Consumption Insurance Against Wage Risk: Family Labor Supply and Optimal Progressive Income Taxation
We show that a calibrated life-cycle two-earner household model with endogenous labor supply can rationalize the extent of consumption insurance against shocks to male and female wages, as estimated empirically by Blundell, Pistaferri and Saporta-Eksten (2016) in U.S. data. In the model, 35% of male and 18% of female permanent wage shocks pass through to consumption, compared to the empirical estimates of 32% and 19%. Most of the consumption insurance against permanent male wage shocks is provided through the presence and labor supply response of the female earner. Abstracting from this private intra-household income insurance mechanism strongly biases upward the welfare losses from idiosyncratic wage risk as well as the desired extent of public insurance through progressive income taxation. Relative to the standard one-earner life cycle model, the optimal degree of tax progressivity is significantly lower and the welfare gains from implementing the optimal system are cut roughly in half.
We thank Greg Kaplan and Luigi Pistaferri for useful conversations at an early stage of this project, as well as Itay Saporta-Eksten for providing important details about the implementation of the BPS method. Krueger gratefully acknowledges financial support from the NSF under grant SES-0820494. The views expressed herein are those of the authors and do not necessarily reflect the views of the National Bureau of Economic Research.