Rising Income Inequality in OECD Countries: Does Fiscal Policy Sacrifice Economic Growth in Achieving Equity?

Abstract

The impact of fiscal policy variables on economic growth and income inequality is estimated with data from a balanced panel of 19 high-income OECD countries for 1995–2015. A simultaneous equations model is estimated to test four hypotheses that link economic growth and income inequality to different components of fiscal policy under debt- and tax-financed fiscal strategies. The results do not provide statistically significant evidence for efficiency–equity trade-off. Regardless of the finance method, an increase in redistributive expenditures reduces income inequality but does not affect economic growth. The overall net impact of non-redistributive expenditures, direct taxation receipts and indirect taxation receipts is the increased income inequality. These results suggest increasing redistributive expenditures financed by direct taxes as a means of reducing income inequality. In addition, reducing non-redistributive expenditures promotes both efficiency and equity objectives, important for countries which are experiencing structural budget deficits.