New Study Brings 'Trickle Down' Illogic to Regulatory 'Costs' Estimates

These days, it seems a week doesn't go by without some conservative advocacy group releasing a new study that purports to measure the total annual costs of federal regulation. In this case, it's literally true. Last week, the reliably anti-regulatory Competitive Enterprise Institute (CEI) put out its annual tally, provocatively titled "Ten Thousand Commandments," which this year finds a total cost of $1.885 trillion for 2015. And the week before that, the just-as-reliably anti-regulatory Mercatus Center published a report that concludes that federal regulations cost $4 trillion in 2012. 

To make things more confusing, these studies follow the same basic two-part template. First, they include only the cost side of the ledger, ignoring the huge benefits that federal regulations produce by protecting people and the environment against unacceptable harms. No reasonable policy evaluation would take such a misguided approach, and the decision to ignore benefits is clearly calculated to mislead audiences into believing that regulations are an inherent drain on the economy. It might be useful for political propaganda, but as far as serious policy analysis, the approach is worthless. 

Second, these studies rely on faulty methodologies and flimsy data that are better at generating gaudy numbers – trillions of dollars! – than they are at describing reality with anything approaching reasonable accuracy. CEI, for example, aggregates decades' worth of inflated cost estimates for individual regulations and then, for good measure, throws in estimates of things that have nothing to do with regulatory costs (e.g., transfer payments for government programs, tax compliance costs, and fines for regulatory violations). 

The Mercatus study deploys a model that purports to measure the cumulative reduced growth in Gross Domestic Product (GDP) due to reduced business investment attributable to regulatory compliance costs. (For now, the title for most outlandish methodology is still held by Drs. Nicole and Mark Crain, who over the course of two studies developed a model that also purported to show how regulations reduced GDP that was based on – no joke – opinion surveys of a small cadre of CEOs.) 

This marks the Mercatus Center's first foray into this subgenre of conservative fan fiction, and given the novel methodology used for measuring regulatory costs, its study is worth a closer look. To begin with, its failure to consider benefits is noteworthy given the authors' apparent preoccupation with maximizing GDP growth as the end-all, be-all of American society. Are we to share their belief that benefits generated by regulations have no salutary effect on economic growth?  

For example, workers will be more productive when their health and that of their families is adequately protected by strong clean air regulations and robust workplace safety standards, which in turns leads to increased profits and economic growth. Similarly, with the assurance provided by strong financial security protections, individuals will be more willing to take the plunge and launch a new small business that creates jobs and spurs innovation. Yet, for all its impressive computer-generated data and baroque mathematical formulas, the biased Mercatus model fails to capture these kinds of regulatory impacts. 

Beyond the study's omission of regulatory benefits, its results are based on such a highly questionable methodology and flimsy data that they should be rejected out of hand. The data come from Mercatus' own "RegData" dataset, which claims to measure how heavily regulated a particular industry is. It does this by counting up the number of "restriction" words, such as "shall" or "must," that are contained in the text of agency regulations. It then cross-references these rules against the industrial sectors they are likely to impact using the North American Industrial Classification System (NAICS). As I've written elsewhere, these data systemically overestimate regulatory impacts, thereby providing a misleading portrayal of the regulatory climate that particular industries face. 

The most interesting aspect of the Mercatus study's flawed methodology, though, is the model it uses. And what makes it so noteworthy is how it flagrantly imports conservatives' unwavering faith in "trickle down" economics into the realm of regulatory policy. 

Note the internal logic at play. It's based on a counterfactual scenario that imagines a world in which business leaders didn't have to spend money on regulatory compliance, and it posits they would have instead used that money to invest in technological innovations that would increase productivity and profitability, leading to overall economic growth. The flawed assumption, of course, is that when corporate CEOs bank more and more profits, they will inevitably pass on this largesse in the form of more jobs and better wages. 

Unfortunately, this romantic fantasy bears little resemblance to what actually occurs. Instead, what we tend to see is that growing corporate profits are usually directed toward other decidedly unproductive uses, such as wasteful mergers and acquisitions or to fatten the compensation package of top-tier executives. In some cases, it just sits and accumulates on the sidelines of the economy. (One recent estimate calculated that American businesses are currently sitting on a collective total of $1.9 trillion in cash.) 

The notion that money spent on regulatory compliance is somehow antithetical to the conservative conception of productive investment is also nonsense. In some cases, money spent on regulatory compliance has spurred industries to make investments that they would not have otherwise made, resulting in increased productivity and profitability for the sector as a whole. 

One great example of this is the Occupational Safety and Health Administration's (OSHA) 1978 cotton dust rule to protect workers from harmful exposures to cotton dust, which can cause byssinosis (or "brown lung" disease). Brown lung disease is a debilitating and potentially fatal ailment that significantly impairs lung function. In 2000, while conducting a review of the rule, OSHA found that it had contributed to a significant decline in the number of byssinosis cases among textile workers in the country, from approximately 50,000 in the early 1970s to around 700 in the mid-1980s. (The review report is here. Warning: huge PDF.) This is a decline of almost 99 percent. 

But that's not all. OSHA's review also found that the investments that textile companies made in new equipment to comply with the rule also served to increase the industry's productivity and profitability. Specifically, the agency found that in the years prior to the rule's full implementation, the industry's productivity rate grew at a rate of roughly 2.5 percent. In the years after, however, the productivity growth rate had increased to 3.5 percent. 

This is hardly an isolated example. We're also finding that the Department of Energy's energy efficiency regulations are helping to spur technological innovations for a wide variety of consumer and industrial products that use electricity, which save money and cut down on carbon dioxide emissions. The rules are also helping to guide the transformation of these markets in a way that promotes order and predictability for affected businesses. 

The bottom line is that the Mercatus study's model rests on a profound – perhaps even willful – misunderstanding of the relationship between regulations and the broader economy, leading it to produce fundamentally misleading results. The trickle-down theory on which it is based has become broadly discredited in the context of tax policy, and its application to regulatory policy should likewise be rejected. No doubt conservatives itching to introduce a new attack line against the federal government will seize on the Mercatus study's results. As for serious discussions of regulatory policy, however, this study and its results have no proper place.