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her
taxes
by
(1 + r) T to finance repayments
(1
nd period after tax income to be She expects her 2 (1 + r) T
T 1 r 0 The PV of this = 0! T 1 r • The net effect is to leave the present value of her income,
and therefore her consumption plan, unchanged
unchanged • Implication:
A balanced budget every year is not
necessarily good. For instance, during a
war instead of raising taxes on an already
overburdened public, it might be welfare
improving to run a deficit; it does not SNat’l
Nat’
this is because taxes have distortionary costs
distortions increase exponentially with taxes 58 62 Government Cuts Taxes by $1
by $1
and Borrows $1 Ricardian View (cnt.)
cnt.)
• The key is: Consumers care about the Present Value of their
Present
tax obligations SNatl Spriv Sgov by < $1 by < $1 by $1 by $1 by $1 Straight from the Permanent Income idea Government’s reducing taxes now and having to
Government’
increase them later doesn’t change the PV of taxes
doesn’
PV It is a shell game Therefore, the consumer is neither better or worse
off Doesn’t change her consumption plan!
Doesn’ The tax cut becomes additional saving Traditional
View
View Ricardian
Unchanged
View It’ll be used to pay the future higher taxes
It’
59 63
63 Example #3 (Ricardian View)
(Ricardian Example #3 (Ricardian View)
(Ricardian
• Government reduces current taxes by 200 without
changing expenditures. What happens to Current
Current
Consumption, Priv. Saving, Nat’l Savings?
Priv.
Nat’ • Suppose private consumption is given by
1
PV Net Inc 2 Y1 = 1,600, Y2 = 1,100, T1 = 400, G1 = 600, G2 = 660,
600,
r = 10% Y1 = 1,600, Y2 = 1,100, T1 = 600, T2 = 660,
600,
G1 = 600, G2 = 660 (balanced budget each period), r = 10%
600,
660 C
SPriv
SNatl =
=
= 64
64 69 Example #3 (Ricardian View)
(Ricardian Empirical Evidence for the U.S. • Suppose private consumption is given by
1
PV Net Inc 2 Federal Deficits & the Real Rate
10.0%
FED DEFICIT
10Y Real Rate
CAB/GDP 8.0% Y1 = 1,600, Y2 = 1,100, T1 = 600, T2 = 660,
600,
G1 = 600, G2 = 660 (balanced budget each period), r = 10%
600,
660 6.0%
4.0%
2.0% What is Perm. Inc., and the PVs of G, T?
Perm.
G,
Perm Inc =
PV(G) =
PV
PV(T) = 0
6 0
8 4.0%
6.0%
8.0%
10.0% 65 73 The “Burden” of Debt in a Nutshell
Burden” Example #3 (Ricardian View)
(Ricardian
C ar ar
M M ar 0
2 0
4 0
0 9
8 ar ar
M 9
6 ar
M M 9
4 9
2 ar ar ar
M M M 8
8 9
0
ar M 8
6 8
4 ar ar
M M 8
2 ar
M 8
0 7
8 ar ar
M M 7
6 ar
M 7
4 ar 7
2 ar ar M ar M M 7
0 0.0%
2.0% M C M C 1
PV Net Inc 2 • Gov takes resources from the economy now
now
but borrows to pay for them! Y1 = 1,600, Y2 = 1,100, T1 = 600, T2 = 660,
600,
G1 = 600, G2 = 660, r = 10%
600,
660, What is Current Consumption, Priv. Saving,
Current
Priv.
Nat’l Savings?
Nat’
C
=
SPriv
=
SNatl
= 67 If this tricks consumers into thinking their
tricks
income is high, they will save less and
k will grow more slowly
equilibrium k will be lower
The issue is the empirical relevance of Ricardian
empirical
equivalence 74 The “Burden” of Debt (Concl.)
Concl.)
Burden” Do We Have to Pay Back the Debt or Not? Even if the world is Ricardian
• Higher future taxes mean higher future tax
distortions • In...
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Full Document
 Spring '07
 Safarzadeh
 Government, Taxes, Deficit, Fiscal Policy, Debt, Public Finance

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