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 multinational 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 European countries and compare results with the US. Results show that potential insurable income risk in Europe is about 45%. Most countries will benefit from an average income tax of 10%, but gains differ widely across countries. (C) 1999 Elsevier Science B.V. All rights reserved.