The distribution of wealth and scal policy in economies with nitely lived agents

We study the dynamics of the distribution of wealth in an overlapping generation economy with …nitely lived agents and inter-generational transmission of wealth. Financial markets are incomplete, exposing agents to both labor and capital income risk. We show that the stationary wealth distribution is a Pareto distribution in the right tail and that it is capital income risk, rather than labor income, that drives the properties of the right tail of the wealth distribution. We also study analytically the dependence of the distribution of wealth, of wealth inequality in particular, on various …scal policy instruments like capital income taxes and estate taxes, and on di¤erent degrees of social mobility. We show that capital income and estate taxes can signi…cantly reduce wealth inequality, as do institutions favoring social mobility. Finally, we calibrate the economy to match the Lorenz curve of the wealth distribution of the U.S. economy. We gratefully acknowledge Daron Acemoglu’s extensive comments on an earlier paper on the same subject, which have lead us to the formulation in this paper. We also acknowledge the ideas and suggestions of Xavier Gabaix and …ve referees that we incorporated into the paper, as well as the conversations with Marco Bassetto, Gerard Ben Arous, Alberto Bressan, Bei Cao, In-Koo Cho, Gianluca Clementi, Isabel Correia, Mariacristina De Nardi, Raquel Fernandez, Leslie Greengard, Frank Hoppensteadt, Boyan Jovanovic, Stefan Krasa, Nobu Kiyotaki, Guy Laroque, John Leahy, Omar Licandro, Andrea Moro, Jun Nie, Chris Phelan, Alexander Roitershtein, Hamid Sabourian, Benoite de Saporta, Tom Sargent, Ennio Stacchetti, Pedro Teles,Viktor Tsyrennikov, Gianluca Violante, Ivan Werning, Ed Wol¤, and Zheng Yang. Thanks to Nicola Scalzo and Eleonora Patacchini for help with ”impossible”Pareto references in dusty libraries. We also gratefully acknowledge Viktor Tsyrennikov’s expert research assistance. This paper is part of the Polarization and Con‡ict Project CIT-2-CT-2004-506084 funded by the European Commission-DG Research Sixth Framework Programme.