Income Inequality and Job Creation

Abstract

This paper shows that rising top income shares affect job creation at firms of different sizes. High-income households save relatively more in stocks and bonds, and less in bank deposits. We propose that a higher income share of top earners therefore channels funds to large firms, but tightens financing conditions for small, bank-dependent firms. In turn, small firms create relatively fewer jobs. Exploiting variation in top incomes across US states and an instrumental variable strategy, we establish that an increase in the top 10% income share reduces the job creation rate of small firms, relative to large firms. Very small firms and those in bank-dependent industries are most affected. Experiments in a quantitative macroeconomic model show that growing top incomes account for 16% of the decline in the employment share of small firms since 1980, and that ignoring the link between inequality and job creation understates welfare effects of income redistribution.

Keywords: bank lending, Financial Frictions, Household heterogeneity, Income inequality, job creation, small businesses

JEL Classification: D22, D31, E44, L25