Income Inequality and the Size of the Public Sector

This paper focuses on the question of how income inequality between two jurisdictions impacts upon government decision-making affecting the size of the public sector. We model policy choices as the outcome of regional representatives' negotiations in the legislature. We show that the more unequal income distribution is, the greater the degree of inefficiency in terms of under-provision of public goods. Particularly, a divergent income trend between rich and poor makes interregional redistributive conflicts more dramatic. Consequently, the larger the income disparity, the smaller the public sector. A wealthier economy as a result may lead to a relatively smaller public sector when income disparity increases.