47 Pages Posted: 27 Mar 2019 Last revised: 25 Jun 2020

Date Written: March 12, 2019

Abstract

Top income inequality has been increasing in the US. Hence, the Pareto parameter as-sociated with the top income distribution is decreasing. In this paper, we provide a theory that links automation technology to the Pareto parameter of the top income distribution. We construct a model in which the span of control is deﬁned by the measure of labor used in production. We model this as a convex cost of labor. This convex cost generates a decreasing returns to scale production function. An improvement in automation enables entrepreneurs to substitute labor with capital and decreases the severity of diseconomies of scale. This leads to higher returns to entrepreneurial skills, a decrease in the Pareto parameter, and an increase in top income inequality. We rationalize the convex cost of labor using a theory of eﬃciency wages. Using cross-industry and cross-country data, we show that there is a signiﬁcant correlation between automation and top income inequality.