Working Paper: NBER ID: w20637
Authors: Charles I. Jones; Jihee Kim
Abstract: Top income inequality rose sharply in the United States over the last 35 years but increased only slightly in economies like France and Japan. Why? This paper explores a model in which heterogeneous entrepreneurs, broadly interpreted, exert effort to generate exponential growth in their incomes. On its own, this force leads to rising inequality. Creative destruction by outside innovators restrains this expansion and induces top incomes to obey a Pareto distribution. The development of the world wide web and a reduction in top tax rates are examples of changes that raise the growth rate of entrepreneurial incomes and therefore increase Pareto inequality. In contrast, policies that stimulate creative destruction reduce top inequality. Examples include research subsidies or a decline in the extent to which incumbent firms can block new innovation. Differences in these considerations across countries and over time, perhaps associated with globalization, may explain the varied patterns of top income inequality that we see in the data.
Keywords: top income inequality; entrepreneurship; Pareto distribution; creative destruction
JEL Codes: E2; J3; O4
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| entrepreneurial effort (L26) | exponential growth in incomes (O49) |
| exponential growth in incomes (O49) | rising inequality (D31) |
| development of the World Wide Web (O50) | increase in growth rate of entrepreneurial incomes (O49) |
| reductions in top tax rates (H29) | increase in growth rate of entrepreneurial incomes (O49) |
| increase in growth rate of entrepreneurial incomes (O49) | raise Pareto inequality (D63) |
| creative destruction by outside innovators (O36) | regulate growth of top incomes (D31) |
| policies stimulating creative destruction (O25) | lower top income inequality (D31) |
| higher rates of creative destruction (O39) | lower top income inequality (D31) |
| changing power law parameter of income distributions (D31) | shifts in top income inequality (D31) |
| share of income going to the top 1% (D33) | function of power law parameter (C51) |