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- Title
ENDOGENOUS GOVERNMENT SPENDING AND RICARDIAN EQUIVALENCE.
- Authors
Bohn, Henning
- Abstract
The paper shows that an optimising model of government behaviour has implications that can differ radically from those of the Ricardian approach, even though both approaches assume rational, forward-looking individuals. Both agree that a tax cut has a smaller effect on consumption than other increases in disposable income because some increase in future taxes is expected. But the optimising model predicts also lower future government spending which reduces the need for higher taxes. The magnitude of the spending change depends on how sensitive the demand for public goods is to cost. With high elasticity, individuals will spend almost as much income from tax cuts as they spend from other disposable income. With zero elasticity, Ricardian equivalence emerges. The policy implications are wide-ranging. Unless the assumption of exogenous government spending is true, correlation between consumption and deficits provides no evidence against forward looking consumer behaviour. Research on the determinants of government spending is needed to determine how rational consumers should react to tax cuts. Perhaps the way in which the current `deficit-problems' in the United States, Germany, and several other countries are resolved - by spending cuts and/or by tax increases - will provide some revealing experiments.
- Subjects
GOVERNMENT spending policy; BUDGET deficits; CONSUMPTION (Economics)
- Publication
Economic Journal, 1992, Vol 102, Issue 412, p588
- ISSN
0013-0133
- Publication type
Article
- DOI
10.2307/2234295