Despite the widespread use of cost-benefit analysis (CBA) of transport projects, some confusion still prevails regarding how to account for taxes. Most important is the effect of distortionary taxation. In general, when labor supply is endogenous, then income taxation and value-added tax (VAT) creates an externality by driving a wedge between labor productivity and the marginal wage. The official guidelines for CBA in Denmark, Sweden and the US do recommend that this externality is accounted for through the marginal cost of public funds. The purpose of this paper is to clarify the issues involved in terms of simple rules that can be applied to the output of a traffic model. We have not been able to find such rules in the literature and therefore see a clear demand for such an analysis. A secondary issue is the relation between the factor prices of firms and the government and the market prices that consumers face. We also see a need to clarify this relationship, especially regarding the transport costs of firms. We formulate a general equilibrium model comprising a representative commuter with endogenous labor supply, a representative leisure traveler, a representative firm and a government. Within this model we first analyze the effect of a marginal change in government spending financed through a distortionary income tax. This gives us the marginal cost of public funds (MCPF). Then we consider marginal changes in travel times for commuters, leisure travelers and firms and compute the welfare effects using the MCPF. The model allows for taxes on transport such that an analysis of the welfare effects of, e.g., road pricing or fuel taxes is accommodated. Again we analyze the welfare effects of marginal changes to transport taxes for commuters, leisure travelers and firms. rules that are applicable in ordinary CBA practice. Generally, transport projects are analysed using a traffic model. In formulating the CBA rules we emphasize the relationship between the welfare effects and changes in travel that can be identified from the output of a traffic model. We find that allowing for endogenous labor supply and distortionary taxes has quite significant implications for the CBA. For the covering abstract see ITRD E137145.
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