The idea that a tax reduction funded by government borrowing has no effect on aggregate demand is known as:

a. the Ricardian equivalence theorem.

b. the expenditure-offset theorem.

c. the balanced budget multiplier.

d. the Keynesian Cross.

The correct answer is a. the Ricardian equivalence theorem

The government funding is generally very effective in increasing national income. But, this government funding is of developmental nature, such as on infrastructure. However, the Ricardian equivalence theorem talks about the spending which is financed through debt. This theorem says that such spending is not leading towards increasing national income. The logic is, although now the government builds capital through debt and leads to development, in long run, the debt has to be paid and the payment amount offsets the increase in national income. Thus, there is no effect finally on national income (aggregate demand).