When health affects income (and viceversa): Policy transmission in a heterogeneous agent life-cycle model

Abstract. Both health and wealth are distributed heterogeneously across the population. These two dimensions are empirically linked by a robust positive correlation between income and life expectancy. Yet the mechanisms underlying this link and the implications for eco-nomic policy remain incompletely understood. This paper develops a life-cycle model with heterogeneous agents to explore the bidirectional relationship between income and health: higher income enables greater health investment, while better health enhances productiv-ity and therefore earnings. We calibrate the model to U.S. data, capturing key empirical aspects of the distribution of income, health and age-at-death. We show that the income-to-health channel is more important early in life, while the health-to-income channel dominates at older ages. We then use this framework to evaluate policies aimed at redistribution or health. We find that income redistribution, while reducing inequality, weakens individuals’ incentives to invest in health, lowering both average life expectancy and aggregate income. In contrast, health subsidies enhance health, raising both longevity and economic output, without reducing income inequality.
JEL Codes: C60, D15, H24, H51, I12, I14.
Keywords: Health, Income, Heterogeneity, Life-cycle model, Policies.