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Inequality and the Size of Government

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  • Weijie Luo
  • Andrew Pickering
  • Paulo Santos Monteiro

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.

Suggested Citation

  • Weijie Luo & Andrew Pickering & Paulo Santos Monteiro, 2017. "Inequality and the Size of Government," Discussion Papers 17/02, Department of Economics, University of York.
    • Handle: RePEc:yor:yorken:17/02
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    References listed on IDEAS

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    Cited by:

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    4. Benos, Nikos & Tsiachtsiras, Georgios, 2019. "Innovation and Income Inequality: World Evidence," MPRA Paper 92050, University Library of Munich, Germany.
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    More about this item

    JEL classification:

    • D78 - Microeconomics - - Analysis of Collective Decision-Making - - - Positive Analysis of Policy Formulation and Implementation
    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy; Modern Monetary Theory
    • H10 - Public Economics - - Structure and Scope of Government - - - General

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