Fiscal Policy and Economic Inequality in the U.S. States

Abstract

To what extent can state governments influence economic inequality? How do state fiscal policies of redistribution affect families in different economic situations? Using a large database of state fiscal policymaking tools (taxing and spending) between 1976 and 2006, we examine the effect of these tools on state-level inequality as well as the average incomes of families in different economic groups. We find that state taxing and spending efforts can influence these indicators of economic inequality, though these fiscal policy tools can have differential effects. Spending on unemployment compensation and cash assistance as well as revenue from taxes on corporations is found to reduce state-level inequality. We also find unemployment compensation to positively benefit the bottom 10th percentile of income earners, whereas the inheritance tax helps all income groups. Corporate tax revenue is associated with higher middle-class incomes, whereas income tax revenue benefits both middle and upper incomes. Sales tax revenue positively benefits wealthy earners. Higher property tax revenue is associated with decreased income for all groups. These results suggest that state governments can affect redistribution through fiscal policies by affecting state-level inequality as well as the economic fortunes of different income groups.