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

• Published in: International tax and public finance Vol. 25; no. 4; pp. 883 - 912
• Main Author: Jacobs, Bas
• Format: Journal Article
• Language: English
• Published: New York Springer US 01.08.2018; Springer Nature B.V
• Subjects: Business Taxation/Tax Law; Cost benefit analysis; Economic models; Economics; Economics and Finance; Fiscal policy; Heterogeneity; Income redistribution; Marginal costs; Public Finance; Public goods; Taxation; Taxes; Use taxes; Samuelson rule; Marginal cost of funds; H50; Optimal taxation; Optimal redistribution; H40; H20; Marginal excess burden; Optimal provision of public goods
• ISSN: 0927-5940; 1573-6970
• DOI: 10.1007/s10797-017-9481-0

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.