Evidence on the Insurance Effect of Marginal Income Taxes
University of Reading
Universite du Luxembourg - Faculty of Law, Economics and Finance
Imperial College Business School; Centre for Economic Policy Research (CEPR)
University "Ca' Foscari" of Venice; CSEF
February 1, 2008
CFS Working Paper No. 2008/06
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: Undiversifiable Earnings Risk, Consumption Insurance, Tax Distortions
JEL Classification: E21, H20, H31
Date posted: September 25, 2008
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