This paper examines the transmission of income inequality into consumption inequality and in so doing investigates the degree of insurance to income shocks. Panel data on income from the PSID is combined with consumption data from repeated CEX cross-sections to identify the degree of insurance to permanent and transitory shocks. In the process we also present new evidence of the growth in the variance of permanent and transitory shocks in the US during the 1980s. We find some partial insurance of permanent income shocks with more insurance possibilities for the college educated and those nearing retirement. We find little evidence against full insurance for transitory income shocks except among low income households. Tax and welfare benefits are found to play an important role in insuring permanent shocks. Adding durable expenditures to the consumption measure suggests that durable replacement is an important insurance mechanism, especially for transitory income shocks.

Recent theoretical work has shown the importance of measuring microeconomic uncertainty for models of both general and partial equilibrium under imperfect insurance. In this paper the assumption of i.i.d. income innovations used in previous empirical studies is removed and the focus of the analysis is placed on models for the conditional variance of income shocks, which is related to the measure of risk emphasized by the theory. We first discriminate amongst various models of earnings determination that separate income shocks into idiosyncratic transitory and permanent components. We allow for education- and time-specific differences in the stochastic process for earnings and for measurement error. The conditional variance of the income shocks is modelled as a parsimonious ARCH process with both observable and unobserved heterogeneity. The empirical analysis is conducted on data drawn from the 1967-1992 Panel Study of Income Dynamics. We find strong evidence of sizeable ARCH effects as well as evidence of unobserved heterogeneity in the variances. Copyright Econometric Society 2004.

We show that the effects of taxes on labor supply are shaped by interactions between adjustment costs for workers and hours constraints set by firms. We develop a model in which firms post job offers characterized by an hours requirement and workers pay search costs to find jobs. We present evidence supporting three predictions of this model by analyzing bunching at kinks using Danish tax records. First, larger kinks generate larger taxable income elasticities. Second, kinks that apply to a larger group of workers generate larger elasticities. Third, the distribution of job offers is tailored to match workers' aggregate tax preferences in equilibrium. Our results suggest that macro elasticities may be substantially larger than the estimates obtained using standard microeconometric methods.

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