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Inequality and the Size of Government

Weijie Luo, Andrew Pickering () and Paulo Santos Monteiro ()

Discussion Papers from Department of Economics, University of York

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.

JEL-codes: D78 E62 H10 (search for similar items in EconPapers)
Date: 2017-02
New Economics Papers: this item is included in nep-mac, nep-pbe and nep-pub
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