Marginal Cost Of Public Funds Research Articles

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.

Marginal Compensated Effects in Discrete Labor Supply Models

This paper develops analytic results for marginal compensated effects of discrete labor supply models, including Slutsky equations. It matters, when evaluating marginal compensated effects in discrete choice labor supply models, whether one considers wage increase (right marginal effects) or wage decrease (left marginal effects). We show how the results obtained can be used to calculate the marginal cost of public funds in the context of discrete labor supply models. Subsequently, we use the empirical labor supply model of Dagsvik and Strom (2006) to compute numerical compensated (Hicksian) and uncompensated marginal (Marshallian) effects resulting from wage changes. The mean Hicksian labor supply elasticities are larger than the Marshallian, but the difference is small.

Should Benefit-Cost Analysis Include a Correction for the Marginal Excess Burden of Taxation?

AbstractThis paper provides an overview of theoretical, empirical, and practical arguments in favor of or against a correction for the marginal excess burden of taxation (MEB). Benefit-cost analysis (BCA) should be used to compare the costs and benefits of a policy measure and its major alternatives, and whenever relevant, also to compare different ways of financing this. The best pragmatic approach is then to assume first that a policy measure is financed out of general tax revenues and then that the MEB of these taxes is broadly counterbalanced by the benefits of redistribution of these taxes. The latter assumption is consistent with the preferences for equality in a country’s current tax system. It is a simple and politically neutral assumption, and it implies that the marginal cost of public funds is equal to 1 and that no correction is needed in BCAs for the MEB. This shortcut assumption does not imply that the tax system is optimal or that BCAs should be distributionally weighted. Choosing an alternative source of financing, i.e., other than general tax revenues, should be regarded as a separate policy measure that should be analyzed separately in a BCA, including its distortionary and distributive effects.

Marginal Cost of Public Funds: From the Theory to the Empirical Application for the Evaluation of the Efficiency of the Tax-Benefit Systems

Abstract We estimate the marginal cost of public funds (MCF) as an overall indicator of the efficiency of tax-benefit systems and their reforms. The novelty of our work is the calculation of a MCF indicator fully based on empirical micro-data representative of the Italian population. This indicator combines the incentives embodied in the tax-benefit system at the intensive and extensive margins with the respective elasticities of labour supply at both margins. Our results first show the importance of taking into account the heterogeneity of the population with women (both single and in couples) facing a more inefficient system than men. Second, our micro-data based indicator shows the potential bias of MCF indicators based on stylized and hypothetical measures of work incentives.

Optimal Design of Agri‐environmental Schemes under Asymmetric Information for Improving Farmland Biodiversity

AbstractInformation asymmetry is one of the main obstacles to the effective design and implementation of agri‐environmental schemes (AES). The literature has generally addressed this issue through the use of principal‐agent models (PAM). We develop a PAM to support optimal design of a new AES for improving farmland biodiversity. We use the results of choice experiments to assess both the costs incurred by the agent for the provision of biodiversity and the resulting social benefits. We also make a number of novel contributions such as the inclusion of a non‐linear non‐compliance detection curve, a sensitivity analysis to identify which parameter estimates have a critical impact on PAM results, and analysis of the efficiency of different sanction scenarios. The results suggest that: (i) the second‐best solutions differ significantly from the optimal solutions attainable with perfect information, with farmers being strongly over‐compensated for the extra costs associated with improved biodiversity; (ii) monitoring levels should be higher; (iii) the sanction system should be tougher. Sensitivity analysis shows the need for accurate estimates of the marginal cost of public funds and the costs and benefits associated with the public goods, which represent the key parameters determining PAM results.

Should CBA's Include a Correction for the Marginal Excess Burden of Taxation?

According to economic theory, taxation drives a wedge between private and public benefits, which distorts labour supply, consumption and investment and leads to loss of welfare. One would therefore expect that in cost-benefit analysis (CBA) of public expenditure a correction is made for the costs of taxation, i.e. for the marginal excess burden of taxation (MEB). However, looking at CBA practice all over the world, textbooks on CBA and various specific CBA guidelines no consensus exists about such a correction. This paper provides for the first time an overview of the theoretical, empirical and practical arguments in favor or against a MEB correction. It argues that in general the best approach for CBA’s is to assume that the MEB is broadly counterbalanced by the benefits of redistribution of these taxes. This assumption is consistent with the preferences for equality in a country’s current tax system and is a simple, pragmatic and politically neutral assumption. This assumption does not imply that the tax system is optimal or that CBA’s should be distributionally weighted. As a consequence, the preferred approach is to assume in general that the marginal cost of public funds is equal to one and then no correction is needed in CBAs for the MEB. Choosing an alternative source of financing, i.e. other than general tax revenues, should be regarded as a separate policy measure that should be analysed separately in a CBA.

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

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.

The Marginal Cost of Public Funds and the Laffer Curve: Evidence from the Canadian Provinces

We estimate tax base elasticities for Canadian provinces to compute the Marginal Cost of Public Funds (MCF) for the three major taxes and assess the revenue implications of tax rate changes. We find that generally the corporate income tax has the highest and the sales tax has the lowest MCF. We also find that four provinces were on the negatively sloped sections of their total revenue Laffer curves with respect to their corporate income tax rate in 2013. The policy implication of this is that there would have been significant welfare gains from reductions in provincial corporate income tax rates.

Economic Analysis and Investment Priorities in Sweden’s Transport Sector

Beginning as a planning tool within Sweden’s national road administration some 50 years ago, benefit-cost analysis (BCA) has come to be a pillar of the national transport policy because of subsequent strategic choices made by the national parliament. These choices made it necessary to widen the analysis of costs to include also externalities and a foregone conclusion was that efficient investment priorities should be made based on BCA. But no one asked whether the political decision makers or the BCA models were up to that task. This paper reviews the institutional framework and practice of BCA in Sweden for transport infrastructure investment, and considers design issues that have been and still are debated, such as whether the discount rate should include a risk term and how to account for the marginal cost of public funds. A main concern with BCA results is the underestimation of construction costs, making transport sector projects look better than they are. Several ex post analyses have established that a higher NPV ratio increases the probability of being included in the investment program proposal prepared by the agency. The requirement to let projects undergo BCA seems to make planners “trim” project proposals by trying to reduce investment costs without significantly reducing benefits. This relationship is weaker among profitable projects. Moreover, there is no correlation between rate of return and the probability of being included in the final program, which is established on political grounds.

Water losses and optimal network investments: Price regulation effects with municipalization and privatization

Abstract We analyze optimal investments, to reduce water losses, in a regulated water industry, with perfectly inelastic demand and private information about local investment efficiency. We compare the public and private ownership cases, both subject to the same regulatory (revenue cap) mechanism. The theoretical analysis is supported by a calibration and simulation exercise. The incentive to invest is affected by ownership, financial structure and revenue cap. Overinvestment results in private firms as the cost of capital is accounted differently. In public firms: (i) the effect of the revenue cap is diluted and investments distortions with respect to a benevolent social planner are negligible; (ii) information rents are valued according to the marginal cost of public funds; (iii) the distortionary taxation and a price inelastic demand drive local politicians to maximize water revenues to finance investments and to increase municipal fiscal gains. Price differences result from differences in ownership and financial structure.

A Comparison of Cost-Benefit and Cost-Effectiveness Analysis in Practice: Divergent Policy Practices in Sweden

This paper compares the implementation of the two economic evaluation methods Cost-Effectiveness/Utility (CEA/CUA) and Cost-Benefit Analysis (CBA) as tools for allocation of national public funds in the health and transport sector in Sweden, respectively. We compare the recommended values for important economic parameters such as the social discount rate, the marginal cost of public funds, and the explicit and implicit valuation of health, and document a number of substantial and unexplained differences in implementation. Such differences are problematic considering that the increasing use of economic evaluations to guide policy decisions also has implied an overlap of application areas. We conclude with a discussion on the need of a harmonized procedure for economic evaluations in the public sector in order to reduce the risk of inefficient allocations purely due to different applications of the methods. Published: Online February 2017. In print December 2017.

The Time-Consistent Public Goods Provision

In this study, we reconsider the optimal nonlinear tax problem with the public good from the perspective of the commitment issue and examine how it affects the condition of the public good provision. We show that the Samuelson rule should be modified when the government cannot commit and the skill types of taxpayers are revealed in the first period. This is true even if the preference of the taxpayers is separable and additive with respect to consumption and leisure. Our analysis also shows how the lack of commitment affects the formula of the marginal cost of public funds and the level of public good provision. Our findings imply that the level of the public good may be excessive in comparison to the case where the government can commit to its tax policy.

Subsidizing and pricing private toll roads with noncontractible service quality: A relational contract approach

In private toll roads, some elements of the private operator’s performance are noncontractible. As a result, the government cannot motivate the private operator to improve them through a formal contract but through a self-enforcing contract that both parties are unwilling to deviate unilaterally. In this paper, we use noncontractible service quality to capture these performance elements. By employing a relational contract approach, we aim to investigate the optimal subsidy plan to provide incentives for quality improvement. We show that government subsidy is feasible in quality improvement when the discount factor is sufficiently high and marginal cost of public funds is sufficiently small. Under feasible government subsidy, we have demonstrated the optimal subsidy plans in different scenarios. Moreover, some comparative statics are presented. Based on the derived subsidy plans, we further investigate the optimal toll price. We find that the optimal toll price generates zero surplus for the private operator and positive surplus for consumers. We then make two extensions of our model to re-investigate the government’s optimal decisions on subsidy plan and toll price when her decision sequence is changed and when government compensation is present upon termination of the relationship. Some implications for practice have been derived from our model results.

Welfare effects of taxation in oligopolistic markets

This paper discusses how marginal costs of public funds are related to various market characteristics under imperfect competition. Under a quite general tax scheme, these costs turn out to be lower the wider the firms' product ranges, the lower the degree of market concentration and the lower the degree of product differentiation. Moreover, marginal costs of taxation are lower in Bertrand markets compared to Cournot markets. In cases when marginal costs of public funds cannot easily be assessed we ask if pass-through rates can provide useful information for policy makers. The market characteristics that we analyze are shown to have opposite effects on pass-through and marginal costs of public funds. It is also demonstrated that the marginal cost of public funds is generally lower for ad valorem taxes than for unit taxes. The main results are based on a linear demand system, but a number of extensions confirm that our main results are reasonably robust.

Social Security Transfers and the Marginal Cost of Public Funds

Recent estimates of the marginal cost of public funds differ substantially. Some studies argue that the efficiency cost of taxation counter the welfare gain connected to redistribution of income. Hence, the efficiency cost of taxation should not be included as a cost of public goods provision. Kleven and Kreiner (2006), however, argue that the cost of public goods provision may double in countries with a large welfare state due to exit from the labor market. This study shows that the cost of public goods provision should be increased with less than 15 percent when categorical transfers redistributed income even though taxation may lead to exit from the labor market.

Introduction

Introduction

Economic Efficiency of Federal Provision of Scientific Information and Support for Science Research in Canada

Federal provision of scientific information and support for science research have declined significantly in recent years, and a trend away from pure research toward applied and commercializable research has begun. This commentary asks whether those and other trends in this area can be justified in terms of economic efficiency. It is argued that the marginal benefits of scientific information and research have likely risen relative to production costs and the marginal cost of public funds has fallen, implying that reduced provision cannot be justified on efficiency grounds. An efficiency rationale for increased support for commercializable research is also lacking. Longer-term trends include the rise of open data, which does make sense, and a relative shift from intramural government research and development toward university-based R&D. The latter shift likely responds to underlying economic factors, but does not warrant a sudden sharp reduction in government research, such as seen recently in Canada.

The Marginal Cost of Public Funds in the Presence of Tax Evasion

This paper studies the Marginal Cost of Funds (MCF) in the existence of tax evasion. When tax evasion is incorporated as a behavioral response to tax rate change, the MCF can be different than the previously estimated ones in the literature. We develop a general equilibrium model of tax evasion, including the expected utility of taxpayers and three different revenue-raising policy instruments (i.e. tax, audit and penalty rate). In an environment where agents can evade tax with the risk of being caught and penalized, the government can use audit and penalty rate as revenue-raising policy instruments in addition to tax rate. In this rich model environment, we analytically derive the MCFs for the alternative policy instruments. We consider two main fiscal reforms: the revision in the nonlinear tax scheme and the changes in the enforcement mechanism (i.e. the audit and penalty rate). The derived MCF for tax rate is greater than the previous ones since it includes risk-bearing cost as well as tax distortion. In order to compare the magnitudes of three different MCFs, we present a numerical example. Our findings suggest that when audit and penalty have low costs and labor supply elasticities are positive, the audit and penalty rate as revenue-raising policy instruments are superior to the tax rate.