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

Bas Jacobs ()
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Bas Jacobs: Erasmus University Rotterdam

International Tax and Public Finance, 2018, vol. 25, issue 4, 883-912

Abstract: Abstract 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.

Keywords: Marginal cost of funds; Marginal excess burden; Optimal taxation; Optimal redistribution; Optimal provision of public goods; Samuelson rule (search for similar items in EconPapers)
JEL-codes: H20 H40 H50 (search for similar items in EconPapers)
Date: 2018
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Handle: RePEc:kap:itaxpf:v:25:y:2018:i:4:d:10.1007_s10797-017-9481-0