Tobin's Q and Inequality

Abstract

Since the early 1980s, equity Tobin's Q has experienced a secular increase in the US, as equity wealth and corporate physical capital have followed divergent trajectories. During the same period, labor productivity and wages have significantly decoupled, leading to a decline in the U.S. corporate labor share. We build an incomplete markets model (in the Bewley-Hugget-Aiyagari tradition) with financial assets and monopoly power to explain the connection between these phenomena. Our model is consistent with several stylized facts of the U.S. economy since 1980. The evolution of capital taxation and the rise of monopoly markups explain the decrease in investment flows and the rise in the market value of existing capital. Wage-productivity decoupling is the natural response not only to the rise of markups, but also to investment sluggishness when capital and labor are complements. We therefore reconcile a simultaneous decrease in the labor share and an increase in the market value of capital with an elasticity of substitution below one. Our model also explains the historical upsurge of equity returns. By explicitly modelling the interaction between monopoly profits and different capital taxes, our framework sheds light on the current debate on capital taxation in the U.S. and elsewhere. We conclude that the secular increase in the relative value of financial wealth is not only a nominal phenomenon, but has had real effects in general equilibrium, rendering a more unequal pre-distributive allocation of income. These secular trends in taxes and market structure have reduced welfare, since the increase of financial wealth, which is mostly experienced by the richest households, occurs at the expense of corporate investment and labor earnings, which are the main source of income for a large portion of the population.

Keywords: Tobin's Q, Equity returns, Asset Prices, Capital-Income ratios, Investment, Dividends and Capital Gains Taxes, Corporate Tax, Monopoly markups, Labor Share, Inequality, Welfare

JEL Classification: E25, E44, E22