Evidence on the Insurance Effect of Marginal Income Taxes
37 Pages Posted: 10 Jun 2008
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Evidence on the Insurance Effect of Marginal Income Taxes
Evidence on the Insurance Effect of Marginal Income Taxes
Date Written: February 2008
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.
Keywords: Consumption Insurance, Tax Distortions, Undiversifiable Earnings Risk
JEL Classification: E21, H20, H31
Suggested Citation: Suggested Citation