Tag Archives: rules

The barriers to brewing

Recently, Evan Feinberg of Generation Opportunity described some of the barriers craft brewers face. In one instance, a brewer — who does not prepare any food — was told he had to install a hood for a food oven that he did not even own. Another brewer — who does not use poultry in his beer — was nearly kept from operating because he did not have the equipment to handle raw chicken.

tasty beerThat’s Chris Koopman and me, writing at U.S. News and World Report. We have a new report on the regulatory barriers to craft brewing in Virginia. Here is an excerpt:

In aggregate, the number of regulatory procedures that we identify (12), the wait times to complete many of these procedures (in excess of 100 days), and the associated costs (e.g., $2,150 for a single license) represent formidable barriers to entry. All of these barriers are in addition to the standard regulatory hurdles that all small businesses must surmount (zoning ordinances, incorporations rules, and tax compliance costs). This means that starting a microbrewery in the state of Virginia requires as many procedures as starting a small business in China or Venezuela, countries notorious for their excessive barriers to entry.

I was astounded to learn that, among other reasons, the state may deny a license if regulators feel that the brewer is “physically unable to carry on the business,” is unable to “speak, understand, read and write the English language in a reasonably satisfactory manner” or if they feel that there are already too many brewers in a particular locality. You can read our new report here.

The “pension tapeworm” and Fiscal Federalism

In his annual report to shareholders, Warren Buffett cites the role that pension underfunding is playing in governments and markets:

“Citizens and public officials typically under-appreciated the gigantic financial tapeworm that was born when promises were made. During the next decade, you will read a lot of news –- bad news -– about public pension plans.”

He zones in on pension mathematics – “a mystery to most Americans” – as a possible reason for accelerating liabilities facing state and local governments including Puerto Rico, Detroit, New Jersey and Illinois. I might go further and state that pension mathematics remains a mystery to those with responsibility for, or interest in, these systems. It’s the number one reason why reforms have been halting and inadequate to meet the magnitude of the problem. But as has been mentioned on this blog before: the accounting will eventually catch up with the economics.

What that means is unrelenting pressure building in municipal budgets including major cities. MSN Money suggests the possibility of bankruptcy for Los Angeles, Chicago and New York City based on their growing health care and pension liabilities.

In the context of this recent news and open talk of big municipal bankruptcy, I found an interesting analysis by Paul E. Peterson and Daniel J. Nadler in “The Global Debt Crisis Haunting U.S. and European Federalism.”(Brookings Institution Press, 2014).

In their article, “Competitive Federalism Under Pressure,” they find a positive correlation between investors’ perception of default risk on state bonds and the unionization rate of the public sector workforce. While cautioning that there is much more at work influencing investors’ views, I think their findings are worth mentioning since one of the biggest obstacles to pension reform has been the reluctance of interested parties to confront the (actual) numbers.

More precisely, it leads to a situation like the one now being sorted out in federal bankruptcy court in Detroit. Pensioners have been told by Emergency Manager Kevyn Orr that if they are willing to enter into a “timely settlement” with the city and state, they may see their pensions reduced by less than the 10 to 30 percent now suggested. Meanwhile bondholders are looking at a haircut of up to 80 percent.

If this outcome holds for Detroit, then Peterson and Nadler’s findings help to illuminate the importance of collective bargaining rules on the structure of American federalism by changing the “rules of the game” in state and local finances. The big question for other cities and creditors: How will Detroit’s treatment of pensions versus bonds affect investors’ perception of credit risk in the municipal debt market?

But there are even bigger implications. It is the scenario of multiple (and major) municipal bankruptcies that might lead to federalism-altering policy interventions, Peterson and Nadler conclude their analysis with this observation:

[public sector] Collective bargaining has, “magnified the risk of state sovereign defaults, complicated the resolution of deficit problems that provoke such crises, heightened the likelihood of a federal intervention if such crises materializes, and set the conditions for a transformation of the country’s federal system.”

When Regulatory Agencies Ignore Comments from the Public

A few days ago, the Department of Energy (DOE) finalized a rule setting energy efficiency standards for metal halide lamp fixtures. Last October I wrote a public interest comment to the DOE to point out several problems with the agency’s preliminary economic analysis for the rule. As part of the Administrative Procedure Act, agencies are required to solicit, and respond to, comments from the public before finalizing regulations. Unfortunately, the DOE failed to even acknowledge many of the points I made in my submission.

As evidence, here are some of the main takeaways from my comment:

1)      The DOE claims consumers and businesses are acting in an irrational manner when purchasing metal halide lamp fixtures because they forgo modest long term energy savings in order to pay a low upfront price for lamp fixtures. Yet the agency offers no convincing evidence to support the theory that consumers act irrationally when purchasing metal halide lamp fixtures. At the same time, roughly 70% of the estimated benefits of the rule are the supposed benefits bestowed upon the public when products people would purchase otherwise are removed from the market.

2)      The DOE is currently adding together costs and benefits that occur in the future but that are discounted to present value using different discount rates. It makes no sense to add together costs and benefits calculated in this manner.

3)      The DOE is using a new value of the Social Cost of Carbon (SCC), a way to measure benefits from reducing carbon dioxide emissions, that may be of questionable validity since the analysts who arrived at the estimate ignored recent scientific evidence. Additionally, the DOE is using the new SCC in its analysis before the public has even had a chance to comment on the validity of the new number.

4)      In its analysis, the DOE is including benefits to foreign countries as a result of reduced carbon dioxide emissions, even while the costs of the metal halide lamp fixture regulation will be borne largely by Americans.

Regarding #1 above, the DOE provided no direct response to my comment in the preamble to its final rule. This even though #1 puts in doubt roughly 70% of the estimated benefits of the rule.

The DOE also failed to respond to #2 above, even though I cited as support a very recent and relevant paper on the subject that appeared in a reputable journal and was coauthored by Nobel laureate Kenneth Arrow.

Regarding #3 and #4, the DOE had this to say:

On November 26, 2013, the Office of Management and Budget (OMB) announced minor technical corrections to the 2013 SCC values and a new opportunity for public comment on the revised Technical Support Document underlying the SCC estimates. Comments regarding the underlying science and potential precedential effect of the SCC estimates resulting from the interagency process should be directed to that process. See 78 FR 70586. Additionally, several current rulemakings also use the 2013 SCC values and the public is welcome to comment on the values as applied in those rulemakings just as the public was welcome to comment on the use and application of the 2010 SCC values in the many rules that were published using those values in the past three years.

In other words, the DOE is committed to continuing to use a value of the SCC that may be flawed since the public has the opportunity to complain to the Office of Management and Budget. At the same time, the DOE tells us we can comment on other regulations that use the new SCC value, so that should reassure anyone whose comment the DOE ignored related to this regulation!

All of this is especially troubling since the DOE is required by statute to ensure its energy efficiency rules are “economically justifiable.” It is hard to argue this rule is economically justifiable when roughly 94% of the rule’s benefits are in doubt. This is the proportion of benefits justified on the basis of consumer irrationality and on the basis that Americans should be paying for benefits that will be captured by citizens in other countries. Without these benefits, the rule fails a benefit-cost test according to the DOE’s own estimates.

The requirement that agencies respond to public comments is designed to ensure a level of democratic accountability from regulators, who are tasked with serving the American public. A vast amount of power is vested in these agencies, who are largely insulated from Congressional oversight. As evidence, Congress has only used its Congressional Review Act authority to overrule major regulations once in its history. If agencies ignore the public, and face little oversight from Congress, what faith can we have that regulators will be held accountable for any harms that inevitably arise from poorly designed regulations?

Environmental Injustice at the EPA

This past week, the EPA’s science advisory board held a public hearing on efforts to measure the “environmental justice” (EJ) impacts of EPA rules. EJ refers to adverse human health and environmental effects of government policies on minority and low income populations in the US. The EPA has released draft guidance to agency analysts who measure these effects, and this hearing was intended to find ways to improve the guidance before it is finalized.

While holding a public hearing is a sign that the EPA is committed to getting this issue right, significant improvements need to be made to the EJ guidance if the EPA does not want the entire EJ project to backfire. Specifically, closer attention should be paid to the costs EPA rules impose on low income and minority populations. Further, improvements in the transparency of agency procedures will help ensure that those with modest incomes are allowed to participate in decisions that will have significant impacts on their health and well-being.

Currently, the EPA is focusing far more on the benefits of its rules to low income and minority groups than on the costs. As evidence, the 81-page draft guidance document contains only two pages related to costs of EPA regulations. In those two pages, the agency argues that costs are often not relevant to environmental justice issues, saying:

Consideration of the distribution of costs in the context of EJ is not always necessary. Often the costs of regulation are passed onto consumers as higher prices that are spread fairly evenly across many households.

This is a striking statement because regulatory costs are regressive exactly in the instances that the EPA describes in this statement. Any time costs of a policy are spread evenly across all citizens, the dollar amount paid to implement a regulation consumes a larger percentage of a poor person’s income than a wealthy person’s income. This is precisely why sales taxes are regressive.

Additionally, as incomes fall due to the costs imposed on citizens complying with regulations, people have fewer resources available to use toward risk reduction and outlays related to improving health. Meanwhile, there is evidence that private risk reduction can be much more effective than public methods of risk reduction, especially when regulations are addressing very small risks that are dwarfed by the other risks individuals face in their everyday lives.

A step in the right direction would be to ask analysts to identify the distribution of costs of EPA regulations, especially for rules that increase the prices of products that EJ populations purchase (e.g. rent, fuel, food, electricity).

Another important component of EJ is to gather meaningful feedback from low income and minority persons before implementing policies. The notice announcing last week’s public hearing was published in the Federal Register on Christmas Eve, making it unlikely that many in the EJ community, especially those with little political influence and low alertness to EPA actions, will even be aware this hearing is taking place, let alone will participate in the event.

If the EPA’s science advisory board is truly committed to improving the lot of the less well-off, it should tell the EPA to do more to measure the costs of environmental rules on low income and minority persons, and to improve transparency of agency procedures so those with less political clout can participate equally in the democratic process.

Markets Fail and Governments Do Too

We often hear that markets fail when it comes to preserving the environment, so government regulation is needed to protect natural resources from the ravages of capitalism. But what happens when government regulations themselves get in the way of innovative ideas that move us towards a cleaner and more environmentally sustainable future?

This is exactly what happened in Logan City, Utah when the local government built a small hydropower turbine and ran into a nightmare of regulatory red tape that led to large cost overruns and far more time committed to the project than was originally anticipated. In the end, the project was delayed four years and ended up costing twice as much as planned.

This abstract from a recent working paper from the Mercatus Center describes what happened:

In 2004 Logan, Utah, saw the opportunity to place a turbine within the city’s culinary water system. The turbine would reduce excess water pressure and would generate clean, low-cost electricity for the city’s residents. Federal funding was available, and the city qualified for a grant under the American Recovery and Reinvestment Act. Unfortunately, Logan City found that a complex and costly federal nexus of regulatory requirements must be met before any hydropower project can be licensed with the Federal Energy Regulatory Commission. This regulation drove up costs in terms of time and money and, as a result, Logan City is not planning to undertake any similar projects in the future. Other cities have had similar experiences to Logan’s, and we briefly explore these as well. We find that regulation is likely deterring the development of small hydropower potential across the United States, and that reform is warranted.

This wouldn’t be the first time that regulations have led to perverse environmental outcomes. To prevent these problems in the future, agencies need to take better account of the expected costs and benefits of their rules before finalizing them. For example, recent analysis by myself and my colleague Richard Williams shows that agencies only rarely estimate dollar values for both benefits and costs of their regulations.

Another improvement would be for agencies to consider more flexible approaches when regulating. For example, the Occupational Safety and Health Administration recently proposed a rule to reduce silica exposure for workers. The rule requires businesses to consider gas masks or other personal protection equipment only as a last resort. Other methods of controlling silica dust, like enclosing work areas or using sprays and vacuums, should be considered first. These methods are likely to be more burdensome than asking workers to wear a gas mask. The agency should consider offering more flexibility to businesses and workers if it wants to relieve some unnecessary burden in its proposed rule.

Of course it’s true that markets can fail. But it’s important to remember that governments often fail too. Only an approach that considers both market failure and government failure can illuminate the best course of action when addressing a serious social problem like environmental degradation. Furthermore, until regulators start acting more like the experts we expect them to be, government is likely to fail just as much, if not more often, than markets.

Energy Efficiency as Foreign Aid?

A recent suite of energy efficiency regulations issued by the Department of Energy (DOE) have been criticized due to the DOE’s claim that consumers and businesses are behaving irrationally when purchasing appliances and other energy using devises. The Department believes it is bestowing benefits on society by “correcting” these faulty decisions. Mercatus Center scholars have written about this extensively here, here, and here.

However, even if we set aside the Department’s claims of consumer and business “irrationality,” a separate rationale for these regulations is also very problematic. The vast majority of the environmental benefits of these rules stem from reductions in CO2 emissions due to lower emissions from power plants. However, in a 2010 report, the US government estimated only 7 to 23 percent of these benefits will be captured by Americans. The rest will go to people in other countries.

Here’s a recent example. In August, the DOE proposed a rule setting energy efficiency standards for metal halide lamp fixtures. In the agency’s analysis, it estimated total benefits from CO2 emission reductions at $1,532 million. Using the more optimistic estimate of the percentage of CO2 related benefits going to the US citizens (23%), Americans should capture about $450 million in environmental benefits from the rule (once we include benefits from reductions in NOx emissions as well). At the same time, the DOE estimates the rule will cost $1,294 million, much of which will be paid by American consumers and businesses. How can the DOE, which is tasked with serving the American public, support such a policy?

One might argue America is imposing costs on the rest of the world with its carbon emissions, and therefore should pay a type of tax to internalize this external cost we impose on others. However, the rest of the world is also imposing costs on us. In fact, US emissions are actually in decline, while global emissions are on the rise.

Even if we assume it is a sensible policy for Americans to compensate other countries for our carbon emissions, is paying for more expensive products like household appliances the best way to accomplish this goal? Given that no amount of carbon dioxide emission reductions in the US will do much of anything to reduce anticipated global warming, wouldn’t the rest of the world be better off with resources to adapt to climate change, instead of (at best) the warm feeling they might get from knowing Americans are buying more expensive microwave ovens? A more efficient policy would be a cash transfer to other countries, or the US could create a fund the purpose of which would be to help other countries adapt to climate change.

Energy efficiency regulations from the DOE are already difficult enough to justify. Knowing they are really just a roundabout form of foreign aid makes these rules look even less sensible.

Maryland’s “severe financial management issues”

Budgetary balance continues to evade Maryland. In FY 2015 the state anticipates a deficit of $400 million. A fact that is being blaming on entitlements, mandated spending, and fiscal mismanagement in the Developmental Disabilities Administration. The agency has been cited by the HHS Inspector General as over billing the Federal government by $20.6 billion for Medicaid expenses.

For over a decade the state has struggled with structural deficits, or,  spending exceeding revenues. The state’s method of controlling spending – the Spending Affordability Commission – has overseen 30 years of spending increases, and its Debt Affordability Commission has compounded the problem by increasing the state’s debt limits in order to expand spending.

For the details, visit my blog post for the Maryland Public Policy Institute. Of related interest is the Tax Foundation’s recent ranking of government spending the states. Maryland ranks 19, and has increased spending by 30.5% since 2011  2001.

The Precautionary Principle vs. Glow in the Dark Plants


In “The Croods,” a box office hit cartoon showing a family of cavemen, the father issues daily warnings to his family that everything new is bad. He explains to his inquisitive daughter that they have survived for so long in their dangerous world by doing exactly the same thing every day and eschewing innovation. In our times, we would call his approach “the precautionary principle.”

The precautionary principle was on display when environmental activists petitioned a startup fundraiser Kickstarter to shut down the Glowing Plant Project, calling it “a new biotech threat coming from Silicon Valley.”  As its name suggests, the project aims to create plants that will glow in the dark using synthetic biology. And while the idea may sound like a fad, it may have practical applications, e.g. living streetlights that would use their own energy to illuminate our cities.

Under pressure, Kickstarter amended its rules to ban startups from rewarding their donors with genetically modified products. The environmental activists further called on the regulators to subject similar projects to independent risk assessments. So far various agencies claimed that the issue is outside their jurisdiction.

The idea of making organisms glow is not new. A few years ago, FDA certified that there was no evidence that the Glofish, produced using similar technology, “pose any more threat to the environment than their unmodified counterparts.” But this will hardly satisfy the environmental groups who believe synthetic biology poses a major threat to conservation and sustainability of biological diversity.

There is logic to the precautionary principle. Innovation can and often does bring new risks. There were no driving related fatalities before the invention of cars and certainly fewer greenhouse gas emissions. And it would take a lightening strike to get a fatal electric shock before the invention of powerful electricity generators. Cars, electricity, vaccines and many other innovations came with substantial risks. But just imagine how riskier and poorer the world would be if we had used a precautionary principle to stifle innovation in those technologies.

My colleague Adam Thierer writes in his recent law review article:

New technologies help society address problems that are associated with older technologies and practices, but also carry risks of their own. A new drug, for example, might cure an old malady while also having side effects. We accept such risks because they typically pale in comparison with the diseases new medicines help to cure. While every technology, new or old, has some risks associated with it, new technologies almost always make us safer, healthier, and smarter, because through constant experimentation we discover better ways of doing things.

He further notes:

The precautionary principle destroys social and economic dynamism. It stifles experimentation and the resulting opportunities for learning and innovation. While some steps to anticipate or to control unforeseen circumstances and “to plan for the worse” are sensible, going overboard with precaution forecloses opportunities and experiences that offer valuable lessons for individuals and society.

So take it from the Croods – if we didn’t take risks and innovate, we’d still be living in caves.

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. 

Why a shutdown threat won’t work

There are many people who think that the Affordable Care Act (ACA) is bad policy. I am among them. There are also many who think that the current trajectory of government spending is unsustainable and economically harmful. I am also among them.

Then there are people who think it would be wise to shut down the federal government if they can’t get language passed that threatens to defund the ACA. (Notice that I didn’t say language that “defunds the ACA”; I said language that “threatens to defund the ACA.” Much of the ACA is actually funded through mandatory spending so Congress would need to pass a full repeal of the bill to defund it. What these folks want is language in the budget resolution saying that the ACA ought to be defunded. The bill might strip out some discretionary funding but most of the ACA would go forward.)

I am not among them.

To help us think through the options, let’s borrow from game theory and employ a decision tree. The House (H) can either choose to pass a continuing resolution (CR) that funds the ACA or a CR that calls for de-funding the ACA. The Senate (S) can choose to pass whatever the House sends them or to reject it. If they reject it, and no CR is passed by October 1, the federal government will shut down. In this case, as the CRS puts it, “substantial ACA implementation might continue during a lapse in annual appropriations that resulted in a temporary government shutdown.” If the Senate passes whatever the House sends them, then it will go to the President (P) who can either sign it or veto it.

At the end you can see the outcomes and the way that each group feels about them.

Options are happy, sad, neutral, and outwardly sad but secretly happy. (click on the images to enlarge):

decision tree

 To figure out the most likely outcome (the “equilibrium”) you do a fancy thing called “backwards induction.” It is actually quite simple: think about how each player would act at each stage, starting at the end of the game, and cross off implausible actions. This will help you eliminate unlikely outcomes. This is what I’ve done below, with dashed lines indicating an action that a particular player is unlikely to take.  

We can with confidence cross off the possibility that the President will veto a CR that keeps the government open and fully funds his signature initiative or that the Senate would reject such a bill.

We can also cross off the possibility that the President would sign or that the Senate would send him something that calls for defunding his signature initiative.

That leaves us with two plausible scenarios: the House doesn’t use the CR as a means to attack the ACA, the CR passes the Senate, and the President signs it. This is the top branch of the game tree. House Republicans will be neutral about this outcome since they will have escaped blame for a shutdown but will have done nothing to stop the ACA. Senate Democrats and the White House will be pleased.

The other somewhat plausible scenario is that the House passes a CR calling to defund the ACA, and the Senate rejects it. The government would shut down and the ACA would mostly be untouched. I’m guessing Republicans would get most of the blame for shutting down the government since they lack a bully pulpit, aren’t as gifted as the president at communicating, and the ideological stereotype is that Republicans would like to see the government shut down any way. The White House and Senate Democrats will be outraged—simply outraged—that Republicans would do this but they will secretly be happy to have one more reason to say Republicans should never be trusted with power.

If Republicans see all of this, they will likely flinch, hold their noses, and pass a CR that doesn’t touch the ACA and hopefully come up with more constructive ways to challenge the policy. But, it is a close call for some House Republicans so for this reason, I’ve only partially crossed off the first bottom fork of the decision tree. decision tree 2

What the tree doesn’t indicate is the long run consequences of a government shutdown. Two and a half years ago, when Washington was staring down a different government shutdown, I drew from the experience of U.S. states to conclude that a shutdown is not in the interest of those who advocate for limited government:

As is often the case, we can look to the American states for some guidance. It turns out that in 23 U.S. states, the government will automatically shut down in the event that the governor and the legislature fail to agree on a budget. In his work on budget rulesDavid Primo examined the theoretical impact of these provisions from a game theoretic perspective. He noted that in states with an automatic shutdown provision, “the legislature will be able to achieve its ideal budget, so long as the governor prefers it to no spending.” (p. 102)

He therefore predicted that states with such a provision will spend more than states without such a rule. He then tested the hypothesis, controlling for a number of other factors known to impact state spending and found that states with an automatic shutdown provision actually spend about $64 more per capita than other states. As he notes, “This effect is remarkably large, given that shutdowns occur rarely.” (p. 103)

This suggests that the federal government’s automatic shutdown provision—by making Congress’s desired spending level a take-it-or-leave-it offer—tends to bias the government toward more spending. By extension, it also suggests that a government shutdown will shift negotiating power toward those who favor more spending. So, paradoxically, fiscally conservative tea partiers stand to lose the most if the federal government shuts down.

Perhaps it is time for them to rethink their support of a shutdown.