The impact of income inequality on public debt

Abstract

In view of the fact that the traditional model of tax smoothing (Barro, 1979) cannot account for the recent generalized increasing trend in public debt (PD), this paper improves the traditional determinants of PD by estimating the impact of income inequality on PD based on a heterogeneous panel of 158 countries over 20 years from 2000 to 2019. First, we find that inequality Granger-causes PD. Then, by using different dynamic panel data methodologies, we find that an increase in inequality is associated with a rise in the PD-to-GDP ratio. This result is robust to different econometric methods and specifications. We find similar results with an alternative measurement of social unrest such as the unemployment rate. Based on these results, we suggest that the dynamics of PD are not only associated to the traditional determinants associated with the tax smoothing across a business cycle, but also to the political and fiscal pressures stemming from changes in inequality and unemployment.