Tax Reform and Automatic Stabilization

American Economic Review · 2002 · Volume 92 · Issue 3

Abstract

An income tax provides implicit insurance by dampening the variability of disposable income and consumption. Using an empirical framework derived from the consumption insurance literature and data from the Panel Study of Income Dynamics we examine the effect of federal income tax reforms of the 1980's on automatic stabilization of consumption. Overall, ERTA and TRA86 reduced consumption stability by about 50 percent. Recently increased EITC generosity restored or enhanced consumption insurance. The welfare cost of moving to the post-TRA86 system is sizable for relatively risk-averse households facing large income risk but is much more modest for the typical household. (JEL H21)

Keywords

Personal Income and Other Nonbusiness Taxes and Subsidies, includes inheritance and gift taxes, Fiscal Policy, Consumer Economics: Empirical Analysis, Comparative or Joint Analysis of Fiscal and Monetary Policy, Stabilization, Treasury Policy, Macroeconomics: Consumption, Saving, Wealth

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