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Tax Reform and Automatic Stabilization

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  • Thomas J. Kniesner

    (Syracuse University)

  • James P. Ziliak

    (University of Wisconsin-Madison)

Abstract

A fundamental property of a progressive income tax is that it provides implicit collective insurance against idiosyncratic shocks to income by dampening the variability of disposable income and consumption. The Economic Recovery Tax Act of 1981 (ERTA) and the Tax Reform Act of 1986 (TRA86) greatly reduced the number of marginal tax brackets and the maximum marginal rate, which limits the ability of households to stabilize consumption in the face of transitory fluctuations in taxable income. We examine the effect of the federal income tax reforms of the 1980s on the associated degree of automatic stabilization of consumption. The empirical framework derives from the consumption insurance literature where the ideal outcome is spatially equal changes in households' marginal utilities of consumption. Because evidence for U.S. households rejects complete consumption insurance we begin with a model of partial consumption insurance, which we use to identify how the degree of partial insurance has changed since ERTA and TRA86. Our data come from interview years 1980-1991 in the Panel Study of Income Dynamics. Although in some cases the tax reforms of the 1980s actually increased the automatic stabilization inherent in a progressive income tax (especially when the Social Security payroll tax and the Earned Income Tax Credit are included), our overall outcome is that ERTA and TRA86 reduced consumption stability by about 50 percent. More recent tax reforms, most notably increased EITC generosity, have restored or enhanced consumption insurance.

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Paper provided by Econometric Society in its series Econometric Society World Congress 2000 Contributed Papers with number 0788.

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Date of creation: 01 Aug 2000
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Handle: RePEc:ecm:wc2000:0788

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Cited by:
  1. Thomas Kniesner & W. Viscusi & James Ziliak, 2010. "Policy relevant heterogeneity in the value of statistical life: New evidence from panel data quantile regressions," Journal of Risk and Uncertainty, Springer, Springer, vol. 40(1), pages 15-31, February.
  2. Yang, Juan & Mitchell, Paul D. & Gray, Michael & Steffey, Kevin, 2007. "Unbalanced Nested Component Error Model and the Value of Soil Insecticide and Bt Corn for Controlling Western Corn Rootworm," Staff Paper Series, University of Wisconsin, Agricultural and Applied Economics 510, University of Wisconsin, Agricultural and Applied Economics.
  3. Dolls, Mathias & Fuest, Clemens & Peichl, Andreas, 2012. "Automatic stabilizers and economic crisis: US vs. Europe," Journal of Public Economics, Elsevier, Elsevier, vol. 96(3), pages 279-294.
  4. Torben Andersen, 2005. "Is there a Role for an Active Fiscal Stabilization Policy?," CESifo Working Paper Series 1447, CESifo Group Munich.
  5. Morissette, Rene & Ostrovsky, Yuri, 2008. "Comment les familles et les personnes seules reagissent-elles aux licenciements? Un eclairage canadien," Direction des etudes analytiques : documents de recherche 2008304f, Statistics Canada, Direction des etudes analytiques.
  6. Morissette, Rene & Ostrovsky, Yuri, 2008. "How Do Families and Unattached Individuals Respond to Layoffs? Evidence from Canada," Analytical Studies Branch Research Paper Series 2008304e, Statistics Canada, Analytical Studies Branch.
  7. Morissette, Rene & Ostrovsky, Yuri, 2005. "The Instability of Family Earnings and Family Income in Canada, 1986 to 1991 and 1996 to 2001," Analytical Studies Branch Research Paper Series 2005265e, Statistics Canada, Analytical Studies Branch.
  8. Ivan Vidangos, 2009. "Household welfare, precautionary saving, and social insurance under multiple sources of risk," Finance and Economics Discussion Series, Board of Governors of the Federal Reserve System (U.S.) 2009-14, Board of Governors of the Federal Reserve System (U.S.).
  9. Reagan Baughman & Stacy Dickert-Conlin, 2009. "The earned income tax credit and fertility," Journal of Population Economics, Springer, Springer, vol. 22(3), pages 537-563, July.
  10. Alan J. Auerbach, 2002. "Is there a role for discretionary fiscal policy?," Proceedings - Economic Policy Symposium - Jackson Hole, Federal Reserve Bank of Kansas City, Federal Reserve Bank of Kansas City, pages 109-150.
  11. Julie L. Hotchkiss & Robert E. Moore, 2007. "Assessing the welfare impact of the 2001 tax reform on dual-earner families," Working Paper, Federal Reserve Bank of Atlanta 2007-27, Federal Reserve Bank of Atlanta.
  12. Ziliak, James P. & Hardy, Bradley & Bollinger, Christopher, 2011. "Earnings volatility in America: Evidence from matched CPS," Labour Economics, Elsevier, Elsevier, vol. 18(6), pages 742-754.

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