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### The Use of Benefit - Cost Analysis in Environmental Policy Making Charles Griffiths* National Center for Environmental Economics, U.S. EPA

Corresponding Author: Charles Griffiths National Center for Environmental Economics Room 4316f EPA East, Mail Code 1 809T U.S. Environmental Protection Agency 1200 Pennsylvania Avenue, N.W. Washington, D.C. 20460 Phone: 202/566

- 2288 Fax: 202/566

- 2338 Email: griffiths.charles@epamail.epa.gov

* Charles Griffiths is an economist in the National Center for Enviro nmental Economics at the U.S. Environmental Protection Agency. The views expressed in this paper are entirely those of the author and do not necessarily represent the views of the U.S. Environmental Protection Agency.2 Abstract There are four general area s that constrain the government economist = s ability to conduct more widely accepted benefit

- cost analysis: legal limitations, institutional constraints, limited resources, and research

related issues. Legally, agencies must design regulation to address p otential economic, environmental, public health and safety, distributive, and equity impacts. In practice, more attention is placed on the scientific, technical, and enforcement issues, leading to institutional shortcuts to conduct the economic analyses. Previously used benefits transfer methodologies are overused because any new application of economic methodologies must be peer reviewed with appropriate time for public comment. Additionally, economic analysis almost always occurs last in the rule devel opment process. This is not to imply that the benefit

- cost analysis at the EPA is substandard, rather it is subject to the same criticism leveled against benefit

- cost analysis conducted by academics, particularly regarding the use of the A value of a stati stical life @ (VSL) and morbidity values. The inescapable truth is that benefit

- cost analysis for policy making will always be a constrained exercise, but it is still useful. The increasing complexity of both the dimensions considered and values used refl ect a desire for more and better benefit

- cost analysis, not less.

Keywords: Benefit

- Cost Analysis, Environmental Policy, Value of a Statistical Life, Willingness to Pay3

Benefit

- cost analysis is the tool by which economists determine if there are positi ve net benefits from regulation, and the need for improved analysis has grown over time. If the most egregious environmental problems were effectively addressed in early environmental regulation, then the largest net benefits have already been captured. Unless either the nature of the environmental problems or society = s preferences have changed, standard economic theory suggests that additional regulation will produce progressively smaller benefits at progressively larger costs. Benefit

- cost analysis mea sures these incremental changes. Benefit

- cost analysis has also gained some opponents. Critics have portrayed benefit

- cost analysis as the weapon of anti

- environmentalists bent on preventing beneficial regulation from being passed. Others have pointed to the limitations of the methodology to discount its importance in decision making. Chief among these limitations is the inability to monetize all of the benefits from environmental regulation. How can net benefits to society from additional regulation be assessed if the benefits are only partially measured? In fact, even if total costs and benefits are fully and accurately measured, a case can be made that certain environmental actions are morally correct, irrespective of whether costs outweigh benefits. The strict utilitarian measure of welfare used by economists can never capture this moral imperative. Into this divide is cast the government = s environmental economist. For all A major regulation, @

he or she is required

to conduct a benefit

- cost analysis , but is limited in his or her ability to do so. In general, there are four areas that constrain the government economist = s ability to conduct more widely accepted benefit

- cost analysis: legal limitations, institutional constraints, limited resources, and research

related issues. Each of these limitations is discussed below.4

Legal Limitations

While most regulatory agencies have a handful of laws that define their primary responsibilities, the EPA is responsible for implementing a plethora of environmen tal laws. The EPA =

s web site states that A ... more than a dozen major statutes and laws form the legal basis for the programs of the Environmental Protection Agency ... @ (EPA 2002b). One list cites thirty

- three environmental laws through which the EPA car ries out its mission (Browner 1995). While these laws allow the EPA to measure the benefits to health and welfare from regulations passed under these statutes, they do not necessarily allow for benefit

- cost analysis. This leads to an interesting discuss ion on interpretation. Does the absence of an explicit call for a comparison of benefits and costs mean that it is not permissible? Morgenstern (1997) reprints a table suggesting that benefit

- cost analysis is A allowable @ only under the Safe Drinking Wat er Act, the Toxic Substances Control Act, and the Federal Insecticide, Fungicide, and Rodenticide Act. It is questionable if it is allowed under the Clean Water Act, the Resource Conservation and Recovery Act, and parts of the Clean Air Act. If fact, t he Supreme Court has recently ruled that while the Clean Air Act requires the EPA to promulgate national ambient air quality standards (NAAQS), these standards must be set to attain and maintain public health. Further, it ruled, the law A ... does not perm

it the (EPA) Administrator to consider implementation costs in setting NAAQS @ (Whitman v. American Trucking Assns., Inc. 2001), effectively disallowing benefit

- cost analysis as a tool for setting the primary NAAQS. Obviously, an analysis can always be don e, but it has been eliminated as a decision making tool.5

Even when benefit

- cost analysis is allowed and required, it is more complicated then simply promulgating regulation when benefits exceed costs. In 1993, President Clinton issued Executive Order 128 66 with a mandate to propose regulation A ... upon a reasoned determination that the benefits of the intended regulation justify its costs. @ This might have been an explicit desire to promote regulation even if it imposed more costs on society than benefit s, or it may have been a more implicit recognition that not all benefits can be monetized in a benefit

- cost analysis. Certainly economists were consulted in its drafting because it included a number of economic concepts such as marketable permits, user fe es, and information provision. It also encouraged the rule makers to move away from design

- based standards and A specify performance objectives, rather than specifying the behavior or manner of compliance that regulated entities must adopt @ (President 199 3). Executive Order 12866 also split the focus of the government economist by encouraging agencies to choose the option that maximizes net benefits A ... including potential economic, environmental, public health and safety, and other advantages; distribut ive impacts; and equity. @ Furthermore, agencies were to design regulation in the most cost

- effective manner, considering A incentives for innovation, consistency, predictability, the costs of enforcement and compliance (to the government, regulated entitie s, and the public), flexibility, distributive impacts, and equity. @ This was a sign of things to come. Before the end of his term, President Clinton would sign four more executive orders that added directives for benefit

- cost analysis, requiring agencies to address issues of environmental justice; include an evaluation of the impact on the health and safety of children; and requiring consultation and collaboration with affected American Indian tribal governments and state, local, and American Indian triba l governments. In addition, benefit

- cost analysis must include6

requirements specified in the Unfunded Mandates Reform Act of 1995 and the Regulatory Flexibility Act of 1980 as amended by the Small Business Regulatory Enforcement Fairness Act of 1996. Eac h additional legal requirement broadens the scope of economic analysis beyond merely comparing benefits and costs, and thus makes the results of the analysis more equivocal.

Institutional Constraints

Before any regulation is made effective, it must be A p roposed @ in the Federal Register and public comment must be sought. During the period of public comment, anyone can either comment on the proposed rule or submit data for consideration. If the data submitted is sufficient to potentially affect the decisi on made about the rule, then it must be published in the Federal Register as well, with another public comment period. During this process, any public meetings regarding the rule must be also be announced. Finally, the text of the final rule must be publ ished, making the rule effective within a certain number of days and becoming part of the Code of Federal Regulations (CFR). Obviously, the Federal Register notices do not include everything that is used in the decision making process, and generally do not include the complete benefit

- cost analysis. This is usually contained in a supporting document. All supporting documents, however, must be cited in the Federal Register notices and made available to the public. In addition, paper copies of everything t hat was used or even considered in the rule making process must be contained in an official docket and open to the public for inspection and contribution. All of this can be a time consuming process. An internal EPA database report (EPA 2002a)7

indicates that the average time that it takes from when an office begins working on a rule to the publication of the proposal is 486 days. This is an underestimate because the start time is counted from the internal A

start action notice @

issued by a program office to the Agency =

s Steering Committee, and advance work must be done prior to this. The average time from proposal to the final rule is 748 days. This means that it takes three or more years to a create new regulation. Three or more years would seem to be more than enough time to conduct a rigorous benefit

cost analysis. The problem is that economics is but one of the issues that must be addressed. Early in the regulation making process, each program office is encouraged to write an A Analytic Blueprint @

f or the rule, where it lays out all of the things that need to be accomplished and how they will be done. Of the many items that need to be addressed, the economic analysis is but one. In practice, more attention is placed on the scientific and technical issues and legal and enforcement issues than on the economic analysis. This may be because most of the people involved in rule making are non

- economists and do not understand some of the more detailed economic concepts. For example, whereas the theoretic ally correct measure of the cost of a rule includes the firm = s compliance costs, the government = s regulatory costs, transitional social costs (e.g., temporary unemployment), and the loss in consumer and producer surplus, most regulations only measure the c ompliance and regulatory costs. This is because these are visible, easy to understand, and easier to estimate. Discussions of demand elasticities and social welfare measures have a tendency to be lost on those without economic training. Similarly, discu ssions of economic benefits tend to focus on easily understandable items, such as health effects and loss of life. The concepts behind other non

- market benefits are often harder to understand for non

- economists.8

Because of the lengthy and complicated proc ess of forming a rule, certain institutional behavior has developed to deal with the economic analysis. The benefit

- cost analysis usually is evaluated only at the national level rather than more regionally or locally. It rarely includes a measure of the inefficiency of the chosen option relative to equivalent pollution reduction by the lowest compliance cost firms. Because review by OMB is required but does not generally derail a rule, this review is viewed as a hurdle to get past rather than a check to make sure that the best regulation has been designed and the best option has been chosen. This leads to an overuse of techniques and willingness to pay values that have been previously accepted by OMB and EPA management, whether or not they are most appro priate, because they are likely to be approved again.

Limited Resources

Beyond the institutional constraints, the government economist faces the traditional resource constraints of limited time and money. In the EPA = s 2003 budget request, economic anal ysis is considered to be part of Goal 8, the sound science section (EPA 2002c). This goal, of the ten listed, commands 4.2 percent of the budget, but economics is only a small part of this. In fact, benefit

- cost analysis is alluded to only twice in the e ntire budget request and none of the budget categories include economics in its description. The practical reality is that economic analysis is not a goal itself, but rather an ancillary activity in the mission of the Agency. This is also reflected in the number of economists hired by the agency. Morgenstern (1997) cites data showing that law was the most common advanced degree at the EPA in 1996, followed by biological science, engineering, and physical science. These9

four disciplines made up 64% of EPA employees with doctorates, masters, or juris doctorates at that time. Economists made up a mere 1.7% of the total. Although things have changed since then, the current percentages are probably similar. Individual benefit

- cost analyses are funded as part of each regulation development process. Generally the analysis is done by outside contractors, although in

- house economic analysis is becoming more frequent. It almost always involves benefits transfer, where the willingness to pay estimates from a prev ious study are used for the policy scenario. It is explicitly recognized in the EPA = s Guidelines for Preparing Economic Analyses (2000a) that this is not the optimal situation, but conducting an original study for anything but the largest regulation is al most an impossibility. This is due to the fact that any new contingent valuation (CV) or revealed preference survey or any novel application of existing economic methodologies must be peer reviewed if it is to be accepted for regulation development, which requires both time and money. The process of conducting a survey is particularly burdensome. Under the Paperwork Reduction Act of 1995, an agency must acquire OMB approval if it collects the same information from
ten or more non

- Federal respondents. Thi s A Information Collection Request @ (ICR) must justify the need for the data, estimate the time and cost burden placed on the public, and must be published in the Federal Register twice, with an appropriate public comment period. The EPA = s Office of Econom

ic Information (OEI) estimates that this process takes a minimum of 180 days to complete. With more than three years in rule development, however, even the ICR burden and peer

review process would be surmountable if it were not for the fact that the econo mic analysis almost always occurs last in the rule development process. This is not a bias against economics, but occurs10

because all other components of the rule must be known before they can be valued. For example, before a CV survey can be done, the p ollutant loadings (both baseline and the counterfactual), exposure scenario, and the regulatory options must be known. However, these are almost never known until management is ready to make its final decision on the rule. This means that economics canno t inform the decision unless a valuation technique is in place that can be run at the absolute last minute. This, inevitably, means some form of benefits transfer.

Research - Related Issues

This is not to imply that the benefit

- cost analysis at the EPA i s substandard. In fact, great care is taken to follow the economics literature properly. This, then, subjects it to the same criticism leveled against benefit

- cost analysis conducted by academics. A particularly contentious issue is the A value of a
stat istical life @ (VSL). Following standard economic practice, EPA economists monetize the changes in risk of death. Using the wage premium that workers require to take on risky jobs or using CV surveys, one can obtain the value that one would pay to reduce the risk of death by, say, 1 in 100,000. Multiplying this value by 100,000 then produces the VSL. 1 Using the twenty

- one wage - risk studies and five stated preference studies reported by Viscusi (1992), the EPA estimated a mean VSL of 4.8 million 1990 doll ars and a standard deviation of $3.24 million (EPA 1997). Inflated to 1999$, this $6.1 million VSL used in most benefit

- cost analysis at the EPA (EPA 2000a). This number has been roundly criticized. Most commonly, it is noted that the wage

- risk studies

us ed to estimate the VSL are based on the risk premiums for middle aged males in blue collar11

occupations in the 1970s and 1980s. Environmental risks affect a more affluent general population today. If the VSL changes with income, as is reasonable to expect, then the EPA's value should be updated for both cross

- sectional and temporal income variations. For example, Revesz (1999) suggests adjusting for the 22.7% higher median income of the general population over the workers in the wage

risk studies, and others (EPA 2000b) have suggested accounting for the average 1.5% real income growth. Since income elasticities for this type of adjustment range widely, from 0.08 to 1.0 (IEc 1999), sensitivity analysis is clearly warranted. Additionally, if it is the very old and very young that are at particularly at risk, then the VSL could be adjusted to account for how preference change with age. Jones

- Lee, et. al. (1993) suggests that the VSL may peak around 40

- 45, but other research contradicts this (Krupnick et. al 2002 ). While corrections for income and age are controversial, they are possible. More problematic are factors that economists know affect the VSL but for which there is no method to take them into account (EPA 2000b). For example, wage

- risk studies capture the risk premium of workers who accept riskier jobs. Economic theory, however, suggests that the workers with the lowest risk premium (that is, those who demand the least increase in their wage) are the ones who will fill the riskiest jobs. This suggests that the VSL is too low, but by an unknown amount. Additionally, the nature of the risk may be important to willingness to pay values. For example, the degree to which the risks have been accepted voluntarily and can be controlled are important to individ ual's behavior and perceptions of risk and, therefore, may affect the VSL. Cancer risk is particularly troublesome since it is accompanied by fear and dread that may affect the individual's willingness to pay. Finally, some have suggested that individual s of compromised health may have a different VSL from more healthy individuals, although12

support for this hypothesis is mixed. Each of these factors suggest that the VSL should be modified, but is unclear by how much and in what direction. 2 There are prob lems beyond those associated with mortality risk as well. Morbidity valuations are also controversial. While there are almost an indescribable number of ways that one might become sick from environmental hazards, robust willingness to pay values exist for a very limited number of conditions, such as chronic bronchitic and asthma attacks (EPA 1997). Absent these values, economists are forced to use the cost

- of

- illness as a proxy. These measures are considered to be a lower bound of the individual's true will

ingness to pay, but even this is not certain because of insurance and other distortions (EPA 2000a). All that is known for sure is that, conceptually, the cost

- of

- illness numbers do not reflect the true willingness to pay values.

Facing Facts

The sum of

these limitations make things look quite bad for both benefit

- cost analysis and the economist. The inescapable truth is that benefit

- cost analysis for policy making will always be a constrained exercise. This is not to say that it is not useful. The incr easing complexity of both the dimensions considered and values used reflect a desire for more and better benefit

- cost analysis, not less. Extreme critics aside, benefit

- cost analysis has been widely embraced as an important input in the regulatory process. For most, its results are controversial only to the degree that economists question that they are comprehensive. We must assure ourselves that all aspects of the problem have been accurately addressed, and any missing components publicly confessed.13

The limitations detailed above should not imply that benefit

- cost analysis for policy making is not done well. Admittedly, some regulation has been proffered with bad benefit

- cost analysis, but OMB has served its function to assail the deficiencies and send t he analysis back for improvement. Rather than impeding good regulation, this has only strengthened the EPA = s resolve to honestly and accurately report benefits and costs. Furthermore, when freed from the constraints of the regulatory process, government al environment economists have produced well respected, high quality work, such as the two benefit

- cost analyses of the Clean Air Act (EPA 1997, 1999). In addition, the EPA = s National Center for Environmental Economics is working on research to advance va luation techniques that may be useful in Agency rule making. In general, benefit

- cost analysis in policy making has been steadily improving and will continue to serve a useful function in decision making Finally, we must remember that benefit

- cost analysi s is but one input into any good regulatory decision. Ultimately, certain intangibles may never be fully captured by economists. Nevertheless, the comparison of benefits that society might enjoy from additional environmental regulation to the associated costs will always be valuable to decision makers.14 References Browner, Carol M. 1995. A The Earth is in Your Hands @ EPA Journal . 21(1)(Winter). EPA

175

- N

- 95

- 001. Retrieved March 13, 2002, from http://www.epa.gov/docs/epajrnal/winter95/04.txt.html Industri al Economics, Incorporated (IEc). 1999. "Recommended Approaches to Adjusting WTP Estimates to Reflect Changes in Real Income.'' Memorandum to Jim DeMocker' Ofice of Policy Analysis and Review, Office of Air and Radiation, U.S. EPA, prepared by Naomi Kleck er and James E. Neumann, June 3. Jones

- Lee, M.W., D. O'Reilly, and P.R. Philips. 1993. "The Value of Preventing Non

- Fatal Road Injuries: Findings of a Willingness

- to

- Pay National Sample Survey, @ TRL Working Paper, WP SRC2. Krupnick, Alan, Anna Alberini, Ma ureen Cropper, Nathalie Simon, Bernie O = Brien, Ron Goeree, and Martin Heintzelman. (2002). A Age, Health and the Willingness to Pay for Mortality Risk Reductions: A Contingent Valuation Study of Ontario Residents, @ Journal of Risk and Uncertainty

, 24, 161

- 186 Mogenstern, Richard D., ed. 1997. Economic Analysis at EPA . Washington, D.C.: Resources for the Future. Revesz, Richard. 1999. "Environmental Regulation, Cost

- Benefit Analysis, and the Discounting of Human Lives," Columbia Law Review, 99(4): 941

- 1017. President. 1993. A

Executive Order 12866 of September 30, 1993: Regulatory Planning and Review. @ Federal Register . 58, no. 190 (October 4): 51735.15

U.S. Environmental Protection Agency. 1997. The Benefits and Costs of the Clean Air Act: 1970

- 1990 . Prepar ed by the Office of Air and Radiation and the Office of Policy, Planning and Evaluation. EPA

- 410

- R

- 97

- 002. U.S. Environmental Protection Agency. 1999. The Benefits and Costs of the Clean Air Act: 1990 to 2010 . Prepared by the Office of Air and Radiation and the Office of Policy. EPA

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- R

- 99

- 001. U.S. Environmental Protection Agency. 2000a. Guidelines for Preparing Economic Analyses

. Prepared by the Office of the Administrator. EPA 240

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- 003. U.S. Environmental Protection Agency. 2000b. Valuing Fatal Cancer Risk Reductions . draft white paper reviewed in Science Advisory Board report no. EPA

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- EEAC

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- 013. U.S. Environmental Protection Agency. 2002a. A Average Time Consumed in Rule Development. @ In Rule and Policy Information Development System (RAPI DS) [database online]. Washington, D.C. [updated March 13, 2002; cited March 13, 2002]. 1 screen. Restricted database available to EPA employees. U.S. Environmental Protection Agency. 2002b. Major Environmental Laws . Retrieved March 12, 2002, from http:

//www.epa.gov/epahome/laws.htm U.S. Environmental Protection Agency. 2002c. Summary of the EPA = s Budget: FY 2003 . Retrieved March 13, 2002, from http://www.epa.gov/ocfo/budget/budget.htm Viscusi, W. K. 1992. Fatal Tradeoffs: Public and Private Responsibili ties for Risk , New York, N.Y.: Oxford University Press. Whitman v. American Trucking Assns., Inc. 2001. 531 U.S. 457 (Supreme Court, February 27).16 Endnotes

1 . Note that this is never interpreted as the value place on one life, it is the v alue placed on a marginal change in risk and offered to an appropriate number of individuals so that, statistically, one life would be saved. 2 . While the EPA is aware of these issues, the Agency = s Environmental Economics Advisory Committee of the Science Advisory Panel has recommended using the current VSL figure.