These limitations required the two biggest Israeli banks to start selling much of their nonfinancial investments. This paper is based on the research report that we prepared for the Brodet Committee at the request of the Israeli Finance Ministry and Antitrust Authority. We explain why we recommended to the Committee that substantial limitations be imposed on bank investment in nonfinancial companies. We provide a detailed analysis of the effects that bank- conglomerate combinations have in a small economy -- such as Israel's -- that is characterized by a great deal of concentration in both the financial and nonfinancial sectors. In particular, we analyze the effects that bank-conglomerate combinations have on the safety and soundness of banks, on the decisions of the investment funds managed by banks, and on the level of competition in the economy in both the short run and the long run.
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In two recent articles, I explore the conceptual question of how human capital would be treated under a pure, comprehensive, accrual income tax, pursuing the analogy to accrual treatment of physical and financial capital, which has received much academic attention. My central conclusion is that conventional income tax treatment of human capital -- taxing wages when earned -- is close to the treatment required by a pure consumption tax, whereas accrual income tax treatment would be quite different from that in existing income tax systems. Professor Zelenak's article largely agrees with my central claims. Much of his article is concerned with criticizing me for advocating a consumption tax, which I do not in fact do. Indeed, I castigate the very type of argument he attempts to attribute to me and relies upon in defending his own views. It is also the case that Zelenak's affirmative arguments for the existing hybrid income/consumption tax and his various objections to particular elements of my analysis are largely without foundation.
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The conventional view of economists is that the optimal supply of public goods must directly take into account the cost of financing them with distortionary taxes, notably the income tax. However, this article demonstrates, under standard simplifying assumptions, that it is possible to finance a public good in a manner that results in no additional distortion by using an adjustment to the income tax that offsets the benefits of the public good. In this case, it is optimal to supply the public good whenever the simple cost-benefit test is satisfied. The article also shows that if a different tax adjustment is made, the difference in outcome will be purely redistributive; thus, any change in distortionary costs will be accompanied by an opposing change in redistributive benefits. In this case, the cost-benefit test should be modified to reflect both of these changes. Finally, it is explained that the present analysis is fully applicable to determining the optimal level of environmental taxes.
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A substantial majority of all capital is human capital, and most revenue from the income tax is from returns on human capital, wage income. Nevertheless, work analyzing the comprehensive, accrual ("ideal") income taxation of capital has focused on physical and financial capital. Applying the learning from this work to human capital suggests that human capital is significantly undertaxed under a conventional income tax, the actual result being close to what would be appropriate under a wage or consumption tax. This undertaxation does not, however, directly alter the marginal return to investments in human capital, although it does affect intertemporal behavior and bear on the interpretation of arguments about whether income is a distributively appealing base for taxation.
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Assessment of damages is a principal issue in litigation and, in light of this, we consider the social justification for, and the private benefits of, accurate measurement of harm. Greater accuracy induces injurers to exercise levels of precaution that better reflect the magnitude of the harm they are likely to generate, and, relatedly, it stimulates uninformed injurers to learn about risks before acting. However, accuracy in assessment of harm cannot influence the behavior of injurers--and is therefore of no social value--to the degree that they lack knowledge of the harm they might cause when deciding on their precautions. Regardless of the social value of accuracy, litigants generally gain by devoting resources toward proof of damages, leading often to socially excessive private incentives to establish damages.
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Whether state and local taxes are deductible is believed to have important effects on revenue, tax equity, and the operation of state and local governments. This Article's analysis of deductibility draws on previous work that addresses the fiscal activity of state and local governments in order to examine the incidence of both taxes and the benefits they finance. The desirability of deductibility is assessed not only by reference to whether it is required by a conceptually pure income tax but also in terms of how it serves the underlying objectives of the income tax. The results of this investigation contradict many of the arguments offered by advocates and opponents of deductibility.
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Much criticism of the income tax involves administration: the enormous complexity of the system is responsible for large compliance costs, public and private, and the tax gap is large despite substantial resources devoted to enforcement. The desire for simplification and improved compliance motivates various incremental reforms as well as proposals for fundamental restructuring of the tax system. But evaluation of such changes is difficult because the underlying problems have not been analyzed in terms of the equity and efficiency concerns that animate more familiar assessments of income tax policy. This article provides a framework for a unified analysis, in which the same factors that are used to justify the choice of the tax base and the rate structure are employed to resolve problems involving complexity, compliance costs, and enforcement difficulties.
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Should property rights be protected absolutely -- by property rules -- or instead by the requirement that infringing parties pay for harm done--that is, by liability rules? In this article, we present a systematic economic analysis of this fundamental question. Our primary object is to explain why liability rules are often employed to protect individuals against harmful externalities (such as pollution and automobile accidents), whereas property rules are generally relied upon to protect individuals from having their possessions taken from them, thereby ensuring a basic incident of ownership. In the course of our analysis, we suggest that a variety of commonly held beliefs about property and liability rules are in error, and we also derive results bearing on legal policy. Notably, we show that, for controlling some important externalities, liability rules (and pollution taxes) are superior to property rules (including many forms of regulation) even when damages must be set using only limited information about harm.
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Income tax burdens, welfare payments, and social security benefits depend on the composition of family units. Substantial controversy exists over the appropriate forms of adjustment, as reflected by the wide variation in methods among programs, across jurisdictions, and over time. In contrast to approaches based on "ability to pay" or equivalence scales, this article uses a utilitarian welfare function to derive the equitable distribution of income for different family configurations. The analysis considers how allocations should depend on family sharing arrangements, economies of scale, altruism among family members, and differences in utility functions among family members.
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Anti-utilitarian norms often are used in assessing tax systems. Two motivations support this practice. First, many believe utilitarianism to be insufficiently egalitarian. Second, utilitarianism does not give independent weight to other equitable principles, notably concerns that reforms may violate horizontal equity or result in rank reversals in the income distribution. This investigation suggests that a policy maker who believes in the Pareto principle -- that any reform preferred by everyone should be adopted - - cannot consistently adhere to any of these anti-utilitarian sentiments. Moreover, the affirmative case for utilitarian tax policy assessment is stronger than is generally appreciated.
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Altruistically motivated gifts involve a species of consumption externality. Donors obtain an altruistic benefit from the effect of their gifts on donees' utility but do not take into account that the benefit to donees is itself relevant to social welfare. The level of gift-giving thus will be lower than is optimal. A subsidy can correct this problem, while compulsory transfers (assuming the state lacks information about who is altruistic) and bargaining between donors and donees cannot. The rationale for subsidizing gifts offered here does not depend on whether the donee's activity is a public good (as with gifts for medical research) or whether the transfer tends to equalize the wealth of donors and donees — factors emphasized in the exisitng literature on the subject.
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Arguments that liability rules are preferable to property rules when bargaining is imperfect are flawed because of the uncertain influence of information-forcing on the bargaining process. Examples advanced in support of the preferability of liability rules are based on examples that appear to support the opposite conclusion that property rules will result in better outcomes. Imperfect bargaining is likely to do better under a liability scheme because bargaining may fail and if it fails liability rules are preferable.
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Legal rules often are complex in order to distinguish different types of behavior that may have different consequences. Greater complexity thus allows better control of behavior. But more complex rules are more costly for individuals to understand ex ante and for a court to apply ex post. Also, because of the cost, some individuals will choose not to learn complex rules. This article models the effects of complexity on individuals' decisions to acquire information, choices about whether to act, and reports of their actions to an enforcement authority. It determines when more complex rules improve welfare and how this depends on whether enforcement involves self-reporting of behavior.
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The federal income tax and major welfare programs do not take into account significant cost-of-living variations among regions. This article considers what adjustments might be appropriate in light of the distributive purposes of tax and welfare systems and concerns about the efficiency of the interregional allocation of resources. Price index problems, differences in amenities, and heterogeneity of individuals' locational preferences are considered.
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The problem of establishing the amount of losses covered by public and private insurance is often characterized by asymmetric information, in which the claimant already knows the extent of a loss but this can be demonstrated to the insurer only at a cost. It is shown that a simple arrangement, which provides greater coverage whenever individuals demonstrate unusually high losses, gives claimants an excessive incentive to establish the amount of their losses. This paper determines what insurance claims process, consistent with the form typically employed in existing insurance arrangements, is optimal.
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Taxation and risk taking are examined in a general equilibrium model that incorporates uncertain government revenue in a nonrestrictive manner and allows the government to influence its revenue through portfolio investments as well as through tax policy. It is demonstrated that each of a wide range of taxes can be decomposed into some combination of a wage tax, an ex ante wealth tax, and a modification of the government's investment portfolio. For example, a tax on investment returns (from risky and riskless assets) is equivalent, with an adjustment in the government's portfolio, to a tax on the riskless component of investment returns or to an ex ante wealth tax -- both of which absorb no private risk and yield certain revenue. The concept of equivalence employed is strong: two regimes are equivalent if, for each state of nature, individuals' wealth and government revenue are the same under both regimes and total investment in each asset is the same. Implications for behavior (private and total risk taking) and welfare are immediate. Moreover, these results are independent of the government's objective function, the manner in which individual utility depends on government expenditures, and some of the restrictive assumptions found necessary in previous treatments of the problem.
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Self-reporting--the reporting by parties of their own behavior to an enforcement authority--is a commonly observed aspect of law enforcement, such as in the context of environmental and safety regulation. We add self-reporting to the model of the control of harmful externalities through probabilistic law enforcement, and we characterize the optimal scheme. Self-reporting offers two advantages over schemes without self-reporting: enforcement resources are saved because individuals who report their harmful acts need not be detected, and risk is reduced because individuals who report their behavior bear certain rather than uncertain sanctions.
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Louis Kaplow & Steven Shavell, Accuracy in the Determination of Liability, 37 J.L. & Econ. 1 (1994).
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Many legal rules, notably rules of procedure and evidence, are concerned with achieving accuracy in the outcome of adjudication. In this article, we study accuracy in the conventional model of law enforcement. We consider why reducing error in determining liability is socially valuable and how error and its reduction affect the optimal probability and magnitude of sanctions.
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Various authors, notably Eaton and Rosen (1980a) and Varian (1980), have proposed that income taxation may be justified to some extent on the ground that it serves as social insurance against uncertainties in labor income. They assume that private insurance is unavailable. primarily because of moral hazard, and demonstrate that some taxation is efficient because the benefits of mitigating risk exceed incentive costs. This note suggests that private insurance should be considered explicitly in examining this question. Moral hazard problems limiting private insurance coverage are not alleviated by government insurance. Moreover, in the presence of moral hazard, government insurance, through labor income taxation or otherwise, may be an inefficient policy because private insurance decisions are distorted. More traditional justifications for redistributive taxation are unaffected by this argument.
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Louis Kaplow, Shifting Plaintiffs Fees Versus Increasing Damage Awards, 24 Rand J. Econ. 625 (1993).
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Shifting successful plaintiffs' fees to defendants and increasing damage awards are alternative ways to achieve similar results: increasing plaintiffs' incentives to sue and raising defendants' expected payments. This paper shows that relying on higher damage awards is more efficient than shifting plaintiffs' fees. The reason is that fee-shifting is, perversely, more valuable for plaintiffs with higher litigation costs. Thus, it is possible to substitute higher damage awards for fee-shifting in a manner that leaves deterrence unaffected while eliminating the suits of plaintiffs with the highest litigation costs.
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Does taxation for public goods generally involve a distortionary cost? Are Pigouvian taxes desirable because they raise revenue without having to resort to distortionary taxes? Should decisions concerning public goods or Pigouvian taxes depend on whether their incidence is regressive? The answer to these questions may be negative, contrary to conventional wisdom, if one considers a different and arguably more natural method of achieving budget balance than is typically assumed.
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Should legal rules be chosen only on the basis of their efficiency or also on the basis of their distributional effects? This article demonstrates that redistribution accomplished through legal rules is systematically less efficient than redistribution accomplished through the income tax system -- even though the latter distorts incentives to work. In particular. a regime with an inefficient legal rule can be replaced by a regime with an efficient legal rule and a modified income tax system designed so that every person is made better off.
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The transition from one legal environment to another — such as that involved with electric utility deregulation — raises concerns about the efficiency of the adjustment process and questions of whether gains and losses caused by the change warrant mitigation, such as through compensation and windfall taxation. This investigation addresses the latter issue from an ex ante perspective that analyzes the effect of the anticipation of transition relief on incentives and risk bearing.
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Louis Kaplow, Human Capital and the Income Tax (NBER Working Paper No. w4299, Mar. 1993).
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This article examines how to treat human capital -- perhaps the vast majority of the capital stock -- under an ideal, Haig-Simons income tax. Innate ability, investments in human capital, and uncertainty in future earnings are considered. It is demonstrated that conventional income tax treatment and proposed modifications are closer to implementing a consumption tax than an income tax. Approximating ideal income tax treatment may be feasible, but assessing its desirability would require further inquiry.
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Richard Musgrave has recently offered a new defense of the concept of horizontal equity (HE)-the requirement of equal treatment of equals-as an independent norm in assessing tax policy. This defense is significantly more elaborate than the brief sketch he offered in his pioneering treatise or in his subsequent work on the subject. Musgrave’s latest contribution is important because prior literature developing and applying HE measures gives little justification for this norm. The gap in the literature remains, however, because Musgrave assumes what must be demonstrated and suggests an index of HE that is implausible.
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This Article offers an economic analysis of the extent to which legal commands should be promulgated as rules or standards. Two dimensions of the problem are emphasized. First, the choice between rules and standards affects costs: Rules typically are more costly than standards to create, whereas standards tend to be more costly for individuals to interpret when deciding how to act and for an adjudicator to apply to past conduct. Second, when individuals can determine the application of rules to their contemplated acts more cheaply, conduct is more likely to reflect the content of previously promulgated rules than of standards that will be given content only after individuals act. The Article considers how these factors influence the manner in which rules and standards should be designed, and explores the circumstances in which rules or standards are likely to be preferable. The Article also addresses the level of detail with which laws should be formulated and applied, emphasizing how this question concerning the laws' relative simplicity or complexity can be distinguished from that of whether laws are given content ex ante (rules) or ex post (standards). In so doing, it illuminates concerns about the over- and underinclusiveness of rules relative to standards.
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Income tax burdens on family units are adjusted to reflect differences in ability to pay attributable to whether the unit consists of a single individual or a married couple and how many dependents are present. Substantial controversy exists over the appropriate forms of adjustment, and existing approaches to taxation of the family vary greatly across jurisdictions. This article derives equitable relative tax burdens for different family configurations from a utilitarian welfare function. The analysis considers how relative burdens should depend on the extent to which resources are shared among family members, the existence of economies of scale, the presence of altruism among family members, whether expenditures on children should be viewed as part of parents' consumption, and the possibility that some family members (children) have different utility functions from others.
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This article considers whether the demand for legal advice about potential liability for future acts is socially excessive. using the standard model of accidents, we find that the answer depends on the type of advice and the form of liability. When advice provides information about properly determined liability, the demand for advice is socially optimal under strict liability but is socially excessive under the negligence rule. When advice identifies errors the legal system is expected to make, the demand for advice is socially excessive under both liability rules.
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Even when society would wish to deter all acts of some type, such as tax evasion and many common crimes, the benefits from deterrence often will be insufficient to justify the expenditures on enforcement that would be required to deter everyone. If some individuals are not deterred, however, they will bear risk when fines are employed as a sanction. As a result, it may be optimal to reduce total risk-bearing costs by reducing the number of individuals who bear any risk. This can be accomplished by increasing enforcement above the level that would be justified considering only the benefits of deterrence and the direct costs of enforcement. Another possibility is that it may be optimal reduce the risk borne by those who act, by employing fines below the maximum feasible level. This latter result constitutes an instance in which the well-known implication of Becker's analysis that it is optimal to employ extreme sanctions for all offenses is invalid.
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A significant source of risk arises from uncertainty concerning future government policy. Government action - tax reform, deregulation, judicial decisions, budgetary shifts - produces gains and losses for those who invested under preexisting rules. The effects of government relief - compensation, grandfathering, phase-ins - on ex ante incentives and risk bearing are examined using a model in which private insurance is available. It is demonstrated that government relief is inefficient, even when private insurance is subject to moral hazard, because relief shields individuals from some of the effects of their actions.
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Whether personal income tax deductions are appropriate refinements to the concept of income or unwarranted tax expenditures continues to be the subject of debate. The casualty loss and medical expense deductions are frequently justified on the ground that ability to pay is reduced by largely unavoidable expenditures or losses. This article reconsiders the question taking account of the availability of private insurance, which is in fact widespread for relevant losses in both areas. When individuals can insure, the second level of insurance implicit in the casualty loss and medical expense deductions distorts consumption choices and insurance decisions. In particular, individuals may be more exposed to losses because of tax deductions commonly believed to mitigate them. Given the option, individuals would prefer a regime that eliminated the deductions and offered correspondingly lower tax rates.