The Opportunity Costs of Public Funds Concepts and Issues

This paper reviews the main conceptual issues regarding the notion of Opportunity Cost of Public Funds (OCPF) and its use in normative economics. This notion occupies only a marginal and sometimes anecdotal role in the public economic literature and appears to be too often used without the definitional unambiguousness that would make it helpful for economic analysis. This situation is unsatisfactory considering the importance of (some of) the mechanisms described by the concept and the magnitude of these effects that are such as to heavily impact any budgetary practice. We find that among the mechanisms that economists call "opportunity costs" the deadweight loss and, to a lesser extent, administrative costs seem to be the most relevant, whereas the impact of the crowding out is more discussible. We also analyze how the question of opportunity costs is contingent upon some hypothesis about the financing mechanism of the public expenditures and we suggest that the most likely situation is the one where public expenses are financed through the eviction of other alternative uses of the public funding. We also provide a review of available quantifications and recommendations to the practitioners.