Barro on the Ricardian Equivalence Theorem

Abstract

Is public debt issue equivalent to taxation? This is an age-old question in public finance theory. David Ricardo presented the case for the affirmative.1 Professor Robert J. Barro reexamines the question in his recent paper (1974) without, however, making reference to Ricardo or other early contributors. Although his discussion is carefully qualified to allow for exceptions under specified conditions, the thrust of Barro's argument supports the Ricardian theorem to the effect that taxation and public debt issue exert basically equivalent effects. Barro's central emphasis is on demonstrating that, under reasonable conditions which involve overlapping generations of persons with finite lives, taxpayers will capitalize the future obligations that public debt issue embodies. To the extent that this capitalization occurs, government bonds do not add to the perceived net wealth in the economy. From this Barro infers that the substitution of debt for tax finance will exert no expansionary effect on total spending. There are two questions here. Are the future tax liabilities fully capitalized? And, even if they are, does this necessarily imply that the fiscal policy shift exerts no effect on total spending? To establish the second result, it is necessary to examine the differential impacts of taxation and debt issue, quite apart from the question of the capitalization of future taxes. Barro wholly neglects this necessary part of any comparative analysis of the two fiscal instruments, and, because of this neglect, his conclusion is not nearly so relevant for policy as it seems to be. This neglect may stem from Barro's failure to specify properly the inclusive set of transactions that debt issue represents.