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The marginal cost of public funds is one at the optimal tax system

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  • Bas Jacobs

    (Erasmus University Rotterdam
    Tinbergen Institute
    CESifo)

Abstract

This paper develops a Mirrlees framework with skill and preference heterogeneity to analyze optimal linear and nonlinear redistributive taxes, optimal provision of public goods, and the marginal cost of public funds (MCF). It is shown that the MCF equals one at the optimal tax system, for both lump-sum and distortionary taxes, for linear and nonlinear taxes, and for both income and consumption taxes. By allowing for redistributional concerns, the marginal excess burden of distortionary taxes is shown to be equal to the marginal distributional gain at the optimal tax system. Consequently, the modified Samuelson rule should not be corrected for the marginal cost of public funds. Outside the optimum, the marginal cost of public funds for distortionary taxes can be either smaller or larger than one. The findings of this paper have potentially important implications for applied tax policy and social cost–benefit analysis.

Suggested Citation

  • Bas Jacobs, 2018. "The marginal cost of public funds is one at the optimal tax system," International Tax and Public Finance, Springer;International Institute of Public Finance, vol. 25(4), pages 883-912, August.
    • Handle: RePEc:kap:itaxpf:v:25:y:2018:i:4:d:10.1007_s10797-017-9481-0
    DOI: 10.1007/s10797-017-9481-0
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    More about this item

    Keywords

    Marginal cost of funds; Marginal excess burden; Optimal taxation; Optimal redistribution; Optimal provision of public goods; Samuelson rule;
    All these keywords.

    JEL classification:

    • H20 - Public Economics - - Taxation, Subsidies, and Revenue - - - General
    • H40 - Public Economics - - Publicly Provided Goods - - - General
    • H50 - Public Economics - - National Government Expenditures and Related Policies - - - General

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