Ricardian equivalence suggests that a debt-financed tax cut may have little effect on aggregate demand because households:
Correct answer: A. Expect future taxes and increase saving
- A. Expect future taxes and increase saving
- B. Immediately spend all additional income
- C. Treat government debt as private money
- D. Assume interest rates remain permanently zero
Explanation
The theory holds that households may anticipate future taxes needed to repay public debt and save the temporary increase in disposable income. Therefore, debt-financed tax cuts may not increase consumption by as much as a permanent tax reduction.
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Government revenue and expenditure are analysed through taxation, public borrowing, budgets, subsidies, transfers and public debt. The topic explains how fiscal policy affects resource allocation, income distribution, economic stability and growth, while distinguishing direct from indirect taxes, progressive from regressive taxation, and public goods from goods supplied by private markets.
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