Corruption and Income Inequality in the United States

I. INTRODUCTION An increasing number of empirical studies (e.g., Keefer and Knack 1997; Knack 1996; Knack and Keefer 1995; Mauro 1995; Mo 2001; Pellegrini and Gerlagh 2004) present persuasive evidence regarding the detrimental effects of corruption on various economic variables such as the growth rate of income. Corruption is defined in all of these studies as the use of public office for private gain. Corruption not only affects the growth rate of income but also affects the income inequality. The benefits from corruption are likely to accrue to the better connected individuals . who belong mostly to high income groups (Gupta, Davoodi, and Alonso-Terme 2002, 23). According to Johnston (1989), corruption favors the "haves" rather than the "have not" particularly if the stakes are large. In other words, the burden of corruption falls disproportionately on low-income individuals. Corruption affects income inequality through several channels. First, individuals who belong to low-income groups pay a higher proportion of their income as bribes than the individuals who belong to high-income groups. A corruption survey conducted by World Bank in Cambodia reveals that low-income individuals on average spend 2.3% of their income on bribes compared to 0.9% for higher income individuals. Second-as Gupta, Davoodi, and Alonso-Terme (2002) argue, corruption generates a tax system which disproportionately favors the high-income individuals. Corruption leads to tax evasion, which in turn leads to lower tax revenues. Lower tax revenues reduce the government's ability to finance programs to improve the distribution of income. Corruption also leads to a less-progressive tax structure worsening the income distribution. Third, corruption causes inequality in asset ownership (Gupta, Davoodi, and Alonso-Terme 2002). As Tanzi (1998) argues, only the better connected individuals get the most profitable government projects. This leads to the creation of a small group of asset owners who have the resources to bribe the government officials and increase their assets even further causing inequality in asset ownership. Because assets are used as collateral to borrow and invest, high inequality in asset ownership reduces the ability of lower income individuals to borrow and invest and hence reduces their opportunities to increase their incomes. Fourth, corruption diverts government spending away from programs that benefit mostly low-income individuals such as education and health to, for example. defense programs that create opportunities for corruption (Chctwym, Chetwyn, and Spector 2003). This creates skill inequality which increases income inequality. Finally, corruption raises the costs of public goods provision and reduces the quantity of public goods provided by the government. As lax revenues are used in the provision of public goods, higher costs lead to higher taxes. This again disproportionately favors high-income individuals for two reasons. First, the low-income individuals are the ones who mostly benefit from public goods provided by the government and second, high-income individuals are the ones who have the resources to evade taxes by bribing the government officials. II. A BRIEF OVERVIEW OF THE LITERATURE Although there are some theoretical studies analyzing the effects of corruption on income inequality (Chong and Gradstein 2007; Eicher, Gareia-Penalosa, and Van Yperspele 2009; Mandal and Marji 2010; Spinesi 2009), surprisingly, there are not too many empirical studies (Chong and Calderon 2000a, 2000b; Gupta, Davoodi, and Alonso-Terme 2002; Gyimah-Brempong 2002; Li. Xu, and Zou 2000; Uslaner 2006, 2008; You and Khagram 2005). Using cross-country data Li, Xu. and Zou (2000) and Chong and Calderon (2000) find an inverse U-shaped relationship between corruption and income inequality. They find a positive relationship between corruption and income inequality in high-income countries and a negative relationship in low-income countries. …