Outline and Explain the Ricardian Equivalence Theorem and...

Outline and explain The Ricardian Equivalence Theorem and assess the evidence bearing on it. The Ricardian Equivalence Theorem, developed by David Ricardo and advanced by Robert Barrow in the 19th century, suggests that taking into account the government budget constraint a budget deficit will have no effect on national saving- the sum of private and public saving, in an economy. In this essay I am going to explain the reasoning behind this, assess its likelihood and finally review evidence either supporting or opposing the theorem. In an economy, if government spending exceeds government revenues, borrowing money (for example by issuing government bonds or increasing taxation) can finance the deficit. Ricardian Equivalence states†¦show more content†¦This is taking into account the assumption that family with children are altruisc, and evidence of this varied with Seater 1993 supporting this but Bernheim stating that his findings were conflicting with altruism3. Barrow furthered his claim by questioning the effect of childless families, and argued that ‘childless family’s consumption decisions increase next generation’s burden of taxes for families with children’3 and therefore families with children keep this in mind and leave more to them. A major factor, which is ignored in Ricardian Equivalence, is that of uncertainty. This was brought forward by Feldstein 1988, and argued that if parents were unsure about future streams of income, they would be unable to calculate how much bequest they should leave. Ricardian Equivalence also might fail as taxes tend to be distortionary. People might change their behavior in response to tax changes, for example on wages, where it may in fact lead to some agents working less and consequently reducing output. Evidence for Ricardian Equivalence. In 1992, George Bush tried to avoid a recessionary period in America by altering income taxes. He cut income tax in 1992, only to increase it again the following year in 1993. Ricardian view predicts that consumers should view wealth as being unchanged and thus save their increased disposable incomes in order to be able to meet the