Non-linearities in the relationship between public debt and inequality

Abstract

ABSTRACT This paper examines the possible nonlinear relationship between public debt and income inequality. The literature extensively examines the non-linear growth effects of public debt, whereas its inequality effects are not investigated sufficiently. Public debt can be used to finance distributive policies, thereby improving income equality. However, high public debt levels can also harm economic growth and decrease the fiscal space due to sustainability concerns, high risk premia, and large debt service burden. Hence, it is possible that public debt can have non-linear effects on inequality. The empirical analysis documents that the relationship between public debt and inequality is positive with a declining marginal effect in the case of advanced countries. However, developing countries display a U-shape relationship, implying that public debt is initially associated with declines in inequality, while higher levels of debt are associated with higher levels of inequality. The analysis also shows that the determinants of inequality can differ greatly between advanced and developing countries.