Evidence on the Insurance Effect of Redistributive Taxation
Paper number: 08/09
Paper date: October 17, 2008
Paper Category: Working Paper
Charles Grant, Christos Koulovatianos, Alexander Michaelides and Mario Padula
If households face uninsurable idiosyncratic earnings risk, theory predicts that redistributive tax and transfer systems have both an insurance and a distortionary effect. Exploiting the substantial variation of tax and transfer systems across US states we investigate the necessary traces of these two effects in the data: that state-level measures of redistributive taxation should correlate negatively with, (a) the standard deviation, and (b) the mean, of the within-state consumption distribution. We find that the first correlation is robust, supporting strongly the presence of an insurance effect. The distortionary effect can also be detected in the data but it is less precisely estimated.