A New Test of Ricardian Equivalence Using the Narrative Record on Tax Changes

Abstract

This paper empirically tests the Ricardian equivalence hypothesis with a narrative measure of tax shocks. The present value, at the time of legislation,for tax increases motivated solely by concerns for improving the fiscal health of the government is used for the tests. These tax news represent a switch from debt to tax financing that should have no effects on the economy if Ricardian equivalence holds as a good approximation. Such a tax increase seems to have positive e ects on real GDP in the post-1980:IV period. However, this is due to fiscal anticipation as many of the tax increases are implemented with substantial delays and distortionary taxes increase economic activity before taxes go up, which is caused by intertemporal substitution. Therefore, Ricardian equivalence is rejected.