ILO Research Paper No. 1

Income Inequality, Redistribution and Poverty: Contrasting rational choice and behavioural perspectives

This paper revisits the relationship between inequality and redistribution. The findings challenge the narrow concept of rational choice and points towards fairness orientations, which is emphasized in behavioural economics for a better understanding of redistributive outcomes.

Based on the standard axiom of individual utility maximization, rational choice has postulated that higher income inequality translates into greater redistribution by shaping the median voter’s preferences. While numerous papers have tested this proposition, the literature has remained divided over the appropriate measure for redistribution. Revisiting the original contribution by Meltzer and Richard, the present paper argues that the median voter hypothesis implies that relative redistribution should increase in line with inequality. An empirical test based on 110 observations from the Luxembourg Income Study fails to find any support for the hypothesis. By contrast, voters’ actual preferences offer a better guide to understanding redistributive outcomes. The findings challenge the narrow concept of human motivation that underpins rational choice, and point to the importance of fairness orientations that have been emphasized in behavioural economics.