Tag Archives: Federal Government

Does Anyone Know the Net Benefits of Regulation?

In early August, I was invited to testify before the Senate Judiciary subcommittee on Oversight, Federal Rights and Agency Action, which is chaired by Sen. Richard Blumenthal (D-Conn.).  The topic of the panel was the amount of time it takes to finalize a regulation.  Specifically, some were concerned that new regulations were being deliberately or needlessly held up in the regulatory process, and as a result, the realization of the benefits of those regulations was delayed (hence the dramatic title of the panel: “Justice Delayed: The Human Cost of Regulatory Paralysis.”)

In my testimony, I took the position that economic and scientific analysis of regulations is important.  Careful consideration of regulatory options can help minimize the costs and unintended consequences that regulations necessarily incur. If additional time can improve regulations—meaning both improving individual regulations’ quality and having the optimal quantity—then additional time should be taken.  My logic behind taking this position was buttressed by three main points:

  1. The accumulation of regulations stifles innovation and entrepreneurship and reduces efficiency. This slows economic growth, and over time, the decreased economic growth attributable to regulatory accumulation has significantly reduced real household income.
  2. The unintended consequences of regulations are particularly detrimental to low-income households— resulting in costs to precisely the same group that has the fewest resources to deal with them.
  3. The quality of regulations matters. The incentive structure of regulatory agencies, coupled with occasional pressure from external forces such as Congress, can cause regulations to favor particular stakeholder groups or to create regulations for which the costs exceed the benefits. In some cases, because of statutory deadlines and other pressures, agencies may rush regulations through the crafting process. That can lead to poor execution: rushed regulations are, on average, more poorly considered, which can lead to greater costs and unintended consequences. Even worse, the regulation’s intended benefits may not be achieved despite incurring very real human costs.

At the same time, I told the members of the subcommittee that if “political shenanigans” are the reason some rules take a long time to finalize, then they should use their bully pulpits to draw attention to such actions.  The influence of politics on regulation and the rulemaking process is an unfortunate reality, but not one that should be accepted.

I actually left that panel with some small amount of hope that, going forward, there might be room for an honest discussion about regulatory reform.  It seemed to me that no one in the room was happy with the current regulatory process – a good starting point if you want real change.  Chairman Blumenthal seemed to feel the same way, stating in his closing remarks that he saw plenty of common ground.  I sent a follow-up letter to Chairman Blumenthal stating as much. I wrote to the Chairman in August:

I share your guarded optimism that there may exist substantial agreement that the regulatory process needs to be improved. My research indicates that any changes to regulatory process should include provisions for improved analysis because better analysis can lead to better outcomes. Similarly, poor analysis can lead to rules that cost more human lives than they needed to in order to accomplish their goals.

A recent op-ed penned by Sen. Blumenthal in The Hill shows me that at least one person is still thinking about the topic of that hearing.  The final sentence of his op-ed said that “we should work together to make rule-making better, more responsive and even more effective at protecting Americans.” I agree. But I disagree with the idea that we know that, as the Senator wrote, “by any metric, these rules are worth [their cost].”  The op-ed goes on to say:

The latest report from the Office of Information and Regulatory Affairs shows federal regulations promulgated between 2002 and 2012 produced up to $800 billion in benefits, with just $84 billion in costs.

Sen. Blumenthal’s op-ed would make sense if his facts were correct.  However, the report to Congress from OIRA that his op-ed referred to actually estimates the costs and benefits of only a handful of regulations.  It’s simple enough to open that report and quote the very first bullet point in the executive summary, which reads:

The estimated annual benefits of major Federal regulations reviewed by OMB from October 1, 2002, to September 30, 2012, for which agencies estimated and monetized both benefits and costs, are in the aggregate between $193 billion and $800 billion, while the estimated annual costs are in the aggregate between $57 billion and $84 billion. These ranges are reported in 2001 dollars and reflect uncertainty in the benefits and costs of each rule at the time that it was evaluated.

But you have to actually dig a little farther into the report to realize that this characterization of the costs and benefits of regulations represents only the view of agency economists (think about their incentive for a moment – they work for the regulatory agencies) and for only 115 regulations out of 37,786 created from October 1, 2002, to September 30, 2012.  As the report that Sen. Blumenthal refers to actually says:

The estimates are therefore not a complete accounting of all the benefits and costs of all regulations issued by the Federal Government during this period.

Furthermore, as an economist who used to work in a regulatory agency and produce these economic analyses of regulations, I find it heartening that the OMB report emphasizes that the estimates it relies on to produce the report are “neither precise nor complete.”  Here’s another point of emphasis from the OMB report:

Individual regulatory impact analyses vary in rigor and may rely on different assumptions, including baseline scenarios, methods, and data. To take just one example, all agencies draw on the existing economic literature for valuation of reductions in mortality and morbidity, but the technical literature has not converged on uniform figures, and consistent with the lack of uniformity in that literature, such valuations vary somewhat (though not dramatically) across agencies. Summing across estimates involves the aggregation of analytical results that are not strictly comparable.

I don’t doubt Sen. Blumenthal’s sincerity in believing that the net benefits of regulation are reflected in the first bullet point of the OMB Report to Congress.  But this shows one of the problems facing regulatory reform today: People on both sides of the debate continue to believe that they know the facts, but in reality we know a lot less about the net effects of regulation than we often pretend to know.  Only recently have economists even begun to understand the drag that regulatory accumulation has on economic growth, and that says nothing about what benefits regulation create in exchange.

All members of Congress need to understand the limitations of our knowledge of the total effects of regulation.  We tend to rely on prospective analyses – analyses that state the costs and benefits of a regulation before they come to fruition.  What we need are more retrospective analyses, with which we can learn what has really worked and what hasn’t, and more comparative studies – studies that have control and experiment groups and see if regulations affect those groups differently.  In the meantime, the best we can do is try to ensure that the people engaged in creating new regulations follow a path of basic problem-solving: First, identify whether there is a problem that actually needs to be solved.  Second, examine several alternative ways of addressing that problem.  Then consider what the costs and benefits of the various alternatives are before choosing one. 

Don’t like the fiscal cliff? You’ll hate the fiscal future.

Absent an eleventh-hour deal—which may yet be possible—the Federal government will cut spending and raise taxes in the New Year. In a town that famously can’t agree on anything, nearly everyone seems terrified by the prospect of going over this fiscal cliff.

Yet for all the gloom and dread, the fiscal cliff embodies a teachable moment. At the risk of mixing metaphors, we should think of the fiscal cliff as the Ghost of the Fiscal Future. It is a bleak lesson in what awaits us if we don’t get serious about changing course.

First, some background. Over the last four decades, Federal Government spending as a share of GDP has remained relatively constant at about 21 percent. This spending was financed with taxes that consumed about 18 percent of GDP and the government borrowed to make up the difference.

After a decade of government spending increases and anemic economic growth, federal spending is now about 24 percent of GDP (a post WWII high, exceeded only by last year’s number) and revenues are about 15 percent of GDP (the revenue decline can be attributed to both the Bush tax cuts and to the recession).

But the really telling numbers are yet to come.

The non-partisan Congressional Budget Office now projects that, absent policy change, when my two-year-old daughter reaches my age (32), revenue will be just a bit above its historical average at 19 percent of GDP while spending will be nearly twice its historical average at 39 percent of GDP. This is what economists mean when they say we have a spending problem and not a revenue problem: spending increases, not revenue decreases, account for the entirety of the projected growth in deficits and debt over the coming years.

Why is this so frightful? The Ghost of the Fiscal Future gives us 3 reasons:

1) As spending outstrips revenue, each year the government will have to borrow more and more to pay its bills. We have to pay interest on what we borrow and these interest payments, in turn, add to future government spending. So before my daughter hits college, the federal government will be spending more on interest payments than on Social Security.

2) When the government borrows to finance its spending, it will be competing with my daughter when she borrows to finance her first home or to start her own business. This means that she and other private borrowers will face higher interest rates, crowding-out private sector investment and depressing economic growth. This could affect my daughter’s wages, her consumption, and her standard of living. In a vicious cycle, it could also depress government revenue and place greater demands on the government safety net, exacerbating the underlying debt problem.

This is not just theory. Economists Carmen Reinhart and Kenneth Rogoff have examined 200-years’ worth of data from over 40 countries. They found that those nations with gross debt in excess of 90 percent of GDP tend to grow about 1 percentage point slower than otherwise (the U.S. gross debt-to-GDP ratio has been in excess of 90 percent since 2010)

If, starting in 1975, the U.S. had grown 1 percentage point slower than it actually did, the nation’s economy would be about 30 percent smaller than it actually is today. By comparison, the Federal Reserve estimates that the Great Recession has only shrunk the economy by about 6 percent relative to its potential size.

3) Things get worse. The CBO no longer projects out beyond 2042, the year my daughter turns 32. In other words, the CBO recognizes that the whole economic system becomes increasingly unsustainable beyond that point and that it is ludicrous to think that it can go on.

What’s more, if Congress waits until then to make the necessary changes, it will have to enact tax increases or spending cuts larger than anything we have ever undertaken in our nation’s history. As Vero explains:

By refusing to reform Social Security, lawmakers are guaranteeing automatic benefit cuts of about 20-something percent for everyone on the program in 2035 (the Social Security trust fund will be exhausted in 2035, the combined retirement and disability trust funds will run dry in 2033, and both will continue to deteriorate).

In other words, if we fail to reform, the fiscal future will make January’s fiscal cliff look like a fiscal step. I’ve never understood why some people think they are doing future retirees a favor in pretending that entitlements do not need significant reform.

You might think that we could tax our way out of this mess. But taxes, like debt, are also bad for economic growth.

But it is not too late. Like Scrooge, we can take ownership of the time before us. We can make big adjustments now so that we don’t have to make bigger adjustments in a few years. There is still time to adopt meaningful entitlement reform, to tell people my age to adjust our expectations and to plan on working a little longer, to incorporate market incentives into our health care system so that Medicare and Medicaid don’t swallow up more and more of the budget.

Some characterize these moves as stingy. In reality, these types of reforms would actually make our commitments more sustainable. And the longer we wait to make these inevitable changes, the more dramatic and painful they will have to be.

For all the gloom and dread, the Ghost of Christmas Yet to Come was Scrooge’s savior. In revealing the consequences of his actions—and, importantly, his inactions—the Ghost inspired the old man to take ownership of the “Time before him” and to change his ways.

Let us hope that Congress is so enlightened by the Ghost of the Fiscal Cliff.

Would a Biennial Federal Budget Save Money?

According to news reports, a number of members of Congress are urging the “Super Committee” to recommend that the Federal Government move to a two-year budget cycle. The advocates of biennial budgeting span the political spectrum and include Democrats Jeanne Shaheen and Kent Conrad as well as Republicans Paul Ryan and Johnny Isakson.

The idea has long been championed by fiscal conservatives who hope that it will reduce spending. But does it? According to Paula Kearns of Michigan State University, the theoretical impact of a biennial budget process is ambiguous. It might decrease spending if it shifts power from the legislature to the executive, but it might increase spending if it makes the spoils of lobbying that much more durable and encourages special interest groups to lobby for largesse. In a 1994 study, Professor Kearns examined the impact of biennial budgeting at the state level. After controlling for other factors, she found that states with a biennial budget process actually spend more per-capita than states with an annual budget process.

This result was confirmed in a 2003 study by Mark Crain (now of Lafayette College, though he was at GMU when he conducted this research). Crain found that, other factors being equal, states with a biennial budget process spend about $120 more than states with an annual budget process (I’ve converted this figure into 2008 dollars).

Of course, per-capita spending isn’t everything. Maybe biennial budgeting leads to more spending, but it is better spending?

For a review of this and other institutions that affect spending, see my new working paper with Mercatus Center Masters Fellow, Nick Tuszynski.

Tough Love

Last week, Michael Powell over at New York Times’s Economix blog characterized my position as one of “tough-love.” That is probably a fair way to put it. 

In an example of un-tough-love, yesterday’s Grey Lady featured an article by Christopher Edley Jr. (dean of the University of California, Berkeley, School of Law). In it, Dean Edley argues that states ought to be allowed to borrow directly from the Treasury:   

[S]tates are managing huge budget crises with the only tools they have, cutting spending and raising taxes — both of which undermine the federal stimulus.

That’s why the best booster shot for this recovery and the next would be to allow states to borrow from the Treasury during recessions. We did this for Wall Street and Detroit, fending off disaster. It’s even more important for states.

From my view, such a policy would permanently enshrine the notion that states are too big to fail. We know that states have a spending problem. According to data from the Bureau of Economic Analysis, for the last 9 years, the inflation-adjusted average annual growth rate of state and local government spending was 2.6%. At the same time, the private economy—on which state and local governments depend for their tax revenue—only grew at an average annual growth rate of 1.4%. In other words, states are already spending at a faster rate than the economy can create wealth. Furthermore, they are doing this without the power to deficit spend (for general operating expenses) or the power of the printing press. 

Allowing states the permanent ability to rely on the Federal Treasury would, of course, change all of that. How might we expect them to behave under those circumstances? Important research by the University of Rochester’s David Primo gives us some idea. It turns out that while all states save Vermont have balanced budget requirements, these requirements vary considerably from state to state. Some are allowed to carry deficits over from one year to the next while others are not. Furthermore, others are required to balance their planned spending, while others must balance their actual budgets at the end of the year. Lastly, some states are checked by independent courts, while others are not. In sum, some states face strict balanced budget requirements while others face weak balanced budget requirements. In his analysis, Professor Primo found that state and local spending in states with strict balanced budget requirements averaged $3,336 per citizen. In contrast, in states with weak requirements, the average was $3,756 per citizen.

The Federal Government’s balanced budget requirement isn’t weak; it is nonexistent (you might say they are on the honor system). So what might we expect spending to look like if every state in the union could borrow from the Federal Government whenever it was expedient?  I prefer tough love.

Will We Learn From Greece?

A few weeks ago Thomas Hoenig, the president of the Federal Reserve Bank of Kansas City, warned, “Greece is a lesson for us…. We shouldn’t be so arrogant to think that that couldn’t happen to us.” Mr. Hoenig was talking about our “very, very significant deficit” at the federal level.

Mr. Hoenig is right to worry about the Federal Government’s financial footing, but as a growing number of commentators have argued, the comparison between Greece and the U.S. states may be more apt than that between Greece and the U.S. Federal Government.

Like Greece, nearly every state in the union faces a major budget gap. The National Governors Association and the National Association of State Budget Officers estimate that these gaps total $127.4 billion for the remainder of 2010, 2011 and 2012. Like Greece, these gaps manifested themselves during the recession but their underlying cause is unsustainable levels of government spending. Like Greece, the states have made unrealistic promises to their public employees in the form of unfunded pensions and health benefits. Like Greece, these promises loom as the single largest threat to fiscal solvency in the coming years. And like Greece, the states have a limited number of ways to deal with the situation: they may not declare bankruptcy and they may not inflate their way out of the mess.

In both situations, however, the governments can appeal to the next level of government for aid. In the US, the states received some $135 billion from the Federal Government in the stimulus package passed last spring. And in Europe, the EU has promised to bail out Greece to the tune of $146 billion. These actions send the signal that the US and the EU apparently think that some governments are too big to fail. They also establish a strong incentive for US state and EU member nations to live beyond their means.

The Economist recently noted another similarity between Greece and the US states: as in Greece, many leaders at the state government level are reluctant to make the tough choices necessary to deal with the problem.

This last comparison, however, may prove false. That is because the Greeks may finally be on the verge of addressing their problem. This week, the ruling Socialist Party, PASOK, unveiled their reform proposals and on Friday, the government agreed to the bill. According to Reuters, “The reform cuts benefits, curbs widespread early retirement, increases the number of contribution years from 35-37 to 40 and raises women’s retirement age from 60 to match men on 65.”

My colleague Eileen Norcross has just written a paper with AEI’s Andrew Biggs which reveals the scope of the pension problem in the state of New Jersey. They found that the pension system there is underfunded by as much as $170 billion. Note that this one state’s pension problem dwarfs the $127.4 billion sum total of all state budget gaps over the next two and a half years.

Worse, these unfunded liabilities will come due soon. A series of studies by Joshua Rauh (Northwestern) and Robert Novy-Marx (University of Chicago) find that seven states will run out of pension money by 2020. And when they do, the costs will be enormous. When Illinois’s pension system goes broke in 2018, for example, the state’s pensions costs will be nearly half the size of the entire 2008 state budget.

If Mr. Hoenig is right and Greece is a lesson, let’s hope that policy makers in the US learn it before the pension crisis hits.

What Spending Contraction?

Eileen has a great response to Ezra Klein’s piece on the “anti-stimulus.” Klein writes that “[state] budget shortfalls are the equivalent of a massive anti-stimulus, which some experts believe has overwhelmed the $787 billion stimulus passed by the federal government in 2009.” Have state budget cuts really overwhelmed federal budget expansions?

The National Governors Association, in conjunction with the National Association of State Budget Officers, recently released their “Fiscal Survey of States. In it, they show that, indeed, aggregate state general fund expenditures declined by 4.3% in 2009 and 6.8% in 2010. Assuming fiscal stimulus actually works (and that is not a point that should be readily conceded), it is plausible that these huge declines would be enough to offset any increases in spending by the federal government. But the fact is they come nowhere close to offsetting the Federal Government’s massive spending spree.

If you pop over to the White House’s Office of Management and Budget website, you can see what the Federal Government has been up to. At the same time that aggregate state spending was falling by 4.3% and 6.8%, federal spending was increasing by a whopping 17.9% (2009) and 5.8% (2010). This, combined with the fact that the Federal Government spends trillions while states spend hundreds of billions (in the aggregate), means that the state spending contraction comes nowhere close to offsetting the federal spending increase.

In the chart below, I combine the data from NGA/NASBO with the data from the White House Office of Management and Budget. You judge for yourself. Does this look like a massive fiscal contraction to you?

Do Keyensians Understand Politicians?

Alan Blinder has a thought-provoking article on Greece in the Wall Street Journal (with more Greek metaphors than Jason had Argonauts). His central claim is that governments should take their cues from St. Augustine, who asked God to make him chaste, but not yet. Because of the recession, the argument goes, we ought to run deficits as the “oracle” Keynes counseled.

But once things turn around, we should concentrate on balancing the books. The general strategy is: Run deficits in times of famine and surpluses in times of feast. This type of argument is quite popular now and was repeated ad infinitum at a gathering of left-of-center thinkers I attended last summer. It has also become a common argument for those who advocate tax increases rather than spending cuts to deal with state budget crunches.

Even if we conceded the Keynesian point that deficit spending is what the doctor ordered, and there are many who are not prepared to do so, what shall we make of the Keynesians’ view of politics? From my perspective, politicians simply don’t behave as the Keynesian model predicts. In the 74 years since Keynes wrote his General Theory, the U.S. has been in a recession just 17 percent of the time. Still, during those years, the Federal Government ran deficits 84 percent of the time. As Buchanan and Wagner argued several decades ago in Democracy in Deficit:

Keynesian economics has turned the politicians loose; it has destroyed the effective constraint on politicians’ ordinary appetites. Armed with the Keynesian message, politicians can spend and spend without the apparent necessity to tax.

Thankfully, at the state level, the politicians are not turned fully loose. This is because every state but Vermont has a balanced budget requirement. If, however, the new norm is for states to turn to the Federal Government for bailouts during a downturn, these balanced budget requirements will become increasinly meaningless. It is my guess that, like their federal counterparts, state politicians will fail to behave as the Keynesian model predicts.

Ancient History? State and local governments lobby D.C. for money

The Los Angeles Times reports St. Helena, California spent $150,000 on a lobbyist (more than Philadelphia or St. Louis) to help direct more federal funds to the Napa Valley city. It isn’t an isolated case, or a new story.

The incentive to petition for  federal funds  has been in place for more than a century. And since this period, it has been argued and debated, that federal grants are a means around The 10th Amendment, imposing the policy priorities of the federal government on the states.

(Indeed, this is the basis for various sovreignty amendments, Minnesota Governor Tim Pawlenty’s rejection of the health care bill, and Texas Governor Rick Perry’s opposition to the stimulus.)

As Chris Edwards writes in Downsizing the Federal Government, “Federal granting began during the late 19th century, expanded during the early 20th cenutry, and exploded during the 1960s….today there are 800 state and local aid programs ranging from Medicaid ($225 billion) to Boating Safety Financial Assistance ($120 million).”

In addition to imposing federal policies, grants, as intergovernmental aid, stimulate more spending on the state and local levels. Federal grants may feel like free money, but they come with strings and impose costs on state and local budgets.

Over the decades, states and local governments have grown addicted. The current revenue crisis in the states has only enhanced the temptation to petition Washington for more to fill shortfalls and maintain larger governments.

Opensecrets.org, shows state and local governments spent $41 million through June on D.C. lobbying. The Commonwealth of Pennsylvania put $740,000 towards lobbying over the past decade. Boone, North Carolina dedicated $40,000 in the past three years. Even the District of Columbia’s Mayors Office spent $20,000 to lobby Capitol Hill.

How do politicians feel about their constituents hiring additional manpower to direct more federal funds to local coffers? Rep. Howard McKeon (R-Calif.), a former mayor of Santa Clarita, was at first offended when his city hired a Washington lobbyist, but found they could be helpful, “It’s kind of a team effort. I’m certainly not omnipotent.”

Before putting a lobbyist on their books, local governments might want to pause and consider the full price of spending money, to ask for money, that will lead  them to need even more money in the future.