One-Size-Fits-All Regulations are a Bad Deal for Low-Income Americans

February 03, 2015

Sofie E. Miller

We're all affected by regulations; they change our circumstances and the choices that are available. Regulations have benefits and costs, but often the people who benefit from regulations aren’t the same people who bear the costs. Unfortunately, for many regulations, the costs are borne by America's poorest households.

Our research at the George Washington University Regulatory Studies Center has identified at least three ways in which regulations disparately impact the poor: through upfront costs that may not be offset by long-term savings, by increasing commodity prices, and by over-regulating risks.

Upfront Cost, Long-Term Savings

Many regulations impose on consumers a high upfront cost that is expected to be offset over time by long-term incremental savings. For example, energy efficiency standards limit the energy or water use of appliances such as dishwashers, air conditioners, refrigerators, and microwaves. Decreased water and energy use translates to savings in consumer energy bills over the lifespan of the appliance. However, it also translates to higher upfront costs for consumers to buy more efficient appliances.

To determine whether the long-term benefits of energy savings outweigh consumers' higher upfront equipment costs, the value of future savings must be discounted to be compared with current costs. Because consumers will receive the benefit of reduced energy bills over the entire lifetime of their appliance, regulating agencies must discount those benefits to make them comparable with the upfront costs resulting from the standards. However, it's not certain what the appropriate discount rate is, and assuming a discount rate that is too high or too low could effectively misallocate consumption preferences over time. Lower discount rates imply that present consumption is valued relatively low compared to future consumption, whereas higher discount rates imply future consumption has less value relative to present consumption.

In fact, we find in the literature that actual discount rates for consumer appliances also vary quite a bit by income, with low-income households using much higher discount rates than higher-income households. But in its analysis of energy efficiency standards, the discount rates used by the Department of Energy (3 and 7 percent) are only representative of high-income households. Importantly, due to higher discount rates, median-income households, low-income households, and senior-only households are more likely to bear net costs as a result of these types of rules, while high-income households are more likely to benefit. In this way, implementation of energy efficiency standards may act as a transfer payment from lower-income households to higher-income households.

Different people have different circumstances and therefore different time preferences. Instead of recognizing this, agencies treat consumers as though they have identical preferences and constraints, which forces the poor to make investments that have a lower rate of return than they can afford, and deprives them of the opportunity to spend that money on more urgent needs.

Increased Commodity Prices

Regulations that increase commodity prices can also have a regressive effect. Environmental regulations like the Renewable Fuel Standard and the EPA's proposed carbon emission rules for power plants cause the prices of commodities like food and electricity to increase.

While wealthier consumers may find these cost increases tolerable, low-income consumers are less able to do so. For households that are struggling financially, commodities like fuel and food consume larger portions of household income, and any price increase can limit their available options. For this reason, regulations that increase commodity prices can act like a regressive tax.

Risk Regulation

In a working paper for the Mercatus Center, Diana Thomas finds that "regulation has a regressive effect: It redistributes wealth from lower-income households to higher-income households by causing lower-income households to pay for risk reduction worth more to the wealthy." This is because regulations that reduce risks can impose unavoidable costs that are passed on to every household, regardless of income.

It may be no surprise that the risk standards set by agencies often reflect the risk-preferences of high-income Americans. However, one surprising side-effect of regulations that reduce risk is that they may increase net risks for low-income Americans by leaving them with less disposable income to purchase the incremental increases in safety that they value the most (such as moving to a marginally safer neighborhood, or replacing an old car). Poor households are likely to have many more opportunities to purchase safety improvements than wealthier ones, who may be much closer to the point of diminishing returns. Forcing everyone to accept the diminishing returns available through more stringent risk regulation can put poorer households at greater risk overall.

It's apparent that there's a problem with enforcing one-size-fits-all regulations. In order to regulate, agencies have to treat consumers as if they were homogenous, with the same preferences, discount rates, and incomes. Because that's the case, it shouldn't be a surprise that regulations often reflect the time and risk preferences of high-income Americans. Unfortunately, that means that the benefits of these rules accrue to high-income households while low-income households bear the burden.