Regulations should be judged at the margins

Yesterday, the President signed an executive order directing federal agencies to repeal two regulations for every new one they adopt. The response has been predictable. Supporters praise it for potentially stemming the tide of federal regulations. Critics assert that it is a dire threat to our lives, air and water, and everything else we hold dear.

I suspect that the truth lies somewhere in the middle. The general thrust of the executive order—reducing regulations and giving agencies an incentive to internalize regulatory costs—is a good one. There are an incomprehensible number of obscure federal regulations controlling most everything we do and, even though we can’t possibly know them all, subjecting us to criminal punishment should we run afoul of them.

Prior presidents have tried to rein in the vast administrative state by requiring agencies to engage in cost-benefit analysis for new regulations. This reform, since confirmed by the Supreme Court as a core principle of administrative law, has been of limited effectiveness. Unfortunately, there are many ways for bureaucrats to deflate cost estimates and inflate benefits. Call it the Enron-style of regulatory accounting. Perhaps the best example is the new source rule for power plants. This regulation effectively precludes the construction of any new coal-fired power plants. Yet the EPA boldly predicted that the regulation would have neither costs nor benefits.

The new executive order builds on the prior approach by requiring agencies to identify two regulations to repeal for every new one. It also fixes an overall budget for each agency’s regulatory costs. The compliance costs of any new regulation will have to be offset by the costs avoided by the repealed regulations.

Although this may improve things in the short term, the executive order is a poor approach to long-term regulatory reform. The basic problem with both the executive order and the arguments of its opponents is that they focus on overall costs when marginal costs (and benefits) are the key thing. Take, for instance, this criticism of the executive order:

There is no question that our regulatory system, over all, benefits Americans immensely. Federal regulations keep our air clean, our water drinkable, our workplaces safe, and our access to energy reliable. Government estimates have routinely shown (in the administrations of both parties) that the combined benefits of major regulations far outstrip the costs. An arbitrary cap on future rulemaking would deprive us of many necessary protections and of even more net benefits.

This is a dreadful approach to measuring the costs and benefits of a regulation. It is a basic principle of economics that we must think in terms of marginal costs and benefits. The question, in other words, is how costs and benefits compare when you marginally increase or decrease regulation.

costcurve_-_marginal_cost

Usually, the first ton of pollution reduced is rather cheap and extremely beneficial. But the last is another story entirely.  Suppose the first ton of reduction costs $10 and returns $100 in benefits. The second ton costs $20 and returns $75. The third costs $50 and returns $50. And the fourth costs $100 and returns $10. In this scenario, a limit should be set to reduce emissions by 3 tons. That’s the point where the marginal costs and benefits are equal. Going further would be a net harm, purchasing $10 in benefits for $100. However, if you mistakenly compared overall benefits, a reduction of 4 tons seems perfectly reasonable—it achieves $235 in benefits for only $180 in costs. But this obscures the fact that the standard is foolishly set at an overly burdensome level.

Critics of the executive order and agencies operating under the prior policy miss this critical point. Unfortunately, the new executive order does nothing to shift the focus towards marginal costs and benefits. It may even make things worse in the long term, by doubling down on the overall costs approach while eschewing consideration of benefits entirely.

For instance, the executive order appears to require agencies to wholly repeal regulations, rather than lessening them to the marginally beneficial point, in order to adopt new ones. This would put agencies to a Sophie’s choice, requiring them to eliminate two overly burdensome regulations to adopt a new beneficial one when the best result may be to relax but retain all three.

The prospect of deregulation, and the expansion in liberty that will entail, is a cause for optimism. I suspect the initial repeals will be significantly positive, as agencies have every incentive to pick the low-hanging fruit first (that is, unless bureaucrats attempt to undermine a President they dislike by intentionally choosing repeals unwisely). But for sustained regulatory reform, we need to fix the process by requiring agencies to justify regulations at the margin rather than on the whole.

3 thoughts on “Regulations should be judged at the margins

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s