NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

Distortionary Taxes and the Provision of Public Goods

Charles L. Ballard, Don Fullerton

NBER Working Paper No. 3506 (Also Reprint No. r1820)
Issued in October 1993
NBER Program(s):   PE

When comparing marginal costs and benefits of a public project, most economists think in terms of adding together the marginal costs of production plus marginal costs of additional distortionary taxation. This paper clarifies how the "revenue effect" offsets the "distortionary effect." For Cobb-Douglas utility with a marginal increase in a proportional wage tax, they exactly offset each other and the Samuelson rule is unaffected. Also, with a preexisting wage tax, an incremental lump-sum tax has only this "revenue effect:" it increases labor supply, increases tax revenue from the preexisting wage tax, and thus makes the project easier to fund. In our numerical example, the incremental lump-sum tax costs taxpayers only $.77 per dollar raised.

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Document Object Identifier (DOI): 10.3386/w3506

Published: Journal of Economic Perspectives, Vol. 6, No. 3, pp. 117-131 (Summer 1992).

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