Throughout the 2016 campaign and the first months of his administration, President Trump has repeatedly pledged to dramatically reduce the regulatory burdens imposed on American businesses by federal agencies.

One of the more significant actions taken by the President to fulfill this commitment came early in his administration in the form of Executive Order (“EO”) 13771, titled “Reducing Regulation and Controlling Regulatory Costs.”  The EO imposes two restraints on executive departments and agencies (“agencies”) while formally exempting independent regulatory bodies like the Federal Energy Regulatory Commission from its terms.  Both restraints have long been sought by regulatory reformers.

First, the EO establishes a kind of regulatory “paygo” by requiring each agency to eliminate two existing regulations for every new one that it issues.  This provision quickly became known as the “one-in-two-out” requirement.  Second, the EO establishes a kind of regulatory budgeting process for agency rulemaking by setting a cap on the incremental compliance cost that may be imposed by an agency on the entities it regulates.  For fiscal year 2017, the EO sets the incremental cost cap at zero.  In future fiscal years, the Director of the Office of Management and Budget will establish an incremental cost allowance for each agency.

Some commentators have criticized the EO for directing agencies to focus too much attention on the cost of their regulations and not enough attention on the benefits that can result from their regulations.  However, official guidance from the White House Office of Information and Regulatory Affairs (“OIRA”) makes clear that the EO is to have no effect on the primary governing importance of EO 12866 regarding regulatory review and planning.  In particular, OIRA guidance makes clear that, except where prohibited by law, agencies must continue to assess and consider both the benefits and the costs of their regulatory actions, and must issue regulations only upon a reasoned determination that benefits justify costs.

President Trump’s EO, by combining requirements for regulatory paygo and regulatory budgeting, has opened up a new chapter in the decades-long debate about the costs and benefits of federal regulation, and how best to ensure that the requirements imposed by agencies on regulated entities are cost effective.  The EO is not likely to be the last word in this debate.

Several groups have filed lawsuits challenging the legality and constitutionality of the EO.  Even if the Trump administration prevails in all such litigation, the EO, by its very nature can be rescinded by a future administration disposed to do so.  And even if the EO remains on the books, its interpretation and application may vary significantly depending on the policies of future administrations, just as the interpretation and application of EO 12866 has varied over the years from one administration to the next.

Also, the debate about the costs and benefits of federal regulation will continue because the participants, while they agree with the general principle that benefits should exceed costs and have expressed continuing commitment in principle to the importance and usefulness of benefit cost analysis, they have never come to agreement about how in practice to measure the actual benefits and costs associated with a particular regulation.

For many years now, almost every new rulemaking has triggered the same sort of dispute.  The issuing agency and supporters of the new regulation say that the benefits of the proposal will far exceed the cost of its implementation, while critics complain that the agencies’ analysis inflates projected benefits and downplays the cost of implementation.  Each side attacks the assumptions, analysis and conclusions of the other at length and often with ferocious intensity, but without achieving any determinative analytical resolution of their disagreement.  How much a proposed rule will cost and how much it will benefit society, the answers to those questions, always depend on who you ask.  Agency benefit cost analysis fails to resolve disputes about regulatory costs and benefits for two fundamental reasons.

First, the directives to agencies contained in EO 12866 and elsewhere are largely illusory.  While there are many directives stating what an agency “shall” do, “should” do or “must” do when assessing and considering benefits and costs, the actions directed to be taken are themselves described using only the most general and non-specific terms, often with significant qualifications.  As a result, the directives in EO 12866 and elsewhere offer only very general guidance that leaves the agency free to follow almost any approach it may choose to assess, and come to conclusions about, the benefits and costs of a proposed regulation.

Second, benefit cost analysis, as currently performed by agencies, totally lacks the basic structural characteristics and attendant discipline that are present in any methodology properly described by the term “benefit cost analysis.”  For example, in the case of a business enterprise trying to decide how best to allocate its limited resources, management performs benefit cost analysis when considering a possible project.  Management estimates the economic benefits that will flow from the project and the costs that will be incurred.  They then calculate the ratio of benefits to costs, often called the Profitability Index.  If the Profitability Index for the project exceeds 1.0, management’s benefit cost analysis supports a decision to make the investment.

The important point is that a single entity, management, makes the estimates, performs the calculations and is accountable for the results of its analysis.  If the actual benefits of the project actually do exceed the costs incurred, then management will capture those economic rewards.  If the actual costs of the project exceed the benefits produced, management will be accountable for those losses.  Hence the discipline of the exercise, a discipline that provides a strong incentive to carefully evaluate each proposed business project.

By stark contrast, the benefit cost analysis performed by agencies provides no such discipline.  The agency makes the estimates and performs the ratio calculation but it is in no meaningful way accountable for the results of the exercise.  An agency neither captures the benefits nor incurs the cost of a regulatory “project.”  Benefits are dispersed across society and costs are imposed on the regulated entities and their stakeholders.  Neither benefits nor costs are typically assessed with any rigor after a new regulation is implemented.  What those might be always depends on who you ask.

In failing to provide a rigorous methodology that can objectively resolve disputes about the benefits and costs of particular regulations, the benefit cost analysis based upon EO 12866 and other executive orders has failed to check the relentless regulatory expansion of the administrative state.  Is there some way to modify and enhance the benefit cost analysis performed by federal agencies so that the process disciplines agency decision making the same way that benefit cost analysis currently disciplines the decision making of businesses in the private sector?

Congress is reported to be hard at work on tax legislation that not only cuts rates but also reforms a number of significant provisions in the tax code.  This legislative effort presents Congress with an opportunity to consider whether and how tax reform might be used to enhance agency benefit cost analysis and thereby provide some statutory support to the long-running efforts made to reduce unnecessary regulatory burdens and ensure that regulatory requirements are cost effective.

Congress could provide some dramatic support for such efforts, and create a strong enforcement mechanism to backstop President Trump’s EO, if it amended the tax code to include a fully refundable and transferable tax credit for one hundred percent of the actual incremental costs incurred going forward by a regulated entity to comply with the regulatory requirements imposed on the entity by federal agencies. 

Currently, a regulated entity can deduct its compliance costs as an expense against its taxable income and thereby gain partial relief from the economic burden imposed by the regulatory requirements.  The tax credit proposed here would provide several additional benefits to the regulated entity taking the credit.  And such a credit would also provide a number of benefits to society at large.  Entity and societal benefits, the points in favor of such a tax credit, can be summarized as follows:

  • It is appropriate to reimburse a regulated entity for its compliance costs.  Such costs are not fines or penalties or awarded damages resulting from a failure to comply with regulatory requirements.  Such costs are incurred by a blameless entity in the normal course of business to achieve and maintain compliance with new regulations that the government has determined have societal benefits in excess of the cost to implement them.  The societal benefits are dispersed to the general public, to taxpayers in general.  The proposed credit would provide a mechanism for those benefitted taxpayers to reimburse the entities that funded the benefits resulting from the new regulatory requirements.
  • A refundable transferable tax credit would fully and consistently reimburse an entity for its compliance costs.  Unlike a tax deduction, reimbursement would not be contingent upon the entity having taxable income.  Reimbursement for compliance costs should not depend on the taxable income of the regulated entity.  All such entities should receive equal treatment.
  • The tax credits claimed following enactment of the proposal would clearly record total compliance costs on the financial accounts of the federal government.  By bringing the currently hidden cost of regulation out into the open for all to see, the tax credit would generate information that could support a truly meaningful national discussion about the costs and benefits of regulation. 
  • By imposing the cost of regulation on the regulator instead of the regulated, the tax credit would compel federal agencies to conduct benefit cost analysis with the same discipline that now characterizes the benefit cost analysis conducted by private sector businesses.
  • By putting the actual cost of regulation on the books of the federal government, the tax credit would provide the kind of post-implementation cost assessment that is often called for today, but seldom carried out.
  • The tax credit, available equally to all regulated entities, would eliminate the economic advantage that larger established companies currently have over their smaller competitors when it comes to bearing the cost of regulatory compliance.  By levelling the field in this way, the tax credit could reduce the incentives that established companies have to support burdensome regulations that they can afford to comply with more easily than their smaller, less well established competitors.
  • By reducing the incentives to use regulation to establish competitive advantage, the tax credit could reduce the amount of corporate resources currently diverted from productive endeavors and innovation to rent seeking.
  • Such a tax credit would be fully self-funding because compliance costs will be incurred and credits claimed only when an agency determines that the societal benefits of a new regulation justify the compliance costs resulting from its implementation.
  • By making regulated entities indifferent to the cost of compliance, such a tax credit would eliminate the incentives that regulated entities now have to engage in costly and time consuming disputes with agencies about the results of agency analysis.  Federal agencies have always claimed that their benefit cost analysis is the product of technical expertise that should be respected and accepted.  If the federal government  bears the cost to implement a new regulation, then everyone concerned is likely to respect and accept the analysis that supports the decision to implement.
  • By eliminating the need for a regulated entity to absorb and/or pass through its compliance costs, such a tax credit would eliminate the economic distortions that currently result from the imposition of regulatory burdens, e.g., lower wages, higher prices and the diversion of capital from productive applications to compliance.

There are many benefits that would result from the enactment of the proposed tax credit and its provision of a powerful enforcement mechanism to discipline the benefit cost analysis performed by federal agencies.  The numerous benefits make a strong case that Congress should give serious consideration to the proposal.  Let the debate begin!

J. Kennerly Davis, Jr. is a former Deputy Attorney General for Virginia, and he currently serves on the Executive Committee of the Administrative Law & Regulation Practice Group. Contact him at: