4. The Marginal Cost of Public Funds: Concept, Measurement, and Applications

This chapter elaborates upon the marginal cost of public funds (MCF)—a measure of the cost imposed on the private sector in raising an additional dollar of tax revenue. In this chapter, we provide a basic introduction to the MCF concept, with numerical examples using a simple demand and supply model. We then describe three approaches to measuring the MCF with examples from previous studies. Finally, we review two examples of the use of the MCF in public policy analysis. The first is an assessment of the gains from a tax reform that shifts some of the tax burden from the corporate to the personal income tax base in Alberta. The second example illustrates how the MCF can be used to derive optimal matching rates for intergovernmental infrastructure grants in a federation.