Combining Distributional Weights and the Marginal Cost of Funds

Both distributional weights and the marginal cost of funds (MCF) play important roles in cost-benefit analysis, and both are based on the premise that individual lump sum taxes are unavailable. Yet the existing literature has largely treated them separately. This article proposes to combine these two concepts to form a set of person-specific MCFs. The person-specific MCFs play both the role of distributional weights and the role of the efficiency multiplier (i.e., the MCF). When using person-specific MCFs, the simple Samuelson rule needs two adjustments when it comes to a distortionary tax system. First, each individual's benefit from a public project's outputs should be divided by his or her person-specific MCF to become a cost-comparable measure. Second, an indirect revenue effect from the project's output, due to the output's impact on individuals' behaviors and, hence, on tax revenues collected, should be deducted from the project's cost to arrive at the project's net revenue requirement.