The Political Economy of Income Inequality and Redistribution

This dissertation addresses three interlinked questions that revolve around the theoretical finding of Meltzer and Richard (1981) which predicts a monotonic relationship between income inequality and redistribution. Chapter one studies an overlapping-generations political economy where all young, who differ in their productivity, and old agents vote on two tax rates, levied on the young’s income. These tax rates finance social security system and intragenerational income redistribution. We characterise a unique sequential voting equilibrium where both programmes survive if intragenerational income redistribution’s median voter has lower income than generalized mean. We show that a rise in generalised mean income increases the size of social security, decreasing the size of intragenerational income redistribution. We conclude that, unlike the Meltzer and Richard’s (1981) result, monotonicity between intragenerational redistribution and income inequality disappears in a bidimensional policy space. Chapter two analyses the effect of in-group altruism on redistribution. All consumers, who differ in their productivity and belong to different social groups, vote over a redistributive tax rate. We show that in presence of in-group altruism, agents’ preferred tax rate depends on their income, the generalised mean income and on their social groups’ average income. We conclude that rich prefer high, and poor prefer low redistribution, and that the decisive voter may not have necessarily the median income. Chapter three studies how effective tax revenues are allocated to cash versus in-kind transfers. Agents with pretax income differences vote over a tax rate and the allocation of effective tax revenues to in-kind and cash transfers. We find that agents choose only in-kind transfers if the median voter’s has high income and an increase in income inequality increases the equilibrium tax rate. If median voter has sufficiently low income, both transfers are chosen and an increase in income inequality increases the equilibrium tax rate and in-kind transfers.