## Utilitarianism comes to benefit-cost analysis

by on May 20, 2023

Kevin Drum points to an obscure, but radical proposal to change the way the US government does benefit cost analysis. The Office of Management and Budget has released draft guidance saying

One practical approach to implementing weights that account for diminishing marginal utility uses a constant-elasticity specification to determine the weights for subgroups defined by annual income. To compute an estimate of the net benefits of a regulation using this approach, you first compute the traditional net benefits for each subgroup. You can then compute a weighted sum of the subgroup-specific net benefits: the weight for each subgroup is the median income for that subgroup divided by the U.S. median income, raised to the power of the elasticity of marginal utility times negative one. OMB has determined that 1.4 is a reasonable estimate of the income elasticity of marginal utility for use in regulatory analyses.

This is pretty obscure, but what it means is that, a project that delivers a dollar of benefits to each of a group of poor people is worth more than a project that delivers a dollar of benefits to each of a group of poor rich people.

A lot more !

Kevin uses a graph to illustrate, showing that an extra dollar for the median household is worth 50 times as much as an extra dollar for a household with an income of \$1 million a year. Conversely, an extra dollar for households at the bottom of the income distribution is worth 12 times as much as an extra dollar at the median.

It’s actually simpler to get the intuition of you use an elasticity of 1, which corresponds to logarithmic utility. Then you can sum up the implications by saying that a given percentage increase (or reduction) in income yields the same additional (or reduced) utility no matter who gets it. So, for example, if a policy halved Elon Musk’s income, while doubling the income of a single randomly chosen US household, it would be evaluated as neutral. If the policy doubled the income of two households, it would be beneficial. More generally, you can just add up all the percentage changes in income from the project (included the taxes needed to finance* it). If that sum is positive, the project should be approved.