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Should Marginal Cost of Public Funds Include the Revenue Effect?

Summary

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.

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Correspondence to Ming Chung Chang.

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The authors are grateful for helpful comments by one anonymous referee and the editor of this journal, Professor Klaus Neusser. The authors also would like to thank the participants of a seminar in the Graduate Institute of Industrial Economics, National Central University, Taiwan, in 2006, for their valuable comments.

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Open Access This article is distributed under the terms of the Creative Commons Attribution 2.0 International License ( https://creativecommons.org/licenses/by/2.0 ), which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited.

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Chang, M.C., Wu, S. Should Marginal Cost of Public Funds Include the Revenue Effect?. Swiss J Economics Statistics 147, 1–16 (2011). https://doi.org/10.1007/BF03399339

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  • DOI: https://doi.org/10.1007/BF03399339

JEL-Classification

  • H2
  • H4

Keywords

  • marginal cost of public funds
  • Pigou effect
  • revenue effect
  • Ramsey taxation
  • public good