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Brooks Wilson's Economics Blog: The Tea Party and the Ricardian Equivalence Hypothesis

Tuesday, April 20, 2010

The Tea Party and the Ricardian Equivalence Hypothesis

People in the Tea Party movement believe that the government has grown too large and that taxes are too high.  Their interpretation of Bush and Obama administrations' policies has created consternation among most democrats and many republicans.  Most recently, President Obama described his frustration with tax protesters ("Obama says he's amused that Tea Partiers haven't thanked him for tax cuts").
MIAMI – President Barack Obama said Thursday that he's amused by the Tea Party tax protests that took place around Tax Day and that contrary to claims of demonstrators, he has cut taxes.

"You would think they'd be saying thank you," he said at a fundraiser in Miami.
Setting aside any debate about the impact of the administration's policy until now, the president does not seem to be as farsighted as members of the Tea Party who realize that tax rates must rise to pay for a sustained increase in government expenditures. 
In 1974, Robert Barro published the "Ricardian Equivalence Hypothesis" which states that interest rates and aggregate demand do not change based on funding of government expenditures by taxes or debt.  A tax cut today will create a deficit that must be paid in the future and tax payers respond to cuts in taxes with an equivalent increase in savings. 

Today's economic outlook differs from the conditions in the hypothesis.  We have not replaced tax funding of government expenditures with debt funding.  Instead, the administration and the Congress have dramatically raised government spending and expanded healthcare entitlements creating what appears to be a permanent increase in government expenditures.  Under these conditions, a permanent increase in government expenditures would increase interest rates and not increase aggregate demand.  Tea Party members rationally conclude that their taxes will increase in the future.

1 comment:

  1. Patricia Gager25/4/10 2:45 PM

    I am not a member of the "Tea Party" movement, but consider myself conservative and vote republican. I read about Mr. Obama's frustration with tax protesters and Obama's quote "You would think they'd be saying thank you." I must say I was very annoyed with his mockery of people who realize there is no escaping raising taxes to compensate for overspending. Furthermore, if you raise taxes on those who are more fortunate financially, how is that cutting taxes. It's like talking out of both sides of your mouth. Oh I cut taxes.... Oh if you make more money you will pay more taxes. Rearranging who pays taxes is not a tax cut, Mr. Obama!