Nobody From Nowhere (@i8dc)

Occasional Common Sense

Why Would Ricardian Equivalence Advocates Be Against Higher Taxes?

with one comment

As I discussed this morning, some conservative economists argue that additional stimulus spending would be ineffective due to the Ricardian equivalence theory, which says that since bigger deficits necessarily mean higher future taxes, the private sector would react by reducing current saving by the same amount as the present value of higher future taxes, which is the same amount as the additional deficit.  Simply put, deficit spending is ineffective because it crowds out private spending on a 1:1 basis.

Under the theory, deficit spending generates the exact same result as taxation – a decrease in private sector spending equivalent to the deficit or tax.   But run the theory the other way: increasing current taxes to reduce the deficit should have no impact on private spending.  And yet, I’ve never seen one of them say that raising taxes would have no impact on the economy.

Either deficit spending is ineffective, or raising taxes wouldn’t hurt.  You can’t apply your theory in one case but not the other.

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Written by David Clayton

September 2, 2011 at 12:20 am

Posted in Punditry

One Response

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  1. You are confusing two different ideas, Ricardian equivalence and supply-side incentives. Ricardian equivalence does imply that conservatives should be indifferent between lower taxes and more saving versus higher taxes and lower saving. However, the core conservative argument is about incentives.

    In the supply-side model, higher taxes reduce incentives to work, produce, etc. As a consequence, even allowing for strict Ricardian equivalence lower taxes and higher saving will yield better outcomes because of higher net output (GDP).

    The obvious question is how large are the incentive effects in the real world. Extreme supply-side thinking holds that the increase in output is so large that taxes on the extra production will pay for tax cuts. Obviously, most liberal economists don’t believe any such thing. Indeed, most conservative economists (versus politicians) don’t either.

    However, you might be surprised at how high liberal estimates of incentive effects are. Brad DeLong suggests that the deadweight cost of taxation is 1/3rd. See http://delong.typepad.com/sdj/2009/01/best-anti-stimulus-argument-from-kevin-murphy.html for a reference.

    In real life, the evidence for Ricardian equivalence with respect to taxation is slim to none. Any review of saving rates shows that the are driven by economic aversion (fear) and wealth effects. I also find the evidence in favor of supply-side economics to be limited (other than as covert Keynesianism).

    However, if you intend to argue against something, you need to understand the logic of your opponents.

    peterschaeffer

    September 9, 2011 at 11:37 am


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