Costs of Taxation and Benefits of Public Goods with Multiple Taxes and Goods

28 Pages Posted: 20 Apr 2016

See all articles by James E. Anderson

James E. Anderson

Boston College - Department of Economics; National Bureau of Economic Research (NBER)

Will J. Martin

International Food Policy Research Institute (IFPRI)

Date Written: September 1, 2010

Abstract

The recent public economics literature involves an apparent consensus that income effects reduce the costs of raising revenues and hence increase the desirable level of public good provision. Higher taxes can indeed reduce the demand for leisure -- and hence increase the supply of taxed labor -- through income effects. However, the consensus is wrong because the income effects of taxes must be considered symmetrically with those from provision of public goods. This paper uses a model with multiple public goods and taxes to derive consistent measures of the marginal benefits of publicly-provided goods and their marginal social costs. With this model, the authors show that either compensated approaches excluding these income effects or uncompensated approaches including them may be used. If an uncompensated measure of the marginal cost of funds is used, however, the benefits of providing public goods should be adjusted with a simple, benefit multiplier not previously seen in the literature. Once this is done, the optimal level of public provision is independent of whether compensated or uncompensated approaches are used. Proper accounting for these income effects -- or their omission using a compensated approach -- appears to substantially raise the hurdle for government provision where there are substantial taxes bearing on labor.

Keywords: Economic Theory & Research, Public Sector Economics, Debt Markets, Emerging Markets, Taxation & Subsidies

Suggested Citation

Anderson, James E. and Martin, William J., Costs of Taxation and Benefits of Public Goods with Multiple Taxes and Goods (September 1, 2010). World Bank Policy Research Working Paper No. 5410, Available at SSRN: https://ssrn.com/abstract=1670497

James E. Anderson (Contact Author)

Boston College - Department of Economics ( email )

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William J. Martin

International Food Policy Research Institute (IFPRI) ( email )

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