Can redistributive state taxes reduce inequality?

Abstract

Do income taxes levied at a state or regional level affect the after-tax distribution of income? Or do workers merely move between regions, causing pre-tax wages to adjust? This question is relevant both in across states in the United States, and across countries within the European Union. Using the full income tax parameters for all US states from 1977-2002, I create a “simulated tax redistribution index”, which captures the mechanical impact of the changes in tax policy on the gini coefficient, but is exogenous to any behavioral response. Analyzing the effect of this redistribution index on inequality, I find that gross wages do not adjust so as to fully offset the effect of more redistributive taxes. Exploring the adjustment process further, I create a new class of tax redistribution measures, based on the S-Gini, which differentially weight effects at the bottom and top of the distribution, and conclude that neither taxes that particularly affect the rich or the poor seem to affect the distribution of wages. Redistributive taxes do not appear to affect interstate migration or total state personal income. From a political economy perspective, I also find some evidence that more inequality leads states to implement more redistributive taxes, which may help explain why earlier studies observed a positive relationship between redistribution and inequality.