Income Inequality and Economic Growth: A Re-Examination of Theory and Evidence

We re-examine the theoretical and empirical relationship between income inequality and economic growth in an endogenous growth model with a at tax on income, distributive conflicts among agents and median voter dynamics. We show that when government spends tax revenue on the provision of public goods in the form of both production and consumption services, the theoretical relationship between inequality and economic growth is neither strictly positive nor strictly negative but that it is ambiguous. An empirical evaluation of the theoretical findings is done by applying a semi-parametric model on a sample of 55 low-income, lower-middle-income, upper-middle-income and high-income countries for the period 1980 to 2010. Results show that the relationship between income inequality and growth takes the form of an inverted-U shape in that income inequality initially has a positive impact on growth up to an average Gini coefficient threshold of 35.92 beyond which it negatively impacts on growth.