The impact of fiscal shocks on real GDP and income inequality: What do Australian data say?

Abstract

This paper examines the impact of three fiscal policy shocks on per capita real GDP and income inequality in Australia during the period 1965–2014. A small structural vector autoregressive (SVAR) model is constructed for an open economy for contemporaneous identification and estimation purposes. Based on the evidence of one cointegrating vector among the variables, a structural vector error correction (SVEC) model is specified for the long run. Direct taxation, indirect taxation receipts and government spending are identified as permanent fiscal policy shocks. The convergent use of two different models (SVAR & SVEC) strengthens the credibility of the results. The results have three key policy implications. First, a reduction in direct taxation receipts increases per capita real GDP without increasing income inequality. Second, a reduction in government expenditure significantly increases income inequality. Third, the adverse effect of indirect taxation receipts on income inequality is greater than the redistributive effect of government expenditure, which questions the widely held fiscal policy strategy of using indirect taxation to finance redistributive expenditure.