Social cost-benefit analysis is considered an important tool for governments and applied policy analysts to decide whether to implement public projects, such as investments in infrastructure, climate change, education, research health care, income support, public job programs, and so on. A public project needs to be implemented if the weighted net benefits (i.e., benefits minus costs) of the project to all people in society is positive.
An important question in social cost benefit analysis is whether the cost-side of the social cost-benefit analysis should take into account the cost of the distortions created by the taxes that are required to finance public projects. Jacobs (2018) investigates this old question. His main and surprising result is that social cost-benefit analysis should not be corrected for the marginal cost of public funds as long as taxes are optimally set, since the marginal cost of public funds is equal to 1. Intuitively, tax distortions only emerge if the government cares for income redistribution. Lower inequality brings social benefits, which in the social optimum are equal to deadweight costs of taxation. Consequently, there is no need to adjust social costs benefit analyses for the distortionary costs of taxation if taxes are optimized.
This research laid the scientific foundation for the decision of the Dutch Minister of Finance not to correct official policy guidelines for social-cost benefit analyses in the Netherlands for the deadweight costs of taxation (Ministerie van Financiën, 2017). This decision was reached based on the advice of an expert working group (Werkgroep Kosten van Belastingheffing en Maatschappelijke Kosten-Baten Analyses, 2017). Jacobs was one of the members of this working group, which consisted of academics and high-level policy officials from various Dutch ministries.
The main insight that the marginal cost of public funds is equal to 1 in the tax optimum, also shows that environmental policies should not be less ambitious in a world with tax distortions, as earlier literature suggested (Jacobs and De Mooij, 2015). Indeed, the distortions associated with higher taxes to finance ambitious climate policies should not play a role in deciding on the desirability of such policies.
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