The Role of Education and Household Composition for Transitory and Permanent Income Inequality. Evidence from PSID Data

Transitory and permanent shocks to income have been shown to be important determinants of household consumption. This paper shows that there are significant differences in the development of transitory and permanent inequality of household income between demographic groups since the 1980s. Using data from the Panel Study of Income Dynamics the educational attainment and the composition of a household are found to play a key role. While permanent inequality increases steadily for educated households, it is flat over large parts of the sample period for the less educated households. Transitory inequality increases for all households headed by couples whereas it is constant for single households. Taken together, permanent shocks explain on average a larger part of the income variance of educated households whereas transitory shocks are relatively more important for the less educated. These results that can be explained by changes to skill demand and an increased female labor force participation are potentially able to explain empirical findings on the transmission of changes in income inequality to consumption inequality.