Recently, the Office of Management and Budget has published new procedures for evaluating government regulation (Circular A-4) and economic policies (Circular A-94). What is unique about this guide is that it weighs the benefits and costs of new regulations and policies based on the income of those affected. The goal is to help reduce inequality. The costs and benefits that correspond to low-income people are weighted more; those that correspond to high-income people have less weight.
an article from Viscusi et al. (2024) explains what this policy consists of and some of its challenges. First, Viscusi explains that the policy assigns explicit weights to policies by income group using the following formula:
So how does this formula impact the weight we give to benefits and costs for different groups? Well, if we assume that the median income in the United States is $75,000, then the value of the costs and benefits for someone earning $25,000 weighs 4.7 times more than that of a median person; Someone who earns $400,000 weighs 90% less than the average person.
At first glance, this may seem like a reasonable policy; Reducing inequality is a laudable policy goal. However, these weights can also create inefficient policies. For example, consider the case where each person in society owns a house whose value is equal to his income. In this case, income weights mean that the homes of the wealthiest people are weighted downward. But we also get a strange result. As Visculsi writes:
Somewhat paradoxically, market home values rise at higher income levels, but weighted home values fall.
You can see this in the table above, where a $25,000 home is valued at $116,000 but a $1,000,000 home has a weighted value of only $26,613. This can lead to the strange scenario where a protection policy Disaster protection could be enacted only if it were applied to protect lower-value homes rather than higher-value homes. While this may seem acceptable at first glance (the rich could perhaps buy their own insurance), it creates inefficient policies.
Consider the case where policymakers were considering building a seawall to reduce flooding. Let’s say building the seawall costs $1,000 per house and the flood risk is 1%. If this were in a poor area, where all homes cost $25,000, it would not be worth building the wall based on a standard OMB calculation because the expected losses are only $250 (i.e., $25,000 x 1% = $250). However, with the new weighting scheme, $25,000 homes are worth $116,000, so the OMB would say they should be built ($116,000 x 1% = $1,116 > $1,000). However, if the goal were redistribution, it would be more effective to give poor homeowners $1,000 rather than installing a sea wall that only costs $250 per house.
Overall, Viscusi’s article reaches six conclusions:
- Created quantitative distributional weights. The OMB approach creates explicit and operational distributional weights.
- Great impact. Viscusi believes that “weightings will have profound effects on cost-benefit analyses”
- Inefficient. Viscusi believes that “the application of OMB weights is potentially very inefficient.” Part of the reason is that income is heavily skewed to the right; Part of the reason is that there may be more efficient mechanisms to reduce income inequality.
- Grouping matters. How the policies of the OMB groups will matter. If there is a city that has half poor and half rich neighborhoods, the cost-benefit will increase for the poor neighborhoods and decrease for the rich neighborhoods. If another city also has half poor and half rich individuals but the individuals live next to each other, the individuals in this mixed city would not benefit as much from the OMB approach because the OMB would not be able to segregate the policy by income since all neighborhoods are mixed income.
- Mortality risks. The OMB excludes health benefits and risks from the inequality weighting procedure. However, if these were applied to reduce health risks, they would explicitly value the lives of low-income people much more than those of high-income people.
- Interaction with other policies. Viscusi notes that “there is no discussion about how the pesos will interact with other progressive elements of the administration’s policy.”
I encourage you to read the full article. here.
