Cost Benefit Comments

The Biden Administration is proposing major changes to cost-benefit analysis used in all regulations. The preamble here, and the full text here. It is open for public comments until June 20. 

Economists don't often comment on proposed regulations. We should do so more often. Agencies take such comments seriously. And they can have an afterlife. I have seen comments cited in litigation and by judicial decisions. Even if you doubt the Biden Administration's desire to hear you on cost-benefit analysis, a comment is a marker that the inevitable eventual Supreme Court case might well consider. Comments tend only to come from interested parties and lawyers. Regular economists really should comment more often. I don't do it enough either. 

You can see existing comments:  Search for Circular A-4 updates to get to https://www.regulations.gov/docket/OMB-2022-0014, then select “browse all comments.” (Thanks to a good friend who sent this tip.) 

Take a look at comments from an MIT team led by Deborah Lucas here and by Josh Rauh. These are great models of comments. You don't have to review everything.   Make one good point. 

Cost benefit analysis is useful even if imprecise. Lots of bright ideas in Washington (and Sacramento!) would struggle to document any net benefits at all. Yes, these exercises can lie, cheat, and steal, but having to come up with a quantitative lie can lay bare just how hare-brained many regulations are. 

Both Josh and the MIT response focus on the draft proposal's use of ultra-low discount rates, ranging from historic TIPS yields to arguments for zero or negative "social" discount rates. Josh emphasizes a beautiful compromise: always show the annual stream of costs and benefits. Then it's easy enough to apply different discount rates. No Black Boxes. 

Discount rates seem like a technical issue. But they matter a lot for climate policies, or for policies with substantial cost but putatively permanent benefits, because of the long horizons. For example, climate change is alleged to create costs of 5% of GDP in 100 years. So, let's assume a 0% discount rate -- treat the future just like the present. How much is it worth spending this year to eliminate additional climate change in 2100? Spend means real spending, real reductions in everyone's standard of living, not just funny money billions on twitter. 

If you answered "5% of GDP" (roughly $3,500 per person) that's wrong, for two crucial reasons. First, the economy grows over time. At a modest 2% real growth, US GDP will be 7.4 times as large in 100 years as it is today, or 640% greater. (e^2=7.4). Thus, 5% of GDP in 100 years, discounted at 0%,  is 7.4 x 5% or 37% of today's GDP, or $17,500 per person today. Second, the gain is forever -- 5% of 2123 GDP, but 5% of 2124 GDP, and so on. Discounted at a zero rate, 5% of 2123 forever after that is worth... an infinite amount today. But GDP keeps growing after 2123. If you discount at anything less than the growth rate of GDP -- 2% in my example -- 5% of (growing) GDP forever is worth an infinite amount!  So what if $250 billion subsidizing huge battery long range electric cars made by union labor in the USA from hypothetical US made lithium mines might, all in, save a thimbleful of carbon per car (is it even positive?), if the benefits are infinite, go for it. 

If you discount by a low, but somewhat more reasonable number like 7%, then a dollar in 100 years is worth 0.09 cents today (100 x e^-7). Now you know where to put your thumb on the climate scales! 

You might be wondering, if our great grandchildren are going to be so fantastically better off than we are, let them deal with it. Or you may be wondering that maybe there are other things we could do with money today that might speed up this magical growth process and do 5% better. For an infinite amount of money, is there nothing we can do to raise the growth rate from 2% to 2.05%? 

The latter opportunity cost question is, I think, a good way to think of discount rates. The average real return on stocks is something like 5%, at least. The average pre-tax marginal product of capital is higher; pick you number but it's in the range of 10% not 1%. The right "discount rate" is the rate of return on alternative uses of money. Josh and the MIT team are exactly right to point out that using the rate of return on risk free government bonds is a completely mistaken way to discount the very risky costs of climate damage -- that 5% is a very poorly known number -- and the even riskier benefits of the government's shifting climate policy passions. But I think phrasing the experiment in terms of opportunity costs rather than proper discounting of risky streams makes it more salient, despite the decades I have spent (and an entire book!) on the latter approach. Businesses can take $1 today and turn it in to, on average, $1.07 next year. Why take away that money for a project that yields $1.00 or $1.01 next year? 

The former question has a deeper consequence. Why should we suffer to help people, even our grandchildren, who will be on average 7.4 times better off than we are? How much would you ask your great grandparents to sacrifice to make you 5% better off than you are today? 

Here the low discount rate clashes interestingly with another part of the proposal: equity and transfers. 

From the preamble p. 12: 

A standard assumption in economics, informed by empirical evidence (as discussed below), is that an additional $100 given to a low-income individual increases the welfare of that individual more than an additional $100 given to a wealthy individual. Traditional benefit-cost analysis, which applies unitary weights to measures of willingness to pay, does not usually take into account how distributional effects may affect aggregate welfare because of differences in individuals’ marginal utility of income. Related to the topic of distributional analysis is the question of whether agencies should be permitted or encouraged to develop estimates of net benefits using weights that take account of these differences.26 The proposed revisions to Circular A-4 suggest that agencies may wish to consider weights for each income group affected by a regulation that equal the median income of the group divided by median U.S. income, raised to the power of the elasticity of marginal utility times negative one.

Now wait a darn-tootin' minute. The "standard" doctrine in economics is that you cannot make intra-personal utility comparisons. Utility is ordinal, not cardinal. Here cardinal-utility utilitarianism with equal Pareto-weights is about to be carved into federal stone. (To decide social benefit of taking from A and giving to B, you construct a social welfare function \(u(c_A) + \lambda u(c_B)\). This needs you to use the same \(u()\) for A and B, and agree on a Pareto-weight \(\lambda\) implicitly one here.) 

Imagine a simple regulation: take a dollar from Joe ($100,000 income) and give it to Kathy ($50,000 income). By this standard such a straightforward transfer passes a cost-benefit test.  

But this does not get applied over time. Taking a dollar from you and me, and at a discount rate of 0% giving it to our great grandchildren who will be 7.4 times better off should set off massive inequity alarm bells. Nope. 

Indeed, you can deduce a discount rate from the inequality goal. Pure undiscounted intergenerational equity requires a discount rate proportional to the economic growth rate. 

(With power utility, an intervention that costs A $1 to give B $\(e^{rt}\) just passes a cost-benefit test if \[c_A^{-\gamma} = e^{rt} (c_B)^{-\gamma}.\]  If B is \(e^{gt}\) times as well off as A, \(c_B=e^{gt} \times c_A\) then we need  \(r=\gamma g\). \( \gamma\) is usually a number a bit bigger than one.  The preamble's discussion of \(\gamma\) values is pretty good, settling on a number between one and two. However, they haven't really heard of the finance literature: 

Evidence on risk aversion can be used to estimate the elasticity of marginal utility. In a constant-elasticity utility specification, the coefficient of relative risk aversion is the elasticity of marginal utility. There are numerous different estimates of the coefficient of relative risk aversion (CRRA), using data from a variety of different markets, including labor supply markets,29 the stock market,30 and insurance markets.31 Relevant estimates vary widely, though assumed values of the CRRA between 1 and 2 are common.32

30 Robert S. Pindyck, “Risk Aversion and Determinants of Stock Market Behavior,” The Review of Economics and Statistics 70, no. 2 (1988): 183-90 uses stock market data and estimates the CRRA to be “in the range of 3 to 4"

Since then, of course, the whole equity premium literature sprang up with coefficients 10 to 50. Shh. That would justify insane levels of equity. 

The draft also encourages all sorts of unquantifiable non-economic "benefits," but I'll leave that for another day. 

Read and comment. 

BTW, despite my negative tone and picking on these elements, much of the draft is quite good. Here is a particularly nice piece, from p. 26 of the full text 

j. A Note Regarding Certain Types of Economic Regulation

In light of both economic theory and actual experience, it is particularly difficult to demonstrate positive net benefits for any of the following types of regulations:

 price controls in well-functioning competitive markets;

 production or sales quotas in well-functioning competitive markets;

 mandatory uniform quality standards for goods or services, if the potential problem can be adequately dealt with through voluntary standards or by disclosing information of the hazard to buyers or users; or

 controls on entry into employment or production, except (a) where needed to protect health and safety (e.g., Federal Aviation Administration tests for commercial pilots) or (b) to manage the use of common property resources (e.g., fisheries, airwaves, Federal lands, and offshore areas).

Well, FAA tests and rules for commercial pilots is not actually quite so obvious and really needs a cost benefit test. "Commercial pilot" does not mean "airline pilot," it means can you do anything in an airplane and get money for it. But leave that for another day, these principles if applied could clean out a lot of mischief. Well, I guess many on the progressive left or nascent national-conservative right would deny there is such a thing as a "well-functioning competitive market." 

Update: 

I should have added: It's insane to make a once and for all cost benefit analysis, especially for projects with 100 year horizons. All regs should be re evaluated every 5 to 10 years, and use experience to update costs and benefits. 

 

   

Work requirements

The debate over work requirements for social programs is hot and heavy. I'll chime in there as I don't think even the Wall Street Journal Editorial pages have stated the issue clearly from an economic point of view.  As usual, it's getting obfuscated in a moral cloud by both sides: How could you be so heartless as to force unfortunate people to work, vs. how immoral it is to subsidize indolence, and value of the "culture" of self-sufficiency. 

Economics, as usual, offers a straightforward value-free way to think about the issue: Incentives. When you put all our social programs together, low income Americans face roughly 100% marginal tax rates. Earn an extra dollar, lose a dollar of benefits. It's not that simple, of course, with multiple cliffs of infinite tax rates (earn an extra cent, lose a program entirely), and depends on how many and which programs people sign up for. But the order of magnitude is right. 

The incentive effect is clear: don't work (legally). As Phil Gramm and Mike Solon report, 

Since 1967, average inflation-adjusted transfer payments to low-income households—the bottom 20%—have grown from $9,677 to $45,389. During that same period, the percentage of prime working-age adults in the bottom 20% of income earners who actually worked collapsed from 68% to 36%.

36%. The latter number is my main point, we'll get to cost later. Similarly, the WSJ points to  a report by Jonathan Bain and Jonathan Ingram at the Foundation for Government Accountability that

there are four million able-bodied adults without dependents on food stamps, and three in four don’t work at all. Less than 3% work full-time.

3%. 

Incentives are a budget constraint to government policy, hard and immutable. Your feelings about people one way or another do not move the incentives at all. A gift of money with an income phase-out leads people to work less, and to require more gifts of money.  That's just a fact. 

What to do? 

One answer is, remove the income phaseouts. Give food stamps, medicaid, housing subsidies,  earned income tax credits, and so forth, to everyone, and don't reduce them with income. Then the disincentive to work is much reduced. (There is still the "income effect," but in my judgement that's a lot smaller for most people in this category.) 

Rather obviously, that's impractical. Even the US, even if r<g or MMT are true, would run out of money quickly. That's the problem with Universal Basic Income. Even $20,000 x 331 million = $6.6 trillion, essentially the entire federal budget right there, and $20,000 of total support is a lot less than people with $0 income get right now. (Gramm, Ekelund and Early, and Casey Mulligan estimate about $60,000 is the right number here.)  Put another way, to eliminate the work disincentive in the social programs, we would have to jack up marginal tax rates on everyone to such stratospheric levels that nobody works. You can't escape disincentives. 

So, support for the unfortunate must be limited somehow. That's why we limit it to people below a certain income level. But even if each individual program maintains a reasonable marginal phaseout, they add up across programs, and next thing you know we're back to 100% phase out. 

Posit that work is still desirable,  to earn some money, to contribute to your fellow citizens, to reduce the need for income assistance, and to build human capital.  (Plus the more ephemeral goals all sides of the debate ascribe to work -- self reliance, life meaning, self-respect, participation in society, and so forth. I promised no moral or sociological arguments, but these values being shared by both sides of the debate, I can make a little exception. Nobody thinks that an entire lifetime of living on a government check, doing nothing but drink take drugs and play video games all day, makes for a desirable society, no matter who they vote for.)  

If so, if the social safety net creates a 100% marginal tax rate on work, and if abandoning income phaseouts will bankrupt the state, then we have a problem. 

Work requirements are an imperfect method to try to replace the incentive to work that social programs eliminate. Our government does this sort of thing all over to transfer income but contain the disincentives: Subsidize gas, and then regulate against its use for example. 

It is inefficient, as you can tell from the brouhaha. It's much more efficient to get people to work by saying "if you earn a dollar, you can keep it," rather than "if you earn a dollar we'll take it away from you but we're going to force you to work." As the WSJ details here and often, the rules are complex, and people and governments game them. Just who should work? Progressives will quickly find a sick single mother taking care of elderly parents and commuting to some horrible fast food job who falls through the cracks, and they are right. Rules and bureaucracies are very rough substitutes for market incentives. More importantly, if you're working for money, you find the best job you can, you work hard, you look for better opportunities. If you're working to satisfy a bureaucratic work requirement in the face of a 100% tax rate, you find the easiest job you can, you don't care about the money and thereby the social productivity of the work, and you do as little as possible. 

So I'm not defending work requirements as a perfect offset to a 100% marginal tax rate. But they are there for a reason, as a very rough offset to some of the huge disincentives that means-tested programs pose. The point today is that we should start to understand and debate work requirements in this framework. If you're going to remove market incentives, you need some replacement. 

By the way, supposedly socialist Europe, after its experience with "the dole" in the early 1990s, is much more heard-hearted about these sorts of incentives than we are. Progressives who think we should both emulate nordic countries and also expand our safety net should go look at nordic countries. 

Is there a better way? I've long played with the idea of limiting help by time rather than by income. That's how unemployment insurance works. We understand that replacing people's paycheck forever if they lose their job has bad incentive effects. Unemployment is understood as a temporary misfortune, and understanding the incentives, you get unemployment checks for a limited amount of time. Could not many other programs aimed at misfortune also be limited by time -- but then allow you to keep each extra dollar of earnings? Perhaps even unemployment should be a fixed amount of time, and you can keep receiving it for the full (normally) 26 weeks even if you get a job. 

The trouble with that, of course, is that some people will not get their acts together in the required time, and then you have to be heartless. But is it not just as heartless to say to a person who had been on food stamps, earned income tax credit, social security disability and housing voucher, "well, congrats on getting  a job, and a good one, that pays $60,000 per year. Now we're taking away all your benefits. Enjoy the $1?" 

Also, the safety net does include a detailed bureaucracy to determine who is needy. Disability, unemployment, and so forth look hard at these issues. Replicating that with a different set of rules for each program seems mighty wasteful. 

Another wild idea: Good economists all understand that consumption, not income, is the right measure of well being. That's why consumption taxes are a good idea, and we should measure consumption diversity not income diversity. (I don't use the word "inequality" anymore as it prejudices the right answer.) One advantage of a consumption tax is that it would be easier to condition benefits on consumption rather than income. If you work and save the results, you can keep your benefits. 

One last point, which maybe should be the first point. It is a bit scandalous that income phase outs in social programs take away benefits based on market income, but not social program income. If you have food stamps and earn an extra $10,000 of income, you can lose your foods stamps. If you get housing worth $10,000, you don't lose anything. Ditto in the entire social program system. This is an immense distortion towards putting effort into obtaining more social programs rather than working. Phasing out based on consumption, including cash and non cash benefits, would make a lot more sense. But one could phase out benefits based on which other benefits you receive too. Disincentives come from the social program and tax system overall, and any hope of continuing disincentives and saving money must take a similar integrated system approach. 

The argument also is over how much money the programs cost. That leads to "how could you be so heartless" vs. "but the country will go broke," also going nowhere. A focus on incentives offers the way out. Fix the incentives, and we end up helping people who need it a lot better, we end up with a lot fewer people who need help, and spend a lot less money. Win win win. 

There is no clean answer. A main lesson of economics is that there is always a tradeoff between help and disincentives, between insurance and moral hazard. We can make this tradeoff a lot more efficient than it is, but we can't totally eliminate the tradeoff. 

The bottom line remains, this discussion would be a lot more productive discussion if we talked about the constraint posed by incentives, rather than the usual moral mudslinging.    

Update:

So work requirements are a little tightened, but not if you have Medicaid. WTF? Medicaid is limited by income. The incentive spaghetti here would be fun to unravel. Of course, we have an  additional reason to stay below the income cap for Medicaid. We have an additional incentive to sign up for Medicaid, which may be the idea here. "Get a job, lose your food stamps, or sign up for this free government program." Hmm. Feel free to riff on this one in the comments...