Heterogeneity in Talent or in Tastes? Implications for Redistributive Taxation

Do differences in tastes for leisure play an important role in determining income inequality? Using NLSY79 data on the joint distribution of lifecycle earnings and work hours, we fit a simple lifecycle model in which workers are heterogeneous in (i) their ability to accumulate human capital (talent), (ii) their preferences over consumption vs. leisure (taste), and (iii) their initial human capital. We find that tastes play a large role: 71\% of earnings variation at age 44 is due to tastes, rather than talent or initial human capital. These findings are driven by the high standard deviation in "permanent" work hours and a large positive correlation between work hours and earnings. Intuitively, tastes matter because they affect the path of wages via their effect on human capital investment. Finally, we show that exchanging the sources of income variation between talent and tastes changes redistributive tax rates significantly, particularly when heterogeneity is due to differences in the marginal utility of consumption, rather than leisure.