Examining The Relationship Between Income Inequality, Taxation And Economic Freedom: A Panel Cointegration Approach

Income inequality has become an important challenge for both developed and developing countries. Taxation and economic freedom are considered as important factors affecting income inequality. This paper aims at the empirical investigation of the causal relationships between income inequality, taxation and economic freedom by applying panel cointegration techniques and Pooled Mean Group (PMG) estimation method on a panel of 58 countries, over the period 1995-2016. The empirical evidence supports a bidirectional long-run causal effect between taxes-to-GDP ratio and income inequality with tax-to-GDP ratio to cause negative impact on income inequality and thus revealing the redistributive role of taxes. Furthermore, we find a positive effect of the economic freedom on income inequality, suggesting a trade-off between economic freedom and income equality.