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As noted in Section 7.2.4 shadow prices have to be applied to market prices when these prices do not reflect the true opportunity costs. Shadow prices have also been applied to the funds used to finance mitigation programmes. Public expenditures, regardless of the benefits they confer, impose a cost on society, which reflects the “marginal excess burden” of a tax policy. The marginal costs of public funds should include the impacts of eventually reduced distortions compared with existing tax systems, as well as administration costs, compliance costs, the excess burden of tax evasion, and avoidance costs incurred by the taxpayers. Slemrod and Yizhaki (1996) also suggest the distributional impacts of public funds collection be included.
The marginal costs of public funds are critically dependent on the dead-weight loss associated with distortionary taxation, which is dependent on the specific tax structure in place in the non-policy case. To evaluate the true social cost of the funds it is necessary to estimate or know the marginal cost of public funds, that is the cost per dollar of finance, which is greater by US$1 than the welfare cost of raising the tax revenue. In general there will not be one figure for this cost for the whole tax system. Each source of finance will have its own marginal cost. In general there will not be one figure for this cost for the whole tax system. Each source of finance will have its own marginal cost15. If such a correction is not made, mitigation policies underestimate the costs of reducing GHGs.
Håkonsen (1997) has surveyed the theoretical discussion of the marginal cost of public funds, and empirical estimates of the marginal costs have been made by the World Bank and others (Devarajan et al., 1999, European Commission, 1998, Ruggeri, 1999).
Estimates tend to suggest that the marginal costs of public funds are larger in developing countries than in developed countries. Devarajan et al. (1999) estimates that these costs vary between US$0.48 and US$2.18 for developing countries and US$1.08 and US$1.56 for the USA. The European Commission uses a value of US$1.28 for the shadow price of public funds.
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