A Task for Trump's OMB Director: Regulatory Reform
The current OMB guidelines for regulatory analysis are strong, but they are old. This may be a reason why agencies are starting to violate them.
Today the Senate Budget Committee is holding a confirmation hearing on the nomination of Rep. Mick Mulvaney (R-SC) for director of the Office of Management and Budget (OMB) in the Trump administration. The OMB is perhaps best known for its role in helping the president prepare his annual budget request to Congress; less well known is the agency’s important role in shaping regulation.
More specifically, the OMB writes guidelines for how regulatory agencies analyze the economic impacts of their largest rules. The current guidelines, known as Circular A-4, were published in 2003. While this document remains very strong in most respects, certain aspects need updating. If confirmed, Mr. Mulvaney would be wise to consider producing new guidance for those areas where Circular A-4 is outdated and better enforcing those areas where the current guidelines have stood the test of time but agency economic analysis nevertheless fails to comply with that guidance.
One area where OMB guidelines could be reexamined concerns the social discount rate used in regulatory analysis. The social discount rate is the interest rate used to calculate the present value of the benefits and costs of regulations. Because these benefits and costs generally occur across different spans of time, they are discounted in analysis in order to compare them in an apples-to-apples manner.
As I explain in a recent paper for the Mercatus Center, the purpose of the social discount rate is to compare a world in which a regulation is enacted with one in which the regulation is not. Thus the proper discount rate is something akin to the rate of return resources would earn if left in the private market. Ignoring this rate of return and using lower discount rates actually neglects the welfare of future generations who might be made better off by leaving resources under private — rather than public — control.
OMB’s current guidance recommends a base-case discount rate of 7 percent. This is the default rate the OMB says agency analysts should use. But agencies are beginning to violate this guidance in a myriad of ways. For some benefits, the present value is never calculated using a 7 percent rate. This has led to cases — most often with energy and fuel efficiency regulations — where benefits calculated at 7 percent are added together with other benefits calculated at different discount rates. Most economists would agree this practice is inappropriate. There is also movement towards using lower discount rates than those recommended by the OMB.
There seems to be some confusion among economists as to why discounting is even necessary for regulatory analysis in this first place. Unfortunately, the current OMB guidelines have likely exacerbated this problem by failing to distinguish between individual discount rates and social discount rates. One rationale OMB offers for discounting is because individuals are impatient and prefer to consume goods and services sooner rather than later. Another rationale is because individuals in the future will be richer than individuals living today — due to economic growth — and so each additional dollar matters a little bit less as a person grows wealthier.
Both of these rationales for discounting are problematic, however, when it comes to regulatory analysis. The problem ultimately lies in confusing individual and societal values. While an individual person might be impatient, this does not mean society shares the same impatience. Will future generations prefer that the benefits of regulations arrive before they are born? Presumably not, in many cases. Although they should prefer economic growth occur as early as possible — even before birth. Nor is it possible to compare the pleasure one gains from a dollar to the pleasure his or her grandchildren will gain from a dollar. These kinds of comparisons involve mind reading.
My analysis finds that a social discount rate of about 7 percent appears to be reasonable, which is in line with current OMB guidelines. A similar study recently recommended 8 percent for advanced countries. As a result, there is probably no need to update drastically OMB’s recommended base-case discount rate used by agencies — 7 or 8 percent is about right.
What is needed, rather, is better enforcement of this discount rate so that the bad habits agencies are developing do not become ingrained. OMB should also make it a priority to explain to agencies, perhaps in new guidance, the purpose of the social discount rate, as well as how this discount rate differs from the discount rates observed in individuals.
The current OMB guidelines for regulatory analysis are strong, but they are old. This may be a reason why agencies are starting to violate them. Some parts of Circular A-4 need updating; other parts just need to be better enforced. Making sure regulators have a clear understanding of the social discount rate and its role in analysis should be a priority for the OMB in the new administration.