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Optimal automatic stabilizers

Author

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  • McKay, Alisdair
  • Reis, Ricardo
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.

Suggested Citation

  • McKay, Alisdair & Reis, Ricardo, 2021. "Optimal automatic stabilizers," LSE Research Online Documents on Economics 108180, London School of Economics and Political Science, LSE Library.
    • Handle: RePEc:ehl:lserod:108180
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    More about this item

    Keywords

    counter-cyclical fiscal policy; redistribution; disortionary taxes;
    All these keywords.

    JEL classification:

    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy; Modern Monetary Theory
    • H21 - Public Economics - - Taxation, Subsidies, and Revenue - - - Efficiency; Optimal Taxation
    • H30 - Public Economics - - Fiscal Policies and Behavior of Economic Agents - - - General

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