Distorting taxes can invalidate Ricardian equivalence because
A) they confuse consumers about the need for government to repay its debt.
B) alternative ways of collecting the same tax revenue produce different amounts of lost welfare.
C) they are inferior to lump-sum taxes.
D) they are more popular, politically, than lump-sum taxes.
E) the distortions are only faced by the business sector.

Question

Quizplus · Accepted Answer

Ricardian equivalence is the theory that when a government increases its debt to finance spending, it will have no effect on aggregate demand because consumers will anticipate future tax increases to repay the debt, leading them to reduce current consumption and save more. However, when taxes are distorted (i.e., they create deadweight losses), alternative ways of collecting the same revenue can lead to different amounts of lost welfare, which undermines the equivalence. This is because the excess burden of a tax reduces the net disposable income of consumers, which can affect their saving and consumption decisions differently depending on the type of tax. Therefore, if taxes are distorted, it becomes less clear whether government spending will have a neutral effect on the economy, which undermines Ricardian equivalence.

Distorting Taxes Can Invalidate Ricardian Equivalence Because