The way economy reacts to change in future fiscal policy is affected by the households’ expectation of the long-term government decisions. It’s a research question whether, or not, individuals’ choices effectively encompass a prevision of the government future budget stance. Indeed, a certain shortsightedness in their forecasting horizon is likely to arise.
The length of individual planning horizon is one of the main factors in the analysis of the impact of future fiscal policy on intertemporal consumption choices. Modigliani and Jappelli used the “life cycle hypothesis” as framework for their research, concluding that sharp variations in the saving ratio depend on changes in the rate of growth of the economy but also on the government decisions. Moreover, they observed that it’s the amount of the expected real interest payment the factor that effectively influences consumption.
As a support to the correlation between private sector decisions and effectiveness of future fiscal policy, it can be added that many OECD economies have experienced co-movements of private saving and fiscal adjustments. However, it’s difficult to identify the direction of causality (if there’s causality) between these two movements and it’s not realistic to imagine that this evidence derives from an individual “conscious tax discounting”.
If individuals’ budget constraints can be written by using the Arrow Debreu (A-D) representation, given an initial level of government debt at t=0, government debt at any time (t>0) must be equal to the sum of the discounted values of future individual tax payments. This reflects the government constraint of balancing its budget intertemporally.
Therefore, a change in the government policies, that don’t alter the sum of the discounted stream of tax revenues, should not affect the equilibrium outcomes (Ricardian proposition). Assuming uniform taxes across individuals, the future scheme of individual lump-sum taxes can be proved to affect their decisions.
Conversely, removing some assumptions (A-D representation of individual budget constraint), government could have permanent budget deficit; as a result, different public policies, leading to the same present value of revenues from taxes, could induce different equilibria as they may have a different impact on individual decisions.