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Evidence on the Insurance Effect of Marginal Income Taxes

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  • Grant, Charles
  • Koulovatianos, Christos
  • Michaelides, Alexander
  • Padula, Mario

Abstract

Marginal income taxes may have an insurance effect by decreasing the effective fluctuations of after-tax individual income. By compressing the idiosyncratic component of personal income fluctuations, higher marginal taxes should be negatively correlated with the dispersion of consumption across households, a necessary implication of an insurance effect of taxation. Our study empirically examines this negative correlation, exploiting the ample variation of state taxes across US states. We show that taxes are negatively correlated with the consumption dispersion of the within-state distribution of non-durable consumption and that this correlation is robust.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 6710.

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Date of creation: Feb 2008
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Handle: RePEc:cpr:ceprdp:6710

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Keywords: Consumption Insurance; Tax Distortions; Undiversifiable Earnings Risk;

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  21. S. Rao Aiyagari, 1993. "Uninsured idiosyncratic risk and aggregate saving," Working Papers 502, Federal Reserve Bank of Minneapolis.
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