” Policy Paradox” by John Edward

John Edward, who teaches economics at Bentley and UMass Lowell, frequently contributes columns on economic issues. Here is his latest:

Some public policies seem to contradict what would serve the public good. This column explains why that can happen. It has nothing to do with political parties. It is not a conservative vs. liberal thing. It has to do with cost-benefit analysis. Probably not the kind you are thinking of though.

The contradiction, or paradox, has to do with concentrated vs. diffuse costs and benefits. This framework explains many of the bad policy choices politicians make.

(Editorial note: the title of this column and the framework discussed are borrowed from a book of the same name by Deborah Stone, currently a lecturer in public policy in the Urban Studies and Planning department at MIT. The policy applications are my own.)

Every policy has winners and losers. Some will enjoy a benefit. Others will pay a cost.

Sometimes the benefits are concentrated on a lucky few. When benefits are concentrated the individual benefits are typically large. Or benefits may be diffuse – spread among a large population. When spread out over a large group, the individual benefits are typically small.

The same is true for costs. They can be concentrated, or diffuse.

Here is the key consideration. Policy will usually favor the concentrated side. The diffuse side usually loses.

Those who receive concentrated benefits, or pay concentrated costs, will work harder to shape public policy. They have more at stake. They become a “special interest.” The concentrated side will be vocal activists for or against a policy. They will put their money where their mouth is. On the diffuse side no one may care enough to organize, raise money, or even pay attention.

We can apply this idea to explain public policies that do not seem to make sense. One example is the film tax credit in Massachusetts. The benefits are concentrated and the costs are diffuse.

The Massachusetts Department of Revenue has thoroughly analyzed the results of the film tax credit:
• For every dollar of spending on film production the state gives away a dollar and a half.
• About two-thirds of the spending and wages earned goes out of state.
• For every full-time job created the state gives away almost $120,000 and the median wage of those jobs is only about half that amount.
• During the first seven years of the tax credit the state lost $357 million in revenue.

The benefits are concentrated on Hollywood studios and movie stars. A few local workers get some part-time work during filming.

We all pay for this bad policy. Governor Baker proposed paying for an increase to the earned-income tax credit with the money the state would save by ending the credit. Yet, the legislature seems determined to keep it.

If everyone who pays more in taxes because of the film tax credit were to unite in opposition the result would be different. That is not going to happen because no individual or group loses that much or is even aware how much it costs them.

When the benefits are concentrated and the costs are diffuse, the benefits side will likely win.

Another example where public policy is failing is Social Security. The Social Security System has been in need of repair for a long time. In this case, the benefits are diffuse and the costs are concentrated.

Social Security is running an annual deficit. The trust fund will be depleted by 2033 if no action is taken. At that point the government will have to reduce retirement benefits.

Fixing the system is not hard. There are obvious solutions:
• Congress could reduce benefits now – the costs would be concentrated on the elderly.
• Congress could delay the age of eligibility – the costs would be concentrated on those nearing retirement.
• Congress could raise or eliminate the cap on income taxed – the costs would be concentrated on high-income earners.

A combination of these policy options would fix the problem. However, the benefits are perceived as diffuse. Young people, who would benefit most, discount the money they might receive in a distant future.

With diffuse benefits and concentrated costs, the costs side likely wins. In this case, nothing happens – Congress has not fixed social security.

Fossil fuel and alternative energy companies are highly competitive. The government struggles in deciding how to treat competing industries. That is because both the benefits and the costs of any policy will likely be concentrated.

The government spends billions of dollars every year subsidizing renewable energy. Solar and wind companies get a concentrated benefit. The cost is concentrated on the oil and gas companies that are competing against them, for example in electricity generation.

Except the oil, gas, and coal industries get billions in subsidies as well. Nuclear energy gets a couple of billion dollars. According to the U.S. Energy Information Administration, total energy subsidies in 2013 were over $29 billion. The competing sectors all lobby for a bigger slice of a very large pie.

When both the costs and the benefits are concentrated, nobody may win. Or they all win, and the rest of us pay more taxes.

There have been a number of proposals to increase the federal gas tax to pay for infrastructure. Here is an example where the benefits are perceived as being diffuse, and the costs are diffuse.

Increasing the federal gas tax by a few cents will cost all drivers, but not much. There was not strong opposition to increasing the gas tax in Massachusetts by three cents a gallon. Voters objected to the automatic increases with inflation.

Everyone who uses transportation infrastructure stands to gain if more money is available to repair roads and bridges. However, the improvements will be incremental. Most people will not even notice the benefit. If they do notice, they probably will not give credit to the extra gas tax they pay.

Proposals to increase the federal gas tax face an uphill battle. There is also no drive to reduce the gas tax.

When a policy introduces both diffuse costs and diffuse benefits, often nothing happens.

The implication of concentrated vs. diffuse costs and benefits is not the paradox. The resulting policies, however, can seem absurd, illogical, or to contradict the public good.

The implication for voters is that we need to concentrate. We need to keep our elected representatives on their toes by letting them know what we think of their policies. We need to elect people who will do what is best for overall society. Too often our elected leaders pander to the moneyed interest.

Ultimately, the diffuse side has one big advantage. It has more votes.