Entrepreneurship and Income Distribution Dynamics: Why Are Top Income Earners Unaffected by Business Cycles?

Business cycles affect income shares of low- and high-income groups in the U.S. economy. Income shares of the bottom three income quintiles are procyclical; while those of the other quintiles are countercyclical. However, the very top five percent income group is unaffected by the business cycle. This study attempts to explain the cyclical behavior of the income distribution over the business cycle, focusing on the top five percent income earners' share, by incorporating an entrepreneurial choice to a heterogeneous agent model with indivisible labor. Two main results emerge. First, the model economy success fully reproduces the acyclical behavior of the income share of the top five percent income earners. Economic expansions allow top income earners to have more entrepreneurial opportunities, which offset a decline in the income share of the top income earners from the workers' side. Second, the model economy replicates reasonably well the income transition matrices over occupational choices obtained from the U.S. data, which documents that entrepreneurial activities are shown to be related to upward movement to higher income groups.