Do Tax Cuts Increase Consumption? An Experimental Test of Ricardian Equivalence

Freie Universität Berlin, School of Business & Economics Discussion Paper No. 2014/16

38 Pages Posted: 8 Sep 2014

See all articles by Thomas Meissner

Thomas Meissner

Technische Universität Berlin (TU Berlin); Maastricht University - Department of Economics

Davud Rostam‐Afschar

University of Mannheim; IZA Institute of Labor Economics; Global Labor Organization; TRR 266 Accounting for Transparency

Date Written: July 12, 2014

Abstract

This paper tests whether the Ricardian Equivalence proposition holds in a life cycle consumption laboratory experiment. This proposition is a fundamental assumption underlying numerous studies on intertemporal choice and has important implications for tax policy. Using nonparametric and panel data methods, we find that the Ricardian Equivalence proposition does not hold in general. Our results suggest that taxation has a significant and strong impact on consumption choice. Over the life cycle, a tax relief increases consumption on average by about 22% of the tax rebate. A tax increase causes consumption to decrease by about 30% of the tax increase. These results are robust with respect to variations in the difficulty to smooth consumption. In our experiment, we find the behavior of about 62% of our subjects to be inconsistent with the Ricardian proposition. Our results show dynamic effects; taxation influences consumption beyond the current period.

Keywords: Ricardian Equivalence, Taxation, Life Cycle, Consumption, Laboratory Experiment

JEL Classification: D91, E21, H24, C91

Suggested Citation

Meissner, Thomas and Rostam-Afschar, Davud, Do Tax Cuts Increase Consumption? An Experimental Test of Ricardian Equivalence (July 12, 2014). Freie Universität Berlin, School of Business & Economics Discussion Paper No. 2014/16, Available at SSRN: https://ssrn.com/abstract=2472975 or http://dx.doi.org/10.2139/ssrn.2472975

Thomas Meissner

Technische Universität Berlin (TU Berlin) ( email )

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Maastricht University - Department of Economics ( email )

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Davud Rostam-Afschar (Contact Author)

University of Mannheim ( email )

L 7, 3-5
Mannheim, 68161
Germany

IZA Institute of Labor Economics ( email )

P.O. Box 7240
Bonn, D-53072
Germany

Global Labor Organization ( email )

Collogne
Germany

TRR 266 Accounting for Transparency ( email )

Warburger Straße 100
Paderborn, 33098
Germany

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