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

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  • Thomas Meissner

    (Freie Universitaet Berlin, Chair of Macroeconomics)

  • Davud Rostam-Afschar

    (German Institute for Economic Research (DIW Berlin) and Freie Univeritaet Berlin, Department of Economics)

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.

Suggested Citation

  • Thomas Meissner & Davud Rostam-Afschar, 2014. "Do Tax Cuts Increase Consumption? An Experimental Test of Ricardian Equivalence," Working Papers 2014003, Berlin Doctoral Program in Economics and Management Science (BDPEMS).
  • Handle: RePEc:bdp:wpaper:2014003
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    Cited by:

    1. Geiger, Martin & Luhan, Wolfgang J. & Scharler, Johann, 2016. "When do fiscal consolidations lead to consumption booms? Lessons from a laboratory experiment," Journal of Economic Dynamics and Control, Elsevier, vol. 69(C), pages 1-20.
    2. Thomas Meissner, 2016. "Intertemporal consumption and debt aversion: an experimental study," Experimental Economics, Springer;Economic Science Association, vol. 19(2), pages 281-298, June.
    3. Orland, Andreas & Rostam-Afschar, Davud, 2020. "Flexible Work Arrangements and Precautionary Behavior: Theory and Experimental Evidence," GLO Discussion Paper Series 493, Global Labor Organization (GLO).
    4. Duffy, John & Li, Yue, 2019. "Lifecycle consumption under different income profiles: Evidence and theory," Journal of Economic Dynamics and Control, Elsevier, vol. 104(C), pages 74-94.

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    More about this item

    Keywords

    Ricardian Equivalence; Taxation; Life Cycle; Consumption; Laboratory Experiment;
    All these keywords.

    JEL classification:

    • D91 - Microeconomics - - Micro-Based Behavioral Economics - - - Role and Effects of Psychological, Emotional, Social, and Cognitive Factors on Decision Making
    • E21 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth
    • H24 - Public Economics - - Taxation, Subsidies, and Revenue - - - Personal Income and Other Nonbusiness Taxes and Subsidies
    • C91 - Mathematical and Quantitative Methods - - Design of Experiments - - - Laboratory, Individual Behavior

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