Recently, the Office of Management and Budget published new procedures for evaluating government regulation (Circular A-4) and economic policy (Circular A-94). What’s unique about this guide is that it weights the benefits and costs of new regulations and policies based on the income of those affected. The aim is to help reduce inequality. Costs and benefits incurred by low-income people are given greater weight; those that benefit high-income people are given less weight.
An article by Viscusi et al. (2024) explains what this policy is and the challenges it poses. First, Viscusi explains that the directive provides for an explicit weighting of policies by income group using the following formula:
How does this formula affect the weight we place on benefits and costs to different groups? If we assume that the average income in the United States is $75,000, then the value of costs and benefits for someone making $25,000 is weighted 4.7 times as much as for the average person; Someone making $400,000 has a weight 90% lower than the average person.
At first glance this seems like a sensible policy; Reducing inequality is a laudable policy goal. However, these weights can also lead to inefficient policies. For example, imagine the case where every person in society owns a house whose value is equal to their income. In this case, the income weights mean that richer people’s homes are downweighted. But we also come to a strange conclusion. As Visculsi writes:
Somewhat paradoxically, at higher income levels, market property values increase while weighted property values decrease.
One can see this from the table above, where a $25,000 home has a value of $116,000, but a $1,000,000 home has a weighted value of only $26,613. This can lead to the strange scenario that a disaster protection policy could only be implemented if it were applied to protect less valuable homes and not to protect more valuable homes. While this may seem acceptable at first glance – rich people might buy their own insurance – it still leads to inefficient policies.
Consider the case where policymakers considered a dam to reduce flooding. Let’s assume the seawall costs $1,000 per home to build and the risk of flooding is 1%. If this were in a poor area – where all houses cost $25,000 – it would not be worth building the wall using a standard OMB calculation because the expected losses are only $250 (i.e. $25,000). Dollars x 1% = $250). However, with the new weighting scheme, $25,000 homes are worth $116,000, so OMB would say they should build them ($116,000 x 1% = $1,116 > $1,000). However, if redistribution were the goal, giving poor homeowners $1,000 would be more effective than building a dam worth only $250 per home.
Overall, the Viscusi paper comes to six conclusions:
- Quantitative distribution weights created. The OMB approach creates explicit and operational distribution weights.
- Big impact. Viscusi believes that “the weights will have a profound impact on benefit-cost analyses.”
- Inefficient. Viscusi believes that “the application of OMB weights is potentially very inefficient.” One reason for this is that income is heavily skewed to the right; One reason is that there may be more efficient mechanisms for reducing income inequality.
- Grouping is important. How important the OMB Group Policies will be. If there is a city that has half poor and half rich neighborhoods, the cost-benefit ratio will be weighted higher for poor neighborhoods and lower for rich neighborhoods. If another city also had half-poor and half-rich people, but they lived next to each other, people in that mixed city would not benefit as much from the OMB approach because OMB could not separate policies by income since all neighborhoods are one have mixed income.
- Mortality risks. OMB excludes health benefits and risks from the inequality weighting process. However, if these were applied to reducing health risks, the lives of low-income individuals would explicitly be valued much more highly than those of high-income individuals.
- Interaction with other policies. Viscusi notes that there is “no discussion about how the weights will interact with other progressive elements of administration policy.”
I encourage you to read the full article here.