Finance

Calculating the Social Cost of Policymaking

Former Maryland Gov. Martin O'Malley, a possible presidential contender, wants more states to adopt a new measurement tool called "net present value plus."
by | February 12, 2015

There's something a little odd about a recent analysis completed for the Maryland Department of Budget and Management. Looking at the cost effectiveness of various state fleet vehicles, the review not only evaluated the cost of fuel, maintenance and insurance, but also "the social cost of carbon emissions." Just how do you even measure a so-called social cost?

In this case, it was done using something called the net present value plus (NPV+), which is a new way to include social and environmental impacts into the overall cost of something. The concept is an expansion of the more common NPV analysis that calculates the lifetime value of a purchase in present terms by incorporating upfront costs with potential savings and expenses down the road, all while accounting for inflation. The "plus" adds tangential factors like the cost of environmental degradation and benefits like ecological resiliency.

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"None of us would buy a home or car if we looked at the outlay in any given year," says former Gov. Martin O'Malley, who opened up the state's capital budget last year to the concept. "But over the course of many years, a car gets us to and from work, and a home gives us a loving place to raise a family. For states, it is important we have a better understanding about what an investment returns over its lifecycle: The sum of the purchase price plus the benefits that come back to us as a people."

The analysis, conducted by the consulting firm Global Footprint Network (GFN), compared the 10-year cost of a Ford Focus -- the state has 745 in its fleet -- with the state's one all-electric Nissan Leaf, which was about twice the initial cost of a Focus. It arrived at the social cost using the Environmental Protection Agency's "social cost of carbon" schedule. In that schedule, carbon dioxide costs climb from $36.34 per tonne (in adjusted 2013 dollars) in 2014 to $46.69 per tonne in 2024. Using three scenarios for gas price trends, the report found that the difference between owning the cars over a decade ranged from no difference at all to the Leaf costing 20 percent more. However, the report concludes that based on Nissan Leaf price trends abroad, the car will actually be cheaper to own and maintain within the next two years.

That gets to the how of measuring social or environmental impact. But the tough part is arguing why states should bother doing this. In Maryland, the answer was relatively easy. As governor, O'Malley was a sustainability champion: He was among the first at the state level to promote the idea of guiding policy and budget decisions using the genuine progress indicator, which measures how development activities impact long-term quality-of-life issues. So for a sustainability guy who is considering a presidential run next year, the work by GFN helped provide the basis for one of O'Malley's last executive orders, which was to direct the state to buy more zero emissions vehicles.

But elsewhere, it's a concept that's tough to sell, especially in a climate where governments are hesitant to spend more money. Perhaps nowhere is that sentiment more obvious than in governments' reticence to issue more debt in the municipal market, despite the fact that interest rates are at all-time lows. In fact, in Iowa, government debt issuance has slowed so much that State Treasurer Michael Fitzgerald is actually urging the state and localities to borrow more money, arguing that governments are missing an opportunity to serve their public at a lower overall cost. And now that Maryland is under the leadership of Republican Gov. Larry Hogan, who has started methodically undoing some of O'Malley's environmental policies, it's unlikely the Democrat's holistic approach to capital budgeting will stick.

The main hurdle to an NPV+ approach, said National Association of State Budget Officers' Scott Pattison, is that there's still the matter of spending more money right now. State revenues have not recovered from the recession. Still, a tool that potentially provides a financial measure for social impact could provide good ammunition for policymakers, Pattison said. And to O'Malley, who brought the highly successful performance measuring tool StateStat to Maryland eight years ago, the concept represents another way to back up policy decisions with numbers. Investing in capital programs, he said, should be no different than the mindset we have toward education investment: that the more kids learn, the more they will eventually earn. "These policies do make a difference, but they require a more holistic understanding of their cost over a lifecycle and their benefits as opposed to this straight jacket approach to budgeting."

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