Two-way relationship between inequality and growth within the fiscal policy channel: an empirical assessment for European countries

Abstract

PurposeWe investigate the role of fiscal policy, through several measures of government revenues and expenditures and redistribution, on disposable and market income inequality and economic growth as well as the interaction between inequality and growth for 31 European countries from 1995 to 2019.Design/methodology/approachWe use a simultaneous equations model to assess the linkage between economic growth, inequalities and fiscal policy variables.Findings(1) While disposable income inequality has a negative effect on all fiscal policy variables, market income inequality has a mixed effects; (2) for Eastern European countries, public consumption and direct taxation positively influence economic growth; conversely, for Western European countries, the effects are negative; (3) disposable and market income inequality have a positive effect on growth for Eastern European countries, and a negative influence on growth for Western European countries; (4) growth contributes to the increase of disposable and market income inequality for Eastern European countries; for Western European countries, the effects are opposite; and (5) fiscal policy allows for the attenuation of disposable income inequality.Originality/valueThe different results between the role of market and disposable income inequality levels lead us to suggest tax progressivity as an important feature to consider when analyse the trivariate relationship between inequalities, fiscal policy and growth. Furthermore, there are different dynamics between inequality and growth, and the role of fiscal policy, on both Eastern and Western European countries.