Should Marginal Cost of Public Funds Include the Revenue Effect?
© Swiss Society of Economics and Statistics 2011
Published: 26 December 2011
It is an important difference in different measures of the marginal cost of public funds whether to take into account the “revenue effect” emphasized by Atkinson and Stern (1974). This paper tries to reconcile two competing measures from a general viewpoint. We demonstrate that the revenue effect represents a distortionary effect associated with commodity taxation as opposed to a “windfall.” We thus derive a new measure which captures the distortionary effect associated with commodity as opposed to lump-sum taxation. This new measure is guaranteed to be higher than unity. Moreover, this new measure lies between the two measures.