Abstract:
Through this study, we try to evaluate the effects that the direct and indirect taxation and the
subsidies provided by the Government have on income inequality. We use Gini coefficient as a
measure of inequality and use annual data for Indian economy for years 1982-2015 and employ
an ARDL-based bounds test approach for testing co-integration. We ascertain the stationarity
properties for all the series, separately using the ADF test, the DF-GLS test and the KPSS
test. We estimate the long-run and short-run coefficients and find that a long-run negative
relationship exists between Gini coefficient and subsidy-related expenditure. The long-run
coefficients of direct and indirect taxation terms are positive but are significant only at 10%. The
short-run coefficients obtained from ECM show that a negative relationship exists between
expenditure on subsidies and Gini coefficient. In short run, direct tax seems to have an
insignificant positive coefficient while indirect tax seems to have a significant unbalancing effect.
We employ the Granger causality tests to confirm direction of causality and find that there runs a
unidirectional causality from direct tax, indirect tax and subsidy to Gini coefficient, while any
causality from Gini to any series is largely insignificant. The results imply that the government
should use the calculated hybrid of tools like direct and indirect taxation and subsidies to have an
equalizing impact on the economy. Moreover, the significant causal relationship from subsidies to
Gini opens up an opportunity for the government to improve the income distribution using
targeted subsidies, for example the Aadhaar-linked Direct Transfer Benefits etc.