Social Security Transfers and the Marginal Cost of Public Funds

Recent estimates of the marginal cost of public funds differ substantially. Some studies argue that the efficiency cost of taxation counter the welfare gain connected to redistribution of income. Hence, the efficiency cost of taxation should not be included as a cost of public goods provision. Kleven and Kreiner (2006), however, argue that the cost of public goods provision may double in countries with a large welfare state due to exit from the labor market. This study shows that the cost of public goods provision should be increased with less than 15 percent when categorical transfers redistributed income even though taxation may lead to exit from the labor market.