Risk aversion and inequity aversion in demand for unemployment benefits

Int Tax Public Finance (2017) 24:198–220 DOI 10.1007/s10797-016-9420-5 Risk aversion and inequity aversion in demand for unemployment benefits Peter G. Backus1,2 · Alejandro Esteller-Moré2,3 Published online: 29 July 2016 © The Author(s) 2016. This article is published with open access at Springerlink.com Abstract This paper is an empirical study of what motivates net contributors to support redistributive policies. While studies in the area have tended to consider broad measures of inequality and support for redistribution in general, we focus on a single, salient relationship between local unemployment rates and demand for spending on unemployment benefits. Using a particularity of the Spanish labour market, we estimate how workers’ stated preferences for unemployment benefits spending respond to changes in the local unemployment rate. We then decompose this response into the part explained by risk aversion, and thus demand for insurance, and the part explained by inequity aversion. Our results suggest that increases in local unemployment rates lead to increased demand by workers for unemployment benefits spending. Moreover, our results are consistent with an insurance motive driving this relationship but provide little support for inequity aversion. Our results suggest that studies of the relationship between inequality and demand for redistribution might benefit from considering both the source and measure of the inequality and the instrument of redistribution. Keywords Preferences for redistribution · Unemployment · Unemployment benefits JEL Classification D64 · H53 · H77 B Peter G. Backus 1 University of Manchester, Oxford Road, M13 9PL Manchester, UK 2 Institut d’Economia de Barcelona (IEB), c/ John M. Keynes, 1-11, 08034 Barcelona, Spain 3 Facultat d’Economia i Empresa, Universitat de Barcelona, c/ John M. Keynes, 1-11, 08034 Barcelona, Spain 123 Risk aversion and inequity aversion in demand… 199 1 Introduction One of the main roles of modern governments is the redistribution of income. There is a growing literature in economics which seeks to understand just why it is that net contributors to a redistributive system support it (Boeri et al. 2001). Nearly every OECD country has a degree of progressiveness in their income tax system (OECD 2008, p. 112) designed to redistribute income from the better off to the worse off indicating a preference among the population for redistribution. Some of the research in this area has shown that the source of the inequality can play a role in determining the degree to which people support redistribution. However, much of the literature on redistributive preferences has focused on a general conception of these preferences and subsequent demand for redistribution. We consider redistributive preferences within the context of a single redistributive instrument: unemployment benefits. In general, the specific policy instrument used to redress inequality has been ignored when studying people’s preferences for redistribution. But the policy instrument is an essential part of the question of redistributive preferences. Piketty (1996) notes “individuals might well share the same ‘values’ as far as distributive justice is concerned, but…they disagree about the way actual inequality between individuals is generated” (p. 8). Where people disagree about the source of inequality, they will likely also disagree about the policy best suited to redress the inequality. It is therefore essential to consider redistributive preferences within the context of a particular instrument since the underlying reasons for why a person supports redistribution might vary from one instrument, say transfers to the poor, to another, say unemployment benefits. In this paper, we examine the relationship between changes in the income distribution, as measured by changes to the unemployment rate, and stated preferences for unemployment benefits. Economists have identified a number of potential motivations underlying support for redistribution like demand for insurance and inequity aversion, and Alesina and Giuliano (2011) note that the empirical disentanglement of these motives is difficult, albeit not ‘fatally’ so. We address this challenge directly and seek to contribute to the empirical work on redistributive preferences (e.g. Dahlberg et al. 2012; Luttmer and Singhal 2011; Guillaud 2013), using a newly constructed data set and a particularity of the Spanish labour market whereby public sector workers enjoy nearly inviolable job security. We estimate the effect of individual unemployment risk and of the local unemployment rate on workers’ declared preferences for redistribution via one instrument: unemployment benefits. We then decompose that effect into the part explained by risk aversion and demand for insurance and the part explained by inequity aversion. Our results suggest that in this case it is demand for insurance that drives declared preferences for redistribution. We find no evidence that inequity aversion plays a role in determining people’s preferences for redistribution via unemployment benefits. Studying the unemployment rate/benefits relationship may provide deeper insight into preferences for redistribution given the saliency of the two. Gimpelson and Treisman (2015) find that there are systematic differences between the perceived and actual level of income inequality when considering income shares. Kuziemko et al. (2015) argue that demand for general redistribution might not be too intense because people are unlikely to be aware of the level and changes in some more general inequality 123 200 P. G. Backus, A. Esteller-Moré metric. Atkinson (2015) also raises the issue of the saliency of changes in income distributions. He notes that a change in the Gini of at least 3 % points may be necessary to be salient. Such a large change generally takes years if not decades to be realised, perhaps reducing the salience of the overall change. Ashok et al. (2016) use broad questions about redistributive preferences1 and inequality2 and find little evidence that rising inequality in the USA has led to increased demand for redistribution over the past 40 years. It is arguable that the absence of any effect in their study is due to the in-salient nature of changes to measures like the Gini or percentile ratios. The level of unemployment, however, is a clearly visible, often reported and simple to comprehend variable making it more likely that individuals will recognise any change and respond, assuming that they respond at all. Moreover, in the case of unemployment, the instrument (unemployment benefits) and the target of the redistribution (the unemployed) are inextricably linked making it simpler to analyse the relationship between the two. While focusing on unemployment goes some way towards addressing issues of salience, it does so at the cost of generality. Our results tell us something about the relationship between unemployment and (...truncated)