Decomposing the rich dad effect on income inequality using instrumental variable quantile regression

•We study how the paternal income affects children's income inequality.•We decompose the impacts into the composition effect and income structure effect.•We use an instrumental variable quantile regression-based method.•The composition effect explains at least 80% of the income difference.•Income structure effect has a significant impact only at lower quantiles.

In this paper we evaluate the relative importance of the two main channels, namely the composition effect and the income structure effect, through which the paternal income affects children's income inequality. Using data on 2677 pairs of father and children from China Health and Nutrition Survey (CHNS), we construct the counterfactual income of children from poor families if they had the same characteristics as children from rich families. We propose an instrumental variable quantile regression-based method to solve the endogeneity problem and decompose the rich dad effect on income inequality into the composition effect and the income structure effect. We find that the composition effect explains at least 80% of the income difference at any quantile, and it explains all the income difference at the top four deciles. Income structure effect has a significant impact only at quantiles between 20% and 40%, where it explains about 20% of the income difference.