Marginal Cost Of Public Funds Research Articles

Water Pricing and Quotas: A Quantitative Analysis from a Private and Social Perspective

AbstractThe current situation of structural water scarcity due to the rise in demand, the reduction in supply as a consequence of climate change, increasingly frequent drought periods, and overall quantitative pressure on water resources creates a need for economic instruments to reduce the amount of water used, especially in the agricultural sector. Thus, water pricing and allocation quotas (proportional reduction of allocations) may be suitable tools to reduce demand or allocate scarce water resources. For a comparative analysis of the performance of these two measures, a Positive Mathematical Programming model has been developed, using the Guadalquivir River Basin as a case study. Additionally, the analysis takes into account the revenue generated from water pricing and the marginal cost of public funds. The results indicate that, from the farmer’s perspective, quotas result in smaller losses than water pricing. However, when considering water pricing along with the revenue generated from this measure, this mechanism would be more beneficial for society as a whole, since the taxes collected could be used for other purposes, albeit with efficiency losses measured by the marginal cost of public funds and the excess burden of taxation.

On the marginal cost of public funds: the implications of charitable giving and warm glow

AbstractThis paper highlights the important impact of charitable giving and warm glow on the identification of the marginal cost of public funds (MCF). We employ the warm glow model of charitable giving to describe taxpayer behaviour, whereas we employ the standard model to evaluate social welfare. We first identify the impact theoretically. Then we conduct simulations to quantify its size numerically. The results of our numerical simulations show that the standard model underestimates the magnitude of MCF by at least 10 per cent. Our work suggests that adopting a non‐welfarist social welfare function can make a significant difference to the identification of MCF.

Fiscal Costs of Climate Policies: Role of Tax, Political, and Behavioural Distortions

Here I review the fiscal costs of carbon pricing and climate policies, paying due attention to second-best as well as first-best polies. This starts with a discussion of when the double dividend hypothesis, i.e. when recycling carbon taxes via lower income taxes boosts employment and lowers the marginal cost of public funds. I propose that recycling carbon tax revenue benefits from considering the income on the whole distribution of households, since this allows one to get a better understanding of the political feasibility of carbon tax reforms. Political feasibility also requires intergenerational and international transfers to ensure all generations and countries benefit from carbon tax reform. The politics of carbon tax reform also requires one to take account of business cycle aspects, heightened salience of carbon taxes, and the propensity of policymakers to procrastinate and prefer subsidies to taxes.

The Interplay Between Subsidy and Regulation Under Competition

This study extends the work of Anand and Giraud-Carrier (2020) [Pollution regulation of competitive markets. Management Science. 66(9), 4193–4206] to an even more general case in which the government offers a subsidy to firms. For the purpose of investigating the interplay between subsidies (rewarding positive externalities) and regulation (punishing negative externalities) under competition, we propose a game-theoretic model to formulate the problem. By Karush–Kuhn–Tucker (KKT) conditions and backward induction, we obtain the following results. They are unique in our new scenario compared to Anand and Giraud-Carrier (2020). First, in terms of abatement, the effects of regulation and subsidy offset when the abatement efficiency is relatively high, and reinforce when abatement is inefficient. From the perspective of social welfare (SW), the effects of regulation are often offset by the effects of subsidy, and vice versa. Second, the relationship between the optimal subsidy rate and regulation depends heavily on the degree of competition and marginal cost of public funds. Third, in product and abatement subsidy schemes, cap-and-trade and taxes remain equivalent under competition. Finally, under certain conditions, a higher product subsidy rate will not necessarily give rise to higher SW at certain regulatory levels. Our research can provide a rationale for social planners who aim to achieve peak of CO2 emissions and carbon neutrality.

Marginal Cost of Public Funds under the Presence of Informality

In this paper, we investigate the behavior of the marginal cost of public funds (MCF) for different taxes under the presence of informality. We build a dynamic general equilibrium model with formal and informal sectors and allow the government to use consumption, capital, and labor income taxes to raise revenue. Using country-level data on taxes, we calibrate and measure MCF for a cross-section of economies. Our results show that different taxes have distinct cost responses to changes in the informal sector size in each country: while MCF of the consumption tax decreases with the increase in the informal sector size, the MCF of the income taxes, capital and labor, display an opposite behavior. Moreover, omitting the informal sector results in an underestimation in the MCF of capital income tax and overestimation in that of the consumption tax.

Aggregate marginal costs of public funds

Aggregate marginal costs of public funds

The MCPF under the pandemic

AbstractThis study examines the marginal cost of public funds (MCPF) to assess the optimality of preventive governmental expenditure based on the optimal nonlinear income taxation with preventive behaviors by both individuals and the government. We show that the optimal condition with respect to preventive government expenditure consists of two parts. One part reflects how the trade‐off between preventive expenditure and consumption should deviate from the laissez faire for high‐skilled and low‐skilled individuals, which is interpreted as the Pigou effect. The other part measures how mimickers benefit from preventive government expenditure, which is called the genetic effect. Whether the MCPF is greater than 1 or not depends on the relative magnitude of the Pigou effect and the genetic effect. Moreover, we examine the MCPF if the government cannot commit to a certain policy and if the types of individuals are completely separated and show that the Pigou effect should be modified.

Rewards versus Imprisonment

Abstract This article considers the possibility of simultaneously reducing crime, prison sentences, and the tax burden of financing the criminal justice system by introducing rewards, which operate by increasing quality of life outside of prison. Specifically, it proposes a procedure wherein a part of the imprisonment budget is redirected towards financing rewards. The feasibility of this procedure depends on how effectively the marginal imprisonment sentence reduces crime, the crime rate, the effectiveness of rewards, and how accurately the government can direct rewards towards individuals who are most responsive to such policies. A related welfare analysis reveals an advantage of rewards: they operate by transferring or creating wealth, whereas imprisonment destroys wealth. Thus, the conditions under which rewards are optimal are broader than those under which they can be used to jointly reduce crime, sentences, and taxes. With an exogenous [resp. endogenous] budget for law enforcement, it is optimal to use rewards when the imprisonment elasticity of crime is small [resp. the marginal cost of public funds is not high]. These conditions hold, implying that using rewards is optimal, in numerical examples generated by using estimates for key values from the empirical literature.

Tax Transparency and Social Welfare: The Role of Government Commitment

Although transparency has long been held as the key principle of taxation, recent behavioral public finance theory has shown that it may reduce social welfare as inattention can alleviate behavioral distortions. This paper extends this analysis by modeling inattention as a noise in the tax rate signal received by Bayesian citizens. In equilibrium, we find that transparency will improve social welfare by ensuring the government's ability to commit to a fairly low tax rate that is socially optimal. Moreover, this model yields a new sufficient statistics formula. Based on typical estimates of attention parameters and marginal cost of public funds, this formula suggests that ensuring tax transparency is worth incurring approximately 10 percent of the revenue currently estimated for the U.S. tax system.

Transport taxes and subsidies in developing countries: The effect of income inequality aversion

We propose a marginal tax reform model that includes both formal and informal sectors in the economy, traffic externalities (congestion, pollution, crashes and noise) and distributional concerns. The marginal cost of public funds (MCF) is derived for fuel taxes and public transport subsidies. The model is applied to Santiago, Chile. If MCFs are computed only taking economic efficiency into account, a revenue neutral reform within the transport sector suggests increasing the car cost and reducing the bus fare in peak periods, and reducing the car cost and increasing the bus fare in off-peak periods. However, including income inequality aversion leads to suggesting lower bus fares and higher car costs in both peak and off-peak periods, significantly changing the economic assessment of current tax and subsidy instruments. The inclusion of traffic externalities has a large effect on the MCF for fuel tax and a mild effect on MCF for bus subsidy.

The Cost of Public Funding with Direct and Indirect Taxation - a Revisit

The paper shows that the marginal cost of public funds (MCF) does not depend on whether public revenue is collected by taxation of consumer goods or income from factors supplied by households on the market. Atkinson and Stern (1974) concluded in their seminal paper that “[...] whether the Conventional Rule provides an under- or over-estimate depends on the choice of taxed good [....].” This conclusion has created confusion in the literature on the MCF and has been the basis for recent literature arguing that the standard measure of the MCF has weaknesses and should be replaced by alternative measures (Jacobs, 2018; Hakonsen, 1998). We show that the conclusion of Atkinson and Stern (1974) on this issue is not valid and is based on an error in their analysis.

A political economy model of the Ganges pollution cleanup problem

AbstractWe study pollution cleanup in the Ganges in Varanasi, India. Voters elect politicians and elected politicians decide how much pollution to clean up. Between the two time periods, there is an election. Politicians are sincere or insincere. The marginal cost of public funds measures how efficiently elected politicians transform tax receipts into pollution cleanup. Voters have identical per period utility functions. We ascertain the equilibrium outcome and per period voter welfare. Second, we show that an increase in reduces the equilibrium pollution cleanup and voter welfare. Third, an insincere politician can delay the revelation of his insincerity. We show that a critical value of exists such that the insincere incumbent separates and loses the election if and only if and that he pools and is re‐elected otherwise. Finally, we note that an increase in can raise voter welfare when politicians are more likely to be insincere.Recommendations for Resource Managers Successful cleanup policies depend on whether elected politicians are sincere or insincere about pollution cleanup. When cleanup is publically financed, the marginal cost of public funds greatly influences how much pollution is cleaned up. In some circumstances, an insincere politician can get elected and do very little to clean up pollution.

Welfare Analysis Meets Causal Inference

We describe a frame work for empirical welfare analysis that uses the causal estimates of a policy’s impact on net government spending. This framework provides guidance for which causal effects are (and are not) needed for empirical welfare analysis of public policies. The key ingredient is the construction of each policy’s marginal value of public funds (MVPF). The MVPF is the ratio of beneficiaries’ willingness to pay for the policy to the net cost to the government. We discuss how the MVPF relates to “traditional” welfare analysis tools such as the marginal excess burden and marginal cost of public funds. We show how the MVPF can be used in practice by applying it to several canonical empirical applications from public finance, labor, development, trade, and industrial organization.

Recovering water for the environment during droughts through public water banks within a monopsony-monopoly setting

Allocation trade is an instrument that has been widely used to recover water for the environment during periods of scarcity (droughts). This paper proposes a water bank operating within a monopsony-monopoly setting with the dual purpose of reallocating water among farmers and acquiring water for the environment during drought periods. The proposed water bank would be managed by a public agency seeking to maximize economic efficiency generated in purchases and sales of water for agriculture and the efficiency generated by the recovery of water allocations for the environment. An additional, innovative feature of the analysis performed is that it considers the inefficiencies in the economy as a whole caused by public spending on water allocation purchases, measured through the marginal cost of public funds. The potential performance of the proposed water bank is simulated by mathematical programming techniques, taking the Guadalquivir River Basin (Southern Spain) as an empirical case study. The results provide evidence that, in terms of economic efficiency, the proposed institutional arrangement outperforms the instruments currently in place to purchase water allocations.

Optimal Deposit Insurance

This paper studies the optimal determination of deposit insurance (DI) when bank runs are possible. In a variety of environments, the welfare impact of changes in the level of deposit insurance coverage exclusively depends on three sufficient statistics: the sensitivity of the likelihood of bank failure with respect to the level of DI, the utility gain induced by preventing the marginal bank failure, which can be expressed in terms of the drop in depositors' consumption, and the direct social cost of intervention in bank failure scenarios, which can be expressed in terms of the probability of bank failure, the marginal cost of public funds, and the mass of partially insured depositors. The same expression applies a) when banks face perfect ex-ante regulation and b) when banks are not allowed to react to policy changes. Under imperfect regulation, because banks do not internalize the fiscal impact of their actions, changes in the behavior of banks induced by varying the level of DI (often referred to as moral hazard) only affect the level of optimal DI directly through a fiscal externality, but not independently. We characterize the wedges that determine the optimal ex-ante regulation, which map to liability-side regulation (e.g., deposit insurance premia) and asset-side regulation. Finally, we explore the quantitative implications of our approach through a direct measurement exercise and a model simulation.

Positioning and negotiations: The case of pharmaceutical pricing

We study a positioning game prior to negotiations where each party invests into influential activities in order to raise voter support for their preferred bargaining outcome. The case chosen for our analysis is a bilateral monopoly where a purchaser meets a pharmaceutical firm and where the two negotiate on the price of a new and innovative medicine. We identify factors that influence on the negotiated price such as treatment effects of the new and the existing drug, production costs of the new drug, the price of the existing drug, the marginal cost of public funds and patient group size. Furthermore, it is shown that the negotiated price, depending on the characteristics of a political cost function with regard to the influential activities, is influenced by the order of moves taken by the parties. Regardless of the strategic interrelationships between the two parties, likely positioning games to be played are those where one of the two negotiating parties acts as a leader while the rival acts as a follower.

Simultaneous optimization of multiple taxes on car use and tolls considering the marginal cost of public funds in Japan

We simultaneously optimize multiple tax instruments (fuel tax, car-ownership tax, and tolls) when these instruments are used as public funds with distortionary labor tax, accounting for pollution, congestion, accident externalities, and fiscal constraints of the tax-related agency and the toll-collecting agency. We quantitatively optimize taxes and tolls using parameters for Japan under three scenarios: (1) imposition of peak and off-peak tolls at different rates and simultaneous optimization of all tax instruments; (2) optimization of only car-related taxes without consolidation of the toll-collecting agency’s fiscal constraints; (3) optimization of only fuel tax. We find that peak toll and fuel tax should be higher, and off-peak toll and car-ownership tax should be lower than the current rate under Scenario 1. Scenarios 1 can improve welfare by 1000 to 2400 dollars/car, and Scenarios 2 and 3 can achieve more than 90% and 20–60% of the welfare gain in Scenario 1, respectively.

The provision of infrastructure: benefit–cost criteria for optimizing local governments

This paper models the provision of a local public good that is simultaneously utilized as a public consumption good and a public intermediate good. Since the public good enters both utility and production functions, it is considered a “generalized public good.” This is done to model the provision of infrastructure by sub-federal governments, which is financed with taxes on local residents. Households are mobile in the model, and the theoretical analysis provides a benefit–cost rule for public good provision by a rent-maximizing local government. Illustrative calculations of the marginal cost of public funds are provided, and they show a wide range of values matching previous estimates of the marginal productivity of infrastructure. The impact of intergovernmental transfers on the provision of infrastructure by rent-maximizing local governments is presented.

Pay-for-performance schemes: Should optimal prices vary across system and clinical quality indicators?

Quality indicators are classified into system or clinical quality indicators. Typically, different levels of an organization steer each of the two types of indicators. Decentralized levels control clinical indicators (blood pressure, blood sugar etc.) while centralized levels control system indicators (waiting time, electronic health records etc.). In this paper we examine optimal pay-for-performance schemes for the two indicators by considering a model consisting of hierarchy of principal-agent interactions where pay-for-performance rewards are distributed to the centralized level (unit of accountability). We find that the optimal pay-for-performance price depends on factors such as the degree and distribution of altruistic preferences, quality costs, the marginal cost of public funds, and the interdependence between the quality variables. The optimal price should differ for system and clinical indicators both when an internal incentive system is in place and when this is not the case. The optimal price for clinical indicators is to reflect the centralized levels’ ability to steer the decentralized level - the type of internal contract that exists between the two levels of the organization. The optimal price for system indicators is independent of the type of internal contract since such indicators are under the control of the unit of accountability. Finally, it is shown that rewarding organizations on the basis of clinical quality indicators can be optimal also when such incentives are not transmitted to the decentralized level of the organization. This conclusion is the result of the indirect effects that non-incentivized variables (system indicators) might have on the incentivized ones (clinical indicators).Published: Online May 2019.

Positive Sanctions versus Imprisonment

This article considers the possibility of simultaneously reducing crime, prison sentences, and the tax burden of financing the criminal justice system by introducing positive sanctions, which are benefits conferred to non-convicts. Specifically, it proposes a procedure wherein a part of the imprisonment budget is re-directed towards financing positive sanctions. The feasibility of this procedure depends on how effectively the marginal imprisonment sentence reduces crime, the crime rate, the effectiveness of positive sanctions, and how accurately the government can direct positive sanctions towards individuals who are most responsive to such policies. A subsequent welfare analysis reveals an advantage of positive sanctions: they operate by transferring or creating wealth, whereas imprisonment destroys wealth. Thus, the conditions under which positive sanctions are optimal are broader than those under which they can be used to jointly reduce crime, sentences, and taxes. With an exogenous [resp. endogenous] budget for law enforcement, it is optimal to use positive sanctions when the imprisonment elasticity of deterrence is small [resp. the marginal cost of public funds is not high]. These conditions hold, implying that using positive sanctions is optimal, in numerical examples generated by using estimates for key values from the empirical literature.