The Effect of Regional Government Expenditures and

Government Transfers on Income Inequality:

Study in Districts/Cities in West Java

Azas Mabrur

Polytechnic of State Finance STAN Jakarta, Indonesia

Abstract. This paper examines the effect of local government spending and

central government transfer on income inequality. The study was conducted

using a panel data model with Fixed Effect model with data samples from 20

cities/districts in West Java during 2013-2017. The results of this study indicate

that total local government expenditures in West Java has the effect of increasing

the Gini coefficient, which means an increase in income inequality, while

government spending in the economic function can reduce the Gini coefficient.

This results shows that Local government expenditure allocations in West Java

have not been able to support inclusive growth. To encourage inclusive growth,

government spending needs to be appropriately allocated, especially prioritized

in the economic function, not in other functions such as administrative and

service functions

Keywords: Gini ratio · Government spending · Income inequality

1 Introduction

The state budget as a form of state financial management is determined every year by

law and implemented for the greatest prosperity of the people. This becomes the main

foundation in the management of gvernment finances, that the main purpose of

managing state finances is to achieve the welfare of the people. The implementation of

the State Budget includes the transfer of funds to the Regional Budget, which has also

increased from year to year, where by 2018 it has reached more than 800 trillion rupiah.

Increased government spending is expected to be able to influence the improvement of

people's welfare achieved by reducing disparities in the level of welfare between groups

in society due to differences in the level of ownership and opportunities for the use of

economic resources for the private sector (Badrudin, 2012).

Prior studies have found a positive relationship between fiscal decentralization and

economic growth (Iimi, 2005) and (Yilmaz, 1999), while others establish no direct

relationship (Martinez-Vazquez & McNab, 2003). however, it cannot be denied that

government spending in developing countries is an economic stimulus that has an

important role in economic growth. economic growth discussed in the last few decades

is fair and equitable economic growth (Aoyagi & Ganelli, 2015). The results of the

study indicate that redistributive fiscal policy and monetary policy aimed at effective

macro stability in promoting inclusive growth. The coefficient of fiscal redistribution

Mabrur, A.

The Effect of Regional Government Expenditures and Government Transfers on Income Inequality: Study in Districts/Cities in West Java.

DOI: 10.5220/0009855000002900

In Proceedings of the 20th Malaysia Indonesia International Conference on Economics, Management and Accounting (MIICEMA 2019), pages 281-288

ISBN: 978-989-758-582-1; ISSN: 2655-9064

281

is significant and positive, which means that the government's redistribution policy is

able to drive inclusive growth.

In addition to being classified in the economic classification of government

expenditures such as personnel expenditure, goods expenditure and capital spending

are also classified based on function. Many public policies are treated as expenditures

but actually should be considered as investments, especially those that invest in human

resources, both at the individual level and at the level of the individual group. These

expenditures include health care, education, and security (Boarini, Causa, Fleurbaey,

Grimalda, & Woolard, 2018). the example shows that some redistributive policies,

especially health spending and higher education, benefit the poor while at the same time

increasing growth through increasing human capital (Benabou, 2000).

The largest example of redistribution was found for Belgium, while Colombia and

Peru showed a rather limited overall redistributive effect. Transfers on average reduce

income inequality by more than 85 percent, while taxes are responsible for redistribution

of 15 percent. in that country, transfers still play a dominant role in reducing the initial

income gap. Among all welfare countries, Continental European countries achieved the

highest level of reduction in initial income inequality (Wang & Caminada, 2011).

In the short term, higher inequality helps economic performance but reduces the

rate of GDP per capita growth further in the future (Halter, Oechslin, & Zweimüller,

2014). Policy reforms that promote growth that tend to reduce income inequality are

needed: among them 1) Improving the quality and reach of education, 2) Promoting

equality in education, 3) Reducing the gap between work protection on temporary and

permanent work (Hoeller, Joumard, & Koske, 2014).

At the local government level, APBD has an important function for the creation of

community welfare. Public welfare in general can be measured by increasing per capita

income of the population, decreasing poverty and unemployment rates and increasing

human development index. Aside from being a stimulus for economic growth,

government spending must also be directed at creating an equitable distribution of

income for all elements of society. This means that economic growth is not only

beneficial for certain groups but must be evenly beneficial for all levels of society. A

recent study concluded that the direct and indirect combined effects of income

redistribution are 'pro-growth' averages. In this study it was found that the treatment for

inequality - redistribution - is no worse for growth than inequality, because some

policymakers might worry (Ostry, Berg, & Tsangarides, 2014).

Income inequality is a condition where the income distribution received by the

community is unequal. Inequality describes the gap between those who have a high

income and those who have a low income. Gini index is the most widely used measure

to measure inequality. This is because there is a direct relationship with the Lorenz

curve where the gini index measures the extent to which the Lorenz curve departs from

the egalitarian line. This is defined as twice the area between the Lorenz curve and the

egalitarian line. The Gini index value lies between zero for complete equality and one

for complete or most extreme inequality (Shah, 2005). Gini index value of 0 indicates

the existence of a perfect income distribution.

Based on data from BPS as of September 2018 the province of West Java has a gini

index of 0.405 higher than the average index in Indonesia of 0.384. This condition places

West Java province in the top 3 provinces with the highest level of income inequality.

BPS data also shows that in the period March 2015 to September 2018, the Gini ratio in

West Java Province was still stagnant, even the position in Sep

tember 2018 increased

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compared to the same period the previous year. This shows that the government's efforts

in not overcoming the inequality of public income have not been optimal.

On the other hand, the regional government budget in West Java Province continues

to increase from year to year. This raises the question whether the local government

spending has not been able to overcome the problem of poverty and welfare disparities

in the people of West Java Province. This study wants to see empirically whether

regional government spending and transfer income from the central government in the

Regional Government in West Java has an influence in reducing income inequality as

measured by a declining Gini ratio.

2 Theory and Hypothesis Development

Politically, a country with increasing economic growth, where the average income in

the economy exceeds the average income, the majority vote tends to support the

redistribution of resources from rich to poor. This redistribution may involve explicit

transfer payments but can also involve public expenditure programs, such as education

and child care, and regulatory policies (Perotti, 1996). in governments that carry out

decentralization, the central government transfers to local governments and local

governments treat it as transfers of income in their budgets. Redistribution will be

carried out by local governments with public expenditure.

Researches try to answer the question how income distribution can influence output

growth. In these studies, the possible reverse causes of the level of development towards

inequality are recognized but ignored (Perotti, 1996) and (Benabou, 2000). Theoretical

models linking income inequality with economic growth through the three channels

(Benabou, 2000). The first is the balance of power in the political system. The second

channel is socio-political instability, which leads to a decrease in security of property

rights. The third channel is the rationing of human capital investment loans due to

imperfections in the capital market. Are specialized channels able to get empirical

support. The conclusion is that the socio-political instability argument is strongly

supported and the interaction between lending constraints and investment in human

resources also provides some support while there seems to be less empirical support for

explanations based on the effects of redistribution through fiscal policy (Perotti, 1996).

In fiscal policy, a high level of income inequality leads to higher demand for

redistribution. this in turn affects growth through the allocation of resources from

investment or through taxes that distort the incentives needed to fund redistribution

(Tanninen, 1999). Studies show that in poor countries, higher inequality tends to inhibit

growth but in rich countries it can actually encourage growth. According to the Kuznets

Curve, inequality first increases and then decreases during the process of economic

development - emerging as a clear empirical order (Barro, 2000). What effect do

various government activities have on inequality? These activities include expenditure

programs, especially education and health, transfers, and non-proportional taxes. The

level of inequality of the country also determines the income redistribution program

through government expenditure, because governments in a more unequal society tend

to spend on redistribution programs. This may not be as efficient as an instrument for

reducing poverty and reducing inequality because the benefits of public spending can

be captured by nonpoor (De Mello & Tiongson, 2006).

The Effect of Regional Government Expenditures and Government Transfers on Income Inequality: Study in Districts/Cities in West Java

283

In this study, researchers will examine whether local government spending has a

positive effect on reducing income inequality

H1: Total local government spending has a positive effect on the Gini Ratio

In terms of government expenditure classifications, does the type of capital expenditure

have a positive effect on reducing income inequality

H2: Capital expenditure has a positive effect on the Gini Ratio

In terms of the expenditure function, does spending in the economic and education

sectors respectively have a positive effect in reducing income inequality

H3: Spending on Economic function has a positive effect on Gini Ratio

H4: Spending on Education function has a positive effect on the Gini Ratio

In terms of the source of income, does income from transfers have a positive effect on

reducing income inequality

H5: Income from transfer has a positive effect on the Gini Ratio

3 Research Method

3.1 Sample and Survey Procedure

The data used in this study are secondary data obtained from the Central Statistics

Agency (BPS) of West Java Province and the Directorate General of Fiscal Balance.

The data collection method in this study was carried out with documentation, i.e.

gathering records / data needed according to the research to be carried out. The data

needed is in the form of district / city Gini Ratio in West Java Province as well as data

on revenue realization and expenditure of city districts in West Java Province.

The data analysis method used in this study is the panel data model, which is a

combination of cross section data from 20 local government and time series from 2013

to 2017. There are three methods that can be used for data processing using panel data,

namely: Common effect model, estimating panel data with the OLS method; Fixed

effect (FE), adding a dummy model to the panel data; and Random effects, taking into

account errors from panel data with the least square method.

3.2 Measures

The panel data regression analysis used in this study requires a model specification test

to determine which model is considered appropriate in the function model regression

process. From the results of the tests conducted, the right model is the fixed effect model

based on the results of the Chow test and Hausman Test which results in both

probabilities of less than the 5% significance level (0.05).

The regression function model that will be used is as follows:

GINI

= β

+ β

TOTBEL

+ β

CAPEX

+ β

BECON

+ β

BEDU

+ β

TRANS

+ e

GINI = Income Inequality

TOTBEL = Total local government spending

CAPEX = Capital Expenditures

BECON = Spending on Economic function

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284

BEDU = Spending on Education function

TRANS = = Income from Central Government Transfers

4 Empirical Result

On average, the city of Bandung had the highest Gini index of 0.440, followed by the

city of Tasikmalaya, while the lowest index is in Indramayu Regency. Based on

observational data, in general the Gini index in urban areas is indeed higher than the

Gini index in rural areas, its mean that in urban areas income inequality is more

pronounced than in income inequality in rural areas.

Table 1. Descriptive Statistics.

GINI L_CAPEX L_TRANS L_EDU L_ECON L_TOTBEL

Mean 0.363540 26.79881 27.93679 27.26403 25.52806 28.45559

Median 0.356015 26.82130 28.02988 27.50975 25.59531 28.49431

Maximu

0.477236 28.06399 28.73285 28.42144 27.62151 29.55902

Minimu

0.279878 25.47274 26.77368 23.03965 21.50634 27.18485

Std. Dev. 0.041067 0.604204 0.470165 0.880707 0.881229 0.541704

Skewness 0.326486 0.089586 -0.575630 -1.953733 -1.318869 -0.275653

Sum 36.35399 2679.881 2793.679 2726.403 2552.806 2845.559

Sum S

. Dev. 0.166964 36.14122 21.88443 76.78890 76.87989 29.05090

Observations 100 100 100 100 100 100

Table 2. The estimation results with Fixed Effect Model.

Variable Coefficient Std. Erro

t-Statistic Prob.

C -2.066697 0.638900 -3.234777 0.0018

L_CAPEX 0.007266 0.017970 0.404318 0.6871

TRANS 0.008655 0.022086 0.391881 0.6963

EDU 0.013071 0.007048 1.854520 0.0676

L_ECON -0.015466 0.006528 -2.369314 0.0204

TOTBEL 0.071416 0.027269 2.618930 0.0107

Effects Specification

Cross-section fixed

(

dumm

variables

)

R-s

uare

0.763575 Mean de

endent va

0.363540

usted R-s

uare

0.687919 S.D. de

endent va

0.041067

S.E. of regression 0.022942 Akaike info criterion -4.499391

Sum s

uared resi

0.039475 Schwarz criterion -3.848098

likelihoo

249.9695 Hannan-Quinn criter. -4.235801

F-statistic 10.09271 Durbin-Watson stat 2.547051

Prob

(

Peterson

)

0.000000

The Effect of Regional Government Expenditures and Government Transfers on Income Inequality: Study in Districts/Cities in West Java

285

The adjusted R-square value is 0.68% so that simultaneously the independent

variable can explain 68% of the dependent variable. From the significance test results,

it can be seen that not all independent variables are significant in the model, where

Prob. t-statistic> a as the degree of confidence of the estimate used (a = 5% = 0.05). In

the regression model above the independent variable Spending on Economic function

(L_ECON) and total local government spending (L_TOTBEL) has a significance <0.05

this means that these two variables have a significant effect on the income inequality

variable (GINI). While the Capital Expenditure variable (L_CAPEX) and Income from

Central Government Transfers (L_TRANS) have not significant to income inequality

(GINI).

4.1 Total Local Government Spending

Intercept value of 0.07 means that an increase in government spending by 1 percent

will increase the gini index by 0.07 so that H1 is rejected. Based on these results, overall

government spending in the districts / cities of West Java actually led to an increase in

the gini index, which means increases the income gap. Government spending, which is

expected to be a stimulus for economic growth in the regions, has increasingly

empirically created a income disparity. This can happen if the output of government

spending has not been able to reach the lower classes of society. So we need better

spending priorities to create inclusive economic growth.

4.2 Spending on Economic Function

Intercept value of -0.015 means an increase in economic function expenditure of 1

percent will reduce the gini index by 0.015 so that H2 is accepted. Economic function

expenditure is government expenditure whose impact is on economic growth and

community welfare so that it is expected to create employment opportunities, reduce

poverty levels and reduce the public income gap.

As for transfer income from the central government as well as spending in education

it has not shown a significant effect on the gini index. In contrast to some previous

studies which provide evidence that spending in education can reduce income

inequality, the results of this research have not found the same role in West Java. this

needs to be further investigated how the role of spending in education in West Java so

that it can be more directed towards the results as expected.

5 Conclusions

Previous studies have shown the effect of government spending on economic growth,

but how it affects the income gap. does government spending have a role in reducing

the income gap or vice versa. The results of this study indicate that total regional

government expenditure has an effect on increasing the Gini index, which means that

the income gap in the community is higher. This can be understood because in general,

government spending does not only benefit the lower class, but even the middle and the

upper class have more benefit from government spending. Meanwhile, government

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spending in West Java that specifically allocated to economic functions has the opposite

effect, which can reduce the Gini index. This is a positive result in encouraging

inclusive growth in West Java Province

Based on these empirical results, the government needs to prioritize budget

allocations for economic functions compared to budget allocations for service and

administrative functions. Appropriate budget allocation is expected to encourage

regional economic growth that is inclusive and equitable and can be felt by all citizens

in the region.

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Appendix

Appendix 1. Gini Index per District / City in West Java.

District/Cit

2013 2014 2015 2016 2017 Avera

Kota Bandun

0,415 0,477 0,441 0,438 0,428 0,440

Kota Tasikmala

a 0,394 0,371 0,485 0,416 0,422 0,418

Kota Bo

0,405 0,363 0,473 0,425 0,410 0,415

Kota Cirebon 0,378 0,404 0,413 0,404 0,411 0,402

Kab Bo

0,382 0,385 0,418 0,401 0,384 0,394

Kota Cimahi 0,404 0,388 0,395 0,416 0,365 0,394

Kota Sukabumi 0,341 0,359 0,428 0,417 0,403 0,390

Kota Depo

0,394 0,365 0,400 0,401 0,352 0,382

Kab Bandun

0,344 0,374 0,397 0,399 0,391 0,381

Kab Purwakarta 0,388 0,369 0,352 0,356 0,389 0,371

Kota Bekasi 0,354 0,329 0,410 0,392 0,351 0,367

Kota Ban

0,341 0,320 0,419 0,367 0,381 0,366

Kab Sumedan

0,337 0,328 0,349 0,367 0,387 0,354

Kab Bandun

Bara

0,309 0,326 0,339 0,357 0,405 0,347

Kab Ma

alen

ka 0,322 0,342 0,353 0,356 0,351 0,345

Kab Kunin

an 0,325 0,370 0,344 0,332 0,320 0,338

Kab Ciamis 0,332 0,310 0,332 0,333 0,364 0,334

Kab Suban

0,331 0,314 0,333 0,348 0,344 0,334

Kab Garu

0,309 0,330 0,306 0,347 0,369 0,332

Kab Karawan

0,319 0,303 0,341 0,344 0,348 0,331

Kab Bekasi 0,329 0,328 0,345 0,309 0,336 0,329

Kab Cirebon 0,321 0,284 0,328 0,356 0,355 0,329

Kab Sukabumi 0,301 0,321 0,356 0,329 0,334 0,328

Kab Cian

0,285 0,280 0,281 0,361 0,348 0,311

Kab Tasikmala

a 0,317 0,294 0,304 0,304 0,319 0,307

Kab Indrama

u 0,27 0,281 0,288 0,262 0,291 0,280

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