The counterplan results in overturning Tax and Expenditure Limitations, which independently solves inequality.

At the same time as Harrison and Bluestone's “great U-turn,” in the mid-1970s there was also a surge in antitax activity. On June 6, 1978, California voters approved Proposition 13, the “People's Initiative to Limit Property Taxation,” which placed a constitutional limit on increases in property tax assessments to two percent per year. Also, in 1978, voters approved the "Headlee" tax limitation amendments to the Michigan Constitution, limiting increases in property taxes to the rate of inflation. Two years later, Massachusetts approved Proposition 2½, which limited increases in the property tax (as well as automobile excise taxes) to only 2.5% per year (hence the name). The current era is one where almost every state has some form of Tax and Expenditure Limitations (TELs) legislation for local governments, and most states have self-imposed limits on state governments (Amiel, Deller, & Stallmann, 2009).

The timing of the reversal of income convergence (the Great U-turn) and the tax revolt movement that occurred in the mid to late 1970s could be a coincidence, but it raises important questions. First, was the tax revolt, and specifically the movement in support of TELs, an attempt by those with higher incomes to protect their income or wealth by lowering their taxes? Alternatively, did the desire for lower taxes by the public result in unintended consequences that exacerbate trends in widening income inequality? Taxes are unequally distributed across income groups and the instruments chosen to limit tax/spending growth—restricting property taxes versus sales taxes or limiting the overall ability to raise taxes or increase expenditures—may have the unintended result of increasing income inequality. Additionally, unintended consequences may be the result of lower revenues and increasing budget inflexibility that result in cuts to programs that address income inequality.

The literature finds that subnational or state-level policies can affect income inequality, positively or negatively. Hatch and Rigby (2015) find that state-level policies, such as social support programs and taxation policy, which can be hindered by TELs, can help reduce income inequality. Kelly and Witko (2012) find that states that tend to be “left-leaning” in terms of fiscal policies tend to have lower growth rates in income inequality than more conservative states, states more likely to impose restrictive TELs. Franko and Witko (2017) find more majoritarian policies are found in states with citizens who are more aware of growing inequality and with left-leaning politicians. At the same time, Bartels (2008), while not specifically addressing the role of TELs in income inequality, lays out a political argument that the rationale behind initiatives such as TELs have exacerbated income inequality. In essence, the presence of TELs limits the flexibility of state governments to implement policies that can help address rising income inequality such as implementing more progressive tax rates relative to income or expanding social support programs.

This study is situated within the broad literature of the impact of political, specifically fiscal, institutions on inequality. In this study, we examine the drivers of state-level income inequality with a focus on how TELs may have influenced those patterns. Arguments about the role of TELs in increasing income inequality include the following: 1) higher-income groups support TELs, particularly limits on the property tax, to protect their assets and income; 2) budget constraints as a result of a TEL result in service cuts that disproportionately affect lower-income groups; 3) there are unintended consequences of people, in general, wanting lower taxes.

The sample frame consists of a panel of the 49 states (we lose one state to missing data) over a 19-year period (1992 to 2010) to model four different measures of state-level income inequality. Generally, the restrictions set up by TELs become binding overtime rather than immediately. There are fourteen states that did not have a TEL during the period under study. In addition, this time period includes two economic cycles, one a major economic downturn, with decreasing and increasing levels of inequality: there was peak in March 2001 and a trough, November 2001: a peak, December 2007, and through, June 2009 (NBER, 2010). Using a pooled panel and time fixed-effects estimators, we find that TELs are associated with income inequality. Revenue and expenditure TELs that are more restrictive are associated with higher levels of income inequality. These results complement the findings of Hatch and Rigby (2015), Kelly and Witko (2012), Bartels (2008) and Franko and Witco (2017) that subnational or state-level policies can have a significant impact, positively or negatively, on income inequality.