Cyclical Labor Income Risk

In this paper, we systematically analyze several labor income definitions by drawing on PSID data, and estimate how the volatility and skewness of income shocks moves with the aggregate activity. We find that volatility is countercyclical, with individual and joint (head+wife) labor incomes being the most volatile, and with hourly wages and post-government joint labor income being the least ones. This suggests that \textit{(i)} intra-family insurance is limited, \textit{(ii)} taxes and transfers remove a large portion of fluctuations in risk, and that \textit{(iii)} hours, not wages, make individual earnings fluctuate over the cycle. By re-estimating the volatility of earnings shocks on the ``young'' (ages 23-39) and ``old'' (ages 40-60) subsamples separately, we find that nearly all the countercyclicality of shocks comes from the young workers, the old subsample exhibits quantitatively muted fluctuations in risk. We then allow for time-varying skewness, and find that the probability of large negative events increases in recessions by more than the probability of large positive events. Taxes and transfers reduce the probability of tail events by a factor of 2 to 3 as compared to other income definitions considered.