Optimizing Well-Being through Public Spending

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Scholars suggest that the revised Circular A-94 will help agencies focus on welfare over efficiency in benefit-cost analysis.

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Fifty percent of U.S. counties experience a climate-related disaster each year—a statistic that may continue to rise as climate change progresses. In the aftermath of such disasters, government agencies spend billions of dollars on repair efforts, making government spending a key part of restoring public well-being.

But a closer look at agency spending patterns reveals an alarming trend. Spending skews away from vulnerable, low-income Americans toward wealthy, white communities.

In a recent paper, Zachary Liscow, a professor at Yale Law School, and Cass R. Sunstein, a professor at Harvard Law School, investigate the role of benefit-cost analysis in agency spending and found that current spending trends divert resources from poor communities. Liscow and Sunstein argue that the revised Circular A-94—the main source of guidance for federal agency spending—offers a strong alternative that prioritizes welfare over efficiency.

Agencies, such as the Federal Emergency Management Agency (FEMA), allocate resources where the “total value from the project is greater than the total costs.” This kind of benefit-cost analysis prioritizes efficiency by maximizing net benefits, Liscow and Sunstein point out.

They claim, however, that maximizing net benefits yields perverse results and explains why agency spending often favors the wealthy.

For example, when FEMA spends according to this efficiency rationale, economists have found that “protecting 10 families in $1 million houses has the same value as protecting 100 families in $100,000 houses.” In turn, the efficiency rationale results in the lopsided distribution of resources because the agency does not have to consider who is receiving the benefit.

Liscow and Sunstein argue that government agencies need better guidance on how to make spending decisions and note that the revised Circular A-94 that has been in effect since November 2023 is a welcome change.

The framework under the previous version of the Circular A-94 aimed “to promote efficient resource allocation” through a benefit-cost analysis of spending that “maximizes net benefits.”

Liscow and Sunstein explain that this benefit-cost rationale is a version of applied utilitarianism, which proposes that as long as the “winners” of federal spending gain more than the “losers,” the winners’ gains will be spread through taxation, and overall well-being will increase.

But as Liscow and Sunstein identify, a key premise of this theory is that the winners will compensate the losers—and in reality, the recipients of funding do not compensate those who do not receive resources because there is no mechanism to do so. For example, recipients of FEMA grants have no means to redistribute grant money, and FEMA lacks the authority to carry out such redistribution.

Furthermore, Liscow and Sunstein claim that “efficient” resource allocation does not maximize welfare, but instead diverts resources from poor communities that have a “stronger distributive claim to public resources.” For example, they suggest that a $200,000 loss from a disaster does not affect a wealthy person to the same extent that loss affects a poorer person who had less to lose in the first place.

The drafters of the revised Circular A-94 also noticed the disconnect between efficiency and well-being, and sought to address this disconnect in their new guidance.

Liscow and Sunstein support the new Circular A-94, which articulates that its objective is to “ promote social welfare through well informed decision-making by the Federal Government,” shifting the goal of government spending away from efficiency towards well-being.

Liscow and Sunstein highlight that under the revised Circular A-94, agencies can use distributional weighting in making spending decisions.

They explain that distributional weighting entails weighing the net benefits of a project across income levels, with a focus on maximizing the weight of positive outcomes for lower-income people and minimizing the impact of positive outcomes for higher-income people.

Liscow and Sunstein also note that the revised Circular A-94 allows agencies the flexibility to use income averaging—when an agency calculates the average value of a particular benefit or cost across the entire population—which can give lower-income groups a greater chance at receiving funding.

In practice, under the new guidelines, an agency could now make its spending decisions based on a formula that averages the value of people’s homes, rather than treating wealthy people’s homes as more valuable than those of the poor, Liscow and Sunstein explain.

Liscow and Sunstein urge that distributional weighting and income-averaging practices “shift grant funding to those with lower incomes and thus a higher marginal utility, thereby increasing welfare.” Liscow and Sunstein further submit that distributional weighting and income-averaging can correct the bias in spending toward the wealthy that was previously present in the efficiency-based Circular A-94 guidance.

Some scholars, however, argue against redistributing through spending or regulation and uphold that taxation is the best method to redistribute funds. Taxation, these scholars insist, maximizes welfare because “everyone values a dollar at a dollar” and may choose how to spend that dollar on the things most valuable to them.

But the U.S. tax code is not designed to redistribute the “socially optimal amount,” so the gains given to the winners are not reallocated to the losers, Licsow and Sunstein note.

Liscow and Sunstein concede that the revised Circular A-94 presents challenging questions for agencies, such as what distributional weights to use, how to account for uncertainties, and how to manage the administrative burden this new method of spending entails.

But they stress that these questions are not insurmountable, and administrability issues should not stand in the way of creating greater equity in spending.