In benefit-cost analysis, public-sector managers seek to learn if society as a whole will be better off by the adoption of a specific social program or public-sector investment project. Rather than seeking to maximize profits or the value of the firm, public-sector managers use benefit-cost analysis to maximize, or at least move toward a maximization of, the excess of marginal social benefits over marginal social costs. With this goal in mind, from an efficiency perspective, the distribution of any social net present-value is of no importance. For example, when the city of Denver sponsors Denver International Airport at an initial cost of $3.5 billion, it makes no difference whether the city pays the entire cost or whether the city, the state of Colorado, and the federal government split these costs. Similarly, if the city of Denver is motivated by the desire to lure business and tourist traffic from Chicago or Los Angeles, the benefits of increased economic activity in Denver that has merely shifted from other transportation centers should not be counted. In both instances, the proper concern is the increase in aggregate social wealth, not aggregate local wealth.
A. Assume that the city of Denver and local airline customers must pay only 10% of the costs of Denver International Airport, with the federal government picking up the other 90% of the tab. Describe how a local benefit-cost analysis of the airport project might be distorted by this cost-sharing arrangement.
B. Under the federal revenue sharing program, the federal government collects tax revenues that are then returned to states and other local units of government to support a wide variety of social programs. Can you see any problems for an efficient allocation of public expenditures when the spending and taxing authority of government is divided in this manner?
C. Can the equity and efficiency implications of social programs and publicsector investment projects be completely separated?