Effect of Government Policies on Urban and Rural Income Inequality

We use three conventional inequality indices—the Gini, the coefficient of variation of income, and the relative mean deviation of income—and the Atkinson index to examine the effect of income tax rates, the minimum wage, and all the major government welfare and transfer programs on the evolution of income inequality for rural and urban areas by state from 1981-1997. We find that these programs have qualitatively similar but quantitatively different effects on urban and rural areas. Most importantly, taxes are more effective in redistributing income in urban than in rural areas, while welfare and other government transfer programs play a relatively larger role in rural area. Effect of Government Policies on Urban and Rural Income Inequality Although income inequality has increased substantially in both urban and rural areas of the United States over the past two decades, the levels of inequality in these areas have evolved differently. We investigate whether these alternate paths are due to different responses to changes in taxes, minimum wage laws, social insurance policies, and transfer programs. We find that government policies have had qualitatively similar but quantitatively different effects on rural and urban areas. Given these quantitative differences, some policies that effectively reduce inequality in urban areas do not work well in rural areas. Using Current Population Survey data for 1981 through 1997, we examine the effects of eight major government policies on welfare using the Atkinson index as well three traditional inequality measures: the Gini index, coefficient of variation of income, and the relative mean deviation of income. In addition to examining the distributional impacts of government policy variables, we determine how changes in macro conditions and demographic variables over time and across the states affect inequality. Our study differs from the literature in four ways. First, we examine the effects of many policies and macro variables at once. Most previous studies considered the effect of only a single policy, ignoring the influences of other government policies, market conditions, and demographics (See references in Moffitt, 1992). Second, we examine the effects of policies on the entire income distribution rather than focusing on income effects of only low-paid workers as have most previous studies. Third, we examine policy effects on both pre-tax and post-tax income inequality in urban and rural areas.