Fiscal Policy and Inequality in Middle- and High-Income Countries: Redistributive Effects of Tax and Spending Shocks

Abstract

Motivated by the sharp increases in public spending following the global financial crisis and the COVID-19 pandemic, we employ the GMM Panel VAR approach at annual frequency between 2004-2014 to investigate the response of alternative income distribution variables to shocks imposed on tax revenues and three key components of social expenditures: social protection, health and education. We confirm the potential of fiscal policy to reduce income inequality, but point to the differential approaches to do so in middle-and high-income countries. We find that the particular expenditure component under consideration matters in terms of the impact on inequality and on different parts of the income distribution, as well as in terms of the implied time profile. In middle-income countries, positive education spending shocks are the most effective in achieving better distributional outcomes. By contrast, in high-income countries, positive health spending and tax shocks have a more pronounced favourable distributional impact. JEL codes: E62, H53, O15