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Report

Income Inequality and Job Creation


Abstract: This paper shows that changes in top income shares affect job creation at firms of different sizes. High-income households save relatively more in stocks and bonds, and relatively less in bank deposits. We propose that a higher share of income accruing to top earners therefore channels funds to large firms, but tightens financing conditions for small, bank-dependent firms. In turn, small firms create fewer jobs than large firms. Exploiting variation in top incomes across U.S. states and an instrumental variable strategy, we estimate that a 10 percentage point (p.p.) increase in the income share of the top 10 percent reduces the net job creation rate of small firms by 2.5 p.p. relative to large firms. Very small firms and those in bank-dependent industries are most affected. Experiments in a quantitative macro model show that growing top incomes account for 16 percent of the overall decline in the employment share of small firms since 1980. The model also reveals that not taking into account the link between inequality and job creation understates the welfare effects of income redistribution.

Keywords: income inequality; job creation; small businesses; bank lending; household heterogeneity; financial frictions;

JEL Classification: D22; D31; E44; L25;

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Bibliographic Information

Provider: Federal Reserve Bank of New York

Part of Series: Staff Reports

Publication Date: 2022-06-01

Number: 1021