The Effect of Capital Share on Income Inequality: Identifying the Time Patterns

TL;DR

This paper investigates how changes in the capital share influence income inequality across different economies over four decades, revealing that the capital share significantly contributes to rising inequality and varies by economic development level.

Contribution

It introduces a structural econometric approach to quantify the time-varying impact of capital share on income inequality across diverse countries.

Findings

A 1 percentage point increase in capital share raises top 5% income share by 0.17 pp.

Advanced economies have stable transmission coefficients despite rising inequality.

Changes in capital share explain about 50% of the increase in income inequality.

Abstract

This study explores the link between the capital share and income inequality over the past four decades across 56 countries. Calculating the capital share from national accounts alongside top income share data from the World Inequality Database, which is based on the Distributional National Accounts methodology, we ensure the consistency in the theory and measurement. Employing a structural econometric approach, we account for heterogeneous and time-varying transmission coefficients from the capital share to personal income inequality. Our findings reveal that a one percentage point (pp) increase in the capital share raises the income share of the top 5% by 0.17 pp on average. Advanced economies show a stable transmission coefficient with rising capital and labor income inequality, while emerging economies experience an increasing transmission coefficient alongside growing capital income inequality. In contrast, a third group exhibits a declining transmission coefficient and rising labor income inequality. Overall, changes in the capital share account for approximately 50% of the rise in income inequality, underscoring its pivotal role over the last four decades.