How State Responses to Economic Crisis Shape Income Inequality and Financial Well-Being

Abstract This study examines how state government responses to economic crisis, in the form of unexpected changes in state fiscal policy, influence income inequality. State governments are vital actors in times of fiscal stress as nearly every state must make difficult policy decisions related to taxes and spending to address budget deficits, both of which are policies that shape the income gap. Focusing on periods of fiscal stress is important for the study of state inequality as those with fewer resources are the most likely to experience the consequences of their state’s fiscal response during these times. Using time-series cross-sectional data, this research demonstrates that income inequality increases when states respond to economic crisis by relying on unexpected spending cuts. These effects tend to persist even after initial economic downturns. In addition, one individual-level implication of the aggregate relationship between state policy responses and inequality—that people will be worse off financially when their states emphasize budget cuts in response to economic decline—is assessed using several post–Great Recession surveys. The findings have implications for the future of inequality in the United States and provide potential paths for state fiscal reform.