Ricardian Equivalence Theorem
The Ricardian Equivalence Theorem is the proposition that the method of financing any particular path of government expenditure is irrelevant. More precisely, the choice between levying lump-sum taxes and issuing government bonds to finance government spending does not affect the consumption of any household nor does it affect capital formation. The fundamental logic underlying this argument was presented by David Ricardo in Chapter XVII (‘Taxes on Other Commodities than Raw Produce’) of The Principles of Political Economy and Taxation (1821). Although Ricardo clearly explained why government borrowing and taxes could be equivalent, he warned against accepting the argument on its face: ‘From what I have said, it must not be inferred that I consider the system of borrowing as the best calculated to defray the extraordinary expenses of the state. It is a system which tends to make us less thrifty — to blind us to our real situation’ (1960, pp. 162–3).
KeywordsGovernment Bond Future Consumption Marginal Propensity Bequest Motive Debt Finance
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