Job Market Paper
This paper investigates the role of changes in households’ portfolio choices in explaining wealth inequality dynamics in three complementary ways. First, a decomposition of changes in US wealth shares between 1989 and 2019 shows that portfolio changes can account for 3.5 p.p. of the total 7.8 p.p. increase in the wealth share of the top 1%, mainly due to wealthy households holding a rising amount of high-return assets. Second, an analytical model shows that portfolio adjustments magnify the impact of a fall in top tax rates on wealth inequality beyond what their direct impact in savings would predict. The decrease in tax rates also induces a shift towards high-return and high-risk assets, which further increases the saving rate and raises the volatility of households' portfolio, leading to higher wealth inequality. Third, I develop a quantitative model of households' savings and portfolio choice and analyse the decrease in US tax rate progressivity since 1975. Relative to when portfolios are kept fixed, allowing households to react by changing their portfolio composition amplifies the impact of taxes on the top 1% wealth share by approximately 20% in the transition dynamics exercise from 1975 to 2019, and by 25% when in the new steady state.