On the Treatment of Taxes
in a Cost-Benefit Analysis
Per-Olov Johansson
Stockholm School of Economics
and
CERE
Outline.


A simple CBA-rule for a tax-distorted
economy.
How is this rule related to:

Marginal Cost of Public Funds?


Marginal Excess Burden of Taxes?



“Dasgupta-Stiglitz-Atkinson-Stern tradition”.
“Harberger-Pigou-Browning tradition”.
On empirical evidence.
An alternative approach.
Mirrlees approach ignored. Applicable?
2
A GE Cost-Benefit rule for a
small project;


Public good.
No distortionary taxes.
NPV  B  C
Samuelson (1954)
3
A GE Cost-Benefit rule for a
small project;

Distortionary taxes.
t  p x
“Tax wedge”

 
1
NPV   B  r N 

C
i
i
1   1 

Impact of tax on
“tax wedges”.
Impact of
project on
“tax wedges”.
NPV  B 
1
1 
i
C
Preferences weakly
separable in the
project.
4
Marginal Cost of Public Funds.
MCPF ti
Gahvari (2006)
Monetary welfare cost of raising an additional
euro in taxes.
MCPF ti 
1
1  i

 
1
NPV   B  r N 

C
i
i
1   1 

V (.) / ti
1

Marginal u of income N (.) / ti
V(.) = indirect utility f.
N(.) = Tax revenues.
5
Marginal Excess Burden of Taxes.
Willingness to pay for avoiding an increase in
a tax (related to the change in tax revenue).
WTP
MEB 
1
R
6
CGE models often used to estimate MEB.
Multiply project costs by (1 + MEB)?
MEB different thought experiment
from a CBA.
Gahvari (2006)
Auerbach and Hines (2002)
Marginal tax increase:
1  MEB / t w
1
 MCPF 
1   tw
This equality holds
for all taxes.
tw
7
Use CGE models to estimate MCPF when
there are many different tax instruments.
 MCPF VAT



 MCPF Income tax 


Capital
tax
 MCPF



.


 .



 .

 .





UK; Spain: MCPF = 1?
Sweden (Transport sector): MCPF = 1.2.
8
1+MEB
MCPF
Min
Max
Browning
(1976)
USA
1.08
1.16
Hansson
(1984)
Sweden
1.22
2.98
Hansson and
Stuart (1985)
Sweden
1.05
36.40
Hansson
(1984)
Sweden
0.71
2.29
Hansson and
Stuart (1985)
Sweden
0.78
7.10
Agell et al.
(1998)
Sweden
1.08
23.80
Kleven and
Kreiner (2003)
OECD
Spain
Sweden
0.82
0.78
1.88 (1.34)
3.41 (1.74)
Alonso-Carrera and Manzano (2003), González-Páramo and Sanz Sanz (2004).
9
An Alternative Treatment of Taxes:
Looking for reasonable shortcuts.
NPV  B  C  (t  p  dx  t w  w  d)  r N
B  C  (1  t )
t = 0.18.
B  C  (1  t w )
tw = 0.3.
t = 0.25.
tw = 0.3.
10
This approach captures MCPF + MCPF
0.7-1.18.


0.7-1.25.
Alonso-Carrera and Manzano (2003) MCPF:
 0.65-0.7, 1, 1.26-1.32, 1.74-2.9.
Sorensen (2010): 1 + MEB:
 1.16-1.35.
OECD (Kleven and Kreiner): 0.8-1.3,
0.8-1.7.
11
V  V ( p  (1  t ), w  (1  t w ), T , g )
N (T , t , t w , g )  T  t  p  x  t w  w    p  x g  w   g
MCPF ti 
1 V / ti

 N / ti
1
ti
MCPF 
1  i

 
1
NPV  WTP  r N 

dg

C
i
i
1 
1 

12