Question

According to the Ricardian equivalence theory, rational individuals may consider a higher budget deficit as leading to increased future taxes. Do you agree or disagree with this premise?

a) Agree, because individuals anticipate higher taxes in the future and adjust their current saving or spending accordingly.
b) Disagree, as individuals may not always make rational decisions regarding government deficits and future tax obligations.
c) Partially agree, recognizing that some individuals may alter their behavior, while others may not consider future tax implications.
d) None of the above.

Answer 1

The Ricardian equivalence theory suggests that rational individuals adjust their behavior based on the expectation of future tax implications caused by a higher budget deficit. They may save more in anticipation of the future tax burden.

Step-by-step explanation:

The Ricardian equivalence theory argues that rational individuals consider a higher budget deficit as leading to increased future taxes. The theory suggests that individuals anticipate higher taxes in the future and adjust their current saving or spending accordingly. This is because they believe that the additional borrowing today will eventually have to be repaid through higher taxes.

For example, if the government increases its deficit by borrowing more money, rational individuals may expect that the government will need to raise taxes in the future in order to repay the debt. In response, these individuals may choose to save more in anticipation of the future tax burden.

Therefore, I agree with the premise of the Ricardian equivalence theory (option a) because it suggests that individuals react to budget deficits by adjusting their behavior based on their expectation of future tax implications.