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Prepared by Gian Maria Milesi-Ferretti.
If the public expects an expenditure reduction (for example if there is a deficit bias but not an excess spending bias), the private sector will expect it to occur sooner under a budget rule, because the rule constrains the budget balance. In this case, the tax cut would stimulate an increase in private consumption which is larger under a rule than under discretion.
With distortionary taxes, the reduction in tax rates would tend to stimulate labor supply while the reduction in spending would tend to increase leisure because of a positive wealth effect. The net effect on production would be ambiguous. See footnote 67.