Reallocating Government Spending to Reduce Income Inequality: Panel Data Evidence from the Middle-Income Countries

This paper is the first to examine the theoretically ambiguous inequality impact of financing social spending sectors through cuts in the remaining sectoral expenditures of the national government budget within middle-income countries. Employing panel data analysis based on a disaggregated dataset of 51 middle-income countries covering 11 years (2005-2015), we find that: (i) the income gap can be reduced if the education sector is financed by cuts in public spending on the transport and communication sector, the defence sector, and other sectors; (ii) it is possible to reduce inequality with all percentiles benefiting. We also split the sample by national income levels, and reveal that: (iii) the equalizing role of government spending reallocations in favour of the agricultural sector becomes manifest in the subsample of upper middle-income countries; (iv) the inequality-reducing impact of spending reallocations towards the social protection and health sectors becomes clearer in the subsample of lower middle-income countries. More importantly for policymaking and in the long run, (v) such reallocations tend to reduce inequality within both the upper and lower middle-income countries. We therefore conclude that greater consideration should be given to the redistributive effects of government budget reallocations than is typically the case.