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Optimal automatic stabilizers

McKay, Alisdair and Reis, Ricardo (2016) Optimal automatic stabilizers. Discussion Paper Series (11337). Centre for Economic Policy Research, London, UK.

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Abstract

Should the generosity of unemployment benefits and the progressivity of income taxes de- pend 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 inefficient business cycles driven by aggregate shocks through matching frictions and nominal rigidities. We derive an augmented Baily-Chetty formula showing that the optimal generosity and progressivity depend on a macroeconomic stabilization term. Using a series of analytical examples, we show that this term typically pushes for an increase in generosity and progressivity as long as slack is more responsive to social programs in recessions. A calibration to the U.S. economy shows that taking concerns for macroeconomic stabilization into account raises the optimal unemployment benefits replacement rate by 13 percentage points 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: Monograph (Discussion Paper)
Official URL: http://www.cepr.org
Additional Information: © 2016 The Authors
Divisions: Economics
Subjects: H Social Sciences > HB Economic Theory
H Social Sciences > HC Economic History and Conditions
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
Sets: Departments > Economics
Date Deposited: 01 Jul 2016 16:44
Last Modified: 12 Jun 2019 23:25
URI: http://eprints.lse.ac.uk/id/eprint/67047

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