Inequality, segregation, and redistribution

Mainstream economic theory predicts that countries with large inequalities in pre-tax income distribution will be more redistributive than countries which are more equal in this respect. Empirical studies, however, offer no strong support for this theoretical prediction. In fact, a number of studies indicate that the opposite may be true, namely that countries which are more equal in terms of pre-tax income distribution are more redistributive than less egalitarian societies. The present paper offers an explanation to this puzzle. In a model of endogenous choice of location and endogenous aversion against inequality, we argue that large pre-tax differences in income may lead to a residential segregation of rich and poor. Such segregation may reduce the social attachment between groups in society, and reduce the willingness of the rich to make transfers to the poor. Conversely, societies with small pre-tax differences in income may be characterized by larger transfers and a less segregated population structure.