How Important Is Health Inequality for Lifetime Earnings Inequality?

Abstract 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 among the less educated and those in poor health. Next, we develop a life-cycle model of labour supply featuring risky and heterogeneous frailty 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 28% at age 55. About 60% 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.