Are unconditional lump-sum transfers a good idea?

• Published in: Economics letters Vol. 209; p. 110088
• Main Authors: Chen, Yunmin, Chien, YiLi, Wen, Yi, Yang, C.C.
• Format: Journal Article
• Language: English
• Published: Amsterdam Elsevier B.V 01.12.2021; Elsevier Science Ltd
• Subjects: Consumption; Economic inequality; Heterogeneity; Heterogeneous agents; Income inequality; Income taxes; Incomplete markets; Inequality; Lump sum; Lump-sum transfers; Public debt; Public liquidity; Ramsey problem; Risk aversion; Social welfare; Tax legislation; Taxation; Universal basic income; Wealth; Wealth distribution; Lump-sum transfers; Public liquidity; Ramsey problem; Incomplete markets; Heterogeneous agents; Universal basic income
• ISSN: 0165-1765; 1873-7374
• DOI: 10.1016/j.econlet.2021.110088

The role of unconditional lump-sum transfers in improving social welfare in heterogenous agent models has not been thoroughly understood in the literature. We adopt an analytically tractable Aiyagari-type model to study the distinctive role of unconditional lump-sum transfers in reducing consumption inequality due to ex-post uninsurable income risk under borrowing constraints. Our results show that in the presence of ex-post heterogeneity and in the absence of wealth inequality, unconditional lump-sum transfers are not a desirable tool for reducing consumption inequality—the Ramsey planner opts to rely solely on public debt and a linear labor tax (in the absence of a lump-sum tax) to mitigate income risk without the need for lump-sum transfers, in contrast to the result obtained by Werning (2007), Azzimonti and Yared (2017), and Bhandari et al. (2017) in models with ex-ante heterogeneity. •The role of unconditional lump-sum transfers in improving social welfare in heterogenous agent models has not been thoroughly understood in the literature.•We adopt a tractable model to study the role of unconditional lump-sum transfers in reducing consumption inequality.•Our results show that unconditional lump-sum transfers are not a desirable tool for reducing consumption inequality compared to government debt.