## Circular A-4

September 17, 2003

TO THE HEADS OF EXECUTI V E AGENCIES AND ESTABLIS H MENTS

Subject: Regulatory Analysis

This Circular provides the Office of Managem e nt and Budget’s (OMB = s) guidance to Federal agencies on the developm ent of regulator y analysis as required u nder Section 6(a)(3 )(c ) of Executive Order12866, A Regulatory Planning and Review, @ the Regulatory Right-to-Know Act, and a variety of related authorities. The Ci rcular also pro v ides guid a n ce to agen cies on the regulatory accounting statem ents that are re quired under the Regulator y Right-to-Know Act.

This Circular refines O M B = s A best practices @ docum e nt of 1996 ( http://www.whitehouse.gov/om b/inforeg/riaguide.htm l ), which was issued as a guidance in 2000 ( http://www. whitehouse.gov/omb/ m e m o randa/m 00-08.pdf ), and reaffir m ed in 2001 ( http://www.whitehouse.gov/om b/ m e moranda/m 01-23.htm l ). It replaces both the 1996 A best practices @ and the 2000 guidance.

In developing this Circular, OMB first de veloped a draft that was subject to public comment, interagency review, and peer review . Peer reviewers in cluded Cass Sunstein, University of Chicago; Lester L a ve, Carneg ie M e llon Unive r sity; Milton C. W e instein and
Jam e s K. Hammitt of the Harvard School of Pub lic Health; K e rry Sm ith, North Carolina State University; Jonathan Weiner, Duke Universi ty L a w School; Douglas K. Owens, Stanford University; and W

. Kip Viscusi, Harvard La w School. Altho ugh these in dividuals su bm itted comments, OMB is solely responsible fo r the final content of this Circular.

A. Introductio n

This Circular is designed to assist analysts in the re gulatory agencies by defining good regulatory analysis

B called either A regulatory analysis @ or A anal ysi s @ for brevity

B and standardizing the way bene fits and costs of Federa l regulatory actions are m e asured and reported. Executive O r der 12866 requires agencies to cond uct a regulatory analysis for econom i c ally significant regulatory actions as defined by Sect ion 3(f)(1). This requirem ent applies to rulem a kings that rescind or m odi f y existing rules as well as to rulem a kings that estab lish new requirem e nts.

The Need for Analysis of Proposed Regulatory Actions 1

Regulatory analysis is a tool regulato r y agencies use to an tic ipate and ev a l uate the lik e ly consequences of rules. It provides a f o rm al way of organizing the evid ence on the key effects

B

1 W e use the te r m

“prop o se d” t o refe r to any r e gulato r y action s u n d e r co nsid eration regardless of th e stage of th e regu lato ry pro c ess.

1good and bad

B of the various alternatives that should be considered in developing regulations. The m o tivation is to (1) learn if the b e nef its of an action are likely to justif y the cos t s o r (2) discover which of various possible alterna tives would be the most cost-effective.

A good regulatory analysis is designed to inform the public and other parts of the Governm e nt (as well as the agency conducting the analysis ) of the effects of alternative actions. Regulatory analys is so m e ti m e s will show that a proposed action is m i sg uided, but it can also dem onstrate that well-conceived ac tions are reasonable and justified.

Benef it-cos t analys is is a prim ar y tool used for regulatory analysis. 2 W h ere all b e nef its and costs can be quantified and expressed in m o netary units, benefit-co st analysis provides decision m a kers with a clear indica tion of the m o st efficient altern ative, th at is, the a lte rnative that generates the largest net benefits to society (ignoring distributional eff ects). This is useful inform ation for decision m a kers and the public to receive, even when econom i c efficiency is not the only or the overriding pub lic policy objective.

It will not always be possible to express in m onetary units all of the im portant ben e f its and costs. When it is n o t, the m o st efficient al ternative will not necess a r ily be the on e with the largest quantified and m onetized net-benefit estim a te. In such cases, you should exercise professional judgm ent in determ ining how i m portantthe non-quantified bene fits or costs m a y be in the context of the overall analysis. If the non-quantified benefits and costs are likely to be im portant, you should carry out a A threshold @ ana l ysis to ev alu a te th ei r significance. T h reshold

or A break-ev e n @ analysis answers the question, A H o w s m all could the valu e of the non-quantified benefits be (or how large would the value of the non-quantified costs need to be) before the rule would yield zero net benefits? @ In addition to threshold anal ysis you should indicate, where possible, which non-quantified effect s are m o st important and why.

Key Elemen ts of a Regu latory Analysis

A good regulatory analysis should include th e following three basic elem ents: (1) a

statem ent of the need for the proposed action, (2) an exam ination of alte rnative approaches, and (3) an evaluation of the benef its and costs—quantitative and qua litative—of the proposed action and the m a in alte rnative s identif i ed by the ana l y s is.

To evaluate properly the benefits and costs of regulations and their alternatives, you will need to do the following:

• Explain how the actions required by the rule are linked to the expected benefits. For

exam ple, indicate how addition a l saf e ty equi pm ent will reduc e saf e ty r i sk s. A sim ilar analysis sho u ld be done fo r each of the alternativ es.

• Identify a baselin e. Benefits and cos t s are defined in com p arison with a clearly s t ated alte rnative. This norm a lly will b e a A no action @ b a seline: wh at the wor l d will be like if the proposed rule is not a dopted. Comparisons to a A next best @ alterna tive are also especially u s eful.

2 See Misha n E J (1994), Co st -Ben efit Ana l ysis , f o urt h e d i t i on, R o ut l e dge

, New Y o r k

.

2• Identify the expected undesirable side-eff ects and ancillary benefits of the proposed regulatory action and the alternatives. These should be added to the direct benefits and costs as appropriate.

W ith this inform ation, you should be able to assess quantitatively the benefits and costs of the proposed rule and its alte rnatives. A com p l e te regulatory analysis includes a discussion of non-quantified as well as quantified benefits and costs. A non-quantified outcom e is a benefit or cost that has not been quantifie d or monetized in the analysis. W h en there are important nonmonetary values at stake, you should also iden tif y them in your analysis so policym akers can

com p are them with the monetary benefits and costs. W h en your analysis is com p lete, you should present a summ ar y of the benefit and cost estim ates for each altern ative, includ ing the qualitative and non-m o netized fact ors affected by the rule, so th at readers can evaluate them

.
As you design, execute, and write your regul atory analysis, you should seek out the opinions of those who will be af f ecte d by the reg u lation as w e ll a s the v i e w s of those individua ls and organizations who m a y not be affected but have special knowledge or insight into the regulatory issues. Consultation can be useful in ensuring that your analysis addresses all of the relevant issues and that you have access to a ll pe r tinen t data. Ea rly consultation can be especially helpful. You should not lim it consultati on to the final stages of your analytical efforts.

You will find that you cannot condu ct a good regul ato r y analysis accord ing to a formula. Conducting high-quality analys is req u ires com p etent p r ofessional judgm ent. Different regulations m a y call for different emphases in the analysis, dependi ng on the nature and

com p lexity of the regulatory issues and the sensitivity of the benef it and cost es tim ates to th e key

assum p tions.

A good analysis is transparent. It should be possible for a qualified third party reading the report to see clear ly how you arrived at your estim ates and conclusions. For transparency = s sake, you should state in your report what assumpti ons were used, such as the tim e horizon for the analysis and the discount rates ap plied to future benefits and cost s. It is usually necessary to provide a s e nsitiv ity ana l ysis to rev e al whethe r, a nd to what extent, the r e sults of th e analys is ar e sensitive to plausib l e ch anges in the m a in assumptions and num e ric inputs.

A good analysis provides specific references to all sources of data, appendices with docum entation of m odels (where nec e ssary ), a nd the resu lts o f f

o rm al sensitiv ity and other uncertainty analyses. Y our analysis should also have an executive summ ary, including a standardized account ing statem ent.

B. The Need for Federal Regulatory Action

Before recommending Federal regulatory action, an agency must dem o nstra t e th at th e proposed action is necessary. If the regulatory in tervention results from a statutory or judicial directive, you should describe the specific au thority for your action, th e extent of discretion available to you, and the regulat ory instrum e nts you m i ght use. Executive Order 12866 states that A Federal agencies should prom ulgate only such regulations as are required by law, are

necessa ry to inte rpre t the law, or ar e m a de necessary by com p elling need, such as m a terial

3f a ilures of p r iva t e m a rkets to pro t ec t or im pr ove the health and safe ty of the public, the environm ent, or the well bei ng of the Am erican people ... . @

Executive O r der 12866 also states that A Each agen cy shall iden tify the prob lem that it intends to address (including, where applicable, the failures of private m a rkets or public institutions that warrant new agency action ) as w e ll as assess the significance of that problem

. @ Thus, you should try to explain wh ether the action is intended to address a significant m a rket failure or to m eet som e other com p elling public need such as improving governm e ntal processes

or prom oting intangible values such as distribu tional fairness or privac y. If the regulation is designed to correct a significant m a rket failure, you should describe the failure both qualitatively and (where feasible) quan titatively. You should show that a governm e nt intervention is likely to do m o re good than harm . For other interventions , you should also provide a dem onstration of

com p elling social purpose and the likelihood of e ffective action. Although intangible rationales do not need to be quantified, the analysis s hould present and evalua te the strengths and lim itations o f the relev a n t argum ents f o r these in tangible v a lu es.

Market Failure or Other Social Purpose

The m a jor types of m a rket fa ilu re in clude: exte r n ality, m a rk et power, and inadequate or

asymm e tric inform ation. Correcting m a rket failu res is a reason for regul ation, but it is not the only reason. Other possible justifications include im proving the functioning of governm e nt,

rem oving distributional unfairness, or prom oting privacy and personal freedom

.

1. Externality, common property resource and public good

An externality occurs when one party' s ac tions im pose uncompensated benefits or costs on another party. Environm ental problem s are a cl ass i c case of external ity. For example, the

sm oke from a factory m a y adversel y affect the health of loca l residen t s wh ile soiling the property in nearby neighborhoods. If bargaining were costle ss and all property rights were well defined, people would elim inate externalities through bargaining without the need for governm e nt regulation. 3 From this perspective, ex ternalities arise from high tran sactions costs and/or poorly defined prop erty rights th at prev ent p e ople fr om reaching efficient ou tco m es through m a rket transactions.

Resources that m a y becom e congested or ove rused, such as fisheries or the broadcast spectrum
, represent common property resources. A Public goods, @ such as defense or basic scientific research, are goods where provision of the good to som e individuals cannot occur without providing the sam e level of benef its free of charge to other individuals.

2. Market Pow e r

Firm s exercise m a rket power when they redu ce output below what would be offered in a

com p etitive industry in o r der to ob tain higher prices. They m a y exercise market power collectively or unilaterally. Gove rnm e nt action can be a source of m a rket power, such as when regulatory actions exclude low-co st im ports. Generally, regulati ons that increas e m a rket power

3 See C o ase R H (1960), Jou r na l o f La w and Econ om ics , 3, 1- 4 4

.

4for selected entities should be avoided. Howe ver, there are so m e circum stances in which

governm e nt m a y choose to validate a m onopoly. If a m a rket can be served at lowest cost only when production is lim ited to a single producer

B local g a s an d electricit y distribution services, for exam ple

B a natural monopoly is said to exist. In such cases, the governm ent m a y choose to approve the monopoly and to regula te its prices and/or producti on decisions. Nevertheless, you should keep in m i nd that technological advances often affect econom ies of scale. This can, in turn, transform what was once consid ered a na tural m onopoly into a m a rket where co mpetition can flourish.

3. Inadequate or Asymmetric Inform ation

Market failu res m a y also result from inad equate o r asymm e tric inform ation. Because inform ation, like o t her g oods, is cos t ly to produ ce and dissem i nate, your evaluation will need to do m o re than dem onstrate the possible existence of incom p lete or asymm e tric inform ation. Even though the m a rket m a y supply less than the full am ount of infor m ation, the am ount it does supply m a y be reasonably adequate and therefor e not require governm e nt regulation. S e llers have an incentive to provide inform ation th rough advertising that can increase sales by highlighting distinctive characte ristics of their products. Buye rs m a y also obtain reasonably adequate inform ation about product characteris tics through other channels, such as a seller offering a warranty or a thir d party providing inform ation.

Even when adequate inform ation is availabl e, people can m a ke m i stakes by processing it poorly. Poor inform ation-processing often occurs in cases of low probability, high-consequence events, bu t it is not lim ited to such s i tuations . For instance, people som e tim e s rely on m e ntal rules-of-thumb that produce errors. If they ha ve a clear m e ntal im age of an incident which

m a kes it cognitiv ely A availab l e, @ they m i ght overstate th e prob ability th at it will occu r. Individuals som e ti m e s process inform ation in a biased m a nner, by being too optim istic or pessim i stic, without taking sufficien t account of the fact that the outcom e is exceeding l y unlik ely
to occur. W h en m i stakes in inform ation pro cessing occur, markets m a y overreact. When it is tim e-consum ing or costly for consum ers to evaluate com p lex inform ation about products or services (e.g ., m e dical th erapies), they m a y e xpect governm e nt to ensu re that m i ni m u m quality standards are m e t. However, the m e re possibi lity of poor inform ation processing is not enough to justify regulation. If you think there is a prob lem of infor m ation processing that needs to be addressed, it should be carefully docum ented.

4. Other Social Purposes

There ar e ju stif ica tions f o r regulatio ns in addition to correcting m a rket failures. A regulation m a y be appropriate when you have a clearly identified m easure that can make

governm e nt operate m o r e efficiently. In a ddition, Congress establ ishes som e regulatory

program s to redistribute resources to select groups. Such regulations should be exam ined to ensure that they are botheffective and cost-effective. Congre ss also authorizes som e regulations to prohibit discrim i nation that conflicts with generally accepted norm s wi thin our society. Rulem a king m a y also be appropr iate to protect privacy, perm i t m o re personal freedom or prom ote other dem o cratic aspirations.

5Showing That Regulatio n at the Fed e ral Leve l Is the Best W a

y to Solve the Problem

Even where a m a rket failure clearly exists , you should consider other m e ans of dealing with the failure before turning to Federal regulat ion. Alternatives to Fe deral regulation include antitrus t enforcem ent, consum er-initiated li tigation in the product liability system , or adm i nistrative com p ensation sys t em s.

In assessing whether Federal regulation is th e best solution, you should also consider the possibility of regulation at the S t at e or local level. In som e cases, the nature of the market failure

m a y itself suggest the m o st appropriate govern m e ntal level of regulation. For exam ple, problem s that spill acros s State lines (such as acid rain whose precursors are transported widely in the atm o s phere) are probably be st addressed by Federal regulat ion. More localized problem s, including those that are common to m a ny areas, m a y be more efficiently addressed locally.

The advantages of leaving regulatory issues to State and lo cal authorities can be substantial. If public values and pref erences differ by region, t hose differences can b e reflected in vary ing State and loca l regu lato ry polic ies. M o reover, States and localities can serv e as a testing ground for experim e ntation with alterna t ive regu lato r y polic ies. One State ca n learn f r om another = s ex perien ce while local jurisdictions m a y com p ete with each other to establish the best regulatory policies. You should exam ine the prope r extent of State and local discretion in your rulem a king context.

A diversity of rules m a y generate gains fo r the public as governm e ntal units com p ete with each o t her to serve the public , b u t duplicativ e regulation s can also b e costly. W h ere Federal regulation is clearly appr opriate to address interstate comm er ce issues, you should try to exam ine whether it would be m o re efficient to retain or reduce State and local regulation. The local benefits of State regulation m a y not justif y the na tiona l co sts of a fragm e nted regulatory system

. For exam ple, the increas ed com p liance costs fo r firm s to m e e t different State and local regulations m a y exceed any advantages associat ed with the divers ity of State and lo cal regulation. Your analysis should consider the possibility of re ducing as well as expanding State and local rulem a king.

The role of Federal regulation in facilitating U.S. particip ation in global markets should also be considered. Harmonization of U.S. and i n ternational rules m a y require a strong Federal regulatory role. Concerns that new U.S. rules could act as non-tariff ba rriers to im ported goods should be evaluated carefully.

The Presumption Against Economic Regulation

Governm e nt actions can be unintentionally ha rmful, and even useful regulations can im pede m a r k et efficiency. For this reason, ther e is a presum ption agai nst certain types of regulatory action. In light of both econom i c theory and actual experience, a particularly dem a nding burden of proof is required to dem o nstr ate the need for any of the following types of regulations:

• price contro ls in com p etitive m a rkets ;

6• production o r sales quotas in com p etitive m a rkets ;

• m a ndatory uniform quality stand a rds for goods or services if the potential problem can be adequately dealt with thr ough voluntary standards or by di sclosing inform ation of the hazard to bu yers or us ers ; or

• controls on entry into employm e nt or pr oduction, except (a) where indispensable to protect health and safety (e.g., FAA tests for co mm ercial pilots) or (b) to m a nage the use of comm on property resources (e.g., fisheries, airwaves, Federal lands, and offshore

areas ).

C. Alternativ e Regulatory Approaches

Once you have determ ined that Fed e ral regulat ory action is appropria te, y ou will need to consider alternative regulatory approaches. Ordinarily, you wi ll be able to elim inate som e alternatives through a prelim inary analysis, leaving a m a nage able num ber of alternatives to be evaluated according to th e for m al principles of the Executive Orde r. The num b er and choice of alternatives selected for detailed analysis is a m a tter of judgment. There must be some balance between thoroughness and the practical lim its on your analytical capacity. W ith this qualification in m i nd, you should nevertheless explore m odifi cations of some or all of a regulation = s attributes or provisions to identify appropriate alte rnatives. The f o llowing is a list o f alterna tive regula t ory actions that you should consider.

Differen t Choices Defined by Statu t e

When a statute es tablish e s a specific re gulatory requirem e nt and the agency is considering a m o re stringent standard, you should exam ine the benefits and costs of reasonable alternatives that reflect the range of the agency = s statutory discretion, including the specific

statu t ory req u irem ent.

Differen t Complianc e Dates

The tim ing of a regulation m a y also have an im portant effect on its ne t benefits. Benefits

m a y vary significantly with different com p lian ce dates where a delay in im ple m entation m a y result in a substantial loss in future benefits (e.g., a delay in implem e ntation could result in a significant reduction in spawning stock and jeopard ize a fishery). Sim ilarly, the cost of a regulation m a y vary substantially with different com p liance dates for an industry that requires a

year or m o re to plan its production runs. In th is instance, a regulation that provides sufficient lead tim e is likely to achieve its goals at a m u ch lower overall cost th an a regulation that is effective imm e diately.

Differen t Enforcemen t Methods

Com p liance alte rnatives f o r Federal, Stat e, o r local enforcem ent include on-site inspections, periodic reporting, and noncom pliance penalties stru ctured to provide the most appropriate incentives. When alte rnative m onitoring and reporting m e thods vary in their benefits and costs, you should identify th e m o st appropriate enforcem ent fra m e w ork. For exam ple, in

7som e circum stances random m onitoring or param e tric m o nitoring will be less expensive and nearly as effective as continuous m onitoring.

Differen t Degrees of S t ringency

In general, both the benefits and costs associ ated with a regu lation will in creas e with the level of stringency (although m a rginal costs generally incr ease with stringency, whereas

m a rginal benefits m a y decrease). Y ou should study alternative levels of stringency to understand more fully the relationship between stringency a nd the size and distribution of benefits and costs

am ong diffe r ent groups.

Differen t Requirements for Different Sized Firms

You should consider setting di fferent requirem e nts for large and sm all firm s, basing the requirem e nts on estim ated differences in the exp ected co sts o f com p liance or in the expected benefits. The balance of benef its and costs can shift depending on the size of the firm s being regulated. S m all fir m s m a y find it more costly to com p ly with r e gula tio n, especially if there a r e large fixed costs required for regulatory com p lian ce. On the other hand, itis not efficient to place a h eav ier burd e n o n one segm ent of a regulated indu stry solely b e cause it can b e tte r afford the higher cost. This has the poten tial to load costs on the m o st productive firm s, costs that are disproportionate to the dam a ges they create. You should also rem e m b er that a rule with a signif i can t impact on a s ubstantial nu m b er of sma ll en tities w ill tr igger th e requirem e nts set f o r t h in the Regulatory Flexibility Act. (5 U.S.C. 603( c), 604).

Differen t Requirements for Different Geographic Regions

Rarely do all regions of the country benefit uni form ly from governm e nt regulation. It is also unlikely that co sts will be un iform l y di strib u ted across the country. Where there are significant regional variations in benefits and/or costs, you shoul d consider the possibility of setting different requirem e nt s for the different regions.

Performance Standards Rather than Design Standards

Perform a nce standards express requirem e nts in term s of outc o m e s rather than specifying the m eans to those ends. They are generally supe rior to engin eering o r design stand a rds because perform a nce standards give the regulated parties the flexibility to achieve regulatory objectives in the m o st cost-effectiv e way. In general, you should take into accoun t both the co st savings to the regu lated parties of the greater flexibi lity and the cos t s of assuring co mpliance th rough monitoring or som e other m eans.

Market-Oriented Approaches Rather than Direct Controls

Market-oriented approaches that use econom ic incentives should be explored. These alte rnatives include f ees, penalties, s ubsidies, m a rketable perm its or offse t s, changes in liab ility or property rights (including policie s that a lte r th e incentives o f in surers and insured parties), and required bonds, insurance or warranties. One example of a market-oriented approach is a

8program that allows for averaging, banking, a nd/or trading (ABT) of credits for achieving additional em ission reductions beyond the required air em ission standards. ABT program s can be extrem ely valuable in reducing costs or achiev ing earlier or greater bene f its, par tic ular ly when the costs of achieving compliance vary across production lin es, facilities, or firm s. ABT can be allowed on a plant-wide, firm -wide, or region-wide basis ra ther than vent by vent, provided this does not pro duce unacceptable local air quality o u tcom es (such as A hot spots @ from local pollution co ncentr ation )

.
Information a l Measures Rather than Regulatio n

If intervention is contemplated to ad dress a m a rket failu re th at arises from inadequate or

asymm e tric inform ation, inform ational rem e dies will often be preferred. Measures to im prove the availability of information include governm e nt establishm ent of a st andardized testing and rating system (the use of which could be m a ndatory or voluntary), m a ndatory disclosure requirem e nts (e.g., by advertising, labeling, or enclosures), and governm e nt provision of inform ation (e.g., by governm ent publications, tele phone hotlines, or public interest broadcast

announcem e n ts). A regulatory m easure to im prove the availability of in form ation, particularly about the co ncealed characteristics of products , p r ovides consum ers a greater cho i ce th an a

m a ndatory product standard or ban.

Specific inf o rm ational m easures should be evalua ted in term s of their benefits and costs. Som e effects of infor m a tional m easures ar e easily overlooked. The costs of a m a ndatory disclosu re requirem e nt for a consumer product w ill includ e n o t only th e cost of gathering and communicating the required inform ation, but also the loss of net benefits of any infor m ation displaced by the m a ndated inform ation. The other costs also m a y include the effect of providing inform ation that is ignored or m i sinterpreted, an d inefficiencies ar is ing f r om the ince ntive that

m a ndatory disclosure m a y give to overinvest in a particular characteristic of a product or service.

Where inform ation on the benefits and costs of alternative info rm ational measures is insufficient to provide a clear choice between them, you should consider the least intrusive inform ational altern ativ e sufficient to accom p lish the regu latory objectiv e. To correct an inform ational m a rket failure it m a y be sufficien t for governm e nt to esta blish a standardized testing and rating system without m a ndating its u s e, because com p eting firm s that sco r e well accord ing to the system should thereby ha ve an incentiv e to publicize th e fact.

D. Analytical Approaches

Both benefit-cost analysis (BCA) and co st-effectiveness analysis (CEA) provide a system atic fram ework for iden tifyin g and ev aluating the likely outco m e s of alterna tiv e regulatory choices. A major rulem a king should be supported by both types of analysis wherever possible. Specifically, you should prepare a CEA for all m a jor rulem a kings for which the prim ary benefits are im proved public health and sa fety to the extent that a valid effectiveness

m easure can be developed to represent expected health and safety outcom e s. You should also perform a BCA for m a jor health and safety rulemaki ngs to the extent that valid m onetary values can be assigned to the prim ary expected hea lth and safety outcom e s. In undertaking these analyses, it is im portant to keep in m i nd the larger objective of anal ytical consistency in

9estim ating benefits and costs across regulations a nd agencies, subject to statutory lim itations. Failure to maintain such consistency m a y preven t achievem e nt of the m o st risk reduction for a given level of resource expenditure. For all other m a jor rulem a kings, you should carry out a BCA. If som e of the prim ary benefit categorie s cannot be expressed in monetary units, you should also conduct a C E A. In unusual cases wh ere no quantified information on benefits, costs and effectiveness can be produced, the regulatory analysis should present a qualitative discussion of the issues and evidence.

Benefit-Cost Analysis

A distinc tiv e f eature of BCA is that both benefits and cost s are expressed in m onetary units, which allows you to evaluate different regula tory options with a vari ety of attributes using

a common m easure. 4 By m easuring increm ental benefits and costs of successively more stringent regulatory alternatives , you can identify the al ternative that m a xim i zes net benefits.

The size of net benefits, the absolute differe nce b e tween the p r ojected ben e fits and cos t s, indicates whether one policy is m o re efficient than another. T h e ratio of benefits to co sts is no t a

m eaningful indicator of net benefits and should not be used for that purpose. It is well known that considering such ratios alon e can yield m i sleading results.

Even when a benefit or cost cannot be expr essed in m onetary units, you should still try to

m easure it in term s of its physical units. If it is not possible to m eas ure the physical units, you should still describe the benef it or cost qualitatively. For m o re inform ation on describing qualitative infor m ation, see the section “ Develop ing Benefit a nd Cost Estimates. ”

When i m portant benefits and costs cannot be expressed in m onetary units, BCA is less useful, and it can even b e m i sleading

, because th e calcu lation of net benefits in such cases does not provide a full evaluation of all relevant benefits and costs.

You should exercise profe ssional judgm e nt in identifying the importance of nonquantified factors and assess as best you can how they m i ght change the ranking of alternatives based on estim a ted net benefits. If the non-qua ntified benefits and costs are likely to be im portant, you should recommend which of the n on-quantified factors are of sufficient im portance to justify considera tion in the regulatory decision. This discussion should also include a clear explanation that support designating these non-quantif ied factors as im portant. In this case, you should also consider conducting a th reshold analysis to help decision makers and other users of the analysis to understand the poten tial significance of thes e factors to the overall analys is.

Cost-Effectiveness Analysis 5

4 Mish an EJ (1 99 4)

, Co st-Ben efit An a l ysis

, f o urt h e d i t i on, R out l e d g e, Ne w Yo rk

. 5 For a full disc ussion of CE A, see Gol d , ML , Si egel, JE, R u ssell, LB, a n d Weinstein, MC ( 1 996), Co st Effectiven ess in Hea lth and Med icin e: Th e Repo rt o f

th e Pan e l on C o st-Effectiven ess in Hea lth and Med icin e , Ox fo r d Uni v er sity Press, Ne w Yo rk

.

10Cost-effectiveness analy s is can p r ovide a rigo rous way to identify options that achieve the m o st effective use of the reso urces available without requiring m onetization of all of relevant benefits or costs. Generall y, co st-effectiv eness analysis is designed to compare a set of regulatory actions with the sam e prim ary outcom e (e.g., an increase in the acres of wetlands protected) o r m u ltiple o u tcom es that can be in teg r ated into a single num erical index (e.g., units of health im provem e nt).

Cost-effectiveness results based on averages ne ed to be treated with great care. They suffer from t h e sam e drawbacks as b e nefit-co st ratio s. The a lte rnative th at exhib its the sm allest cost-effectiv eness ratio m a y not be the best option, just as th e alte rnative with the h i g h est benefit-cost ratio is not alwa ys the one that m a xim i zes net benefits. Increm ental costeffectivenes s analys is (d iscussed b e low) can help to avoid m i stakes that can occur w h en policy choices are based on av erage co st-effectiveness.

CEA can also be m i sleading when th e A effectiven ess @ m easure does not appropriately weight the consequences of the altern atives. For exam ple, when effectiveness is m easured in tons of reduced pollutant em i ssions, cost-effectiv eness es tim ates will be m i sleading unless the reduced em issions of diverse pol luta nts resu lt in the sam e health and env i ronm ental b e nef its.

When you have identified a range of alternatives (e.g., different levels of stringency), you should determ ine the cost-effectiven ess of each opti on com p ared with the baseline as well as its increm ental cost-effectiv eness com p ared with suc cessively more stringent requirem e nts. Ideally, your CEA would present an array of cost-effect iveness estim ates that would allow comparison across different alternatives. However, analyzing all possible com b inations is not practical when there are m a ny options (including possible interaction effects). In these cases, you should use your judgm ent to choose reasonable altern atives for careful consideration.

When constructing and com p aring increm enta l cost-effectiveness ratios, you should be careful to d e term ine whether the various alternativ es are m u tually ex clus iv e or whether they can be com b ined. If they can be com b ined, you should consider which m i ght be favored under different regulatory budget constraints (im p licit or explicit). You should also m a ke sure that inferior alternatives identified by the principles of strong and weak dom i nance are elim inated from consideration. 6

The value of CEA is enhanced when there is cons isten c y in th e analys is across a div e rs e set of possible regulatory actions. To achieve consistency, you need to carefully construct the two key components of any CEA: the cost and the A effectiveness @ or perf orm a nce m e asures for the alternative policy options.

W ith regard to m easuring costs, you should be sure to include all th e relevant costs to society

B whether public or private. Rulem a king s m a y also yield cost savings (e.g., energy savings associated with new tec hnologies). The num e rator in the cost-ef f ectiveness ratio should reflect n e t costs, defined as the gro s s cost in curr e d to com p ly with the req u irem ents (s om etim es

6 G o ld ML , Sie g el JE, Rus s ell LB, a n d W e i n stein MC ( 1 996)

, Cost Effectiveness i n Healt h and Medicine: The Rep o rt of t

h e P anel o n C o st -E f f

ectiveness in Health and Me dicine

, Ox fo rd U n iv er sity Pr ess, N e w Yo rk , p p

. 2 84- 28 5.

11called A tota l @ costs) m i nus any cost savings. You should be careful to avoid double-counting effects in both the num erator and the denom inator of the cost-effectivenes s ratios. For exam ple, it would be incorrect to reduce gross costs by an estim ated monetary v a lue on life extension if life-years are already us ed as the eff ectiv eness m easure in the denom inator.

In constructing m easures of A effectiv eness @ , final outcom e s, such as lives saved or lifeyears sav e d, are preferred to m easures of interm ed iate outputs, such as tons of pollution reduced, crashes avoided, or cas es of dis ease avoided. Where th e quality of the m easured un it varies (e.g., acres of wetlands vary substantially in term s of their e c ologic a l benef i ts), it is im portant tha t the

m easure capture the variability in the value of the selec t ed A outcom e @ m eas ure. You should provide an explanation of your c hoice of effectiveness m easure.

Where regulation m a y yield several different beneficial ou tco m es, a cost-effectivenes s

com p arison becom e s m o re difficult to interpret b ecause there is m o re than one m easure of effectivenes s to inco rporate in the an alysis. To arrive at a sin g le m easure you will need to weight the v a lue of disparate b e nefit catego r ies, b u t this com p utation ra ise s som e of the sam e difficulties y ou will enco unter in BCA. If you can assign a reasonable m onetary v a lue to all of the regu latio n = s different benefits, th en you should do s o. But in this case, you will be doing BCA, not CEA.

When you can estim a te the m onetary value of some but not all of the ancillary benefits of a regulation, but cannot assign a m onetary value to the prim ary m e asure of effectiveness, you should subtract the m one tary estim ate of the ancillary benefits from the gross cost estim ate to yield an estim ated net cost. (This n e t cost es tim ate for the rule m a y turn out to be negative

B that is, the m onetized b e nefits exceed the cost of the rule.) If you are unab l e to estim ate th e value of

som e of the ancillary benefits, the cost-effectiveness ratio will be overstated, and this should be acknowledged in your analysis. CE A does not yield an unambiguous choice when there are benefits or costs that have not been incorporated in the net-co st estim a tes. You also may use CEA to compare regulatory alternat ives in cas es where the s t atute specifies the level of benefits to be achieved.

The Effectiveness Metric for Public Health and Safety Rulemakings

When CEA is applied to public health and sa fety rulem a kings, one or m o r e m easures of effectivenes s m u st be selected that p e rm its com p arison of reg u lato ry alternative s . Agencies

curren tly us e a variety o f effectiveness m easures.

There are relatively sim p le m easures such as the num b er of lives saved, cases of cancer reduced, and cases of paraplegia prevented. Sometim es these m easures account only f o r mortality inf o rm ation, such as the number of lives saved and the num ber of years of life saved. There are also m o re comprehensive, integ r ated m easures of effectivenes s such as th e num b er of "equivalent lives" (ELs) saved and the num ber of "quality-adjus ted life years" (QALYs) saved.

The m a in advantage of the integrated m easures of effectiveness is th at they account f o r a rule' s im pact on m o rbidity (nonfat al illness, injury, im pair m e nt and quality of life) as well as

prem ature death. The in clusion of morbidity eff ects is im portant becau s e (a) som e illn esses (e.g.,

12asthm a ) cause m o re instances of pain and su ffering than they do prem ature death, (b) som e population groups are known to experience elevated rates of morbidity (e.g, the elderly and the poor) and thus have a strong inte rest in m o rbidity m easurem e n t 7 , and (c) som e regulatory alternatives m a y be more effective at preven ting morbidity th an prem ature death (e.g., som e advanced airbag designs m a y di m i nish the nonfatal injuries caused by ai rbag inflation without changing the frequency of fatal in jury prevented by airbags).

However, the m a in drawback of thes e integ r at ed m easures is that they m u st m eet some restric tive as sum p tions to repres ent a va lid m easure of individ u al preferen ces. 8 For example, a QALY measure im plicitly assum e s that the f r a c tio n of re m a ining lifespan an individual would give up for an im prove ment in health-related qu ality of life does not depend on the rem a ining lifespan. Thus, if an individual is willing to give up 10 years of life am ong 50 rem a ining years for a given health im provem e nt, he or she would al so be willing to give up 1 year of lif e am ong 5

rem a ining years. To the extent that indivi dual preferences deviate from these assum p tions, analytic results from CEA using QALYs could di ffer fromanalytic results based on willingnessto-pay-m eas ures. 9 Though willingn es s to pay is g e nera lly th e preferred econom i c m e t hod for evaluating preferences, the CEA m e t hod, as applie d in m e dicine and health, does not evaluate health chang e s using ind i vidual willin gness to pay

. W h en perform i ng CEA, you should consid er using at least one integrated m easure of effectiven ess when a rule creates a significan t impact on both m o rtality and m o rbidity.

When CEA is perform e d in specific rule m a king contexts, you should be prepared to

m a ke appropriate adjustm e nts to ensure fair treatm ent of all segm ents of t h e population. Fairness is important in the choice and execution of effectiv eness m easures. For example, if QALYs are used to evaluate a lifesaving rule ai m e d at a population that happens to experience a high rate of disability (i.e., where the rule is not designed to affect the disa bility), the n u m b er of life years saved should n o t necessarily be dim i nish ed sim p ly because the rule sav e s th e lives of people with life-shortening disabili ties. Both analytic sim p licity and fairness suggest that the estim ated number of life years saved for the di sabled population should be based on average life expectan cy infor m ation for the relev a nt age coho rts. More generally, when num e ric adjustm e nts

are m a de for life expectancy or quality of life, analysts should prefer use of population averages rather than infor m ation derived from subgroups dom inated by a particular dem ographic or incom e group.

OMB does not require agencies to use any speci fic m easure of effectivenes s. In fact, OMB encourages ag encies to repo rt r e sults with multiple m easures of ef f ectiv eness that of f e r different insights and perspectives . The regulatory analysis shoul d explain which m e a s ures were selected and why, and how they were im ple m ented.

The analytic discretion provide d in choice of effectivene ss measure will create som e inconsis tency in how agencies evalu a te th e sam e injuries and diseases, an d it will be d i fficult for

7 R u ssel l LB a n d Si s k J E ( 2 00 0) , “M o d el i n g Age Di ffe renc es in C o st E ffe ctiveness Analysis”, In terna tio na l Jo urna l of Tec h nology Assessme n t i n Health Care

, 16 (4 ), 1 158 -11 6 7

. 8 Plisk i n JS, Shep ard DS, an d Wein stein MC (198 0), "U tilit y Fun c tio ns for Life Years and Health Stat u s ," Oper at i o ns Re searc h , 28 (1 ), 2 06- 224

. 9 Hammitt JK (2 002 ), "QALYs Versus WTP," Ri sk A nal ysi s , 22( 5) , pp . 985 -10 0 2

.

13OMB and the public to draw m eaningful co m p ar isons between rulem a kings that em ploy different effectiv eness m easures. As a result, ag encies sho u ld use th eir web site to provide OMB and the public with the underlying data, incl uding m o rtality and m o rbidity data, the age distribution of the affected populatio ns, and the s e verity and duration of disease cond itions and

traum a , so that OMB and the public can cons truct apples-to-apples com p arisons between rulem a kings that em ploy different measures.

There are sensitiv e techn i cal and eth i cal issues as sociated with choosing o n e or m o re of these integrated m easures for use throughout the Fe deral governm ent. The Institute of Medicine (IOM) m a y assem b le a panel of specialists in cost-ef f ectivene ss analys is a nd bioeth ics to evaluate the advantages and disadvantages of th ese different m easures and other m e asures that have been s uggested in the academ ic literatur e. OMB believ e s that the IOM guidance will provide Federal agencies and OMB useful insi ght into how to im prove the m e asure m ent of effectivenes s of public h ealth and safety regulations.

Distribution al Effects

Those who bear the costs of a regulation and those who enjoy its be nefits often are not the sam e people. The term A distributional effect @ refers to the im pact of a regulatory action across the p opulation an d econom y, divided up in various ways (e.g., incom e groups, race, sex, industrial sector, geography). Be nefits and costs of a regula tion m a y also be distributed unevenly over tim e , perhaps spanning several generations. Distributional effects m a y arise through @ transfer paym e n ts @ that stem from a regulatory action as well. For exam ple, the

revenue co llected throug h a fee, su rcharge in excess of the co st of services provided, or tax is a transfer p a y m ent.

Your regulatory analysis shoul d provide a separate descript ion of distributional effects (i.e., how both benefits and cost s are distributed among sub-populations of particular concern) so that decision m a kers can properly consider themalong with the effects on econom ic efficiency. Executive O r der 12866 authorizes this approach. Where distributive effects are thought to be im portant, the effects of various regulatory altern atives should be descri bed quantitatively to the extent possible, including the m a gnitude, like lihood, and severity of im pacts on particular groups. You should be alert for situ ations in which regulatory alte rnatives result in significant changes in treatm e nt or outcom e s for different groups. Effects on the distribution of incom e that

are transm itted through changes in m a rket prices can be im portant, albeit som e ti m e s difficult to assess. Your analysis should also present info rmation on the stream s of benefits and costs over tim e in order to provide a ba sis for assessing intertem poral distributional consequences, particularly where interg enera tional effects are concerned.

E. Identifying and Measuring Benefits and Costs

This Section provides guidelines for your prep aration of the benefit and cost estim a tes required by Executive O r der 12866 and the A Regulatory Right-to-Know Act. @ The discussions in previous sections will help you identify a workab le num ber of alternatives for consideration in your analysis and an appropriate analytical approach to use.

14General Issues

1

. S c o p e o f A n a l y s i s

Your analysis should focus on benefits and cost s that accrue to citi zens and residents of the United S t ates. W h er e you choose to evaluate a regulation that is likely to have effects beyond the borders of the United States, these eff ects should be reported separately. The tim e fra m e for your analysis should cover a period long enough to encom p ass all the im portant benefits and costs likely to result from the rule.

2

. D e v e l o p i n g a B a s e l i n e

You need to m easure the benefits and costs of a rule against a baseline. T h is baseline should be the best assessm e nt of the way the world would look absent the proposed action. The choice of an appropriate baseline m a y require consideration of a wide range of potential factors, including:

• evolution of the m a rket,

• changes in external facto r s affecti ng expected benefits and costs,

• changes in regulations prom ulgated by the ag ency or other governm e nt entities, and

• the degree o f com p liance by regulated entitie s with oth e r r e g u lations.

It m a y be reasonable to forecas t that the wo rld abs e nt the regulation will resem b le the present. If this is the case, however, your base line should reflect the future effect of current

governm e nt program s and policies. For review of an existing regulation, a baseline assum i ng

A no change @ in the regulatory program generally provi des an appropriate basis for evaluating regulatory alternatives. When m o re than one ba seline is reasonable and the choice of baseline will sign ificantly affect estim ated benefits and co sts, you sho u ld consid er m easuring benefits and costs against alternative baselines. In doing so y ou can analy ze the effects on benefits and costs of m a king different assumptions about other agencies = regulations, or the degree of compliance with your own existing rules. In all cases, you must evaluate bene fits and costs against the sam e baseline. You should also discuss th e reason ab leness of the b a selines used in the s e ns itiv ity analyses. F o r each baseline you use, you should id entify the key uncertainties in your forecast.

EPA = s 1998 final PCB disposal rule provides a good exam ple of using different baselines. EPA used several alternative baselines, each re flecting a d i fferent interpretation of existing regulatory requirem e nts. In part icular, one baseline reflected a litera l in te rpretation of EPA = s 1979 rule and another the actual im plem entation of that rule in the year immediately preceding the 1998 rev i sion. The u s e of m u ltiple baselines i llustrated th e substan tial effect changes in
EPA = s im ple m entation policy could have on the cost of a regulatory program

. In the years after EPA adopted the 1979 PCB disposal rule, change s in EPA policy -- especially allowing the disposal of autom obile A shredder fluff @ in m unicipal landfills -- re duced the cost of the program by m o re than $500 m illion per year.

In som e cases, substantial portions of a rule ma y s i mp l y r e s t at e statutory requirem e nts that would be self-im p lem e nting, even in the ab sence of the regulatory action. In these cases,

15you should use a pre-statute baseline. If you are able to separate out those areas where the agency has discretion, you m a y also use a post-st atute baseline to evaluate the discretionary elem ents of the action.

3. Evaluation of Alternatives

You should describe the alternatives availa ble to you and the reasons for choosing one alternative over another. As noted previously, alternatives tha t re ly on inc e ntive s and of f e r increased flexibility are o f ten m o re cost-effectiv e than m o re prescrip tiv e ap proaches. F o r instance, user fees and infor m ation dissem i nati on m a y be good alternativ es to direct comm andand-control regulation. W ithin a command-and-c ontrol regulatory progr am , perfor mance-based standards generally offer advantages over stan dards specifying design, behavior, or m a nner of

com p liance.

You should carefully consider all appropriate alternatives for the key attributes or provision s o f the rule. T h e previous discuss i on o u tlin es exam ples of appr opria te alter n ative s

. Where there is a A continuum @ of alternatives for a standard (s uch as the level of stringency), you generally should analyze at least three options: the preferred option; a m o r e stringent option that achieves ad dition a l ben e fits (and p r esum ably co sts m o re) beyond those realized by th e preferred option; and a less stringent option that costs less (and presum ably generates fewer benefits) than the preferred option.

You should choose reasonable alternatives de serving careful consideration. In som e cases, a regu lato ry progr am will f o cus on an option that is ne ar or a t the lim it of technical feasibility. In this case, the analysis would not need to exam ine a m o re stringent option. For each of the options an alyzed, you sh ould com p are the an ticip ated benefits to the co rresponding

costs.

It is not adequate sim p l y to report a com p arison of the agency = s preferred option to the chosen baseline. W h ene v er you report the benefi ts and costs of alternative options, you should present both total and in crem ental benefits and costs. You should present increm ental benefits and costs as differences from the corresponding estim ates associated with th e next less-stringent alte rnative. 10 It is im portant to em phasize that in crem ental effects are sim p ly differences between successively more st ringen t alte rnatives. Results inv o lving a co mparison to a A next best @ altern ative m a y be especially u s eful.

In som e cases, you m a y decide to analyze a wide array of options. In 1998, DOE analyzed a large num ber of options in setting ne w energy efficien cy stan dards for ref r igerato r s and freezers and produced a rich am o unt of inform ation on their relativ e effects. This analysis --

exam ining more than 20 alternative perform a nc e standards for one class of refrigerators with top-m ounted freezers -- enabled DOE to select an option th at p r oduced $20 0 m o re in estim ated net benefits per refrigerator thanthe least attractive option.

10 For t h e least st ring en t altern at iv e, you shou ld esti m a te th e in crem en tal b e n e fits and co sts relativ e to th e baselin e. Thus, for t h is a lternative, t h e i n crem ental effects woul d be t h e sam e as the corres ponding to tals. Fo r each altern ativ e th at is m o re strin g e n t th an t h e least string en t altern ativ e, y o u sh ou l d estimate th e in crem e n tal b e n e fits and co sts relativ e to t h e clo s est less-st rin g e n t altern ativ e.

16You should analyze the benefits and costs of different regulatory provisions separately when a rule includes a nu m b er of distinct provisions. If the existe nce of one provision affects the benefits or costs arising f r om another provision, the analysis becom e s m o re com p licated, but the need to exam ine provisions separately rem a ins. In this case, you should evaluate each specific provision by determ ining the net benefits of the proposed regulation with and without it.

Analyzing all possible com b inati ons of provisions is im practi cal if the nu mber is la rg e and interaction effects are widespread. You need to use judgm e nt to select the m o st significant or relevant provisions for such analysis. You are e xpected to d o cum e nt all of the alte rn ative s tha t were consid ered in a list or tab l e and which we re selected for em phasis in the m a in analysis.

You should also discuss the stat utory requirem e nts that affect the selection of regulatory approaches. If legal constraints p r ev ent the sele c tion of a reg u lato ry actio n that be st s a tisf i e s the philosophy and principles of Executive Order 12866, you should identify these constraints and estim ate their opportunity cost. Such inform ation m a y be useful to Congress under the Regulatory Right-to-Know Act.

4. Transparency and Reproducibility of Results

Because of its influen tial nature and its sp ecial role in the rule m a king process, it is appropriate to set m i nimum quality s t andards for regulatory analysis. Yo u should pro v ide docum entation that the analysis is based on the best reasonably obtainabl e scien tif ic, technical, and economic inform ation available. To ach ieve this, you should rely on peer-reviewed literature, w h ere available, and provide the source for all original inform a tion.

A good analysis should be transparent and your results m u st be reproducible. You should clearly set out the basic assum p tions, m e thods, a nd data underlying the anal ysis and discuss the uncertainties associated with the estim a tes. A qu alified third party readin g the analysis should be able to understand the basic elem ents of your analysis and the way in which you developed your estim ates.

To provide greater access to your analysis, you should gene rally post it, with all the supporting docum e nts, on the internet so the publi c can review the findings. You should also disclose the use of outside consultants, thei r qualifications, and hist ory of contracts and

em ploym e nt with the ag ency (e.g., in a preface to the RIA). Where other com p elling interests (such as privacy, intellectual prope rty, trade s ecrets, etc.) p r even t the public release of data or key elem ents of the analysis, you should apply esp ecially rigorous robustn ess checks to analytic results and docum e nt the analytical checks used.

Finally, you should assure com p liance with th e Infor m ation Quality Guidelines for your agency and OMB = s A Guideline s f o r Ensuring and Maxim i zing the Quality, Objectiv ity, Utility, and Integrity of Infor m a tion Dissem i nated by Federal Agencies @ ( A data quality guidelines @ ) http://www.whitehouse.gov/om b/ fed r eg/reproducible.htm l

.

17Developing Benefit and Cost Estima tes

1. Som e General Considerations

The analysis docum ent should discuss the expe cted benefits and costs of the selected regulatory option and any reasonable alternatives . How is the proposed action expected to provide the anticipated benefits and costs? W h at are th e m o netiz ed value s of the pote n tia l rea l increm ental benefits and costs to societ y? To present your results, you should:

• include separate schedules of the m o netized benefits and costs that show the type and tim ing of be nefits and costs, and express the estimates in this table in constant, undiscounted dollars (for m o re on discounting see “ Discount Rates ” be lo w);

• list the benefits and costs you can quantify, but cannot m onetize, including their tim ing;

• describe benefits and costs you cannot quantify; and

• identify or cross-reference the data or st udies on which you base the benefit and cost estim ates.

When benefit and cost estim ates are uncertain (f or m o re on this see “ Tr e a tment of
Uncertain ty ” below), you should report benefit and cost estim a tes (including benefits of risk reductions) that reflect the full probability di stribution of potential consequences. W h e r e possible, p r esent probab i lity d i stribu tions of be nefits and cos t s and includ e the upper and lower bound estim ates as com p lem e nts to cent ral tendency and other estim a tes.

If funda m e ntal scientific disagreem e nt or lack of knowledge preven ts construction of a scien tifically defensible probability distribut ion, you should describ e ben e fits or cos t s under plausib l e scenarios and characterize the evid en ce and assum p tions underlying each alternative scenario.

2. The Key Concepts Needed to Estim a te Benefits and Costs

“Opportunity cost @ is the appropriate concept for valu ing both benefits and costs. The principle of A willingness -to-pay @ (WTP) captures the notion of opportunity cost by m e asuring what individuals are willing to for go to enjoy a particular benefit. In general, econom i s ts tend to view W T P a s the m o st appropriate m easur e of opportunity cost , but an individual = s A willingn essto-accept @ (WTA) com p ensation for not receiving th e im provem e nt can also provide a valid

m easure of opportunity cost.

WTP and WTA are comparable m e a s ures unde r special circum stances. WTP and WTA

m easures may be com p arable in the f o llowing s i tu ations: if a regulation af fects a price change rathe r than a quantity ch ange; th e ch ange being e v aluated is s m all; there a r e re asonably close substitute s a v ailab l e; an d the incom e ef f ect is s m all. 11 Howe ver, em pirical evidence from experim e ntal econom ics and psychology shows that even when incom e /wealth effects are “sm a ll”, the m easured differences between W T P and W T A ca n be large. 12 WTP is generally

11 See Hanem a nn WM ( 1 99 1 )

, American Economic Review , 8 1 (3 )

, 635 -64 7

. 12 See Kahnem a n D, Knetsch J L , a n d Thale r RH (1991) , " A nom al i e s: The En do wm ent Effect, L o ss Aversion, a n d St at us Qu o B i a s ," Jour nal of Economic Pers pectives 3( 1) , 19 2-2 0 6

.

18considered to be m o re readily m easurable. A doption of WTP as the m easure of value im plies that individual preferences of the affected population should be a guiding factor in the regulatory analys is.

Market p r ic es provide rich data f o r e s tim a ting be nef its and co sts based on willingn ess- topay if the goods and services affected by the regulation are traded in well-functioning

com p etitive m a rkets. The opportun i ty cost of an alternative includes the value of the benefits forgone as a result of choosing that alternativ e. The opportunity cost of banning a product -- a drug, food additiv e, or h azardous ch em ical -- is th e forgone net benefit (i. e ., lost cons um er and producer surplus 13 ) of that product, taking into account the m itigating effects of potential substitute s.

The use of any resource has an opportunity co st regardless of whether the resource is already owned or has to be purchased. That opp ortunity cost is equal to the net benef it the resource would have provided in the absence of the requirement. For example, if regulation of an industrial plant affects the use of additiona l land or buildings with in the existing plant boundary, the cost analysis should include the opportunity cost of using the additional land or f acilities.

To the extent possible, you should monetize a ny such forgone benefits and add them to the other costs of that alternative. Y ou should al so try to m onetize any cost savings as a result of an alternativ e and either add it to the benefits or subtract it from the costs of that altern ative. However, you should not assum e that the A a v oi de d @ costs of not doing another regulatory alternative represen t the benef its of a regulatory action where there is no direct, necessary relationship between the two. You should also be careful when the costs a voided are attributable to an existing regulation. Even when there is a d i rect relatio nship between the two regulatory action s , the use of avoided costs is p r oblem atic b ecause the existing regu lation m a y not

m a xi m i ze net benefits and thus m a y itself be questionable policy. (See the section, A Direct Use of Market Data, @ f o r m o re deta il.)

Estim ating benefits and costs when market pr ices are hard to m easure or m a rkets do not exist is m o re difficult. In these cases, you needto develop appropriate proxies that simulate

m a rket exchange. Estim ates of willingness-to-p ay based on revealed preference m e thods can be quite useful. As one example, analysts som e tim e s use A hedonic price equations @ based on multiple reg r ession analysis of m a rket behav i or to sim u late m a rket price s f o r the co mmodity of interest. The hedonic technique allo ws analysts to develop an estim ate of the price for specific attributes associated with a product. For inst ance, a house is a product ch aracterized by a variety of attributes including the num ber of room s, total floor area, and t ype of heating and cooling. If there are enough data on transactio ns in the housing m a rket, it is possible to develop an estim a te of

the im plicit pr ice f o r s p ecif i c a ttr ib utes, such a s the im plicit price of an a ddition a l ba throom or for central air conditioning. This technique can be extended, as well, to develop an estim ate for

13 C o nsum er su r p l u s i s t h e di f f e rence bet w ee n what a

co ns u m er pay s fo r a uni t of a go o d and t h e m a xi mu m am ount th e con s u m er wou l d b e willin g to p a y for t h at un it. It is measu r ed b y t h e area b e tween th e p r ice andt h e d e m a n d

cur v e fo r t h at u n i t

. P r o d u cer s u r p l u s i s t h e di ffe rence bet w e e n t h e am ount a p r o d u cer i s p a i d f o r

a uni t o f a g o o d a n d

t h e m i nim u m am ount t h e pr o d u cer w o ul d acc ept t o su p p l y t h at u n i t

. It i s m easured by t h e area bet w ee n t h e pri ce and the supply curv e fo r t h at u n it.

19the im plicit price of public goods th at are not directly traded in m a rkets. An analyst can develop im plicit price estim a tes for public go ods like air quality and access to pu b lic parks b y assessing the effects of these goods on the housing m a rket . Going through the analytical process of deriving benefit estim a tes by sim u lating m a rket s m a y also suggest alternative regulatory strategies th at create such m a rkets.

You need to guard against double-counting, sinc e som e attributes are em bedded in other broader m easures. To illustrate, when a regula tion im proves the quality of the environm ent in a community, the valu e of real estate in the co mm unity generally rises to ref l ect the greater attractivenes s of living in a better env i ronm ent. Sim p ly adding the increase in property values to the estim ated value of improved public health would be double counting if the increase in property values reflects the im provem e nt in pub lic health. T o avoid this problem you should separate the em bedded e ffects on the value of prop erty arising from i m proved public health. At the sam e time, an analy s is that fails to incorporate the cons eq uence of lan d use chang e s when accounting for costs will not capture the full effects of regulation.

3. Revealed Preference Methods

Revealed preference m e thods develop estim ates of the value of goods and services -- or attributes of those goods and services -- based on actual m a rket decisions by consum e r s, workers and other m a rket participants. If the m a rket part icipant is well inform ed and confronted with a real choice, it m a y be feasible to determ ine accu rately and precisely the monetary value needed for a rulem a king. There is a large and well-deve loped literature on reveal ed preference in the peer-reviewed, applied econom ics literature.

Although these m e thods are well grounded ineconom i c theory, they are som e tim es difficult to implem e nt given the com p lexity of ma rket transactions and th e paucity of relevant data. W h en designing or evaluating a revealed preference study, the following principles should be considered:

• the m a rket s hould be co mpetitiv e. If the m a rket isn = t com p etitiv e (e.g., m onopoly, oligopoly), then you should consider m a king adju stm e nts such that the price reflects the true value to society (often called the A shadow price @ );

• the m a rket should not exhibit a significant information gap or asymm e tric inform ation problem . If the m a rket suffers from i n fo r m ation problem s, then you should discuss the divergence of the price from the underlyi ng shadow price and consider possible adjustm e nts to reflect th e underlying shadow price;

• the m a rket should not exhibit an externality. In this case, you should discuss the divergence of the price from the underlyi ng shadow price and consider possible adjustm e nts to reflect th e underlying shadow price;

• the specific m a rket participants being studi ed should be representative of the target populations to be affected by the rulem a king under consideration;

• a valid research design and fra m ework for anal ysis should be adopted. Exam ples include using data and/or m odel specifications that includ e the m a rkets for substitute and

com p le m e nt ary goods and services and using reasonably unrestricted functional forms. When specifying substitute and com p lem e ntar y goods, the analysis should preferably be

20based on data about the range of alternatives perceived by m a rket part icipants. If such data are not available, you should adopt plausible assum p tions and describe the lim itations o f the analys is.

• the statistical and econom e tric m ode ls em ploye d should be appropriate for the application and the resulting estim ates should be robust in response to plausi ble changes in m odel specification and estim a tion technique; and

• the results should be consis tent with econom ic theory.

You should also determ ine whether there are m u ltiple revealed-preferen c e studies of the

sam e good or service and whether anything can be learned by com p aring the m e thods, data and findings from different studies . Professional judgm e nt is re quired to determ ine whether a particular study is of sufficient quality to justif y use in regulatory anal ysis. W h en studies are used in regulatory analysis de spite their technical weaknesses (e.g., due to the absence of other evidence), the regulatory analysis should discuss a ny biases or uncertainties th at a r e likely to arise due to those weaknesses. If a study has m a jor weaknesses, the study should not be used in regulatory analysis.

a. Direct Uses of Market Data

Econom ists ordinarily consider m a rket pr ices as the m o st accurate m easure of the

m a rginal value of goods and services to society. In som e instances, however, m a rket prices m a y not reflect the true value of goods and services due to m a rket im perfections or governm e nt intervention. If a regulation involves changes to goods or services where the m a rket price is not a good m eas ure of the value to society, you should use an estim ate that reflects the shadow price. Suppose a particular air pollutant dam a ges crops . One of the benefits of contro lling that pollutant is the value of the crop yield increase as a result of the controls. That value is typically

m easured by the price of the crop. H o wever, if the price is held above the m a rket price by a

governm e nt program that affects supply, a value estim ate based on this price m a y not reflect the true benefits of controlling the pollutant. In this case, you should calcula te the value to society of the increase in crop yields by estim a ting the sha dow price, which reflects the value to society of the m a rginal use of the crop. If the m a rginal use is for exports, you should use the world price. If the m a rginal use is to add to very large surplus stoc kpiles, you should use the value of the last units released from storage minus storag e cost. If stockpiles ar e large and growing, the shadow price m a y be low or even negative.

Other goods whose m a rket prices m a y not refl ect their true value include those whose production or consum ption results in substantial (1 ) positive or negative external effects or (2) transfer p a y m ents. For exam ple, the observed ma rket price of gasoline may not reflect m a rginal social value due to the inclus ion of taxes, other governm e nt interventions, and negative externalities (e.g., pollution). This shadow pric e m a y also be needed for goods whose m a rket price is substantially affected by existing regulations that do not m a xi m i ze net benefits.

b. Indirect Uses of Market Data

Many goods or attributes of goods that are affected by regulation--such as preserving environm ental or cu ltu ral am enities-- a re not trad e d direc tly in m a rkets. The value f o r these

21goods or attributes arise both fr om us e and non-use. Estim ation of these values is difficult because of the absence o f an organized m a rket. However, overlook ing o r ignoring th ese valu es in your regulatory analysis m a y significantly under state the benefits and/ or costs of regulatory action.

A Use values @ arise where an individual derives satisf action from using the resource, either now or in the future. Use values are associ ated w ith activities such as swimming, hunting, and hiking where the individual m a kes use of the natural environm ent.

“Non-use values @ arise w h ere an individual p l aces va lue on a resource, good or service even though the individual will not use the re source, now or in the future. Non-use value includes bequest and existence values.

General altruism for the health and welfare of others is a closely related concept but m a y not be strictly considered a A non-use @ value. 14 A general concern for the welfare of others should supplem ent benefits and costs equally; hence, it is not necessary to m easure the size of general altruism in regulatory analysis. If th ere is eviden ce of selective altruism , it need s to b e considered s p ecifically in both benefits and costs.

Som e goods and services are indirectly traded in m a rkets, which m eans that their value is reflected in the prices of related goods and services that are directly traded in m a rkets. Their use values are typically estim a ted through revealed preference m e thods. Exam ples include estim a tes of the values of environm ental a m enities derive d from travel-cost stud ies, and hedonic price models that m easure differences or changes in the value of real es tate. It is im portant that you utilize revealed preference m odels that adhere to econom ic criteria th at are consistent with utility

m a xi m i zing behavior. A l so, you should take partic ular care in designing protocols for reliably estim ating the values of these attribu t es.

4. Stated Preference M e tho d s

Stated Preference M e tho d s (SPM) have been developed and used in the peer-reviewed literature to estim ate both A use @ and A non-use @ values of goods and services. They have also been widely used in regulatory analyses by Fede ral agencies, in part, because these m e thods can be creatively em ployed to address a wide variety of goods and servic es that are not easy to study through revealed preference m e thods.

The distinguishing feature of these methods is that hypothetical ques tions about use or nonuse values a r e posed to s u rvey respo ndents in o r der to ob tain willingn ess

- to-pay estim ates relevant to benefit or cost estim a tion. Som e examples of SPM includ e contingent valuation, conjoin t ana l ysis and ris k -trad e of f analysis. Th e surveys use d to obta i n the health-utility v a lues used in CEA are sim ilar to stated-preference su rveys but do not entail m onetary m easurem ent of value. Nevertheless, the princi ples governing quality stated-p reference research, with som e obvious exceptions involving m oneti zation, are also relevant in de signing quality health-utility research.

14 See McConn ell K E (19 97)

, Jo u r na l o f

En vi ro nm en ta l Econ om ics an d Ma nag em en t
, 32 , 22 -37

.

22When you are designing or evaluating a stated -preference study, the following principles should be considered:

• the good or service being eval uated should be explained to the respondent in a clear,

com p lete and objective fashion, and the su rvey instrum e nt should be pre-tested;

• willingn ess-to-pay ques t ions should be designe d to focus the respondent on the reality of budgetary lim itations and alerte d to the availability of s ubstitute goods and alternative expenditure options;

• the survey instrum e nt should be designe d to probe beyond general attitudes (e.g., a "warm glow" effect for a particular use or non-use value) and focus on the m a gnitude of the respondent' s econom i c valuation;

• the analytic results should be consistent w ith econom ic theory using both "internal" (within respondent) and "external" (betw een respondent) scope tests such as the willingn ess to pay is larg er (sm a ller ) when m o re (less) of a go od is provid e d;

• the subjects being interviewed should be selected/sam pled in a statistically appropriate

m a nner. The sam p le fram e should adequately cover the target population. The sample should be drawn using probability m e thods in o r der to gen e ralize the re s u lts to the target population;

• response rates should be as high as reasonably possible. Best survey practices should be followed to achieve high response rates. Low response rates increase the potential for bias and raise concerns about the generalizabil ity of the results. If response rates are not adequate, you should conduct an analysis of non-response bias or further study. Caution should be used in assessing the representa tiveness of the sample based solely on dem ographic profiles. S t atistical adjust m e nts to reduce non-response bias should be undertaken whenever feas ible and appropriate;

• the m ode of adm i nistration of surveys (in- person, phone, m a il, com puter, internet or multiple m odes ) should be appropriate in light o f the nature of the questions being po sed to respondents and the length and co mplexity of the instrum e nt;

• docum entation should be provided about the ta rget population, the sam p ling fra m e used and its coverage of the target population, the design of the sample including any

stra tif ica tion or clus ter i n g, the cum u lative res ponse rate (including re spo n se rate at each stage of selection if appli cable); the item non-response rate for critical questions; the exact wording and sequence of questions and other inform ation provided to respondents; and the training of interviewers and t echniques they em ployed (as appropriate);

• the statistical and econom e tric m e thods used to analyze the collected data should be transparen t, well suited for the an alys is, and applied with rigor and care.

Professional judgm ent is necessary to apply thes e criteria to one or m o re studies, and thus there is no m echanical for m ula that can be used to determ ine whether a particular study is of suf f i cient qu ality to ju stif y use in reg u lato ry analysis. W h en studies are used despite having weaknesses on one or more of these criteria, those weaknesses should be acknowledged in the regulatory analysis, including any re sulting b i as e s or uncer ta inties that are like l y to r e s u lt. If a study has too m a ny weaknesses with unknown consequences for the quality of the data, the study should not be used.

23The challenge in designing quality stated-pre ference studies is arguably greater for nonuse values and unfa m iliar use valu es than for familiar goods o r serv ices th at are traded (directly or indirectly ) in m a rket transactions. Th e good being valu ed m a y have little m eaning to respondents, and respondents m a y be for m ing their va luations for the first tim e in response to the questions posed. Since these values are eff ectively constructed by the respondent during the elicitation, the instrum e nt and m ode of adm i nistra tion should be rigorousl y pre-tested to m a ke sure that responses are not sim p ly an artifact of specific features of instrum e nt design and/or mode of adm i nistration.

Since SPM generate data from respondents in a hypothetical sett ing, often on com p lex and unfa m iliar goods, special care is dem a nded in th e design and execution of surveys, analysis of the results, and characterization of the uncer tainties. A stated-preference study m a y be the only way to obtain quantitative inform ation a bout non-use values, though a num ber based on a poor quality study is no t necessarily superior to n o num b er at all. Non-use values that are not quantified should be presented as an “intangible” be nefit or cost.

If both revea l ed-preferen ce and state d -preferen c e studies tha t are direc tly applic able to regulatory analysis are availabl e, you should consider both ki nds of evidence and compare the findings. If the results diverg e significantly, you should com p are the overall size and quality of the two bodies of evidence. Othe r things equal, you s hould prefer revealed preference data over stated preference data because revealed preference data are based on actu a l decisions, where

m a rket participants enjoy or suffer the consequences of their decisions. Th is is no t g e nera lly th e case for respondents in stated preference survey s, where respondents m a y not have sufficient incentives to offer thoughtful respon ses that are more consistent w ith their preferences or m a y be inclined to b i as th eir resp ons es for one reason or another.

5. Benefit-Transfer Methods

It is often preferable to collect origin al data on revealed p r eference o r stated preference to support regulatory analysis. Yet conducting an orig inal study m a y not be fe asible due to the tim e and expense involved. One alternative to conduc ting an original study is the use of "benefit transfer" m e thods. (The transfer m a y involve co st determ ination as well). The practice of

A benef it tr an sf er @ began with transferring ex isting estim ates o b tained from indirect market and stated preference stud ies to new contexts (i .e., the context posed by the rulem a king). The principles that guide transferri ng es tim a tes from i ndirect m a rket and s t ated preference s t udies should apply to direct m a rket studies as well.

Although benefit-transfer can provide a quick, low-cost a pproach for obtaining desired monetary values, the m e thods are often associat ed with uncertainties a nd potential biases of unknown magnitude. It should theref ore be treated as a last-resor t option and not used without explicit justification.

In conducting benefit transfer, the first step is to specify the value to be estim ated for the rulem a king. You should identify the relevant m easur e of the policy change at this initia l stage. For instance, you can derive the relevant willingness-to-pay m easure by specifying an indirect utility function. This identification allows you to A zero in @ on key aspects of the benefit transfer.

24The next step is to identify appropriate stud ies to conduct benefit tr ansfer. In selecting transfer studies for either point transf ers or function transfers, you s hould base your choices on the f o llowin g criter ia:

• The selected studies should be based on ad equate data, sound and defensible em pirical

m e thods and techniques.

• The selected studies should docum e n t para m e ter estim ates of the valuation function.

• The study context and policy context should have sim ilar populations (e.g., dem ogra phic characteristics). The m a rket size (e.g., target population) between th e study site and the policy site should be sim ilar. For exam ple, a study valuing water quality im prove ment in Rhode Islan d should not be used to v a lue pol icy that will affect water quality through out the United S t ate s

.

• The good, and the m a gnitude of change in th at good, should be sim ilar in the study and policy contexts.

• The relevant characteristics of the study and the policy contexts should be sim ilar. For

exam ple, the effects exam ined in the original study should be A revers ible @ or “irreversible” to a degree that is sim i lar to the regulatory actions under consideration.

• The distribution of property ri ghts should be sim ilar so that the analysis uses the sam e welfare m e a s ure. If the property rights in the study context support the use of W T A

m easures while the rights in the rulem a ki ng context support the use of WTP m easures, benefit transfer is not appropriate.

• The availability of subs titutes across study and po licy con t exts should be sim ilar.

If you can choose between transf erring a function or a point es tim ate, you should transfer the entire dem a nd function (referred to as benef it function transfer) rather than adopting a single point es tim ate (referred to as benefit point transfer). 15

Finally, you should not use benefit tr ansfer in estim a ting benefits if:

• resources are unique or have uni que attributes. F o r exam ple, if a policy change affects

snowm obile use in Yellowstone National Par k, then a study valuing snow mobile use in the state of Michig an sh ould not be used to value change s in snowm obile use in the Yellowstone National Park.

• If the study exam ines a resource that is uni que or has unique attr ibutes, you should not transfer benefit estim a tes or benefit f unctions to value a different resource and vice versa.
For exam ple, if a study values visibility im provem e nts at the Grand Canyon, these results should not be used to value visibi lity im prove m e nts in urban areas.

• There are significant p r oblem s with applying an A ex ante @ valuation estim ate to an A ex post @ policy context. If a policy yields a significant change in the attributes of the good, you should not use the study estim a tes to valu e the change using a benefit transfer approach.

• You also should not use a value develope d from a study involving, sm all m a rginal

15 See Loo m is J B ( 199 2)

, Wate r Res ource s Re searc h

, 28 (3 ), 7 01- 705 an d Kir c ho ff

, S, C o lb y, BG, andLaFr an ce, JT ( 199 7)

, Jou r n a l o f

En viron m en ta l Econ om ics an d Ma nag em en t
, 33 , 75- 93

.

25changes in a policy context involving la rge changes in the quantity of the good.

Clearly, all of these criteria are difficult to m eet. However, you should attem p t to satisfy

as m a ny as possible wh en choosing studies from the existing econom ic literature. P r ofessional judgm ent is required in determ ining whether a part icular transfer is too speculative to use in regulatory analysis.

6. Ancillary Benefits and Countervailing Risks

Your analysis should look be yond the direct benefits and di rect costs of your rulem a king and consider any im portant ancillary benefits and countervailing risks. An ancillary benefit is a favorable im pact of the rule that is typically unr elated or secondary to the statutory purpose of the rulem a king (e.g., reduced refinery em issions due to m o re stringent fuel econom y standards for light trucks) while a counter vailing risk is an adverse econom ic, health, safety, or environm ental consequence that occurs due to a rule and is not already accounted for in the direct cost of the rule (e.g., adverse safety im pacts from m o re stringen t fuel-econom y standards for light trucks).

You should begin by considering and perhaps listing the possible an cillary benefits and countervailing risks. However, highly specula tive or m i nor consequences m a y not be worth further formal analysis. Analytic priority s hould be given to those ancillary benefits and countervailing risks that are im portant enough to potentially cha nge the rank ordering of the

m a in alterna tives in the a n alysis. In s o m e cases th e m e re consideration of these second ary effects m a y help in the generation of a superi or regulatory alternativ e with strong ancillary benefits and fewer countervailing risks. For inst ance, a recent study suggested that weight-based, fuel-economy standards could ach ieve energy savings with fewer safety risks and em ploym ent losses than would occur under the current regulatory structure.

Like other benefits and costs, an effort s hould be m a de to quantify and m o netize ancillary benefits and countervailing risk s. If monetization is not f easible, quantification should be

attem p ted through use of inform ative physical units . If both monetization and quantification are not feasible, then these issues should be presen ted as non-quantified benef its and costs. The

sam e standards of inform ation and analys is quality that apply to direct b e nefits and costs should be applied to ancillary benefits and countervailing risks.

One way to com b ine ancillary benefits and countervailing risks is to ev aluate th ese effects separately and then put both of these eff ects on the benefits side, not on the cost side. Although it is theoretically appr opriate to include disbenefit s on the cost side, legal and

programm a tic considerations gene rally support subtracting the disb enefits from direct benefits.

7. Methods for Treating Non-Monetized Benefits and Costs

Sound quantitative estim ates of benefits and costs
, where feasible, are pref erable to qualitative descriptions of benefits and costs because they help decision makers understand the

m a gnitudes of the effects of alternative actions. However, som e i m portant benefits and costs (e.g., privacy protection) m a y be inherently too difficult to quantify or m o netize given current

26data and m e thods. You should carry out a care ful evaluation of non-quantified benefits and costs. Som e authorities 16 refer to these non-m onetized and non-quantified effects as “intangible”.

a. Benefits and Costs that are Difficult to Monetize

You should monetize quantitative estim a tes whenever possible. Use sound and defensible values or procedures to monetize bene fits and cos t s, and ensure that k e y an alytical

assum p tions are defensible. If m onetization is impossible, explain why a nd present all available quantitative inform ation. For exam ple, if you can quantify but cannot m o netize increases in water quality and fish populations resulting fr o m water quality regulation, you can describ e benefits in term s of stream m iles of im proved water quality for boaters and increases in gam e fish populations for anglers. You should describe the tim i ng and likelihood of such effects and avoid double-counting of benefits when estim a tes of m onetized and physical effects are m i xed in the sam e analysis.

b. Benef its and Costs tha t a r e Dif f i cult to Quantif y

If you are not able to quan tify the ef fects, you should pres ent any relevant quantitative inform ation along with a description of the unqua ntified effects, such as ecological gains, im prove m e nts in quality of life, and aesthetic beauty. You should provide a discussion of the strengths and lim itations of the qualitative information. This should include inform ation on the key reason(s) why they cannot be quantified. Inone instance, you m a y know with certainty the

m a gnitude of a risk to w h ich a substantial, but unknown, number of indivi duals are exposed. In another instance, the existence of a risk m a y be based on highly speculative assum p tions, and the

m a gnitude of the risk m a y be unknown.

For cases in which the unqua ntified benefits or costs a ffect a policy choice, you should provide a clear explanation of th e rationale behind the choice. Su ch an explanation could include detailed inform ation on the nature, tim i ng, likelihood, location, and distribution of the unquantified benefits and costs. Also, please include a summary tabl e that lists all the unquantified benefits and costs, and use your pr of essional judgm e nt to highlight (e.g., with categories or rank ordering) t hose that you believe are m o st im portant (e.g., by considering factors such as the degree of certainty, exp ected m a gnitude, and reve rsib ility of ef f ects).

While the focus is often placed on d i fficult to qu antify benefits of regulatory action, som e costs are dif f icult to qu antify as well. Certain p e rm itting req u irem ents (e.g., EPA = s New Source Review program ) restrict the decisions of producti on facilities to shift to new products and adopt innovative m e thods of production. While these program s may im pose substantial costs on the

econom y, it is very difficult to quantify and m one ti ze these effects. Sim ilarly, regulations that estab lish em ission s t and a rds f o r rec r eation a l veh i cl es, like motor bikes, m a y adversely affect the perform a nce of the vehicles in term s of driveab ility and 0 to 60 m iles per hour acceleration. Again, the c o st assoc i a t e d with the lo ss of thes e attributes m a y be difficult to quantify and monetize. T h ey need to be analyzed qualitatively.

16 Mish an EJ (1 99 4)

, Co st-Ben efit An a l ysis

, f o urt h e d i t i on, R out l e d g e, Ne w Yo rk

.

278. Monetizing Health and Safety Benefits and Costs

We expect you to provide a be nefit-cost analysis of m a jor health and safety rulem a kings in addition to a CEA. The BCA provides ad d itional ins i ght because (a) it provid e s so m e indication of what the public is willing to pay for im prove m e nts inhealth and safety and (b) it offers additional information on preferences for h ealth using a different research design than is used in CEA. Since the health-preference m e thods used to support CEA and BCA ha ve som e different strengths and drawbacks, it is im portant that you prov ide decision m a kers with both perspectives.

In m onetizin g health b e n e fits, a W T P m easure is the conceptu ally app r opriate m easure as

com p ared to other alternatives (e.g., cost of illness or lifetim e earnings), in part because it

attem p ts to capture pain and suffering and other quality-of-life effects. Using the WTP m easure for health and safety allows you to directly com p are your results to the other benefits and costs in your analysis, which will typi cally be based on WTP.

If well-conducted revealed-preference studies of relevant health and safety risks are available, you should consider using them in de veloping your monetary estim ates. If appropriate revealed-preference data are not available, you should use valid and relevant data fromstatedpreference s t udies. You will need to use your pro f essional jud g m e nt when you are faced with lim ited inform ation on revealed p r eference s t udies and substa ntia l inf o rm ation based on stated preference s t udies.

A key advantage of stated-preference and h ealth-utility m e thods com p ared to revealed preference m e thods is that they can be tailored to address the ra nges of probabilities, types of health risks and specific populations affected by your rule. In m a ny rulem a kings there will be no relevant inform ation from reveal ed-preference studies. In this situation you should consider

comm issioning a stated-preference study or usin g values from published stated-preference studies. For the reasons discu ssed previously, you should be cau tious about using values from stated-preference studies and describe in th e an aly s is the d r awbacks of this approach.

a. Nonfatal Health and Saf e ty Risks

W ith regard to nonfatal health and safety risk s, there is enorm o us di versity in the nature and severity of i m paired health sta t es . A traum a tic inju ry tha t can be treate d ef f e ctivelyin the

em ergency room without hospitaliz ation or long-term care is diffe rent from a traum a tic injury resulting in paraplegia. Severity differences are also im portant in evaluation of chronic diseases. A severe bo ut of bronchitis, t hough perhaps less frequent, is f a r m o re painful and debilitating than the m o re frequent bouts of m ild bronchitis. The duration of an im pa ired health state, which can range from a day or two to several years or even a lifetime (e.g., birth defects inducing

m e ntal retardation), need to be considered carefully. Inform ation on both the severity and duration of an im paired health state is nece ssary before the task of m onetization can be perform e d.

When m one tizing nonfatal health effects, it is important to consider two com ponents: (1) the private dem a nd for prevention of the nonfatal health effect, to be represented by the

28preferences of the target population at risk, and (2) the net financia l externalities a ssociated with poor health such as net changes in public m e dical costs and any net changes in econom i c production that are not experien ced by the target population. Re vealed-preference or statedpreference s t udies are necessary to es tim ate the private d e m a nd; health eco nom i cs data from published sources can typically be us ed to es tim ate the financial externalities caused by changes in health status. If you use lite rature values to m o netize nonfatal health and safety risks, it is im portant to m a ke sure that the values you have selected are appropriate f o r the severity and duration of health effects to be addressed by your rule.

If data are not available to support m one tization, you m i ght consid er an alternative approach that m a kes use of h ealth-utility studies. Although the econom ics literature on the monetary valuation of impaired hea lth states is growing, there is a m u ch larger clin ical literature on how patients, providers and com m unity residents value diverse health st ates. This literature typically m easures health utilities based on the standard gam b le, the tim e tradeoff or the rating scale m e thods. This health utility inform ation m a y be com b ined with known m onetary values for well-defined health states to estimate m onetary values for a wide range of health states of different severity and duration. If you use this approach, you should be careful to acknowledge

your assum p tions and the lim itations of your estim a tes.

b. Fatality Ris k s

Since agencies often design health and safety regulation to reduce risks to life, evaluation of these benefits can be the key part of the anal ysis. A good analysis m u st present these benefits clearly and show their importa nce. Agencies m a y choose to m onetize these benefits. T h e willingn ess-to-pay app r o ach is the best m e thodol ogy to use if reductions in fatality ris k are monetized.

Som e describe the m onetized value of s m all chan ges in f a ta lity risk as the "value of statistical life" (VSL) or, less preci sely, the "value of a life." The latter phrase can be m i sleading because it su ggests erron e ously th at the m onetization exercise tries to p l ace a A value @ on individu al lives. You should m a ke clear that thes e term s refer to the m easurem ent of willingn ess to pay for reductions in only sm all risks of prem a t ure death. They have no application to an identifiable individual or to very large reductions in i ndividual risks. They do not suggest that any individual = s life can be expressed in m onetary term s. Their sole purpose is to help describe better the likely benefits of a regulatory action.

Confusion about the term "statist ical life" is also widespread. This term r e fers to the sum of risk reductions expected in a population. For ex am ple, if the annual risk of death is reduced by one in a m illion for each of two m illion people, tha t is said to represe n t two "statistic al lives " extended per year (2 m illion peop le x 1/1,000,000 = 2). If th e annual risk of death is reduced by one in 10 m illion f o r e a c h of 20 m illion people, that also rep r esents two statis tic al live s extended.

The adoptio n of a value f o r the proje c ted r e duc tion in the ris k of prem ature m o rtality is the subject of continuing discus sion within the econom ic and public policy analysis comm unity. A considerable body of academ ic literatu r e is av aila b l e on th is subject. T h is literatu re involves either explicit or im plicit valuati on of fatality risks, and generally involves the use of estim ates of

29VSL from studies on wage com p ens a tion for occ upational hazards (which genera lly are in the range of 10 -4 annually), on consum er product purchase and use decisions, or from an e m erging literature us ing stated preference approaches. A s ubstantial m a jor ity of th e resulting e s tim ates of VSL vary from roughly $1 m illion to $10 m illio n per statistical life. 17

There is a continuing debate within the econom ic and public policy analysis comm uni ty on the m e rits of using a single VSL for all situ ations versus adjusting the VSL estim ates to reflect the s p ecific ru le context. A variety of factors have been iden tif ie d, includ ing whether th e mortality risk involves sudden death, the fear of cancer, and the extent to which the risk is voluntarily incurred. 18 The consensus of EPA = s recent Scien ce Advisory Board (SAB) review of this issue was that the availabl e literature does not support adjust m e nts of VSL for most of these factors. The panel did conclude th at it was appr opria te to ad just VSL to ref l ect chan ges in incom e and any tim e lag in the occu rrence of adv e rse health effects.

The age of the affected population has also been identified as an im portant factor in the theore tic al litera ture. Ho wever, the e mpirica l ev idence on age and VSL is m i xed. In light of the continuing questions over the effect of ag e on VSL estim ates, you should not use an ageadjustm e nt factor in an analysis u s in g VSL estimates. 19

Another way that has been used to express re duc tions in f a tality r i sks is to use the lif e expectancy m e thod, the A value of statistical life-y ears (VSLY) extend ed. @ If a regulation protects individu als whose average rem a ining life expectancy is 40 years, a risk re duction of one fatality is expressed as A 40 life-years extended. @ Those who favor this a lternative approach emphasize that the valu e of a statistical life is no t a sing le number relevant for all si tuations. In particular, when there are significant diffe rences between the effect on lif e expectancy for the population affected by a particular health ri sk and the populations studied in the labor m a rket studies, they prefer to adopt a VSLY approach to reflect those differences. You should consider providing estim ates of both VSL and VSLY, while recognizi ng the developing state of knowledge in this

area.

Longevity m a y be only one of a number of rele vant considerations pe rtaining to the rule. You should keep in m i nd that regulations with greater num be rs of life-years extended are not necessarily better than regulations w ith fewer numbers of life-y ears exten d ed. In any event, when you present estim ates based on the VS LY m e thod, you should adopt a larger VS LY estim ate for senior citizens because s e nior citizen s face larg er overall health risk s from all c a uses and they m a y have accu mulated sav i ngs to spend on their hea lth and s a fety. 20

The valuatio n of f

a tality risk r e ductio n is an evo l v i ng are a in b o th resu lts a nd

m e thodology. Hence, you should utilize valuation m e thods that you consider appropriate for the

17 See Viscusi W K a n d Al dy JE

, Jou r na l o f

Ri sk and Un cert a in ty( f or th co mi n g ) and Mro z ek J R and T a ylor LO ( 200 2)

, Jou r n a l o f

Po licy Analysis a n d Manag em en t
, 21 (2 ), 2 53- 270

. 18 Di st i n ct i o ns b e t w een “ v ol u n t a ry ” an d “i nv o l unt ary ” s h oul d be treate d with care

. Ris k s are best consi d ered to fall wi t h i n a co nt i n uum fr om “vol unt a r y ” t o “i nv ol u n t a ry ” wi t h ve ry few ris k s at either e n d of this ra nge. T h ese term s are also related to diffe re nces in t h e c o st of a voi di n g ri sks

. 19 Gr aham JD (2003), Mem o ra ndum to th e Presid en t’s Man a g e m e n t Co un cil, Ben e fit-C o st Meth od s an d Lifesav i ng Ru les. Th is m e m o r a ndu m ca n b e f oun d at h ttp://www. w h iteho use

. g o v /om b /inf o re g/pm c_be ne fit_cost

_

m em o.pd f

20 Of fi ce of I n f o r

m at i on an d R e gul at o r y Af fai r s, OM B

, M e m o ra n dum t o t h e Presi d ent ’ s M a nagem e nt C o unci l

, i b i d

.

30regulatory circum stances. Sin ce the lite ratu re-ba s ed VSL estim a tes m a y not be entire ly appropriate for the risk being evaluated (e.g., the use of occupa tional risk prem ia to value reductions in risks from environm ental hazards) , you should explain your se lection of estim ates and any adjustm e nts of the estim a tes to reflect th e nature of the risk be ing evaluated. You should present estim ates based on alternativ e approach es, and if you m onetize mortality risk reduction, you should do so on a consistent ba sis to the extent feasible. You should clearly indicate the

m e thodology used and docum e nt your choice of a particular m e thodology. You should explain any significant deviations from the prevai ling state of knowledge. If you use different

m e thodologies in different rules, you should clearly disclose the fact a nd explain your choices.

c. Valuation of Reductions in Health an d Saf e ty Risks to Child r e n

The valuation of health outcom es for children and infants poses special challenges. It is rarely feasible to m easure a ch ild' s willingness to pay for heal th im prove ment and an adult' s concern for his or her o w n health is not necess a r ily relevan t to valuation of child health. For

exam ple, the wage prem ium s de m a nded by work ers to accept hazardous jo bs are not readily transferred to rules that accom p lish health g a ins for children.

There are a few studies that exam ine parental willingness to pay to invest in health and saf e ty f o r th eir ch ild ren. Som e of these studies suggest that parents m a y value children’s health more strongly than their own hea lth. Although this parental pers pective is a prom ising research strategy, it m a y need to be expanded to include a so cietal interest in chil d health and safety.

W h ere the p r im ary objec tive of a ru le is to r e duce the r i sk of in jury, dis e ase or m o rtality

am ong children, you should conduct a cost-effectiven ess analysis of the rule. You may also develop a benefit-cost analysis to th e extent that v a lid m onetar y values can be assigned to the prim ary expected health outcom e s. For rule s where health gains are expected am ong both children and adults and you decide to perform a benef it-co st a n alysis, the monetary values for child ren sho u ld be at least as large as the va lues for adults (for th e sam e probabilities and

outcom e s) unless there is specific and co m p elling evidence to suggest otherwise. 21

Discount Rates

Benefits and costs do not always tak e place in the sam e ti m e period. W h en they do no t, it is inco rrect s i m p ly to add all of the ex pected ne t b e nefits or co sts withou t taking accou n t of when the actually occur. If benef its or cos t s are d e lay e d or otherwise separated in tim e from each other, the difference in tim i ng should be reflected in your analysis.

As a first step, you should present the annual ti m e stream of benefits and costs expected

to resu lt f r o m the rule, c l ear ly iden tif y ing when th e benefits and costs are expected to occur. The beginning p o int for your stream of estim ates shou ld be the y e ar in which th e final ru le will beg i n to have effects, even if that is expected to be som e tim e in the future. The ending point should be far enough in the future to encom p ass all the sign ificant benefits and costs likely to result from the ru le.

21 Fo r m o re i n f o r

m at i on, see D o cki n s C

., Jen k i n s R R

, O w en s N, Si m on NB

, and W i ggi ns L B (2 0 0 2 )

, Risk Analysis

, 2 2 (2 )

, 335 -34 6

.

31In presenting the stream of be nef its and costs, it is im portant to m easure them in constant dollars to avoid the m i sleading eff ects of inflation in your estim a tes. If the benefits and costs are initially m easured in prices reflecting expected future inflation, you can c onvert them to constant dollars by dividing through by an appropriate inflation index, one that corresponds to the inflation rate underlying the initial estim ates of benefits or costs.

1. The Rationale for Discounting

Once these prelim inaries are out of the wa y, you can begin to adju st your estim ates for differences in tim ing. (This is a separate calcula tion from the adjustm e nt needed to remove the effects of fut u re inflation.) Benefits or costs that occur sooner are generally m o re valuable. The

m a in rationales for the discounting of future im pacts are:

(a) Resources that ar e inves t ed will nor m a lly earn a positiv e re turn, so cur r e n t consum ption is m o re expensive than future consumption, since you are giving up th at expected return on investm e nt when you consum e today. (b) Postponed b e nefits also have a cost because peo p le generally prefer present to future

consum ption. They are said to h a ve positiv e time preference. (c) Also, if consum ption continues to increase ov er tim e, as it ha s for m o st of U.S. history, an increm ent of consumption will be less valu able in the future than it would be today, because the princ i ple of dim i nishing m a rginal utility im plies that as tota l c onsum ption increases, th e value of a m a rginal unit of consumption tends to decline.

There is wide agreem ent with point (a). Ca pital investm e nt is pr oductive, but that point is not suf f i cient by itself to expla i n p o sitiv e in ter e st ra tes and observed sa ving behavior. To understand these phenom e na, points (b) and (c) ar e also necessary. If people are really indifferent between consum ption now and later, then they should be willing to forgo current

consum ption in order to consum e an equal or sli ghtly greater am ount in the future. T h at would cause saving rates and investm e nt to rise un til interest ra tes w e re dr iven to zero and c a pita l was no longer productive. A s long as we observe pos itiv e interes t rates and saving rates below 100 percent, people m u st be placing a higher va lue on current consum ption than on future

consum ption.

To reflect this preference, a discount factor should be us ed to adjust the estim ated benefits and costs for differences in tim ing. The further in the future the benefits and costs are expected to occur, the more they should be di scounted. The discount fa ctor can be calculated given a discount rate. T h e for m ul a is 1/ (1+ the discount rate) t where A t @ m easures the num ber of years in the future that the benefits o r costs are expected to occur. Bene fits or costs that have been adjus t ed in this way are called A discounted present values @ or sim p ly A present v a lues @

. When, and only when, the estim a ted benefits and costs have been discounted, they can be added to dete rm ine the over a ll value of net benefits.

322. Real Discount Rates of 3 Percent and 7 Percent

OMB = s basic guidance on the discount rate is provided in OMB Circular A-94 ( http://www.whitehouse.gov/om b/circulars/index.htm l ). This Circular points out that the analytically preferred m e thod of handling tem p oral differences between benefits and costs is to adjust all the benef its and costs to ref l ect th eir value in equivalent units of consum ption and to discount them at the rate consum ers and save rs would normally use in discounting future

consum ption benefits. This is som e tim es called the A shadow price @ approach to discounting because do ing such calculations req u ires you to value benefits and costs using shado w prices, especially fo r capital goo ds, to correct for m a rket distortions. These shad ow prices are not well established f o r the United States. Furtherm ore, the distribution of i m pacts from regulations on capital and consum ption are not always well known. Consequentl y, any agency that wishes to tackle this challeng ing analytical task should check with OMB before proceeding.

As a default position, O M B Circ ular A-94 states that a real discount rate of 7 percent should be used as a base-case for regulatory anal ysis. The 7 percent rate is an estim ate of the average before-tax rate of return to private cap ital in the U.S. econom y. It is a broad m easure that reflects the returns to real es ta te and sm all business c a pita l as well as c o rporate cap ita l. It approxim a tes the opportunity cost of capital, and it is the appropriate disc ount rate whenever the

m a in effect of a regulation is to disp lace o r alte r the use of capital in th e p r ivate sector. OMB revised C i rcular A-94 in 1992 after extensiv e inte rnal review and public comm ent. In a recen t analysis, OMB found that the average rate of retu rn to capital rem a ins ne ar the 7 percent rate estim ated in 1992. Circular A-94 also recomm en ds using other discount rates to show the sensitivity of the estim ates to the discount rate assum p tion.

Econom ic distortions, including taxes on capital, create a dive rgence between the rate of return that savers earn and the private rate of re tu rn to cap ita l. This dive rg ence per s is ts despite the tend ency for capital to flow to where it can earn the highest rate of return. Although m a rket forces will p u sh after-tax rates of retu rn in diffe rent sectors of the econom y toward eq uality, that process will not equate pre-tax rate s of return when there are diffe rences in the tax tre a tm ent of investm e nt. Corporate capital, in particular, pays an additional layer of taxation, the corporate incom e tax, which requir e s it to ea rna higher pre-tax rate of return in order to provide investors with sim ilar after-tax ra tes of return com p ared with non-corpor ate investm e nts. The pre-tax rates of return better m easure society = s gains from investm e nt. Since th e rate s of return on capital are higher in som e sectors of the economy than ot hers, the governm ent needs to be sensitive to possible im pacts of regulatory policy on capital allocation.

The effects of regulation do not alw a ys fall ex clusively or prim arily on the allocation of capital. W h e n regulation prim arily and directly af fects privat e consum ption (e.g., through higher

consum er prices for goods and services), a lower discount rate is appropriate. The alternative most often used is som e tim es called the A social rate of tim e preference. @ T h is sim p ly m eans the rate at whic h A society @ discounts future consumption flows to th eir present value. If we take the rate that the average saver uses to discount future consum ption as our measure of the social rate of tim e preference, then the real rate of return on long-term gove rnm e nt debt m a y provide a fair approxim a tion. Over the last thirty years, this ra te has averaged around 3 pe rcent in real term s on a pre-tax basis. For example, the yield on 10-ye ar Treasury notes has av eraged 8.1 percent since

331973 while the average annual rate of change in the CPI over this period has been 5.0 percent, im plying a real 10-year rate of 3.1 percent.

For regulatory analysis, you s hould provide estim a tes of net benefits using both 3 percent and 7 percent. An example of this approach is E P A = s analysis of its 1998 rule setting both ef

f l uent lim its f o r waste w ater dis c ha rges and a i r toxic em ission lim its f o r pulp and pa per m ills. In this analysis, EPA developed its present-value estim ates using real discount rates of 3 and 7 percent applied to benefit and cost stream s th at extended forward for 30 years. You should present a sim ilar analysis in your own work.

In som e instances, if the r e is reason to exp ect that the regu lation will cau s e resour ces to be reallocated away from privat e investm e nt in the corporate s ector, then the opportunity cost

m a y lie outside the range of 3 to 7 percent. Fo r exam ple, the average re al rate of return on corporate capital in the United St ates was approxim ately 10 percen t in the 1990s, returning to the

sam e level observed in the 1950s and 1960s. If you are uncertain about the nature of the opportunity cost, then you should present benefit and cost estim a tes using a higher discount rate as a further sensitivity analysis as we ll as using the 3 and 7 percent rates.

3. Tim e Prefer ence for Health-Related Benefits and Costs

When future benefits or costs are hea lth-related, som e have questioned whether discounting is appropriate, since the rationale for discounting mone y m a y not appear to apply to health. It is true that lives saved today cannot be invested in a bank to save m o re lives in the future. But the resources that would have been us ed to save those lives ca n be invested to earn a higher payof f in future lives save d. People have been observed to prefer health gains that occur imm e diately to iden tica l health g a ins that oc cur in the future. Also, if future health gains are not discounted while future costs are, then the fo llowing perverse result occurs: an attractive investm e nt today in future health im provem e nt can always be m a de m o r e attractive by delaying the investm e nt. For such reasons, there is a prof essional consensus that fu ture he alth e f f e cts, including both benefits and costs, should be disc ounted at the sam e rate. This consensus applies to both BCA and CEA.

A comm on challenge in health-re lated analysis is to quantify the tim e lag between when a rule takes ef fect and when the resulting physical improvem e nt s in health st atus will be observed in the target population. In such situations, you m u st carefully consider the tim ing of health benefits bef o re perform i ng present-value calculations . It is not reasonable to assum e that all of the benefits of reducing chronic d i seases such as cancer and card iovascular disease will occur imm e diately when the ru le tak e s effect. For ru les addressing traum a tic injury, this lag period

m a y be shor t. For chron i c dis eases it m a y take years or ev en decades for a rule to ind u ce its full beneficial effects in the target population.

When a delay period between exposure to a t oxin and increased probability of disease is likely (a so-called latency peri od), a lag between exposure reducti on and reduced probability of disease is also likely. T h is latter period has some tim es been referred to as a "cessation lag," and it m a y or m a y not be of the sam e duration as th e latency period. As a general m a tter, cessation lags will only apply to populati ons with at least som e high-leve l exposure (e.g., before the rule

34takes effect). For populations with no such prior exposure, such as those born after the rule takes effect, only the latency period will be relevant.

Ideally, your exposure-risk m odel would allow calculation of reduced risk for each year following exposure cessation, accoun ting for total cum u lative exposure and age at the tim e of exposure reduction. The present-value benefits estim ate could then reflect an appropriate discount factor for each year' s risk reduction. Recent analyses of the cancer benefits stemm i ng from reduction in public exposure to radon in dri nking water have adopted this approach. They were supported by form a l risk-assessm ent m odel s that allowed estim ates of the tim ing of lung cancer incid e nce and m o rtality to vary in respons e to differen t radon expo sure lev e ls. 22

In m a ny cases, you will not have th e benefit of such detailed risk as sessm ent m odeling. You will need to use yo ur professio n al judgm ent as to the av erage cessation lag for th e chronic diseases affected by your rule. In situations where inform ation exists on latency but not on cessation lags, it m a y be reasonable to use latenc y as a proxy for the cessation lag, unless there is reason to believe that the two are different. W h en the average lag tim e between exposures and disease is unknown, a range of pl ausible alternative values for the tim e lag should be used in your analysis.

4. Intergenerational Discounting

Special ethical cons iderations arise wh en com p aring benefits and costs across generations. Although most people dem onstrate tim e preference in their own consum ption behavior, it m a y not be appropriate for societ y to dem onstrate a s i m ilar preference when deciding between the well-being of current and future generations . Future citizens w ho are affected by such choices cannot take part in m a king them , and today = s so ciety m u st act with

som e consideration of th eir inte rest.

One way to do this would be to follow the sam e discounting techni ques described above and supplem ent the analysis with an explicit discussion of the intergenerati onal concerns (how future generations will be affected by the regula tory decision). Policym akers would be provided with this ad dition a l info rm ation without ch anging the general appro ach to discoun ting.

Using the sam e discount rate across genera tions has the advantage of preventing tim einconsistency problem s. For exam ple, if one us es a lower discount rate for future generations, then the evaluation of a rule that has short-term costs and long-term benefits would becom e m o re favorable merely by waiting a year to do the anal ysis. Further, using the sam e discount rate across generations is attractive fr om an ethical standpoint. If one expects future generations to be better off, then giving them the advantage of a lower discount rate would in effect transfer resources from poorer people today to richer people tom o rrow.

Som e believe, however, that it is ethically im perm issible to discount the utility of future generations. That is, governm ent should treat all generations equa lly. Even under this approach,

22 C o m m i t t ee on R i sk Assessm ent o f E x po su r e t o R a do n i n Dri nki ng W a t e r, B o ar d o n R a di at i on Ef fect s R e search

, Co mmissio n on Lif e Sciences (1 996 )

, Ri sk Assessme n t of Ra do n i n Dri n ki ng Wat e r , Natio n a l Research C o un cil, Natio n a l Acade m y Press, Wash ing t on , DC.

35it would still be correct to discount f u ture costs and consum ption benefits generally (perhaps at a lower ra te th an f o r intr ag enera tiona l analys is), du e to the expectation that future generations will be wealthier and thus will value a marginal dolla r of benefits or costs by less than those alive today. Therefore, it is appropria te to discount f u ture benefits and costs relative to current benefits and costs, even if the welfare of future generations is not being discounted. E s tim ates of the appropriate discount rate appr opriate in this case, from the 1990s, ranged from 1 to 3 percent

per annum

. 23

A second reason for discounting th e benefits and costs accruing to future generations at a lower rate is increased uncertainty about the appr opriate value of the disc ount rate, the longer the horizon for the analys is. Private m a rket rates p r o v ide a r e liab le ref e r e nce f o r determ ining how society values tim e within a generation, but fo r extrem ely long tim e periods no com p a r able private rates exist. As explained by Martin W e itzm a n 24 , in the lim it f o r the deep f u ture, the properly averaged certainty-equivale nt discount factor (i.e., 1/[1+r] t ) corresponds to the

m i ni m u m discount rate h a ving any su bstantial po s itiv e probab i lity. From today = s persp ectiv e, the only relevant lim iting scenario is the one with the lo west discount rate

B all of the other states at the far-dis t ant tim e are relatively much less im portan t becau se their expected present value is so severely reduced by the power of com pounding at a higher rate.

If your rule will have importan t intergenera tional benefits or costs you m i ght consid er a further sensitivity analysis usi ng a lower but positive d i scoun t ra te in add i tion to calcu lating net benefits using discount ra tes of 3 and 7 percent.

5. Tim e Prefer ence for Non-Monetized Benefits and Costs

Differences in tim ing should be considered even for benefits a nd costs that are not expressed in m onetary units, incl uding health benefits. The tim i ng differ e nces can be handled through discounting. EP A estim ated co st-effectiveness in its 1998 rule, A Control of Em issions from Nonroad Diesel Engines, @ by discounting both the m oneta ry costs and the non-monetized

em ission reduction benefits over the expected useful life of the engines at the 7 pe rce n t rea l ra te

recomm ended in OMB Circular A-94.

Alternatively, it m a y be possible in som e cases to avoid discounting non-monetized benefits. If the expected flow of bene fits begins as soon as the cost is incurred and is expected to be constant over tim e , then annua lizing the cost stream is suffic ient, and further discounting of benefits is unnecessary. Such an analysis m i ght produce an estim ate of the annualized cost per ton of reduced em issions of a pollutant.

6. The Internal Rate of Return

The internal rate of return is the discount rate that sets the net present value of the discounted benefits and costs equal to zero. The internal rate of return does not generally

23 Por t n e y PR and W e yan t JP, ed s. (1 999 )

, Disco u n ting a n d In terg en era tio na l Eq u ity , Res o urces for the Future, Was h ington, D C

. 24 W e i t z m a n M L I n P o rt ney PR an d Wey a nt J P , e d s. ( 1 9 9 9 )

, D i scoun tin g and I n terg en era t i o na l Equ ity , R e sources fo r the F u tu re, Was h in gto n , D C

.

36provide an acceptab l e decision crit erion, and regu lations with the hi ghest internal rate of return are not necessarily the most bene ficial. Nevertheless, it does pr ovide useful inform ation and for

m a ny it will of f e r a m eaningf ul indic a tion of regulation = s im pact. You should consider including the internal rate of return im plied by your regulatory analysis al ong with other inform a tion about discounted net present values.

Other Key Considerations

1. O t h e r B e n e f i t a n d C o s t C o n s i d e r a t i o n s

You should include these effects in your analys is and provide estim a tes of their m o netary values when they are sig n ificant:

• Private-sector com p liance costs and savings;

• Governm e nt adm i nistrative costs and savings;

• Gains or losses in consum ers ' or producers' surpluses;

• Discomfort or inconvenience costs and benefits; and

• Gains or los s es of tim e in work, leis ure and/or comm uting/travel settings.

Estim ates of benefits and costs should be based on credible changes in technology over tim e. For exam ple, retro s pective stu d ies m a y provide evid e n ce that A learning @ will likely reduce the cost of regulation in future years. The weight you give to a study of past rates of cost savings resulting from innovation (including A learn i ng cu rve @ effects) should depend on both its tim eliness and direct relevance to the proces ses affected by the regulatory alternative under consideration. In addition, you shoul d take into account cost-saving innovations that result from a shift to regulatory perf orm a nce standards a nd incentive-based policies. On the other hand, significant costs m a y result from a slowing in th e rate of innovation or of adoption of new technology due to delays in the re gulatory approval process or the setting of m o re stringent standards for new facilities thanexisting ones. In som e cases agencies are lim ited under statute to consider only technologi es that have been demonstrated to be f easible. In these situ ations, it

m a y be useful to estim ate costs and cost savings assum i ng a wider range of technical possibilities.

When characterizing technology changes over tim e, you should assess the likely technology changes that would have occurred in the absence of the regulatory action (technology baseline). T echnologies change over tim e in both reasonably functioning m a rkets and im perfect

m a rkets. If you assum e that technology will re main unchang ed in the abs e nce of regu lation when technology changes are likel y, then your analysis will over-sta te both the benefits and costs attributable to the regulation.

Occasionally, cost sav i n g s or other form s of benefits accrue to parties affected by a rule who also bear its cos t s. For exam ple, a require ment that engine m a nuf acturers reduce em issions from engines m a y lead to technolog ies that im prove fuel eco nom y. These fuel saving s will

norm a lly accrue to the engine purch asers, who also bear the costs of the technologies. There is no apparent m a rket failure with regard to the m a rket value of fuel saved because one would expect that consum ers would be willing to pay for increased f u el econom y that exceeded the cost

37of providing it. W h en these cost savings are substantial, and particularly when you estim ate them to be greater than the co st associated with achieving them, you should exam ine and discuss why m a rket forces would not accom p lish th ese g a in s in the absence of regulation. As a general

m a tter, any direct costs that are averted as a result of a regulatory action should be m o netized wherever po ssible and either add e d to the benefits or subtracted from the costs of tha t alte rnative.

2. The Difference b e tw een Costs (o r Benefits) and Transfer Paym ents

Distinguishing between real co sts and transfer paym ents is an im portant, but som e times difficult, problem in cost estim ation. Benefit and cost estim ates should reflect real resource use. Transfer paym ents are monetary paym ents from one group to another that do not affect total resources available to society. A regulation that restricts the supply of a good, causing its price to rise, produces a transf er from buyers to se llers

. The net re duction in th e tota l surp lus (consum er plus producer) is a real co st to society, but the transfer from buyers to sellers resulting from a higher price is not a real cost sin ce the net reduction autom a tically accounts for the transfer from buyers to sellers. However, tr ansfers from the United States to other nations should be included as costs, and tran sfers from ot her nations to the United States as benefits, as long as the analysis is conducted from the United States perspective.

You should not include transfers in the estim a tes of the benefits and costs of a regulation. Instead, add r ess th em in a separa te discussion of the regulation = s distributional effects. Exam ples of transfer paym ents include the following:

• Scarcity rents and m onopoly profits

• Insurance paym ents

• Indirect taxes and subsidies

Treatmen t o

f

Uncertainty

The precise consequences (benefits and co sts) of regulatory op tions are not always known for certain, but the probabili ty of their occurrence can ofte n be developed. The im portant uncertainties connected with your regulatory decisions need to be analyzed and presented as part of the overall regulatory analys is. You should begin your analysis of uncertainty at the earliest possible stage in developing your an alysis. You should consider both the statistical variability of key elem ents underlying the estim ates of benefits and costs (for exam ple, the expected change in the distribution of automobile accidents that m i ght result from a change in autom obile safety standard s) a nd the inco mplete knowledge about the relevant re lationships (for example, the uncertain knowledge of how som e econom ic activ ities m i ght affect future clim ate change). 25 By assessing the sources of uncerta inty and the way in which benefit and cost estim a tes m a y be affected under plausible assum p tions, you can shape your analysis to inform decision m a kers and the public about the effects and the uncerta inties of alternativ e regulatory actions.

25 I n s o m e contexts, t h e word A v a riab ility @ is u s ed as a synon ym f

o r

statistical v a r i ation that can b e d e scrib e d b y a th eoretically v a lid d i stribu tion fun c tion

, whereas A u n c ertain ty @ refe rs t o a m o re fu n d am ental lack of k

n o wle dge

. Th rou gho u t t

h is d i scu ssion , we u s e th e term “u n c ertain ty” to refer to bo th co n c ep ts.

38The treatm e n t of uncertainty m u st be guided by the sam e principles of full disclosure and transparency that apply to other elements of your regulatory analysis. Yo ur analysis should be credib le, objectiv e, rea lis tic, and scie ntif ica lly ba lanced. 26 Any data and m odels that you use to analyze uncertainty should be fully identifie d. You should also discuss the quality of the available data used. Inferences and assum p tions used in your analysis should be identified, and your analy t ical cho i ces s hould be ex plicitly ev aluated and ad equately jus t ified. In yo ur presentation, you should delineate the strengths of your analysis along with any uncertainties about its conclusions. Y our presentation should also explain how your an alytical choices have affected your results.

In som e cases, the level of scientific un certainty m a y be so large that you can only present discrete alternative scenarios without as sessing the relative likelihood of each scenario quantitatively. For instance, in assessing the potential outcom e s of an environm ental effect, there m a y be a lim ited num b er of scientific studies with stron g ly dive rgen t re su lts. In such cases,

you m i ght present results from a range of plausi ble scenarios, together with any available inform ation that m i ght help in qualitatively determ ining which scenar io is m o st like l y to occur.

When uncertainty has significant effects on th e final conclusion about net benefits, your agency shou ld consid er addition a l res earch p r ior to rulem a king. The costs of being wrong m a y outweigh the benefits of a faster decision. This is true especially for cases with irreversible or large upfront investm e nts. If your agency decides to proceed with rulem a king, you should explain why the costs of devel oping additional infor m ation—inclu ding any harm from delay in public protection—exceed the va lue of that inform ation.

For exam ple, when the uncertainty is due to a lack of data, you m i ght consider deferring the decision, as an explicit regulatory altern ative, pending further st udy to obtain sufficient data. 27 Delaying a decis i o n will a l so h a ve costs, as will f u rthe r ef f o rts at data gathe r ing and analys is. You will need to weigh th e benefits of delay again s t thes e cos t s in m a king your decision. Form al tools for assessing the value of additional infor m ation are now well developed in the applied decision sciences and can be used to help resolve this t ype of com p lex regulatory question.

A Real option s @ m e thods have also fo rm alized the valuation of the added flexibility inheren t in d e laying a decision. As long as tak i n g tim e will lower uncertaint y, either passively or actively through an investm e nt in inform ation gath ering, and som e costs are irreversible, such as the potential costs of a sunk investm e nt, a bene fit can be assigned to the option to delay a decision. That benefit should be considered a cost of taking imm e diate action versus the alternative of delaying that action pending m o re infor m ation. However, the burdens of delay— including any harm to public health, safety, and the environm ent—need to be analyzed carefully.

1. Quantita tive Analysis of Uncerta inty

26 W h en d i ssem i n a tin g inform a tio n , ag en cies sh ou ld fo llow t h eir own in formatio n qu ality g u i d e lin es, issu ed in

con f orm a nce wi t h t h e OM B go ve rnm e nt -wi d e gui del i n es ( 6 7 FR 8 4 5 2

, F e br uary 2 2 , 2 0 0 2 )

. 27 Clem en RT ( 1 996), M a king Har d

Decisions: A n Intr oduct i on to Decision Analysis , secon d ed ition

, Dux bury Press, Pacific Grove.

39Exam ples of quantitative analysis, broadly de fined, would include form al estim ates of the probabilities of environm ental da mage to soil or wa ter, the possible loss of habitat, o r risk s to endangered species as well as proba bilities of harm to hum a n health and safety. There are also uncertainties associated with estim a tes of econom ic benefits and costs, such as the cost savings associated w ith increased energy efficienc y. Thus, your analysis should include two funda m e ntal com ponents: a quantitative analysis ch aracterizing the probab ilities of the relevant

outcom e s and an assignm e nt of econom i c value to the p r oje c ted outcomes. It is ess e ntia l tha t both parts be conceptually consistent. In pa rticular, the quantitativ e analysis should be conducted in a way that perm its it to be applie d within a m o re general analytical fram e w ork, such as benefit-cost analysis. Sim ilarly, the general fram ework needs to be flexible enough to incorporate the quantitative anal ysis without oversim plifying th e results. For exam ple, you should address explicitly the im plications for bene fits and costs of any pr obability distributions developed in your analysis.

As with other elem ents o f regulato r y an alys is, yo u will need to balance th oroughness with the practical lim its on your analytical capab ilities. Your analysis does not have to be exhaustive, nor is it necessary to ev aluate each alternative at every ste p. Attention should be devoted to first resolving or studying the uncerta inties that have the la rgest potential effect on decis i on m a king. Many tim es these will be the larges t sources of uncertainti es. In th e absence of adequate data, you will need to make assum p tions. These should be clearly identified and consistent w ith the relevant sc ience. Your analysis should pr ovide sufficient inform ation for decision m a kers to grasp the degree of scientif ic uncertainty and the robustness of estim ated probabilities, benefits, and costs to changes in key assum p tions.

For m a jor rules invo lvin g annual eco nom i c effects of $1 billio n or m o re, you should present a form al quantitative an alys is of the relev a nt uncertainties about b e nefits and costs. In other words, you should try to p r ovid e som e estim ate of the probability di stribution of regulato r y benefits and costs. In summarizing the proba bility distributions, you should provide som e estim ates of the central tendency (e.g., m ean and m e dian) along with any other information you think will be useful such as ranges, varian ces, specified low-end and high-end percentile estim ates, and other character istics of the distribution.

Your estim ates cannot be m o re precise than their m o st uncertain com ponent. Thus, your analys is sho u ld report es tim ates in a way that re flects the degree of uncertainty and not create a false sense of precision. Worst-cas e or conservative analyses ar e not usually adequate because they do not convey the com p lete probability di stribution of outcom es, and they do not perm it calcu lation of an expected value of net benefits. In m a ny he alth and safety rules, econom i sts conducting benefit-cost analyses m u st rely on form al risk assessm ents that address a variety of risk m a nagem e nt questions such as the baseline risk for the af fected popul ation, the safe level of

exposure or, the am ount of risk to be reduced by various interventions. B ecause the answers to

som e of these questions are dire ctly used in benefits analys es, the risk assessm ent m e thodology must allow for the determ ination of expected bene fits in order to be comparable to expected costs. This m eans that conservative assum p ti ons and defaults (whether m o tivated by science policy o r by precau tiona ry instin cts ) , will be inco mpatible with benefit an alyses a s the y will result in ben e fit estim a tes that exceed the expected value. Whenever it is possible to characterize quantitatively the probability di stributions, som e estim ates of expected value (e.g., m ean and

40m e dian) m u st be provided in addition to ranges, variances, specified low

- end and high-end percentile estim ates, a nd other characteristic s of the distribution.

Whenever possible, you should use appropria te statistical techniques to determ ine a probability distribution of the relev a nt outcom e s. For rules th at exceed th e $1 billion annual threshold, a for m al quantitative analysis of un cer tain ty is req u ired. For r u les with an nual benefits and / or cos t s in the range fro m 100 m illion to $1 billion, you sho u ld seek to u s e m o re rigorous approaches with higher consequence rules. This is es pecially th e case where net benefits are close to zero. More rigorous uncertainty analysis m a y not be necessary for rules in this c a tego r y if sim p ler techniqu es a r e suf f i ci ent to show robustness. You m a y consider the following an alytical approaches th at en tail inc r ea sing lev e ls o f com p lexity :

• Disclose qualitatively the m a in uncertainties in each im portant input to the calculation of benefits and costs. These di sclosures should address the uncer tainties in the data as well as in the analytical results. However, m a jo r rules above the $1 b illion annual threshold require a form al treatm e nt.

• Use a num er ical sensitivity analysis to exam in e how the results of your analysis vary with plausible changes in assum p tions, choices of input data, and alte rnative analytical approache s . Sensitiv ity analys is is e s pecia lly va luable when the inf o rm ation is la cking to
carry ou t a form al probabilis tic sim u lation. Sens itiv ity an aly s is can be u s ed to find

A switch points @ -- critical param e ter values at which estim a ted net benefits change sign or the low cos t alte rnative s w itches. Se nsitiv ity ana l ysis usu a lly proceeds by changing o n e variable or assum p tion at a tim e, but it can also be done by varying a com b ination of variables simultaneously to learn more about the robustness of your results to widespread changes. Again, however, m a jor rules above the $1 billion annual threshold require a for m al treatm ent.

• Apply a form al probabilistic analys is of the relevant uncertainties

B possibly using sim u lation models and/or expe rt judgm e nt as revealed, for exam ple, through Delphi

m e thods. 28 Such a form al analytical approach is a ppropria te f o r com p lex rules where there are lar g e, m u ltiple uncertainties whose analysis ra ises te chnica l challenges, or where the ef fects cascade; it is required fo r rules that exceed the $1 billion annual threshold. For exam ple, in the analysis of regulations addressing air pollution, there is uncertainty about the effects of the rule on future em issions, uncertainty about how the change in em issions will affect air q u ality, uncertain ty about how changes in air quality will affect h ealth, and finally uncertainty abou t the econom ic and social v a lue of the change in health outcomes. In form a l proba bilistic assessm ents, expert solicitation is a useful way to fill key gaps in your ability to assess uncertain ty. 29 In general, experts can be used to q u antif y the p r obability d i stribu tion s o f key parameters and re lationsh i ps. These solicitations, com b ined with o t her s ources of data, can be com b ined in Monte Carlo sim u lations to derive a probability distribution of bene fits and costs. You should

28 The purpose of Delphi m e thods is t o gene rat e suita ble i n form ation for deci sion m a king by eliciting expect j udg m e n t . Th e elicitatio n is co ndu cted t h roug h a su rv ey p r o cess which eli m inates the int e ractions bet w een e xpe rts. See Mor g an M G an d H e nr ion M (1 990 )

, Uncerta in ty: A Gu id e to Dea l i n g with Un certain ty in Quan tita tive Riskand Policy A nalysi s , Cam b ridge Uni v ersity P r e ss. 29 Cooke RM ( 1 991), Exp e rts i n Un certa i n t y: Op in ion an d Su b j ective Proba b ility in S c ience , O x fo rd U n i v ersity
Press.

41pay attention to correlated inputs. O f ten tim es, the standard defau lts in Monte Carlo and other sim ilar sim u lation packages assum e i ndependence across distri butions. Failing to correctly account for correlated distributions of inputs can cause the resultant output uncertainty intervals to be too large, although in m a ny cases the overall ef fect is

am biguous. You should m a ke a special effort to portray the proba bilistic results—in graphs and/or tables—clearly and meaningfully.

New m e thods m a y becom e available in the future. This docum ent is not intended to discourage or inhibit their use, but rather to en cou r age and s t imulate the i r developm ent.

2. Econom ic Values of Uncertain Outcom es

In developing benefit and cost estim ates, you m a y find that there are probability distributions of values as well fo r each of the outcom e s. W h ere th is is the case, you will need to

com b ine these probability distributions to provide estim a ted benefits and costs.

Where there is a dis t ribu tion of outco m e s, you will often find it us eful to emphasize summary statistics or figures that can be r eadily understood and com p ared to achieve the broadest public understanding of your findings. It is a common practice to com p are the A best estim ates @ of both benefits and costs with thos e o f com p eting alternatives. These A best estim ates @ are usually the average o r the expected valu e of benefits and costs. Em phasis on these expected v a lues is app r o p riate as lon g as society is A risk neutral @ with respect to the regulatory alternatives. W h ile this m a y not always be the case, you should in general assum e A risk neutrality @ in your analysis. If you adopt a different assum p tion on risk preference, you should explain your reasons for doing so.

3. Alterna tive Assum p tions

If benefit or cost estim ates depend h eavily on certain assum p tions, you should m a ke those assum p tions explicit and carry out sensi tiv ity analy s es using plaus i ble altern ative

assum p tions. If the value of net benefits changes from positive to negative (or vice versa) or if the relative ranking of regulatory options cha nges with alternative plausible assum p tions, you should conduct further analysis to determ ine wh ich of the alternative assum p tions is more appropriate. Because dif f erent estimation m e thods m a y have hidden assu mptions, yo u should analyze estim ation m e thods carefully to m a ke any hidden assum p tions explicit.

F. Specializ ed Analytical Requirements

In preparing analytical support for your ru lem a king, you should be aware that there are a

num b er of analytic requirem ents im posed by la w and Executive Order. In addition to the regulatory analysis requirem ents of Executiv e Order 12866, you should also consider whether your rule will need specialized analys is of any of the following issues.

42Impact on S m all Businesses and Other Small E n tities

Under the Regulato r y Flexibility Ac t (5 U.S.C. chapter 6 ) , ag encies m u st prepar e a proposed and final "regulatory flexibility anal ysis" (RFA) if the rulem a king could "have a significant impact on a substantial num b er of s m a ll entities." You should consider posting your RFA on the internet so the pub lic can review your findings.

Your agency should have guidelines on how to prepare an RF A and you are encouraged to consult with th e Chief Counsel for Advo cacy of the Sm all Business Adm i nistration on expectations concerning what is an ade quate RF A. Executive Order 13272 (67 FR 53461, August 16, 2002) requires you to no tify the Chief C ounsel for Advocacy of any draft rules that

m i ght have a significant econom ic impact on a s ubstantial num b er of s m all entities. Executive Order 13272 also directs agencies to give every appropriate consideration to any comm ents provided by the Advocacy Office. Under SBREFA, EPA and OSHA are required to consult with

sm all business prior to developing a proposed rule that would have a significant effect on sm all businesses. OMB encourages oth e r agencies to d o so as well.

Analysis of Unfunded Mandates

Under the Unfunded Mandates Act (2 U.S.C. 1532), you m u st prepare a written statem ent about benefits and costs prior to issuing a pr oposed or final rule (for which your agency published a proposed rule) that m a y result in aggr egate expenditure by State, local, and tribal

governm e nts, or by the private sector, of $100,000,000 or more in any one year (adjusted annually for inflation). Your analytical re quirements under E x ecutive Order 12866 are sim ilar to the analytical requirem ents under this Act, and thus the sam e analysis m a y perm it you to com p ly with both analytical requirem ents.

Information Collection, Paperw ork, and Recordkeeping Burdens

Under the P a perwork Reduction Act (44 U.S. C. chapter 35), you will need to consid er whether you r rulem a kin g (or other actions ) will create any addition a l inf o rm ation collection, paperwork or recordkeeping burde ns. These burdens are permissi ble only if you can justify the practical utility of the inf o rm ation for the im plementation of your rule. O M B approval will b e required of any new requirem e nts for a collection of infor m ation im posed on 10 or m o re persons and a valid OMB control num ber m u st be obtaine d for any covered paperwork. Your agency' s CIO should be able to assi st you in com p lying with the Paperwork Reduction Act.

Information Quality Guidelines

Under the In for m ation Quality Law, agency guidelines, in confor m a nce with the OMB

governm e nt-wide guidelines (67 FR 8452, February 22, 2002), have estab lished basic quality perform a nce goals for all inform ation disse m i nated by agencies, including inform ation dissem i nated in support of proposed and final rule s. The data and analysis that you use to support your rule m u st meet th ese agency and OMB quality s t andards. Your agency' s CIO should be able to assist you in assessing inform ation quality. The Statis tical and Science Policy

43Branch of OMB' s Office of Infor m ation and Regul atory Affairs can provide you assistance. This circu l ar d e fines OMB = s m i ni m u m quality standards for regulatory analysis.

Environmental Impa ct Statements

The National Environm ental Policy Act ( 42 U.S.C. 4321-4347) and related statutes and executive orders requ ire agencies to consider the environm ental im pacts of agency decisions, including rulem a kings. An environm ental im pa ct statem ent must be prepared for "major Federal action s sign if icantly af f ecting the quality of the hum a n enviro nm ent." You m u st complete NEPA docum entation before issuing a final ru le. The W h ite House Council on Environm ental Quality has issued regu lations (40 C. F.R. 1500-1508) and ass o ciated guid a nce for im ple m entation of NEPA, ava ilable through CEQ' s website ( http://www.whitehouse/gov/ceq/ ).

Impacts on Children

Under Executive Order 13045, A Protection of Children from Environm ental Hea lth Risks and Safety Risks, @ eachagency m u st, with respe c t to its rules, A to the ex tent perm itte d by law and appropriate, and consistent with the agency = s m i ssion, @ A address disproportionate risks to children that result from environm en tal hea lth r i s k s or saf e ty risks. @ For any substantive rulem a king action that A is like l y to re sult in @ an econom ically significan t rule that concerns A an environm ental health risk or safety risk that an ag ency has reason to believ e m a y disproportionately affect children, @ the agency must provide OMB/OIRA A an evaluation of the environm ental health or safety effect s of the planned regulation on children, @ as well as A an explanation of why the planned regulation is pref erable to ot her potentially and reasonably f easible a lte rnatives co n s idered by the agency. @

Energy Imp a cts

Under Executive Order 13211 (66 FR 28355, May 22, 2001), agencies are required to prepare and subm it to OMB a Statem ent of Ener gy Effects for significant energy actions, to the extent p e rm itted by law. This Statement is to inc l ude a deta ile d statem ent of A any adverse effects on energy supply, distribution, or use (including a shortfall in supply, price increases, and increased use of foreign supplies) @ for the action and reasonable al tern atives and their effects. You need to publish the Statem ent or a summ ary in the related NPRM and final rule. For further guidance, see OMB Memorandum 01-27 (“Gu idance on Im plem enting Executive Order 13211”, July 13, 2001), available on OMB = s website.

G. Accounting Statemen t

You need to provide an accounting statem en t with tables reporting benefit and cost estim ates for each m a jor final rule for your agen cy. You should use th e gu idance ou tlined above to report these estim a tes. W e have include d a suggested format for your consideration.

44Categories of Benefits and Costs

To the extent feasible, you should quantify al l potential increm ental benefits and costs. You should report benefit and cost estim ates wi thin the following three categories: monetized quantified, but not m onetized; and qualitat ive, but not quantified or m onetized.

These categories are m u tually exclusive and exhaustive. Throughout the process of listing prelim inary estim a tes of benefits and co sts, agencies should avoid double-counting. This problem m a y arise if m o re than one way exists to express the sa m e change in social welfare.

Quantifying and Monetizing Benefits and Costs

You should develop quantitative estim ates and convert them to dollar am ounts if possible. In m a ny cases, quantified estim ates are readily conv ertible, with a little effort, into dollar equivalents.

Qualitative Benefits an d Costs

You should categorize or rank the qualitative effects in term s of their im portance (e.g., certainty, likely m a gnitude, and reversibility). Y ou should distinguish the effects that are likely to be significant enough to warrant serious consid eration by decision m a kers from those that are likely to be m i nor.

Treatmen t o

f

Benefits a n d Costs over Time

You should present undiscounted stream s of benefit and cost estim ates (monetized and net) for each year of the analyt ic time horizon. You should presen t annualized benefits and costs using real discount rates of 3 a nd 7 percent. The stream of a nnualized estim ates should begin in the yea r in which the f i nal ru le wi ll begin to have effects, even if the rule does not take effect imm e diately. Please report all m onetized eff ects in 2001 dollars. You should convert dollars expressed in different years to 2001 dollars using the GDP deflator.

Treatmen t o

f

Risk and Uncertainty

You should provide expected-value estim ates as well as distributions about the estim ates, where such infor m ation exists. W h en you provi d e only upper and lower b ounds (in ad dition to best estim ates), you should, if possible, us e the 95 and 5 percent confidence bounds. Although we encourage you to develop estim at e s t h a t c ap tu r e t h e d i s t r i b u t i o nof plausible outcom es for a particular alternative, detailed reporting of such distributions is not required, but should be available upon request.

The principles of full disclosure and transpar ency apply to the trea tm ent of uncertainty.
W h ere there is sign if ican t uncer tain ty and the resulting inferences and/or assum p tions have a critical effect on the benefit and cost estim ates , you should describe the benefits and costs under plausib l e alternative as s u m p tions . You m a y add footnotes to th e table as needed to provide docum entation and references, or to express im portant warnings.

45In a previous section, we identified som e of the issues associated with developing estim ates of the value of reductions in prem at ure mortality risk. Based on this discussion, you should present alternative prim ary estim ates where you use different estim ates for valuing reductions in prem ature mortality risk.

Precis i on of Estima tes

Reported estim a tes should reflect, to the extent feasible, the precision in the analysis. For

exam ple, an estim ate of $220 m illio n im plies ro unding to th e nearest $1 0 m illion an d thus a precis i on of +/-$5 m illio n; sim ilarly, an estim a te of $222 m illion im plies rounding to the nearest $1 m illion and thus, a precis i on of +/-$0.5 m illio n.

Separate Reporting of T r ansfers

You should report transfers se parately and avoid the m i sc lassification of transfer

paym ents as benefits or costs. Transfers occur w h en wealth or incom e is redistributed without any direct change in agg r egate social welfare. To the extent that regulatory outputs reflect transfers rather than net welfar e gains to society, you should iden tify them as transfers rather than benefits or costs. You should also dis tinguish transfers caused by F e deral budget actions -- such as thos e stemm i ng from a rule affecting Soci al Security paym ents -- from those that involve transfers between non-governm e ntal parties -- su ch as m onopoly rents a rule m a y confer on a private party

. You should use as m a ny catego r ies as necessary to describe the m a jor redistributive effects of a regulat ory action. If transf ers have significant efficiency effects in addition to distributional eff ects, you should report them

.
Effects on S t ate, Local, and Tribal Gover nments, Small Bu siness, Wages and Economic Growth

You need to identity th e porti ons of benefits, costs, and tran sfers receiv e d by State, local, and tribal governm e nts. To the extent feasible, y ou also should identify the effects of the rule or

program on sm all businesses, wages, and economic growth. 30 Note that rules with annual costs that are less than one billion dollars are likely to have a m i ni mal effect on econom ic growth.

30 Th e Regu lato ry Flex ib ility Act (5 U.S.C. 603 (c), 60 4).

46OMB#:Agency/ProgramOffice:Rule Title:RIN#:Date:CategoryPrimary EstimateMinimum EstimateMaximum EstimateSource Citation(RIA, preamble, etc.)BENEFITSmonetizedbenefitsAnnualized quantified, butunmonetized, benefits(unquantified)benefitsCOSTSAnnualizedmonetizedcostsAnnualized quantified, butunmonetized, costsQualitative(unquantified)costsTRANSFERSAnnualized monetized transfers:“on budget”fromwhomtowhom?Annualized monetized transfers:“off-budget”Fromwhomtowhom?CategoryEffectsSource Citation(RIA, preamble, etc.)Effects on State, local, and/ortribal governmentsEffects on small businessesEffectsonwagesEffectsongrowth47H. Effective D a te

The effective date of this Circular is Janua ry 1, 2004 for regulatory analyses received by OMB in support of proposed rules, and Janua ry 1, 2005 for regulatory analyses received by OMB in support of final rules. In other word s, this Circular appl ies to the regulatory analyses for draft propos ed rules that are fo rm ally subm itted to OIRA after Decem b er 31, 2003, and for draft final rules that are for m ally s ubm itted to OIRA after Decem ber 31, 2004. (However, if the draft proposed rule is subject to the C i rcular, then the draft final rule will als o be subject to the Circular, even if it is s ubm itted prior to Janu ary 1, 2005.) To the exten t practicable, agencies sh ould co m p ly earlier than these effective dates. Agencies may, on a case-by-cas e bas i s, seek a waiver from OMB if these effective dates are im practical.

48