The Shadowing Role of Redistributive Institutions in the Relationship Between Income Inequality and Redistribution

This paper first points out the lack of consensus between empirical and theoretical studies of income inequality and redistribution. While theoretical papers show that income inequality increases redistribution, empirical studies fail to confirm the same result. The paper later shows that even an exogenously given efficiency of redistributive institutions (ERI) affects the relationship between income inequality and redistribution. This paper also introduces three specifications to endogenize ERI. In these various specifications, increasing inequality reduces the ERI when (1) ERI is an increasing function of average income or (2) political influence on ERI is positively associated with income or (3) the median voter has some prospect of upward mobility. There is one common element in these various specifications. While income inequality increases the pressure for redistribution, it also increases the incentive to reduce the efficiency of redistribution in order to constrain aggregate redistribution. Thus, the main conclusion is that one needs to consider these conflicting effects in order to account for the lack of strong empirical evidence of a positive relationship between income inequality and redistribution.