Abstract
Using a general labor supply model in which individuals choose how much to work conditional on productivities and preferences for consumption relative to leisure, we show that the mapping from earnings and hours worked to productivities and preferences can be expressed entirely in terms of reduced-form labor supply elasticities. We investigate the roles that productivities and preferences play in driving income inequality in the United States. Benchmark labor supply elasticity estimates from the literature imply that productivities drive most income inequality. Preferences become increasingly important relative to benchmark, with larger income effects or larger differences between earnings and hours-worked elasticities. (JEL J22, J24, D31, J31, H24, H31)
Highlights
The determinants of income inequality are a contentious topic of debate among economists, politicians, and policy makers alike
This paper shows that we can use information encoded in labor supply elasticities to learn about the extent to which labor income inequality is driven by heterogeneity in productivities vs. heterogeneity in preferences for consumption relative to leisure
As long as hours are increasing in preferences, our method recovers the correct preference rankings among all individuals; we show in Appendix A.6 that the counter-factual incomes only depend on these ordinal preference rankings
Summary
The determinants of income inequality are a contentious topic of debate among economists, politicians, and policy makers alike Many factors, such as family background, demographics, discrimination, genetics, luck, and work ethic play a role in determining economic success. All of these factors contribute to two higher level determinants of labor income inequality: (1) differences in productivities, i.e., ability to transform labor into personal income, and (2) differences in preferences, i.e., desire for consumption relative to leisure.. Individuals’ normative tastes for redistribution appear to depend on the sources of income inequality; examining the extent to which income inequality is driven by productivity vs preference heterogeneity is a positive step towards understanding the welfare benefits of redistribution.
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