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Optimal automatic stabilizers

Reis, Ricardo and McKay, Alisdair (2020) Optimal automatic stabilizers. Review of Economic Studies. ISSN 0034-6527

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Abstract

Should the generosity of unemployment benefits and the progressivity of income taxes depend on the presence of business cycles? This paper proposes a tractable model where there is a role for social insurance against uninsurable shocks to income and unemployment, as well as business cycles that are inefficient due to the presence of matching frictions and nominal rigidities. We derive an augmented Baily-Chetty formula showing that the optimal generosity of the social insurance system depends on a macroeconomic stabilization term. This term pushes for an increase in generosity when the level of economic activity is more responsive to social programs in recessions than in booms. A calibration to the U.S. economy shows that taking concerns for macroeconomic stabilization into account substantially raises the optimal unemployment insurance replacement rate, but has a negligible impact on the optimal progressivity of the income tax. More generally, the role of social insurance programs as automatic stabilizers affects their optimal design.

Item Type: Article
Official URL: https://www.restud.com/
Additional Information: © 2020 Oxford University Press
Divisions: Economics
Subjects: H Social Sciences > HD Industries. Land use. Labor
H Social Sciences > HJ Public Finance
JEL classification: E - Macroeconomics and Monetary Economics > E6 - Macroeconomic Policy Formation, Macroeconomic Aspects of Public Finance, Macroeconomic Policy, and General Outlook > E62 - Fiscal Policy; Public Expenditures, Investment, and Finance; Taxation
H - Public Economics > H2 - Taxation, Subsidies, and Revenue > H21 - Efficiency; Optimal Taxation
H - Public Economics > H3 - Fiscal Policies and Behavior of Economic Agents > H30 - General
Date Deposited: 05 Jan 2021 14:30
Last Modified: 10 Oct 2021 23:14
URI: http://eprints.lse.ac.uk/id/eprint/108180

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