How Important is Health Inequality for Lifetime Earnings Inequality
Abstract: We study the effect of poor health on labor supply, and its implications for lifetime earnings inequality. Using a dynamic panel approach, we provide empirical evidence that negative health shocks significantly reduce earnings. The effect is primarily driven by the participation margin and is concentrated in less educated and poor health individuals. Next, we develop a life cycle model of labor supply featuring risky and heterogeneous health profiles that affect individuals' productivity, likelihood of access to social insurance, disutility from work, mortality, and medical expenses. Individuals can either work, or not work and apply for social security disability insurance (SSDI/SSI). Eliminating health inequality in our model reduces the variance of log lifetime (accumulated) earnings by 30 percent at age 65. About two-third of this effect is due to the impact of poor health on the probability of obtaining SSDI/SSI benefits. Despite this, we show that eliminating the SSDI/SSI program reduces ex ante welfare.