How Important Is Health Inequality for Lifetime Earnings Inequality?

Roozbeh Hosseini, Karen Kopecky, and Kai Zhao
Working Paper 2021-01
January 2021

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Abstract: Using a dynamic panel approach, we provide empirical evidence that negative health shocks reduce earnings. The effect is primarily driven by the participation margin and is concentrated in less educated individuals and those with poor health. We build a dynamic, general equilibrium, life cycle model that is consistent with these findings. In the model, individuals whose health is risky and heterogeneous choose to either work, or not work and apply for social security disability insurance (SSDI). Health affects individuals’ productivity, SSDI access, disutility from work, mortality, and medical expenses. Calibrating the model to the United States, we find that health inequality is an important source of lifetime earnings inequality: nearly 29 percent of the variation in lifetime earnings at age 65 is due to the fact that Americans face risky and heterogeneous life cycle health profiles. A decomposition exercise reveals that the primary reason why individuals in the United States in poor health have low lifetime earnings is because they have a high probability of obtaining SSDI benefits. In other words, the SSDI program is an important contributor to lifetime earnings inequality. Despite this, we show that it is ex ante welfare improving and, if anything, should be expanded.

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; Hannes Schwandt and David Wiczer for insightful discussions; and R. Anton Braun, Mariacristina De Nardi, Eric French, Dirk Krueger, Kjetil Storessletten, and Richard Rogerson for feedback. They also thank attendees at the Institute for Fiscal Studies conference on Inequality and Transfers over the Life Cycle, the Federal Reserve Bank of San Francisco conference on Micro-Macro Labor Economics, the Barcelona Graduate School of Economics Summer Forum, the Michigan Retirement and Disability Research Center's Researcher Workshop, Shanghai Macro Workshop, and participants at the Society for Economic Dynamics, Midwest Macro, and Southern Economic Association meetings. The authors also thank seminar participants at Bank of Canada, Purdue, PHBS, UAB-IAE, the University of California, Santa Barbara, the University of Hawaii, the University of Minnesota, McMaster University, the University of Southern California's Marshall School, the University of Alabama, the Federal Reserve Bank of Philadelphia, Vanderbilt University, William and Mary, the University of Houston, and the University of Tokyo. See the online appendix Adobe PDF file formatOff-site link 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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