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posted on 03 September 2016

Economic Mobility, Residual Wealth And Policy Implications

from the St Louis Fed

The income and wealth of parents seems to have an effect on the income and wealth of their children. But how likely are children to move to different rungs of the economic ladder than their parents? The second part of our series on intergenerational economic mobility tackles these transitions.

In an article in The Regional Economist, Research Officer and Economist George-Levi Gayle and former Technical Research Associate Andrés Hincapié examined which is more effective for promoting economic mobility: policies that help the poor escape poverty or that limit the advantages of the privileged. They noted that the intergenerational persistence of income and wealth may help shed light on the answer.

The previous blog post in this series noted that income (measured by labor market earnings) appeared to be 33 percent more persistent than wealth. In their Regional Economist article, Gayle and Hincapié also noted that "using one number to summarize the intergenerational persistence of earnings and wealth cannot answer whether such persistence is due to the inability of the poor to escape poverty or the persistence of wealth and income at the top."

"Sticky" Income and Wealth

For further analysis, Gayle and Hincapié examined how "sticky" earnings and wealth positions are from generation to generation. That is, they looked at the likelihood that children end up in the same spot on the economic ladder as their parents.

The authors found that those born to parents in the bottom 20 percent of earners (measured by permanent income, or the average labor market earnings over people's working lives) had a 39 percent chance of remaining in the bottom 20 percent. Those born in the bottom 20 percent of the wealth distribution had a 27 percent chance of staying there. On the other end of the spectrum, those born in the top 20 percent of permanent income and wealth distributions had a 41 and 47 percent chance of staying there, respectively. (Figures showing these transitions are available in The Regional Economist article "Which Persists More from Generation to Generation - Income or Wealth?")

Residual Wealth

Gayle and Hincapié noted that a significant percentage of wealth is explained by permanent income and education. Thus, they also calculated persistence in residual wealth, or wealth net of the effect of permanent income and education.

They found that residual wealth is much less persistent across generations, with an intergenerational elasticity of between 0.17 and 0.21. They wrote: "Hence, more than 50 percent of the persistence in wealth seems to be due to the persistence in permanent income."

Indeed, more mobility is apparent when looking at residual wealth. Gayle and Hincapié noted that 28 percent of children of parents in the top 20 percent ended up in the bottom 40 percent, and 28 percent of children of parents in the bottom 20 percent ended up in the top 40 percent.

Policy Implication

Gayle and Hincapié wrote: "This evidence suggests that policies aimed at human capital advancement, e.g., free preschool for everyone, may be as effective at combating inequality as those aimed at limiting the advantage of the wealthy, e.g., a policy of a high inheritance tax."

Additional Resources

Source

https://www.stlouisfed.org/on-the-economy/2016/august/economic-mobility-residual-wealth-policy-implications

Disclaimer

Views expressed are not necessarily those of the Federal Reserve Bank of St. Louis or of the Federal Reserve System.

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