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Should Marginal Cost of Public Funds include the Revenue Effect?

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  • Ming Chung Chang
  • Shufen Wu

Abstract

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 note 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.

Suggested Citation

  • Ming Chung Chang & Shufen Wu, 2011. "Should Marginal Cost of Public Funds include the Revenue Effect?," Swiss Journal of Economics and Statistics (SJES), Swiss Society of Economics and Statistics (SSES), vol. 147(I), pages 1-16, March.
  • Handle: RePEc:ses:arsjes:2011-i-1
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    More about this item

    Keywords

    marginal cost of public funds; Pigou effect; revenue effect; Ramsey taxation; public good;
    All these keywords.

    JEL classification:

    • H2 - Public Economics - - Taxation, Subsidies, and Revenue
    • H4 - Public Economics - - Publicly Provided Goods

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