When taxes are lump sum, the Ricardian Equivalence Theorem continues to hold in this environment. However, this will not be the case if taxes are distortionary. To see why, consider what happens if the government decides to implement a deficit-financed tax cut. In this case, the tax cut today (Δτ1 < 0) stimulates employment (and hence, output) today so that Δn*1 > 0 and Δy*1 > 0. The tax increase expected in the future (Δτ2 > 0) has the opposite effect, so that Δn*2 < 0 and Δy*2 < 0. Clearly, the timing of taxes does matter here. We can also see why a large deficit today may elicit some concern on the part of the population.
That is, if people understand that a high deficit today must at some point be met with higher future taxes, and if these taxes are distortionary, then people will understand that high deficits today will put a drag on future economic activity.
Hey friend, as we all know that the Ricardian equivalence proposition is an economic hypothesis holding that buyers are forward looking and so internalize the govt's funds constraint when making their utilization selections. Please download my presentation for more detail.
