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The Social Cost of Government Spending in an Economy with Large Tax Distortions. A CGE Decomposition for Norway

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Abstract

We use a CGE model to estimate the social cost of a marginal increase in public expenditure in Norway. Norway exemplifies an economy with high taxes. Distortionary taxes imply wedges between the market prices and the corresponding shadow prices. The shadow prices are unobservable, which is the rationale for using a CGE model to estimate the social cost of government consumption. The social cost is decomposed into a direct resource cost and the cost of public funds. The CGE estimate of the direct resource cost is implicitly a weighted average of different opportunity costs, reflecting distortions in the Norwegian economy. Our estimate of the resource cost equals about ¾ of the ex ante market price of the resources consumed. This gap is due to a positive labour supply response combined with a high effective tax rate on labour income. Our estimate of the social cost of raising public funds through a higher pay-roll tax is about 20 percent of the direct resource cost.

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  • Erling Holmøy & Birger Strøm, 2004. "The Social Cost of Government Spending in an Economy with Large Tax Distortions. A CGE Decomposition for Norway," Discussion Papers 396, Statistics Norway, Research Department.
  • Handle: RePEc:ssb:dispap:396
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    File URL: http://www.ssb.no/a/publikasjoner/pdf/DP/dp396.pdf
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    1. Aaberge, Rolf & Dagsvik, John K & Strom, Steinar, 1995. " Labor Supply Responses and Welfare Effects of Tax Reforms," Scandinavian Journal of Economics, Wiley Blackwell, vol. 97(4), pages 635-659, December.
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    Cited by:

    1. Geir H. Bjertnæs & Taran Fæhn & Jørgen Aasness, 2008. "Designing an electricity tax system in presence of international regulations and multiple public goals: An empirical assessment," Discussion Papers 555, Statistics Norway, Research Department.
    2. Taran Faehn and Elisabeth T. Isaksen, 2016. "Diffusion of Climate Technologies in the Presence of Commitment Problems," The Energy Journal, International Association for Energy Economics, vol. 0(Number 2).

    More about this item

    Keywords

    Tax distortions; Cost-benefit analysis; Cost of public funds; Computable general equilibrium models;

    JEL classification:

    • H20 - Public Economics - - Taxation, Subsidies, and Revenue - - - General
    • H21 - Public Economics - - Taxation, Subsidies, and Revenue - - - Efficiency; Optimal Taxation
    • H43 - Public Economics - - Publicly Provided Goods - - - Project Evaluation; Social Discount Rate
    • J22 - Labor and Demographic Economics - - Demand and Supply of Labor - - - Time Allocation and Labor Supply

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