The trust fund theory of regulation

The trust fund theory of regulation
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Each year, federal agencies issue countless new regulations. For many, agencies present evidence that the public is willing to pay handsomely for good regulatory outcomes.

As a result, many people reasonably conclude the system must be working pretty well. In fact, this measure — what the public is willing to pay for the benefits regulations create — is a critical way the government justifies its rules. 


This logic is problematic, however. To understand how regulations impact overall welfare, we need to know more than just how much someone might be willing to pay for a rule’s benefits. We must also understand how those benefits, and their corresponding costs, evolve through time.

It may sound funny, but each time our government issues a regulation, we as a society are a little like a rich kid with a really big trust fund.

On a personal note, when I was 19, I moved to New York City and ended up living there over a decade. Though I came from a reasonably prosperous Boston suburb, I was unprepared for the wealth I saw in Manhattan. I came to know people who, if they chose to, would never have to work. The reason was simple: inherited wealth.

Most of us can only dream of being so lucky. But in a sense, Americans are fortunate in just the way those rich kids were. We’ve all inherited a trust fund of sorts through the accumulated wealth that society has amassed during the course of human civilization.

Some of us have to struggle more than others to access it, but most ordinary people throughout history weren’t nearly so fortunate.

How does this relate to regulation? 

Each time the government implements a new regulation, there are costs. An individual might pay higher prices for a regulated good. A business owner pays more in compliance. An agency spends more taxpayer money to enforce the rule. Some portion of this spending draws from society’s accumulated wealth.

In other words, regulation displaces some investment. It’s not unlike that rich kid who sells off an investment in his trust fund to spend the cash on something he wants. But what that something is ends up mattering a great deal.

Is he cashing in some stock to purchase a car? Go on vacation? Or, is he doing something entrepreneurial, like launching a business?

For the sake of argument, say he is willing to pay the same amount, $5,000, for the car, the vacation or the business. Additionally, let’s say each costs $4,000, so whichever he chooses, he comes out ahead by $1,000.

This is essentially how the government evaluates regulations: comparing what someone is willing to pay with the cost. The government would be indifferent between these options, but one is a better buy. 

Only the business has the potential to keep the rich kid’s wealth growing. That’s because money left in the trust fund would be growing as returns are reinvested. The only way to offset the returns given up when an investment is sold is to earn an even higher rate of return outside the fund. 

That’s a problem, because most regulations don’t aim to achieve compounding returns like those earned from financial investments. Luckily, it’s not impossible.

If a regulation improves business competition, say by breaking up a monopoly, then a bunch of new businesses might enter a market and create new wealth throughout a community. That could keep the size of society’s “trust fund” growing. 

But many other regulations aim to achieve more nebulous goals. One example is privacy. We might find this goal well worth paying for, but if we regulate to achieve it, we should do so knowing that we’re tapping into our trust fund in a way that probably won’t replenish it.

The real losers won’t be us — we’ll have a grand old time spending down the fund. Our children will be the ones with fewer resources available to pursue their own goals and aspirations.

Of course, amorphous benefits like privacy might indirectly spur wealth-creation, but it seems a lot less likely than if we invest directly in things that make society productive. 

We are all fortunate to live in a country as rich as the United States in the 21st century. But with good fortune comes responsibility. It may seem equitable to sell off the assets our ancestors accumulated to spend on this particular group or that particular cause.

But ultimately, the things we value and are willing to pay for aren’t necessarily the same as what’s in the long-run national interest. 

We need to keep the trust fund growing. Otherwise, we are little more than a rich kid with a lot of toys but not much to show for his life.

James Broughel is a senior research fellow with the Mercatus Center at George Mason University.