The Social Cost of Federal Financing 91 



This may seem to be a cumbersome procedure for deriving one 

 number — the opportunity cost applicable to resource development 

 funds. But there is no short cut. With capital coming from many 

 sources, which face widely differing borrowing and lending rates 

 of interest and whose saving and investment decisions are condi- 

 tioned by altogether different factors, the actual impact of federally 

 financed projects on the economic activities of the other sectors of 

 the economy varies widely. It has been argued, for example, that 

 the true opportunity cost of capital is the rate of return earned on 

 the marginal investments of the most successful private firms, such 

 as DuPont or General Motors, rates which before taxes are in 

 excess of 20 per cent. But this is not the true opportunity cost; 

 reduction of the federal program by $100 million would not result 

 in expansion of investment by such firms of an equal amount. It 

 has also been argued that the interest rate on long-term government 

 bonds measures the social cost of public capital.^ This rate is also 

 inappropriate, because it presupposes that the entire cost of projects 

 is financed out of voluntary bond purchases and that the risks 

 attached to projects are borne by the buyers — two conditions that 

 do not hold. A number of other easily derived rates can be sup- 

 ported by plausible arguments, but in the end the arginnents break 

 down. A sector-by-sector approach, assuming a specific incidence 

 of marginal taxation, is far more trustworthy because it corresponds 

 to the actual conditions under which public capital is raised. 



Before embarking on our detailed quantitative study, a few pre- 

 cautionary comments should be made about our basic assumptions. 

 We take it as axiomatic that a measure of the social cost of capital 

 which is consistent with an economic efficiency approach must 

 accept the sovereignty of consumers' choice, even in matters of 



study, we assume that the fiscal authorities reduce taxes by the appropriate 

 amount, i.e., an amount sufficient to result in the utilization of a bundle of 

 resources equal to the quantity released by the reduction of expenditures. 

 Thus, we assume constancy of effective demand. We also assume that our result 

 is not affected by any redistributions of income attributal)le to the multiplier 

 effects of the two offsetting changes in the budget. 



' The practice of most agencies and the recommendations of Budget Bureau 

 Circular A-47 and of the Sub-Committee on Benefits and Costs of the Federal 

 Interagency River Basin Committee imply this position. See Otto Eckstein, 

 Water Resource Development: The Economics of Project Evaluation (Cam- 

 bridge: Harvard University Press, in press), Chapter iv, for a survey of actual 

 practice. 



