The End of the American Dream? Inequality and Segregation in US cities

Since the '80s the US has experienced not only a steady increase in income inequality, but also a contemporaneous increase in residential segregation by income. Using US Census data, we document a positive correlation between income inequality and residential segregation between 1980 and 2010, both across time and across space, at the MSA level. We then develop a general equilibrium overlapping generations model where parents choose the neighborhood where to raise their children and invest in their children's human capital. In the model, segregation and inequality amplify each other because of a local spillover that affects the returns to education. We calibrate the model to 1980 using Census data and the micro estimates of the local spillover effect derived by Chetty and Hendren (2018b). We then hit the economy with a skill premium shock and show that 20% of the increase in inequality in the short run, and 29% in the long run can be attributed to the feedback effect of the local spillover.