Unformatted text preview: ent Consumption, Priv. Saving,
Current
Priv.
Nat’l Savings?
Nat’
C
SPriv
SNatl 44 Example #2 (Traditional View) The Ricardian View of Deficits • Gov. decreases taxes to 400 without
decreasing spending
C = C0 + (Y – T) ; = 0.60
C0 = 100, Y = 2,000, T = 400, G = 600
400,
600
What is Consumption, Priv. Sav, Nat’l Sav?
’
Consumption Priv.
Nat
C
=
SPriv
=
SNatl
= The Ricardian conclusion is that consumers will
save all such tax cuts, and national savings will
save
national
not change
Private savings will offset the government
deficit We’ll show this in a simple model
We’
• Assume government cuts taxes and runs a
deficit, while holding current and future
while
government expenditures fixed
Taxes are lumpsum
lump 48
48 Brief Review 54 The Ricardian View of Deficits • Deficit = (G + TR + INT)  T
TR INT
Debt/GDP is the usual way we compare deficits
over time and across countries • What is the traditional “burden of the debt”?
debt”
Lower std of living; not the interest payments
not • The “thought experiment” is:
experiment”
Gov cuts taxes while holding spending the same
Bush policy (also the old Reagan policy) Does this change private behavior?
“Traditional View” YES! Reduces Nat’l
View”
Nat’
Savings, k, and therefore steady state y • The budget constraint for a consumer in the
2period model is (discussed in T.6)
PV(consumption) = PV(net income)
(consumption) PV C1 C2
Y
T Y1 2 T1 2 1 r
1 r 1 r Recall that the PV of a series of cash receipts over
PV
time is:
PV X 0 , X 1 , X 2 , X 3 X 0 X1
X2
X3 1 r 1 r 2 1 r 3 51 The Ricardian View of Deficits 55 Ricardian View (cnt.)
cnt.) • Ricardian view: postulates a forwardforwardlooking consumer and examines if a tax cut
will consumption
Simple logic of government’s budget constraint:
government’
PV(Gov Spending) = PV(Tax Revenue)
Otherwise no one would lend to government Current deficits (& therefore lower taxes)
lower
imply future higher taxes
higher
Conclusion: the “tax cut” is not a tax cut in PV
cut”
in 53 • The
government’s
government’
constraint, is: intertemporal budget PV (Gov. Expenditures) = PV (Taxes)
PV PV G G1 G2
T T1 2 PV T 1 r
1 R 56 Ricardian View (cnt.)
cnt.) Ricardian View (cnt.)
cnt.)
• If planned government expenditures do not
change (Fix G1 and G2 )
change • In algebraic terms Government decreases taxes by T today and
finances this tax cut by borrowing, In the next period it needs to increase taxes by (1+r)
(1+
T, to repay the debt and the accumulated interest PV G T1 T T2 T 1 r PV T 1 r Consumer’s budget constraint with this tax cut:
Consumer’ Y2
T 1 r T T1 T 2 1 r 1 r Y2 G 2 Y1 G1 1 r PV Y1 57
57 Ricardian View (cnt.)
cnt.) 60 Ricardian View (cnt.)
cnt.) • What happens to the consumer’s budget constraint?
consumer’ She gets a tax break of T, so her first period income is T She knows that the government has to go out and borrow T to
finance its expenses She also foresees that the government will have to repay its debt
debt
and
it
will
have
to
increas...
View
Full Document
 Spring '07
 Safarzadeh
 Government, Taxes, Deficit, Fiscal Policy, Debt, Public Finance

Click to edit the document details