How Regulatory Math Can Discount Consumers and Manufacturers

How do you value money? The answer to that question sometimes plagues consumers, but it is often at the heart of regulatory decisions every day in Washington, D.C. Similar to interest rates, discount rates used by regulators are an acknowledgement that the costs and benefits of regulation often take place in the future, sometimes decades away. Discounting future benefits and costs to reflect the time value of money is an important component of federal regulation. Manipulating these discount rates can translate to higher purchase prices for consumers and fewer jobs for manufacturers.

For example, in 2011 the Department of Energy (DOE) issued an efficiency rule for refrigeration equipment, at an annual cost of $1.6 billion. At a five percent discount rate, the average consumer can expect to save roughly $24, not a bad deal. Using a seven percent rate, the one generally preferred by the White House, yields a slightly smaller figure: $3. Essentially, given that assumption, consumers break even.

But what if DOE’s math is wrong? What if consumers heavily discount the future benefits of purchasing a refrigerator that might take years to deliver net benefits, through lower operating costs to the household? There is research establishing that actual consumer discount rates easily exceed 10 percent, sometimes approaching 30 percent. A low discount rate might make sense for middle-to-upper income households who have a steady stream of income, but not everyone purchasing a refrigerator has the same preferences, or identical income. DOE essentially treats every consumer as a monolithic group. For example, employing an 11 percent discount rate in the scenario above yields $30 in net consumer costs. In other words, purchasing a DOE approved refrigerator, with its high upfront costs, will result in lower consumer welfare, even after accounting for increased energy efficiency.

Indeed, the agency often acknowledges that consumers lose out from new standards; not every consumer will emerge as a winner in DOE’s calculus. The American Action Forum (AAF) examined every energy efficiency rule issued since 2011 and found 12.6 percent, or 1 in 8, would suffer through net costs from new regulations. They would pay higher upfront costs, but would never be able to recoup these costs through lower operating costs; these new measures are effectively a regulatory tax, typically burdening low-to-middle income households. In one rule for furnace fans, the agency acknowledged up to 30 percent of consumers might suffer net costs because of the regulation.

Why does all of this matter? Because the pace of DOE energy efficiency standards is off the charts and the more regulations issued, the more consumers and manufacturers could lose. The Obama Administration has already finalized 26 “economically significant” (impact on the economy of $100 million or more) DOE regulations. Given the current backlog, this number could easily approach 30 by the time the next president takes the oath of office. By comparison, President Bush issued six and President Clinton issued just four. President Obama is issuing a generations-worth of standards in just eight years.

The cost of these Obama-era regulations eclipses $174 billion or $538 for every man, woman, and child in the U.S. But surely the benefits of these measures exceed the costs? Yes and no. As DOE has acknowledged, many consumers often don’t reap the rewards of tighter efficiency standards. In addition, previous AAF research found the agency routinely over-estimates the number of new efficient units consumers will buy. Fewer efficient products in use translates to lower benefits overall. It turns out that raising the price of goods through regulation will result in consumers refusing to purchase those goods.

Although consumers are often the focus of DOE standards, it is the manufacturers that face the bulk of the compliance burdens. They can often pass the cost of $174 billion in regulation on to consumers, but not without consequences for their business. In AAF’s analysis, we found that the cumulative impact of DOE measures since 2002 has resulted in 19,200 fewer manufacturing jobs. Those in the largest firms (1,000 or more employees) lost the most: 9,500 fewer jobs.

Discount rates might appear to be an esoteric concept, but these little-known rates have profound implications for consumers and manufacturers across the country. As research has shown, using rates that reflect consumer preferences can take a regulation with net benefits and quickly turn it into one with net costs for society. These discount rates have helped to justify regulations that increased prices on consumers and helped to drive down employment in the manufacturing sector. In the future, discount rates should reflect actual consumer preferences.