The Value of Public Insurance Against Idiosyncratic Income Risk: A Variance-Adjustment Statistic

Christopher Busch and Rocio Madera

No 21129, CEPR Discussion Papers from Centre for Economic Policy Research

Abstract: We introduce a tractable method built around an incomplete-markets model to assess the value of public insurance against permanent idiosyncratic income risk. Our approach translates statistical differences between gross and disposable incomes into a welfare-equivalent variance adjustment. Under homoskedastic Gaussian shocks, the variance ratio of permanent shocks to gross and disposable incomes provides a sufficient statistic for the size of insurance. More generally, with cyclical non-Gaussian shocks, public insurance amounts to a variance reduction by 38-49% in Sweden (tax registers) and 24-31% in the United States (PSID), depending on risk attitudes. Consumption-based measures in the PSID confirm our model-based measure.

Keywords: Tax and transfer system; Partial insurance; Incomplete markets (search for similar items in EconPapers)
JEL-codes: D31 D52 E21 (search for similar items in EconPapers)
Date: 2026-02
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