Rising Wealth Inequality: Intergenerational Links, Entrepreneurship, and the Decline in Interest Rate

Abstract

The share of wealth held by the top one percent of Americans has increased from about 24% in 1980 to 40% in 2010. This paper examines the potential role played by three factors in accounting for this increase - decline in the corporate tax rates, increase in the income risk, and the decline in the world interest rates. Our model consists of altruistic households who either run a business or work for others. Entrepreneurial households enjoy high returns due to high productivity while worker households' savings earn the bank deposit rate that is determined in a competitive banking sector and equals the rate of return on foreign bonds. We find that entrepreneurship and intergenerational links via altruism are important factors generating a wealth distribution that mimics the data in the 2000s. However, it is the decline in the interest rate that plays a major role in accounting for the increase in the U.S. wealth inequality since the 1980s. In our model, the decline in the interest rate increases wealth inequality as it affects the two types of households differently. Entrepreneurial households benefit from lower financing costs and increase their investments while worker households face lower returns to their savings as the interest rate declines. Other changes such as the changes in taxation and income risk play a less significant role.