Abstract: This paper models how transfers, a tax rate on labor income, and the distribution of government debt should respond to aggregate shocks when markets are incomplete. A planner sets a lump sum transfer and a linear tax on labor income in an economy with heterogeneous agents, aggregate uncertainty, and a single asset with a possibly risky payoff. Limits to redistribution coming from incomplete tax instruments and limits to hedging coming from incomplete asset markets affect optimal policies. Two forces shape long-run outcomes: the planner’s desire to minimize the welfare cost of fluctuating transfers, which calls for a negative correlation between agents’ assets and their skills; and the planner’s desire to use fluctuations in the return on the traded asset to compensate for missing state-contingent securities. In a multi-agent model calibrated to match facts about US booms and recessions, the planner’s preferences about distribution make policies over business cycle frequencies differ markedly from Ramsey plans for representative agent models.

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