Share of wealth held by the top one percent in the U.S. has increased from 24% in 1980 to 42% in 2012. In this paper, we examine the potential role played by three factors in accounting for this increase: the decline in the progressivity of taxes and the increase in income inequality in the U.S., as well as the decline in the world interest rates. Our model consists of altruistic households who either run a business or work for others. Entrepreneurial households enjoy high returns due to high productivity while the worker household savings earn the bank deposit rate that is determined in a competitive banking sector that equals the rate of return on foreign bonds. While the model economy is calibrated to match the wealth inequality in the U.S. it has other properties that have been difficult to capture in standard life-cycle models such as a positive relationship between life-time income levels and saving rates. We find that the decline in the interest rate plays a major role in accounting for the increase in wealth inequality as it effects the two types of households very differently. Entrepreneurial households benefit from lower financing costs and increase their investments while worker households face lower returns to their savings as the interest rate declines. Other changes such as the decline in the progressivity of taxes plays a less significant role.
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