Redistribution and Investment

This paper studies the trade-offs associated with income redistribution in an overlapping generations model in which marginal savings rates increase with permanent income. By transferring permanent income from high savers to low savers, redistribution lowers aggregate savings, and depresses investment in capital. If more capital is welfare improving, the government faces a trade-off between redistribution and investment which depends on the distribution of marginal propensties to save. I estimate this distribution using U.S. household panel data, and use my estimates to calibrate a quantitative overlapping generations model with uninsurable idiosyncratic earnings risk. I study the effects of a simple labor income redistribution policy in this calibrated model and a standard model with homogeneous marginal savings rates. The direct effect of the policy on the permanent income distribution has no effect on capital in a standard model, but a large effect in the calibrated model. This channel accounts for 23% of the drop in aggregate consumption following the policy.