The Political Effects of Inequality-Increasing Policy: Evidence from a Tax and Welfare Reform

Author – Yonatan Berman.

Abstract :

Income inequality has increased in many developed countries over the past decades. This has been described as “the defining challenge of our time”. A large part of this increase is attributed to changes in redistributive policies that have been prevalent over the past four decades. However, this has not led to substantially-increased support for redistribution. This paper provides evidence that changes in tax and welfare policy have an important electoral effect. The effect is asymmetric. Positively-affected richer voters were more likely to increase their support in parties implementing an inequality-increasing policy change than negatively-affected poorer voters were likely to decrease their support. Such asymmetry sheds light on the reasons inequality-increasing policy may not be met by increased support for redistribution. The paper exploits a major economic reform in Israel that took place in 2003. It negatively affected poorer voters and families with many children, particularly through a large cut in child benefits. It also included a regressive income tax cut, positively affecting richer voters. To assess the electoral consequences of these changes, I combined rich individual-level survey data with municipality-level administrative data. Using a difference-in-differences design, I find that the cut in child benefits had a modest negative impact on support for coalition parties implementing the reform. A 1% reduction in voter income corresponded to a 0.2-0.3 percentage point decrease in the probability of voting for these parties. Conversely, the tax cut had a larger positive impact, with a 1% increase in after-tax income resulting in a 1-2 percentage point increase in the likelihood of voting for the coalition parties. I also explore the origins of these effects. I find the results indicative of identity-based voting that manifests itself in two distinct ways. The first is purely expressive, where voters support parties they identify with for various reasons, but are unlikely to promote policies that are materially beneficial for them. I also observe instrumental identity-based voting, where a specific social identity group, in this case, ultra-orthodox Jews, align their electoral choices with their material interests. In conclusion, the paper identifies clear electoral effects of inequality-increasing fiscal reforms. It highlights their asymmetric effect on poorer and richer voters, which could explain the weak electoral response to rising inequality. It shows that this asymmetry could be the result of rising importance of identity-based voting. The asymmetry can also be due to a higher salience for material issues among richer voters.