Economics Working Paper WP15110
This paper is a positive theory of the distribution of income and the growth rate of the economy. It builds on our earlier work, Meltzer and Richard (1981), on the size of government. How does the distribution of income change as an economy grows? To answer this question we build a model of a labor economy in which consumers have diverse productivity. The government imposes a linear income tax which funds equal per capita redistribution. The tax rate is set in a sequence of single issue election in which the median productivity individual is decisive. Economic growth is the result of using a learning by doing technology, so higher taxes discourage labor causing the growth rate of the economy to fall. The distribution of productivity can widen due to an exogenous increase in technological specialization. This causes voters to raise the equilibrium tax rate and reduce growth. The distribution of pre-tax income widens. We calibrate the model using data from the U.S., U.K. and France. The results of the calibration show that the model is consistent with the facts about changes in income distribution over time in developed countries.