Wednesday, September 11, 2013
John R. Brooks II (Georgetown) presents Fiscal Federalism as Risk-Pooling today at Boston College as part of its Tax Policy Workshop Series hosted by James Repetti and Diane Ring:
In addition to funding government and redistributing income, a redistributive tax-and transfer system, and a progressive income tax in particular, provides social insurance against the risk of uncertain future income. By providing for high taxes for high incomes, and low taxes, exemptions, and transfers for low incomes, a progressive income tax lowers the volatility of potential after-tax income relative to a lump-sum tax. This insurance function is distinct from the redistributive function of the system, since it provides a direct risk-mitigation benefit to the taxpayer himself, rather than simply redistributing income from one taxpayer to another.
This article analyzes the question of at what level of government to best assign the income tax role in a federal system, given both its redistributive and insurance functions. The standard view in the literature is that redistribution is best done centrally, and thus that an income tax is best used by the federal government, rather than state governments. Yet recent empirical work suggests that states can effectively have some role in redistribution. Income insurance, however, can be more effectively done by the federal government, because of its larger risk pool and better ability to handle revenue fluctuations.
This article argues that states will, and likely should, use progressive income taxes as a tool of greater redistribution. At the same time, the insurance function of a progressive income tax can still be nationalized through policies that resemble re-insurance. In particular, this article looks at the idea of a multi-state rainy-day fund as a form of pooled insurance, as well as alternatives that may achieve some of the same benefits.