Frisch seminar: Katinka Holtsmark
The costs of taxation in the presence of inequality
Abstract: This paper proposes a new measure of the marginal cost of public funds (MCF). This new measure more precisely accounts for the distributional aspects of taxation than the standard MCF used in the current literature. We show that using our new measure gives a higher MCF than the measure used in the current literature in all allocations with income inequality. Moreover, due to its regressive distributional consequences, we show that the MCF of a uniform lump-sum tax is always greater than one when not combined with distortive taxes. With an optimal combination of a uniform lump-sum tax and a linear income tax, the MCF can also be greater than one. These findings are in contrast to the previous literature that has used a measure of the MCF that does not fully capture the distributional effects of taxation.