Fiscal adjustments, income inequality and economic growth: an empirical analysis of Japanese prefectures

Purpose This paper investigates the joint relationship between economic growth, income inequality and fiscal adjustments using a panel of 47 Japanese prefectures from 1998 to 2017. Design/methodology/approach To assess jointly fiscal adjustment impacts on growth and inequality and to take into account the interdependence between these variables, the authors use a simultaneous equation model and estimate it by using the three-stage least squares estimation method. Findings The results show evidence of a trade-off between growth and inequality through fiscal adjustments. They reveal that first, fiscal adjustments have contractionary effects on growth. Second, they highlight the disparity between urban and rural taxpayers. Third, they provide evidence of a trade-off between fiscal adjustments and inequality through the labor market. Research limitations/implications Based on the literature, the composition of fiscal adjustments is a crucial factor in analyzing fiscal adjustment impacts on economic growth and income inequality. The authors do not consider this aspect in the analysis; however, fiscal policy outcomes variables are included as a workaround for this. Practical implications These results suggest that authorities favor expenditure-based adjustments as they are less contractionary on the economy. Moreover, they should finance public expenditures through a tax on capital in order to mitigate fiscal adjustment impacts on inequality while promoting growth. Originality/value The paper is novel in testing the existence of a trade-off between economic growth and income inequality through fiscal adjustments at a sub-national level with an additional focus on urban and rural regions.