Understanding the Effect of Parental Education and Financial Resources on the Intergenerational Transmission of Income

Abstract

There are two essential mechanisms in the canonical model of the transmission of income across generations -- parents' financial resources and parental education. We provide novel empirical evidence to disentangle the significance of these two mechanisms in explaining the intergenerational transmission of income. Two reforms in Sweden provide us with natural experiments to separately identify the effects of parents' financial resources versus parental education: an educational reform that exogenously changed the level of compulsory schooling and quality of education of the parent generation and a tax reform that exogenously altered parents' net income. Using Swedish administrative data, we first find that a 1,000 SEK increase in parental income -- as a result of changes to parental education -- leads to a 280 SEK increase in children's income. Second, exploiting the tax reform, we show that a 1,000 SEK increase in parental income, resulting from changes in parents' financial resources, increases children's income by 74 SEK. The relative impacts of these two mechanisms thus suggest that parents' financial resources amount to about 25% of the effect of parental education on children's income. Third, we show that parents' financial resources matter less for sons. Overall, our findings suggest comparatively modest impact of parental financial resources on children's income.

Keywords: Intergenerational Transmission, Education and Inequality, Government Policy, Personal Income and Other Nonbusiness Taxes and Subsidies

JEL Classification: J62, I24, I28, H24