Income Inequality, Tax Policy, and Economic Growth

Source: Siddhartha Biswas, Indraneel Chakraborty, Rong Hai, Becker Friedman Institute for Research in Economics Working Paper No. 2595524, April 7, 2015
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From the abstract:
This paper investigates the impact of reduction of income inequality through tax policy on economic growth. Taxation along different points of the income distribution has a heterogeneous impact on households’ incentives to invest, work, and consume, which may result in a heterogeneous impact on economic growth. The empirical analysis uses U.S. state-level data and micro-level household tax returns over the last three decades. To address potential selection biases in our regression analysis, we utilize both state fixed effects and instrumental variables approaches. We find that, ceteris paribus, reduction of income inequality between low income households and median income households improves economic growth. However, reduction of income inequality through taxation between median income households and high income households reduces economic growth. Further investigation shows that these economic growth effects are attributable both to supply-side factors (changes in small business activity and labor supply) and to consumption demand.