ACADEMIC PAPER Nonlinear analysis of government expenditure and tax rate on income inequality in India Hemachandra Padhan 1 | Ilham Haouas 2 | Shawkat Hammoudeh 3,4 | Aviral Kumar Tiwari 5,6 1 Department of Humanities and Social Sciences (HSS), Indian Institute of Technology (IIT) Madras, Chennai, India 2 College of Business, Abu Dhabi University, Abu Dhabi, United Arab Emirates 3 Lebow College of Business, Drexel University, Philadelphia, Pennsylvania 4 Institution of Business Research, University of Economic Ho Chi Minh, Ho Chi Minh, Vietnam 5 Department of Finance and Economics, Rajagiri Business School, Rajagiri, Valley Campus, Kochi, India 6 South Ural State University, Lenin Prospect 76, Chelyabinsk 454080, Russian Federation, Russia Correspondence Hemachandra Padhan, Department of Humanities and Social Sciences (HSS), Indian Institute of Technology (IIT) Madras, Chennai, India. Email: hemachandrapadhan2016@gmail.com Using annual data for India, we examine the impact of taxation and government expenditure on income inequality by endogenizing GDP, urbanization, economic globalization, remittances inflows and net FDI flows. For the empirical analysis, we use the nonlinear autoregressive distributed lag model, which indicates a long-run interplay between government expenditure and taxation on income inequality. Fur- ther, the results show that a rise in taxation increases the income inequality, while government expenditure reduces the income inequality in the long-run. Contrast- ingly, the findings reveal that GDP, urbanization and economic globalization worsen and remittance inflows and net FDI flows exacerbate income inequality. Therefore, the study suggests that the active policy makers in India can curb rising income inequality by looking at both government expenditure and the sources of taxation before framing any policies related to income distribution. Our results also under- score the close interlinkages between development strategies pursued by India and the wealth gap, which have facilitated the redistribution of gains among those already enjoying high income levels. JEL CLASSIFICATION C32; C54; E62; H2; H4; H5; H54 1 | INTRODUCTION Over the past decades, income inequality (II) has become a noticeable and disturbing phenomenon in most advanced and developing econo- mies. This phenomenon has been caused by a myriad of factors including, inter alia, education, technological innovation and globaliza- tion. A highly striking fact is the substantial variation in average dis- posable wealth across countries and regions, driven mainly by the level and the structure of taxation and spending policies, particularly in developing countries. The fiscal policy-income inequality nexus is relevant to the size of the economy, importance of specific sectors and the vitality of the middle income class. It has also raised a passion- ate debate within political classes in many developing countries including India, which has introduced reforms to help the poor and reduce income inequality (Jha, 2000). This largest global democracy has revised the minimum wage rule, offered several schemes of social security to the poor to guarantee that each individual has a minimum standard of economic welfare including free education, free homes to the homeless and so forth. It has also facilitated equality of opportunity and levied steeply progres- sive taxes on incomes and other direct taxes like the super tax, the excess profits tax and the capital gains tax as well as limitation on divi- dends and so forth. It also imposes high taxes on luxuries and ceilings on agricultural holdings and urban properties. The national progressive tax schemes are applied to the overall individual income, regardless of its origin. It is also of interest to note that the tax schedule has con- stantly been reshaped in India over the period 1986–2008, with the purpose of achieving a general decrease in tax rates and an increase in the exemption level and income corridors. In fact, the growth in the exemption threshold has been similar to that of nominal income (Piketty & Qian, 2009). Furthermore, since the 1980s, the Indian government has not only allowed capital flows but also has liberalized the economy to fill up the gap of inequality through lower restrictions (e.g., tariffs, other Received: 10 December 2019 Revised: 1 May 2020 Accepted: 15 September 2020 DOI: 10.1002/pa.2518 J Public Affairs. 2020;e2518. wileyonlinelibrary.com/journal/pa © 2020 John Wiley & Sons Ltd 1 of 14 https://doi.org/10.1002/pa.2518