Which of the following is a basic assumption of the Ricardian equivalence theorem?
A) Consumers pay no attention to government budget deficits.
B) Consumers think only in terms of the present.
C) If current tax cuts result in budget deficit increases, consumers increase their labor supply today.
D) Consumers consider future tax payments when deciding how much to spend and save today.

Question

Quizplus · Accepted Answer

The Ricardian equivalence theorem assumes that consumers consider future tax payments when making decisions about how much to spend and save today. This means that if current tax cuts result in budget deficit increases, consumers will increase their savings rather than their labor supply because they anticipate having to pay higher taxes in the future to finance the deficit. Options A and B are incorrect because the theorem assumes that consumers do pay attention to government budget deficits and think about the future. Option C is partly correct in that consumers may increase their labor supply in response to tax cuts, but it misses the key point that this effect is offset by increased savings because of future tax expectations.

Which of the Following Is a Basic Assumption of the Ricardian