The Heterogeneous Effects of Government Spending: It’s All About Taxes

Résumé

How expansionary is government spending? We revisit this classic question by taking into account the distribution across households of taxes used to finance these spending. Using US data from 1913 to 2006, we provide evidence that government spending multipliers are positive only when financed with more progressive taxes. We show that this finding can be rationalized in a heterogeneous households model, where a rise in government spending can be expansionary only if financed with more progressive taxes. Key to our results is the model endogenous heterogeneity in households’ marginal propensities to consume and labor supply elasticities. Finally, we analyze tax revenue data on households’ income to provide evidence of our mechanism at the micro level.