Leah Platt Boustan (UCLA, Department of Economics), Fernando V. Ferreira (University of Pennsylvania,  Wharton School), Hernan Winkler (UCLA, Department of Economics) & Eric M. Zolt (UCLA School of Law) have posted Income Equality and Local Government in the United States, 1970-2000 on SSRN. Here is the abstract:

The income distribution in many developed countries widened dramatically from 1970 to 2000. Scholars speculate that inequality contributes to a host of social ills by weakening the public sector. In contrast, we find that growing inequality is associated with an expansion in revenues and expenditures on a wide range of services at the municipal and school district levels in the United States. These results are robust to a number of model specifications, including instrumental variables that deal with the endogencity of local expenditures. Our results are inconsistent with models that predict heterogeneous societies provide lower levels of public goods.