Effects of fiscal consolidation on income inequality: narrative evidence from South America

Based on a narrative dataset constructed by David and Leigh (A new action-based dataset of fiscal consolidation in latin America and the caribbean, IMF Working paper 18/94, 2018) for annual fiscal consolidation shocks, this paper estimates the dynamic effects of fiscal consolidations on income inequality from Jorda's (Am Econo Rev 95:161-82, (2005)) local projections method for nine South American economies in the 1991-2017 period. By decomposing fiscal shocks, the baseline results suggest that spending-based fiscal consolidations significantly increase the Gini index, while tax-based fiscal consolidations do not show statistically significant effects on income inequality. The Gini index for disposable income rises 2.48% in eight years after a spending-based fiscal adjustment of 1% of GDP. The magnitude of this effect is higher than in most of the previous studies carried out for OECD countries. Our main finding for the impact of spending-based fiscal consolidation on inequality in the medium run is robust when using alternative control variables, lag structures, country samples, and the Cyclically Adjusted Primary Balance strategy for identifying the fiscal shocks.