Michael Stepner (UToronto): The Insurance Value of Redistributive Taxes and Transfers
Abstract: Progressive tax and transfer schedules serve a redistributive role by transferring from high-income to low-income individuals, but they also serve an insurance role by transferring from the highincome years to the low-income years within each person’s lifespan. This paper examines how the design of the tax and transfer system provides insurance against income risks by studying the two largest economic shocks faced by working-age households: layoffs and illness. Using 1.6 million layoffs and 1.2 million hospital stays linked to Canadian tax records, I first show that both events cause persistent declines in earnings lasting more than six years. The full tax and transfer system provides substantial insurance against these risks, shrinking the percentage of income lost post-layoff by 40% and post-hospitalization by 60%, which I estimate to be worth 7-10% of total post-event consumption. But less than half of this social insurance comes from the unemployment and disability insurance programs that formally insure these risks. The progressive shape of taxes and transfers provides the majority of social insurance, and is especially important for reducing the risk of catastrophic income losses and mitigating inequality in the income risks of layoffs and hospitalizations. Using a dynamic model, I find that the insurance value of redistributive taxes and transfers is considerable across the entire income distribution, and is more than twice as large at the bottom of the income distribution than at the top.
Economics
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