The local spillover effects of top-income inequality on innovation

The existing literature has widely explored the effects of technological change on income inequality. The reverse relationship – from income inequality to innovation – has received considerably less attention. This paper contributes to filling this gap by advancing and testing the hypothesis that higher levels of top-income inequality have local positive spillovers on entrepreneurship. Our empirical analysis confirms that top-income inequality increases the formation of new establishments and startups across USA cities for the period 2006–2018. Moreover, higher top-income inequality also has quality effects on business formation as it increases the proportion of new high-tech firms. To rationalise these findings, we propose a supply-side mechanism in which high-income households, facing lower marginal utility of income, save more and are more willing to undertake risky investments. Household-level evidence supports this channel, revealing that households in the top-tail of the income distribution display higher risk preferences and a stronger propensity to save.