Pareto models for top incomes and wealth

Our article, Pareto models for top incomes and wealth, writen with Emmanuel Flachaire, just got published in the Special Issue of the The Journal of Economic Inequality, on “Finding the Upper Tail”.

Top incomes are often related to Pareto distribution. To date, economists have mostly used Pareto Type I distribution to model the upper tail of income and wealth distribution. It is a parametric distribution, with interesting properties, that can be easily linked to economic theory. In this paper, we first show that modeling top incomes with Pareto Type I distribution can lead to biased estimation of inequality, even with millions of observations. Then, we show that the Generalized Pareto distribution and, even more, the Extended Pareto distribution, are much less sensitive to the choice of the threshold. Thus, they can provide more reliable results. We discuss different types of bias that could be encountered in empirical studies and, we provide some guidance for practice. To illustrate, two applications are investigated, on the distribution of income in South Africa in 2012 and on the distribution of wealth in the United States in 2013.

One thought on “Pareto models for top incomes and wealth”

  1. une référence à lire sur la distribution : Geerolf, F. (2017). A theory of Pareto distributions. UCLA manuscript.

    A strong empirical regularity is that the distributions of firm size and labor income are Pareto in the upper tail. This paper shows that Pareto tails may arise from some production functions in static assignment models with complementarities. Under limited assumptions on primitives’ distribution, these models then generate Pareto tails for the span of control of CEOs and intermediary managers, and Zipf’s law for firm size. This novel justification for Pareto tails sheds new light on why firm size and labor income are so heterogeneous despite small observable differences. The model receives substantial support in French matched employeremployee data.

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