October 10, 2017

Distributionally Weighted Cost-Benefit Analysis: From Theory to Practice

In CBA practices around the world, benefits are valued regardless of to whom they accrue. This disregards basic economic principles, like declining marginal utility of income, or inequality aversion. This paper argues that if redistribution matters, net benefits must be aggregated using a distributionally weighted CBA. We introduce the building blocks to do so, i.e. a marginal welfare weight selection, a weight normalization and benefit accounting choices, and an analysis of redistribution effects.

A case study about child care benefits in the Netherlands is presented as an illustration. We conclude that guidelines on welfare weights, normalization and practical issues are needed to facilitate experiments with case study applications of marginal welfare weights. We also argue that although distributionally weighted CBA more closely adheres to theoretical foundations, it may be demanding, prone to misuse and might distract attention from the decision problem at hand. Ultimately, welfare weighting could undermine political support for CBA. We end with a summary of other ways to highlight income redistribution in CBAs, like an overview of purchasing power effects. If these are insufficient for informed decision-making, distributionally weighted CBA could be considered as a complementary tool for policies that involve major equity effects.