The Social Cost of Federal Financing 85 



community, which releases the resources for the undertaking. The 

 taxes lead to a reduction of consumption by households, to a 

 decline in investment, or both. The social cost of the capital raised 

 from foregone investment is clear: the investments would have 

 yielded a certain rate of return to the community which would 

 have increased the future flow of real national income. The social 

 cost, therefore, is equal to the foregone rate of return on private 

 investments. 



To estimate the cost of funds which would have been spent for 

 consumption, we must turn to the saving and borrowing behavior 

 of households. Each individual has certain preferences about the 

 allocation of his expenditures over time, more particularly, the 

 allocation between present and future consumption. If he post- 

 pones consumption, he earns interest on the resultant saving; if he 

 pays outstanding debts he reduces his interest payments accordingly. 

 A rational consumer will allocate his expenditures over time in 

 such manner that the rate at which he is willing to give up present 

 consumption for the income stream made possible by the resultant 

 increase of his saving will be equal to the interest rate which he 

 faces in making this choice. Thus, a saver will push his consump- 

 tion to the point where the satisfaction of a future income stream 

 equal to the interest rate is exactly equal to the satisfaction he 

 derives from the marginal dollar of consumption. Similarly, a 

 borrower will derive satisfaction from his marginal dollar of con- 

 sumption equal to the stream of interest payments he must make 

 on this marginal expenditure dollar which he has borrowed.^ 



Figure 13 illustrates this optimum condition of consumer 

 behavior. It shows the consumer's indifference map between 

 present consumption expenditures and increases of his future 

 annual consumption streams. 



If the consumer's income in the present period is represented by 

 point a (Figure 13-a), then he can reach any of the points on the 

 two line segments, ad and ae, which start at that point. Moving to 



" This formulation does not detail the intertemporal optimum conditions 

 between all present and future periods and, hence, cannot describe the entire 

 future time profile of an individual's consumption. It is sufficiently detailed 

 for our limited purposes, however, and we seek to keep our assumptions as 

 simple as possible. The same reasoning can be applied to the rate of substitu- 

 tion of consumption expenditures between any two periods, provided the entire 

 structure of future interest rates is also known for the individual. 



