SOME UNPLEASANT SUPPLY-SIDE ARITHMETIC

Existing macroeconomic theory predicts that cuts in the distortionary tax rate on capital financed by increases in government debt lead to increases in investment and output. These results are generally obtained under the unrealistic assumption that government debt is financed by nondistorting future fiscal policy. However, when current government deficits are financed by future distortionary taxation this paper shows that lower tax rates and higher deficits lead to reductions in investment and output.