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Saturday, September 19, 2015

Unemployment Insurance and Progressive Taxation as Automatic Stabilizers

Some preliminary results from a working paper by Alisdair Mckay and Ricardo Reis:

Optimal Automatic Stabilizers, by Alisdair McKay and Ricardo Reis: 1 Introduction How generous should the unemployment insurance system be? How progressive should the tax system be? These questions have been studied extensively and there are well-known trade-offs between social insurance and incentives. Typically these issues are explored in the context of a stationary economy. These policies, however, also serve as automatic stabilizers that alter the dynamics of the business cycle. The purpose of this paper is to ask how and when aggregate stabilization objectives call for, say, more generous unemployment benefits or a more progressive tax system than would be desirable in a stationary economy. ...
We consider two classic automatic stabilizers: unemployment benefits and progressive taxation. Both of these policies have roles in redistributing income and in providing social insurance. Redistribution affects aggregate demand in our model because households differ in their marginal propensities to consume. Social insurance affects aggregate demand through precautionary savings decisions because markets are incomplete. In addition to unemployment insurance and progressive taxation, we also consider a fiscal rule that makes government spending respond automatically to the state of the economy.
Our focus is on the manner in which the optimal fiscal structure of the economy is altered by aggregate stabilization concerns. Increasing the scope of the automatic stabilizers can lead to welfare gains if they raise equilibrium output when it would otherwise be inefficiently low and vice versa. Therefore, it is not stabilization per se that is the objective but rather eliminating inefficient fluctuations. An important aspect of the model specification is therefore the extent of inefficient business cycle fluctuations. Our model generates inefficient fluctuations because prices are sticky and monetary policy cannot fully eliminate the distortions. We show that in a reasonable calibration, more generous unemployment benefits and more progressive taxation are helpful in reducing these inefficiencies. Simply put, if unemployment is high when there is a negative output gap, a larger unemployment benefit will stimulate aggregate demand when it is inefficiently low thereby raising welfare. Similarly, if idiosyncratic risk is high when there is a negative output gap,1 providing social insurance through more progressive taxation will also increase welfare....

    Posted by on Saturday, September 19, 2015 at 12:23 AM in Academic Papers, Economics, Fiscal Policy, Social Insurance | Permalink  Comments (25)


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