Diversity and redistribution

Abstract

In this paper we analyze the interaction of income and preference heterogeneity in a political economy framework. We ask whether the presence of preference heterogeneity (arising, for example, from different ethnic groups or geographic locations) affects the ability of the poor to extract resources from the rich. We study the equilibrium of a game in which coalitions of individuals form parties, parties propose platforms, and all individuals vote, with the winning policy chosen by plurality. Political parties are restricted to offering platforms that are credible (in that they belong to the Pareto set of their members). The platforms specify the values of two policy tools: a general redistributive tax which is lump-sum rebated (or used to fund a general public good) and a series of taxes whose revenue is used to fund specific (targeted) goods tailored to particular preferences or localities.

Our analysis demonstrates that taste conflict first dilutes but later reinforces class interests. When the degree of taste diversity is low, the equilibrium policy is characterized by some amount of general income redistribution and some targeted transfers. As taste diversity increases in society, the set of equilibrium policies becomes more and more tilted towards special interest groups and against general redistribution. As diversity increases further, however, the only policy that can emerge supports exclusively general redistribution.

Introduction

Societies are heterogeneous both in preferences and in incomes. The consequences of this are manifested in outcomes as diverse as residential and schooling choices to political affiliations, armed conflicts, and breakdowns of society or civil war. From Marxist theories of class struggle to Tiebout models of individual sorting, thinking about heterogeneity among individuals plays a key role in our attempts to understand society.

This paper seeks to understand how diversity in preferences affects the basic conflict between rich and poor, particularly regarding their opposing views on redistribution. More generally, this paper asks how do class and preference conflicts interact? If individuals, particularly those with low income, do not agree on how resources (tax revenue) should be allocated, how does this affect the ability of the poor to press for redistribution? On the one hand, one may think that conflicting preferences over resource allocation may create cleavages among poorer individuals and thus work against their general class interest. On the other hand, the presence of many narrow “special interest groups” may create an incentive for wealthier individuals to ally themselves with the general interest of the poor if this implies a lower overall tax burden. Or, does conflict over the preferred way to allocate resources simply leads to even greater overall redistribution since there are more varied interests to satisfy?

This paper aims to (partially) answer the questions raised above by analyzing how income and preference diversity interact in an environment in which political parties and party platforms are endogenous. The government is assumed to be able to both redistribute income and to fund special interest projects (e.g., local or group-specific public goods), all from proportional income taxation. Individuals differ in income (they can be either “poor” or “rich”) and also as to which special interest project (if any) they benefit from. Heterogeneity in the ability to enjoy a particular project can be thought of as arising directly from differences in preferences (perhaps as a result of different ethnic or religious affiliations) or from differences in geographic locations (if, for example, tax revenue is used to fund local public goods). It can also be thought of as arising from the differential ability of agents to organize themselves in (special interest) groups that then participate in the political arena.

We study the equilibrium of a game in which representatives of different groups form parties, parties propose platforms, and all individuals vote, with the winning policy chosen by plurality. Political parties are restricted to offering platforms that are credible (in that they belong to the Pareto set of their members and hence will not be renegotiated ex post). The platforms specify the values of two policy tools: a general redistributive tax which is lump-sum rebated (or used to fund the general public good) and a series of taxes used to fund the specific (targeted) goods tailored to particular groups, preferences, or localities.

We show that there is an equilibrium in which a party representing the poor wins with a policy of maximum general redistributive taxation. In addition, there also can exist an equilibrium with a heterogeneous political coalition consisting of the rich and a number of interest groups. This coalition engages in a policy of redistribution targeted towards the special interest groups within the coalition and in a lower level of overall redistribution. As the heterogeneous coalition of the rich and the interest groups has an incentive to form to overturn the policy of maximum general redistribution, we focus on its equilibrium platform.

We examine how the policies of the heterogeneous coalition are affected by the degree of diversity in society—i.e., by changes in the probability that any two individuals belong to the same interest group. The degree of diversity matters in this economy since we focus on goods produced with increasing returns to scale. Thus, in the case of geographic diversity, providing a given level of schooling or health care to individuals is more costly if they live in different localities (and hence more schools or hospitals need to be constructed). Or, in the case of preference diversity, providing individuals with a given level of utility from public goods is more costly if they have different tastes over public goods as it requires a greater variety of public goods to be produced (e.g., a park and a school).¹

Our analysis demonstrates that the effect of increased diversity is non-monotonic. Starting from a low level of diversity, we find that increased diversity first serves to dilute class interests, lowering the amount of redistribution from the rich to the poor, but that after some critical level, further increases in diversity reinforce class interests. When the degree of diversity is low, the equilibrium coalition policy is characterized by some degree of general income distribution and some targeted transfers. As a group, however, the poor obtain less income redistribution than if preferences were homogeneous and the rich pay a lower level of total taxes. As diversity increases in society, the set of equilibrium policies this coalition can offer becomes more and more tilted towards the special interest groups and against general redistribution; the poor are made worse off. As diversity increases further, however, this situation is not sustainable. We show that there exists a critical threshold of diversity above which the ruling coalition breaks down and the only policy that can emerge supports exclusively general redistribution. In fact, this policy is identical to the one that would be instituted in the absence of any preference diversity at all. Thus, while at first increased diversity destroys solidarity among different groups of poor individuals, at a sufficiently high level of diversity, conflict in preferences is ignored and the traditional class conflict regains its primacy.

Our paper is organized as follows. In Section 2 we discuss the related theoretical literature. In Section 3 we present the model which includes a description of the economic environment and the political process. Section 4 analyzes the political equilibrium and in Section 5 we examine in depth the effect of diversity on the unique coalition that emerges under these circumstances. We discuss the role of our main assumptions in Section 6 and conclude in Section 7.