Abstract

Top incomes are often related to Pareto distribution. To date, economists have mostly used Pareto Type I distribution to model the upper tail of income and wealth distribution. It is a parametric distribution, with an attractive property, that can be easily linked to economic theory. In this paper, we first show that modelling top incomes with Pareto Type I distribution can lead to severe over-estimation of inequality, even with millions of observations. To overcome this problem, we then show that other Pareto distributions should be used. Two applications illustrate these characteristics, with the distribution of income in South Africa in 2012 and the distribution of wealth in the United States in 2013.