Top income inequality, defined as the income gap within the top 1% income group, has been rising in the United States since the 1980s. Coinciding with this rise, the large reductions in the top marginal tax rate exhibit a strong correlation with the increase in both top income inequality and top income shares. This paper identifies endogenous human capital accumulation as the link between changes in top marginal tax rates and increases in top income inequality. We develop an infinite-horizon, heterogeneous agent model, where human capital accumulation is endogenously characterized by a proportional random growth process which depends on the top marginal tax rate. If the top marginal tax rate decreases, the benefit of human capital accumulation effort will increase, thereby increasing the growth rate of human capital. Since this growth rate pins down the Pareto inequality measure of the top income distribution, a decrease in the top marginal tax rate will lead to amore unequal Pareto income distribution, while simultaneously increasing every top income. The calibrated model finds that the reduction of the top marginal tax rate from 70% to 40% can account for nearly two-thirds of the increase in top income inequality and 68.4% of the increase in the top 1% income share between 1980 and 2010.
Top income inequality rose sharply in the United States over the last 35 years but increased only slightly in economies like France and Japan. Why? This paper explores a model in which heterogeneous entrepreneurs, broadly interpreted, exert effort to generate exponential growth in their incomes. On its own, this force leads to rising inequality. Creative destruction by outside innovators restrains this expansion and induces top incomes to obey a Pareto distribution. The development of the world wide web, a reduction in top tax rates, and a decline in misallocation are examples of changes that raise the growth rate of entrepreneurial incomes and therefore increase Pareto inequality. In contrast, policies that stimulate creative destruction reduce top inequality. Examples include research subsidies or a decline in the extent to which incumbent firms can block new innovation. Differences in these considerations across countries and over time, perhaps associated with globalization, may explain the varied patterns of top income inequality that we see in the data.
Employment, consumption expenditure, and R&Dinvestment have grown faster in the service sector than in the manufacturing sector, resulting in the service-oriented economy. This paper shows that the difference in the idea production across sectors can cause the non-balanced sectoral growth. We build a two-sector growth model with endogenous technology. In this model, new ideas are produced using the current stock of ideas as an input, but the idea stock effect in idea production varies between sectors. Under the complementarity assumption between sectors, we show that this difference in idea production generates the non-balanced growth in R&D investment as well as in employment and consumption expenditure.