Lecture Note 15: Social Cost Benefit Analysis - University of ...

e consistent with an optimally designed tax system?
Exercise 7 This exercise shows that the marginal cost of funds approach can
sometimes work even if the marginal value of private income is not the same
for everyone (that assumption is su¢ cient for it to work). Suppose that h
is di¤erent for the four consumers, but that (1) they all contribute to the cost
of the project and (2) they all bene…t equally from the project ( xh 1 = x1).
Show that under those conditions, it is true that P4 h=1 q1 x1 (SMCF ) C > 0
implies that social welfare is increasing. Would this also be true if the project
only bene…ts consumer 1, i.e., x1 1 > 0 and xh 1 = 0 for h = 2; 3; 4?
4 Conclusion
As a matter of principle, public projects and policy programme do have distributional
impacts because they a¤ect individuals di¤erently and because di¤erent
individuals value the bene…ts and costs di¤erently. From a practical point
of view, short-cut often have to be taken and the distinction between project
which got limited distributional impact and projects with a clear and signi…cant
distributional impact is a useful starting point. For projects with a clear distributional
impact, say an in-work bene…t programme, the adjusted social weights
approach provides a transparent set of rules to apply to reach a sensible decision.
For projects without a clear distributional impact, say procurement of a new
…ghter jet for the army, it may be reasonable to proceed as if everyone is just
the same and focus on selecting projects that pass the e¢ ciency test proposed
by Harberger and it may also make sense in doing so to take into account that
the marginal cost of public funds is greater than one and adjust the …scal ‡ows
accordingly. In doing so, however, one is not really dealing with distributional
issues in a serious way.
5 Notes on the literature
There is a vast literature on social cost bene…t analysis. To navigate it, I
recommend the following core readings. It is useful to stick to one textbook
and I recommend Boardman et al. (2006, 2011). Boardman (2011) chapter 4
and 19 (not 18 as indicated in the course outline) contain an introductionary
discussion of the marginal cost of public funds approach and a little on how to
use distributional weights mostly from a practical point of view. Pearce and
Nash (1981) got some useful material in chapter 3 on distributional weights.
Chapter 5 of the Green Book explains how the UK government deals with
distributional weighting. You may …nd it useful to read the lecture note before
engaging with these readings. The note is intended to provide you with the
theoretical background needed to understand and evaluate the exposition by
Boardman, Pearce and Nash and the material in the Green Book.
Further readings, for those who want a deeper understanding of the material,
the collection of articles, including the introduction chapter, in Layard and
18