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What I'm Listening To... August 31st 2012
I had a short week this week due to illness, so many of my “usual weekly podcasts” didn’t get their turn. Still, pressuring myself over it would defeat the purpose. I just kept on listening to what appealed, and today it was these two items:
- An episode of The Invisible Hand titled “Perverse Incentives”. I’ve already posted some material from this show (see it here). It was an interesting topic… incentives that produce the opposite of the desired effects. When you start thinking about it, these are way more common than you’d think! See the posted excerpt for more of my thoughts…
- This weeks episode of This American Life. The show was called Loopholes. This show is always entertaining. The bulk of this episode was about a somewhat nefarious man you’d have to characterize as a con artist… however, his con only seemed to hurt the insurance companies. Some real morally ambiguous ground here. I ended up rooting for the con-man. This episode doesn’t fit with what I repost to the blog, but I quite recommend it as an hour’s entertaining listening. The con-man story is second, and takes about 2/3 of the show.
That’s it, happy long weekend to those who get one. For general info on What I’m Listening To, click here.
NCLB waivers: South Dakota's ACT problem
I wrote last month that South Dakota’s proposed school accountability system seemed to reward schools that let their worst students drop out.
Under the plan, test scores would have accounted for 50 percent of a school’s grade, while HS completion rates were worth 10 percent.
The South Dakota Department of Education addressed that in its final waiver request. Now, they’re asking that test scores and high school completion be worth 25 points each.
But another perverse incentive occurred to me last night regarding ACT scores.
Under the state’s proposal, ACT scores would account for 10 percent of a high school’s grade. If 60 percent of your students score a 20 or better on the math section and 60 percent score an 18 or better on the English section, your school gets 6 out of the 10 points.
The problem is that, unlike the Dakota STEP, not every student takes the ACT - 81 percent of SD’s 2011 graduates did so - and that would not change under South Dakota’s proposal.
Today, high schools encourage their marginal college prospects to take the ACT. That might change under the new plan, which punishes schools for low ACT scores but does not punish them for students who never take the test.
By contrast, Iowa’s NCLB waiver request would require all HS juniors to take the ACT or SAT. Their legislature has been asked to appropriate $2.5 million to pay for those tests.
So there’s this problem with a lot of young artistic media. The big thing that prevents art from getting made is that it’s labor-intensive, and this is especially true in the case of stuff like films, video games, or even comic books. It’s a Herculean effort to get these things made, and takes a team, and that team needs to eat.
So, you need money. Where does it come from?
Cost recovery - double dipping or a pigovian tax?
In these days of government budget deficits, cost recovery has become a popular catch-cry. While it has legitimate uses in terms of making the “polluter pay”, there is a darker side to cost recovery.
When it is used to fund the targeted regulation of a particular industry or group its use should (generally) be commended. However, when governments force regulators to achieve efficiency improvements year-on-year or when they decide that the budget is just too bloated and needs some razor sharp cutbacks, then cost recovery offers an enticing way of raising revenue and side-stepping the government’s budget cuts.
So what’s a regulator to do? And what should the regulators’ regulator (ie. the Treasury Department) do about this?
In the first instance, one needs to recognise that the government is creating a system of incentives that perversely induces regulatory agencies to turn to any and all methods of raising revenue.
Without sufficient revenue the ability of a regulator to perform its compliance monitoring and enforcement role diminishes, which in turn leads to all sorts of unhappy consequences for the agency.
While the good fight may be fought for a while, eventually budgetary pressures become so intense that the agency is forced to look at raising revenue in ways it didn’t originally envisage. Cost recovery is a particularly tempting revenue-raising method because it is cloaked in righteousness - of course it is right to ask the polluter to pay for policing!
Eventually though, cost recovery leads to a changing of the relationship between regulator and regulatee. And over time it often leads to perverse regulatory outcomes and regulatory capture.
For example, the terms “due process”, “transparency” or “good governance” inevitably lead to the government regulator being transparently accountable for the funds it sources from the industry it regulates. Indeed, industry often demands that the regulator opens its books and proves that it isn’t wasting time and money and that it is operating efficiently.
And if the method of cost recovery is not selected very carefully - taking into account the expectations and norms of the industry being regulated - one can create a scenario where there is a breakdown in discussions and communication between the industry and the regulator. For example, if hourly rates are used to charge companies for the regulator’s time and resources provided to them, these companies have a real incentive NOT to seek the attention of the regulator.
Other perverse incentives are created as well, but we’ll leave the details of this for another time.
Turning back to what Treasury Departments should do about inappropriate cost recovery…there is only one solution and that is improved rules and improved monitoring. A decent set of cost recovery guidelines that set limits on how cost recovery can/should be implemented are the first order of business.
Essentially, through cost recovery guidelines, the Treasury is looking to ensure that the “optimum” level of cost recovery is utilised. Enough so that the polluter indeed pays, but not so much that perverse incentives are created.
A key aspect of the guideline - which ensures the reader understands how they should apply cost recovery - lies in its opening paragraph. This should state, quite emphatically, that “Cost recovery is not the same thing as covering your capital and operating expenditure”. This point is the key to the successful and appropriate use of cost recovery by a regulator.
And, of course, appropriate risk-based compliance monitoring should be undertaken by Treasury…just to give regulators the message that they will be looked at and that their performance will dictate just how closely Treasury will run the rule over them.