Reconciling Recent Estimates of the Marginal Welfare Cost of Taxation.

American Economic Review (Impact Factor: 2.69). 02/1991; 81(1):302-08.
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    ABSTRACT: In this note we discuss how to treat taxes in a cost-benefit analysis (CBA). In particular we relate the shadow price of taxes in CBA to the concepts the marginal cost of public funds MCPF) and the marginal excess burden (MEB) of taxes. In particular we demonstrate that the MCPF is equal to one plus the MEB for a marginal increase in a distortionary tax.
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    ABSTRACT: There is considerable variability in numerical estimates of the marginal social cost of public funds (MCF) due to differences in demand-supply elasticities, differences in the welfare measures of changes in the excess burden of taxation, and differences in the conceptual measure of the MCF used. In a model with standardised parameters, Fullerton finds the different welfare measures of the excess burden make little difference to the numerical estimates, where most of the variance can be explained by conceptual differences. In particular, some studies estimate the conventional Harberger measure of the MCF while others estimate a modified measure. We formally derive the modified MCF in a public good economy and compare it to the conventional measure. Being project specific it must be used and interpreted differently. We also derive the relationship between the actual MCF and the compensated MEB, and extend the conventional MCF to accommodate higher effective marginal tax rates on income due to withdrawal of family and other tax benefits. Key Words: Marginal social cost of public funds, marginal excess burden of taxation.


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