On the Use of Distributional Weights in Social Cost-Benefit Analysis

Abstract

In the cost-benefit analysis of commodity taxes or subsidies, distributional weights complicate the standard textbook "triangle analysis." Net benefits are maximized with optimal subsidies in some circumstances, optimal taxes in others. Demand and supply elasticities play important roles in determining these weighted-welfare effects of commodity taxation. I then explore how to use distributional weights (a) to analyze investment projects and (b) to determine an optimum income-tax structure. In all these applications, the use of distributional weights is shown to have very strong and (to many people) disquieting implications. A final section explores alternative "solutions" to these difficulties.