We investigate how the reduction of income inequality through tax policy affects economic growth. Taxation at different points of the income distribution has heterogeneous impacts on households’ incentives to work, invest, and consume. Using US state‐level data and micro‐level household tax returns over the last three decades, we find that reducing income inequality between low and median income households improves economic growth. However, reducing income inequality through taxation between median and high‐income households reduces economic growth. These asymmetric economic growth effects are attributable both to supply‐side factors (i.e. changes in small business activity and labour supply) and to consumption demand.

We thank Dean Corbae, Mariacristina De Nardi, Lance Lochner, Steve Stern, and participants at the Human Capital and Inequality Conference held at Chicago on December 17th, 2015, for helpful comments and suggestions on an earlier draft of this paper. We also thank Joseph Altonji,

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We thank Dean Corbae, Mariacristina De Nardi, Lance Lochner, Steve Stern, and participants at the Human Capital and Inequality Conference held at Chicago on December 17th, 2015, for helpful comments and suggestions on an earlier draft of this paper. We also thank Joseph Altonji,

No abstract