How Does Fiscal Consolidation Impact on Income Inequality?

Abstract

The authors wish to thank Prof. Sushanta Mallick and to participants to a seminar at the Banque De France for helpful comments. The opinions expressed herein are those of the authors and do not necessarily reflect those of the Banque de France. AbstractIn this paper, we assess the impact of fiscal consolidation on income inequality. Using a panel of 18 industrialized countries from 1978 to 2009, we find that income inequality significantly rises during periods of fiscal consolidation. In addition, while fiscal policy that is driven by spending cuts seems to be detrimental for income distribution, tax hikes seem to have an equalizing effect. We also show that the size of the fiscal consolidation program (in percentage of GDP) has an impact on income inequality. In particular, when consolidation plans represent a small share of GDP, the income gap widens, suggesting that the burden associated with the effort affects disproportionately households at the bottom of the income distribution. Considering the linkages between banking crises and fiscal consolidation, we find that the effect on the income gap is amplified when fiscal adjustments take place after the resolution of such financial turmoils. Similarly, fiscal consolidation programs combined with inflation are likely to increase inequality and the effects of fiscal adjustments on inequality are amplified during periods of relatively low growth. Our results also provide support for a nonlinear relationship between inequality and income and corroborate the idea that trade can promote a more equal distribution of income.Keywords: Fiscal consolidation, income inequality, Kuznets curve. JEL: E62, E64, D63. RésuméDans cet article, nous évaluons l'impact de la consolidation budgétaire sur l'inégalité des revenus. Utilisant un panel de 18 pays industrialisés de 1978 à 2009, nous constatons que l'inégalité des revenus augmente de façon significative pendant les périodes de consolidation budgétaire. En outre, alors qu'une consolidation axée sur la réduction des dépenses semble être préjudiciable pour la distribution des revenus, des hausses d'impôts semblent avoir un effet égalisateur. Nous montrons aussi que la taille du programme de consolidation budgétaire (en pourcentage du PIB) a un impact sur l'inégalité des revenus. En particulier, lorsque les plans de consolidation ne représentent qu'une faible part du PIB, l'écart de revenu se creuse, ce qui suggère que le fardeau associé à l'effort affecte de manière disproportionnée les ménages au bas de la distribution des revenus. Considérant les liens entre crises bancaires et l'assainissement budgétaire, nous constatons que l'effet sur l'écart de revenu est amplifié lorsque des ajustements budgétaires ont lieu après la résolution de ces tourmentes financières. De même, les programmes d'assainissement budgétaire accompagnés d'inflation forte sont susceptibles d'accroître les inégalités et les effets des ajustements budgétaires sur l'inégalité sont amplifiés durant les périodes de croissance relativement faible. Nos résulta...

Functional components of public expenditure, fiscal consolidations, and economic activity

“…Ball et al. () and Agnello and Sousa () corroborate this finding. Moreover, Agnello and Sousa () shows that consolidations driven by spending cuts are more detrimental for income distribution than those driven by tax hikes.…”

“…The distributional effects of fiscal austerity are also under the scope of some studies (Agnello, Fazio, & Sousa, ; Agnello & Sousa, ; Ball et al., ; Furceri, Jalles, & Loungani, ; Mulas‐Granados, ; among others). Income inequality is observed to rise during fiscal consolidations especially if they are spending‐driven.…”

“…For example, Turrini () shows that this impact is temporary and relevant only for public expenditures. A few recent papers are moving the focus of the analysis to the distributional effects of fiscal austerity measures (see, e.g., Agnello & Sousa, ; Ball, Furceri, Leigh, & Loungani, ).…”

The Impact of Fiscal Consolidation on Human Development

“…Mulas‐Granados () shows that fiscal adjustments influence the trade‐off between economic growth and income inequality. Using data for a panel of 18 industrialized countries over the period 1978–2009, Agnello and Sousa () highlight that periods of fiscal consolidation are associated with a rise in income inequality. Moreover, while austerity measures that are driven by spending cuts are particularly detrimental for income distribution, tax hikes tend to be more equitative.…”

“…In the aftermath of the Great Recession and the subsequent emergence of the sovereign debt crisis, a great deal of attention has shifted towards the need to understand the effects of fiscal consolidation packages on the income level and its distribution, or to assess the macroeconomic, political and institutional drivers of the duration of such fiscal adjustments (Mallick & Mohsin, , 2010; Rafiq & Mallick, ; Agnello, Castro & Sousa, ; Agnello & Sousa, ).…”