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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 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.

Keywords: Counter-cyclical fiscal policy; redistribution; distortionary taxes. (search for similar items in EconPapers)
JEL-codes: E62 H21 H30 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-dge, nep-mac, nep-pbe and nep-pub
Date: 2016-06-17
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http://eprints.lse.ac.uk/67049/ Open access version. (application/pdf)

Related works:
Working Paper: Optimal Automatic Stabilizers (2016) Downloads
Working Paper: Optimal Automatic Stabilizers (2016) Downloads
Working Paper: Optimal Automatic Stabilizers (2016) Downloads
Working Paper: Optimal Automatic Stabilizers (2015) Downloads
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