The Distributional Consequences of Government Spending

This paper examines the mechanism through which pro-growth policies such as government spending on infrastructure might a¤ect the dynamics of inequality. We develop a model in which government-provided infrastructure is not only the engine of growth, but also a critical determinant of the distributions of wealth, income, and welfare. Government spending on infrastructure by itself is shown to be an ine¤ective tool of redistribution. It enhances economic growth, but leads to sharply contrasting e¤ects on income inequality over time: inequality falls in the short run, but worsens in the long-run. For infrastructure investment to have a redistributive e¤ect on the economy, it must be …nanced by an appropriate taxation policy. In this respect, the capital income tax serves as an e¤ective redistributive tool if used as a …nancing instrument. The redistributive e¤ects of the consumption tax as an alternative to the more conventional labor income tax are also highlighted. Keywords: Infrastructure, Public investment, Inequality, Equity, Distribution, Economic Growth, Welfare, Fiscal Policy JEL Classi…cation: D31, D33, E25, H54, O15 Department of Economics, Terry College of Business, University of Georgia, Athens, GA 30602 USA. Phone: +1-706-542-3696. Email: [email protected]. yThis paper has bene…ted from initial discussions with Suman Ghosh and Stephen Turnovsky. Financial support from the Terry-Sanford Research Award at the University of Georgia is gratefully acknowledged.