The causal effect of regulation on income inequality across the U.S. states

Abstract

In the last several decades, despite widespread concerns about rising income inequality and increasing federal regulations in the United States, only a small group of researchers have tried exploring and understanding this relationship to date. Relevant empirical studies, overall, find regulations to exacerbate income distribution, thereby increasing income inequality within an economy. Recently, a similar association has been reported for the U.S. However, the existing analysis lacks evidence of a causal effect. Here, I unravel the causal impact of federal regulation of industries on income inequality across the U.S. states for the time span 1990–2013. For this, I address the potential endogeneity of regulation via a non-traditional identification strategy. The results are worth noting. There is reasonable evidence for regulation to be endogenous. Controlling for this yields a positive, statistically, and economically significant impact, implying a substantial increase in income inequality due to increased regulatory restrictions in a state. This contrasts with the findings of the naive estimation strategy, where the endogeneity issue is totally ignored.