The Effectiveness of Consumption Taxes and Transfers as Insurance against Idiosyncratic Risk

Abstract

We quantitatively evaluate the effectiveness of a consumption tax and transfer program as insurance against idiosyncratic earnings risk. Our framework is a heterogeneousagent, incomplete-market model with idiosyncratic wage risk and indivisible labor. The model is calibrated to the U.S. economy. We find a weak insurance effect of the transfer program. Extending the transfer system from the current scale raises consumption uncertainty, which increases aggregate savings and reduces the interest rate. Furthermore, consumption inequality shows a small decrease.