Progressive taxation and the social marginal cost of public funds

This paper describes the calculation of the social marginal cost of public funds (SMCF) for a progressive tax system which distorts individuals' labour supply decisions. A formula for the SMCF indicates that the income and substitution effects of the labour supply response are weighted by the changes in individuals' average and marginal tax rates, respectively. Other well-known formulas for the SMCF are shown to be special cases of this formula, The difference between this formula and the Mayshar (1991) formula is shown to be due to different, but equally valid, ways of computing the change in the average tax rate. The condition under which a marginal tax rate increase may lead to a reduction in revenues is derived, (C) 1998 Elsevier Science S.A.