Why Is the Distribution of Wealth More Unequal than the Distribution of Income: The Importance of Gifts and Bequests in Economic Inequality

Abstract

Inequality in the distribution of wealth may be explained by differences in work effort, ability, savings behavior, rates of return, taxes and transfers, and gift and bequests (private transfers). The relative importance of these factors has important implications for public policy. Policy makers may wish to encourage saving and work effort, for example, but may be less sympathetic to inherited wealth and “windfall” gains. This paper is an attempt to sort out the relative importance in wealth inequality of private transfers and differential rates of return on the one hand and differential savings rates on the other. In particular, the paper employs panel data (The Panel Study on Income Dynamics) to test whether differences in savings rates can explain why, as has been commonly noted, the distribution of wealth is more unequal than the distribution of income. By concentrating on the difference between income and wealth inequality, the paper controls for the importance of work effort and ability: those factors that affect both wealth and income inequality. The paper finds that differential savings rates are a poor explanation for the extra inequality in the distribution of wealth. The paper concludes, therefore, that the degree to which wealth is more unequally distributed than income must be accounted for by private transfers and differential rates of return.