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Income
Do government expenditure inequality
reduce income inequality:
evidence from developing and
developed countries 487
Noor Zahirah Mohd Sidek Received 28 September 2020
Revised 5 March 2021
Department of Economics, Faculty of Business Management, 13 March 2021
Universiti Teknologi MARA, Kedah, Malaysia Accepted 30 March 2021

Abstract
Purpose – This paper aims to re-examine the impact of government expenditure on income inequality.
Existing studies provide mixed results on whether government expenditure reduces or increases income
inequality. In this paper, government expenditure is viewed as a tool for redistribution, hence, its impact on
inequality is examined.
Design/methodology/approach – A sample of 122 countries with 91 and 31 countries categorized as
developing and developed countries is used. The dynamic panel threshold regression is used to examine the
impact of government expenditure on income inequality and to estimate the turning point of the negative or
positive effects.
Findings – The major findings suggest that, in general, government expenditure does reduce income
inequality. Results from developed countries support the inversed U-shaped Kuznet curve where higher
government expenditure initially led to more inequality but would eventually bring about a positive effect
after a certain threshold level. For developing countries, education and development expenditure were the
driving forces towards lower income inequality.
Practical implications – Several policy implications can be derived from this paper. First, government
expenditure is a useful tool to alleviate the problem of income inequality. More integration with the global
economy via trading activities is also an important channel to help reduce income inequality. Finally, better
institutional quality provides an effective ecosystem in promoting better redistribution of income via
government expenditure.
Originality/value – This paper presents a maiden attempt to estimate a threshold value or when
government expenditure starts to reduce or increase income inequality. The sample is segregated into
developed and developing countries to further control the effect of government size and the level of
development of a country.
Keywords Redistribution, Income inequality, Government expenditure,
Dynamic panel threshold regressions
Paper type Research paper

1. Introduction
Income inequality is a perennial issue. Over the years, it has been a topic of great interest
owing to various negative ramifications which could arise if left untreated. Income
inequality might lead to social unrest, socio-political instability, crime or even violent
conflict arising from resentment by those perceived themselves as being unfairly treated. Studies in Economics and Finance
Vol. 38 No. 2, 2021
pp. 487-503
This research is funded by the Ministry of Higher Education Malaysia, Malaysia. Grant No: FRGS/1/ © Emerald Publishing Limited
1086-7376
2019/SS01/UITM/02/40. DOI 10.1108/SEF-09-2020-0393
SEF Left unchecked, it might also lead to social disorder, financial exclusion and institutional
38,2 distrust which has a growth-deterring effect (Goñi et al., 2011; Stiglitz, 2013; Breunig and
Majeed, 2020). In addition, studies have deduced that lower net inequality is a prerequisite
for faster and more durable economic growth (Cingano, 2014; Berg et al., 2018). Other studies
show that redistribution policies aimed at reducing inequality via accumulation of physical
capital, reducing the incentive to invest in education or taking entrepreneurial risks could
488 lead to damaging effects on growth (Checchi et al., 1999; Mookherjee and Ray, 2006; Okun,
2015).
Existing literature often focuses on the following:

how inequality affects growth; and

the growth effects of redistribution of taxes and social transfers.

However, the impact of government expenditure to address inequality is relatively under-

explored. This paper is, therefore, an attempt to determine whether redistribution via
government expenditure tends to reduce or increase income inequality. The classical
redistribution theory by Meltzer and Richard (1981) argues that higher inequality leads to
more redistribution. Houle (2017) showed how inequality results in more redistribution for a
sample of 89 developed and developing democracies. Cingano (2014) and Berg et al. (2018)
are of the view that more unequal societies tend to redistribute more but redistribution may
not translate into higher economic growth. The negative impact of income inequality on
growth in poor and middle-income countries is because of lack of infrastructure and capital
market imperfections, and as such, redistribution would have a positive impact (Gründler
and Scheurmeyer, 2018). However, in the case of developed countries, redistribution is
harmful towards economic growth. Redistribution channels come in different forms. One of
the main redistribution channels is via fiscal policies. Accumulation of both physical and
human capital is normally supported by government expenditure on education at all levels,
i.e. the primary, secondary and tertiary levels. With adequate education and training,
individuals would be able to acquire appropriate capital based on their ability and
accumulate more wealth.
The second channel is through the political-institutional setup. Inequality may foster
political social instability, crony capitalism and nepotism. In societies with high and
proliferating inequality, the upper-income group which enjoys significant political power
may engage in rent-seeking activities or influence policymaking on redistribution, thus
hindering growth in the long run (Alesina and Perotti, 1996; Glaeser et al., 2003). From the
perspective of the institutional theory, strong unions drive the voting power of the working
class towards demanding more redistribution to reduce income and socio-economic
inequalities. Left leaning political parties tend to “represent the poor” and use redistributive
manifestos to increase their chances of winning elections. Should these leftish parties win
and carry out their redistributive agenda, more redistributive spending could reduce socio-
economic inequalities (Bradley et al., 2003; Korpi et al., 2013; Pontusson and Rueda, 2010).
The institutional theory also postulates that electoral systems influence the incumbent
party’s policy choices (Milesi-Ferretti et al., 2002; Persson and Tabellini, 2004). However,
these are long-term measures and in the short run, fiscal reforms and reconsolidation would
be necessary to ensure fiscal policy perform its redistributive function.
Existing studies present mixed results on how government expenditure affects income
inequality. For example, a meta-regression analysis by Anderson et al. (2017) suggests that,
generally, government expenditure negatively affects income inequality, but the conclusions
are influenced by their choice of proxy for income inequality and type of government
expenditure. Lee et al. (2007) and Goerl and Seiferling (2014), argue, inter alia, that
government expenditure has no direct effect on income inequality and that it depends on Income
globalization-related variables such as trade and investment. Doumbia and Kinda (2019) inequality
argue that reallocating government expenditure on defense expenditure towards social
protection and infrastructure reduces income inequality.
In light of the above discussions, the aim of this paper is to examine whether government
expenditure reduces income inequality by controlling the effect of institutions. Our main
contribution goes in the direction of identifying which type of government expenditure
affects income inequality and estimating the threshold value when government expenditure
489
starts to have a significant impact on the reduction of income inequality. First, we select
different types of government expenditure such as expenditure on education, health care,
military and development to capture their impact on income inequality. Such demarcation is
undertaken as each type of expenditure is intended for a different purpose and for a different
target group, and as such, each type of expenditure would yield a different outcome. In
addition, we simultaneously explore the effect of fiscal redistribution in the form of
government expenditure by controlling for institutional factors and debt. We use both
before and after-tax Gini to ensure the robustness of the results. Second, we use the dynamic
panel threshold model (DPTR) to evaluate whether the relationship between income
inequality and government expenditure is nonlinear, and if so, the turning point or the
threshold value could be estimated.. To the best of our knowledge, at the point of writing, no
studies have attempted to use the dynamic panel threshold regression model to estimate the
turning point of the government expenditure-income inequality nexus. The use of the
dynamic panel threshold regression essentially tests the inverted U-shaped Kuznet curve
theory. Third, we split the sample into developed and developing countries as government
expenditure tends to be higher and more focused on social protection in developed
economies in terms of the share of gross domestic product (GDP) and in per capita terms
compared to less developed economies (Ortiz-Ospina, 2016).
As fiscal transfers occur through government expenditure, how such expenditure
impacts inequalities should be thoroughly examined. If a threshold or turning point exists,
then the government can allocate the right amount or percentage of expenditure needed to
reduce income inequality. By segregating the type of government expenditure into
education, health, military and development expenditure, policymakers can elucidate which
type of expenditure can be used as a tool or redistributive measure to alleviate income
inequality. Therefore, policies can be re-designed with this new information.
This paper has a few limitations. The first caveat is the use of annual income per capita
rather than lifetime income. As such, intertemporal factors might be overlooked, and this
could lead to overestimation of the level of inequality (Goñi et al., 2011). However, as lifetime
income data are difficult to estimate and not readily available, the use of annual income is
the best available alternative. Second, this paper does not consider the full effects of
monetary policy on inequality which could probably have a significant impact on inequality
through investment and savings. Third, household debt may undermine any redistribution
effort to reduce income inequality. We do not control for this possibility owing to data
limitations. In addition, we condition the external debt to government expenditure to control
the effect of debt-financed development expenditure and include investment to control the
effect of monetary policy.
The paper is organized in the following manner. Section 2 reviews the theories and
selected literature pertinent to inequality and redistribution. Section 3 provides the empirical
strategy and discussion on the data. Section 4 presents the results and discussion, and
Section 5 concludes the report.
SEF 2. Review of selected literature
38,2 This section reviews the theories that are relevant to this paper, followed by a short review
of selected literature on relevant empirical studies. The Kuznet curve theory was developed
based on the idea that during the course of economic development, income inequalities
would initially increase and subsequently decline, rendering an inverted U-shaped. The
Kuznet curve implies that as a country embarks on industrialization, the population begins
490 to shift from rural to urban or industrial areas to seek better paying jobs. The migration
leads to a larger rural versus urban income gap. After a certain level of average income is
reached via processes associated with industrialization, coupled with trickle-down effects
from such development, the income gap is expected to narrow gradually. The processes
could be the lagged results of redistribution via government expenditures.
According to the power resource theory, the redistribution process emanates from two
sources, which is trade unions and left-wing political parties. Strong trade unions and left
cabinets tend to push for more redistributive policies (Bradley et al., 2003; Iversen and
Soskice, 2006; Herwartz and Theilen, 2017). Electoral results with proportional
representations of both left and right-wing representatives tend to have better redistribution
(Iversen and Soskice, 2006; Persson et al., 2007; Beramendi and Cusack, 2009). In a similar
vein, Acemoglu et al. (2015) propose the concept of standard equalizing effect of democracy,
where more redistribution occurs in more democratic countries.
Earlier literature on redistribution hypothesized a positive relationship between
inequality and redistribution through the endogenous fiscal policy channel, but the
empirical evidence available was mixed. These studies used fiscal policy instruments such
as marginal tax rates, transfers and social expenditure to capture the impact of
redistribution. Gründler and Scheuermeyer (2018) illustrated how redistribution affected
high-income countries in a negative manner but benefited developing or low-income
countries. Milanovic ((2000) showed that more unequal societies had a tendency to
redistribute more. Muinelo-Gallo and Roca-Sagalés (2013) studied 21 organization for
economic cooperation and development countries in a panel setting, with results implying
distributive expenditure reduced both inequality and GDP growth for high-income
countries. In this paper, we note the limitations of redistributive measures using taxes.
Alternatively, this paper views the role of government expenditure as a tool for
implementing redistributive policies.

3. Methodology
3.1 Estimation method
The centrepiece of our analysis is the investigation of the impact of government expenditure
on income inequality. The empirical analysis relied on the DPTR. This method allows
investigation of the impact of government expenditure on income inequality and estimates a
threshold value when government expenditure starts to have a significant impact on income
inequality.
The basic empirical model in equation (1) was based on Gründler and Scheuermeyer
(2018) who propose that the level of development should be held constant to accommodate
the Meltzer–Richard effects. The reduced form of the model yields the following:


IEit ¼ a1 IEit1 þ b 2 log GDPpc it1 þ b 3 Git1 þ b 4 Xit1 r it þ « it þ vit
(1)

where IE is a measure of inequality represented by market Gini in country i at time t. The

level of development and size of the economy are controlled by GDP per capita (GDPpc). The
focal variable of interest is the total government expenditure and types of government Income
expenditure. Xit represents the control variables, whilst r it and « it correspond to country inequality
and time fixed effects, respectively, and vit denotes the error terms. Government expenditure
is categorized as follows:

total government expenditure;

expenditure on education;

expenditure on health; 491

expenditure on military expenses; and

expenditure on development.

This paper examines the threshold level(s) or turning point(s) at which government
expenditure generates a positive or negative effect on income inequality. A major advantage
of the DPTR is that it does not require any specific functional form of nonlinearity. As the
thresholds are endogenously determined, confidence intervals can be constructed using
asymptotic theories, and bootstrapping can be used to assess the significance of the
threshold effect(s). To add more depth to the analysis, we condition the effects of
government expenditure on the qualities of the institutions for robustness. Equation (1) is
restructured to incorporate the possible asymmetric effects of government expenditure on
inequality, as follows:

IEit ¼ a1 IEit1 þ b 2 log GDPpc Þit1 þ b 3 ðGit # g Þ þ b 4 ðGit  g Þ

þ b 5 Xit1 r it þ u i þ « t þ vit (2)

and

IEit ¼ a1 IEit1 þ b 2 log GDPpc Þit1 þ b 3 Git ð Ins # g Þ þ b 4 Git ðIns  g Þ

þ b 5 Xit1 r it þ b 6 ðG  InstÞit1 þ u i þ « t þ vit (3)

where u i is the time-invariant unobserved country-specific effect, « t is the time-specific

effect term and vit is the error term. Equation (2) examines the threshold effects of
government expenditure on inequality where b 3 and b 4 split the sample into low
government expenditure (Git # g ) and high government expenditure (Git  g ). For
robustness, we condition the effects of government expenditure on the level of institutional
qualities as derived in equation (3). Similarly, the sample is split into government
expenditure when institutional quality is low (Git (Ins # g )) and government expenditure
when institutional quality is high ((Git (Ins  g )).
To estimate equations (2) and (3), we use DPTR based on Slesman et al. (2019). DPTR
relies on the instrumental variable threshold to correct for endogeneity bias arising from the
included lag dependent variables. In this paper, we only allow the focal variable,
government spending (G) to be regime-dependent whilst other variables in the regressions
are assumed to be regime-independent.
The estimation procedure is as follows. First, forwards orthogonal deviations
transformation is applied on equation (2) to eliminate the country-specific term, u i from the
regression. The advantage of performing this transformation is that the instrumental
variables threshold estimation procedure can be done to estimate the regression, thus
avoiding serial correlation problems. Secondly, the instrumental variable threshold
estimation is used to estimate the regression. This procedure involves three steps. The first
SEF step is to use OLS estimation on the reduced form of the regression as a function of its
38,2 instrument (IEit–1) by using its own lag values as instruments. The predicted values of
^ it1 are generated to replace the original values of IEit–1 in equation (2). The second step
IE
proceeds with running the sequences of the regressions using OLS as in equation (2) to
compute and determine the value of the threshold, g . The threshold value g is selected
based on the value with the smallest sum of squares residuals or g^ ¼ argmin Sð g Þ:
492 Next, is the construction of the confidence interval where C = { g : LR( g ) # C(a)}, where C
is the asymptotic confidence interval region for g ,C(a) is the percentile asymptotic
confidence interval of the threshold values of the asymptotic likelihood ratio statistics and
finally, LR( g ). The final step is to split the sample into low-G and high-G regimes where the
coefficients are estimated using the generalized methods of moment.

3.2 Data and sources

A panel of 122 countries from both developed and developing countries was chosen based
on the consistent availability of data. Data were drawn from a number of sources and
averaged into a five-year period (Li and Zou, 2002; Cingano, 2014; Kammas and Sarantides,
2019) to deal with missing data and statistical requirements (n > t), and to smooth out
business cycle fluctuations, as well as to capture the short to long term impact. This
approach offers several advantages. First, DPTR minimizes the problem of reverse causality
between government expenditure and income inequality. Second, it is assumed that changes
in government expenditure are not contemporaneous with changes in other control
variables. The lagged effect of inequality is included as, presumably, government
expenditure and inequality tend to be persistent over time and most government
expenditure commitments tend to continue from one year to another. The sample was
divided into eight non-overlapping five-year averaged periods – 1980–1985, 1986–1990,
1991–1995, 1996–2000, 2001–2005, 2006–2010, 2011–2015 and 2016–2018. Only 1980–1985
was a six-year average, and 2016–2018 was averaged on a three-year basis.
For inequality, the Gini coefficients from the Standardized World Income Inequality
Database V8.2 originally by Solt (2019) were used as this data set covers the largest number
of countries for the longest possible period compared to other data sets. The period of study
covered a period of 38 years (from 1980 to 2018) for 122 countries. It should be noted that not
all data were available for these countries during the stipulated period of study. Averaging
the data to a five-year period partly mitigated this issue.
The measure for income inequality was based on the Gini coefficient of market income, a
common practice in income inequality studies. We are aware of other alternative measures
such as wage inequality or ratio inequality, market income, disposable income, post-tax
income and gross income which are calculated in a slightly different manner. Arguably, the
Gini coefficient based on market income is a more suitable measure of income inequality for
this paper as it provides a more comprehensive measure of inequality, enables international
comparison and reflects the overall inequality better as compared to other measures. To
ensure the robustness of the estimates, we incorporated after-tax Gini, although they are
normally used to capture income redistribution.
The log of real GDP was used as a proxy for income where data were derived from Penn
World Table 8.1. Real GDP also served as a control variable for the level of development,
heterogeneity between countries and size of an economy as we presume wealthier economies
to have a larger public sector which would affect the design of their fiscal policy and
redistribution. According to Wagner’s law, more redistribution is the result of economic
development (Esping-Anderson and Myles, 2009; Morgan and Kelly, 2013; Choi, 2019). Data
on government expenditure and the types of government expenditure were retrieved from
the World Development Indicator (WDI). Four different categorical types of government Income
expenditure were used to further explicate the effects of different types of government inequality
expenditure on income inequality. The total government expenditure was disaggregated
into education, health, military and development expenditures, where consistent data were
available from the WDI. All data on government expenditure were expressed in terms of
percentage of GDP. Population growth was used as a proxy for human capital (Barro and
Lee, 2013). Human capital and dependency ratio would capture the extent of social benefits
and pensions needed in the country. Investment was captured by gross fixed capital 493
formation as a percentage of GDP. The effect of international market integration was
captured by openness, which was calculated as the total import plus exports, divided by
GDP. This paper also controlled for the impact of debt-financed government expenditure as
captured by government expenditure conditioned on external debt (Gov_Exp  ext. debt).
All control variable data were derived from the WDI unless indicated otherwise.
For institutional variables, we relied on four proxies to capture the extent of the impact.
The left-wing cabinet was measured using the Comparative Political Dataset 1960–2016 by
Armingeon et al. (2018). This data set categorized the data into five levels of cabinet
composition, namely:
(1) hegemony of right/centre parties;
(2) dominance of right/centre parties;
(3) balance between the right and left parties;
(4) dominance of left-wing parties; and
(5) hegemony of left-wing parties.

In this paper, we experimented with all five proxies but reported the balance between the
right and left parties as this variable gave consistent significant results. Data on corruption
were derived from the Freedom House database whilst data on government effectiveness
and political stability were collected from the World Governance Indicator, World Bank.
The summary of statistics and correlation results are presented in Tables 1 and 2.

Mean Maximum Minimum SD

GINI_MKT 47.4583 68.6000 35.4000 5.3650

GINI_DISP 35.9771 59.6000 22.4000 8.7767
GOV_EXP 77.1163 107.0122 53.9196 8.9261
EDUCATION_GDP 4.7206 8.5596 1.1509 1.3454
HEALTH 7.1802 11.3209 2.0556 2.1359
MILITARY 1.7480 8.5385 0.0000 1.2436
DEV_EXP 21.7943 33.8571 11.9607 3.6124
POP_GROWTH 0.8895 4.5985 1.9110 0.7897
INVESTMENT 21.6165 33.8572 11.9606 3.6512
OPEN 79.6611 220.4068 19.7981 38.1144
EXT_DEBT 23.1880 217.5860 0.0304 32.0208
CAB_COMP 0.6759 0.9339 0.1030 0.2129
GOV_EFF 0.7421 1.0000 0.2500 0.2313
CORRUPTION 0.3010 0.9548 0.0067 0.2676
P_STAB 0.7662 0.9722 0.4871 0.0866
Table 1.
Notes: The descriptive statistics is based on original data for the whole sample Summary statistics
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494

Table 2.
Correlation
GINI_ EXT_ CAB_ GOV_
GINI_MKT DISP GOV_EXP EDU HEA MIL DEV POP_GR INV OPEN DEBT COMP EFF CORR P_STAB

GINI_MKT 1.0000
GINI_DISP 0.4352 1.0000
GOV_EXP 0.0037 0.2740 1.0000
EDU 0.1311 0.4337 0.2859 1.0000
HEA 0.1204 0.4876 0.0041 0.4128 1.0000
MIL 0.0213 0.0091 0.1972 0.0712 0.0984 1.0000
DEV 0.2899 0.2872 0.3538 0.0084 0.0721 0.1404 1.0000
POP_GR 0.1116 0.4332 0.0405 0.1086 0.2492 0.1691 0.0335 1.0000
INVEST 0.3001 0.3284 0.3586 0.0606 0.0478 0.1117 0.9601 0.0578 1.0000
OPEN 0.1460 0.2829 0.3882 0.2393 0.0696 0.1557 0.3264 0.0057 0.3053 1.0000
EXT_DEBT 0.0806 0.4607 0.2339 0.3455 0.5506 0.1677 0.0297 0.1182 0.0745 0.2895 1.0000
CAB_COMP 0.1613 0.4512 0.1937 0.3452 0.6328 0.3141 0.0627 0.2756 0.0607 0.1149 0.4292 1.0000
GOV_EFF 0.0185 0.6644 0.3428 0.5917 0.5307 0.0635 0.1283 0.0948 0.1685 0.2226 0.5280 0.5878 1.0000
CORR 0.1988 0.5300 0.2484 0.5023 0.6724 0.1376 0.0462 0.2204 0.0432 0.0080 0.4891 0.8020 0.7987 1.0000
P_STAB 0.0358 0.3213 0.2340 0.2461 0.3210 0.4855 0.1527 0.2992 0.1143 0.2012 0.2086 0.3395 0.2717 0.3259 1.0000
4. Results and discussion Income
This section is divided into three parts. Section 4.1 presents the estimation of the threshold inequality
impact of government expenditure on the overall sample, and a sample of developing and
developed countries. Section 4.2 discusses the robustness test when government
expenditure was categorized into education, health, military and development expenditures.
Section 4.3 tests the robustness of the results by conditioning government expenditure on
institutions.
495
4.1 Government expenditure and income inequalities: threshold estimates
A lower level of net inequality may imply extensive redistribution policies and measures
undertaken by the government. Table 3 presents the results of the first part of the study
which estimated the threshold values of government expenditure on income inequality. The
results were segregated into three regressions to capture the overall impact before the
sample was split into developed and developing countries. Such demarcation would help us
ascertain whether government expenditure reduced (or increased) inequality when countries
were separated according to the level of development. The heterogeneity between each
country was controlled using GDP. The results indicated that government expenditure
generally helped to alleviate income inequality. They also showed that government
expenditure was more effective in reducing income inequality as governments spent more.
The results were consistent for both Market Gini and After-Tax Gini. The impact of
government expenditure was more pronounced in developed countries, reflecting higher
government spending as a percentage of GDP compared to developing countries as in
Figure 1. The threshold results showed the existence of a threshold effect for the overall
sample and for both developed and developing countries. Table 3 shows the threshold was
higher in developed countries compared to developing countries, thus corroborating the
earlier argument that government expenditure in developed countries is higher relative to
developing countries.
The results showed that a 1% increase in government expenditure was associated with
0.0025% reduction in income inequality in the overall sample. This implies that on average,
countries need to spend at least 0.0025% of GDP to materialize the effect of reduction in
income inequality when using government expenditure as a tool to reduce inequality.
Relatively more government expenditure was needed to reduce inequalities in developed
countries compared to developing countries, at 0.0019% and 0.0010%, respectively, when
market Gini was used. When after-tax Gini was used, a higher percentage of government
expenditure was needed with 0.0029, 0.0025 and 0.0012 for the whole sample, developed and
developing countries, respectively.
All covariates carried the expected signs. The higher the level of development (GDP) or
the bigger the size of the economy, population growth, investment and international market
integration (openness), the more significant was the impact on reducing income inequality.
These results were consistent with Lee et al. (2007). Openness could suggest that trade is one
of the channels to help reduce income inequality. The effect of debt-based government
expenditure was consistently insignificant except in the case of development expenditure. In
addition, the significance and magnitudes of the coefficients were reasonably robust for the
whole sample, developed countries and developing countries.

4.2 Robustness test: segregation of government expenditure into education, health, military
and development expenditures
To further understand the gravity of the issue, government expenditure was examined
according to the type of expenditure, as illustrated in Table 4. The threshold value was
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496

Table 3

estimates
expenditure and
Total government

inequality: threshold
Dependent variable: Market Gini Dependent variable: After tax Gini
Whole sample Developing countries Developed countries Whole sample Developing countries Developed countries

Threshold estimates C 6.539 2.007 4.372 6.001 1.996 4.0231

95% confidence interval [2.851, 8.202] [1.594, 3.972] [2.4736, 6.9921] [2.265, 8.837] [0.984, 3.827] [0.999, 5.826]
Government expenditure (G)  total government expenditure
Git # g 0.0013 (0.0163) 0.0006 (0.0105) 0.0011 (0.0291) 0.0015 (0.0013) 0.0001 (0.0033) 0.0005*** (0.0094)
Git  g 0.0025*** (0.0000) 0.0010*** (0.0000) 0.0019*** (0.0000) 0.0029*** (0.0000) 0.0012*** (0.0000) 0.0025*** (0.0000)
Covariates
GDP 0.4329*** (0.0011) 0.2947*** (0.0520) 0.3645*** (0.1025) 0.4092*** (0.1000) 0.2532*** (0.0954) 0.3001*** (0.1003)
Population growth 0.0035** (0.0017) 0.0024** (0.0000) 0.0013** (0.0006) 0.0031** (0.0016) 0.0021** (0.0010) 0.0010** (0.0004)
Investment 0.2815** (0.1407) 0.0945** (0.0472) 0.1971*** (0.0723) 0.2529** (0.1264) 0.0554** (0.0277) 0.01763*** (0.0041)
Openness 0.1900*** (0.0051) 0.0534** (0.0267) 0.1500*** (0.0001) 0.1775*** (0.0032) 0.0342* (0.02021) 0.1007*** (0.0001)
Gov_exp * External debt 0.0132 (0.0389) 0.0099 (0.0169) 0.0100 (0.0251) 0.0101 (0.0235) 0.0073 (0.0154) 0.0089 (0.0183)
Regime intercept 0.1191*** (0.0003) 0.1092*** (0.0002) 0.0956*** (0.0190) 0.1035*** (0.0080) 0.0554*** (0.0000) 0.0731*** (0.0190)
No. of countries 122 91 31 121 91 30
Observations 976 728 248 976 728 248

Notes: ***, ** and *denote 1%, 5% and 10% significant level, respectively. Confidence interval in square brackets and p-values in brackets
 Income
inequality

497

Figure 1.
Share of government
expenditure as a
percentage of GDP
(2011)

within the confidence interval which indicated the existence of threshold values for all four
types of government expenditure. In the case of developed countries (Table 4a), education
expenditure was significant in reducing income inequality in the lower regime but
insignificant in the higher regime. A 1% increase in the level of government education
expenditure led to a reduction in income inequality of 0.0012% in the lower regime for
market Gini. On the other hand, a 1% increase in development expenditure increased income
inequality by 0.0008%. As theoretically argued by the Kuznet hypothesis, income inequality
would rise initially as a result of economic development but would gradually decrease after
a certain threshold is reached. In this paper, total government expenditure negatively
affected income inequality in the lower regime but reduced income inequality in the higher
regime, this being consistent with the inverted U-shaped Kuznet hypothesis. These results
were consistent with Gregorio and Lee (2002); Abdullah et al. (2015); Park (2017); and Lee
et al. (2020) although these studies used linear estimation. Health-care and military
expenditures seemed to have no statistical impact on income inequality in developed
countries. Despite these findings, we do not negate the importance of health-care and
military expenses as a healthy society would provide the human capital needed for
development. Countries with conflicts or at war normally have higher income inequality.
Hence, military expenditure to ensure political stability and protection of the country from
external and internal threats should provide a conducive environment for economic growth
and job creation; eventually, income inequality would be reduced.
The results for developing countries in Table 4b present different insights. Government
expenditure in education was significant in both high and lower regimes, thus supporting
the proposition that education is one of the keys to reducing income inequality. For
government expenditure on education, a 1% increase led to 0.0015% and 0.0018% reduction
in income inequality in the lower and higher regime, respectively. The coefficients were
relatively robust when after-tax Gini was used. On a similar note, development expenditure
significantly reduced income inequality regardless of the regime. A 1% increase in
development expenditure drove down income inequality by 0.0013% and 0.0015% in the
lower and higher regime, respectively. When after-tax Gini was used, the coefficients
 38,2
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498

Table 4.

expenditure
for government
Robustness test:
alternative measures
Variables Dependent variable: Market Gini Dependent variable: After tax Gini
Threshold variable:
government expenditure (G) Education Health Military Development Education Health Military Development

(a) Developed countries

Threshold estimates C 95% 5.782 3.763 0.367 2.187 5.003 3.009 0.112 1.978
confidence interval [2.874, 6.771] [1.356, 3.065] [0.025, 1.846] [1.115, 4.875] [2.879, 5.997] [1.267, 4.894] [0.002, 1.269] [0.987, 3.847]
Government expenditure  total government expenditure
Git # g 0.0012** (0.0013) 0.0007 (0.0059) 0.0009 (0.0047) 0.0008** (0.0011) 0.0015* (0.0010) 0.0001 (0.0038) 0.0001 (0.0040) 0.0012*** (0.0004)
Git  g 0.0019 (0.0039) 0.0013 (0.0027) 0.0012 (0.0056) 0.0017** (0.0008) 0.0008 (0.0025) 0.0007 (0.0027) 0.0008 (0.0045)0.0014*** (0.0000)
Covariates
GDP 0.5008*** (0.000) 0.5523*** (0.000) 0.5010*** (0.000) 0.5617*** (0.000) 0.4882*** (0.000) 0.5017*** (0.000) 0.4982*** (0.000) 0.4432*** (0.000)
Population growth 0.0027** (0.0012) 0.0017** (0.0008) 0.0028** (0.0014) 0.0032** (0.0016) 0.0012** (0.0060) 0.0010** (0.0005) 0.0013** (0.0006) 0.0022** (0.0011)
Investment 0.1446** (0.0723) 0.1984** (0.0992) 0.2761** (0.1380)0.1764*** (0.0001) 0.0997* (0.0589) 0.0153** (0.0076) 0.1008** (0.0504) 0.0885* (0.0442)
Openness 0.1141*** (0.0000)0.1098*** (0.0004)0.0991*** (0.0001)0.0967*** (0.0002)0.0931*** (0.0001)0.0832*** (0.0003)0.0775*** (0.0005)0.1070*** (0.0005)
Gov_exp * External debt 0.0076 (0.0389) 0.0092 (0.0164) 0.0074 (0.0103) 0.0051** (0.0025) 0.0035 (0.0100) 0.0075 (0.0106) 0.0057 (0.0240) 0.0031** (0.0015)
Intercept 0.0200*** (0.0003)0.0198*** (0.0011)0.0102*** (0.0009)0.0298*** (0.0003)0.0177*** (0.0003)0.0099*** (0.0009)0.0101*** (0.0005)0.0139*** (0.0040)
No. of countries 31 31 31 31 31 31 31 31
Observations 248 248 248 248 248 248 248 248
(b) Developing countries
Threshold estimates C 95% 2.990 1.563 0.763 3.115 1.993 1.102 0.321 1.342
confidence interval [0.925, 5.549] [0.511, 3.065] [0.131, 1.654] [1.365, 5.114] [0.852, 3.725] [0.595, 2.893] [0.110, 1.317] [0.907, 5.765]
Government expenditure – total government expenditure
Git # g 0.0015** (0.0012) 0.0012 (0.0053) 0.0001 (0.0031) 0.0013** (0.0016) 0.0016* (0.0004) 0.0001 (0.0055) 0.0001 (0.0036) 0.0015** (0.0004)
Git  g 0.0018*** (0.0000) 0.0015 (0.0057) 0.0002 (0.0029)0.0015*** (0.0000) 0.0019*** (0.0000) 0.0002 (0.0019) 0.0001 (0.0017)0.0019*** (0.0000)
Covariates
GDP 0.2391*** (0.0000)0.2153*** (0.000) 0.2254*** (0.000) 0.2193*** (0.000) 0.2008*** (0.000) 0.2087*** (0.000) 0.2163*** (0.000) 0.2001*** (0.000)
Population growth 0.0011** (0.0000) 0.0015** (0.0000) 0.0011** (0.0000) 0.0020** (0.000) 0.0010** (0.0000) 0.0010** (0.0000) 0.0009** (0.000) 0.0012** (0.000)
Investment 0.0552*** (0.0003)0.0232*** (0.0001)0.0328*** (0.0000)0.0499*** (0.0000)0.0431*** (0.0004)0.0117*** (0.0018) 0.0109* (0.0064)0.0355*** (0.0000)
Openness 0.0338*** (0.0000)0.0372*** (0.0001)0.0311*** (0.0000)0.0367*** (0.0001)0.0224*** (0.0001)0.0288*** (0.0222)0.0201*** (0.0002)0.0266*** (0.0001)
Gov_exp * External debt 0.0022 (0.0114) 0.0022 (0.0301) 0.0038 (0.0117) 0.0029 (0.0210) 0.0021 (0.0225) 0.0019 (0.0197) 0.0026 (0.0205) 0.0041 (0.0261)
Intercept 0.0032*** (0.0000)0.0065*** (0.0000)0.0063*** (0.0000)0.0032*** (0.0000)0.0046*** (0.0000)0.0021*** (0.0000)0.0033*** (0.0000)0.0014*** (0.0000)
No. of countries 91 91 91 91 91 91 91 91
Observations 728 728 728 728 728 728 728 728

Note: ***, ** and *denote 1%, 5% and 10% significant level, respectively
increased to 0.0015 and 0.0019 in the lower and higher regimes, respectively. The results Income
imply that any form of development-related expenditure is bound to help reduce inequality. inequality
Consistent with the results in developed countries, health-care and military expenditures
were statistically insignificant. Similar findings where higher government spending
promotes economic development in developing countries can be found in Asimakopoulos
and Karavias (2016); Kim et al. (2018); and Di Liddo et al. (2018), and probably suggest the
existence of Wagner’s Law.
499
4.3 Robustness test: conditioning the impact of government expenditure on institutional
quality
Table 5 reports the results for the sensitivity of the impact of government expenditure on the
reduction of income inequality by conditioning government spending on institutional
quality. In general, the results suggest that better institutional quality expedite the reduction
of income inequality when government expenditure is used as a tool, thus lending support to
the institutional theory. The results imply that a reduction in corruption is vital to ensure
that government expenditure is properly channelled to targeted recipients. Additionally, an
effective government provides a conducive ecosystem for policies to be executed effectively
and efficiently as purported by policy objectives. The results also lend support to the
standard equalizing effect of democracy suggested by Acemoglu et al. (2015). In a similar
vein, both cabinet composition and political stability help establish the needed ecosystem to
ensure the effectiveness of government expenditure, thus echoing the power resource theory
which postulates that a balanced cabinet composition would push for more redistributive
policies, and hence, higher government expenditure (Bradley et al., 2003; Herwartz and
Theilen, 2017).
Table 5a and 5b also shows that the threshold values for government expenditure
conditioned on institutional quality were higher in developed countries, thus suggesting that
the impact of government expenditure on income inequality rests on embedded institutional
qualities. Countries with higher scores for corruption (lower corruption), political stability,
government effectiveness and cabinet composition can expect to enjoy more efficient and
effective government expenditures, hence leading to a reduction of income inequality. A 1%
increase in government expenditure led to 0.011%–0.0031% improvement in inequality for
developed countries, and 0.13%–0.22% improvement in developing countries for market
Gini. The percentage was slightly lower when after-tax Gini was used with figures ranging
from 0.0009% to 0.0015% and 0.0009% to 0.0013% for developed and developing countries,
respectively. These results imply that given an efficient institutional setup, a lower
percentage of government expenditure could deliver relatively similar results. Similar
arguments on how institutional qualities affect the economy by providing a conducive
ecosystem for the economy to thrive have been discussed by Aidt et al. (2008) and Slesman
et al. (2019). The control variables remained relatively consistent in signs and size for both
developed and developing countries, and for both market and after-tax Gini.

5. Conclusion
This paper offers a maiden attempt to specifically analyse the impact of various types of
government expenditure on income inequality by estimating a threshold value when
government expenditure starts to have a significant impact on reducing or increasing
income inequality.
The results suggest that in developing countries, government expenditure reduces
income inequality, especially expenditures on education and development. When the sample
is segregated into developed and developing countries, developed countries seem to
 38,2
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500

Table 5.

government
expenditure on
Robustness test:
conditioning total

institutional quality
Dependent variable: Market Gini Dependent variable: After tax Gini
Government expenditure  Institutional variables
Cabinet Government Cabinet Government
composition effectiveness Corruption Political stability composition effectiveness Corruption Political stability

(a) Developed Countries

Threshold estimates C 5.765 4.753 2.974 5.765 5.877 3.661 1.778 2.763
95% confidence interval [2.365, 6.990] [1.975, 6.365] [0.987, 4.322] [2.754, 7.115] [1.908, 6.821] [0.990, 5.977] [0.876, 2.527] [0.879, 3.556]
Government expenditure (G)  total government expenditure conditioned on institutional variables
Git (Ins # g ) 0.0008 (0.0045) 0.0009 (0.0092) 0.0005 (0.0019) 0.0008 (0.0075) 0.0001 (0.0055) 0.0007 (0.0049) 0.0006 (0.0077) 0.0001 (0.0032)
Git (Ins  g ) 0.0025*** (0.0000) 0.0031*** (0.0000) 0.0022*** (0.0000)0.0011*** (0.0000) 0.0010*** (0.0000) 0.0015** (0.0005) 0.0011** (0.0005) 0.0009* (0.0005)
Coviarates
GDP 0.5593*** (0.000) 0.5582*** (0.000) 0.4979*** (0.000) 0.4324*** (0.000) 0.5046*** (0.000) 0.4966*** (0.000) 0.3117*** (0.000) 0.3221*** (0.000)
Population growth 0.0009** (0.0000) 0.0008** (0.0000) 0.0009** (0.000) 0.0005** (0.000) 0.0002** (0.0000) 0.0002** (0.0000) 0.0003** (0.000) 0.0001** (0.000)
Investment 0.0238* (0.0110) 0.0244** (0.0140) 0.0201* (0.0118)0.0115*** (0.0001) 0.0110* (0.0065) 0.0111** (0.0055) 0.0098* (0.0057) 0.0076* (0.0041)
Openness 0.0409*** (0.0000) 0.0400* (0.0236) 0.0432*** (0.0000)0.0411*** (0.0000)0.0395*** (0.0000) 0.0377* (0.0223) 0.0279*** (0.0000)0.0325*** (0.0000)
Gov_Exp * ext. debt 0.0024 (0.0064) 0.0020 (0.0090) 0.0021 (0.0070) 0.0021 (0.0077) 0.0019 (0.0055) 0.0018 (0.0070) 0.0018 (0.0071) 0.0017 (0.0055)
Intercept 0.0095*** (0.0000) 0.0067*** (0.0000) 0.0065*** (0.0000)0.0058*** (0.0000)0.0076*** (0.0000) 0.0059*** (0.0000) 0.0097*** (0.0000)0.0043*** (0.0000)
No. of countries 31 31 31 31 31 31 31 31
Observations 248 248 248 248 248 248 248 248
(b) Developing Countries
Threshold estimates C 95% 1.998 1.527 2.754 1.001 0.997 0.877 0.775 0.767
confidence interval [0.977, 6.214] [0.697, 2.255] [0.328, 4.652] [0.847, 4.116] [0.261, 2.322] [0.532, 2.985] [0.259, 1.227] [0.331, 2.760]
Government expenditure (G) – total government expenditure conditioned on institutional variables
Git (Ins # g ) 0.0002 (0.0327) 0.0014 (0.0531) 0.0011 (0.0119) 0.0005 (0.0051) 0.0001 (0.0087) 0.0007 (0.0083) 0.0006 (0.0035) 0.0001 (0.0075)
Git (Ins  g ) 0.0013*** (0.0000) 0.0022*** (0.0000) 0.0019*** (0.0000)0.0016*** (0.0000) 0.0001 (0.0052) 0.0009** (0.0005) 0.0011** (0.0005) 0.0013* (0.0006)
Coviarates
GDP 0.2888*** (0.000) 0.1359*** (0.000) 0.1491*** (0.000) 0.2373*** (0.000) 0.2115*** (0.000) 0.1184*** (0.000) 0.1414*** (0.000) 0.2912*** (0.000)
Population growth 0.0023** (0.0000) 0.0022** (0.0000) 0.0019** (0.000) 0.0031** (0.000) 0.0011** (0.0000) 0.0009** (0.0000) 0.0032** (0.000) 0.0027** (0.000)
Investment 0.0057* (0.0033) 0.0064** (0.0031) 0.0051* (0.0030)0.0033*** (0.0000) 0.0041* (0.0024) 0.0039** (0.0018) 0.0025* (0.0014)0.0015*** (0.0000)
Openness 0.0325*** (0.000) 0.0449* (0.0263) 0.0322*** (0.000) 0.0472*** (0.000) 0.0255*** (0.000) 0.0376* (0.0222) 0.0213*** (0.000) 0.0275*** (0.000)
Gov_Exp * ext. debt 0.0032 (0.3265) 0.0042 (0.1432) 0.0057 (0.0993) 0.0098 (0.0335) 0.0025 (0.0455) 0.0026 (0.0659) 0.0039 (0.0871) 0.0055 (0.0761)
Intercept 0.0862*** (0.0000) 0.0225*** (0.0000) 0.0615*** (0.0000)0.0122*** (0.0000)0.0235*** (0.0000) 0.0476*** (0.0000) 0.0217*** (0.0000)0.0009*** (0.0000)
No. of countries 91 91 91 91 91 91 91 91
Observations 728 728 728 728 728 728 728 728

Note: ***, **and *denote 1%, 5% and 10% significant level

experience an increase in inequality when tested against government development Income
expenditure. This is consistent with the inversed U-shaped Kuznet hypothesis where, in the inequality
growth literature, economic growth initially increases income inequality but will eventually
reduce inequality after a certain level of development is reached. However, this may not be
the case for developing countries where education and development expenditures are
necessary to reduce income inequality.
The results also highlight the importance of institutional setup in terms of government
effectiveness and control of corruption in ensuring effective delivery of government
501
expenditure to the target group of recipients. A more balanced cabinet composition is a
prerequisite for government effectiveness and serves as a check and balance mechanism
which is necessary to control corruption. Besides, political stability is a requisite for
governments to function effectively.
Several policy implications could be derived from this paper. First, to combat income
inequality, government expenditure could be an effective tool. Education and development
expenditures are the key drivers towards reduction in income inequality. Second, even in
developed countries, government expenditure plays an important role in reducing income
inequality. Finally, the quality of institutions, as reflected by cabinet composition,
government effectiveness, control of corruption and political stability, plays a crucial role in
ensuring effective delivery of intended policies to address income inequality.

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North-Holland, Vol. 1, pp. 93-131.

Corresponding author
Noor Zahirah Mohd Sidek can be contacted at: nzahirah@uitm.edu.my

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