Identifying and Estimating the Longrun Effect of Income Distribution on Aggregate Consumption

Permanent components of income and  consumption are obtained by functional Beveridge-Nelson decomposition of U.S. Consumer Expenditure Survey data. From the permanent income distribution, we identify two factors the level (aggregate) and the spread (redistribution) that affect permanent consumption. Longrun consumption is most positively affected by households with monthly earnings of around $2,000, households with lower income have negative effects on aggregate consumption, and those with $5,000 or more respond little to income redistribution. Limited income sharing across households, high entry barriers, and nontrivial adjustment costs associated with both human and physical capital accumulation may contribute to the empirical findings. Taking the estimated longrun response function as the optimal behavior of households, counterfactual taxation exercises suggest that purely redistributive policies can increase the permanent component of aggregate consumption by 250%.