James M. Poterba

INTERVIEWER: Today is May 3rd, 2010. I am Karen Arenson. We are talking this afternoon with professor James Poterba, the Mitsui professor of economics at MIT, whose specialty is taxes and how they affect people in companies, and the decisions they make. He officially joined the MIT economics department in 1983 and served as its associate department head and department head for 13 years. Two years ago, in an appointment applauded by economists on the right and the left he was named president and chief executive of the National Bureau of Economic Research, a high profile organization with more than 1000 research associates at colleges and universities across North America. It is also the arbiter of when the United States enters and leaves recessions. Jim, thanks for talking with us today. Let's talk about taxes.

Most people run away from the subject, you seem to run toward it. What attracts you?

POTERBA: You know, I think taxes are a place where if you are interested in economics and the effect of incentives on the behavior of people and on firms, if you've also got a willingness to dig into some details and find it interesting to learn about institutional rules and structures it's an ideal place for someone with that joint interest to apply their tools. And I've in fact, found taxes interesting for a long time. I think it actually goes back-- if my memory serves-- to my freshman year in high school when I was on my high school debate team. The debate subject for the year, this was at a time in the early 1970s when revenue sharing was an active topic of discussion when a lot of states and localities were struggling, not completely unfamiliar today, was something like resolve that the federal government should finance primary and secondary education in the United States. And there was discussion then of should we have a national value added tax? Should the federal government use the income tax to finance what's usually a property or sales tax financed expenditure in most US localities? So I learned something about taxes then and I liked it, and have been following that interest in one way or another, more or less, ever since.

INTERVIEWER: As a debater you were probably expected to be ready to take both sides of that argument, but did you have a favorite between the two?

POTERBA: Ninth grade is long enough ago that I'm not sure whether I felt affirmative or negative was easier in those days. But you're right, and I think that the fact that then as now there were always arguments plus and minus for any tax that you could think of, and that these were not simple, easy recommendations. But rather, one can lay out a menu of here's what you could do. Here are the positives and here are the negatives associated with that. I've actually always found that very attractive. I'm not someone who's very much given to making strong policy prescriptions, but I like the analytical part that lies behind the policy so that one can try as an economist to help the politicians or the decision-makers to understand the consequences of different choices and then leave it to the process to decide.

INTERVIEWER: Do you recall whether other students, your teammates or your opponents really got into this topic too? Or whether some of them were put off by--

POTERBA: My vague recollection is that most people thought this was a pretty dry and dull topic. And that I was probably a little bit at the enthusiastic extreme relative to the set of people who were, as ninth graders, learning about value added taxes.

INTERVIEWER: Did you have any sense then, ah-ha, this is going to be my life's work?

POTERBA: I don't think so. I learned at that stage and throughout the rest of my high school debating career because we often tackled questions that had a lot of economics in them. I think that back in my senior year in high school the topic was something about the allocation of scarce world resources, and that of course is really front and center to thinking about how economists might sort of play a role. It wasn't really until I got to college that I was drawn into economics as more than a side light. In fact, when I came to college I thought that I would be a scientist of some sort, probably a chemist or a chemical engineer. Although I didn't come to MIT as an undergraduate, I do remember my MIT undergraduate admissions interview. Because when the interviewer said, do you have any questions about MIT? I think the only thing I asked was, does Paul Samuelson teach undergraduate economics courses? And the interviewer parried the question in just the right way and said, well I think he probably teaches some more advanced courses, typically.

But I must have been interested enough in economics to be thinking about it at that point as a sort of rising senior in high school. But it was really when I got to college and wanted to continue to be involved in debate that my debate coach basically said well, you know these science courses, with all these labs, it's very hard for you to travel a lot and participate in debate activities if you take a lot of chemistry and physics and biology. So at that point in my freshman year, I said, well I better sign on for economics and math doesn't have labs, so I'll take some of that. And some other courses that sort of turned out to be fitting in with that broad interest. At that point I really was drawn into realizing what economic analysis could do at the sort of more substantive and deeper analytical level. I really started to find it very interesting. So at that point there was no looking back.

INTERVIEWER: When you were in high school and you started looking at the tax issues do you remember whether you talked to your parents about their taxes or said, let me look at a tax return. Or I'll help you fill it out?

POTERBA: There must be something in the genes about taxes because my father, who is about to turn 90 still does his own income tax return with pencil and paper. A task that I find amazingly daunting. I certainly am helped by some computer programs in doing my taxes. But I don't think we had family discussions about tax issues. I'm pretty sure that I didn't know much about our household finances until well beyond my move out of the house to go to college.

INTERVIEWER: What's your general view of the American system of taxation now?

POTERBA: It could certainly be made better. And I think we are unfortunately held hostage by a political process that puts a lot of special interest influence into the making of tax policy. You know, the broad prescription that most economists and I would offer for raising revenue is to try to find as broad a tax base as one can. And then to raise revenue on that base with as low a set of rates as you can manage, subject to carrying out whatever redistributive objectives the society chooses to have. So a simple flat tax on everybody's income at the same rate doesn't seem like it's the way to go because one would like to do some redistributive activity and to help those who are less fortunate.

At the same time, the very high marginal tax rates that one saw during the 70s and 80s in countries like Scandinavia-- even to some degree in the United States-- I think there's been a sense that those very high rates create a lot of distortions. They encourage people to find ways to avoid taxes, to evade taxes, whether legally or illegally. And they may discourage productive activity in the economy. So somehow, in trying to navigate between those two poles is the challenge. And what we have at the moment is an income based tax system, but one that has a large number of special deductions and exemptions for various activities, many of which I think are rather difficult to justify on clear analytical or policy grounds. And I think that the way I would like to see us go, at least initially, we have a huge revenue hole in the US that needs to be filled going forward. And what I think the first step should be is to try to do some base broadening and reign in some of those deductions, see if we can collect sufficient additional revenue there. I suspect we need higher rates as well, and it'll be less painful to raise the rates if the base is broader so that we don't exacerbate some of these distortions. But it's going to be a very interesting decade for people interested in tax policy because the projections at this point going forward from 2010 suggest that we have a long-term deficiency in our revenue capacities relative to the set of expenditure programs we have in place. And there's going to be enormous interest, I think, in figuring out how we tackle those problems.

INTERVIEWER: Are you seeing any kind of increased interest, either among undergraduate or graduate students? Or even among some of your professional colleagues?

POTERBA: I think you can see it most easily in the many academic economists who I interact with. And even within the narrow field of what we call public finance, the people who study tax issues. For a decade or a decade and a half there has been growing interest within the academic study of government in the economy. In understanding various expenditure programs, looking at medical care insurance, looking at social security. Taxes, in part because they were relatively low by historical standards, had attracted less interest I would say, for a while. The last 18 months when the US embarked on a historic stimulus program in peacetime, and when suddenly the long-term forecast that had always been there saying, the US is going to need more revenue when the baby boomers retire. Those projections were always 15, then 10, then 8 years away and what happened in 2008 when the federal government undertook a vast array of new spending programs was that the projections which had said relatively modest budget deficits followed by an increase-- sunny followed by showers and clouds late tonight and tomorrow became cloudy followed by severe thunderstorms by evening. And people suddenly realized we've got to think much harder about the fiscal dynamic that we are engaged in. So I've seen much more discussion focusing on budget deficits, on the effect of government stimulus programs, on how to think about raising taxes, and I expect that's the beginning of what's going to be a snowballing effect as people think about that going forward.

INTERVIEWER: Are there any countries whose tax systems you particularly admire? Who do it the way you're describing?

POTERBA: They're few and far between to be honest. And the problems that arise from the political economy of making tax policy in the US are hardly unique. There are though a few examples where you can find situations where tax rates have been raised or the base has been broadened in a striking way. New Zealand adopted a value added tax at one point, about a decade ago. And in most countries in Europe where there's a value added tax it's a form of a sales tax basically. So usually there's a question of which goods will be taxed under the value added tax? And just as in the US states there's always a question of which goods will bear sales tax? Should food, should restaurant meals, should education, should medical care be taxed under the sales tax? The same question comes up with the value added tax.

New Zealand managed to do something very different from virtually all the other countries where most of the countries leave about half of the consumption that's done out of the value added tax base. New Zealand actually got not just to 100 percent, but actually taxes more consumption than appears to show up in the government's national accounts. I think they were just committed to the proposition that we are going to allow no exclusions. Once you've got some religion that that's going to be the principle that's going to guide you, if you can sort of really stay with it and beat back all of the special pleading for special deals, that can get you to a place that leads to a somewhat more efficient tax system.

Even in the US there is some evidence of hope that goes back to 1986. Because in '86 we had a significant tax reform that commanded bipartisan support. Bill Bradley for example, a democratic senator from New Jersey, was a large proponent of doing something to reform the tax system. President Reagan at the same time was eager to see something happen. The congress basically came together and did something that was pretty painful, in that they cut back on a number of special deals that were in the tax code for various industries and various interest groups. They lowered rates at that time and managed to basically keep the total revenue, not quite constant, but within hailing distance of constant. And the fact that that happened 25 years ago, I take some hope from because I think it does at least raise the possibility that when there's real sense that we need to urgently do something on the tax code the US system can actually get it done, but it's going to be a challenge.

INTERVIEWER: President Reagan actually had two rounds in major tax changes, right? He'd done one in '81 or '82--

POTERBA: That's right. And in fact, the '81 tax cut was a tax cut. It was much less of a reform of structure as opposed to take all the rates down. And then it became very clear shortly after the '81 cut that we'd gone too far and that we were running deficits. And in '82 and '83 and '84 there were tax bills that tried to lean against that wind and collect more revenue. But I think it was partly a sense through all that process that the whole system just needed to be overhauled. And that's what led to reductions in top rates for example, from 50 to 28 in the '86 bill. At the same time that we did other things, for example, we taxed capital gains more than we had before, we changed some of the depreciation rules for businesses. We did a lot of different things that added up to a sort of simplification of the tax system. Since then there has been a gradual chipping away at the sort of steps that were taken in '86. The tax codes become more complicated, we've done a lot of social engineering through the tax system, and those are all things that I think they may all have justifications for them, but one needs to take a sort of top to bottom look at those issues.

INTERVIEWER: Do taxes really distort behavior? If you look across the landscape, what do you see?

POTERBA: I think there are two ways to answer or to think about that. The part that is easiest to address is that when taxpayers-- whether they are firms or they're individuals-- see a chance to reduce their tax liability without too much reconfiguring of what their real decision-making looks like, they run for it. I'll give you two examples. One is in the 1986 reform when the capital gains rate was going to be going up, taxpayers could tell that they were facing a lower tax rate in 1986 than they were going to face in 1987 or beyond. You look back at the history of realized capital gains in the US in say, 1983 through 1986, it was $90 billion, $102 billion, $105 billion, $370 billion, $90 billion, $72 billion. So basically there was a clear move to just move all of the capital gain realizations forward through time and take advantage of those low rates. The same thing happened in 1992.

When President Clinton had been elected it was clear the tax rates were likely to go higher. Wall Street firms that typically pay bonuses early in January accelerated those bonuses and paid them in December of 1992. That effect even then, prior to the rapid growth of Wall Street over the last decade and a half, even then that move of bonuses from January to December is enough so that the national income accounts for the US show a special adjustment factor in labor income because things moved across the year. Those are both examples of short-term re-timing. You see similar things with people giving to charity. If they know their tax rates are going to change from one year to the next they try to make the gift in the year with the higher tax rate. The harder question is whether if you change the tax structure substantially and you leave it in place and don't fiddle with it for awhile, whether moving from one system to another leads to substantial changes in behavior.

My sense is that that's harder to tell just because we have fewer examples in which the tax system has stably moved from one place to another. But I do think that people's willingness to exert lots of effort to take on risky propositions and see whether they can create businesses or create new occupations, I think that is probably sensitive to the after tax rewards that they could earn. That when the tax rates are really high, the days when you might face of 70 percent tax rate on your labor income if you were really successful-- I think that did probably have a dampening effect on how much people were willing to work in those stages.

INTERVIEWER: There's been widespread use of taxes that are not only aimed at trying to change behavior-- I mean, sometimes explicitly so-- as well as to raise revenue, like the so-called sin taxes on products like cigarettes or alcohol. Have those been affected or--

POTERBA: Absolutely. There's no doubt if you look at situations where say the cigarette tax has been increased by a state that spending on cigarettes declines or the consumption of cigarettes declines and we know that-- again, stay with cigarettes, we know that young smokers tend to be more sensitive to the price per pack than older smokers. So that what you typically see is that when you jack up the price significantly with a tax that leads some people to not start smoking, and that may have of course, some important public health benefits. But the cigarette tax example is a good one for showing how the short run and the long run can look different. I think there's very little controversy that in the long run if the cigarette tax is higher that there will be fewer smokers and that smokers who do smoke will smoke less. However if you look at the short run movements around the time when the cigarette taxes go up, take for example, California, which I think increased their cigarette tax by $0.50 or $1.00 a pack in the late 1980s.

In the month before the tax increase took affect cigarettes were flying off the shelves in California supermarkets and other venues. And in the month after the tax took effect cigarette sales fell precipitously. So if an economist without the knowledge of how the complexities of behavior might work out were to go and look at, right before and right after the tax increase, you'd conclude that this paradoxical result, cigarette sales fell right after the taxes went up as you would expect them to. But very, very sharply. And what you found was that this kind of hoarding behavior exacerbated the effect of the tax. Made it look much larger in the very short run than it was in the longer haul. That's part and parcel of why I found the analysis of taxes interesting. Because it's not something where there's a very simple, one size fits all analytical strategy. You need to think about these interesting institutional details, like the fact that cigarettes are storable and that some California smokers were filling their garages with cartons of cigarettes.

INTERVIEWER: They don't get stale after a while.

POTERBA: Staleness I don't know, but they do burn. And one of the concerns with the hoarding behavior was that people would be putting lots of flammable stuff in their garages and I think there was a slight increase in the reported rates of home fires and things like that.

INTERVIEWER: They weren't talking about the hearth?

POTERBA: That's right.

INTERVIEWER: Let's go back to your childhood. You talked about tripping over taxes in ninth grade, but where were you raised and what were you like as a child?

POTERBA: Well, I lived on Long Island. I still have a Long Island accent, I think, even though I moved when I was in seventh grade. But I lived in Long Island and I lived in eastern Pennsylvania in Bucks County when I was in high school. I don't think I had much the markings of economics at that stage. As a high school student I was-- as I said I was interested in math and computers and science. I don't think I quite realized yet that economics had some analytical and mathematical components that might actually link up with those interests. I had a paper route. I was on my debate team. I was tapped to run the student store in our middle school or lower high school, which I remembered was a very early introduction to what it was like to try to run a business. To try to prevent the big kids from jumping over the wall and stealing the candy out of the store was always a challenge for the little nerdier kids who were thought to be in charge of the store and keeping the books.

INTERVIEWER: Did you figure out a way?

POTERBA: We tried to make them our friends. That was our best strategy, but we never resorted to bribery, which would be the other option. Those are the sort of things that I remember being involved in. A number of economists who I've talked about their-- what drew them into economics-- I think the root of thinking that science and math would be a career and then discovering in college that economics has some elements like that. That amongst the social sciences it turns out to be a relatively quantitative one. That there is a route for using some of those tools, but that also mixes in the kind of interesting public policy elements that people might find fascinating. I don't think my experience is all that atypical in terms of the way I was drawn into economics.

INTERVIEWER: But if it weren't for the debate you might have gone to all the science labs and turned into a biologist?

POTERBA: I think that's right. I mean I absolutely think that small nudges can be very important in the way things play out. And my high school had a ninth grade economics course that I remember and it was relatively introductory. So I think we discussed how prisoners of war traded cigarettes in POW camps in the Second World War. I remember we did something on an Indian tribe called the Kwakiutls that had particular tribal customs for how they traded and decided what was produced. It turned out that my high school economics teacher in ninth grade was the roommate of the high school debate coach and the way in which the debate team did its recruiting was that the two of them would talk and they would try to find out who might seem interested in this. So literally my launch into doing debate and probably doing economics was back in ninth grade when my teacher came in and said, you're going to go and try out for the novice debate team this afternoon. And I dutifully did it and I've always been very grateful for the fact. That moment was a watershed moment in shifting the things I was doing.

INTERVIEWER: Did you know any economists growing up? What did your parents do?

POTERBA: My dad was an accountant, my mom was a school teacher, and neither of them quite knew what academics was about until well after my joining the faculty at MIT when they would ask, are you teaching this semester? And I would say yes. They would say, how much? And I would say, well six hours a week. They would look back mystified and say what do you do with the rest of the week? So the whole academic enterprise and the notion of research and teaching going hand in hand and working with graduate students and things like that. It took a long time for that to work its way into the fabric of my household.

INTERVIEWER: Well, but one was in education and the other was in numbers, and you do both.

POTERBA: That's right. And in fact, if you look back, at some level this fuses the two things together.

INTERVIEWER: How did you decide where to go to college and you talked a little about what to study, but--

POTERBA: I'll be honest. I faced a very tough choice between MIT and Harvard. I really thought that MIT had an astonishing-- although, I didn't know much about economics besides Paul Samuelson being here, I knew that MIT was great at all of the science things that I was interested in. Most of my debate friends-- and I had a national group of friends who I would sort of compete against-- the ones of those who I knew who were thinking about this choice were by and large leaning toward Harvard. And since I thought I wanted to do debating in college and MIT's debate team didn't have quite as much depth as the Harvard debate team I decided well, I'll head off in that direction.

It turned out that the MIT/Harvard connection continued to play out because while I was debating my freshman and then my sophomore year in college there was an MIT debate team coached by an economics graduate student at Harvard by the name of Larry Summers. Larry was working on his dissertation at Harvard while spending time at MIT, which had been his undergraduate school, working with their debate team. He'd been a very successful college debater at MIT. Bringing some economic analysis in fact, at a very high level into the collegiate debate circuit.

And it was the Thanksgiving weekend or thereabouts in my sophomore year and Larry and I were both at a debate tournament at Wake Forest in North Carolina. And we went for a walk during one of the breaks and Larry said, you know, I'm thinking about hiring a research assistant, and I was wondering if you'd like to think about doing that? And I said, well, I just really don't know that I'd have time to do it given the demanding travel and work schedule that our debate team imposes. And we had a conversation and he said well maybe you want to think about whether you prefer to do research assistant work than do debate. And that was really a monumental decision for me to have to think through. But once the idea had been floated and the appeal of being able to do more than be a consumer of the research that other people had been doing-- instead of using that research to try to build arguments one way or the other, but the notion of being a producer of some of that research had a certain appeal. And it took me about two months of noodling over this offer before I finally decided right after the New Year in my sophomore year in college that I'd actually switch over and I'd leave the debate team. I'd signed on for this research assistant activity.

Again, I was living under this charmed star because the first two economists I worked for were Kim Clark who was a Harvard graduate student at that point, but went on to be a very successful professor at the Harvard Business School, the dean at the Harvard Business School, and Larry Summers. And it'd be hard to think of a better way to jump into this field than by working for a duo like that.

INTERVIEWER: Do you remember what kinds of projects you did for them and what they wanted you to do?

POTERBA: Oh, vividly. The first thing I did was I collected data-- this is pre the era of online downloadable data, remember. Kim was doing some work on the productivity of the cement industry in the US and the role of labor inputs in the productivity of cement factories. Cement's a very capital intensive industry, so collecting detailed data on the cement firms and their plants was on key part of his research. So I was identifying and copying data on the capital stock that the workers used in cement factories. These are places that have kilns that produce cement for all across the US I was creating that and typing it into punch cards so we could do statistical analysis.

And then Larry and Kim collaborated on work, which even today has been very influential in economics. We were studying the role of labor market transitions, movements between employment and unemployment out of labor force, and the way things like unemployment insurance and other public programs affected those transitions. I had as I mentioned, been interested in computer programming and I'd done a fair amount of computer work. So I was writing computer code for them that was basically doing data analysis with information that we'd received from the Bureau of Labor Statistics and Labor Department on some of these labor market flows and transitions. We were also trying to simulate the effect of different public policy programs. And for example, I remember we had-- one of the issues always was, at what point would a worker who had become unemployed just give up if they hadn't found a job. After 6 months or 9 months or 12 months? When would they finally say I'm throwing in the towel that I'm just getting out of the labor force? And I remember programming something called the indomitable worker.

The indomitable worker was somebody who would never throw it in, who would basically just keep searching and searching and searching. We were interested in trying to understand how long in the worst case scenario-- if you were really committed to finding a job how long could it take you to finally get employment? And how that varied over the course of the business cycle and with different state unemployment insurance programs and things like that. The fact that today, 30 odd years later, I can still remember some of the things that we worked on at that point. And it speaks to just how exciting a time it was and how exciting a team it was to be working on as we worked on these various issues.

INTERVIEWER: And you had begun to take the economics sequence in your freshman year?

POTERBA: My freshman economics teacher was a second year Harvard graduate student named Jane Katz who had just come from the University of Chicago where she'd been an undergraduate. She had been steeped in the exciting price theory, economics as a lens of understanding all kinds of human behavior, that we associate with Gary Becker and Milton Friedman and others like that. Then of course I was studying this in Cambridge, in a place where there was a lot of interest in how to design policies that might be able to affect the macroeconomy. People like Larry Summers, Marty Feldstein was Larry Summers' thesis adviser as a graduate student, and I subsequently worked for Marty as an undergraduate.

I remember seeing Bob Solow from MIT come and speak to the Undergraduate Economics Club my freshman year. Bob had written a paper called, "Up and Down the Phillips Curve with Gun and Camera." The Phillips curve is a relationship between unemployment and inflation. I thought anyone who could be a professional economist write a paper with a title like that, which I just loved, was really neat and I remember seeing Bob who then was probably about my age now come and just talk to the undergraduates. It seemed like what he was doing was really interesting and exciting. A variety of these things fit together in sort of creating a clear sense of economics as an exciting place to go.

INTERVIEWER: And this was late 70s, mid 70s?

POTERBA: Bob Solow came to visit sometime around January 1977. My working with Larry Summers began in early 1978. Economics was more in the national news then than it was probably any time until the last couple of years. Because we were coming out of stagflation. There was a sense, there was a malaise in the economy. People were trying to figure out what you could do to get things back on the roaring path that we'd been on in the 1960s. And I'm sure that that played some role in drawing me into this.

INTERVIEWER: But wasn't it a period where we weren't really coming out. We didn't really come out until the early 80s and that economics were kind of in disfavor? I mean, were you conscious of that?

POTERBA: I don't think that part quite connected, but I think I knew that the economy was creating problems for the society. But I think that beyond that I wasn't yet far enough along to understand that at the more rarefied levels that economics was going through a wrenching transition as the policies which it seemed to work so well during the 1960s were suddenly coming under much more active attack by various wings within the economics profession. And there was skepticism in places like Washington and other national capitals as to whether economics had much to offer in solving these problems.

INTERVIEWER: Did URPE, the radical economists, have much of a foothold in your--

POTERBA: Not much. And it may say something that my introductory economics teacher was a Chicago trained person who would be very much the other end of the spectrum from the radical political economists and whatever. Those issues never really much came on to the radar screen.

INTERVIEWER: Sam Bowles was in the department then or not really?

POTERBA: Sam Bowles was certainly around. I'm not sure exactly when Sam Bowles was at Harvard, but he was-- in the Harvard economics department. Sam Bowles is someone who I don't think I've ever met, but I know by his work. He was someone who had done a lot of work on the mathematical microeconomics. He'd actually taught some of the introductory graduate courses at Harvard, I believe, in that area. And I certainly had a book of problems that he'd worked and shared with graduate students, and I used at various points as a late stage undergraduate. But he was also a leader of those arguing that neoclassical economics may have missed some of the important insights here. That part I don't think I ever connected with particularly much.

INTERVIEWER: So you managed to do all this research work after all the hours of debating and you still came out with amazing grades. You were summa cum laude, Phi Beta Kappa. Did you go in with that as a goal of yours and did you feel pressure to achieve it at some point? Or did you do it effortlessly?

POTERBA: I think to be perfectly honest I remember a lot more about the research assistant work than I do about the sort of worry about grades and things. But I think the truth be told, by the time I was through my sophomore year I had gotten a really clear sense of how much fun research could be. And at that point I tried to configure my classes and other things in such a way that I was picking up the tools that I needed along the way to be able to pursue what was then becoming clearly a professional interest in economics. But I'm trying to figure the right way to say-- I shied away from what might have been the most difficult and demanding undergraduate general education courses on the grounds that I really wanted to be able to spend my time hanging around with the economist graduate students, and doing research work. So I for example, took linear algebra courses and things like that, that I knew were going to come in handy. I took an advanced statistics course that my graduate student friends said was a good thing to go and study. In retrospect, it's a little hard for me know.

INTERVIEWER: They worked on challenging, they just weren't broadening I guess.

POTERBA: Those were hard courses and they were courses that I knew I had to work hard in and I did well in, but I didn't take courses that I might have taken with a broader focus in the sciences or in some of the humanities that were known to be difficult and really demanding courses, but where people came out and said, I learned so much in that course. It was great though because I was spending my time learning in the research carrel where I was typing data in and running programs.

INTERVIEWER: So speaking of incentives and distortions and behavior, it sounds like there was a bit of that there. Had there been a couple of pass/fail courses might you have taken one or two? Are there courses you look back that you're sorry you didn't take now?

POTERBA: I do remember taking a pass/fail history course that I was particularly interested in, and I do remember the professor calling me in afterwards and saying, you got an A minus in the course, aren't you disappointed you took it pass/fail. And I do remember a little bit of cognitive dissonance surrounding that. The more scary experience was the second semester of my senior year, there was a course in numerical analysis. Basically, how to use applied mathematical techniques in various kind of computer solution problems of things that could be handy in economics. And I'd signed up for this course, it was a graduate level course in the applied math department. And it was taught in a very big lecture hall, but there was a very small group of students-- there were only five of us in the beginning. But the professor, who was terrific would come and write and we'd go up and down on all the blackboards of the room. And not too long after we got started, by around President's Day weekend, two of the students stopped coming. And at some point, a few weeks after that I turned to the other two and I said, well, I guess it's just the three of us. And they said, oh no, we're just auditors. We're not taking this course. And I said, well, why not? And they said, well he's well known to have a C median and we didn't want to take this course for credit.

So there I was as a second semester senior, needing this course to graduate, and locked in to getting through this thing. So what I do remember quite vividly is spending the last six weeks of my senior year when most of my contemporaries were on the banks of the Charles or exploring Boston and going on various kinds of field trips doing a lot of learning numerical analysis and applied linear algebra. It was a great experience. It was a fantastic thing. Since I was the only one in the course for a grade we somehow turned the final evaluation into a research presentation or project that I did in the professor's office. And it was fantastic. I still remember Professor Anderson. It was a great learning experience. But that's one that if I've been doing it over, I might not have locked into my second semester of senior year.

INTERVIEWER: What did you do after college?

POTERBA: Well, again I followed a path that I don't think I put a whole lot of thought into ex ante. I applied for the various international scholarships that people apply for and I was fortunate enough to win a Marshall Scholarship to go to England. And I asked my undergraduate thesis adviser, who was Marty Feldstein where he would recommend I go if I were going to England. And he actually had done his doctoral work at Nuffield College at Oxford. So he said, well, I think the answer is Nuffield College at Oxford. So I packed my bags and headed off to England for what I thought would be two years. I'd in fact planned to come to graduate school here at MIT in economics and I'd been accepted. Oh, actually no, I hadn't been accepted. I'd applied. And I sent in an application, but I then-- I don't know, maybe I failed to withdraw it or something, but I remember getting a call from Robert Bishop who was then the chair of the MIT Admissions Committee saying, what's up with you? We have an application or we have you on a list of NSF grant recipients, but we don't have an application.

That's what it was. I'd applied for a fellowship, but never applied to MIT because I had gotten the Marshall in December and the deadline for applying for graduate fellowships was before the Marshall notification, but the deadline to apply to graduate school was later. So I never applied to MIT, but it seemed like I won a fellowship to come to graduate school. They were very concerned they lost my folder. So I got this call and I said, well I'm going to England for two years, but fear not. I'm planning to go do a Master's and I'll come back and come to graduate school when I'm done.

So I went to England and there was a wonderful collection of people who I encountered. I interacted with Mervyn King, who was very interested in taxes and public policy. Even though Mervyn was based in Birmingham, not Oxford, I was able to commute on the train to London and meet with him there. John Fleming, who was a friend of Marty Feldstein's and was then an economic adviser to the Bank of England, was based at Nuffield College at Oxford and we got to know each other quite well. And he was a key force in helping to point me toward dissertation topics. Terrence Gorman, who actually been Marty Feldstein's thesis adviser was now-- 25 years later-- still around and I was actually able to do some classes and some lectures with him. Jim Mirrlees, who was an eminent public finance economist was in Oxford at that stage. David Hendry was an econometrician who came to Oxford.

So it was all a very exciting time, and I did the Master's coursework. I turned in a Master's thesis and at that point there were some three year graduate fellowships in England that were running. And there was some pressure, I've always thought, to demonstrate that one could do a graduate degree, get a PhD in three years at that stage. So when I turned in the Master's thesis the examiner said, you know, if you wanted to stay for a third year we could probably give you a PhD. Well that was a complete new development because I really hadn't been planning on that. I had thought I would come back to the US I was a little reluctant to stay for a third year because my girlfriend, who has now been my wife for 27 years, Nancy Rose, who's also a member of the economics faculty here at MIT, was at that point a first year graduate student at MIT.

We had met at freshman registration in college. We'd gone out at various stages during college and having been two years on the other side of the Atlantic-- even though I'd come back and been in the US in the summers, it was clear that things were wearing a little thin by that stage. So I was very eager to come back to the US and in particular to come back to Cambridge and MIT.

Again, I was living under the right star. It turned out that an MIT assistant professor, who had been teaching an undergraduates statistics course at MIT was wooed away by the justice department at that stage, Marilyn Simon was her name, and she unexpectedly left the department. So MIT was looking for somebody to come and serve as an instructor in the fall of 1982 as a statistics teacher. And Jim Mirrlees, who I'd been working with at Oxford, was a good friend of Peter Diamond here at MIT; they'd written a lot of papers together and they were close collaborators. So somehow or another, I got a call from Cary Brown, who was the long-time chairman of the MIT economics department, offering me a princely sum of $10 thousand if I'd be willing to come and teach this undergraduate statistics course in the fall of 1982. Of course, this was like Brer Rabbit being asked to be thrown into the briar patch. I couldn't think of anything better to do. And Oxford was happy to let me take a term off at that point while still moving ahead with the progress toward my dissertation. So I came to MIT in July of 1982.

I set up shop as an instructor and, at the same time it just so happened that MIT's then empirical data-oriented tax person, Larry Summers, had decided to take a job at Harvard. So there was an opening on the faculty, not just for a statistics instructor, but for somebody who might be a more permanent fixture. It was a little stressful because I knew that that job was there, the faculty knew that I was on the premises and that I might well fit that bill. Unlike when today's graduate students go to interview for a job at an institution, they fly in in the morning, they run through a day long gauntlet of interviews, they give a seminar at the end of the day, they have a nice dinner with some of the faculty, they head back to the airport the next morning and they're gone, however, my experience was sort of stretched out over three months and involved various people coming along and saying, hey how about we go have coffee. Let's talk about what you're working on, whatever.

Well fortunately, by around the end of November the word came that the faculty had voted to extend an assistant professor offer. And at that point they said, you know, we understand if you'd like to explore other options, but with my girlfriend, Nancy, on the premises and MIT being the incredible department it was, the need to look elsewhere just didn't even strike me as worth doing. So I more or less accepted on the spot. That left me with the task of finishing my graduate work in Oxford. And speaking to the careful reading of institutional detail, I learned that the requirements of graduate study at Oxford were that you needed to be-- each term you needed to be within hearing distance of Tom Tower's bell at Christ Church for 42 nights during the term. So I returned for 42 nights during the winter term and for another 42 nights during the spring term, and defended my dissertation at the end of that time, returned to MIT as an assistant professor and at that point realized that to be honest, the great thing about studying at Oxford had been that there was more emphasis on starting your research very early on. Some people could get a doctorate in England at that time without taking any courses. If you produced a body of research that would do it.

So the faculty treated even the first year graduate students almost as co-equals. You know, tell us about your research, I'll tell you about mine. That was a fantastic thing to be dropped into as a 21-year-old or 22-year-old. And the good side was I got started on research right away. The downside was that I didn't take as many courses as I would have taken if I was here in the US going through a standard graduate program. So when I came back as an instructor and then as an assistant professor one of the things I did was I enrolled in or at least audited a number of the graduate courses. So it is a sort of unusual experience my first year as an assistant professor. I would be teaching the graduate public finance course and then sitting next to some of my students when we were taking the econometrics course and things like that. But it was a really terrific blend of different educational experiences that all worked out very well.