This paper examines how happiness affects the income generating capacity of individuals and thereby the distribution of income. It is hypothesized that happiness impacts upon the income generating capacity of individuals directly by stimulating work efficiency, and indirectly by affecting their allocation of time for paid work. Both these effects of happiness on income are tested in a model consisting of an income generating function and a work-hour equation. The Australian panel survey data from the first 14 Waves of HILDA (2001-2014) are used to estimate the model. The income flows of happiness and other variables obtained from the model are inserted into the inequality decomposition equations (rules) to obtain their relative contributions. The study concludes that happiness has a positive and significant effect on income generation and contributes to the reduction of inequality in Australia.