1. Introduction

Government officials may use their authority for private gain in designing and implementing public policies.

This phenomenon –defined broadly as corruption (Tanzi 1997a)– may result in enriching these officials as well as private individuals who obtain a larger share of public benefits or bear a lower share of public costs. In this way, corruption distorts the government’s role in resource allocation. It has been argued (Tanzi, 1995) that the benefits from corruption are likely to accrue to the better-connected individuals in society, who belong mostly to high-income groups. Thus, corruption would affect not only broad macroeconomic variables, such as investment and growth, but also income distribution. It has been further contended that corruption increases poverty by creating incentives for higher investment in capital-intensive projects and lower investment in labor-intensive projects (United Nations Development Programme, 1997). Such a bias in investment strategy deprives the poor of income-generating opportunities.

To date, no empirical evidence has been presented to corroborate the relationship between either corruption and income distribution or corruption and poverty. This paper seeks to ascertain if such relationships are supported by cross-country data.

Many studies have investigated the efficiency implications of corruption through its impact on investment, growth, and expenditure allocations. The empirical results show that corruption lowers investment and, consequently, economic growth (Mauro, 1995; Knack and Keefer, 1996). There is some discussion in the literature on whether the negative impact on growth operates through reduced private investment or through reduced public investment. The recent paper by Tanzi and Davoodi (1997) provides evidence that corruption actually increases public investment, especially investment in unproductive projects, and squeezes expenditure allocations for operations and maintenance, thereby lowering the productivity of the public capital stock. The paper also shows that corruption tends to reduce government revenue, which limits the ability of the government to provide goods and services critical to its population. In a somewhat similar vein, Mauro (1997) shows that corruption distorts the composition of public expenditure; corrupt governments spend relatively less on education because of the limited scope for collecting bribes under this type of spending. This does not mean, however, that education spending is exempt from corrupt practices; in fact, in many developing countries, government payrolls are inflated by ghost workers –workers who are on the payroll but do not actually exist, including ghost teachers (Abed et al, 1998).

In general, the corruption literature has tended to emphasize the efficiency implications of corruption, while overlooking its distributional consequences.1 In part, this reflects the belief that the rich or well-connected typically use bribes to be the first in line for a rationed government good or service, and the poor or individuals at the lower end of income distribution obtain the rationed good or service after waiting in line (Bardhan, 1997). In this way, bribes are assumed to clear the market because they reflect individuals’ willingness to pay. These views, similar to the early efficiency-enhancing views of corruption (Leff, 1964; Huntington, 1968), ignore that corruption may create permanent distortions from which some groups or individuals can benefit more than others. They also ignore that individuals with high willingness to pay are not necessarily the intended beneficiaries of government programs. Moreover, the distributional consequences of corruption are likely to be more severe the more persistent the corruption,2 and the more entrenched the vested interests. The impact of corruption on income distribution is also a function of the government’s involvement in allocating and financing scarce goods and services.3 Finally, empirical work on the distributional consequences of corruption has been hindered by a lack of consistent and reliable cross-country data on income inequality and poverty that only lately has been rectified (Deininger and Squire, 1996; Ravallion and Chen, 1997).

This paper is organized as follows. The next section lists arguments on how corruption may affect income inequality and poverty. Section III presents two models of income inequality and poverty. Sections IV and V document the direct and indirect impacts of corruption on income inequality and poverty. Section VI summarizes the results and policy implications of this paper’s findings.

1 Exceptions include Tanzi (1995) and Rose-Ackerman (1997a). For an exhaustive review of the corruption literature, see Rose-Ackerman (1997b) and Tanzi (forthcoming).
2 See Bardhan (1997) for a discussion of the persistence of corruption and the empirical section of this paper for supporting evidence.
3 See Tanzi (forthcoming) for a discussion of the political economy of corruption and the reform of the state.