Do policies and institutions matter for pre-tax income inequality? Cross-country evidence

Abstract

Do policies and institutions matter for pre-tax income inequality? I build an annual panel of 43 countries for the period 1980–2016 to document cross-country facts. I find robust correlations between pre-tax income shares and economic policy—financial development, trade openness, government expenditure, and income taxation—even after controlling for economic development. I further find that proxies of institutional quality—e.g., state development, corruption, or political exclusion—mediate the relationship between top income shares and economic policy, in particular for trade openness and government expenditure. The role of institutions in allowing or limiting rent-seeking can rationalize the results.