When income differences hurt or excite: The nonlinear effect of regional inequality on subjective wellbeing

Combining information from the European Union Statistics on Income and Living Conditions and the European Social Survey, we investigate the relationship between subjective well‐being and income inequality using regional inequality indicators and individual data. We assume that inequality aversion and perception of social mobility affect the impact of regional inequality on subjective well‐being in opposite directions. We find evidence of an inverse U‐shaped effect of inequality, where inequality starts to have a positive effect on subjective well‐being that becomes negative with a switch point before the average of the Gini index for the entire sample. The rationale for our nonlinear finding is that Hirschman's tunnel effect (and the positive effect of perceived social mobility) prevails for low levels of inequality, while inequality aversion and negative relative income effects are relatively stronger when inequality is higher. Robustness checks on different sample splits are consistent with the hypothesis of the two drivers.