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The Effects of Fiscal Policies When Incomes are Uncertain: A Contradiction to Ricardian Equivalence

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  • Martin Feldstein

Abstract

This paper shows that when earnings are uncertain the substitution of deficit finance for tax finance or the introduction of an unfunded social security program will raise consumption even if all bequests reflect intergenerational altruism. Thus, contrary to the theory developed by Barro and a number of subsequent writers, an operative bequest motive need not imply Ricardian equivalence. Since there is no uncertainty in the present analysis about the date of each individual's death, this conclusion does not depend on imperfections in annuity markets. Nor does it depend on the existence of non-lump-sum taxes and other distortions. Rather it follows from the result derived in the paper that, when an individuals future earnings are uncertain, his future bequest is also uncertain and his consumption therefore rises more in response to an increase in his current disposable income than to an equal present value increase in the disposable income of his potential heirs.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 2062.

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Date of creation: Nov 1986
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Publication status: published as From The American Economic Review, Vol. 78, No. 1, pp. 14-23, (March 1988).
Handle: RePEc:nbr:nberwo:2062

Note: EFG ME PE
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  1. Kotlikoff, Laurence J & Spivak, Avia, 1981. "The Family as an Incomplete Annuities Market," Journal of Political Economy, University of Chicago Press, vol. 89(2), pages 372-91, April.
  2. Barro, Robert J., 1974. "Are Government Bonds Net Wealth?," Scholarly Articles 3451399, Harvard University Department of Economics.
  3. Kotlikoff, Laurence J & Summers, Lawrence H, 1981. "The Role of Intergenerational Transfers in Aggregate Capital Accumulation," Journal of Political Economy, University of Chicago Press, vol. 89(4), pages 706-32, August.
  4. Feldstein, Martin, 1982. "Government deficits and aggregate demand," Journal of Monetary Economics, Elsevier, vol. 9(1), pages 1-20.
  5. Robert B. Barsky & N. Gregory Mankiw & Stephen P. Zeldes, 1987. "Ricardian Consumers With Keynesian Propensities," NBER Working Papers 1400, National Bureau of Economic Research, Inc.
  6. DREZE, Jacques H. & MODIGLIANI, Franco, . "Cosumption decisions under uncertainty," CORE Discussion Papers RP -119, Université catholique de Louvain, Center for Operations Research and Econometrics (CORE).
  7. Benjamin M. Friedman & Mark Warshawsky, 1985. "The Cost of Annuities: Implications for Saving Behavior and Bequests," NBER Working Papers 1682, National Bureau of Economic Research, Inc.
  8. O'Driscoll, Gerald P, Jr, 1977. "The Ricardian Nonequivalence Theorem," Journal of Political Economy, University of Chicago Press, vol. 85(1), pages 207-10, February.
  9. Sandmo, Agnar, 1970. "The Effect of Uncertainty on Saving Decisions," Review of Economic Studies, Wiley Blackwell, vol. 37(3), pages 353-60, July.
  10. Abel, Andrew B, 1985. "Precautionary Saving and Accidental Bequests," American Economic Review, American Economic Association, vol. 75(4), pages 777-91, September.
  11. B. Douglas Bernheim & Andrei Shleifer & Lawrence H. Summers, 1986. "Bequests as a Means of Payment," NBER Working Papers 1303, National Bureau of Economic Research, Inc.
  12. Eckstein, Zvi & Eichenbaum, Martin S & Peled, Dan, 1985. "The Distribution of Wealth and Welfare in the Presence of Incomplete Annuity Markets," The Quarterly Journal of Economics, MIT Press, vol. 100(3), pages 789-806, August.
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