This paper’s goal is to examine the effect of foreign aid on income inequality and poverty reduction for the period 1971–2002. Since simple cross-country regressions cannot be taken as ‘true’ time series findings we focus on dynamic panel data techniques, which allow accounting for potential simultaneity and heterogeneity problems. We find some weak evidence that foreign aid is conducive to the improvement of the distribution of income when the quality of institutions is taken into account; however, this result is not robust. This finding is consistent with recent empirical research on aid ineffectiveness in achieving economic growth or promoting democratic institutions.