The Effect of Fiscal Policy Shocks on Income Inequality and Household Poverty Reduction: Evidence from Nigeria

Abstract

This study aims to investigate fiscal policy shocks' impact on Nigeria's Income Inequality and Household Poverty. Using the impulse response function and variance decomposition technique within the Bayesian Vector Autoregressive framework (BVAR), findings from the study show that from year 2 to 15, a 1% shock to tax revenue (i.e., when taxes are suddenly changed) generates a reduced average impact of 0.036% on household poverty. In contrast, household poverty increases with shocks to government expenditure (i.e., when government expenditures are suddenly altered) in the short run, with an average impact of 0.022%. In other words, household poverty increases in the short run (years 2 to 4) and decreases in the medium to long run (years 5 to 15) with shocks to government expenditure. Similarly, the results show that shocks to tax revenue reduce income inequality (years 2 to11), and it increases the gap between the rich and the poor in the long run (years 12 to 15). Meanwhile, shocks to government expenditure increase the gap between the rich and the poor in the short to medium run (year 2 to 6) while decreasing the gap in the medium to long run (year 7 to15). The implication of these findings suggests that shocks to tax revenue directly benefit low-income families and individuals in Nigeria. Moreover, as unanticipated alteration of government expenditure increases household poverty and income inequality in the short run to medium run, any shock to government expenditure (internal or external) should be combated with pro-poor policy action.