THE FISCAL AND INSTITUTIONAL EFFECTS ON INCOME INEQUALITY: AN EMPIRICAL ANALYSIS

Abstract

This study investigates how fiscal policy and institutional factors influence income distribution within and across countries by employing the panel data technique for 117 countries over the period of 20 years (2000-2019). Based on the ordinary least squares, random effects, fixed effects, two-stage least squares, and system generalized method of moments techniques, the study established the following results. First, the results on the relationship between fiscal policy and income inequality showed that while a few fiscal policy instruments appear to generally reduce income inequality, others increase income inequality in a model involving both developed and developing countries. Thus, public debt, education expenditure, and government consumption reduce income inequality, and direct tax structure also has the potential of reducing income inequality. On the other hand, health expenditure and indirect tax system tend to increase income inequality. Second, with respect to the effect of institutional quality on income inequality, the study found that government effectiveness reduces income inequality. However, corruption was observed to increase the level of income inequality. Similarly, democracy was found to stimulate income inequality among the sampled countries. Third, when the countries were disaggregated into their various income groups, the results showed that public debt increases income inequality in low-income countries but reduces income inequality in lower-middle-income, upper-middle-income, and high-income countries. Income tax and government consumption were found to have no effect on income inequality across the four income groups. Health expenditure increases income inequality in low-income, lower-middle-income, and high-income countries but reduces income inequality in upper-middle-income countries. Education expenditure reduces income inequality in high-income countries but has no significant impact in low-income, lower-middle-income, or upper-middle-income countries. Fourth, the effect of institutional quality with respect to various income groups showed that government effectiveness tends to increase income inequality in lower-middle-income countries, reduces income inequality only in high-income countries, and showed no effect on income inequality in low-income, or upper-middle-income countries. More so, corruption appears to reduce income inequality in lower-middle-income countries but has no influence on income inequality in low-income, upper-middle-income, or high-income countries. Similarly, democracy has no impact on income inequality across the four income groups. Fifth, with respect to the control variables, GDP per capita, foreign direct investment, and Urbanization consistently reduce income inequality, population growth increases income inequality, trade openness showed mixed results on income inequality, and surprisingly, inflation appears to reduce income inequality.

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