Federalism and primary-income inequality

Abstract

ABSTRACT The paper studies the effects of federalism on primary-income (before taxes and transfers) inequality. A jurisdiction in a federal system chooses an economic policy for the interests of the jurisdiction, but the policy is determined uniformly at the national level in a unitary system. A jurisdiction with more resources can choose a higher level of public inputs such as productivity-enhancing investment and hence attract more businesses in a federal system, but a jurisdiction in a unitary system cannot. More business activities result in higher incomes, and income inequality is higher in a federal system than in a unitary system. The paper also provides an empirical analysis, and available evidence suggests that primary-income inequality is higher in a federal system.