Swiss Journal of Economics and Statistics

, Volume 147, Issue 1, pp 1–16 | Cite as

Should Marginal Cost of Public Funds Include the Revenue Effect?

Open Access


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.


H2 H4 


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


  1. Aronsson, Thomas (2008), “Social Accounting and the Public Sector”, International Economic Review, 49 (1), pp. 349–375.CrossRefGoogle Scholar
  2. Atkinson, Anthony B., and Nicholas H. Stern (1974), “Pigou, Taxation and Public Goods”, Review of Economic Studies, 41, pp. 119–128.CrossRefGoogle Scholar
  3. Atkinson, Anthony B., and Joseph E. Stiglitz (1980), Lectures on Public Economics, McGraw-Hill, New York.Google Scholar
  4. Ballard, Charles L. (1990), “Marginal Welfare Cost Calculations: Differential Analysis vs. Balanced-Budget Analysis”, Journal of Public Economics, 41 (2), pp. 263–276.CrossRefGoogle Scholar
  5. Ballard, Charles L., and Don Fullerton (1992), “Distortionary Taxes and the Provision of Public Goods”, Journal of Economic Perspective, 6 (3) pp. 117–131.CrossRefGoogle Scholar
  6. Ballard, Charles L., John B. Shoven and John Whalley (1985), “General Equilibrium Computations of the Marginal Welfare Costs of Taxes in the United States”, American Economic Review, 75, pp. 128–138.Google Scholar
  7. Batina, Raymond G., and Toshihiro Ihori (2005), Public Goods: Theories and Evidence, Springer, New York.Google Scholar
  8. Besley, Timothy, and Ian Jewitt (1991), “Decentralizing Public Good Supply”, Econometrica, 59 (6), pp. 1769–1778.CrossRefGoogle Scholar
  9. Bös, Dieter (1989), Public Enterprise, Economics Theory and Application, 2nd ed., North-Holland, Amsterdam.Google Scholar
  10. Browning, Edgar K. (1976), “The Marginal Cost of Public Funds”, Journal of Political Economy, 84, pp. 283–298.CrossRefGoogle Scholar
  11. Browning, Edgar K. (1987), “On the Marginal Welfare Cost of Taxation”, American Economic Review, 77, pp. 11–23.Google Scholar
  12. Chang, C., and Hsiao-Ping Peng (2009), “Structure Regulation, Price Structure, Cross Subsidization and Marginal Cost of Public Funds”, The Manchester School, 77 (5), pp. 618–641.Google Scholar
  13. Christiansen, Vidar (2007), “Two Approaches to Determine Public Good Provision under Distortionary Taxation”, National Tax Journal, 60 (1), pp. 25–43.CrossRefGoogle Scholar
  14. Dahlby, Bev (2008), The Marginal Cost of Public Funds: Theory and Applications, MIT Press, Cambridge, Mass. and London.CrossRefGoogle Scholar
  15. Diamond, Peter A. (1975), “A Many-Person Ramsey Rule”, Journal of Public Economics, 4, pp. 335–342.CrossRefGoogle Scholar
  16. Feldstein, Martin (1997), “How Big Should Government Be?”, National Tax Journal, 50 (2), pp. 197–213.Google Scholar
  17. Fullerton, Don (1991), “Reconciling Recent Estimates of the Marginal Welfare Cost of Taxation”, American Economic Review, 81 (1), pp. 302–308.Google Scholar
  18. Karras, Georgios (1996), “The Optimal Government Size: Further International Evidence on the Productivity of Government Services”, Economic Inquiry, 34 (2), pp. 193–203.CrossRefGoogle Scholar
  19. King, Mervyn A. (1986), “A Pigovian Rule for the Optimum Provision of Public Goods”, Journal of Public Economics, 30, pp. 273–291.CrossRefGoogle Scholar
  20. Liu, Liqun (2003), “A Marginal Cost of Funds Approach to Multi-Period Public Project Evaluation: Implications for the Social Discount Rate”, Journal of Public Economics, 87, pp. 1707–1718.CrossRefGoogle Scholar
  21. Mayshar, Joram (1990), “On Measures of Excess Burden and their Application”, Journal of Public Economics, 41, pp. 263–289.CrossRefGoogle Scholar
  22. Mayshar, Joram (1991), “On Measuring the Marginal Cost of Funds Analytically”, American Economic Review, 81, pp. 1329–1335.Google Scholar
  23. Ng, Yew-Kwang (2000), “The Optimal Size of Public Spending and the Distortionary Cost of Taxation”, National Tax Journal, 53 (2), pp. 253–272.CrossRefGoogle Scholar
  24. Pigou, Arthur C. (1947), Public Finance, Macmillan, London.Google Scholar
  25. Slemrod, Joel, and Shlomo Yitzhaki (2001), “Integrating Expenditure and Tax Decisions: The Marginal Cost of Funds and the Marginal Benefit of Projects”, National Tax Journal, 54 (2), pp. 189–201.CrossRefGoogle Scholar
  26. Snow, Arthur, and Ronald S. Warren, Jr. (1996), “The Marginal Welfare Cost of Public Funds: Theory and Estimates”, Journal of Public Economics, 61, pp. 289–305.CrossRefGoogle Scholar
  27. Stern, Nicholas (1986), “A Note on Commodity Taxation: The Choice Of Variable and the Slutsky, Hessian and Antonelli Matrices (SHAM)”, Review of Economic Studies, 53, pp. 293–299.CrossRefGoogle Scholar
  28. Stiglitz, Joseph E., and Partha Dasgupta (1971), “Differential Taxation, Public Goods and Economic Efficiency”, Review of Economic Studies, 38 (114), pp. 151–174.CrossRefGoogle Scholar
  29. Stuart, Charles E. (1984), “Welfare Costs per Dollar of Additional Tax Revenue in the United States”, American Economic Review, 74, pp. 352–362.Google Scholar
  30. Tirole, Jean (1988), The Theory of Industrial Organization, MIT Press, Cambridge, Mass. and London.Google Scholar
  31. Wildasin, David E. (1984), “On Public Good Provision with Distortionary Taxation”, Economic Inquiry, 22, pp. 227–243.CrossRefGoogle Scholar

Copyright information

© Swiss Society of Economics and Statistics 2011

Authors and Affiliations

  1. 1.The Graduate Institute of Industrial EconomicsNational Central UniversityChung-Li CityTaiwan
  2. 2.The Graduate Institute of Industrial EconomicsNational Central UniversityTaiwan

Personalised recommendations