Valuation of Government Policies and Projects

Abstract

Governments play a central role in the allocation of capital and risk in the economy. Evaluating the cost to taxpayers of government investments requires an assumption about the government's cost of capital. Governments often take their borrowing rate to be their cost of capital, which implicitly treats the market risk associated with their activities as having no cost to taxpayers. This article reviews the theoretical and practical rationale for treating market risk as a cost to governments, presents an interpretive review of the growing literature that applies the concepts and tools of modern finance to evaluating the costs of government policies and projects, and suggests directions for future research. Examples considered include deposit insurance, Fannie Mae and Freddie Mac, the Federal Reserve's emergency lending facilities, student loans, real infrastructure investments, and public pension plans.

Risk Mitigation and Sharing in Motorway PPPs: A Comparative Policy Analysis of Alternative Approaches

“…Although taxpayers are residual claimants who bear project risk in the traditional delivery case (Lucas 2010(Lucas , 2012, non-tradability means that no price for the claim can be established. Risk therefore cannot be transparently priced in the traditional case.…”

Social Risk, Fiscal Risk, and the Portfolio of Government Programs

“…, is the risk premium stemming from the cyclicality of taxes and re ‡ects the interaction between the government's social and …scal risk management motives. Speci…cally, if a program leads to increased taxes in bad times, tax distortions reduce private consumption precisely when it is most valuable, leading the 11 In contrast to U.S. budgeting procedures, economists have frequently argued-see Lucas (2012) and the citations within-that the government should include a risk adjustment term Cov [M 1 ; X 0 1 (q)] when assessing the budgetary cost of government programs. Of course, as Lucas (2012) notes, a proper cost-bene…t analysis requires one to risk adjust both the social bene…ts and and the outlays associated with a program-i.e., one adds…”

Pricing Government Credit: A New Method for Determining Government Credit Risk Exposure

“…2 Furthermore, these estimates were to be updated annually to reflect information on the actual and expected program performance. However, a growing literature contends that the FCRA underestimates the true costs associated with these programs and that a "fair value approach" offers a better metric for evaluating the costs that federal guarantees impose on taxpayers (see, for example, Congressional Budget Office [2012]; Lucas [2014a,b]; Hanson, Scharfstein, and Sunderam [2016]; Kelly, Lustig, and Van Nieuwerburgh [2016]; Lucas, [2012Lucas, [ , 2016; and Heaton, Lucas, and McDonald [2010]). 3 In general, the distinction between the FCRA and fair value methods rests on the choice of the discount rate used in determining the present values of the programs.…”