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"Permanent Income" Inequality

Giovanni Gallipoli () and Brant Abbott ()

No 1033, 2017 Meeting Papers from Society for Economic Dynamics

Abstract: We estimate the degree of inequality of ``permanent income'', as well as trends over time. Our notion of permanent income is related to Friedman's (1957) original idea, but does not assume linear-quadratic utility. We account for financial and real wealth, as well as the certainty equivalent value of a household's potential future earnings, thus providing a monetary statistic directly related to economic welfare, which is not true of income or wealth alone. We combine publicly available consumption and income data from the PSID with net worth data from the SCF to produce our estimates. Our method imposes no restrictions on the dynamics of observed income processes and features state-dependent stochastic discount factors, as opposed to the risk-free discount factors commonly used to estimate the present value of lifetime earnings. We show that stochastic discount factors depend on many sources of risk beyond income risk, e.g. marital uncertainty. We use our estimates of permanent income to study how inequality in the U.S. evolved between 1989 and 2013, and how the human component of wealth varies over the life cycle of different households. Our findings suggest that accounting for human wealth significantly changes the assessment of aggregate inequality and of its evolution. Specifically, we find that: (i) top $10\%$ and top $1\% $ shares of permanent income are substantially smaller (roughly 1/2) than the corresponding shares of net worth typically reported in the literature; (ii) however, top shares of permanent income have grown much faster over the 1989-2013 period than top shares of net worth, suggesting that actual inequality has increased more than previously thought. For instance, the share of financial wealth owned by the top $10\%$ of the wealth distribution grew over that period by 8 percentage points while the share of permanent income attributable to that same group grew by 14 percentage points. Finally, we find that the share of households who sit at the top of both the net worth and human wealth distributions has actually decreased between 1989 and 2013, indicating that increased concentration of permanent income is not due to a small set of households holding increasing shares of all types of wealth. Instead, increasing concentration of permanent income is mostly due to the growing importance of real/financial wealth as a share of total wealth.

New Economics Papers: this item is included in nep-dge
Date: 2017
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Working Paper: Permanent-Income Inequality (2019) Downloads
Working Paper: Permanent-Income Inequality (2019) Downloads
Working Paper: Permanent-Income Inequality (2019) Downloads
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