Social Segregation, Misperceptions, and Emergent Cyclical Choice Patterns

This paper examines the puzzle of why economic inequality has not resulted in political countermeasures
to mitigate it, and proposes that the reason is due to misperceptions of economic inequality caused by
segregation in social networks. We model taxation and voting behavior with an exponential income
distribution and a Random Geometric Graph-type model to represent homophily, which leads to people
perceiving their own income rank and income to be close to the middle. We find that people base their
beliefs about mean income on a compound of the true mean and their local perception in the network,
and that higher homophily causes lower implemented tax rates, which explains why redistribution
preferences appear decoupled from actual inequality. In a dynamic extension, we also demonstrate that a
rich set of dynamic behaviours can emerge from rational updating beliefs about efficiency. Misperceptions
not only decrease redistribution in a static setting, they also hinder agents from adapting and learning
towards the unbiased tax rate in a dynamic sense. As policy implications, we suggest two measures to
counteract this: educating people about the actual income distribution and promoting diversity to reduce
homophily.