Optimal Automatic Stabilizers

67 Pages Posted: 20 Jun 2016

See all articles by Alisdair McKay

Alisdair McKay

Boston University - Department of Economics

Ricardo Reis

London School of Economics & Political Science (LSE); National Bureau of Economic Research (NBER); Centre for Economic Policy Research (CEPR)

Multiple version iconThere are 2 versions of this paper

Date Written: June 2016

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

McKay, Alisdair and Reis, Ricardo A.M.R., Optimal Automatic Stabilizers (June 2016). NBER Working Paper No. w22359. Available at SSRN: https://ssrn.com/abstract=2797953

Alisdair McKay (Contact Author)

Boston University - Department of Economics ( email )

270 Bay State Road
Boston, MA 02215
United States

HOME PAGE: http://people.bu.edu/amckay

Ricardo A.M.R. Reis

London School of Economics & Political Science (LSE) ( email )

Houghton Street
London, WC2A 2AE
United Kingdom

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Centre for Economic Policy Research (CEPR)

London
United Kingdom

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