Evidence on the Insurance Effect of Redistributive Taxation

If households face uninsurable idiosyncratic earnings risk, theory predicts that re-
distributive tax and transfer systems have both an insurance and a distortionary e®ect.
Exploiting the substantial variation of tax and transfer systems across US states and
over time we investigate the necessary traces of these two effects in the data: that
state-level measures of redistributive taxation should correlate negatively with, (a) the
standard deviation, and (b) the mean, of the within-state consumption distribution.
We find that the first correlation is robust, supporting strongly the presence of an
insurance effect. The distortionary effect can also be detected in the data but it is less
precisely estimated.