Working Paper: NBER ID: w22359
Authors: Alisdair McKay; Ricardo Reis
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: unemployment benefits; income taxes; business cycles; automatic stabilizers
JEL Codes: E62; H21; H30
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| economic slack (E24) | generosity of unemployment insurance (J65) |
| generosity of unemployment insurance (J65) | macroeconomic stabilization (E63) |
| economic slack (E24) | optimal progressivity of income taxes (H21) |
| optimal progressivity of income taxes (H21) | macroeconomic stabilization (E63) |