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Deficit-financed tax cuts and interest rates

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  • Sylvain Leduc

Abstract

Why do proposals to lower taxes often meet with opposition in Congress. One argument is that lowering taxes without an equivalent fall in government spending may lead to future budget deficits, which will translate into higher long-term interest rates and a lower level of income. Sylvain Leduc discusses the theoretical arguments under which budget deficits lead to higher interest rates. He also surveys empirical studies that used data on expected budget deficits to document the possibility that increases in future budget deficits are associated with higher real long-term interest rates.

Suggested Citation

  • Sylvain Leduc, 2004. "Deficit-financed tax cuts and interest rates," Business Review, Federal Reserve Bank of Philadelphia, issue Q2, pages 30-37.
  • Handle: RePEc:fip:fedpbr:y:2004:i:q2:p:30-37
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    File URL: http://www.phil.frb.org/files/br/brq204sl.pdf
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    References listed on IDEAS

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    1. Wachtel, Paul & Young, John, 1987. "Deficit Announcements and Interest Rates," American Economic Review, American Economic Association, vol. 77(5), pages 1007-1012, December.
    2. Barro, Robert J, 1974. "Are Government Bonds Net Wealth?," Journal of Political Economy, University of Chicago Press, vol. 82(6), pages 1095-1117, Nov.-Dec..
    3. Barro, Robert J, 1979. "On the Determination of the Public Debt," Journal of Political Economy, University of Chicago Press, vol. 87(5), pages 940-971, October.
    4. Alberto Alesina & Guido Tabellini, 1990. "A Positive Theory of Fiscal Deficits and Government Debt," Review of Economic Studies, Oxford University Press, vol. 57(3), pages 403-414.
    5. Thomas Laubach, 2009. "New Evidence on the Interest Rate Effects of Budget Deficits and Debt," Journal of the European Economic Association, MIT Press, vol. 7(4), pages 858-885, June.
    6. S. Rao Aiyagari, 1989. "How should taxes be set?," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Win, pages 22-32.
    7. Seater, John J, 1993. "Ricardian Equivalence," Journal of Economic Literature, American Economic Association, vol. 31(1), pages 142-190, March.
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    Keywords

    Deficit financing ; Taxation ; Interest rates;

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