Aggregate Labor Income Research Articles

A Further Look at the Propagation of Monetary Policy Shocks in HANK

AbstractWe provide quantitative guidance on whether and to what extent different elements of Heterogeneous Agent New Keynesian (HANK) models amplify or dampen the response of aggregate consumption to a monetary policy shock. We emphasize four findings. First, the introduction of capital adjustment costs does not affect the aggregate response, but does change the transmission mechanism so that a larger share of indirect effects originates from equity prices rather than from labor income. Second, incorporating estimated unequal incidence functions for aggregate labor income fluctuations leads to either amplification or dampening, depending on the data and estimation methods. Third, distribution rules for monopoly profits that allocate a larger share to liquid assets lead to greater amplification. Fourth, assumptions about the fiscal reaction to a monetary policy shock have a stronger effect on the aggregate consumption response than any of the other three elements.

Household balance sheet channels of monetary policy: A back of the envelope calculation for the euro area

This paper formulates a back of the envelope approach to study the effects of monetary policy on household consumption expenditures. We analyze several transmission mechanisms operating through direct, partial equilibrium channels—intertemporal substitution and net interest rate exposure—and indirect, general equilibrium channels—net nominal exposure, as well as wealth, collateral and labor income channels. The strength of these forces varies across households depending on their marginal propensities to consume, their balance sheet composition, the sensitivity of their own earnings to fluctuations in aggregate labor income, and the responsiveness of aggregate earnings, asset prices and inflation to monetary policy shocks. We quantify all these channels in the euro area by combining micro data from the HFCS and the EU-LFS with structural VARs estimated on aggregate time series. We find that the indirect labor income channel and the housing wealth effect are strong drivers of the aggregate consumption response to monetary policy and explain the cross-country heterogeneity in these responses.

Endogenous Longevity and Optimal Tax Progressivity

We study the impact of endogenous longevity on optimal tax progressivity and inequality in an overlapping generations model with skill heterogeneity. Higher tax progressivity decreases both the longevity gap and net income inequality, but at the expense of lower average lifetime and lower aggregate labor supply and income. We find that the welfare-maximizing income tax is less progressive than in the case of exogenous longevity and that the present US income tax should redistribute less. Our result is robust to the empirically observed range of labor supply elasticity and the assumptions of both missing annuity markets and tax deductibility of private health expenditures.

The Agricultural Productivity Gap and Self-Employment Bias in the Labor Income Share

We propose a theory-based adjustment to the labor income share to correct for the self-employment bias. Through a two-sector neoclassical framework with agriculture and non-agriculture, we derive the productivity-adjusted aggregate labor income share in terms of the agricultural productivity gap, and the labor income share in non-agriculture and value-added factor shares. We then construct a novel dataset on the labor income share at a sector level comprising of 53 countries. By applying the theory-based adjustment to our data, the average values for the aggregate and agricultural productivity-adjusted labor income share are 0.42 and 0.51, respectively. The gap between the productivity-adjusted and unadjusted figures are statistically significant only in agriculture, which can be attributed to the heavily underreported income from self-employed workers in agriculture. These findings appear robust at a more disaggregated level of non-agricultural sectors, as self-employment explains almost 98% of the variation in this gap.

Envelope wages, hidden production and labor productivity

Abstract We evaluate the relative importance of aggregate labor productivity versus income taxes and social contributions for tax compliance in an economy with a large degree of informality. Empirical evidence points out that tax evasion in Europe happens through partially concealing wages and profits in formally registered enterprises. To this end, we build a model in which employer-employee pairs of heterogeneous productive capacities make joint decisions on the degree of tax evasion. The quantitative model is used to analyze the case of Bulgaria which has the largest informal economy in Europe and underwent a number of important tax reforms over the period 2000–2014, including the introduction of a flat income tax in 2008. The estimation strategy relies on matching the empirical series for the size of the informal economy and other aggregate outcomes for 2000–2014. Our counterfactual experiments show that the most important factor for the changing size of the informal economy is labor productivity, which accounts for more than 75% of the change. The variation in corporate income tax accounts for the rest. We find that the 2008 flat tax reform did not play any visible role in coping with informality.

Persistent Heterogeneous Returns and Top End Wealth Inequality

Are there simple and observable aggregate statistics that might help determine and forecast the degree of wealth inequality? Do they explain the differences in wealth inequality across economies and over time? To answer these questions, we build a general equilibrium, neoclassical growth model, in which the stationary wealth distribution has heavy right tail with the Pareto tail index, Pt. In the simplest cases of the model, the tail index depends on interest rate (r), growth rate (g), aggregate labor income share (EY), and aggregate capital to output ratio, (KY), summarized in a formula Pt = Pt ( r,g,EY,KY) (rather than the simple gap r-g , put forth in Thomas Piketty's “Capital in the 21st century”). In addition, financial development, production technology, corporate and wealth taxes affect the tail index through their effects on these sufficient statistics. When we calibrate the model to the U.S. economy, we find that the model requires significant persistent heterogeneous returns to investment in order to generate the tail index of U.S. wealth distribution. In this calibration, earnings inequality and, to a lesser extent, initial wealth distribution have negligible effects on top end wealth inequality. The transition of the model economy after a uniform wealth destruction shock or changes in corporate tax (but not after a financial deregulation shock) produces the joint dynamics of EY, KY, and wealth inequality experienced in major developed economies after World War II. Lastly, we find empirical evidence for persistent heterogeneous returns in the PSID surveys.

Envelope Wages, Hidden Production and Labor Productivity

We evaluate the relative importance of aggregate labor productivity versus income taxes and social contributions for tax compliance in an economy with a large degree of informality. Empirical evidence points out that tax evasion in Europe happens through partially concealing wages and profits in formally registered enterprises. To this end, we build a model in which employer-employee pairs of heterogeneous productive capacities make joint decisions on the degree of tax evasion. The quantitative model is used to analyze the case of Bulgaria which has the largest informal economy in Europe and underwent a number of important tax reforms over the period 2000–2014, including the introduction of a flat income tax in 2008. The estimation strategy relies on matching the empirical series for the size of the informal economy and other aggregate outcomes for 2000–2014. Our counterfactual experiments show that the most important factor for the changing size of the informal economy is labor productivity, which accounts for more than 75% of the change. The variation in corporate income tax accounts for the rest. We find that the 2008 flat tax reform did not play any visible role in coping with informality.

Multi Fibre Arrangement and Wage Inequality: Firm and State‐level Evidence from India and a Theoretical Model

AbstractThe phased elimination of Multi Fibre Arrangements (MFA) for textile and apparel has been one of the most compelling trade policy reforms that removed a system of bilateral quotas. The reform brought in significant changes in the industrial structures for exporters from the south, including India. Has the labour‐intensive high‐employment textile and clothing industry in India benefited from this global move towards freer trade? For India, the industry has witnessed unprecedented market concentration of export‐oriented firms. Firm‐level empirical estimate illustrates that workers in the export‐oriented firms in India are adversely affected due to withdrawal of quota. Accumulation of net fixed assets and growth of sales impart positive impact on firm‐level wages that cannot outweigh negative impact due to fall in exports. We also find negative impact of profit on aggregate wage bill for the industry with firms spread over 11 major states in India. We show that the mean deviation of industry‐level wage is positively and significantly associated with mean deviation of the number of factories at the state level and negatively with profit. Finally, a brief analytical exercise obtains conditions under which joint withdrawal of quota and import tariff could raise the aggregate labour income in developing countries, in general.

A Pure Capital Market Complementarity between Immigrants and Natives

This work presents a model aiming to evaluate the impact of rural-urban migration on the aggregate stock of loanable funds and investment by the urban population. Much higher investment costs for immigrants in cities prevent their acquisition of either human or physical capital. That is the reason why immigrants self-select as net lenders and affect urban labor earnings by means of the availability of new loanable funds for investment. This reduces the local interest rates and facilitates urban aggregate investment, especially by the new generations of natives. As a result of that, the aggregate labor income of natives increases unambiguously with the size of new immigration waves.

Optimal portfolios with wealth-varying risk aversion in the neoclassical growth model

This paper provides a rationale for fixed portfolios that exhibit fund separation as an optimal general equilibrium strategy when heterogeneous investors have wealth-varying relative risk aversion in the context of the standard stochastic neoclassical growth model. Agents’ wealth heterogeneity varies endogenously through time. Preferences exhibit linear risk tolerance with respect to consumption, consumption and labor are separable and the momentary utility function for leisure is isoelastic. Production possibilities are represented by J neoclassical technologies which are subject to shocks. I show that any competitive equilibrium allocation that is Pareto optimal can be supported by means of constant portfolios with only a few assets: a mutual fund of stocks, a consol and two other securities perfectly linearly correlated with aggregate labor income and the wage rate. Remarkably, this result holds in spite of the changing degree of agents’ heterogeneity and wealth-varying relative risk aversion, both stemming from movements in the stock of capital.

Industry‐Specific Human Capital, Idiosyncratic Risk, and the Cross‐Section of Expected Stock Returns

ABSTRACTHuman capital is one of the largest assets in the economy and in theory may play an important role for asset pricing. Human capital is heterogeneous across investors. One source of heterogeneity is industry affiliation. I show that the cross‐section of expected stock returns is primarily affected by industry‐level rather than aggregate labor income risk. Furthermore, when human capital is excluded from the asset pricing model, the resulting idiosyncratic risk may appear to be priced. I find that the premium for idiosyncratic risk documented by several empirical studies depends on the covariance between stock and human capital returns.

Human Capital and Asset Pricing

From the optimal behavior of arbitrary number of consumer-investors who act as to maximize their life-time utility of consumption and leisure, this paper derives a continuous-time intertemporal asset pricing model with stochastic human capital, leisure, consumption, and investment opportunities. Explicit demand functions for assets are derived and it is shown that, with heterogeneous human capital, the classic fund separation results may no longer hold. The human capital is modeled to include not only its marketed benefits but also its non-market benefits by the use of aggregate labor income and three macro variables in labor statistics: the average weekly employment hours, the unemployment rate, and the labor participation rate. Three flexibility parameters are introduced to explicitly account for the hidden unemployment, the self-employment, and the time spent on job-related activity such as work-commute and so on. Although a formal and comprehensive test is left as a future research task, two pieces of evidence are provided. First, a quick revisit of the equity premium puzzle shows that my model is plausible to explain the observed equity premium with the actual data. Then a preliminary test using returns of the 25 Fama-French size B/M portfolios shows that my model captures about 75% of the total variation in the cross-section returns and that the unemployment rate plays a critical role in explaining the cross-section returns.

Lifecycle Deficit and Public Age Reallocations for India’s Elderly Population: Evidence and Implications Based on National Transfer Accounts

Using the computational framework of National Transfer Accounts, this paper offers new results and explanations on the role of public support to India’s elderly population in 2004–05. New results refer to computed (a) lifecycle deficit (LCD) based on age profiles of aggregate labour income and consumption and (b) public age reallocations based on age profiles of transfers and asset based reallocations. The results show that the LCD of elderly population is about 34% of the LCD of all ages, or 3.74% of GNP. Surprisingly, net public transfers to elderly individuals are strongly negative and asset-based allocations are financed by dis-saving, because the taxes paid by the elderly population substantially exceed the benefits they receive and they pay both interest on previously accumulated public debt and paying off that debt. Public age reallocations finance elderly individuals’ consumption by less than 0.50% and the largest burden of financing public transfers falls on elderly for whom the net public transfers is −13.33% of labour income. The heavy burden on the elderly population is attributable in part to India's tax system and partly on the absence of programs that provide support to elderly individuals. If the present private sector's support for elderly individuals is not sustainable due to changes in the social obligations and in the absence of a universal pension scheme, a reduction in the direct tax outflows for the elderly population may be a policy imperative in India's public age reallocations.

Tax buyouts

The paper studies a fiscal policy instrument that can reduce fiscal distortions without affecting revenues, in a politically viable way. The instrument is a private contract (tax buyout), offered by the government to each citizen, whereby the citizen can choose to pay a fixed price in exchange for a given reduction in her tax rate for a period of time. We introduce the tax buyout in a dynamic overlapping generations economy, calibrated to match several features of the US income, taxes and wealth distribution. Under simple pricing, the introduction of the buyout is revenue neutral but, by reducing distortions, benefits a significant fraction of the population and leads to sizable increases in aggregate labor supply, income and consumption.

Earnings Inequality and the Equity Premium

We present data from the Survey of Consumer Finances showing that the increased earnings (labor income) inequality, in combination with increased stockmarket participation, has roughly doubled stockholders’share of aggregate labor income in the last four decades. We explore the impact of the increase in this share on returns to equity and returns to a risk-free bond in a model with limited stockmarket participation, labor income and borrowing constraints. The main result is that the increase in stockholders’ share of aggregate labor income has lead to 130 basis points (45 percent) decrease in the ex ante equity premium (i.e. the discount rate applied to equity). The reason for this change is that the increase in stockholders’share of aggregate labor income leads to a change in income composition for stockholders - an increase in the fraction of their income that consists of labor income and a decrease in the fraction that consists of dividend income. This reduces the covariance between stockholder income growth and dividend growth. The size of the decrease in the equity premium implied by our model roughly coincides with the historical change in the post-1951 equity premium implied by the simple dividend growth model in Fama and French (2002).

Idiosyncratic labour income risk and aggregate consumption: An unobserved component approach

We investigate the importance of aggregate and consumer-specific or idiosyncratic labour income risk for aggregate consumption changes in the US over the period 1952–2001. Theoretically, the effect of labour income risk on consumption changes is decomposed into an aggregate and into an idiosyncratic part. Empirically, aggregate risk is modelled through a GARCH process on aggregate labour income shocks and individual risk is modelled as an unobserved component and obtained through Kalman filtering. Our results suggest that aggregate labour income risk explains a negligible fraction of the variance of aggregate consumption changes. A more important part of aggregate consumption changes is explained by the unobserved component. The interpretation of this component as reflecting idiosyncratic labour income risk is supported by the finding that it is negatively affected by received consumer transfers. Idiosyncratic labour income risk thus matters for the aggregate economy.

Redistributing Gains from Globalisation

This paper analyses the effects of redistribution in a model of international trade with heterogeneous firms in which a fair-wage effort mechanism leads to firm-specific wage payments and involuntary unemployment. The redistribution scheme is financed by profit taxes and gives the same absolute lump-sum transfer to all workers. In this setting a higher tax rate reduces aggregate labour income and makes the income distribution more equal, with unemployment remaining unaffected. International trade increases aggregate income, income inequality and the unemployment rate, ceteris paribus. If, however, trade is accompanied by a suitably chosen increase in the profit tax rate, it is possible to achieve higher aggregate income and a more equal income distribution than in autarky, provided that the share of exporters is sufficiently high.

The Bright Side of Shiller-Swaps: A Solution To Inter-Generational Risk Sharing

This paper investigates the diversification demand of an agent, who is faced with the alternative to swap aggregate labor income risk into equity exposure, through her individual account in a mandatory pension scheme. The framework for the analysis is a life-cycle model of a borrowing constrained individual's consumption and portfolio choice in the presence of uncertain labor income and realistically calibrated tax and pension systems. Pension benefits stem from both a defined benefit and a notionally defined contribution part, the latter being indexed to stochastic aggregate labor income. We show that agents, depending on state and swap premium, will be either buyers or sellers of such a swap, and that inter-generational risk sharing can therefore be achieved.

Earnings Inequality and the Equity Premium

We present data from the Survey of Consumer Finances showing that the increased earnings (labor income) inequality, in combination with increased stockmarket participation, has roughly doubled stockholders' share of aggregate labor income in the last four decades. We explore the impact of the increase in this share on returns to equity and returns to a risk-free bond in a model with limited stockmarket participation, labor income and borrowing constraints. The main result is that the increase in stockholders' share of aggregate labor income has lead to 130 basis points (45 percent) decrease in the ex ante equity premium (i.e. the discount rate applied to equity). The reason for this change is that the increase in stockholders' share of aggregate labor income leads to a change in income composition for stockholders - an increase in the fraction of their income that consists of labor income and a decrease in the fraction that consists of dividend income. This reduces the covariance between stockholder income growth and dividend growth. The size of the decrease in the equity premium implied by our model roughly coincides with the historical change in the post-1951 equity premium implied by the simple dividend growth model in Fama and French (2002).

Idiosyncratic Labour Income Risk and Aggregate Consumption: An Unobserved Component Approach

We investigate the importance of aggregate and consumer-specific or idiosyncratic labour income risk for aggregate consumption changes in the US over the period 1952-2001. Theoretically, the effect of labour income risk on consumption changes is decomposed into an aggregate and into an idiosyncratic part. Empirically, aggregate risk is modelled through a GARCH process on aggregate labour income shocks and individual risk is modelled as an unobserved component and obtained through Kalman filtering. Our results suggest that aggregate labour income risk explains a negligible fraction of the variance of aggregate consumption changes. A more important part of aggregate consumption changes is explained by the unobserved component. The interpretation of this component as reflecting idiosyncratic labour income risk is supported by the finding that it is negatively affected by received consumer transfers. Idiosyncratic labour income risk thus matters for the aggregate economy.