Research

We study the optimal design of means-tested transfers and progressive income taxes. In a simple analytical model, we demonstrate an optimally negative relation between transfers and income-tax progressivity due to redistribution and efficiency concerns. In a rich dynamic model, we quantify the optimal plan with flexible tax-and-transfer functions. Transfers should be larger than currently in the U.S. and financed with moderate income-tax progressivity. Transfers are key to implement higher progressivity in average than in marginal tax-and-transfer rates, achieving redistribution while preserving efficiency. Quantitatively, the left tail of the income distribution determines optimal transfers, whereas the right tail determines income-tax progressivity.

This paper studies how the added worker effect - intra-household insurance through increased spousal labor market participation - varies over the life-cycle. We show in U.S. data that the added worker effect is much stronger for young than for old households. A stochastic life-cycle model of two-member households with job search in a frictional labor market is capable of replicating this finding. The model suggests that a lower added worker effect for the old is driven primarily by better insurance through asset holdings. Human capital differences between employed young and old contribute to the difference but are quantitatively less important, while differences in job arrival rates play a limited role.

We study the sources of individual earnings risk in frictional labor markets, focusing on the role firms play for their workers’ earnings risk. First, using administrative matched employer-employee data from Denmark, we document key properties of the worker earnings growth distribution, the firm revenue growth distribution, and their joint distribution. The worker earnings and firm revenue growth distributions exhibit strong deviations from normality, in particular excess kurtosis, with many workers and firms experiencing very small changes to their earnings/revenues, but a significant minority experiencing very large changes. Large earnings losses are more likely for workers in firms with negative revenue growth, driven both by separations to unemployment and earnings losses on the job. Second, we develop a model framework consistent with the data, with four key features: i) frictional labor markets and on the job search to capture unemployment risk and wage growth through a job ladder, ii) multi-worker firms to capture gross and net worker flows, iii) risk averse workers such that earnings risk matters, and iv) contracting with two-sided limited commitment because earnings of job stayers are changing infrequently in the data. Third, we use the model to explore policies designed to mitigate earnings fluctuations.

We analyze the dynamics of the equity-efficiency trade-off along the growth path. To do so, we incorporate the optimal income taxation problem into a state-of-the-art multi-sector structural change general equilibrium model with non-homothetic preferences. We identify two key opposing forces. First, long-run productivity growth allows households to shift their consumption expenditures away from necessities. This implies a reduction in the dispersion of marginal utilities, and therefore calls for a welfare state that declines along the growth path. Yet, economic growth is also systematically associated with an increase in the skill premium, which raises inequality and the desire to redistribute. We quantitatively analyze these opposing forces for two countries: the U.S. from 1950 to 2010, and China from 1989 to 2009. Optimal redistribution decreases in China, as the role of non-homotheticities prevails at early stages of development. For the U.S., the rising income inequality dominates and the welfare state should become more generous.