6 - Externalities and the Government Agenda

Summary

In most situations economists are convinced that markets are better suited than governments to bring about a pattern of expenditures that will please consumers. One big problem, however, is that, while pleasing consumers, producers can be producing costs for others (externalities such as pollution) that the factories’ prices do not account for. Economists think placing a tax on pollution can increase the price of the product so that consumers will have to pay the full cost to society of purchasing it. On the other hand, when consumers educate their children, those in the broader society gain in addition to what parents would be willing to pay. A subsidy for external benefits of education may thus be justified. Both kinds of externalities can be seen as providing an agenda for government.

Externalities can also be used to indicate the level of government that should be intervening with a tax or a subsidy. Noise pollution from a rowdy bar can be a local responsibility because adjoining towns will rarely be affected. But noise pollution from airlines would have to be addressed by the federal government.

Cost–Benefit analysis: Since the 1980s benefit–cost analysis has been used in a host of federal agencies. One of its principal functions has been to slow down or kill proposals for new regulations from tunnel-visioned departmental advocates. A high-level advocate for benefit–cost analysis under President Obama said as much when he noted that, under Democratic presidents, departmental leaders too often saw regulations as a simple transfer “from the bad guys (the corporations) to the good guys (the people).” Costs could get out of hand.Traditionally, benefit–cost analysts tried to figure out what the benefits and costs of new programs or regulations would be for consumers. For example, they could begin their analysis of the benefits of programs to reduce air pollution by noting that housing values increased where pollution was low.

Unfortunately, in the Obama administration, analysts began to substitute their beliefs about what consumers should choose for actual evidence about what consumers do choose. Consumer sovereignty thus disappeared. And, in the Trump administration, evidence about the costs of new regulations was welcome, but not evidence about benefits. Thus, benefit–cost analysis in the federal government is currently in crisis.