The Distributional Consequences of Government Spending

Santanu Chatterjee

University of Georgia

May 2008

ABSTRACT

This paper examines the effect of fiscal policy and provision of productive public goods on the dynamics of growth and inequality. A model is developed in which public infrastructure is both an engine of growth and a determinant of the distributions of wealth, income, and welfare. The design of government spending and taxation policies is a critical source of (i) the growth-inequality relationship, and (ii) the efficiency-equity trade-off, both in transition as well as the steady-state. For example, growth-enhancing government spending policies can generate sharp intertemporal trade-offs in the evolution of income inequality: inequality falls in the short run, but gradually increases over time to worsen in the long-run. The existence of an efficiency-equity trade-off depends on the taxation policy used to finance government spending. In this respect, the capital income tax serves as an effective tool of egalitarian redistribution. The redistributive effects of the consumption tax as an alternative to the more conventional labor income tax are also highlighted.

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