A Schumpeterian Model of Top Income Inequality

NBER Working Paper No. 20637

Issued in October 2014, Revised in July 2015

NBER Program(s):Economic Fluctuations and Growth, Labor Studies, Public Economics



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 and a reduction in top tax rates 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.

Acknowledgments

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Document Object Identifier (DOI): 10.3386/w20637

Published: Charles I. Jones & Jihee Kim, 2018. "A Schumpeterian Model of Top Income Inequality," Journal of Political Economy, vol 126(5), pages 1785-1826.

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