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Inequality and the size of US state government

Working Paper 2021-594

Abstract

The median voter theory of government size argues that increased income inequality brings about greater demand for redistribution (Meltzer and Richard, 1981). However, this prediction is rejected empirically using US state-level data. Following Luo (2020), with the twist that income inequality is engendered from differences in capital income as well as differences in labor productivity, the purpose of this paper is to analyze how income inequality affects the size of US state government. Inequality induced by differences in capital income, derived from the Panel Study of Income Dynamics data, is found to be negatively associated with state government size. Moreover, this paper shows that capital income inequality plays a key role in poor states, whilst labor income inequality does in rich places regarding the explanation of the change in state government.

Authors: Weijie Luo.

Keywords: capital income, labor income, inequality, size of government
JEL: D78, E62, H10