Roozbeh Hosseini, Karen Kopecky, and Kai Zhao
Working Paper 2021-1a
January 2021 (Revised November 2021)

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Abstract: We study the effect of poor health on labor supply and its implications for lifetime earnings inequality. Using a dynamic panel approach, we provide empirical evidence that negative health shocks significantly reduce earnings. The effect is primarily driven by the participation margin and is concentrated among the less educated and those in poor health. Next, we develop a life cycle model of labor supply featuring risky and heterogeneous health profiles that affect individuals' productivity, likelihood of access to social insurance, disutility from work, mortality, and medical expenses. Individuals can either work or not work and apply for social security disability insurance (SSDI/SSI). Eliminating health inequality in our model reduces the variance of log lifetime (accumulated) earnings by 30 percent at age 65. About two-thirds of this effect is due to the impact of poor health on the probability of obtaining SSDI/SSI benefits. Despite this, we show that eliminating the SSDI/SSI program reduces ex ante welfare.

JEL classification: D52, D91, E21, H53, I13, I18

Key words: earnings, health, frailty, inequality, disability, dynamic panel estimation, life-cycle models

The authors thank Jordan Herring for outstanding research assistance. They are grateful to Hannes Schwandt and David Wiczer for insightful discussions. They thank R. Anton Braun, Mariacristina De Nardi, Eric French, Dirk Krueger, Hamish Low, Kjetil Storessletten, and Richard Rogerson for feedback. They also thank attendees at the IFS conference on Inequality and Transfers over the Life Cycle, the Federal Reserve Bank of San Francisco conference on Micro-Macro Labor Economics, Barcelona GSE Summer Forum, MRDRC Researcher Workshop, Shanghai Macro Workshop, SED, Midwest Macro, and SEA meetings as well as seminar participants at the Bank of Canada, Purdue, PHBS, UAB-IAE, UCSB, University of Hawaii, University of Minnesota, McMaster University, USC Marshall School, University of Alabama, the Federal Reserve Bank of Philadelphia, Vanderbilt, William and Mary, University of Houston, and University of Tokyo. See the online appendix for supplemental material. The views expressed here are those of the authors and not necessarily those of the Federal Reserve Bank of Atlanta or the Federal Reserve System. Any remaining errors are the authors' responsibility.

Please address questions regarding content to Roozbeh Hosseini, University of Georgia/Federal Reserve Bank of Atlanta; Karen Kopecky, Federal Reserve Bank of Atlanta/Emory University; or Kai Zhao, University of Connecticut.

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