Fiscal Rules and Income Inequality: The Case of OECD Countries

Abstract

Fiscal rules act as binding institutions for fiscal policies worldwide. While previous studies have focused on the budgetary and financial effects of fiscal rules, their effects on social problems remain largely unexplored. This study examines how fiscal rules affected income inequality in OECD countries between 1990 and 2015. The results show that fiscal rules adversely affect income inequality, and a battery of robustness tests support these results. The paper infers that constraining a government's discretionary expenditure and possibly strengthening procyclicality may explain these results. The effects are heterogeneous in that income inequality worsens as aging progresses, when a conservative or nonruling party has a parliamentary majority, and when there is a substantial national debt. The findings suggest that using fiscal rules to improve fiscal soundness may conflict with reducing income inequality, making it necessary to discuss a new cogent fiscal framework to achieve both goals.