Paper short abstract:

We document (i) a negative relationship between the level of transfer progressivity and the stage of economic development and (ii) a negative relationship between the ability to insure consumption against income shocks and economic development.

Paper long abstract:

With micro panel data from 32 countries including the poorest and the richest in the

world we document (i) a negative relationship between the level of transfer progressivity

and the stage of economic development and (ii) a negative relationship between the ability

to insure consumption against income shocks and economic development. Importantly,

our measure of transfer progressivity includes both public and private net transfers across

households—e.g. food transfers. Using an overlapping generations model in which agents

differ in permanent productivity, face income shocks and accumulate physical and human

capital through learning-by-doing (a labor choice), we find that cross-country differences

in transfer progressivity go a long way in explaining the larger ability to insure consumption

in poor countries than in rich countries. Then, we use our model to assess the role

of transfer progressivity in explaining income per capita differences across countries. We

find that decreasing progressivity of poor countries to the levels of rich countries increases

income per capita of poor countries by 62%. However, a reduction in progressivity is not

necessarily welfare improving because although it increases the incentives to work and accumulate

physical and human capital, at the same time, it reduces social insurance—and

redistribution. Taking into account the trade-off between growth and insurance, we find

that moving poor economies to their optimal transfer progressivity increases their GDP per

capita by 56% and increases their welfare by 18% in consumption equivalent terms.