12 of heteroscedasticity and autocorrelation. We mitigate the bias introduced by high instrument count by replacing instruments by their principal components.

**<u>Table 1. Fixed Effects Regressions 1995-2011</u>**

||1|2|3|4|5|6|7|8|
|---|---|---|---|---|---|---|---|---|
||Gini|Gini|Gini|Gini|Gini|Gini|Gini|Gini|
|Lagged Dependent Variable|0.455***|0.455***|0.430***|0.433***|0.425***|0.422***|0.420***|0.415***|
||[0.094]|[0.094]|[0.090]|[0.090]|[0.092]|[0.088]|[0.092]|[0.092]|
|∆(Cyclically Adj. Primary Surplus/GDP)t-1|-0.181***|-0.182***|-0.179**|-0.176**|-0.162**|-0.153**|-0.153**|-0.157**|
||[0.063]|[0.062]|[0.067]|[0.064]|[0.060]|[0.057]|[0.057]|[0.058]|
|(GDP Growth per capita)t-1||0.025|0.021|0.037|0.035|0.049|0.050|0.044|
|||[0.067]|[0.069]|[0.073]|[0.071]|[0.069]|[0.069]|[0.072]|
|(Employment rate)t-1|||-0.284***|-0.294***|-0.251**|-0.307**|-0.301**|-0.272**|
||||[0.096]|[0.099]|[0.111]|[0.112]|[0.109]|[0.111]|
|(Inflation)t-1||||0.073**|0.076***|0.076***|0.076***|0.078***|
|||||[0.026]|[0.026]|[0.026]|[0.026]|[0.024]|
|(Sub-national Social Expenditure)t-1|||||0.217***|0.348***|0.345***|0.348***|
||||||[0.072]|[0.068]|[0.069]|[0.069]|
|(Federal Social Transfers/GDP)t-1||||||-1.073***|-1.036***|-0.915**|
|||||||[0.322]|[0.345]|[0.363]|
|(Years of Education)t-1|||||||-0.007|0.027|
||||||||[0.017]|[0.018]|
|(Returns to Education)t-1||||||||-0.094|
|||||||||[0.065]|
|Constant|0.000|0.000|0.000|0.000|0.000|0.000|0.000|0.000|
||[0.000]|[0.000]|[0.000]|[0.000]|[0.000]|[0.000]|[0.000]|[0.000]|
|Time Dummies|Yes|Yes|Yes|Yes|Yes|Yes|Yes|Yes|
|Time Effects|Yes|Yes|Yes|Yes|Yes|Yes|Yes|Yes|
|Pesaran (2004) cross-sectional dependence<br>test|-1.87*|-1.89*|-2.05**|-2.04**|-2.19**|-2.28**|-2.28**|-2.30**|
|Observations|405|405|405|405|405|405|405|405|
|Number of groups|27|27|27|27|27|27|27|27|
|R-squared|0.589|0.589|0.606|0.609|0.614|0.621|0.621|0.622|
|Driscoll-Kraay standard errors in brackets. Nul<br>independece. *** p<0.01, ** p<0.05, * p<0.1 . T|l hypothesis<br>ime effects|of Pesaran<br>coefficients|(2004) test<br>not reporte|for regress<br>d to save s|ion residua<br>pace.|ls is cross|-sectional||

The results obtained (Table 2) confirm the association between inequality measures, the employment rate and federal social transfers, as well as the link between the cyclically adjusted-primary balances and reductions in inequality. Nevertheless, the coefficient for the inflation rate is no longer statistically significant. The estimated coefficient (semi-elasticity) for changes in the primary balance continues to be statistically significant and is larger than what we obtained for fixed-effects regressions, ranging from around –0.26 to -0.51.

Diagnostic tests reject the null of cross-sectional independence in the residuals for most specifications, despite the inclusion of time dummies, thus the results should be interpreted with caution. In addition, AR tests do not indicate the presence of serial correlation of the residuals. As far as the validity of instruments is concerned, the Hansen test suggests that overidentifying restrictions are valid, but the Sargan test rejects the validity of these restrictions. Nevertheless one should bear in mind that the Sargan test statistic is not robust to heteroskedasticity or serial correlation.