How Does Fiscal Consolidation Impact on Income Inequality?

Abstract

The authors wish to thank Prof. Sushanta Mallick and to participants to a seminar at the Banque De France for helpful comments. The opinions expressed herein are those of the authors and do not necessarily reflect those of the Banque de France. AbstractIn 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: E62, E64, D63. RésuméDans cet article, nous évaluons l'impact de la consolidation budgétaire sur l'inégalité des revenus. Utilisant un panel de 18 pays industrialisés de 1978 à 2009, nous constatons que l'inégalité des revenus augmente de façon significative pendant les périodes de consolidation budgétaire. En outre, alors qu'une consolidation axée sur la réduction des dépenses semble être préjudiciable pour la distribution des revenus, des hausses d'impôts semblent avoir un effet égalisateur. Nous montrons aussi que la taille du programme de consolidation budgétaire (en pourcentage du PIB) a un impact sur l'inégalité des revenus. En particulier, lorsque les plans de consolidation ne représentent qu'une faible part du PIB, l'écart de revenu se creuse, ce qui suggère que le fardeau associé à l'effort affecte de manière disproportionnée les ménages au bas de la distribution des revenus. Considérant les liens entre crises bancaires et l'assainissement budgétaire, nous constatons que l'effet sur l'écart de revenu est amplifié lorsque des ajustements budgétaires ont lieu après la résolution de ces tourmentes financières. De même, les programmes d'assainissement budgétaire accompagnés d'inflation forte sont susceptibles d'accroître les inégalités et les effets des ajustements budgétaires sur l'inégalité sont amplifiés durant les périodes de croissance relativement faible. Nos résulta...

Austerity, inequality, and private debt overhang

“…and Agnello and Sousa (2014) find that the aggregate and distributional effects of fiscal consolidations are amplified in periods of economic slack. Given this, it is possible that our emphasis on nonlinear effects across the credit cycle are simply a relabeling of nonlinear effects across the business cycle.…”

“…These channels are found to be important in explaining the distributional consequences of monetary policy shocks by Coibion, Gorodnichenko, Kueng, and Silvia (2012 Anderson, Inoue, andRossi 2016, andMumtaz andTheophilopoulou 2016), and fiscal consolidations, in particular (see, e.g., Agnello andSousa 2014 andBall, Furceri, Leigh, andLoungani 2013). However, none of these studies allows the effects to differ according to the state of the credit cycle.…”

The impact of fiscal consolidations on the functional components of government expenditures

“…Assessing the trade-off between consolidation of public finances and economic growth is fundamental for the formulation of effective policies. Several studies look at this relation and try to identify the determinants, impact, timing and the length of fiscal consolidations (Alesina et al, 2008;Alesina and Ardagna, 2010;Barrios et al, 2010;Cimadomo et al, 2010;Sanz, 2011;Cimadomo, 2012;Ball et al, 2013;Bi et al, 2013;Afonso and Jalles, 2014;Anderson et al 2014;Agnello and Sousa, 2014;Cafiso and Cellini, 2014;Agnello el al., 2015;Cugnasca and Rother, 2015;Afonso and Jalles, 2016;Agnello et al, 2016). Others take into account the kind of consolidation to show that successful consolidations are primarily based on spending cuts rather than increasing taxes (Alesina and Perotti, 1995 A fixed-effects estimator is used in the empirical analysis and the results show that spending on public services increases during fiscal consolidations, while spending on defence, public order, health, education and social protection is significantly cut.…”

Is fiscal fatigue a threat to consolidation programmes?

“…The literature presented so far has typically focused on the effect of fiscal adjustments on aggregate income, on the trade-off between economic growth and income inequality (Mulas-Granados, 2005), or on income inequality (Agnello and Sousa, 2014).…”