Accounting for cross-country differences in intergenerational earnings persistence

Western economies exhibit substantial differences in the degree of intergenerational earnings persistence between fathers and sons. Earnings persistence is relatively low in Northern Europe and relatively high in the US, Britain, and Southern Europe. In this paper I first document that there is a strong negative cross-country correlation between intergenerational earnings persistence and tax progressivity, and intergenerational earnings persistence and public expenditure on tertiary education. I then develop an intergenerational life-cycle model of human capital accumulation and earnings, which features progressive taxation, public education expenditure, and borrowing constraints among the determinants of earnings persistence. I calibrate the model to US data and use it to quantify how earnings persistence in the US changes as I introduce policies from Denmark. Denmark is an interesting example because it is the country in my sample with the highest and most progressive taxes and the greatest expenditure on tertiary education, as well as the lowest earnings persistence. I find that the Danish policies would reduce earnings persistence in the US by reducing parental/individual incentives for investing in human capital, thereby creating a weaker relationship between the parent’s financial resources and the child’s earnings. Quantitatively, taxation is more important than education expenditure. Introducing a Danish tax policy in the US reduces the intergenerational elasticity of earnings from 0.47 to 0.35, or about 40% of the difference between the US and the Scandinavian countries, which have the lowest earnings persistence among the countries in my sample. I also find that borrowing constraints have a very limited impact on earnings persistence.