The Social Cost of Federal Financing 79 



model the social cost can easily be imputed. An analysis based 

 upon the competitive model would go like this: The cost of capital 

 is measured by the interest rate. Insofar as the necessary taxes 

 reduce marginal investments of firms, they prevent the creation of 

 a stream of returns whose relationship to the foregone investment 

 would have been just equal to the interest rate. Similarly, taxes 

 which fall on consumption reduce the present levels of consumption 

 for which people are willing to pass up the opportunity of collect- 

 ing the market rate of interest. In other words, the consumer 

 places the same value on the expenditure of the marginal consump- 

 tion dollar as on a perpetual income stream equal to the interest 

 rate. Thus, if government desires to place an economic value on 

 the cost of raising capital through taxation, it can simply apply 

 the market rate of interest. ^ 



Unfortunately, the American economy does not fit the competi- 

 tive model closely enough to permit use of so simple a procedure. 

 The substantial risk premiums in the terms on which business can 

 borrow, and the rationing of credit to some businesses and to most 

 consumers, preclude the existence of a unique rate of interest and 

 prevent consideration of any single actual rate as a measure of 

 the social cost of capital. Yet, in considering alternative methods 

 of financing water resource development and in evaluating the 

 economic worth of projects, reasonable estimates of the social cost 

 of federal funds are essential. Since the market cannot be considted 

 for the price of capital, as competitive theory would suggest, it is 

 necessary to derive an estimate by more complicated empirical 

 procedures which take account of some of the complexities of the 

 process by which savings are actually channeled into investment. 



That is the task undertaken in this chapter. First, as background 

 for our inquiry, we shall examine the salient facts about saving and 

 borrowing in the United States in a recent year. Then, through 

 the use of models, we shall attempt to derive a figure that can serve 

 as a measure of the social cost of public funds used in development 

 of water resources. 



^This assumes that the taxes arc raised witlioiit causing any distortion in 

 decisionmaking. If there are tax-induced distortions in the economy's alloca- 

 tion of resources, the true social cost of raising capital hy taxation will be 

 greater than the market rate of interest. 



