Consumption, Wealth, and Income Inequality: A Tale of Tails

Abstract

We provide evidence that the distributions of consumption, labor income, wealth, and capital income exhibit asymptotic power-law behavior with a strict ranking of upper tail inequality, in that order, from the least to the most unequal. We show analytically and quantitatively that the canonical heterogeneous-agent model cannot replicate the proper ranking and mag-nitudes of these four tails simultaneously. Mechanisms addressing the wealth concentration puzzle in these models through return heterogeneity lead to a mirror consumption concen-tration puzzle. We match the cross-sectional data on these four Pareto tails by positing a combination of non-homothetic, wealth-dependent preferences and scale-dependent returns to capital. We underscore the importance of these results by showing that all four dimensions of top inequality jointly determine the long-run elasticity that governs the revenue-maximizing capital tax rate.

Reference

Alexandre Gaillard, Christian Hellwig, Philipp Wangner, and Nicolas Werquin, “Consumption, Wealth, and Income Inequality: A Tale of Tails”, TSE Working Paper, n. 23-1493, December 2023.