Optimal automatic stabilizers

Alisdair McKay and Ricardo Reis

LSE Research Online Documents on Economics from London School of Economics and Political Science, LSE Library

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 programmes in recessions than in booms. A calibration to the US 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 programmes as automatic stabilizers affects their optimal design.

Keywords: counter-cyclical fiscal policy; redistribution; disortionary taxes (search for similar items in EconPapers)
JEL-codes: E62 H21 H30 (search for similar items in EconPapers)
Pages: 32 pages
Date: 2021-10-01
New Economics Papers: this item is included in nep-dge, nep-mac and nep-pbe
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (16)

Published in Review of Economic Studies, 1, October, 2021, 88(5), pp. 2375 - 2406. ISSN: 0034-6527

Downloads: (external link)
http://eprints.lse.ac.uk/108180/ Open access version. (application/pdf)

Related works:
Journal Article: Optimal Automatic Stabilizers (2021)
Working Paper: Optimal Automatic Stabilizers (2016)
Working Paper: Optimal Automatic Stabilizers (2016)
Working Paper: Optimal automatic stabilizers (2016)
Working Paper: Optimal automatic stabilizers (2016)
Working Paper: Optimal Automatic Stabilizers (2016)
Working Paper: Optimal Automatic Stabilizers (2015)
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