Raúl Ramos, Hugo E. Silva
Abstract
This paper examines the rationale for public transport subsidies when revenues are raised through distortionary taxation, captured by the Marginal Cost of Public Funds (MCF). While first-best arguments such as scale economies and the Mohring effect justify subsidies, their relevance in second-best settings depends on the fiscal cost of raising funds. We compare general and partial equilibrium approaches, highlighting their advantages and limitations in incorporating key efficiency arguments, externalities, and labor market effects. Building on this, we develop a unified analytical framework that derives second-best pricing rules for public transport and assesses the welfare implications of subsidies under different conditions of scale economies, congestion, and labor taxation. Our framework clarifies when subsidies increase welfare and when the fiscal cost of financing them outweighs efficiency gains, providing both theoretical insights and policy-relevant guidance.
