Income Skewness, Redistribution and Growth: A Reconciliation

The so-called "fiscal policy approach predicts that increases in income skewness should be associated with an intensification of redistributive efforts, at least in democracies. If redistribution is detrimental to growth, then this implies that a poor middle class is bad for long-run productivity; a prediction which has found empirical support. However, cross-country studies tend to find a negative association between income skewness and the amount of redistribution taking place, and, a positive relationship between redistributive taxation and growth. This paper offers a reconciliation of the existing theory and these puzzling findings. Specifically, the model predicts that the traditionally stipulated chains of causality holds within countries, whereas the puzzling correlations mentioned above may arise across countries. We provide a test of our explanation and find support for our approach using data on income taxes, taxes on property and expenditures on education.