The dynamic effects of fiscal discretion on income distribution in the EU-27

Abstract

Based on panel data for the EU-27 from 1990 to 2017, this paper develops a novel three-steps framework to assess the dynamic effects of spending-based discretionary fiscal policy on income distribution and inequality. The steps are the following: 1) extract the discretionary fiscal component by estimating a well-known fiscal rule model, 2) use that com- ponent to estimate the dynamics of income distribution given a discretion’s shock by ARDL models and 3) investigate the short-, medium- and long-term effects by computing IRFs via Local Projections by Jordà, 2005. Overall, I find supportive evidence on the heterogeneity in the response of income distribution to discretionary changes in government spending and a weak performance of discretion in terms of income redistribution durability. Such hetero- geneity is shown as i) a significant and positive, yet transitory, income redistributive power of discretion and ii) a persistent and detrimental impact on the top 1 share of the distribution. In addition, these results complement with i) significant in the short-term and ii) persistent in the long-run inequality alleviation. Such results are robust to multiple specifications regarding lag selection criteria, time indicators inclusion and sign non-linearities (asymmetries).