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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    • "Applied Economic Perspectives and Policy Following Fullerton (1991) "
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    • "Measures of the marginal excess burden of taxes are typically formulated in terms of an equivalent variation , see, for example, Fullerton (1991). The EV is the maximum amount of money the individual is willing to pay in order to avoid that distortionary tax increase. "
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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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    • "This is confirmed by Fullerton [8] who uses a standardised model to show how almost all the variability in the estimates for wage taxes in the U.S. by Stuart [19], Ballard, Shoven and Whalley (BSW) [4] and Browning [5] arise from differences in the conceptual measure of the MEB. 2 Stuart measures it as (CS − dR)/dR, with CS being compensating surplus and dR the actual (observed) change in tax revenue, BSW as (EV −dR)/dR, with EV being the equivalent variation, and Browning as (EV − dR * )/dR, with dR * being the change in tax revenue when utility is held constant at the new level. 3 Since CS and EV have similar values for small tax changes any difference in the estimates arises from the measure of the change in tax revenue. "
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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.
    Preview · Article · Jan 2010
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