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American Economic Association

The Economics of Federal Credit Programs. by Barry P. Bosworth; Andrew S. Carron;Elisabeth H. RhyneReview by: Donald D. HesterJournal of Economic Literature, Vol. 26, No. 4 (Dec., 1988), pp. 1769-1771Published by: American Economic AssociationStable URL: http://www.jstor.org/stable/2726881 .

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Book Reviews 1769

in Italy, concluding among other things that the data do not support Ricardian equivalence. The section also includes an interesting survey of historical thought on British budgetary policy during the years 1914-46 (Dimsdale) and of Keynesian thinking on budgetary deficits (Ar- tis), the persistence of which at that time were thought necessary to offset secular stagnation in aggregate demand, rather than, as in the U. S. today, as a consequence of deliberate choice of policy mix.

The remaining third of the book contains four essays by Boskin, Bagella, Paganetto and Eltis on various empirical and theoretical issues asso- ciated with the supply-side effects of government debt. The simple but telling arithmetic offered by Eltis makes apparent the perils of basing fiscal policy on assumptions as embodied in the more extreme forms of the Laffer curve and other manifestations of supply-side economics. Boskin makes two major points: first, that effects on interest rates, capital inflows and import leakages greatly weaken the expansion- ary role of budgetary deficits, and secondly that the major effect of the budget on private saving comes from intergenerational transfers embodied in explicit and implicit debt policies such as unfunded social security programs. The volume ends with two theoretical pieces, analyzing the longer-run role of debt in steady and sto- chastic states. Gorini considers public debt in a long-run neoclassical model contrasting it with its role in a long-run Keynesian framework. Flemming considers debt along with consump- tion taxes in a welfare optimizing model in which government borrowing can serve to mod- ify tax rate fluctuations and thereby welfare losses.

Posner's concluding overview provides some interesting insights and observations but hardly serves to synthesize the material and its implications for the conduct of fiscal policy. A key feature not present in early versions of the Tobin-type neoclassical model is that of capital flows. Tax reduction and a shift in policy mix towards higher interest rates will attract capital inflow, permitting increased capital formation and a higher rate of growth. As a result, foreign investors will claim a rising share of GNP due to foreign debt service, but total income remaining for domestic use will nevertheless rise. It would be interesting to explore the magni-

tude of this residual gain. Such will be the case so long as foreign investors do not decide to withdraw their funds. At the same time, the rise in the exchange rate and fall in net exports will occasion a costly dislocation of industry while the foreign debt raises questions of intergenerational and international equity. Although this volume does not address the latter prob- lems, its findings do suggest that considerations of financial stability and growth alone would conclude the current U. S. fiscal stance to be neither a desirable nor a responsible choice of policy.

PEGGY B. MUSGRAVE

University of California, Santa Cruz

The economics of federal credit programs. By BARRY P. BOSWORTH, ANDREW S. CARRON, AND ELISABETH H. RHYNE. Washington, DC: Brookings Institution, 1987. Pp xii, 214. $26.95. ISBN 0-8157-1038-0. JEL 87-1079 Federal credit programs are a large and

poorly understood component of U.S. capital markets. Between 1980 and 1985 about 17 per- cent of all funds raised flowed through these programs. This short book is an ambitious at- tempt to describe them and to establish criteria for evaluating their contributions. It analyzes the growth and contributions of programs that service housing, business, agriculture, and edu- cation.

The authors argue that federal programs have been sources of financial market innovation such as mortgage insurance and loan pools which led to standardized loan contracts and secondary markets in the private sector. They "believe that loan subsidies are an inefficient means of promoting a reallocation of resources or a redistribution of income" (p. 17). They argue that programs are difficult to assess because accounting controls are deficient.

Our basic recommendation is that government credit programs be operated more like private banks: they should be required to maintain a balance sheet statement of assets and liabilities and to use income-expense accounting. (p. 160)

It is hard to fault the principle that accounts should be informative and distinguish between stocks and flows. It is also hard to fault the major thesis urged in this book that subsidies advanced through credit programs should be



1770 Journal of Economic Literature, Vol. XXVI (December 1988)

viewed with a critical eye. Credit is fungible and subsidies can easily not end up in the hands of intended recipients. Putting such ideas into practice is the rub. If a government program is removed or added, in a general equilibrium framework prices and interest rates on all assets are likely to change. As Hakansson [1982] has argued, the welfare effects of such changes are exceedingly difficult to sign. In a general equilibrium setting, subsidies are difficult to define and measure, unless they are of the politically indefensible lump sum variety. The authors are to be congratulated for having the courage to swim in such surf; their analysis and conclusions are plausible and insightful.

The authors err when they claim that credit programs were conceived to shore up weak credit markets during the Great Depression. Federal land banks were established in 1916, Federal Intermediate Credit Banks in 1923, and the Federal Reserve was established as a federal credit program for banks in 1914 when the discount window opened. Federal credit programs increased in number during the depression, but their greatest growth has occurred in the last twenty-five years. The timing of growth deserves a more searching discussion than this book provides.

The authors cite three rationales for establish- ing credit programs: 1) the existence of credit market imperfections, 2) a desire to change the allocation of real resources, and 3) a desire to change the distribution of income. They argue that programs which eliminate market imperfections improve efficiency and do not require large subsidies. They recommend that credit programs be operated off the budget, so that losses or subsidies will be transparent to legisla- tors and voters and not commingled with general government funds.

In the second chapter, a taxonomy of programs is proposed: asset exchange programs, subsidized credit programs, loan guarantees and insurance, and special project guarantees. The authors' discussion favors asset exchange and actuarially sound insurance programs because only small subsidies are likely to be required. Using an argument in an empirical ap- pendix, they conclude "that purchases of private assets financed by a sale of government securities will have only a transitory influence

on the cost of borrowing in the private market" (p. 29). Their evidence is not compelling; they used an instrumental-variables estimation pro- cedure to analyze asset demands without speci- fying a complete model. They studied market segmentation, not credit programs. Federal credit programs transform private sector debt so that it more closely resembles government securities. That alone should drive up interest rates on government securities.

In Chapters 3 through 6 useful discussions of institutions and programs for different sectors of the economy are provided. A general reader can get a good overview of how credit programs work from these chapters. A minor quibble is that the most recent information reported in most tables is for 1984. Later information must have been available. Throughout these chapters the point is repeatedly made that distortions arise when subsidies are linked to credit. They suggest that it would be better to effect subsidies through direct grants.

Why doesn't the government sever subsidies from loan programs? I found no clear analysis of this question in the book. My interpretation of the practice is that it is very awkward to enact legislation that effects conspicuous transfers from one large group to another intergener- ationally or across broad occupations. Obviously any transfer to one group comes from the purse of another; it is hard to forge voting majorities that redistribute overtly. In the absence of a consensus about the desirability of redistribution, Congress attempts to obfuscate redistribution by resorting to complex loan and guarantee programs. The real contribution of this book is to say that such degenerate political games are ineffective in reaching targeted groups and potentially costly.

Chapter 7 provides arguments and examples for accounting and budgetary reform. Chapter 8 briefly cautions against similar costs and inef- fectiveness in state and local government tax- exempt bond financing and in industrial policy proposals.

In conclusion, this is a provocative and worth- while contribution toward understanding a complex set of U.S. capital market instruments and institutions.

DONALD D. HESTER

University of Wisconsin, Madison



Book Reviews 1771

REFERENCE

HAKANSSON, NILs H. "Changes in the Financial Mar- ket: Welfare and Price Effects and the Basic Theo- rems of Value Conservation," J. Finance, Sept. 1982, 37(4), pp. 977-1004.

The effects of taxation on capital accumulation. Edited by MARTIN FELDSTEIN. National Bu- reau of Economic Research Project Report series. Chicago and London: University of Chicago Press, 1987. $59.50. Pp. ix, 490. ISBN 0-226-24088-6. JEL 88-0128 The notion that taxes affect savings and in-

vestment decisions-and thus the rate of capital accumulation-is hardly controversial. Dis- agreements arise over the specific ways that taxes exert these effects and the magnitudes of the effects. The 14 research studies in this volume shed considerable light on these issues.

Scope of Topics. The papers cover a wide range of issues. Most focus on the accumulation decisions of firms rather than households. Two papers-by Martin Feldstein and Joosung Jun and by Alan Auerbach and James Hines-examine the relationship of tax policy to the overall level of fixed investment by firms. Three other papers focus on how tax policy is related to the composition or location of investment: Roger Gordon, Hines, and Lawrence Summers examine the ways that taxes affect incentives to invest in structures (as opposed to equip- ment); Patric Hendershott assesses the effects of tax rules on the composition of investment in terms of fixed investment, inventories, and owner-occupied housing; Michael Boskin and William Gale explore the effects of changes in U. S. tax policy on choices by domestic and foreign firms as to whether to invest in the U.S. or abroad.

Several papers concentrate mainly on estab- lishing the nature of incentives created by tax rules, giving less attention to the magnitudes of the behavioral responses to these incentives. Papers by Saman Majd and Stewart Myers and by Auerbach and James Poterba examine how firms with (temporary) losses have very different investment and borrowing incentives from firms that currently show profits. Summers re- ports some survey results indicating the ways that industrial corporations evaluate investment options, and considers the implications of these

practices for the relative effectiveness of accel- erated depreciation rules and investment tax credits. Mervyn King examines the implications of shifting to a "cash flow" corporate income tax, which would tax corporations on the net cash flow received from their activities rather than on any accounting measure of income.

Two studies concentrate on household saving behavior. Steven Venti and David Wise evaluate the effects on savings of changes in annual limits to Individual Retirement Accounts. Gregory Mankiw analyzes the effects of changes in after-tax interest rates on saving and con- sumption, and on the composition of consump- tion in terms of expenditures on durable and nondurable goods. A paper by Lawrence Lind- sey examines households' decisions to realize capital gains and the sensitivity of realizations (and tax revenues) to changes in capital gains tax rates.

Finally, two studies consider the responses of both households and firms by employing disaggregated computable general equilibrium models to assess tax reform proposals. Don Fullerton and Yolanda Henderson evaluate the potential efficiency gains and losses implied by the Treasury's November 1984 and the White House's May 1985 tax reform proposals. (Some features of these proposals were eventually in- cluded the Tax Reform Act of 1986.) Charles Ballard, John Karl Scholz, and John Shoven assess the effects of various possible value- added taxes.

Contributions. The papers in this volume make two important sorts of contributions. First, they provide recent (and in many cases, more reliable) empirical estimates of the re- sponsiveness of savings and investment to tax policy changes. In addition, they often yield considerable insights as to how taxes influence the composition, as opposed to the overall level, of savings or investment. This attention to com- positional effects constitutes a recent refine- ment in the analysis of the effects of taxation, and, as discussed below, offers rewards in terms of policy insights. The papers are of interest largely because of their empirical results rather than their methodologies (although the paper by Majd and Myers innovatively applies an op- tion pricing approach to the modeling of tax asymmetries, and the paper by Auerbach and



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