Income inequality, size of government, and tax progressivity: A positive theory

Abstract

I investigate the relationship between income inequality and the composition of public spending in redistributive policies. I extend the Meltzer–Richard model of voting over redistribution allowing voters to choose not only the amount of a uniform lump-sum transfer, but also the level of provision of a public good. The governmental budget is balanced; thus these two choices determine the tax rate on labor income. The multidimensionality of the policy space implies that there is no Condorcet winner. I adopt a citizen-candidate model of electoral competition to tackle this problem. I show that the progressivity of the tax system is increasing in the mean-to-median income ratio while the size of the government need not be. This means that higher income inequality implies a more progressive tax system but, in contrast with the traditional analysis, it may also result in a smaller size of government. Such results are consistent with the most recent findings in the empirical literature.