Macroeconomic Theory and Policy – Midterm Exam | © Sanjay K. Chugh 14 Problem 4: An Alternative Interpretation of Ricardian Equivalence? (30 points) Consider a modified version of the two-period framework with government studied in Chapter 7. By “government” here we will mean just the “fiscal authority;” suppose there is no “monetary authority” at all. The government and the representative consumer each live for both periods of the economy, and suppose there are never any credit constraints on the consumer. The government does not have access to lump-sum taxes, only proportional consumption taxes. However (this is different from our baseline framework), the consumption taxes the government collects in a given period are not restricted to be levied on consumption from only in that period. To be more precise, suppose that total consumption tax revenues the government collects in period 1 are based only on period-1 consumption (because there was no period zero, say). However, total consumption tax revenues the government collectsin period 2 are based on both period-1 consumption andperiod-2 consumption. That is, a portion of the revenue collected in period 2 is based on period-1 consumption, and the remaining portion of the revenue collected in period 2 is based on period-2 consumption. Denote by 1,1τthe tax rate on period-1 consumption that is levied in period 1; denote by 1,2τthe tax rate on period-1 consumption that is levied in period 2; and by 2,2τthe tax rate on period-2 consumption that is levied in period 2. There is no 2,3τ(which would represent the tax rate on period-2 consumption that is levied in period 3) because the economy does not exist in period 3.