The Growth-Inequality Relationship in A Model with Discrete Occupational Choice and Redistributive Tax

Abstract

Growth-inequality relationship is reexamined in a neo-classical growth model with discrete occupational choice and incomplete markets for human capital. In our model a fiscal redistributive tax program directly impacts the steady state distribution of human capital by influencing the occupational choice of the agents. Growth and income inequality are endogenously driven by the evolution of the proportion of innovators in the economy and the redistributive tax rate. The correlation between growth and factor shares depends crucially on the interaction between the redistributive tax policy and the initial distribution of human capital. The model predicts that the growth rate and income inequality are positively related across countries with different redistributive tax regimes. On the other hand, countries with different redistributive tax regimes as well as different initial distribution of human capital do not show any robust correlation between growth and inequality. The correlation depends on the skill intensity of the production technology and the degree of institutional barriers to knowledge diffusion. The lesson from the cross-country growth-inequality regression is that it is necessary to adequately control for the differences in initial distribution of human capital, and technology, as well as differences in redistributive tax regimes.