The Overly Facile Comparison Between Regulations and Taxes

Romney’s argument for a regulatory cap equates regulations with taxes.  My initial reaction was that this was an absurd comparison – taxes are payments to the government, whereas regulations reduce externalities.  But after further thought, I decided that my initial reaction was a little too facile.  Regulatory costs do have some of the same economic effects as taxes, but the effects are more complex and attenuated. It’s a mistake to equate regulations and taxes, as Romney does — but a more complicated mistake than I thought initially.

To keep the discussion simple, let’s assume that regulatory costs are passed on to consumers in the form of higher prices. That’s something like a sales tax.  One problem with sales taxes is that consumers shift to other products that aren’t taxed, so demand is distorted by the tax.  But this is less of a problem if the regulation affects broad sectors of the economy like energy, because it is harder for consumers to find other products to switch to.  EPA regulations cover most of the economy — something conservatives frequently complain about — so the “sales tax” effect may be small.

The other effect of regulatory costs is that goods cost more.  This could produce an indirect effect that is something like the impact of an income tax.  Just as the income tax reduces the reward for an extra hour of work, regulatory costs do the same thing because the income from that extra hour doesn’t go as far in purchasing goods. It’s hard to know how big this effect of taxes is, but it’s plausible to assume that the effect does exist.

But the effect on labor supply is more complicated for regulations than it is for taxes.  The benefits side of the pollution regulation can counter the effect on labor.  Healthier people may be willing to work more hours for the same pay or may stay in the workforce longer.  Furthermore, they can shift consumption from medical care to things they value more. Also, some things like outdoor recreation become more appealing for healthier people.  For example, healthier people have an incentive to work longer to pay for outdoor vacations and recreational equipment. And healthier people have higher life expectancies, so at the margin they have a little more reason to earn money they can save for retirement. It’s even possible that the net effect of environmental regulations is actually to increase labor supply.

The bottom line seems to be that regulations are a bit like taxes, but only in a complicated and attenuated way.  Their distortionary effects on consumption and labor are probably smaller than those coming from taxes and have to be balanced against their direct positive benefits to society.  Before I spent a lot of time worrying about the tax-like impact of regulations, I’d like to see a lot more modeling and empirical evidence. The regulatory cap mistakenly equates the two and could probably be compared with using a cannon to kill a mouse.

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Reader Comments

10 Replies to “The Overly Facile Comparison Between Regulations and Taxes”

  1. if you are going to make the simplifying assumption that “regulations reduce externalities” then you should make the same assumption about taxes — that is, that they are a means of providing for public goods. Both impose costs on certain groups in return for alleged benefits. Insofar as taxes fail to serve this purpose in many cases, the same argument can be made of regulations. Many regulations do little more than transfer rents from one group to another (see, e..g, the most recent biodiesel reg which — according to the EPA itself — will increase particuate pollution, but has the benefit of helping soy farmers). Further, regulations and taxes both produce potentially off-setting behavior. Although both apply throughout the economy, they don’t apply equally everywhere, leaving lots of opportunities to make adjustments on the margin — and that’s where all important effects occur. And so on. If the aim is to get beyond the overly simplistic equation of regulation=taxes, it will require a more sophisticated analysis than has been offered here.

    1. Jonathan–I’m not sure why you’re reacting so sharply to a post that makes a concession toward your position. Please keep in mind the argument I’m replying to: Romney’s assertion that a regulation with a compliance cost of $X is completely equivalent to a tax of $X, even if the regulation passes a cost-benefit test. I would think that as a libertarian you would resist the conclusion that a prohibition on imposing a risk on someone else is equivalent to a mandate to contribute to public expenditures.

      In any event, it seems to me that there’s a justification for treating regulatory costs as being more closely tied with regulatory benefits than taxes are tied to government expenditures. You can can separate an analysis of the incentive effect of a tax from the incentive effect of the expenditure because tax money can be spent for any purpose, whereas a regulation that cuts an externality is really inseparable from its effect on the externality.

      Also, keep in mind that we’re not talking about the directly efficiency effects of regulations, but rather the possibility that increased compliance costs indirectly distort consumption choices or diminish incentives for labor by raising the prices of goods. Of course, if a regulation is just a transfer of rents, it’s a bad regulation — but you don’t need the analogy with taxes to reach that conclusion.

  2. if you are going to make the simplifying assumption that “regulations reduce externalities” then you should make the same assumption about taxes — that is, that they are a means of providing for public goods. Both impose costs on certain groups in return for alleged benefits. Insofar as taxes fail to serve this purpose in many cases, the same argument can be made of regulations. Many regulations do little more than transfer rents from one group to another (see, e..g, the most recent biodiesel reg which — according to the EPA itself — will increase particuate pollution, but has the benefit of helping soy farmers). Further, regulations and taxes both produce potentially off-setting behavior. Although both apply throughout the economy, they don’t apply equally everywhere, leaving lots of opportunities to make adjustments on the margin — and that’s where all important effects occur. And so on. If the aim is to get beyond the overly simplistic equation of regulation=taxes, it will require a more sophisticated analysis than has been offered here.

    1. Jonathan–I’m not sure why you’re reacting so sharply to a post that makes a concession toward your position. Please keep in mind the argument I’m replying to: Romney’s assertion that a regulation with a compliance cost of $X is completely equivalent to a tax of $X, even if the regulation passes a cost-benefit test. I would think that as a libertarian you would resist the conclusion that a prohibition on imposing a risk on someone else is equivalent to a mandate to contribute to public expenditures.

      In any event, it seems to me that there’s a justification for treating regulatory costs as being more closely tied with regulatory benefits than taxes are tied to government expenditures. You can can separate an analysis of the incentive effect of a tax from the incentive effect of the expenditure because tax money can be spent for any purpose, whereas a regulation that cuts an externality is really inseparable from its effect on the externality.

      Also, keep in mind that we’re not talking about the directly efficiency effects of regulations, but rather the possibility that increased compliance costs indirectly distort consumption choices or diminish incentives for labor by raising the prices of goods. Of course, if a regulation is just a transfer of rents, it’s a bad regulation — but you don’t need the analogy with taxes to reach that conclusion.

  3. Regulation serves to pass on risk. Gun regulation is a an example where Zina Haughton or theater goers in Aurora have risk transfered because of social misogeny and racial fears. Pedestrians assume risks from how the public peace ise regulated. In bundling the commons risk is transfered to reduce independence. Eric Biber didnt go so far but had a nice post yesterday titled “A business opportunity for climate skeptics” on risk analytics for environmental management.
    Taxes on the other hand build infrastructure for the regulated sphere like roads for high speed cars or interstate sales of guns.

  4. Regulation serves to pass on risk. Gun regulation is a an example where Zina Haughton or theater goers in Aurora have risk transfered because of social misogeny and racial fears. Pedestrians assume risks from how the public peace ise regulated. In bundling the commons risk is transfered to reduce independence. Eric Biber didnt go so far but had a nice post yesterday titled “A business opportunity for climate skeptics” on risk analytics for environmental management.
    Taxes on the other hand build infrastructure for the regulated sphere like roads for high speed cars or interstate sales of guns.

  5. Dan — One reason I respond so sharply is because you simply assume that a regulation necessarily controls an externality or prevents one party from imposing a cost or a risk on another. in theory, this is what regulations should do (just as taxes should provide for public goods). In reality, however, I see no reason to assume regulations conform to this ideal any more often than do tax revenues (that’s why I gave an example of a brand new environmental regulation that not only doesn’t reduce risks for others, it increases them). If you want to limit your analysis to some idealized subset of regulations, fine, but then I don’t think you are providing a particularly incisive critique of Romney’s claim. As for whether we should treat regulatory costs as more closely tied to regulatory benefits, again this depends on all sorts of (unjustified) assumptions about the nature and incidence of such costs.

    And, FWIW, here’s my piece on Romney’s reg agenda:
    https://www.law.upenn.edu/blogs/regblog/2012/06/26-adler-romney-rhetoric.html

    1. Jonathan, If you look at Romney’s pdf on regulations, that’s explicitly the argument he makes for why we need a regulatory cap /in addition/ to a cost-benefit screen. He gives an example of ten regulations, each of which is individually justified, adding up to a $1 billion in compliance costs. He then argues that the $1 billion in compliance costs is equivalent to a $1 billion in taxes. So I was trying to work through that claim and consider how, in that sort of situation, a regulation might or might not have the same distortionary effects as taxes.

      It seems entirely appropriate to address Romney’s actual claim rather than focusing on situations where the regulation was otherwise deficient. As I said in the my post, my conclusion was that the Romney claim had most substance than I originally thought, but that in the situations he describes the distortionary effects of regulations are probably considerably lower than those of taxes. If you’re aware of any economics literature on this issue, I’d be interested in pursuing the question further.

      I think you’re right, by the way, that economists should really do the same analysis when considering the size of government issues — not consider the effects of taxes on incentives by themselves but couple them with the possible positive effects of government programs on the economy. That’s what they tend to do nowadays when considering distributional impacts, but I think the scholarship on taxes hasn’t taken the step that you recommend yet.

      By the way, I appreciate your engagement on these issues. The invitation to appear as a guest blogger on Legal Planet still stands.

  6. Dan — One reason I respond so sharply is because you simply assume that a regulation necessarily controls an externality or prevents one party from imposing a cost or a risk on another. in theory, this is what regulations should do (just as taxes should provide for public goods). In reality, however, I see no reason to assume regulations conform to this ideal any more often than do tax revenues (that’s why I gave an example of a brand new environmental regulation that not only doesn’t reduce risks for others, it increases them). If you want to limit your analysis to some idealized subset of regulations, fine, but then I don’t think you are providing a particularly incisive critique of Romney’s claim. As for whether we should treat regulatory costs as more closely tied to regulatory benefits, again this depends on all sorts of (unjustified) assumptions about the nature and incidence of such costs.

    And, FWIW, here’s my piece on Romney’s reg agenda:
    https://www.law.upenn.edu/blogs/regblog/2012/06/26-adler-romney-rhetoric.html

    1. Jonathan, If you look at Romney’s pdf on regulations, that’s explicitly the argument he makes for why we need a regulatory cap /in addition/ to a cost-benefit screen. He gives an example of ten regulations, each of which is individually justified, adding up to a $1 billion in compliance costs. He then argues that the $1 billion in compliance costs is equivalent to a $1 billion in taxes. So I was trying to work through that claim and consider how, in that sort of situation, a regulation might or might not have the same distortionary effects as taxes.

      It seems entirely appropriate to address Romney’s actual claim rather than focusing on situations where the regulation was otherwise deficient. As I said in the my post, my conclusion was that the Romney claim had most substance than I originally thought, but that in the situations he describes the distortionary effects of regulations are probably considerably lower than those of taxes. If you’re aware of any economics literature on this issue, I’d be interested in pursuing the question further.

      I think you’re right, by the way, that economists should really do the same analysis when considering the size of government issues — not consider the effects of taxes on incentives by themselves but couple them with the possible positive effects of government programs on the economy. That’s what they tend to do nowadays when considering distributional impacts, but I think the scholarship on taxes hasn’t taken the step that you recommend yet.

      By the way, I appreciate your engagement on these issues. The invitation to appear as a guest blogger on Legal Planet still stands.

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Dan Farber

Dan Farber has written and taught on environmental and constitutional law as well as about contracts, jurisprudence and legislation. Currently at Berkeley Law, he has al…

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