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

Abstract

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.

Overadaptation to Climate Change? The Case of the 2013 Finnish Electricity Market Act

“…In addition, CBA is distributionally insensitive (Adler 2013, in DRR CBA see Hallegatte et al 2016) and often fails to analyse the distortionary effects of raising public funds, reflected primarily as impacts on the labour supply. (Boadway 2006;Bos et al 2018).…”

Distributionally Weighted Cost-Benefit Analysis: From Theory to Practice

“…However, the necessary transfers are not usually forthcoming nor can they be costlessly implemented 3 (e.g. Working group Marginal Cost of Public Funds andCBA, 2016 andBos et al 2017).…”

“…There is an abundant literature on marginal welfare weights and their estimates. Marginal utility elasticity estimates are based on stated preferences from surveys, behavioral evidence from life 6 This was part of the research carried out by the authors on behalf of the Dutch Working Group on the role of Marginal Cost of Public Funds in CBA (see also Bos et al, 2017 andJacobs, 2016). In the course of the work a number of simulations were carried out to investigate the effects of differentiated welfare weights.…”