Designing a leaky bucket: Meltzer and Richard (1981) with endogenous ineffi ciency in redistributive institutions

Contrary to what Meltzer and Richard (1981) assume, and due to inefficient in-kind transfers, the administrative costs of enforcement and redistribution, the tax payers cost of compli- ance and non-compliance, what tax payers paid for income redistribution is never completely redistributed. Extending their model, we study the relationship between inequality and redistribution when there are endogenously determined inefficiencies (leakage) in re-distributive institutions. The level of leakage is decided on in a constitutional period by a designing voter that ranks higher than median. By increasing the cost of redistribution, the leakage reduces future medianís demand for equilibrium redistribution; it also increases the incentives to work and the future income. In societies with high (low) levels of initial inequality, the designing voter sets inefficient (efficient) redistributive institutions. Since the past inequality reduces the demand for redistribution (through leakage) and current inequality increases the demand for redistribution, the net effect of inequality on redistribution is not clear. This provides an explanation for the weak correlation between income inequality and equilibrium redistribution obtained in many cross-country regressions.