Tag Archives: regulation

A Helpful Reminder: Environmental Regulations Are Regressive

President Donald Trump promised to loosen energy and environmental regulations during his campaign, and he’s already taken some steps to fulfill this pledge.

Earlier this month, Trump announced that he was reviewing the aggressive auto fuel-economy standards put in place by the Obama Administration. Now, Reuters is reporting that Trump will sign a new executive order this week to relax regulations on the fossil fuel industry.

Even without getting into the details, we all know how the political battle lines will be drawn on this issue. Democrats and progressives will be opposed to the regulatory cutbacks while Republicans and conservatives will be pleased. The left will decry the implications for climate change and the right will cheer it as a boon to economic growth.

But what often goes unmentioned in this debate is the distributive impact of environmental regulations. The fact is that most environmental regulations are economically regressive*–that is, they harm the poorest people more than everyone else.

Defining Regressivity

As a quick primer, regressivity and progressivity are concepts that are generally used in the context of taxes. The terms describe how the tax rate changes for people with higher incomes. For this purpose, the tax rate that matters is the effective income tax rate–which is calculated simply as the amount of tax paid over the amount of income earned.

We would say that a tax is regressive in nature if the effective income tax rate decreases as income rises. A tax is progressive in nature if the effective income tax rate increases as income rises. And if the effective tax rate stays the same as income rises and falls, then the tax would be proportional, also known as a “flat tax”.

Based on these definitions, the US federal income tax system is theoretically progressive in nature–it is designed such that richer people pay a higher share of their income than poor people. (In extreme cases, loopholes might flip this result, but this is the intent.)

Meanwhile, a sales tax on groceries would tend to be regressive in nature. Rich people and poor people both spend a somewhat similar amount each month on groceries, they would also pay a similar amount in sales tax. The richer person may pay more tax in absolute terms. But if we divided the tax paid by each person by their respective incomes, we would find that the poor person is paying a greater share of their income than the rich person. Thus, it’s regressive.

While the terms regressive and progressive are most commonly used for taxes, they can be applied to other policies as well. Any policy that harms poor people more than rich people could be appropriately described as regressive.

Why Environmental Regulations Are Regressive

Environmental regulations are often described in very positive terms: energy efficiency, clean energy, fuel-economy, and so on. At least superficially, these ideas seem silly to oppose. Oh, so you’re against efficiency, huh? What’s wrong with you?

The problem is that these terms obscure the underlying costs to consumers. Let’s take the Clean Power Plan (CPP) as an example. And before we get into details, note that the following economic analysis applies regardless of one’s position on climate change.

The CPP required a 32% reduction in US carbon dioxide emissions through 2030, using 2005 as a baseline year. These reductions were to be achieved substantially through carbon dioxide emission limits on existing power plants.

To the Obama Administration’s credit, the CPP did not mandate, in detail, how states were to achieve this goal. Instead, it gave them flexibility to determine how it would be done–a few suggestions included building more renewable energy, building nuclear power plants, or investing in carbon capture technology, commonly branded as “clean coal”.

The common characteristic of each of these options is that they would cost more money than the status quo. Market costs of renewable energy options like solar and wind have come down recently, but they are still more expensive than carbon dioxide-emitting alternatives. Similarly, retrofitting or rebuilding a coal power plant with carbon capture technology is naturally more expensive than using the plant that already exists today.

It follows that, whatever the CPP’s intention, it would have the effect of making energy more expensive than it otherwise would be. In this way, it has the same net effect as a sales tax that only applies to energy. The way the cost increases is different, but the end-consumer is still paying more.

We can also safely assume that energy usage among different people does not vary as widely as income varies. In general, a family earning $200k a year is not going to use 10 times the energy of a family living off $20k per year. Thus, if we adopt a policy that increases everyone’s energy cost, we have a regressive outcome–poor people get harmed more than rich people as a share of their income.

This same basic analysis would hold for fuel-economy standards, energy efficiency, and others. Boiled down, the mechanism is straightforward. Regulations force businesses to invest additional resources to create a compliant product. Since it costs more to produce, part of the cost will be passed on to the consumer in the form of prices that are higher than they would be otherwise. And since environmental regulations tend to affect the prices of basic necessities where rich and poor alike spend a somewhat fixed amount, the price increase is more impactful to the poor people. So by themselves, environmental regulations are generally regressive.

Implications

For conservatives and libertarians, the fact that environmental regulations tend to be regressive is just one more reason to keep them at a bare minimum (and getting rid of many that are on the books today).

But for progressives, it is a more complicated picture. The fact that environmental regulations happen to be regressive does not automatically mean progressives would oppose them. There are high-profile cases, such as Philadelphia’s recent soda tax, where left-leaning politicians adopted a plainly regressive tax in pursuit of ostensibly more important goals–funding pre-K education and improving health. For many progressives, climate change might warrant a similar treatment–perhaps poor people will have to bear a lower standard of living in order to cap emissions?

Wherever you come down on that, the key is to recognize that trade-offs do exist. Environmental regulation is a case where two progressive priorities will often come into direct conflict: helping poor people live a better life right now or protecting the environment from climate change in the long run.

As the debate and bipartisan grandstanding around environmental regulation heats up, it’s worth keeping the underlying economics in mind.

*If the environmental regulation in question amounts to the enforcement of basic property rights, this regressive outcome would not hold. For instance, a law that prevents other people people from dumping waste on your property without your consent could possibly be viewed as an environmental regulation, but it would not have the same economic implications explained here.

 

DC Considers Cracking Down on Short-term Rentals

A new article at the Foundation for Economic Education discusses how local politicians in Washington DC are considering imposing new requirements on short-term rental providers. Per FEE author Iain Murray, the new proposed regulations would require an owner to:

*Submit their properties to a full inspection to ensure compliance with fire, health, building, and zoning codes, and ensure that the property complies with Americans with Disabilities Act requirements; 

*Send a notification letter to neighbors about their intent to rent out their property;

*Operate the license under their personal name and not through a corporate entity;
be present throughout the visitor’s stay; and 

*Only advertise through a hosting platform like AirBnB if they have a business license.

The best part is that, if these regulations are violated, they can be punished by fines or imprisonment (!) up to six months.

It seems clear that, if passed, these regulations would be sufficiently onerous to be effective. And of course, that’s precisely the problem. The new regulations would discourage private room-sharing, eliminating (or reducing) a source of income for many property owners in the area and raising the cost of visiting DC for many would-be travelers. Meanwhile, the likely beneficiaries are the established interests–primarily hotel chains and possibly some DC residents, who are opposed to having a guesthouse in their neighborhood.

In a way, this is a small issue. Even if the proposed bill is passed, it only affects DC and it only affects one industry within DC. But in another way, it’s nearly a perfect archetype of a bad regulation. Indeed, it has almost every attribute we would expect from a new economic regulation, namely the following:

  • Regulation pushed by special interests. Costs are shared widely, mostly among consumers
  • Creates artificial competitive advantage for existing businesses relative to new competitors.
  • Preexisting legal remedies should have been sufficient to address any actual problems that existed.
About the only thing this regulation is missing is that it doesn’t appear to disproportionately harm poor people like most such regulations. Still 3 out of 4 is pretty good score.
So let’s run through the key elements.
Pushed by Special Interests
In this case, the main interest groups are hotels and their labor unions, as noted in the article. It’s not difficult to see how they would benefit from such rules. If AirBnB can’t operate in DC, that means more revenue for hotels and more job security for their employees. This much is straightforward.
The reason such groups are strong enough to get legislation like this seriously considered may be less obvious. There are many more people that benefit from AirBnB (travelers, businesses catering to tourists, and property owners that rent spaces out) than those that would stand to benefit from this legislation. So how is it that rules like this can possibly gain traction?
Well, economists would argue the problem is one of concentrated benefits and diffuse costs. The net impact of the regulation is likely to make us all, on balance, worse off, and more individuals will be harmed and helped. The trouble is that the harm that each individual experiences (a slightly higher vacation cost, for instance) is much smaller than the benefit that can be gained by the hotel industry by eliminating their competition legislatively. As a result, the hotel industry has a much stronger incentive to hire lobbyists pushing this bill than anyone else has to oppose it. For the hotels, it’s a huge issue; for us, it’s a minor inconvenience. So hotels can easily win.
And of course, it goes without saying that the resources the hotels and unions expend on lobbying to get a bill past are basically wasteful for the economy as a whole. Lobbyists of this sort do not create value for anyone. Instead, they are just trying to transfer market share to their clients, away from a superior competitor in AirBnB and other short-term rental services. In other words, it’s like that old adage: “If you can’t beat them, hire K Street to get politicians to outlaw their business model.”
It Benefits Established Interests
It’s not a coincidence that hotels would already meet most of the requirements that would be expected of the short-term rentals, like getting a fire inspection or having a proper business license. Superficially, these may seem like reasonable enough requirements, but each one raises the costs of participating in the markets and thus gives a relative advantage to businesses that already meet them.
The same dynamic plays out with most new economic regulations. People often assume that businesses despise new regulations, and on a personal level, that may be true. But most of the time, new regulations have the unintentional (or intentional, depending on your cynicism) consequence of strengthening the relative position of the larger companies in the industry. For example, if new costly regulations got imposed on app developers tomorrow, the major casualties won’t be Apple or Google. They already have large compliance and legal teams that can deal with whatever the government decides to throw at them. Instead, it’s the small business and the start-up that gets hit–because now they’re forced to hire a new resource or spend time complying with a new rule instead of refining or selling their product. So all businesses may hate regulations, but it’s typically the small businesses that bear the brunt of the consequences.
It’s Completely Unnecessary
This is probably the most important point of all. One of the apparent catalysts for the push to regulate DC’s private short-term rental market was a high-profile rental that was used for extravagant celebrity parties, much to the chagrin of the neighbors. To the extent that local politicians aren’t just looking for donations from the hotel lobbies, this is the good intention the regulation aims at–ensuring tranquility in the neighborhoods and preventing abuses from rowdy tourists, or something like that.
But there’s no need for explicit regulations to address this need. In general, enforcing the legitimate property rights of the neighbors should be sufficient. Property rights already protect me from having a next door neighbor that decides to play loud music till ungodly hours of the morning. That’s why I can, just as the neighbors did in DC, call the cops and file complaints against unduly loud residents in my area. And if the behavior persists, I could conceivably sue the property owner for damages because they have violated my property rights. On the contrary, if the short-term tenants are doing nothing to violate my property rights, I have no legitimate or legal way to object to their presence. That is how it should be.
It’s equally important to note that while most interpretations of property rights would offer legal protection against disruptive and unduly obnoxious neighbors, requiring a fire inspection and a business license would do nothing at all to solve this problem. Nor would requiring the owner of the property to be a particular type of legal entity. Other than preventing short-term rentals altogether, there’s really no plausible mechanism for how the new regulations would prevent the abuses observed.
And if we wanted to remove any ambiguity from what’s included in property rights, individuals could also negotiate homeowners’ agreements (HOAs) within their neighborhoods. Such agreements are already widely used and would stipulate explicitly the acceptable uses of the property, noise restrictions, etc. As with property rights, enforcement of HOAs doesn’t require a new regulation. It just requires the government to enforce private contracts, which it is already empowered to do.
In other words, the basic powers of government are already designed to solve any of the actual problems created by short-term rentals. And the new regulations being proposed are nothing but the cynical ploy of an industry that is unable or unwilling to compete legitimately.* In this way, this small example from DC showcases the attributes common to economic regulations in general. And like most (if not all) other economic regulations, the justification for DC’s short-term rental regulations quickly falls apart.
*The hotel industry might be able to make a case that the existing regulations on them actually prevent them from competing fairly right now. But even if that’s true, that’s an argument for lifting regulations on hotels, not making things worse for everyone.

The Opposite of Government Regulation Isn’t Chaos; It’s Choice

Among the ostensibly scary ideas promoted by libertarians is the cause of deregulation. For those on the left, this term comes with a substantial amount of political baggage for being associated primarily with the presidency of Ronald Reagan. And for almost all regular Americans, the concept has been tarnished by the financial crisis of 2008-2009, which many people believe was somehow caused by financial deregulation. There is basically no basis for this claim. But Americans needed a scapegoat, and our politicians naturally preferred to point fingers at a lack of government involvement in the economy, rather than an excess of such involvement.

In any case, the point is that deregulation has a bad image. And while much of this may be undeserved, part of it also stems from a failure of free market supporters to explain what this would look like in practice. Properly understood, deregulation is not about eliminating all rules and regulations for private businesses, and the ideal world is not one where businesses “regulate themselves” as critics often claim. Rather, the goal is to eliminate politically-imposed regulations and allow for customer preferences and competition to create standards and norms that may be desirable and maximize choice. In other words, what we want is a system of private regulation.

In a new article for the Foundation of Economic Education, Bob Murphy does an excellent job fleshing out what such system of private regulation would look like in practice, and he uses the room-sharing service, AirBnB, as a real world approximation. The whole piece is worth reading, but one part of his analysis in particular is worth elaborating on here.

Murphy suggests that we need to distinguish between two types of rules /regulations (emphasis in original):

…we can loosely define a sensible rule as one that may increase the final price to the renter, but only by providing more benefits that he or she would voluntarily pay for, if acting on the basis of complete knowledge and in one’s own long-run interest.

In contrast, an absurd rule is one that forces owners to alter the mix of room attributes in a way that raises the total price more than the renter would be willing to pay for the increase in perceived value, even taking into account the initial lack of knowledge and the human foibles of shortsightedness and weak willpower.

So to make these definitions more intuitive, a sensible rule might be something like requiring all properties listed on AirBnB to be free from any rabid rat infestations. I’ve got nothing against rats, but just about everyone would likely prefer / expect to not have a rat as a roommate while on vacation. Moreover, it’s the sort of thing that we also might not think to ask; rat-free is not commonly listed under amenities after all. It could raise the price of a room to ensure it’s rat-free, but at least in a US context, it’s tough to imagine someone would seek out the cheaper alternative.

Contrast this with something like a requirement to have all rooms have a queen-sized mattress or a private bathroom. These things may be nice to have, and they are standard features in every hotel I’ve ever stayed in. But they also raise the price considerably. And by the mere fact that the hostel industry can profitably exist–by providing low-cost lodging without either feature mentioned above–we know that at least some people are unwilling to pay a higher price for these features. Thus, under Murphy’s framework, requiring such things would be an absurd rule.

This in turn offers an insight into why we should prefer private regulations over political ones. In a best case scenario for democracy, politicians will try to cater to the opinions of the majority. So assuming the district they live in is an affluent district or state, this might mean that a majority of people (or at least, of likely voters) would want a private bathroom in a hotel room or apartment. So when the topic of regulations comes up, the politician will call for private bathrooms to be required in all hotels. Indeed, if the politician wasn’t just appealing to his affluent base, we can imagine him putting an egalitarian spin on it, something like, “I believe that, in the wealthiest country in the world, no family, no matter how poor, should be denied access to having their own bathroom and shower. We are a better country than that.” Or, we could imagine a more conservative branding on it as well, with slogans such as, “Make America modest again,” or, “Make America shower again.”

So this noble reform gets passed into law, and all accommodations are now required to provide a private bathroom in each room. On its face, this sounds great, until we realize what really happened. Before, there were some people, whether because they were poor or just oddly frugal, who would prefer a lower price and a shared bathroom. Now, because political regulations are almost always one-size-fits-all solutions, those people no longer have the choice to get a lower-cost room. Depending on their particular circumstances, maybe it means they’re homeless periodically, cancel a planned trip, or maybe they can bear the increased cost. In any case, they are made worse off. So this is one key problem with political regulations–the uniform nature of them often restricts choice and, at best, merely codifies the opinion of the majority.

A second problem is how slow such regulations are to change. Let’s imagine a law is passed and pretty much everyone agrees it’s a bad idea. Maybe it was an okay idea at the time and technology has since made it obsolete. Or maybe it was a bad idea to begin with. It doesn’t really matter for our purposes. As an example, in Louisiana, the state requires florists to have a license in order to legally provide floral services. This limits the number of florists in existence (since it’s harder to become one) and thus drives up prices for consumers. Since it’s not clear how much damage can be done by negligent flower arrangements, it’s safe to say this only benefits one group–the existing florists who were already forced to waste time and money acquiring a license. Except for said florists, everyone agrees this is a stupid rule. And yet it persists. Why is this?

Well, one reason bad laws stick around is that, depending on the position, elections only happen once every couple years. So unless it’s really outrageous and worthy of a recall, most of the time you have to wait until several months before you can vote out a politician that voted for a bad law. Then, a more significant problem is that it will only be one of many issues that matter in the election. And chances are, floral policy won’t be the top priority for most voters. Instead, they’ll vote based on another issue, and small bad ideas like floral licenses can live on indefinitely.

Of course, once we include any degree of corruption or special-interest lobbying in the mix, political regulations are likely to be even further divorced from consumer preferences, and cause further harmful distortions of the free market. For all of these reasons, private regulation should be preferred.

So we should continue to champion deregulation, but we should be careful to explain to paint a constructive and plausible alternative to critics. The opposite of government regulation is not a world of financial collapse and anarchic chaos. Rather, it’s a world where consumer preferences and competition help improve the products and services that are available. And in almost every area where the government has not caught up to regulate new technologies, it’s already here.

For more on this theme, check out the rest of Bob Murphy’s piece. Here’s the link:

AirBnB: Regulation without Government