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Optimal Automatic Stabilizers

Author

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  • Alisdair McKay

    (Department of Economics Boston University)

  • Ricardo Reis

    (Columbia University
    Centre for Macroeconomics (CFM))

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.

Suggested Citation

  • Alisdair McKay & Ricardo Reis, 2016. "Optimal Automatic Stabilizers," Discussion Papers 1618, Centre for Macroeconomics (CFM).
  • Handle: RePEc:cfm:wpaper:1618
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    More about this item

    Keywords

    Counter-cyclical fiscal policy; Redistribution; Distortionary 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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