Introduction to a Symposium on Regulatory Budgeting

By Fred Thompson & Murray Weidenbaum

The extent of government regulation of business in America has reached record levels according to the Center for the Study of American Business (1997). This conclusion is based on two measures: the cost of operating the federal regulatory apparatus and the number of people employed by it. They show [see Figure 1] that:

FIGURE 1

This would be a matter of little concern if we believed that the benefits of government regulation of business in America always justified its costs. Unfortunately, that is not the case. Regulation usually costs a lot, it often does little good (Committee for Economic Development, 1998).

Proposed Reforms

The interesting question is not whether government regulation is flawed, but how it could be improved? The last few years have witnessed renewed interest in procedural reform.

The 103d Congress, in the Job Creation and Wage Enhancement Act of 1995, proposed to fix regulation by requiring all new rules costing more than $25 million to be subjected to a rigorous benefit-cost analysis. Mandatory benefit-cost analysis cropped up again in the flagship regulatory reform bill proposed during the 104th Congress, the Risk Assessment and Cost-Benefit Act, H.R. 1022. H.R. 1022 passed the House on a 286-to-141 vote, but it was strongly opposed by the Clinton administration.

For over twenty years the Executive Branch has required mandatory benefit-cost analysis of all new significant, substantive federal rules issued by agencies under the President's jurisdiction (Thompson & Jones, 1980). This policy was reiterated by President Clinton's Executive Order #12,866. What was contentious about H.R. 1022 was not the concept, but the enforceability of benefit-cost analysis. The Clinton administration wanted to retain agency discretion, allowing rules to stand as long as the analyses showing that benefits justified costs were not "arbitrary and capricious, or an abuse of discretion." Many reformers wanted a stronger provision that would have subjected proposed rules to substantive judicial review. When the bill was toned down in the Senate, (S. 343), to meet the Administration's objection, some of its proponents, especially those who wanted benefits to outweigh costs and to subject regulatory analyses to a strict judicial review standard, lost interest in the bill (Shanahan, 1997).

Regulatory Budgeting

The Regulatory Accountability Act, proposed by Representative Lamar Smith (R-Tex.) during the 104th, would have required the president to submit an annual regulatory budget to Congress with estimates of the costs to be imposed by the various programs and agencies. Each year Congress would have had to approve the regulatory budget the same way it approves appropriations. By making explicit the costs of regulation, supporters believed Congress and the executive branch would be pressured to reduce the regulatory burden. The Regulatory Accountability Act never came up for a vote (Shanahan, 1997).

Regulatory Accounting

The Regulatory Accounting Act, passed in the final weeks of the 104th Congress, required the executive branch to produce a one-time report for Congress estimating the total costs of all federal regulations. Moreover, it directed the OMB to report significant public suggestions to correct any part of any regulatory program that is "inefficient, ineffective, or not a sound use of the nation's resources." The initial response by OMB was disappointing (OMB, 1997). It merely conveyed a total of the estimated benefits and costs, compiled by adding up the unevaluated numbers provided by the regulatory agencies themselves. Devoid of any supporting detail by agency or program, the OMB report will have to be expanded in order to provide even the rudimentary basis for a regulatory budget. (A second OMB report is required by September 30, 1998.)

If people are going to give serious consideration to the regulatory budget concept, it must be given tangible form. But better regulatory cost measures make sense whether a regulatory budget is contemplated or not. At a minimum, better cost measures are needed to improve cost estimates. If the numbers used in debates over regulatory proposals were more reliable, they might just possibly be taken more seriously. Right now few people believe them, and for good reason (see Littrell and Thompson, 1997).

How Much Does It Cost?

In the aggregate, the estimated costs of regulation are substantial. The most widely-used compliance cost figures are those reported by Thomas D. Hopkins (this issue) . Hopkins estimated that federal regulation in the U.S. cost about $700 billion per annum (in 1996 $) or $7,000 per household, based on subtotals in four categories: environmental regulation; other social regulation; economic regulation, and process regulation. Much of the costs of "process regulation" relate to "tax paperwork." Hopkins also determined that the annual costs of U.S. federal regulations are higher ($5,500 per employee) for small firms (<20 employees) than larger (>500 employees) firms ($3,000 per employee), although again much of the difference has to do with tax compliance.

At about the same time that Hopkins developed his baseline estimates of the total cost of federal regulation in America, Hahn & Hird (1991) estimated that it cost between $327 billion to $401 billion, or $434 billion to $508 billion if the incremental cost of new regulations enacted in 1990 were included. Their estimates reflect the following categories:

1. Dead-weight losses from Economic Regulation, $46 billion annually

2. Transfers associated with economic regulation, $172 to $210 billion.

Hahn & Hird found that the ratio of transfers to efficiency costs for 15 types of economic regulation ranged from 2 to 1 to 12:1. They used an average of 3 to 1 to estimate efficiency losses.

3. All other regulation, $78 billion to $107 billion.

Unlike Hopkins, Hahn and Hird exclude the paperwork burden induced by the Internal Revenue Code and Federal Acquisition Regulation from their definition of government regulation on the presumption that these costs should be attributed to other governing instruments: spending and taxing, and included in the analysis of those instruments, as is automatically the case with most government spending and is an accepted part of technical tax analysis (see Diewert, Lawrence, and Thompson, 1998).

Hahn and Hird (1991, p. 248) note that "most traditional economic regulations do not yield net economic benefits (only transfers and costs)." Thus, properly measured (i.e., ignoring transfers which are not a social cost) economic regulation "represents a net cost to society." Subtracting transfers from their total and benefits from social regulation, which Hahn and Hird estimated at between $42 billion to $182 billion per annum, they concluded that the net cost of regulation was on the order of $44 billion per annum, which is a lot in absolute terms, but less than one percent of U.S. GDP. This estimate reflects the fact that the first major federal environmental laws, however crude, were very effective. Most dimensions of air and water in most regions have improved substantially since 1970, despite a 30 percent increase in population and a 100 percent increase in economic output.

Unfortunately, most environmental programs approved since 1972 have not been as cost effective, but have led to rapidly increasing costs in the form of private and public expenditures, regulatory uncertainty and delay, and litigation. This predicament is reflected in Resources for the Future's estimates of the costs and benefits of 1990 amendments to the Clear Air Act, which Hahn and Hird later incorporated into their totals. According to Resources for the Future, the 1990 Clean Air Act, which included new regulations governing nonattainment areas, mobile pollution sources, air toxins, acid rain, and stratospheric ozone, would cost an additional $30 billion but produce incremental benefits of only $14 billion, imposing a net drain on the economy of over $15 billion annually.

William Niskanen (1991) responded to the Hahn and Hird study by asking whether the annual net cost of regulation could really be as low as $44 billion. He concluded that the answer is clearly "no" for several reasons, some of which Hahn and Hird acknowledge. The expected costs of disposing of hazardous wastes are excluded from their analysis, as are the costs of endangered species protection, and a variety of workplace standards such as the minimum wage and other wages and hours regulation, the Americans with Disabilities Act, and the Civil Rights Act of 1991. The Hahn and Hird study also does not deal with price and entry controls in the public utilities, finance, insurance and real estate services, radio and TV broadcasting, and professional services industries. They also acknowledged that the political costs of regulation should be included in their estimate. The problem is that there is no widely accepted theory in this area. In principle, "these costs should equal the costs of shifting to and maintaining the new political equilibrium minus the costs of maintaining the old political equilibrium appropriately discounted" (p. 246). Such data are hard to observe, however, and their relative magnitude is uncertain. Consequently, they omitted these costs from their estimate.

Other regulatory costs omitted from consideration by Hahn and Hird, as well as other studies of the aggregate cost of government regulation, are the costs of the liability system administered through the courts (which were estimated at $21 billion in 1987) and various mandatory no-fault compensation schemes such as workers' compensation (whose premiums totaled $31 billion in 1991), about $25 billion per annum after transfers are subtracted (Viscusi, 1995: 20). Against these costs, Viscusi would also set the benefits of accident reduction. The U.S. National Safety Council (Accident Facts, Chicago, 1993, p. 21, cited in Viscusi, 1995: 27) reports that the accidental death rate varied from 14.3 in 100,000 in Hong Kong to 81.2 in Hungary. In the U.S., the accidental death rate was 38.3, almost one-half due to automobile accidents. For Canada, it was 33.3.

The omissions problem is perhaps most clearly explained by Hopkins who notes that his estimate of the aggregate annual cost of federal regulation in the U.S. is "a patchwork quilt of studies and estimates with some important patches missing and others only partial coverage." Moreover these studies vary in their concept of "regulation" and in their definitions, methodology, and quality of data. As Niskanen observed, this conclusion holds a fortiori for Hahn and Hird.

Niskanen also pointed to a study by Dale Jorgenson and Peter Wilcoxen (1990) that suggested that the costs of environmental regulation were four to five times higher than estimated by Hahn and Hird. Jorgenson and Wilcoxen looked at the effects of environmental regulation on thirty-five industry groups and on the total US economy. They found that environmental regulations enacted prior to 1990 reduced the national product by about 2.6 percent and that the 1990 Clean Air Act would reduce it by a further 0.6 percent once its impact was complete. In a $7 trillion economy, 3.1 percent is $225 billion. It should be noted that a general equilibrium model of the US constructed by Hazilla and Kopp (1990), produced similar results. Their model showed large and pervasive impacts from environmental regulation and significant intertemporal effects. Using a similar approach, Gray (1987) also identified significant intertemporal effects from social regulation. He concluded that OSHA and EPA regulation reduced growth in the average manufacturing industry by .44 percent per annum.

Niskanen (1992) concluded from his review of the Hahn and Hird study and the other evidence mentioned here that the upper bound on the net cost of regulation could be as much as $400 billion per annum. Well, maybe.

Aggregate Data Is Not Much Good for Policy Making

Even if we knew what the aggregate compliance cost of regulation was, and the fact is that we can only approximate it in the crudest fashion, that information would not be very useful. What we need is information on individual regulatory programs. Two models are reported here. "In Estimating OSHA Compliance Costs," economist Harvey S. James, Jr. finds that previous studies substantially underestimate the true economic burden of OSHA regulations. His estimates, based on regulatory impact analyses (RIAs) commissioned by OSHA of 25 major rules issued by the agency after 1980, show that manufacturers in 1993 paid an additional $6,300 each year on average per firm for the 25 OSHA regulations established since 1980. James' analysis also reveals that:

James says an important advance in our understanding of the full economic impact of OSHA regulations will come only after a reliable survey of compliance expenditures is established. He suggests a survey similar to the Pollution Abatement and Control Expenditures (PACE) reports produced annually by the Bureau of the Census for the

Environmental Protection Agency (EPA). James concludes that his estimate provides a reasonable basis for establishing a regulatory budget for federally-mandated occupational health and safety regulations.

Do We Need a Regulatory Budget?

The next two articles this issue, Clyde Crews' "Implementing a Regulatory Budget" and Samuel Hughes' "Regulatory Budgeting" explain the basic justification for regulatory budgeting and how a regulatory budget would be implemented. This justification is quite simple, really: government regulation is the economic equivalent of government spending and ought, therefore, to be treated in a similar manner by legislators. Both federal regulations and federal expenditure programs require that resources be devoted to the pursuit of objectives the nation collectively deems worthwhile. The basic difference is that, in the case of federal expenditures, the resources are first collected through taxes (or debt issuance) and then expended directly by the government. In the case of regulation, the government simply orders individuals or firms in the private sector to make the necessary outlays.

Both Crews and Hughes argue that, from this perspective, the need for a centralized process for coordinating regulation to parallel that of expenditures is readily apparent. They also explain how such a mechanism could be established and what it might look like.

Of course, one could treat expenditure and regulation alike by treating them both like regulation. But most people accept that the existing budget process leads to better decisions, in a way that regulatory review does not -- not optimal, or even good decisions, just better ones. According to the late Aaron Wildavsky, the budget process works because it brings spending interests into conflict, thereby forcing elected officials to acknowledge scarcity. This guarantees that budget examiners will have allies among their political masters, making it possible for them to compel spenders and their sponsors to justify their proposals. The adversarial nature of the process also encourages political evaluation of benefits and costs and mutual adjustment on the part of participants (Jones, 1996-1997). Without political allies, all the onus of cutting would fall on budget examiners, who have no real constituencies of their own.

A Regulatory Budget, Not

The final article in this symposium, Roy Meyers' "Regulatory Budgeting: A Bad Idea Whose Time Shouldn't Come," is, therefore, of particular interest. Unlike the other authors featured here, Roy Meyers is not primarily a regulatory policy specialist, but is instead one of America's foremost students of the budgetary process. While Professor Meyers acknowledges the need for regulatory control and that the costs of existing regulations are often extremely high compared to their benefits, he expresses doubt that the current budget process should be emulated. Meyers contends that the budget process is terribly flawed in a number of respects; e.g., distortions created by over reliance on myopic basis of accounting, silly macro goal of a balanced budget, etc. Implicitly, he is saying that advocates of a regulatory budget are like the opera producer who heard one tenor sing so he hired the other one. Since mandatory regulatory review has turned out to be something of a toothless wonder -- a triumph of process over purpose -- regulatory reformers have turned to the budget process, without actually knowing very much about how it actually works -- or how badly.

Meyers argues that the greatest failure of current federal budgeting is that it accepts unjustified rationales for spending. He notes that the Government Performance and Results Act (GPRA) is an attempt to deal with this problem and that the end result could be better budgeting. He suggests that perhaps regulatory decision making is actually ahead of spending budgeting in this regard -- at least the review process expects formal identification and often quantification of supposed benefits.

Meyers grants that the regulatory review process often fails to do this well, perhaps because the numbers don't really "count;" they're not added up and publicized the same way the spending budget does with obligations and outlays. But he insists that there are other reasons for the failures of the current review process. One of them is it's often difficult to define and count regulatory benefits with precision. This is a problem with the spending budget as well.

Meyers optimal solution would be to expand GPRA's forced learning about the relationships between government actions and social outcomes to include other policy tools besides spending. Agencies would set goals, identify performance indicators, measure current performance, and compare to alternative performances expected from using a range of tools, including regulations, tax expenditures, etc. Meyers has found that this kind of analysis exposes weird policy choices in a number of area, including endangered species, safe drinking water, etc. But he also claims that there are policy areas where such comparative analysis often will not lead to significant policy changes -- e.g., housing.

Meyers concludes that he would support collection of information on the compliance cost of regulation; that "we should be concerned about liberty in the regulatory arena, just as we are concerned about the total tax take." But he is not yet convinced that we should be most concerned about compliance cost, which pretty much takes us back to where we started with this.

 

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Fred Thompson is the Grace and Elmer Goudy Professor of Public Management and Policy, Atkinson Graduate School of Management, Willamette University, Salem, Oregon, 97301.

 

Murray Weidenbaum is Chairman of the Center for the Study of American Business and Mallinckrodt Distinguished University Professor at Washington University in St. Louis, St. Louis, Missouri, 63130-4899. He was chairman of the Council of Economic Advisers to President Reagan.