Abstract: This paper studies optimal insurance against idiosyncratic wage shocks in a life cycle model with intensive labor supply and endogenous retirement. When the fixed cost of work is increasing in wage, the optimal retirement wedge provides stronger incentives for delayed retirement with age. Retirement benefits that resemble the US Social Security system can implement the optimum. Calibrated numerical simulations suggest that a mix of retirement benefits that increase with claiming age, and age-dependent linear taxes, is close to optimal.
Online Analytic Appendix | Online Computational Appendix
Chicago Fed WP, No 2018-18, 2018 version | Chicago Fed Letter, No 419, 2019
Abstract: Half of the jobs in the U.S. feature pay-for-performance. We study nonlinear income taxation in a model where such labor contracts arise as a result of moral hazard frictions within rms. We derive novel formulas for the incidence of arbitrarily nonlinear reforms of a given tax code on both average earnings and their sensitivity to output risk. We show theoretically and quantitatively that, following an increase in tax progressivity, the higher sensitivity of earnings to performance caused by the crowding-out of private insurance is almost fully offset by a countervailing performance-pay effect driven by labor supply responses. As a result, earnings risk is hardly affected by policy. We then turn to the normative analysis of a government that levies taxes and transfers to redistribute income across workers with different levels of uninsurable productivity. We find that setting taxes without accounting for the endogeneity of private insurance is close to optimal. Thus, the common concern that standard models of taxation underestimate the cost of redistribution is, in the context of performance-based compensation, overblown.