Economics and the mid-life crisis have much in common: Both dwell on foregone opportunities

C'est la vie; c'est la guerre; c'est la pomme de terre . . . . . . . . . . . . . email: jpalmer at uwo dot ca

. . . . . . . . . . .Richard Posner should be awarded the next Nobel Prize in Economics . . . . . . . . . . . .

Monday, January 24, 2005

Tsunami Relief: Income and Substitution Effects

There has been considerable debate/discussion of the question "Will all the outpouring of donations for tsunami relief reduce the amount of donations to other charities this year?" I raised this question in an earlier post, but the topic has come under heavy discussion by Daniel Gross in Slate and Virginia Postrel at the dynamist blog, both linked to by Daniel Drezner [thanks to Ben Muse for the pointer].

What if there has been an income effect from gubmnt donations? This effect would be analogous to "Ricardian Equivalence":
In simple terms, the theory can be described as follows. Governments may either finance their spending by taxing current taxpayers, or they may borrow money. However, they must eventually repay this borrowing by raising taxes above what they would otherwise have been in future. The choice is therefore between "tax now" and "tax later".
The analogy would be that if the gubmnt is going to donate money to tsunami relief, it will eventually have to figure out some way to pay for those donations. Ricardian Equivalence (coupled with rational expectations) would imply that potential donors will anticipate that taxes will increase either today or in the future to pay for these increased gubmnt donations. This anticipated reduction in wealth will tend to induce potential donors to reduce their own giving today.
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