Inequality and the Size of Government

Weijie Luo; Andrew Christopher Pickering; Paulo Santos Monteiro

Inequality and the Size of Government

Weijie Luo, Andrew Christopher Pickering, Paulo Santos Monteiro

Economics

Research output: Working paper › Discussion paper

Abstract

The median voter theory of government size predicts that greater inequality leads to greater demand for redistribution and larger government (Meltzer and Richard, 1981). However, this prediction is often rejected empirically. This paper distinguishes between income inequality induced by differences in labor productivity and income inequality induced by differences in capital income. Whilst the standard argument applies to productivity-induced income inequality, greater capital income inequality leads to smaller government if, as often observed, capital income is difficult to tax. Using OECD data, government size and capital income inequality (proxied by the top 1% income share) are found to be negatively related in both fixed effects and instrumental variable regressions. Moreover, controlling for capital income inequality yields a positive and significant relationship between government size and labor income inequality, as originally conjectured.

Original language	English
Pages	1-37
Number of pages	37
Publication status	Published - 17 Feb 2017

Keywords

capital income
inequality
size of government

Access to Document

https://www.york.ac.uk/media/economics/documents/discussionpapers/2017/1702.pdf

Cite this

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AB - The median voter theory of government size predicts that greater inequality leads to greater demand for redistribution and larger government (Meltzer and Richard, 1981). However, this prediction is often rejected empirically. This paper distinguishes between income inequality induced by differences in labor productivity and income inequality induced by differences in capital income. Whilst the standard argument applies to productivity-induced income inequality, greater capital income inequality leads to smaller government if, as often observed, capital income is difficult to tax. Using OECD data, government size and capital income inequality (proxied by the top 1% income share) are found to be negatively related in both fixed effects and instrumental variable regressions. Moreover, controlling for capital income inequality yields a positive and significant relationship between government size and labor income inequality, as originally conjectured.

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