The Political Economy of Redistributive Taxation and Growth: Reconciling Theory with Evidence∗

The so-called fiscal policy approach predicts that a relatively poorer middle class (i.e., a lower median/mean income ratio) should lead to more redistributive efforts, and thereby to lower growth. While the reduced form prediction appears to be consistent with the data, the individual mechanisms have at best received only limited support. In fact, some studies even find a positive link between the income share of the middle class and redistribution, and between taxation and growth. We construct a political-economy endogenous growth model which demonstrates that these puzzling patterns may arise if one fails to take the impact of economic institutions on growth and inequality into account. We argue this reconciles the theory with the seemingly conflicting evidence