Can income differences explain the racial wealth gap? A quantitative analysis

Abstract

We use a quantitative, overlapping-generations, incomplete markets, life-cycle model to explore the extent to which income differences can explain the racial wealth gap. The model features race, education, and family structure-specific stochastic household income processes estimated using data from the PSID, race and education-specific lifespan risk, an income floor, and intergenerational transfers of wealth and labor market ability. A calibrated version of the model fully accounts for the racial wealth gap observed in the data. In addition, it endogenously generates an empirically plausible degree of wealth inequality, both conditional and unconditional on race, and is broadly consistent with observed patterns of wealth accumulation over the life cycle. Simulations of the model suggest that income differences, on their own, can explain 43.0% of the racial wealth gap in levels, while bequest motives and intergenerational transfers of wealth, in the presence of income differences, account for 28.6% and 25.8% of the gap, respectively. We find that the income floor has a negligible impact on the racial wealth gap in levels, but causes the ratio of median wealth (white/black) to more than double as it disproportionately reduces the incentive that low income, low wealth households, the majority of whom are black, have to save. We also find that differences in lifespan risk have only a small impact on the racial wealth gap levels, but lead to a 13.7% increase in the ratio of median wealth.