This Ricardian Equivalence thing

OK, so not even Ricardo thought it actually worked but there is this idea that tax cuts which will be followed by tax rises don\’t provide a stimulus to the economy. For rational people save the tax cuts in order to pay the future taxes. I don\’t think I actually believe this, at least not whollly. However:

The Chancellor will say on Monday that tax increases and a reduction in future spending plans are necessary to pay off the borrowing that will fund short-term emergency tax cuts.

Loudly announcing that taxes will have to rise in the future is a pretty good way of ensuring that more people do indeed save the tax cuts and thus diminish the effects of the boost.

Well done Alistair. So nice having a lawyer trying to run the economy isn\’t it?

4 thoughts on “This Ricardian Equivalence thing”

  1. For rational people save the tax cuts in order to pay the future taxes

    Wrong. It’s not as complicated as that.

    It makes no difference whether the gummint takes this extra money off us in taxes (and out of our pockets, never to be returned) or in extra borrowing*, because that money will never be returned either…

    Scenario: assume that gummint said “We need to spend an extra £30 billion this year. Would every taxpayer lend us £1,000, please?” so we all shell out.

    Then the gummint says “Oh, by the way, if you were expecting to get your money back next year, you won’t because we are going to charge you an extra £1,000 tax. We’ll just net it off for you”

    In cash flow terms there is absolutely no difference between higher taxes now or higher borrowing now* and higher taxes later. Even if people DON’T know that taxes are going to increase, cash flows are exactly the same. Money that you have lent to the gummint cannot be spent elsewhere.

    * The fact that a country can borrow from other countries complicates this a bit.

  2. The question the needs to be answers is “Who is stupid enough to lend money to this government to fund their spending spree?”
    I suspect the government is planning to raise the capital requirements of the banks again to force them to buy gilts. Cunning but this means the banks have less to lend to us poor punters.
    Then again, us poor punters are sensibly not wanting to borrow money going into a recession.

  3. You’re missing one point: the people receiving the tax cuts today are highly unlikely to be the people paying for them tomorrow.

    Leaving aside the inter-generational thing, it’s pretty clear that the government will give tax cuts to their favoured constituencies and will target the rises at thee mugs who have suffered every other rise they’ve sneaked through in the last ten years.

    In such a situation, it is entirely rational for the winners to spend their tax cuts… it’ll be somebody else who pays for them.

  4. Taking up Richard’s point, which I agree with: Those of us who will be paying higher taxes in the future will start curtailing our expenditure now, so we can afford the coming tax hike. So the stimulus will be still be annulled by people saving to pay for it. Just different people doing the spending and the saving.

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