Recognizing the Losers in Benefit-Cost Analysis

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Policymakers should consider direct compensation for people who regulations negatively affect.

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Among President Joe Biden’s numerous challenges is addressing the alienation so many have about government. With so many causes of this alienation, no easy solutions exist. The Biden Administration’s responses will have to be multifaceted.

To begin to address the resentment so many have toward government, the Biden Administration should require regulators to suggest how to compensate communities that bear the cost of regulations that nevertheless deliver net benefits to the public at large.

The context is admittedly arcane—how policymakers evaluate regulation, specifically through benefit-cost analysis (BCA). BCA is used to determine whether a regulation’s benefits will exceed its costs.

For instance, if those who gain from a regulation are willing to pay $20 for the benefits, and the regulation imposes costs on those who lose only $10, the benefits exceed the costs, passing the BCA test. If those who gain would pay only $5 for the benefits while the costs are $10, the regulation fails under BCA. Many books and studies debate the practical complications and controversies of BCA, but this balancing is its core.

Despite these controversies, BCA has received bipartisan endorsement through executive orders from Presidents Ronald Reagan, Bill Clinton, and Barack Obama.

President Donald J. Trump, however, took some issue with BCA by adding extraneous limitations to regulations that would typically pass a BCA test. These limitations included requirements that aggregate costs stay within a regulatory budget and that a regulation cannot be adopted without identifying two others to be eliminated, regardless of net benefits.

Shortly after his inauguration, President Biden rescinded those Trump executive orders. Nevertheless, President Biden has still endorsed the use of BCA.

Why has BCA generally received such widespread support?

This support follows from the principle that the purpose of regulation is to correct market failures. In a market, for example, if buyers are willing to pay $20 for an item with a price of $10, they will buy it. If they are willing to pay only $5, they will not buy the item. Moreover, if a market is working well—that is, with competition and an absence of harmful side effects—the $10 price will reflect costs of $10. A regulation passes the BCA test if, and only if, it matches the outcome one would get if markets worked well.

A major challenge of BCA, however, is measuring benefits and costs where markets do not exist to indicate their monetary value, which presents an enormous practical complication of the BCA requirement.

There is one crucial difference, however, between the BCA test and the market outcome it is designed to emulate. In the market, the buyer valuing the good or service at $20 has to pay the $10 for it. With BCA, the regulation passes the test as long as the willingness to pay $20 exceeds the $10 cost. Those who bear that $10 cost need not be paid anything.

As Hamlet said, “Aye, there’s the rub.” Economists, myself included, justify BCA by observing that it holds only when the winners—those getting the $20 benefit—could compensate the losers—those bearing the $10 cost. The winners in principle could pay the losers something between $10 and $20—say $15—leaving both sides $5 better off.

Suppose that the U.S. Environmental Protection Agency adopts a regulation to eliminate a pollutant. This action would provide health benefits to the public worth an estimated $125 million. Enacting this regulation, however, will put some polluting firms out of business, resulting in $80 million in costs from lost profits and wages in communities where those businesses and workers are located. But the benefits exceed the costs by $45 million, so this regulation passes the BCA test. Those workers and businesses, however, are not compensated for their losses.

Eliminating the pollutant is still a good idea, as is the BCA test that underlies it. But the workers and communities will understandably resent being passed over as merely a number in a policy calculation.

President Biden can try to address this resentment. He and his regulators will rarely, if ever, be able to compensate the losers directly. But he could require—as part of the regulatory impact analysis that accompanies executive branch regulations—a description of financial, educational, or community development programs that might compensate the losing workers and their communities. To mitigate resentment without unduly complicating regulation, this assessment might be limited to proposing taxes or programs for affected people and communities below the median or mean U.S. income.

The numerous measures the United States has adopted during the COVID-19 pandemic to protect public health serve as examples of this disproportionate effect.

The benefits of pandemic-related public health measures likely exceed their costs. The costs of these measures, however, disproportionately fall on businesses and workers that depend on people being able to gather together in public—restaurants, hotels, theaters, and brick-and-mortar retail, among other establishments.

As a consequence, relief programs often include specific support programs for these sectors, as well as broader programs to protect individuals who lost jobs from evictions and hunger. These measures are incorrectly called “stimulus” programs. They should be more accurately described as programs to compensate individuals who were not well off before the pandemic and now bear the costs of programs to limit the spread of the coronavirus.

Moving forward, President Biden could order the BCAs of new regulations to include similar compensation recommendations. President Biden and regulators cannot be required to enact that compensation—only the U.S. Congress can do that. But by showing the public that the government cares enough about people who pay the price for regulations and other policies that benefit the general public, individuals in communities—especially low-income, rural communities—might feel and be less neglected.

This recommendation can be one small step among many necessary ones to fulfill the new Administration’s aspirations to unify the country.

Tim Brennan

Tim Brennan is a professor emeritus of public policy and economics at the University of Maryland, Baltimore County.