Ricardian equivalence and fiscal distortions in th

Authors: Peter A Prazmowski

Publish Date: 2013/01/06

Volume: 46, Issue: 1, Pages: 109-125

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Abstract

This paper tests the Ricardian equivalence hypothesis in the context of the Dominican Republic DR The results rejected the Ricardian theorem but a weaker version is shown to have significant implications for the DR If the government borrows to increase spending private consumption is crowded out and the economy will suffer in the long run The outcome is worst if the government borrows to deliver a tax cut In particular for every RD 100 of additional debt incurred to finance government primary spending private consumption and gross domestic product GDP fall by a meaningful RD 215 and RD 115 respectively If the debt is used to finance the tax cut the fall is RD 215 in both consumption and output Interestingly if the government uses taxes to cover a budget deficit the effect is neutral and consistent with Ricardian equivalence The paper argues that fiscal distortions are in part responsible for these multipliers Distortions are estimated to be 21  coming from different sources including taxes evasion and fiscal drainage These findings suggest that the DR could benefit from either reducing the level of fiscal distortions or the size and scope of the Dominican government If however the government continues to pursue an active fiscal role under the current environment it will generate an unnecessary burden to consumption and economic growthI would like to thank Professor Robert M Kunst and two anonymous referees for invaluable comments and suggestions to the paper I am also grateful to Dr Jose SánchezFung and the University of London ISA for the invitation to participate in the “Dominican Republic Issues and Prospects” conference Finally I would like to thank Ms Jeanet Cabrera for precious research assistance and the American Chamber of Commerce of the Dominican Republic for inviting me to several forums and for participating in the 2011 Dominican Week at Washington DC The author takes full responsibility for any errors and omissions in the article

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