Inequality and the Size of US State Government

ABSTRACT

The median voter theory posits that rising income inequality should increase the demand for redistribution. Yet, empirical studies using US state‐level data often reject this prediction. By accounting for labor supply responses to non‐labor income, we show that inequality driven by capital income differences—measured using Panel Study of Income Dynamics data—is negatively associated with state government size. Furthermore, we find that capital income inequality significantly impacts government size in poorer states, whereas labor income inequality is the dominant factor in wealthier states.