The Effect of Inequality on Growth: Theory and Evidence from the Indian States

The paper examines the effect of inequality on growth among the subnational states in India. Theoretically, growth of the regional economy is driven by productive public investment in the provision of health and education services financed by a linear output tax, and the optimum tax rate is determined by the median voter. In contrast to existing results, the authors obtain an ambiguous relationship between initial inequality and subsequent economic growth. Analysis of the Indian state‐level data suggests that rural inequality influences growth of total output more than urban inequality, and does so negatively. The indicator of intersectoral inequality is more important in explaining sectoral output growth.