How Does Fiscal Consolidation Impact on Income Inequality?

32 Pages Posted: 15 May 2012  

Luca Agnello

Banque de France

Ricardo M. Sousa

University of Minho; Economic Policies Research Unit (NIPE); London School of Economics & Political Science (LSE) - Financial Markets Group; London School of Economics

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Date Written: May 1, 2012

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.

Keywords: Fiscal consolidation, income inequality, Kuznets curve

JEL Classification: E62, E64, D63

Suggested Citation

Agnello, Luca and Sousa, Ricardo M., How Does Fiscal Consolidation Impact on Income Inequality? (May 1, 2012). Banque de France Working Paper No. 382. Available at SSRN: https://ssrn.com/abstract=2060097 or http://dx.doi.org/10.2139/ssrn.2060097

Luca Agnello (Contact Author)

Banque de France ( email )

Paris
France

Ricardo Magalhaes Sousa

University of Minho ( email )

Campus Gualtar
Braga, 4710-057
Portugal
+351253604584 (Phone)
+351253676375 (Fax)

HOME PAGE: http://www.eeg.uminho.pt/economia/rjsousa

Economic Policies Research Unit (NIPE) ( email )

Campus de Gualtar
Braga, 4710-057
Portugal
+351253604584 (Phone)
+351253676375 (Fax)

HOME PAGE: http://www.eeg.uminho.pt/economia/rjsousa

London School of Economics & Political Science (LSE) - Financial Markets Group ( email )

Houghton Street
London WC2A 2AE
United Kingdom

London School of Economics ( email )

Houghton Street
London, WC2A 2AE
United Kingdom

HOME PAGE: http://econ.lse.ac.uk

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