Planned Updates to U.S. Regulatory Analysis Methods are Likely Relevant to EAs

The U.S. Office of Management and Budget (OMB) has proposed an update to Circular A-4, which provides guidance to federal agencies regarding methods of regulatory analysis. Changes to analysis methodology could substantially impact the type and content of future regulations, and the 2022  Legal Priorities Project writing competition examined potential ways to improve such analysis methods from an EA perspective. 

OMB's proposed update makes a significant number of changes to circular A-4. I have only taken a first look at the proposal, but several sections seem quite significant for EA causes. in general, the proposed changes appear to benefit policies that improve future wellbeing, prevent catastrophic risks, and/or (in certain circumstances) improve the wellbeing of people outside the United States. 

Catastrophic Risks

The proposed update adds explicit discussion of catastrophic risks, which are not mentioned in the current version of Circular A-4. The updated guidance allows for the consideration of impacts on future generations when analyzing the benefits of policies that reduce the chance of catastrophic risks. 

The time frame for your analysis should include a period before and after the date of compliance that is long enough to encompass all the important benefits and costs likely to result from the regulation${.}^{19}$ See the section “Discount Rates” for more details on the appropriate time frame for an analysis. If benefits or costs become more uncertain or harder to quantify over time, that does not imply that you should exclude such effects by artificially shortening your analytic time frame; instead, consult—as appropriate—the discussion in the section “Treatment of Uncertainty.”

[19] For example, when assessing the benefits of a regulation that could prevent a catastrophic event with some probability, it may be appropriate for you to consider not only the near-term effects of averting the catastrophic event on those who would be immediately affected, but also the long-run effects on others—including future generations—who would be affected by the catastrophic event.

Geographic Scope of Analysis

The proposed update allows for the consideration of impacts to non U.S. citizens residing abroad as part of the primary analysis in certain circumstances, which was not allowed in the previous guidance. 

In certain contexts, it may be particularly appropriate to include effects experienced by noncitizens residing abroad in your primary analysis. Such contexts include, for example, when:

• Assessing effects on noncitizens residing abroad provides a useful proxy for effects on U.S. citizens and residents that are difficult to otherwise estimate;
• Assessing effects on noncitizens residing abroad provides a useful proxy for effects on U.S. national interests that are not otherwise fully captured by effects experienced by particular U.S. citizens and residents (e.g., national security interests, diplomatic interests, etc.); 
• Regulating an externality on the basis of its global effects supports a cooperative international approach to the regulation of the externality by potentially inducing other countries to follow suit or maintain existing efforts; or 
• International or domestic legal obligations require or support a global calculation of regulatory effects.

Near-Term Discount Rates

The proposed update changes the default social discount rate over the next 30 years to 1.7%, from 3% in the previous guidance. 

One approach assumes that the real (inflation-adjusted) rate of return on long-term U.S.  government debt provides a fair approximation of the social rate of time preference. It is the rate available on riskless personal savings and is therefore a rate at which individuals may increase future consumption at the expense of current consumption. It is also the rate at which society as a whole can trade current consumption for future consumption. Over the last thirty years, this rate has averaged around 1.7 percent in real terms on a pre-tax basis. OMB arrives at this figure by considering the 30-year average of the yield on 10- year Treasury notes minus the average annual rate of change in the consumer price index (CPI) over the period within that 30 years that 10-year Treasury Inflation Protected Securities are not available (currently, 1993 to 2002), and the yield of 10-year Treasury Inflation Protected Securities over the period they are available (currently, 2003 to 2022). This produces a real 10-year rate of 1.7 percent, and corresponds to a social rate of time preference of 1.7 percent. For simplicity, transparency, and tractability, OMB is setting one default rate for social rate of time preference for all effects from the present through 30 years into the future, rather than a more elaborate discount rate schedule.

Long-Term Discount Rates

The proposed updates include a more substantial discussion of long-term discounting, including explicitly citing Derek Parfit in discussing why applying any discounting associated with pure time preference across generations may not be justifiable. 

Special ethical considerations arise when comparing benefits and costs across generations. Although most people demonstrate time preference in their own consumption behavior, which may vary by the good or service at hand, it may not be appropriate for society to demonstrate a similar preference when deciding between the well-being of current and future generations. Future citizens and residents who are affected by such choices cannot take part in making them, and today’s society must act with some consideration of their interest. 

Some believe that it is ethically impermissible to discount the utility of future generations.${}^{163}$  That is, government should treat all generations equally. Even under an approach that does not discount the utility of future generations, it is often appropriate to discount long-term consumption benefits and costs—although at a lower rate than the near-term effects more likely to fall on a single generation—if there is an expectation that future generations will be wealthier and thus will value a marginal dollar of benefits or costs by less than those alive today, or a non-zero probability of sufficiently catastrophic risks. To account for these special ethical considerations, an extensive literature uses a “prescriptive” approach to long-term discounting, determining the appropriate degree of weight that society should place on the welfare of future generations.

[163] See, e.g., Derek Parfit, Reasons and Persons (Oxford: Oxford University Press, 1984); Frank P. Ramsey, “A Mathematical Theory of Saving,” Economic Journal 38, no. 152 (1928): 543-559

In general, it appears that the updated guidance leaves substantial flexibility in picking an approach to long-term discounting

A distinct reason for discounting the benefits and costs accruing to future generations at a lower rate is uncertainty about the appropriate value of the discount rate. Private market rates provide a reasonably reliable reference for determining the rate at which society is willing to trade consumption over time within a few decades, but for extremely long time periods no comparable private rates exist. Because future changes in the social rate of time preference are uncertain but correlated over time, the certainty-equivalent discount rate will have a declining schedule. The appropriate discount rate declines because it is the average of the cumulative discount factors, not an average of the discount rates, that matters.

There are various reasonable approaches to long-term discounting that account for uncertainty and other relevant factors, and therefore lead to dynamic discount rates over time. One approach uses data from historical interest rates in financial markets to project uncertainty in the future path of such rates. This approach is a way of extending the use of financial market data to determine the discount rate in the long-term. Another approach is to explicitly use an economic model for welfare analysis, for example the Ramsey model discussed earlier, to generate a discount rate schedule tailored to the regulatory context. As noted previously, when taking a descriptive approach to generating a discount rate schedule, the parameters of the Ramsey formula can be calibrated to observed market data on real interest rates or to allow the discount rate to be a function of empirical estimates of the pure rate of time preference, the elasticity of the marginal utility of consumption, and per capita consumption growth. When taking this alternative approach, agencies should report information on their discount rate schedule in order to provide useful information to the public.