
Consumption Taxes and Divisibility of Labor under Incomplete Markets
Abstract
We analyze lumpsum transfers financed through consumption taxes in a heterogeneousagent model with uninsured idiosyncratic wage risk and endogenous labor supply. The model is calibrated to the U.S. economy. We find that consumption inequality and uncertainty decrease with transfers much more substantially under divisible than indivisible labor. Increasing transfers by raising the consumption tax rate from 5% to 35% decreases the consumption Gini by 0.04 under divisible labor, whereas it has almost no effect on the consumption Gini under indivisible labor. The divisibility of labor also affects the relationship among consumptiontax financed transfers, aggregate saving, and the wealth distribution.
Introduction
What is the effect of government transfers on inequality and risk sharing when households face labor income uncertainty? Previous studies, such as FlodÈn (2001) and AlonsoOrtiz and Rogerson (2010), find that increasing lumpsum transfers financed through labor and/or capital income taxes substantially decreases consumption inequality and uncertainty in a general equilibrium model with uninsured earnings risk. However, little is known about the impact of increasing consumptiontax financed transfers. Does it help people smooth consumption and does it reduce inequality? What is the impact on efficiency? The present paper analyzes these questions quantitatively.