Fiscal Policy, Income Distribution, and Growth

Abstract

This study seeks to discern whether the current distribution of income determines the evolution of future income distribution and economic growth through fiscal policy. Fiscal policy consists of transfer payments or an income tax. Fiscal policy is determined by the level of development, distribution of income, and degree of political franchise. Reduced form equations are obtained from the political equilibrium endogenous growth models addressing distributional issues. Empirical tests of these reduced form equations are carried out using cross-country data and time series data from India and Taipei,China. The cross-country evidence suggests that lagged income distribution is linked to future economic growth and income distribution through transfer payments. Time series evidence from Taipei,China suggests that low-income economies have to implement low levels of direct taxes, which is accompanied by a worsening distribution of income, in order to promote economic growth.