Idiosyncratic Risk in the U.S. and Sweden: Is there a Role for Government Insurance?

We examine the effects of government redistribution schemes in an economy where agents are subject to uninsurable, individual specific productivity risk. In particular, we consider the trade-off between positive insurance effects and negative distortions on labor supply. We parameterize the model by estimating productivity processe on Swedish and U.S. data. The estimation results show that agents in the U.S. are subject to more idiosynchratic risk than agents in sweden. Distortions are significant but agents, particularly in the U.S., still like some government insurance. As a result of this exercice, we can construct Laffer curves for both countries. These peak when labor income tax rates are around 60 percent.