Income inequality and job creation
May 2021 (revised February 2026)
Summary
Focus
This paper studies how income inequality affects job creation and finds that it reduces the number of jobs created by smaller firms.
Contribution
While existing research looks at the effects of inequality on households, this paper is among the first to show that income inequality also affects businesses. This evidence is based on four decades of data on top income shares across US states, combined with detailed information on job creation by firms of different sizes.
Findings
Rising income inequality reduces job creation by small relative to large firms. High-income households save relatively less in the form of bank deposits than do low-income households. Thus, rising top income shares reduce banks' access to deposits and hence their ability to lend. As small firms depend more on bank financing than large firms, the contraction in lending hinders job creation at small firms. The paper provides evidence for these effects, complementing the analysis with a macroeconomic model for simulation experiments.
Abstract
We propose a novel channel through which rising income inequality affects job creation and macroeconomic outcomes. High-income households save relatively more in stocks and bonds but less in bank deposits. A rising top income share thereby increases the relative financing cost for bank-dependent firms, which in turn create fewer jobs compared to other firms. Exploiting variation in top income shares across US states and an instrumental variable strategy, we provide evidence for this channel. We then build a general equilibrium macroeconomic model with heterogeneous households and heterogeneous firms and calibrate it to our empirical estimates. The model shows that the secular rise in top incomes accounts for 13\% of the decline in the employment share of small firms since 1980. Through the new channel, rising inequality also reduces the labor share and aggregate output. Model experiments show that ignoring the link between inequality and job creation understates welfare effects of income redistribution.
JEL-classification: D22, D31, G21, L25
Keywords: income inequality, job creation, small businesses, bank lending, household heterogeneity, financial frictions
