Designing Smarter Regulation with Improved Benefit-Cost Analysis

Abstract

Benefit-cost analysis is required for many regulatory decisions in the United States and many other countries. In this paper, I examine a standard textbook model that is used in benefit-cost analysis as it is actually applied. My primary objective is to suggest how including other key factors in the analysis could promote the development of smarter regulation.

I begin by presenting a standard economic model for government intervention in markets, which balances benefits and a narrow definition of costs. I then introduce a richer normative theory that considers several political and economic factors that are frequently not considered in analyzing real-world applications. Examples include costs associated with rent seeking, design and implementation, and raising revenues. The richer theory suggests that the government should supply less of a good, or ask the private sector to provide less of that good, than the standard economic model suggests. The reason is that intervening in markets is often more costly than the standard model assumes. In special cases, the theory provides guidance on the setting of socially optimal taxes and subsidies. I then explore how the theory needs to be modified in the presence of biased estimates of benefits and costs. I conclude with a discussion of how the theoretical framework can be applied to the actual design of regulatory policy.

Keywords: benefit-cost analysis, public choice, political economy, public finance, implementation analysis