Abstract
I document that (i) the mean and dispersion of pre-tax labor earnings grow faster over the life-cycle in the U.S. than in some European countries; (ii) these facts are largely driven by individuals with at least a college degree. I study these differences in labor earnings inequality using a life-cycle model of human capital accumulation and elastic labor supply which features non-linear taxation, in conjunction with a college choice and complementary investments during college. The model economy accounts for the differential mean earnings growth patterns of individuals with and without a college degree in the United States, as well as the observed within-group inequality over the life cycle. I find that non-linear taxation significantly suppresses pre-tax earnings, reduces college attendance, and investments during college. More generous subsidies and transfers for college exacerbate labor earning inequality. I find that differences in taxation and college subsidies alone account for 94% of the differences in mean earnings, and 80% of the differences in variance of log earnings over the life-cycle across the U.S. and European countries. To fully reconcile the model with data, the role of differences in initial conditions appear key.
Published Version
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