Risk and potential insurance in Europe

This paper argues that risk is related to long-run volatility of income and therefore stabilization policies should target permanent fluctuations. We show that such fluctuations can, in principle, be insured away by a multina tional fiscal federation which smooths income cross-sectionally and has no ex ante permanent redistribution effects. We propose a measure of risk and a measure of potential insurable risk. We estimate these measures for the E uropean countries and compare results with the US. Results show that potent ial insurable income risk in Europe is about 45%. Most countries will benef it from an average income tax of 10%, but gains differ widely across countr ies. (C) 1999 Elsevier Science B.V. All rights reserved.