Which hypothesis says tax cuts may not raise demand if people expect future taxes?

Ricardian equivalence says tax cuts may not increase demand when households expect higher future taxes.

The hypothesis holds that forward-looking consumers recognize the government’s budget constraint. If the government finances a tax reduction by borrowing, households may understand that the debt will eventually require taxes. They therefore save the extra disposable income instead of spending it, leaving aggregate demand unchanged under the theory’s strict assumptions.

David Ricardo discussed the basic idea in his 1820 “Essay on the Funding System,” comparing current taxation with government bonds used to finance war. Ricardo was skeptical that people would behave this way in practice. Antonio de Viti de Marco developed related arguments in the 1890s, and Robert J. Barro independently gave the proposition a modern theoretical treatment in the 1970s.

Ricardian equivalence is not a claim that every tax cut has no effect. It depends on demanding assumptions, including forward-looking households, functioning credit markets, unchanged government spending, and the expectation that future taxes will actually be paid. Borrowing constraints, finite lifetimes, uncertainty, and differing propensities to consume can weaken the result.

The key distinction is between tax financing and debt financing, not between taxation and government spending itself. A tax cut paired with genuinely higher public spending can still raise demand.