Abstract

TAXES AND PUBLIC DEBT: A PARADOXICAL RELATIONSHIP. Rev.fac.cienc.econ. [online]. 2016, vol.24, n.2, pp.7-28. ISSN 0121-6805.  https://doi.org/10.18359/rfce.2223.

This paper shows that an increase in debt aimed at reducing taxes may increase it in the long run. This occurs whenever a tax increase reduces the expectation of savings in an amount greater than public debt decreased initially. The reason why the debt grows is because the tax increase reduces investment and this has two effects: (i) decreases the production level, which causes a decrease in the tax base, i.e., meaning the government income; (ii) the interest rate increases and thus the cost of past debt. Against this background, the government is forced to increase public debt to maintain constant spending. In this paper, statistical evidence is offered for five European countries that shows that public debt is explained by the investment, as it results in the theoretical model; this suggests that the austerity policies implemented in these countries in order to reduce debt, may be counterproductive.

Keywords : Investment; Fiscal policy; Taxes; Debt; Crisis; Effective demand.

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