Fiscal Policy and Income Distribution

Abstract

This paper studies the distributional implications of fiscal policy. After a review of the Chilean experience in the eighties, a general equilibrium, two-period optimizing model is developed to evaluate the welfare effects of fiscal adjustment following an increase in the external payments of the publicly held external debt. The model considers two private sector representative agents: a capitalist and a worker. The government finances the external transfer with an internal transfer. The following fiscal policies are analyzed: lump sum transfers, direct taxes, inflation tax, public investment, and public debt. There are three channels by which the adjustment policy affects the welfare of private agents. The first channel is the direct impact of fiscal policy on private sector agents income. The second channel is related to the impact of the adjustment policy on growth and future income. Third, a current adjustment causes a future fiscal deficit which then involves an additional internal transfer between private sector agents.