A Primer on the Efficent Valuatio'n 

of Fringe Benefits 

C. Eugene Steuerle 

U.S. Department of the Treasury 

OTA Paper 51 December 1982 

OTA Papers are circulated so that the preliminary

findings of tax research conducted by staff 

members and other associated with the Office of 

Tax Analysis may reach a wider audience. The 

views expressed are those of the authors, and do 

not reflect Treasury policy. Cments are 

inv ited , but OTA Papers should not be quoted

without permission from the authors. Managing

editors are Michael Kaufman, Harry Grubert, and 

Ralph Bristol. 

Office of Tax Analysis 

U. S. Treasury Depar bnent , Room 404 O 

Washing ton, D. C. 20220 

Issued: December 1982 
ABSTRACT 

In absence of an income tax, few goods or services would 

be purchased by employees from their employers. However,

nontaxability of a fringe benefit causes inefficiency by leading

employees to demand the good as a fringe benefit even when they

value it at less than its marginal cost. This study determines 

bounds on the valuation of a fringe benefit by employees and on 

the amount of cash compensation that would be forgone to receive 

the benefit. 

When the marginal cost to an employer of providing a good to 

employees is less than the market price of that good, there may

be efficiency reasons for valuing the good for tax purposes at 

less than market price. However, complete examination of all 

efficiency conditions requires a discarding of the simple notion 

that valuing a fringe benefit at marginal cost is efficient. 

If valuation is ever to.be provided at less than market price,

considerations of both efficiency and administration require that 

the discount from market price valuation should be allowed only

for a reasonable or verifiable difference between the marginal 

cost of providing the good on the open market and the cost of 

providing it to employees. 
Y 

A PRIMER ON THE EFFICIENT VALUATION OF FRINGE BENEFITS 

I INTRODUCTION 

In recent years the value of fringe benefits has been a 

steadily increasing portion of the compensation of employees. 

(Hartmark and Steuerle, 1980: Chamber of Commerce). One of 

the major-reasons for the increased demand for fringe 

benefits is that many of these fringe benefits are not 

subject to taxation (Sunley, 1977), either because of 

specific statutory exemptions, regulations and rulings, or 

because of Congressional intervention to prevent regulatory 

change (Parnell, 1980). Several U.S. Congresses and 

Administrations have groped with the question of whether 

certain fringe benefits should be included in income subject 

to taxation (Lubick, 1978: Chapoton, 1981). 

Of special concern have been fringe benefits which are 

products or services ,of an employer's business (Ferguson, 

1981) or which are indirectly related to the employee's job. 

Even if a number of these benefits were subject to taxation, 

a major question remains to be resolved: What is the 

appropriate measure of compensation to impute to employees as 

taxable income? Is it zero (as in much of current practice), 

the marginal cost to the employer, the price that the 

employee would pay for the benefit (however that would be 
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determined), or the market price of the Benefit? &/ For 

instance, should employees of transportation companies be 

taxed on free trips when they take seats that would otherwise 

be unoccupied under existing pricing mechanisms? How much 

income should executives be attributed because of free use of 

automobiles or discounts on purchases of automobiles? 

-

Improper valuation of fringe benefits can distort labor 

and consumer markets (Kosters and Steuerle, 19811, lead to 

sizeable welfare losses in the economy (Browning, 19791, and 

affect the distribution of compensation across workers 

(Smeeding, 198'1) Although the choice of the appropriate 

measure of compensation is dependent upon various 

considerations, including equity and administrative 

simplicity (Nolan, 19771, this note is concerned principally 

with efficiency considerations. 

IIm THE VALUATION OF FRINGE BENEFITS IN ABSENCE OF TAXATION 

In absence of all taxes, it is possible to place limits 

on the value of a fringe benefit to an employee. First, an 

employee will never value a fringe benefit more than the 

market price of that benefit. This does not mean that the 

-1/ U.S. Treasury regulations state that "if services are 

paid for other than in money, the fair market value of the 

property or services taken in payment must be included in 
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Y 

employee would be unwilling to buy the item of concern if the 

market price were higher. However, he would not be willing 

to substitute the fringe benefit for cash compensation if the 

loss of cash compensation was greater than the market price. 

Thus, suppose an individual is willing to pay $10 for a 

widget, but the market price of widgets is $8. The value of 

the widget received as in-kind compensation, then, is never 

greater than $8, the value of wage compensation that would 

allow him to purchase the widget. 2/ 

From the employer's standpoint, a major concern is the 

marginal cost of providing the benefit. As long as the 

employee places a value on the benefit greater than the 

marginal cost, there is an incentive for the employer and 

employee to bargain so that the fringe benefit can be 

received as compensation. Of course, it is worthwhile for 

the employer to bargain with any person, employee or 

otherwise, to provide or sell an object if that person will 

pay the employer more than his cost. However, if the 

employee (or other individual) values the object at less than 

the marginal cost to the employer, then no bargain would be 

struck. In the case of an employee, the employer can provide 

greater benefits at lower cost simply by providing cash 

compensation. 

-2/ The difference between $10 and $8 in this case 

represents consumer surplus. 
-4-

In general, then, we have 

Marginal Cost Of Fringe to Employer -

< Benefit to Employee -< Market Price (a) 

In normal circumstances, equation (I) would be written 

not as an inequality, but as an equality. Employees would 

demand the fringe benefit up to the point that their 

valuation of an extra benefit equaled the extra cost to the -

employer. The employer, in turn, would provide or produce 

the benefit for either his employees or the market up to the 

point that his cost equaled the market price, i.e., until he 

could make no more profit. Since marginal cost would equal 

market price, the employee normally would prefer cash 

compensation to the fringe benefit; after all, for the same 

cost to the employer, he could buy the fringe benefit on the 

open market or not buy it, as he desired. Thus, an employee 

would usually avoid a contract in which payment of a fringe 

benefit was specified, for there could be no advantage in 

foreclosing options on how to spend his compensation. We 

conclude that in a nontax world there would need to be 

exceptional circumstances for employees and an employer to 

bargain for payment of a fringe benefit in lieu of cash 

compensation; in particular, a necessary, but not sufficient, 

condition is that there must be a lower marginal coat to the 

employer than to other producers for providing the fringe 

benefit to the employee. We will return to this point later. 
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c 

I 

111. '& VALUATION OF NONTAXABLE FRINGE BENEFITS IN TXE 

PRESENCE OF INCOME TAXATION. 

The addition of income taxes complicates the issue 

considerably. When cash compensation is subject to income 

taxation, but a fringe benefit is excluded from the tax base, 

then' distortions are created as employees demand more of the -. 

fringe benefit than is efficient. 

An excessive amount of a fringe benefit is demanded 

because of the tax savings that it generates. One can derive 

the amount of cash compensation that an employee would 

require to forgo receiving a fringe benefit by adding the tax 

savings to the after-tax price that the employee would be 

willing to pay for that benefit. If "t" is the employee's 

marginal tax rate, then 

r

Equivalent Value of Value 

Cash = Fringe Benefit + Tax Savings = 

Compensation to Bnployee 

Working from equation (2), the value of the tax savings 

can be calculated as the cash price that the employee is 

willing to pay for the fringe benefit times his marginal tax 

rate divided by one minus his marginal tax rate, i.e. 

Tax Savings = Value to mployee x (t/l-t) 
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One way of viewing equations (2) and (3) is that the 

government effectively intervenes to offer a potential tax 

savings when an employee consumes goods and services 

furnished directly by an employer. This tax savings may or 

may not be shared with the employer through lower total 

compensation costs. Suppose that an employee is willing to 

work for $100 a week. Also assume that the cost of the 

fringe benefit to the employer, the market value of the 

fringe benefit, and the valuation placed on the fringe 

benefit by the employee are all the same. If the government 

steps in with a potential $10 in tax savings, the employee 

may now be willing to work for $90 in total employer 

compensation a week. On the other hand, if the employer was 

willing to pay $100 in total cost of compensation, he may 

still be willing to pay that amount; the employee then reaps 

the full value of the tax savings. In effect, a bargaining 

area is created, and the total cost of compensation paid by 

the employer to the employee, excluding tax savings, varies 

between the $90 and $100: including tax savings, it varies 

between $100 and $110. 

? 

fn general, the employer will not substitute a fringe 

benefit for cash consumption unless the wage reduction is at 

least equal to his marginal cost. The employee in turn wiff 

not give up more in wage reduction than the full cash value, 

including tax savings, of the fringe benefit: 
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Wage < Value of Fringe + Tax 

cost

Marginal -

< 

Reduction - Benefit to Employee Savings (4 1 

Because the tax savings may be shared with the employer 

through lower compensation costs, the employer may be willing 

to provide the fringe benefit even when the employee values 

the benefit at less than marginal cost. For instance, 

suppose a fringe benefit has a marginal cost and a market 

price of $20, but that an-employee in a 50 percent tax 

bracket values the benefit at only $14. Then the value of 

benefit to the employee, plus the tax savings, equals $28. 

As long as the employee is willing to ''pay'' $20 or more of 

that $28 to the employer in the form of reduced wages, then 

the employer will be willing to provide the fringe benefit 

"free" (without direct charge) to the employee. 8 

Inefficiency almost inevitably results from 

nontaxability of a good or service provided as a fringe 

benefit because employees generally demand the good or 

service even when they value it (exclusive of tax savings) at 

less than its marginal cost of production. The difference 

between employee value and employer cost represents the 
-aamount of wasted resources of land, labor and capital which 

are prevented from being used for more productive (or more 

highly valued) purposes. In fact, it would be normal for the 

employee to demand the benefit up to the point that his 

equivalent cash compensation equals employer cost, so that, 

at the margin, the tax savings actually represent the amount 

of wasted resources. 3 /

-

Usually, we know neither the exact value of the fringe 

benefit nor the value of the tax savings to the employee. 

However, we do know that the value of the fringe benefit to 

the employee, excluding tax savings, must still be less than 

or equal to market price: 

Value of Fringe < Market (5) to Employee - Price 

Therefore, combining equations (21, (31, (4)and (51, we 

can derive certain observable limitations on the value of a 

nontaxable fringe benefit, both excluding and including the 

tax savings: 

Marginal Cost - Market t < Value to < Market 

To Employer Price l=t - Employee - Price (6) 

Marginal Cost < Equivalent Cash < Market - t) (7) To Employer - Compensation - Price 

3/ Equation (4) becomes an equality: marginal cost = 

equivalent cash compensation = value of fringe benefit to 

employee plus tax savings, or tax savings = marginal cost 

less value of fringe benefit to employee. 
-9-

. 

IV. EFFICIENT VALUATION OF FRINGE BENEFITS FOR TAX PURPOSES 

Because of the inefficiencies that can result when 

fringe benefits are not subject to taxation, it is often 

proposed that fringe benefits be treated as income subject to 

tax to the employee receiving those benefits. We know that 

taxation is efficient if the fringe benefit is counted in 

taxable income at its value to the employee. However, when 

the marginal cost to the employer does not equal market 

price, the equations derived so far only give us broad bounds 

on how to determine that value. The question then remains of 

how to assess the value of the fringe benefit; not all 

assessment values will bring about an efficient allocation of 

resources 

In order to answer this question, it is necessary to 

examine more closely the conditions that should hold if the 

method of tax assessment is efficient. We will label these 

conditions as bargaining efficiency (i.e., exchange 

efficiency within the employer-employee world), productive 

efficiency and distributive efficiency. These conditions are 

simple extensions of the three conditions of welfare 

economics (Samuelson, 1970, pp. 230-249). 

Barqaininq Efficiency. Bargaining efficiency requires 

that the employee and employer should bargain to substitute 

fringe benefits for cash if and only if equation (I) holds 
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true. This is an efficiency condition that existed naturally 

in the nontax world. If the employer cannot provide the 

fringe benefit at a cost less than market price, then the 

employee should not demand payment in-kind rather thamcash. 

Even if marginal cost is less than market price, the employee 

still should not demand an additional fringe benefit unless 

his valuation of the extra benefit is greater than the cost 

of producing that benefit. 

In some articles (e.g. Clotfelter, 19791, it is noted 

that efficiency would result if the tax assessed value 

equaled the value of the fringe benefit to the individual. 

In effect, there would be no tax savings to the employee from 

demanding the fringe .benefit; he would pay in after-tax 

dollars exactly what the fringe benefit was worth to him, but 

ne more. 

While, theoretically, assessment at employee value would 

result in bargaining efficiency, tax authorities are unable 

to determine valuations and preferences of employees except 

as they are revealed in open markets where prices are 

explicit. In the market for fringe benefits, prices often 

are implicit and concealed in the process of wage 

negotiation. Moreover, employees may place different values 

on different amounts of a fringe benefit, and it is the 

marginal valuation that tax authorities would need to 

determine. Equation (5) could be used to place some bounds 

on valuation which could be observed empirically, but these 

bounds are fairly wide. 
-11-

Y 

In absence of information on preferences, any tax 

assessed value ,abovemarginal cost has a probability that it 

could also be above the marginal value of the fringe benefit 

to the employee. Consequently, since receipt of an in-kind 

benefit could increase taxable income by more than the value 

of the benefit to the employee, a rule requiring assessment 

above marginal cost has a probability of preventing a bargain 

from beljng struck even though lkth the employer and employee 

could profit from the exchange. On the other hand, if the 

tax authorities were to assess the fringe benefit at marginal 

cost, then the employee would continue to demand the fringe 

benefit as long as both his own valuation is greater than the 

marginal cost, and the employer's marginal cost was less than 

the market price. To the extent that the employee's own 

valuation is greater than the tax-assessed value, he may 

receive a windfall in tax reduction, but he still has an 

incentive to demand the fringe benefit only as long as his 

valuation is above cost. Thus, tax assessment at marginal 

cost achieves bargaining efficiency in the employer-employee 

world. 

This logic, although perhaps less formally presented, 

has been used as a basis for arguing that marginal cost 

assessment should be the general rule for taxing fringe 

benefits. Nonetheless, the analysis is incomplete. To 

evaluate more fully the efficiency question, it is necessary 

to determine what assessment values will achieve productive 

and distributive efficiency, as well as bargaining 

efriciencv. 
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Productive Efficiency. Productive efficiency requires 

that a good be produced by the lowest cost producer. If 

there is more than one producer, then in equilibrium each 

will produce the good .at the same marginal cost, which will 

also be the lowest cost possible. An employer should provide 

a fringe benefit to his employees only if his cost of 

production or provision is the lowest possible. 

Normally, there would be no debate over whether marginal 

cost valuation or market price valuation of the fringe 

benefit is correct. The marginal cost (including a 

reasonable rate of return on capital) to the lowest cost 

producer generally equals the market price. Else more profit 

could be made by producing more of the good: marginal cost 

would rise with greater production of the good until that 

cost equaled market price. Therefore, if the employer is 

among the lowest cost producers, normally his cost for the 

good would be equal to the market price. In fact, if an 

employer can provide a good on the open market at the same 

cost that he can provide it to his employees, and that cost 

is less than market price, then he actually reveals 

productive inefficiency if he provides the good only to his 

employees. 

In summary, productive efficiency normally requires that 

the employer, as producer or buyer of the fringe benefit, be 

able to provide the fringe benefit at the lowest cost, and 
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that he provide that good on the open market to all 

consumers. Tax assessment at market price would be efficient 

because the producer, to be efficient, would provide the good 

up to the point that price equaled marginal cost. 

An exception to market price assessment, therefore, 

needs to be considered only if the employer's cost function 

for providing the benefit to employees is both less than any 

other producer's cost function and less than his own cost 

function for providing the benefit to other consumers. In 

that.case, there may be justification for assessing the 

fringe bene.fit at a price different from the normal market 

price because, in effect, the employee market would comprise 

a different relevant market. The market price for employees 

in their market would reflect production under a differenct 

cost function than production for other consumers. To 

determine the extent to which tax-assessed value should 

differ from market price when there are different cost 

functions for different consumers, however, we must examine 

the third condition for an efficient allocation of resources. 

Distributional Efficiency. In the case in which there 

is one cost function for providing a good, distributional 

efficiency requires that the good be purchased by the persons 

willing to pay the most for the good. In these circumstances, valuation of the good at market price provides the 

correct clearing mechanism for distributing the good to those 

L 
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persons with the greatest demand for the good. Valuation at 

less than market price for a given employee may result in his 

purchase of the good even when there are other consumers who 

value the good more highly. 

However, as in the case of productive efficiency, an 

exception must be made when a producer can actually provide a 

good at a lower cost for a given group of consumers than for 

another group. In that case, market price in the different 

markets should refLect marginal cost in the different 

markets. In such a world, distributional' efficiency requires 

not that the good be sold to the consumer willing to pay the 

highest price, but rather to that consumer for whom "value 

added", or the difference between price and cost, is the 

greatest 

With most goods sold on the open market, this 

distributional efficiency results from the profit-maximizing 

behavior of producers. If one group of consumers can be 

supplied in a separate market at a lower than average 

cost, that group will tend to receive the good at a price 

which reflects this lower cost. Competition will direct 

supply to any market in which the difference between price 

and cost is greatest. 

In the presence of an income tax, distributional 

efficiency is maintained if tax considerations do not lead a 
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consumer to purchase a good even though his valuation of that 

good (relative to cost) is less than some other consumer's 

valuation. In the case of fringe benefits, this implies that 

the tax-assessed value of the benefit must equal market price 

in the relevant market. If the employees' market is open, 

e.g., if the benefit is purchased from a supplier other than 

the employer, the relevant market price may be easy to 

identify. For instance, if a type of insurance policy would 

cost an individual SX, but, because of economies of scale, a 

firm can purchase a group policy for a per capita cost of $Y, 

then the efficient tax assessment is clearly $Y. 

For some fringe benefits, however, there is no open 

market on which the exchange between employers and employees 

(or an identical exchange) takes place at an observable 

price. Nonetheless, there may be an alternative means of 

ascertaining or approximating what this "market price" for 

employees would have been. The market price for employees 

should differ from market price for other consumers only by 

the difference in marqinal costs of providing the good to the 

different groups. Thus, suppose a fringe benefit could be 

. offered to a set of employees at a cost, ce, and, under the 

most profitable circumstance, could be sold on the open 

market at a price, pm, but at a cost, cm. Then an efficient 

tax valuation would equal: 

p, - (cm - Celt provided ce 2 c,. 
- 

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This is basically a benefit-cost rule designed to maximize 

sales where the difference between price and marginal cost is 

greatest . 

Generally, as we have noted, competition would lead 

_. 

marginal cost to rise to the point that it equaled market 

price in each relevent market. In this case, pm - cm, and 

equation (8) would imply tax assessment at marginal cost in 

the employee market. Again, it should be clear that marginal 

cost in this sense includes some normal return to capital 

(including both bondholders and equity owners). 

Regardless of whether competition lowers the market 

price to marginal cost, distributional efficiency still 

demands that the good be sold to those persons for whom 

value-added is highest, i.e. that the employer maximize 

profits. Let us rewrite equation (8) as 

'e 9 (pm - cm), provided ce 1 cm. 

Since (pm - cm) is a measure of additional value added if 

the good is sold on the market rather than to the employee, 

equation ($') can be seen to demand that the tax base of an 

employee receiving a frinqe benefit should include not only 

the marginal costs of the employer, but also the employer's 

opportunity cost of not selling the qood in another market. 
-17-

. 

This opportunity cost must be the maximum profit lost by 

not disposing of the good in any other way. It is not always 

sufficient to examine existing markets to determine the 

potential profit that is forgone. For instance, if a 

transportation company furnishes transit or if a retail 

outlet sells a perishable good on the open market for 

price pm8 and p, is too high to clear the supply of the good 

or service, then the marginal cost plus the opportunity cost 

of giving the excess supply to employees may appear to be 

close to zero. Yet the opportunity cost cannot be designated 

as zero unless other markets for disposing of the excess 

supply have been properly searched. In this case, an 

opportunity cost of zero makes sense only if no one other 

than an employee would be willing to pay anything to relieve 

the producer of the excess supply. 

Another example may be given by the cartel or monopolist 

wishing to maintain a price well above marginal cost. To 

begin with, monopoly or cartel pricing is a sign of 

productive inefficiency. Assume that a monopolist's cost 

function for providing the good as a fringe benefit to 

employees and to consumers on the open market is exactly the 

same. To allow a tax assessment at marginal cost for the 

fringe benefit may promote productive efficiency, but it also 

supports the distributional inefficency caused by the 

monopolist's decision to limit the number of persons who can 

buy at marginal cost. 

c 
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V. ADMINISTRATIVE ASPECTS OF EFFICIENCY RULES 

Although this paper is concerned with efficiency 

considerations, we cannot help but comment on the 

administrative aspects of the different rules which are 

promulgated on efficiency, but not administrative, grounds. 

For purposes of taxing a fringe benefit, valuation at market 

price has always been recognized to provide the simplest 

administrative method, while the naive rule that pric-ing 

should be at marginal cost, even if it were correct, would 

involve enormous complexity and dispute over how to measure 

that cost. Adding opportunity cost to marginal cost--the 

correct.solution from an efficiency standpoint--would ahd 

only further complexity if one had to measure opportunity 

cost as well as marginal cost. 

Fortunately, adding opportunity cost to marginal cost 

(equation 8') is equivalent to subtracting from market price 

the difference between marginal costs of providing the good 

to two different groups of customers (equation 8). In this 

form, the correct efficiency rule comes closer to an 

administrable rule than any proposed efficiency rule other 

than strict market pricing. Data on market prices are 

generally available, and most marginal costs of producing a 

good are common to all markets and therefore do not have to 
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be calculated in detejrmining any difference in marginal costs 

between providing a good to employees and providing it to 

others. In equation terms, one needs only to acquire data on 

p, and on (cm - ce), but not on either cm or c 

e by 

themselves. 

As as example, suppose a retail merchant was to provide 

his merchandise free to his employees. He might reasonably 

assert that he did not have to pay for advertising costs to 

his employees: however, other costs such as operating the 

store, paying overhead, and accounting for transactions would 

be the same (even if zero for some excess inventory) 

regardless of the buyer. For this merchant, therefore, the 

reasonable discount from market price could be approximated 

simply by looking at his costs of advertising and ignoring 

all other costs. In practice, a -de minimis rule could be 

provided to cover this type of situation. 

Other cases may be somewhat more difficult,but safe 

harbor rules could be used to approximate the actual 

situation. Even in such difficult and highly debated case 

as free rides to employees of transportation companies, it 

is probably less the marginal cost differences that cause a 

problem than the measurement of the relevant market price. 

For instance, airline stewards might be able to fly free, 

but only under a type of pass which would be equivalent to a 

standby-standby ticket. It is the failure of the airline to 

sell such an equivalent product on the open market that makes 
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it difficult to determine the market value of the employee 

pass, but the marginal cost of providing such a pass is 

likely not to vary much between employees and other users. 

A reasonable and efficient solution in this case might be to 

allow a standard percentage discount (as determined under a 

-de minimis or safe harbor rule) from the price of the lowest 

price discount ticket available. 

While this discussion is not meant to suggest that there 

is still not a substantial amount of difficulty, any rule 

must have some standard by which to judge its adequacy. ff 

it is deemed appropriate to provide valuation of certain 

types of fringe benefits at other than market price, then the 

standard of efficiency seems to be appropriate. If de 

minimis rules and safe harbor rules are then established on 

the basis of reasonable differences in marginal costs, the 

amount of arbitrariness can at least be kept to a minimum. 

VI. SUMMARY 

In the absence of an income tax, a good provided as a 

fringe benefit would be valued by an employee at less than or 

equal to the market price of the good but at greater than or 

equal to the marginal cost to the employer of providing the 

benefit. For most goods, market price would equal marginal 

cost. The employee would then avoid payment in-kind since, 

for the same employee cost, cash compensation would always 

be valued as much or more than a fringe benefit-
-21-

When cash compensation is taxed, however, nontaxability 

of a fringe benefit may cause inefficiency by leading 

employees to demand a benefit even when they value it at less 

than marginal cost. They may also share the tax savings from 

special treatment of the fringe benefit with their employer. 

If the fringe benefit is not treated as income subject to 

tax, one can still ascertain bounds on the value of the 

fringe benefit by the employee: however, these bounds are 

fairly wide 

Efficient tax assessment for fringe benefits is 

dependent upon three conditions: bargaining efficiency, 

productive efficiency and distributive efficiency. 

Bargaining efficiency between employer and employee requires 

that any tax valuation placed on the fringe benefit should 

fall somewhere between marginal cost and the value placed by 

the employee on the fringe benefit. In absence of full 

information on valuations by employees, marginal cost 

valuation would safely avoid interfering in an 

employer-employee bargain where both could profit from the 

exchange. 

Productive efficiency requires that the employer should 

provide a fringe benefit only if he is the lowest cost 

producer of that benefit. Moreover, if he is lowest cost 

producer, he should provide the good to any customer for whom 
-22-

valuation is greater than marginal cost, and he should ' 

provide the good up to the point that marginal cost equals 

market price. If the employer faces different cost functions 

for different consumers (including his employees), then the 

market prices in the separable consumer markets should 

reflect differences in those costs. 

Distributive efficiency requires that goods be 

distributed to consumers who are willing to pay the highest 

price relative to cost. If producers face the same cost 

curve for all consumers, distributive efficiency is achieved 

by having all consumers, including employees, face the same 

price curve. Thus, for most goods, tax assessment at market 

price is sufficient and necessary to achieve distributive 

efficiency. 

If employers are the lowest cost providers of a good to 

their employees, however, and the cost of providing the good 

to employees is less than the cost of providing the good to 

other consumers, then efficient tax assessment would require 

valuation for employees at the market price that would be 

relevant in the employee market. The assessed value of the 

fringe benefit should equal market price in the nonemployee 

market less the difference between cost of providing the good 

to the nonemployee market and the cost of providing it to 

employees. Another interpretation of this efficiency rule is 
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that the tax assessed value for fringe benefits should equal 

marginal cost plus opportunity cost, where opportunity cost 

is a measure of the maximum profit obtainable from selling 

the.good to consumers other than employees. 

Complete examination of all efficiency conditions 

therefore requires a discarding of the simple’notion that 

valuing a fringe benefit at marginal cost is efficient. 

If valuation is ever to be provided at less than market 

price, considerations of both efficiency and administration 

require that the discount should be allowed only for a 

provable or reasonable or vedfiable difference between the 

marginal cost of providing the good on the open market and 

the cost of providing it to employees. 
-24-

BIBLIOGRAPHY 

Browning, Jacqueline. "Esthating the Welfare Cost of Tax 

Preferences." Public Finance Quarterly 7 (April 1979): 

pp8 199-2190 

Chamber of Commerce of the United States. Employee Benefits 

Washington, D.C.: Chamber of Commerce of the United 

States, various years. 

ChaPoton, John E. b Egger, Roscoe L., Jr. "Statement before 

the Subcommittee on Select Revenue Measures of the 

Committee on Ways and Means." Washington, D.C.: U.S. 

Treasury Department, May 13, 1981. 

Clotfelter, Charles T. "Equity, Efficiency and the Tax 

Treatment of In-Kind Compensation." National Tax 

Journal XXX (March 1979): pp. 51-60. . 

Ferguson, Bradford L. "Income Tax Trea'tment of Employee

Fringe Benefits." National Tax Association -- Proceedings of the Seventy-fourth Annual Conference 

(1981), pp. 97-103. 

Kosters, Marvin H. and Steuerle, Eugene. "The Effect of 

Fringe Benefit Tax Policies on Labor and Consumer 

Markets." National Tax Association -- Proceedings of 

the Seventy-fourth Annual Conference (19811, pp. 86-92. 

Lubick, Donald C. "Statement before the Task Force on 

Employee Fringe Benefits of the Ways and Means 

Committee." Washington, D.C.: U.S. Treasury

Department, August 14, 1978. 

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