As a result, they will save, rather than spend, the extra disposable income from the initial tax cut, leaving demand and output unchanged.
[citation needed] David Ricardo was the first to propose this possibility in the early nineteenth century; however, he was unconvinced of its empirical relevance.
[6] In 1979, Barro defined the Ricardian equivalence theorem as follows: "... shifts between debt and tax finance for a given amount of public expenditure would have no first-order effect on the real interest rate, volume of private investment, etc.
[citation needed] However, even in a laboratory setting where all assumptions required are ensured to hold, behaviour of individuals is inconsistent with Ricardian equivalence.
[8] In the same issue James M. Buchanan also criticized Barro's model, noting that "[t]his is an age-old question in public finance theory", one already mooted by Ricardo and elaborated upon by de Viti.
[1] In a response to the comments of Feldstein and Buchanan, Barro recognized that uncertainty may play a role in affecting individual behaviour with respect to government finance.
Nevertheless, he argued that "it is much less clear that this complication would imply systematic errors in a direction such that public debt issue raises aggregate demand.
"[10] In 1977, Gerald P. O'Driscoll commented that Ricardo, in expanding his treatment of this subject for an Encyclopædia Britannica article, changed so many features of it as to result in a Ricardian Nonequivalence Theorem; he elaborated all the reasons why the proposition would not hold.
[5] However, research by Chris Carroll, James Poterba[14] and Lawrence Summers[15] shows that the Ricardian equivalence hypothesis is refuted by their results.
If the Ricardian equivalence hypothesis is true, the rational consumers of the economy, who expect the government to raise taxes, try to reduce their consumption and increase their saving.
In other words, Ricardian equivalence does not mean that any countercyclical efforts will fail, but outlines the necessary conditions for that failure and, naturally, for success at the same time.
In this story, if these processes can be changed by the government, or, in any way, the additional income can be believed not to be withdrawn later, the initial tax cut will induce a rise in public consumption expenditures.