An Axiomatic Framework for Cost-Benefit Analysis

TL;DR

This paper introduces the Relative Policy Value (RPV), an axiomatic measure for cost-benefit analysis that overcomes MVPF limitations, providing more reliable welfare comparisons and aggregations in policy evaluation.

Contribution

Develops a new axiomatic framework to construct RPV, improving welfare analysis by addressing MVPF's paradoxes and aggregation issues without losing core properties.

Findings

RPV allows better welfare comparison and aggregation.

Reanalysis shows uncertainty in previous MVPF-based policy evaluations.

Provides computational methods for statistical inference on welfare measures.

Abstract

In recent years, the Marginal Value of Public Funds (MVPF) has become a popular tool for conducting cost-benefit analysis; the MVPF relies on the ratio of willingness-to-pay for a policy divided by its net fiscal cost. The MVPF gives policymakers important information about the equity-efficiency trade-off that is not necessarily conveyed by absolute welfare measures. However, I show in this paper that the usefulness of MVPF for comparative welfare analysis is limited, because it suffers from several empirically important economic paradoxes and statistical irregularities. There are also several practical issues in using the MVPF to aggregate welfare across policies or across population subgroups. To address these problems, I develop a new axiomatic framework to construct a measure that quantifies the equity-efficiency trade-off in a better way. I do so without compromising on the core features of the MVPF: its unit-free property, and the main preference orderings underlying it. My axiomatic framework delivers a unique (econo)metric that I call the Relative Policy Value (RPV), which can be weighted to conduct both comparative and absolute welfare analyses (or a hybrid combination thereof) and to intuitively aggregate welfare (without encountering the issues in MVPF-based aggregation). I also propose computationally convenient methods to make uniformly valid statistical inferences on welfare measures. After reanalyzing several government policies using my new econometric methods, I conclude that there is substantial economic and statistical uncertainty about welfare of some policies that were previously reported to have very high or even "precisely estimated infinite" MVPF values.