Evaluating Public Expenditures: Does It Matter How They are Financed?

This paper reviews the relationship, or lack of it, between two bodies of literature dealing, respectively, with cost-benefit analysis and the marginal cost of public funds (MCF). It argues that, while there are no simple answers to the question of how, or to what extent, different methods of financing public expenditures should enter formally into the analysis of particular public expenditure decisions, the question is nonetheless important. When the financing of a project can firmly be linked to certain types of finance with low or no distortionary effects, it is inappropriate to apply a correction for the shadow price of fiscal resources (MCF). On the other hand, except in such cases as a practical matter an MCF correction of (say) 20 percent or so at the least does no harm and may be useful. The principal conclusion emerging from this review, however, is that far more attention needs to be paid in general not only to links between financing and spending decisions but also, more importantly, to ensuring that the process by which spending decisions are made is structured to ensure that those who make the decisions are as fully informed as possible and, equally important, that those who are affected by the decisions are also made as aware as possible of all the relevant consequences, both on the spending and financing sides of the decision.