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How does Fiscal Consolidation Impact on Income Inequality?

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  • L, Agnello.
  • R, M. Sousa.

Abstract

In 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.

Suggested Citation

  • L, Agnello. & R, M. Sousa., 2012. "How does Fiscal Consolidation Impact on Income Inequality?," Working papers 382, Banque de France.
    • Handle: RePEc:bfr:banfra:382
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    More about this item

    Keywords

    Fiscal consolidation; income inequality; Kuznets curve.;
    All these keywords.

    JEL classification:

    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy; Modern Monetary Theory
    • E64 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Incomes Policy; Price Policy
    • D63 - Microeconomics - - Welfare Economics - - - Equity, Justice, Inequality, and Other Normative Criteria and Measurement

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