Fiscal Performance and Income Inequality: Are Unequal Societies More Deficit-Prone?

Some Cross-Country Evidence

Authors

  • Martin Larch

    1. European Commission Directorate-General for Economic and Financial Affairs, Bruxelles
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    • I would like to thank Adi Brender, Marco Buti, Jozef Konings, Jakob von Weizsäcker, the participants of the European Commission DG ECFIN lunch seminar of 6 May 2010 and of the contributed session on Budget Deficits of the 2010 Annual Congress of the European Economic Association for helpful comments. Research assistance by Marion Labouré and Marie Scharfenberg is gratefully acknowledged.

Summary

A bias towards running deficits is an entrenched feature of fiscal policy making in most developed economies. Our paper examines whether this tendency is in any way associated with the personal distribution of income of a country. It takes inspiration from theoretical work according to which distributional conflicts may give rise to deficit spending or to delayed fiscal adjustment. Although these theories have been around for years the empirical literature on the determinants of fiscal performance has so far paid little or no attention to the possible role played by different degrees of income inequality. Our results suggest that this neglect was not justified. Using cross-country data we find evidence that a more unequal distribution of income can weigh on a country's fiscal performance. These findings can be relevant in the aftermath of the post-2007 global financial and economic crisis in particular when designing fiscal exit strategies. The success and sustainability of such strategies may inter alia depend on their distributional implications.

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