Latest / The Fiscal Policy Podcast with Fexingo: Government Budgets, Stimulus, and Public Spending / How the Government Decides Whether a Benefit Is Worth Its Cost
Transcript
- Lucas: So the federal government is about to spend something like six trillion dollars this year, and buried in every rule and regulation is a little piece of math that decides if that spending is worth it. It's called cost-benefit analysis, and the manual for how to do it just got its first major rewrite in over twenty years. Luna: You mean that dry document people call Circular A-4? I've heard it's the nerdy heart of federal rulemaking. Lucas: Exactly. The Office of Management and Budget issued it in 2003, and it basically tells agencies like the EPA, the Department of Transportation, even the Department of Labor, how to weigh the costs and benefits of any major regulation. In 2023 they updated it for the first time since then. And it's been quietly reshaping how hundreds of billions of dollars are justified. Luna: So what actually changed? I read it was mostly about how you count future benefits. Lucas: That's the heart of it. The big fight is over something called the discount rate. That's the number you use to shrink future costs and benefits into today's dollars. The old guidance pushed agencies to use three percent and seven percent. The new one says, well, those are still okay, but they added something called a 'near-zero' rate for certain long-term effects. Think climate change, where the benefits of reducing carbon emissions show up decades from now. Luna: So a lower discount rate makes future benefits look bigger? Lucas: Right. With a three percent rate, a benefit of one hundred dollars fifty years from now is worth about twenty-two dollars today. At near zero percent, it's almost the full hundred. So the choice of discount rate can flip a regulation from a net cost to a net benefit. Luna: And that's where the social cost of carbon comes in. It's basically a number that puts a dollar value on each ton of carbon dioxide emitted, used in cost-benefit analysis for environmental rules. Lucas: Exactly. That number has been a political football. Under the Trump administration, the EPA calculated it at around one dollar per ton if you only counted domestic damages and a high discount rate. The Biden administration pushed it to over one hundred and ninety dollars per ton, using a global estimate and a lower discount rate. And that single number can swing the benefit side of a rule by hundreds of billions. Luna: So if you're an economist at the EPA and you want a rule to pass, you just adjust the social cost of carbon? Lucas: That's the cynic's view. But there's real economic theory behind it. The question is: how much should we weigh the welfare of future generations? That's what the discount rate is really about. And the new Circular A-4 acknowledges that for catastrophic, long-term risks, a near-zero rate might be more appropriate. Luna: But doesn't that open the door to agencies just picking whichever number gets them the answer they want? Lucas: It's a valid concern. The OMB tried to set some guardrails by requiring sensitivity analysis — showing results under different discount rates. But the social cost of carbon is still determined by an interagency working group, not an independent body, so the number can change with each administration. Luna: Let's talk about another big change — how they value human life. I've heard the government uses something called the 'value of a statistical life'. Lucas: Yes, that's a number that's been around for decades, and it's controversial. Right now, the Department of Transportation uses around thirteen million dollars per statistical life saved. That's based on studies of what people are willing to pay to reduce their risk of death. But the new guidance tells agencies to consider whether that number should be adjusted for income levels and age — which some economists argue makes sense, but it gets politically explosive. Luna: I can see why. If you say a poor person's life is worth less, that sounds terrible. Lucas: Exactly. So the OMB was careful to say that you shouldn't apply a blanket income adjustment, but you should think about distributional effects. They also added a new emphasis on analyzing how costs and benefits fall on different groups — low-income communities, minority populations, future generations. That's a big shift from the old 'total net benefits' approach. Luna: So it's not just about the total number anymore. It's about who wins and who loses. Lucas: Right. And that's a huge deal. For example, a rule that reduces air pollution might have a net benefit overall, but if the costs fall on small businesses in a particular region, that's something agencies now have to explicitly consider. The new guidance provides a framework for doing that analysis, but it's not prescriptive — it just says 'do it and explain it'. Luna: What about the older debates, like cost-benefit analysis itself being a bad idea? There are scholars who say some things shouldn't be reduced to a dollar figure. Lucas: That's a fair critique. The economist Frank Ackerman has argued that cost-benefit analysis routinely underestimates the costs of inaction on climate change because it can't capture tipping points or irreversible damages. And there's also the problem of 'monetization' — putting a price on things like biodiversity or cultural heritage. The OMB guidance says you should quantify what you can and qualitatively describe the rest. But in practice, agencies often default to the numbers they have. Luna: So despite the update, it's still an imperfect tool. Lucas: Absolutely. But it's the tool we have. And it's better than no analysis at all. The alternative is making decisions based on gut feeling or political pressure, which is what a lot of spending was before the 1980s. Ronald Reagan's executive order 12291 required cost-benefit analysis for major rules, and that's when this whole enterprise really took off. Luna: Let's get concrete. Can you give me an example of a recent rule where the choice of discount rate really mattered? Lucas: Sure. Take the EPA's rule on methane emissions from oil and gas operations, finalized last year. The EPA estimated the benefits using a social cost of carbon of around one hundred and ninety dollars per ton, and a three percent discount rate. That gave benefits of about four billion dollars. But if you used the Trump-era figure of one dollar per ton and a seven percent discount rate, the benefits would have been something like two hundred million dollars — a twenty-fold difference. That rule was justified because of that choice. Luna: So the same rule could be a no-brainer or a boondoggle depending on what numbers you plug in. Lucas: Exactly. And that's why the OMB update is so important. It tries to make the assumptions more transparent. For example, it requires agencies to report the net benefits under at least two discount rates, and to describe the sensitivity of the results to key uncertainties. That's a step toward honesty, even if it doesn't resolve the underlying disagreement. Luna: Now let's talk about something that came up in a previous episode — how the government's discount rate shapes its own investment decisions. Is this the same concept? Lucas: Related, but not exactly. The Office of Management and Budget also sets a discount rate for evaluating federal investments, like building a new highway or buying equipment. That's typically around two percent real, because the government can borrow at very low rates. But when you use that low rate to justify a project, you're essentially saying that future benefits are almost as valuable as current ones. That can lead to overinvestment in projects with long payback periods, like some infrastructure. Luna: So the same tool has two different purposes — one for regulations, one for spending. And both are contested. Lucas: Yes. And they often conflict. A regulation might be justified with a low discount rate, while a spending project might be rejected because its benefits are too far in the future. But the deeper point is that the government is making value judgments about time and risk, and those judgments have trillion-dollar consequences. Luna: You know, Lucas, when we talk about the government making these kinds of decisions, it reminds me of how we rely on our listeners to help us keep doing this kind of deep dive. It's not something you often hear on a podcast. Lucas: That's true. And if you've been finding these fiscal policy discussions useful, or if something clicked for you today, listener support is what keeps this show ad-free and independent. If you ever want to chip in, you can do that at buy me a coffee dot com slash fexingo. It's a small gesture that helps a lot. Luna: Yeah, even a coffee a month helps us keep digging into the numbers behind the headlines. But let's get back to that methane rule for a second. You said the benefits were estimated at four billion — but are those benefits real, or are they just projections? Lucas: They're projections, of course. The EPA models how much methane will be reduced, then values the avoided climate damages. But there's a lot of uncertainty in those models. The actual reduction could be higher or lower depending on how industry responds. That's another layer of uncertainty that cost-benefit analysis tries to capture with sensitivity ranges. Luna: So even with the best analysis, you're still making a bet about the future. Lucas: Exactly. And that's what makes this such a fascinating and frustrating area. The numbers look precise, but they're built on assumptions that can shift with the political winds. The 2023 update to Circular A-4 doesn't end the debate — it just makes the battle lines clearer. Luna: So what would you say to a listener who wants to understand a specific regulation? How would they know if the cost-benefit analysis is reasonable? Lucas: First, look at the discount rate they used. If it's three percent, they're taking a long-term view. If it's seven percent, they're skeptical of future benefits. Second, see if they included the social cost of carbon — and what number they used. And third, check the sensitivity analysis. If the benefits only exceed costs under one set of assumptions, that's a red flag. The OMB now requires that kind of transparency, so it's all in the rule's preamble. Luna: That's a great practical takeaway. So next time you see a headline about a new EPA rule, you can dig into the fine print. Lucas: Exactly. And that's the kind of civic literacy we could all use a little more of. Because at the end of the day, these analyses decide where trillions of dollars go — and who benefits.