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OMB Papers

Towards a Regulatory Budget:
A Working Paper on the Cost of Federal Regulation (1979)

Jim Tozzi, ed. 1979.


Proposals for a regulatory budget are beginning to be discussed by critics of the current regulatory system. There is a growing recognition that displaying all of the direct and indirect costs of regulation in a single document would be useful in formulating both regulatory and broader economic policy. Such a regulatory budget is analogous to the annual Federal budget, except that costs to the private sector are included along with the government expenditures on regulatory programs.

The fundamental premise of the regulatory budget is that regulation is to a great extent an economic problem. A myriad of national goals are all competing for a share of our limited resources. The dollars spent on passive restraint systems for automobiles could be spent by the government on cancer research, by private citizens on housing, or by anyone on anything from smoke detectors to skateboards. The question is what is the correct size of the regulatory budget—how much of our national income should we devote to regulatory purposes?

Before proceeding, the reader may wonder why regulatory expenditures is a meaningful aggregate. After all, regulations address a wide variety of national objectives and are themselves widely diverse in their characteristics. The principle reason for considering them together is that government must internalize in its decision process the costs it imposes on the private sector. To do this, government must have some idea of the magnitude of the costs it imposes. Regulatory actions, unlike many government actions, are likely to impose costs on the private sector that are a large multiple of their direct Federal budgetary costs. These costs have been largely implicit in regulatory decisionmaking. In fact, decisions have often been made without adequate knowledge of their full cost. It is now coming to be recognized that these costs are significant and that their magnitude have an impact on overall economic performance.

A regulatory budget could be as important as the traditional Federal budget for effective government management. In regulating, there are opportunities to make tradeoffs between costs to the private sector and costs to the government. Regulators are more sensitive to direct government expenditures where they face accountability in the appropriations process than they are to the compliance costs faced by the private sector for which they are not accountable. Regulatory approaches that rely on government imposition of costs rather than government assumption of or accountability for costs could be favored. Just as free disposal encouraged excess emissions into the atmosphere, the absence of a regulatory budget could encourage excess unaccountable costs and excess regulation. Should not government be accountable for all of the costs it imposes?

Policy decisions regarding the regulations now in effect have already been made. Whether these decisions were explicit or implicit (1) the level of total regulatory costs has been imposed; (2) the relative sizes of the various regulatory programs have been decided; (3) the set of regulations within a program has been determined; and (4) the method of control used by each regulation has been decided. Each step implies that alternative costs, programs, and methods were rejected.

These regulatory decisions were made by government in a manner that differs from the market sector. The standard economic analysis of the market sector treats decisionmaking as a simultaneous mess that reaches an outcome costs and activities where marginal costs equal marginal benefits. The process for the government sector is sequential and guided by political and economic forces. The Federal budget process with the President proposing and the Congress enacting an annual budget ceiling starts with item (1) in the list in the preceding paragraph and works downward from the total to the expenditures for implementation of the components of a program. The current emphasis on limiting the size of the deficit is an example of this. The regulatory process starts with item (3) and moves downward to (4) explicitly but works upward implicitly. Because the movement upward has been characterized by implicit decisions, the relative costs of the various regulatory programs have been haphazard and the magnitude of total costs has been unforeseen.

Because the governmental process is sequential, changing the sequence is likely to change the outcome. Also, because much of the governmental process is implicit, making it fully explicit is likely to change the outcome. The regulatory budget is designed to do both.

As the Annual Report of the Council of Economic Advisers stated: ". . . there is no institutional framework within the Federal Government—analogous to the budget for Federal spending programs—in which the total costs of regulations are brought together to permit the evaluation of economic impacts, setting of priorities, and the like." Others have made similar arguments.

The Regulatory budget

As an institutional framework to provide an overview and management, a regulatory budget merits exploration.

In a nutshell, the budget would show all federal expenditures for regulatory activities, along with private sector costs of compliance. Such a budget could also provide a framework to evaluate the cost-effectiveness of regulatory activities and to assess regulatory priorities. Once costs are established, the regulatory agencies would have strong incentives to improve estimates of the benefits of regulation. The point is that a regulator, budget could initiate a process that will directly improve the measurement of costs, which ire turn will lead to improved benefit measurement and an assessment of the overall impart of regulations on the economy.

Some Economic Implications of a Regulatory Budget

Regulation can be defined as the attempt to direct toward some end, through a wide variety of means, the activities of individuals, commercial and industrial firms, and government itself. Over the past five years regulation has attracted increasing scrutiny by those within and outside government alike. One reason for this attention is our increasing awareness of its economic costs. No really careful estimates have been made of the annual costs of all federal regulatory activity, but it may be $50 billion and perhaps considerably more. Since these costs may add to product prices, and since inflation has been and continues to be a serious economic problem, regulation has come under microscopic examination.

There are other equally important reasons for our current preoccupation with regulation. For example, because of scientific advances, we can now detect chemical substances at extremely low levels in the food we eat, the water we drink, and the air we breathe at home, at play and on the job. This has made possible careful examinations of the links between various pollutants, toxic and otherwise, and the impairment of human, animal, and plant health. Thus, a heightened knowledge of the possible benefits of regulation, coupled with an understanding of its potential costs, has brought it to the forefront.

Those calling for a change in the stringency of regulation seem equally divided into two camps: in one camp are advocates of stricter regulation of air and water pollutants, solid waste disposal, drugs and other consumer products, the prices of energy and other inputs, conditions in the workplace, and entry and exit in certain industries; in the other are those who feel that we are currently over-regulated in these very same areas and that we as a society could benefit from less, or at least very different, regulation.

Those favoring less regulation have come up with a number of proposals that they feel will help us, in their words, "get a handle on regulation." These proposals include both reforms of the current regulatory process (generally involving increased use of cost-benefit or cost-effectiveness analysis), as well as more fundamental changes in regulation such as the legislative veto, by which one or both hoses of Congress could over-rule a regulatory agency in its rulemaking process.

The regulatory budget (hereafter abbreviated as the RB) is another proposal that would represent a fundamental change n our approach to regulation. It is a mechanism that would limit the costs of those actions that federal regulatory agencies could force the private sector and other levels of government to undertake in any given period. If we refer to these latter costs as compliance costs, we can say that the RB would serve to limit regulatory agencies in the compliance costs they can impose on society during some time period in much the same way that the federal expenditure budget limits the departments of the federal government in their expenditures in any given year.

This section discusses in very general terms some of the economic implications of adopting a RB. In doing so, of course, we will be forced to make some assumptions about the way a RB would work. Since the concerns giving rise to discussions of the RB are similar to those which led, less than 60 years ago, to the creation of the federal expenditure budget (see Part I, p. 5) we have chosen to analyze the RB in the same terms that students of public finance have used to analyze the expenditure budget. That is, we will discuss the RB in terms of its effects on the allocation of resources, the stabilization of the economy, and the distribution of economic well-being. Needless to say, we can but touch on each of these important questions here.

The RB and Resource Allocation

In thinking about the allocative effects of a RB, one is struck by one apparent irony. The advocates of the RB claim that it is needed to improve resource allocation, yet the regulatory agencies whose activities might curtail were themselves created to remedy the market failures that prevented private transactions from resulting in a Pareto optimal allocation of resources. For example, the ICC, the CAB, the FCC, and the FPC (now the FERC) were created to regulate natural monopolies in industries where increasing returns to scale were alleged to mitigate against competition. The

EPA was created in response to a recognition that classic production externalities, in the form of air, water and other forms of pollution were the rule rather than the exception in modern industrial societies. If these externalities were uncorrected, we could almost certainly be assured that private costs of production would fall short, perhaps far short, of social costs; hence, overproduction (relative to the social optimum) of "dirty" products would result.

Similarly, the CPSC and OSHA were created out of the belief that consumers and workers had too little information about the products they purchased and certain of the conditions under which they were employed. Since information is generally a public good, it is often underprovided, hence the government's decision to be the provider in these cases. In doing so regulatory agencies were created to remedy an information failure that may have stood in the way of efficient resource allocation.

Therefore, in thinking about the RB it is well to keep in mind that such a device could constrain agencies whose job it is, in theory at least, to improve resource allocation. This is no less true for the so-called "social" regulatory agencies—EPA, OSHA, CPSC, FDA—than it is for the older, "economic'' ones such as the ICC whose job it is to regulate the purported natural monopolies. Moreover, to the extent that all these agencies are behaving efficiently in the economic sense of the word, encumbrances upon their activities may worsen, not improve, the allocation of resources.

Given this caveat, how might the RB be expected to improve resource allocation? First, regulatory agencies might be issuing regulations for which the benefits fall short of casts. If this is so, any mechanism that would prevent such regulations from being issued could improve resource allocation. This the RB might do if agencies were forced to come before the "authorizing" and "appropriating" committees that dole rout compliance cost allotments and present evidence that the regulations for which they are requesting authorizations are socially beneficial. In other words, the institution of an RB might force regulatory agencies to estimate more carefully the benefits they will be providing society.

Alternatively, of course, the RB might give rise to skillful attempts to exaggerate beneficial effects of regulation in much the same way the current budgetary process sometimes pits departmental puffery against the sharp knife of the appropriations committees. In summary, then, the RB may force regulatory agencies to come up with useful, well-designed programs if they want to get their fair share of the overall regulatory budget allotment for any given year.

Next, the RB may, through the process discussed above, lead to a better allocation of resources across the regulatory programs in a particular agency. Suppose, as should be the case, that a regulatory agency's goal is to provide the public the most protection, broadly defined, as possible. Once an agency was given its compliance cost allotment for the year, it should seek to issue that set of regulations that provides the greatest protection possible for that allotment. This will occur when the last dollar of compliance costs the agency is empowered to impose produces equal additional protection across its regulatory programs (in much the same way individual utility maximization in standard economic theory implies equalization of marginal utilities across goods and services).

Note, however, that similar process may take place now, in the absence of a cap on the compliance costs regulatory agencies can impose. In contrast to those who claim that regulatory agencies are completely unconstrained in their actions, they may in fact be partially constrained by the limits on their direct budgets—the amount they can actually expend in a fiscal year can testing, litigation, salaries, etc. Since as a result of the legislation passed by Congress many agencies have more regulations to issue than they could ever get out in one year, they must choose which areas to devote their attention to. Presumably, they are guided in this selection process by some sense of the seriousness of the problems its each of their areas of jurisdiction.

One may believe that regulatory agencies are unconstrained in their appetites and pursue new areas of intervention in willy-nilly fashion. If so, a regulatory budget may be a means of forcing administrators to consider the effect across a whole range of regulatory programs of the last allotted dollar of compliance cost. If, on the other hand, one believes that the costs of testing, litigating and regulation writing are such that no agency can hope to do all the regulating it wishes, the existing federal expenditure budget may be serving part of the purpose of the RB. One cannot deny, however, that the RB would impose a more definite limit on compliance costs than might be imposed by the expenditure budget.

The RB might have the same effect on resource allocation across regulatory agencies that it is intended to have within individual agencies. That is, the creation of a RB may force those who administer it (presumably the Office of Management and Budget) to phase out compliance cost allotments in such a way as to maximize the benefits resulting from the total amount of regulatory activity permitted in any ore year. Regulatory resources would be efficiently allocated when the last dollar of compliance costs produced an equivalent gain in welfare (be it in the form of environmental improvement, consumer protection, or occupational health) regardless of the agency to which it was appropriated.

Again, however, while the direct expenditure budget takes no explicit account efficiency in regulation, it may serve this purpose to some extent. This will be true if, to take a hypothetical example, EPA is given a large expenditure appropriation for its toxic substance program because Congress feels that regulations in that area are especially important to get out, as compared, say, to CPSC regulations regarding ladders or bathtubs.

There is one additional respect in which a RB may improve resource allocation through regulation. Currently regulatory agencies are often unaware of what each other are doing. In fact, some claim that this is true of the programs within single agencies. If so, benefit-cost analyses of individual regulations may be incorrect for failing to take account of other regulations. For example, the air quality benefits of increased mass transit may be less than originally calculated if, through some other regulatory program, emissions control devices cut pollution from on-the-road vehicles.

A RB may eliminate such errors in the calculation of benefit-cost ratios. This it would do by forcing individual agencies to examine all their regulatory programs at one time or by necessitating a broad look at regulation across all agencies by the committees that would establish the regulatory allotments for each agency in each year. It is interesting to note that one form of such coordination is now underway in the present regulatory regime. Both the Regulatory Council and the Interagency Regulatory Liaison Group are bodies whose purpose it is to recognize the possibly synergistic or duplicative effects of regulation on particular firms, industries, or sectors of the economy. It remains to be seen whether these groups or others like them can obviate the need for the kind f broad overview a RB might provide.

Finally, we should note that even the institution of a RB cannot guarantee improvements in resource allocation. Regulatory agencies could elect to squander their compliance cost allotment on politically popular forms of regulation even though there exit other, more socially beneficial, targets of regulatory opportunity. Similarly, the committees that allocate the compliance cost allotments across agencies could do so in an uneconomic way—in effect, we could be stuck with a "regulatory pork barrel" to parallel the inefficient projects which some claim result from parts

of the direct expenditure budget. Therefore, the RB appears to be neither a necessary nor a sufficient condition for efficiency in regulation. Rut it certainly has the potential for improving resource allocation, especially if the improvements to the current regulatory process discussed above are slow to come.

The RB and Stabilization Policy

While its effects on resource allocation may be uncertain, the RB may have some appeal as a mechanism through which macroeconomic concerns are reflected in the regulatory process. There can be no denying the significant impact our overall regulatory program has on the economy. Nor can one deny that regulation would come under much closer scrutiny wire it handled differently than it is now. That is, suppose the federal government bore directly the compliance costs its regulatory agencies now impose on the private sector and other units of government, and that these costs had to be met with revenues from increased taxes or reductions in other federal programs. If this were the case, regulation would compete with other programs for scare funds. And it seems reasonable to assume that we would in such a situation see different kinds of, if not less strict, air and water pollution controls, auto emissions standards, occupational safety requirements, drug testing laws and so on, if only because the government would have a more direct stake in minimizing the cost of regulation. In the process of considering the size of these regulatory expenditures, the government would be forced to debate their macroeconomic effects in the same way these effects enter into discussions of additional defense or other kinds of expenditures. This will be more pronounced the larger are these expenditures and their likely macro effects.

In a recent study for CEQ and EPA, Data Resources s Incorporated (DRI) examined the macroeconomic effects of only those federal air and water pollution and solid waste disposal programs already on the books (it ignored regulations yet to be written in both areas). According to DRI these programs alone were substantial enough to significantly affect both the unemployment rate (which was lower by 0.3 of a percentage point annually because of pollution control spending) and the inflation rate (which was 0.2 to 0.3 of a percentage point higher because of the environmental programs examined). All regulations taken together will surely have mush more significant effects on macroeconomic activity.

According to CEQ, federal environmental regulation imposed compliance costs on the private and public sectors of $22 billion in 1978, or about one percent of GNP. By comparison, direct federal outlays in that year totaled $451 billion or 21 percent of GNP. According to CEQ, however, the ratio of environmental compliance costs to GNP is expected to grow at least temporarily in the 1980's. If this is also true of other regulatory programs, their compliance costs must surely be considered in discussions of aggregate economic performance. In fact, it has already been suggested by Haveman and Smith that one component of our regulatory system, our environmental statutes, be phased in with an eye toward macroeconomic conditions. They suggest that we may wish to slowdown the introduction of new regulations when there is little excess capacity in theeconomy, but accelerate the pace of regulation when the capital investment required would likely not be devoted to new, output-expanding investment. This principle may motivate those who favor a RB as a means of controlling the impact of regulation on aggregate economic activity.

There are three considerations that make it difficult to be precise about the macroeconomic effects of a regulatory budget. First, to date no one has tried to determine how the benefits of regulation feed back into the economy. That is, the improvements in human health, the increased agricultural output, the enhanced recreational opportunities and other positive effects of regulation have yet to be translated into increased or decreased job opportunities, higher or lower product prices, or an altered balance of trade in the same way compliance costs have been. This is due primarily to the difficulty in estimating these benefits, in physical much less dollar terms. Yet when such benefit estimates have been attempted, the results indicate that they are of considerable economic importance. Hence, before we can speculate as to the effect of the RB on the economy writ large, we will have to understand better the economic effects of regulatory benefits.

We can speculate one aspect of this subject, however. At last some and perhaps a considerable portion of the benefits of current regulation take the form of human health and environmental improvements at future dates. This is due not only to the long latencies associated with occupationally or environmentally induced cancers and other illnesses, but also to the continual accumulation of non-degradable wastes in the environment, accumulations that will not take their toll on plant and animal life for some time.

Such latencies between the point of regulatory intervention and the realization of benefits characterize at least some of the programs of EPA, CPSC, FDA, and OSHA. One implication of this is that although the present discounted value of future benefits may exceed the costs of a regulation or set of regulations, the "front-loading" of costs may impose certain kinds of macroeconomic hardships during the period in which the regulations are put in place. The period between 1970 and today may qualify as such a period.

Of course not all benefits of regulation are deferred. After all, unsafe consumer products may do their damage quickly as well as over a longer period; air and water pollution may have acute effects in addition to its latent effects on all forms of life; drugs with unforeseen side effects can induce birth defects within a year as well as set in motion genetic changes that may not manifest themselves for years. Other examples abound.

Yet to the extent that benefits are deferred, one important observation bears mention While we may today be feeling the macroeconomic effects of the compliance costs of regulation, we may within the next ten years or so begin to experience the beneficial effects. These might take the form of reductions in the number of cancer deaths, slowdowns in hospital admissions and doctor visits, improved ambient environmental conditions, and so on. And yet these will be extremely difficult to recognize—much less translate into macroeconomic effects—because we will not know what these and other indicators of well-being would have looked like in the absence of regulation some years before.

Let us summarize our discussion to this point. First what little evidence that exists on the cost of regulation suggests that these costs are surely large enough to influence overall macroeconomic conditions. This is corroborated by the DRT study that looks at federal air and water pollution regulation alone. To date, no one has looked at the macroeconomic effects of the benefits of regulatory programs primarily because of the difficulty in determining them precisely. And yet these effects must be determined if we are to understand well the overall effect of regulations on our economy. One guess we can venture is that the costs of regulation are front-loaded for the most part, while at least some of the corresponding benefits will not show up for years. To the extent that the costs of regulation produce adverse macroeconomic effects (remember, some of these programs have very positive effects, as well) we may be trading off current discomfort for future improvements of very real but uncertain nature.

There are two other reasons why it may be difficult to determine the effects of the RB on the macroeconomy. The first is Friedman's observation, made many years ago in his Essays in Positive Economics, that tools used to stabilize the economy can in fact be destabilizing if not used carefully. What we must recognize is that the leads and lags characterizing the "full-employment policy" Friedman analyzed also characterize the costs and benefits of regulation. Hence, any attempt to use regulation to serve counter-cyclical goals—or to attempt to limit regulation for the same purpose runs the risk of backfiring.

For example, consider an agency forced to choose between two regulations competing for the last dollars of its compliance cost budget. The RB might constrain the agency to choose the regulation with the least total compliance costs even though that regulation might produce the most immediate and adverse macroeconomic effects because of the circumstances of its timing.

Because we know uncomfortably little about the size of compliance costs at all, much less about their timing and their macroeconomic effects, we should be extremely cautious in presuming to use the RB to serve stabilization goals. The futility of attempting to accomplish multiple goals—in this case both stabilization and the correction of market failures—using one instrument, regulation, is also well known and should be borne in mind in discussions of the RB.

A final problem remains to be discussed. How will the Office of Management and Budget, or the Congressional committees in charge of the RB, establish the overall ceiling on compliance costs in any given year? How much is too much or too little? There exist similar problems in arriving at the optimal size of the federal (or other governmental) expenditure budget. Some critics argue that the federal government is too small; others suggest that the phenomenon of the pork barrel, wherein the costs of inefficient projects are spread among hundreds of thousands of taxpayers, will lead to a sub-optimally large public sector.

Suffice it to say that the problem of determining the optimal size of the overall RB may be even greater. At least it is the case in federal budgeting that one can often visualize what one is losing when appropriations are denied—fewer schools are built, less submarines are afloat, or more children go uninnoculated. It is much more difficult to know what we as a society forego by denying FDA its saccharin ban, EPA its stricter new source performance standards, CPSC its lawnmower regulations, or the Energy Department its "tilt" gasoline pricing rule.

In such cases as these we can only speculate as to the likely direction of error relative to some unknown optimum amount of regulation. Generally, it may be that because the benefits of regulation are less visible than schools, ships or flu shots, they will seem less real. If so, we might get under-regulation through the RB process. On the other hand the authorizing or appropriating committees may be led to believe that unrealistically calamitous consequences will follow if the overall RB, or the allotment to a particular agency, is not granted. In such cases, regulation could be excessive.

We have now touched on three reasons why the RB may have uncertain or unfavorable effects on macroeconomic stability: the difficulty of determining the macroeconomic effects of regulatory benefits, the difficulty of controlling the timing of regulations even when their positive and negative effects are known, and the problems inherent in deciding what the total size of the RB should be in any year (i.e., how much in total compliance costs do we distribute among the agencies?).

Nevertheless, it is undeniable that economic and social regulation does have perceptible, perhaps substantial, macroeconomic effects. In spite of the emphasis its proponents have given to its supposedly desirable allocative effects, the RB appears to be most desirable on stabilization grounds. We currently quibble about the stimulative or inhibitive effects of adding or subtracting an extra billion or two from the federal budget. This makes no sense while we are at the same time devoting little or no systematic attention to similar effects associated with the whole of our regulatory apparatus.

There is no reason this systematic attention must come from the RB, of course. Part of the Administration's regulatory reform package is designed to promote a better understanding of the benefits and costs of regulation. This has led on several occasions to discussions of the macroeconomic manifestations of individual regulations or sets of rules. But if the existing process does not consider macroeconomic effects as a matter of course, and if the RB is seen as a vehicle toward this end, it may prove attractive even to those not disenchanted with the current state of regulation.

Distributional Considerations and the RB

In addition to the allocative and stabilization purposes of the federal expenditure budget, it is also intended to influence the distribution of income and welfare among citizens. That is, the budget is used to alter the distribution of income resulting from a private market system in which individuals' initial endowments of skills, wealth, and opportunity are unequal. While the RB is not intended to parallel the federal budget in this important respect, it could have distributional implications worth brief mention here. However, these are of less importance in passing on the desirability of an RB than are its allocative and macroeconomic effects.

Key to understanding the distributional consequences of a RB is a knowledge of the distributional effects of the programs a RB may curtail. Once again, no clear signs arise. For example, some evidence suggests that the air quality improvements resulting from the Clean Air Act are distributed in a pro-poor fashion. This is because the poor often live in the dirtiest neighborhoods within metropolitan areas—near freeways, factories, commercial establishments and the like. Hence, they benefit more than wealthy suburbanites when air quality is improved. And they would suffer the most if a RB led to curtailments of air quality programs in metropolitan areas.

On the other hand, the benefits from existing water quality programs currently appear to be primarily recreational. Since water-based recreation (boating, camping, fishing) appears to be more the province of the rich than the poor—with some notable exceptions—curtailment of water quality programs may impinge on those in higher as opposed to lower income groups.

The consequences of regulatory programs on the distribution of income have been identified in very few cases. In addition to the difficulty of benefit incidence discussed above, we must also consider the mechanisms by which regulatory programs are financed. That is, we must include information on the distribution of the costs of regulation. Therefore, it is nearly impossible to hazard a guess as to the effects of scaling back individual regulations, much less those associated with a possible across-the-board reduction in regulatory activity.

We may be able to say something about intergenerational distribution, however, even if we do not know how those in different income groups in the present generation will fare. Recall our discussion above about the intertemporal distribution of the benefits and costs of regulation. The latter tend to fall on current consumers in the form of higher product prices or, perhaps, the unavailability of certain products; the benefits, however, are often in the form of improvements in the health of individuals many years later, or even improvements in the environment or workplace of their children or grandchildren. To the extent a RB curtailed the programs of an agency providing future benefits at the expense of current costs (which it may not do at all), it would be trading current for future welfare. Those who feel that future generations are inevitably better off than present ones may find this fair. Those who feel that we are already passing on enough "unpleasant surprises" to our descendants may find this doubly objectionable. Nevertheless, this possible pro-present bias may be the only kind of distributional consequences we can speculate about.


It is necessary to recognize two points at the outset of this discussion. First, a regulatory budget is only one of several alternative approaches to regulatory reform. Second, the wide range of proposals that have been offered reflects major differences in conceptions of the nature of the need for regulatory reform. In these circumstances, a thorough appraisal of the economic rationale of a regulatory budget (RB) would have to weigh an RB against other possibilities in the light of an evaluation of the problems presented by regulation—with due regard given to legal, political and administrative constraints as well as strictly economic factors.

No attempt is made here to go into all of these issues, or even to argue that some form of an RB would be feasible. The discussion is directed to the much more limited question of whether the idea of an RB is reasonable in terms of some broadly accepted economic perspectives on public policy. In particular, the focus is placed on macro-economic policy and, especially, principles of efficient resource allocation.

Macro-Economic Policy

Over the past several years, the regulatory programs of the Federal Government have apparently become large enough to have a noticeable impact on the rate of inflation, unemployment, productivity and other macro-economic magnitudes. It is for this reason that there is now discussion of what bearing (if any) macro-economic policy should have on regulatory programs. In particular, the question raised here is whether an RB would have a reasonable role to play in macro-economic policy.

The expenditure budget plays a key role in the fiscal side of stabilization policy. Attention in this respect is focused on the Federal Government's budget deficit or surplus. If the Government operates at a deficit, there is a net addition to aggregate demand, as the Government spends more than it withdraws through taxes, which tends to stimulate the economy.*/ Conversely, a surplus implies a net reduction in aggregate demand and hence will tend to slow the economy. Clearly, controlling these effects requires controls over Federal revenues and spending; i.e., a budget system.

However, a quick look at the various types of regulatory programs that presently exist is enough to raise doubts about whether this sort of thinking could be carried over to an RB. From the standpoint of macro-economic policy, it is probably reasonable to distinguish these types of regulatory activities:

  • regulations that impose substantial direct compliance costs (e.g., on pollution control equipment);
  • licensing, permitting and review requirements that delay investments;
  • regulation of prices, entry, exit and service levels that reduce economic efficiency;
  • regulations that alter the magnitudes of taxes and transfers.

The costs involved in any one of these regulatory activities clearly do not have the same macro-economic impact as costs imposed by other sorts of regulatory activity, or macroeconomic impacts that mirror those of the expenditure budget. Consequently, it would not be very enlightening to view the macro effects of regulation in terms of the total cost figure shown in an RB, much less to add such a figure to Federal spending. In short, an RB would not be "like the expenditure budget" insofar as macro-economic policy is concerned. The character of any macro-economic role of an RB cannot, then, be defined by casual references to that of the expenditure budget, but must be established in terns of the tasks of macro-economic policy.

Short-run macro-economic policy is directed to the inflation rate, the rate of unemployment, and the balance of payments. The principle instruments used are monetary and fiscal policy and, increasingly over the past two decades, prices and incomes policy (i.e., wage/price guidelines or controls). The objective of the exercise, of course, is to hold the rates of inflation and unemployment and the trade deficit to acceptable levels.

It is difficult to see that an RB would play a useful active role in this process, for several reasons. First, there is so much uncertainty in the timing of costs imposed by regulation that any effort to adjust these costs to macro-economic conditions on a time horizon of a few months could easily be counterproductive. Second, much regulation is very broadly similar in its macro-economic effects to a tax on a business activity, and there is no good time to impose such taxes, as they tend to increase both unemployment and inflation. Third, start and stop regulation would create uncertainties which are in themselves costly.

These comments are objections to using an RR as an active tool of stabilization policy. An RB might, however, usefully serve in a different role. Bunching up of major new regulatory programs within a relatively short period of years exacerbates problems of inflation and unemployment, and simply by showing the costs of proposed regulations in comparison to the cost of existing regulation, an RB could help in limiting these problems.

Long-run macro-economic policy is primarily concerned with growth in real income, which entails a concern with productivity and the overall efficiency of the economy. These questions are obviously bound up with problems of resource allocation. In fact, when a long-run view is taken, there is a question as to whether regulatory programs are best viewed in terms of resource allocation or macro-economic considerations.

This is particularly true of major environmental and social regulations. Those concerned with macro-policy objectives point out that these regulatory programs not only create problems for the conduct of stabilization policy, but over the long run, reduce productivity and the rate of growth in real income and tend to worsen the trade-off between inflation and unemployment. The typical rejoinder points out that these regulations provide real benefits which, however, are largely excluded from existing measures of GNP, the price level and productivity. This line of argument slides past the fact that existing statistics on GNP, inflation, productivity, and so on—however imperfect for some purposes describe situations for which the Federal Government has major responsibilities—i.e., stabilization policy. Nevertheless, the central claim is that these regulatory programs should be viewed in terms of resource allocation, in which case the question is whether the programs are efficiently designed and whether their benefits are worth their costs.

Both sides of this debate have clearly a point—inflation, unemployment, and productivity are key national concerns, as are the objectives of regulatory programs. If so, the fact that legitimate grounds for debate exist is an argument for an RB, as all RB would be helpful in framing the problem, which major regulatory programs present, of balancing competing national priorities.

Resource Allocation

The expenditure budget is the major vehicle through which an administration expresses its policies on the allocation of resources among Federal programs and between the public and private sectors. Spending by regulatory agencies is, of course, part of the budget, but the costs that regulation imposes on individuals, firms, and other levels of government are not subject to any budgetary system. Yet, both Federal expenditures and many Federal regulatory activities withdraw resources from private use and redirect those resources to public purposes. Viewed from this perspective, the question is: why shouldn't regulatory compliance costs be subject to a budget constraint? Is there something different about regulation that makes imposition of a budget inappropriate?

Rationale of a Budget: It is useful before turning directly to this question, to briefly sketch the role of the expenditure budget as an allocational mechanism, which starts with the fact that the Government is responsible for the provision of public goods. The requirement. for government provision of public goods (and semi-public goods) arises from the fact that the market will not supply public goods in the appropriate amount because (by definition) nonpayers cannot be excluded from consumption. The Government's power to tax and create money virtually guarantees that it can meet financial commitments entailed by its provision of public goods. But real resources are limited, so the Government—whether or not the fact is recognized—faces a problem of resource allocation.

The general requirements for an efficient solution to this problem are as follows:

  • individual programs must be cost effective; i.e., costs must be minimized for the level of benefits required;
  • programs must be ranked in terns of net benefits; programs with negative net benefits eliminated or cut back; and resources must be shifted among marginal programs until there are no further shifts that would increase overall net benefits of the programs in the budget;
  • the overall scale of the budget must be adjusted until the net benefits of marginal programs is just equal to the value of the marginal resources transferred from the private to the public sector.

These criteria are not directly concerned with the question of what mechanism should be used to make allocational decisions. However, it is clearly to the point to ask whether a possible decision-making mechanism is a help or a hindrance in arriving at efficient allocations.

Viewed from this perspective, the key aspect of the expenditure budget—i.e., the budget for the Executive Branch as a whole—is simply that it provides the format for making the necessary decisions. First, the overall budget ceiling provides a means of gauging the trade-off between the net benefits of goods supplied by the Government and the goods and services supplied by the private sector. Second, a budget system forces a comparison of programs within an agency. Third, a budget system involves making trade-offs among the programs of various agencies.

The importance of these points can be illustrated by considering a different sort of system. In particular, suppose that individual agency budgets are subject to Congressional approval but that, in place of the overall budget for the Executive Branch, agencies are required to submit each of their programs to a rigorous cost-benefit analysis. Apart from other considerations, this system would have two major economic flaws.**/ First, the costs or benefits of a program are sometimes dependent on features of another program, and these relationships could not be handled with moving away from the completely decentralized mechanism hypothesized. Second, the value of public goods is not revealed in any market, but must be established through the political process.***/ The decentralized system assumed would not present the relevant choices where a budget system can do so.

Of course, use of a budget system does not ensure that allocational decisions will be made correctly. However, in the absence of a budget system, it would be virtually impossible to make explicitly the relevant comparisons. Overall decisions on trade-offs then emerge as the result of many decisions presumably made by individual agencies and Congressional Committees and there is no reason to assume that these overall results would be rational.

Application to Regulation: Regulatory programs are different from expenditure programs in legal and political terms, and these differences perhaps contain strong reasons why the costs of regulatory programs imposed on the private sector should not be subject to a budget constraint. But—laying this point aside—the economic rationale of a budget as a way of making allocational decisions applies in a straightforward way only to some types of regulation.

The fit is close for environmental and social regulations. These regulations are characteristically directed to "public buds"—e.g., air pollution—which share a key feature with public goods. Where the market tends to produce too little of public goods, because the returns cannot be fully appropriated by the producer, it tends to yield too much of "public bads," because producers are not forced to bear the full costs of their activities. In both cases, the rationale for government actions lies in internal effects that the market ignores, and the appropriate government response requires spending—to produce public goods or to reduce production of public bads. Moreover, in both cases there are genuine questions of more or less spending and of balancing competing ends against limited resources, which is exactly the situation in which a budget makes sense.

The economic thinking behind the use of a budget as an allocational mechanism doesn't work so well for economic regulation; i.e., control of prices, entry, exit, and service levels. Economic regulation rarely presents choices of the degree of cost, or spending, involved in achieving some reasonably well-defined goal. Typically, the costs of economic regulation appear to be by-products of policies adopted for a variety of reasons and, as was noted in an earlier paper, the issue is often whether the regulation is needed at all. In these circumstances, it is not clear what would be the point of attempting to impose a budget constraint.


This discussion has offered three conclusions on the economic rationale of an RB:

  1. An RB would not have any active role to play in stabilization policy.
  2. There does not seem to be a good rationale for dealing with economic regulation through a budgetary system.
  3. There is an economic rationale, grounded on allocational concerns, for applying a budget system to the costs of environmental and social regulation.


*/The effects of a budget deficit (or a surplus) are, of course, far more complex than this simple statement indicates. Among other things, the effect of a deficit depends on the degree of capacity utilization in various sectors of the economy and the level of inventories; whether the deficit is financed by borrowing or creation of cash; whether the deficit is created by additional spending, or a reduction in taxes and, if taxes are reduced, which taxes; the monetary and trade policies that are pursued; and expectations.

**/ Unless the rule was to accept all programs with positive net benefits, a third problem would be present—the lack of a mechanism for establishing a uniform cut-off level of net benefits.

***/ In cost-benefit analysis, an attempt is made to infer from various observed behavior and market prices what value individuals place on various goods or services or consequences which are not valued through a market. While such imputations can be very informative, they do not have the status of values revealed by actual consumer (or voter) choices.

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