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The Marginal Cost of Public Funds Is the Ratio of Mean Income to Median Income

Queen's University

This article is a proof and critique of the theorem in its title. The marginal cost of public funds is the relative price of dollars in the hands of the government, with dollars in the hands of the public as the numeraire. It is the appropriate mark-up of benefit over cost for public sector projects and programs. With no deadweight loss in taxation, the marginal cost of public funds would have to be one. It exceeds one to account for the deadweight loss from taxpayers'maneuvers to reduce the tax they pay: tax evasion, substitution of leisure for labor, and so on. It is the ratio of mean to median income when public expenditure and taxation are arranged in the interest of the median voter.

Key Words: marginal cost of public funds • median voter • shadow price • lump sum taxation

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