## Circular A-4
September 17, 2003

TO THE HEADS OF EXECUTIVE AGENCIES AND ESTABLISHMENTS Subject: Regulatory Analysis This Circular provides the Office of Management and Budget's (OMB's) guidance to Federal agencies on the development of regulatory analysis as required under Section 6(a)(3)(c) of Executive Orderl2866, "Regulatory Planning and Review," the Regulatory Right-to-Know Act, and a variety of related authorities. The Circular also provides guidance to agencies on the regulatory accounting statements that are required under the Regulatory Right-to-Know Act.
This Circular refines OMB's "best practices " document of 1996 (htit)://www.whitehouse.gov/omb/inforeg/riaguide .html), which was issued as a guidance in 2000 (http://www.whiteliouse.gov/omb/memoranda/m00-08.pdf), and reaffirmed in 2001 (http://www.whitehouse.gov/omb/memoranda/m01-23.html). It replaces both the 1996 "best practices" and the 2000 guidance. In developing this Circular, OMB first developed a draft that was subject to public comment, interagency review, and peer review. Peer reviewers included Cass Sunstein, University of Chicago; Lester Lave, Carnegie Mellon University; Milton C. Weinstein and James K. Hammitt of the Harvard School of Public Health; Kerry Smith, North Carolina State University; Jonathan Weiner, Duke University Law School; Douglas K. Owens, Stanford University; and W. Kip Viscusi, Harvard Law School. Although these individuals submitted comments, OMB is solely responsible for the final content of this Circular.
A. Introduction This Circular is designed to assist analysts in the regulatory agencies by defining good regulatory analysis - called either "regulatory analysis" or "analysis" for brevity - and standardizing the way benefits and costs of Federal regulatory actions are measured and reported. Executive Order 12866 requires agencies to conduct a regulatory analysis for economically significant regulatory actions as defined by Section 3(f)(1). This requirement applies to rulemakings that rescind or modify existing rules as well as to rulemakings that establish new requirements. The Need forAnalysis of Proposed Regulatory Actions' Regulatory analysis is a tool regulatory agencies use to anticipate and evaluate the likely consequences of rules. It provides a formal way of organizing the evidence on the key effects -
1 We use the term "proposed" to refer to any regulatory actions under consideration regardless of the stage of the regulatory process.

1 

## CircularA-4 September 17, 2003

TO THE HEADS OFEXECUTIVE AGENCIES AND ESTABLISHMENTS 

### Subject: RegulatoryAnalysis
This Circular provides the Office ofManagement and Budget's (OMB's) guidance to Federal agencies onthe development ofregulatory analysis as required under Section 6(a)(3)(c) ofExecutive Order12866, "Regulatory Planning and Review," the Regulatory Right-to-Know Act, and a variety ofrelated authorities. The Circular also provides guidance to agencies onthe regulatory accounting statements that are required under the Regulatory Right-to-Know Act.
This Circularrefines OMB's "best practices" document of 1996 (http://www.whitehouse.gov/omb/inforeg/riaguide.html), which was issued as a guidance in 2000 (http://www.whitehouse.gov/omb/memoranda/mOO-08.pdf), andreaffirmed in 2001 (http://www.whitehouse.gov/omb/memoranda/mOI-23.html). Itreplaces both the 1996 "best practices" and the 2000 guidance.
In developing this Circular, OMB first developed a draft that was subject to public comment, interagency review, and peerreview. Peerreviewers included Cass Sunstein, University ofChicago; LesterLave, Carnegie Mellon University; Milton C. Weinstein and James K. Hammitt ofthe Harvard School ofPublic Health; Kerry Smith, North Carolina State University; Jonathan Weiner, Duke University Law School; Douglas K. Owens, Stanford University; and W. Kip Viscusi, Harvard Law School. Although these individuals submitted comments, OMB is solelyresponsible for the final content ofthis Circular. 

### A. Introduction
This Circular is designed to assist analysts in the regulatory agencies by defining good regulatory analysis

- called either "regulatory analysis" or "analysis" for brevity

- and standardizing the waybenefits and costs ofFederal regulatory actions are measured and reported. Executive Order 12866 requires agencies to conduct a regulatory analysis for economically significantregulatory actions as definedby Section 3(f)(1). This requirement applies to rulemakings that rescind ormodify existing rules as well as to rulemakings that establish new requirements. 

### The Need forAnalysis of ProposedRegulatoryAction/ Regulatory analysis is a tool regulatory agencies use to anticipate and evaluate the likely consequences ofrules. Itprovides a formal way oforganizing the evidence on the key effects

-

I We use the term "proposed" to refer to any regulatory actions under consideration regardless ofthe stage ofthe regulatory process.

1good and bad - of the various alternatives that should be considered in developing regulations.

The motivation is to (1) learn if the benefits of an action are likely to justify the costs or (2) discover which of various possible alternatives would be the most cost-effective. A good regulatory analysis is designed to inform the public and other parts of the Government (as well as the agency conducting the analysis ) of the effects of alternative actions. Regulatory analysis sometimes will show that a proposed action is misguided , but it can also demonstrate that well

-conceived actions are reasonable and justified. Benefit-cost analysis is a primary tool used for regulatory analysis.2 Where all benefits and costs can be quantified and expressed in monetary units, benefit-cost analysis provides decision makers with a clear indication of the most efficient alternative , that is, the alternative that generates the largest net benefits to society (ignoring distributional effects). This is useful information for decision makers and the public to receive, even when economic efficiency is not the only or the overriding public policy objective. It will not always be possible to express in monetary units all of the important benefits and costs

. When it is not, the most efficient alternative will not necessarily be the one with the largest quantified and monetized net-benefit estimate. In such cases, you should exercise professional judgment in determining how important the non-quantified benefits or costs may be in the context of the overall analysis. If the non-quantified benefits and costs are likely to be important, you should carry out a "threshold" analysis to evaluate their significance

. Threshold or "break-even" analysis answers the question, "How small could the value 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 analysis you should indicate, where possible, which non-quantified effects are most important and why. Key Elements of a Regulatory Analysis A good regulatory analysis should include the following three basic elements: (1) a statement of the need for the proposed action, (2) an examination of alternative approaches, and (3) an evaluation of the benefits and costs

- quantitative and qualitative-of the proposed action and the main alternatives identified by the analysis. To evaluate properly the benefits and costs of regulations and their alternatives , you will need to do the following: o Explain how the actions required by the rule are linked to the expected benefits. For example, indicate how additional safety equipment will reduce safety risks

. A similar analysis should be done for each of the alternatives. o Identify a baseline

. Benefits and costs are defined in comparison with a clearly stated alternative

. This normally will be a "no action" baseline: what the world will be like if the proposed rule is not adopted. Comparisons to a "next best" alternative are also especially useful.

2 See Mishan EJ (1994), Cost-Benefit Analysis, fourth edition, Routledge, New York.

2 good andbad

- ofthe various alternatives that should be considered in developing regulations. The motivation is to (1) learn ifthe benefits ofan action are likely tojustifythe costs or (2) discover which ofvarious possible alternatives would be the most cost-effective.
A goodregulatory analysis is designedto informthe public and otherparts ofthe Government (as well as the agency conducting the analysis) ofthe effects ofalternative actions. Regulatory analysis sometimes will show that

## aproposed action is misguided, but it can also demonstrate that well-conceived actions are reasonable andjustified.
Benefit-cost analysis is a primary tool used for regulatory analysis. 2 Where allbenefits and costs canbe quantified and expressed inmonetary units, benefit-cost analysis provides decision makers with a clear indication ofthe most efficient alternative, that is, the alternative that generates the largest netbenefits to society (ignoring distributional effects). This is useful information for decision makers and the public to receive, even when economic efficiency is not the only orthe overridingpublic policy objective.
Itwill not always be possible to express in monetaryunits all ofthe important benefits and costs. When it is not, the most efficient alternative will not necessarilybe the one withthe largest quantified and monetizednet-benefit estimate. In such cases, you should exercise professionaljudgment in determining how importantthe non-quantifiedbenefits or costs maybe inthe context ofthe overall analysis. Ifthe non-quantifiedbenefits and costs are likely to be important, you should carry out a "threshold" analysis to evaluate their significance. Threshold or "break-even" analysis answers the question, "How small could the value ofthe non-quantified benefits be (orhow large wouldthe value ofthe non-quantified costs needto be) before the rule would yield zero netbenefits?" In addition to threshold analysis you should indicate, where possible, which non-quantified effects are most important and why. 

### Key Elements of aRegulatoryAnalysis
A goodregulatory analysis should include the following three basic elements: (1) a statement ofthe need for the proposed action, (2) an examination ofalternative approaches, and (3) an evaluation ofthebenefits and costs-quantitative and qualitative-ofthe proposed action and the main alternatives identifiedby the analysis.
To evaluate properly the benefits and costs ofregulations and their alternatives, you will need to do the following:

III Explainhowthe actions required by the rule are linked to the expectedbenefits. For example, indicate how additional safety equipmentwill reduce safety risks. A similar analysis should be done for each ofthe alternatives.

III Identify a baseline. Benefits and costs are defined in comparison with a clearly stated alternative. This normally will be a "no action" baseline: what the world will be like if the proposedrule is not adopted. Comparisons to a "nextbest" alternative are also especiallyuseful.

2 See Mishan EJ (1994), Cost-BenefitAnalysis,**four~h** edition, Routledge, New York.

2® Identify the expected undesirable side-effects and ancillary benefits of the proposed regulatory action and the alternatives. These should be added to the direct benefits and costs as appropriate. With this information, you should be able to assess quantitatively the benefits and costs of the proposed rule and its alternatives. A complete regulatory analysis includes a discussion of non-quantified as well as quantified benefits and costs. A non-quantified outcome is a benefit orcost that has not been quantified or monetized in the analysis. When there are important nonmonetary values at stake, you should also identify them in your analysis so policymakers can compare them with the monetary benefits and costs. When your analysis is complete, you should present a summary of the benefit and cost estimates for each alternative, including the qualitative and non-monetized factors affected by the rule, so that readers can evaluate them. As you design, execute, and write your regulatory analysis, you should seek out the opinions of those who will be affected by the regulation as well as the views of those individuals and organizations who may 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 all pertinent data. Early consultation can be especially helpful. You should not limit consultation to the final stages of your analytical efforts. You will find that you cannot conduct a good regulatory analysis according to a formula. Conducting high-quality analysis requires competent professional judgment. Different regulations may call for different emphases in the analysis, depending on the nature and complexity of the regulatory issues and the sensitivity of the benefit and cost estimates to the key assumptions. A good analysis is transparent. It should be possible for a qualified third party reading the report to see clearly how you arrived at your estimates and conclusions. For transparency's sake, you should state in your report what assumptions were used, such as the time horizon for the analysis and the discount rates applied to future benefits and costs. It is usually necessary to provide a sensitivity analysis to reveal whether, and to what extent, the results of the analysis are sensitive to plausible changes in the main assumptions and numeric inputs. A good analysis provides specific references to all sources of data, appendices with documentation of models (where necessary), and the results of formal sensitivity and other uncertainty analyses. Your analysis should also have an executive summary, including a standardized accounting statement. B. The Need for Federal Regulatory Action Before recommending Federal regulatory action, an agency must demonstrate that the proposed action is necessary. If the regulatory intervention results from a statutory or judicial directive, you should describe the specific authority for your action, the extent of discretion available to you, and the regulatory instruments you might use. Executive Order 12866 states that "Federal agencies should promulgate only such regulations as are required by law, are necessary to interpret the law, or are made necessary by compelling need, such as material

3 8 Identify the expected undesirable side-effects and ancillary benefits ofthe proposed regulatory action and the alternatives. These shouldbe added to the direct benefits and costs as appropriate.
With this information, you should be able to assess quantitatively the benefits and costs ofthe proposedrule and its alternatives. A complete regulatory analysis includes a discussion of non-quantified as well as quantified benefits and costs. A non-quantified outcome is a benefit or cost that has not been quantified ormonetized in the analysis. Whenthere are important nonmonetary values at stake, you should also identify them in your analysis so policymakers can compare them with the monetary benefits and costs. Whenyour analysis is complete, you should present a summary ofthe benefit and cost estimates for each alternative, including the qualitative and non-monetized factors affected bythe rule, so that readers can evaluate them.
As you design, execute, and write your regulatory analysis, you should seek out the opinions ofthose who will be affected by the regulation as well as the views ofthose individuals and organizations who may notbe affected buthave special knowledge or insight into the regulatory issues. Consultation canbe useful in ensuring that your analysis addresses all ofthe relevant issues and that youhave access to all pertinent data. Early consultation canbe especially helpful. You should not limit consultation to the final stages ofyour analytical efforts.
You will find thatyou cannot conduct a goodregulatory analysis according to a formula. Conducting high-quality analysis requires competent professionaljudgment. Different regulations may call for different emphases in the analysis, depending on the nature and complexity ofthe regulatory issues and the sensitivity ofthe benefit and cost estimates to the key assumptions.
A good analysis is transparent. It shouldbe possible for a qualified third party reading the report to see clearly how you arrived at your estimates and conclusions. Fortransparency's sake, you should state inyour report what assumptions were used, such as the time horizon for the analysis and the discount rates applied to future benefits and costs. Itis usually necessary to provide a sensitivity analysis to reveal whether, and to what extent, the results ofthe analysis are sensitive to plausible changes in the main assumptions and numeric inputs.
A good analysis provides specific references to all sources ofdata, appendices with documentation ofmodels (where necessary), and the results offormal sensitivity and other uncertainty analyses. Your analysis should also have an executive summary, including a standardized accounting statement. B. 

### TheNeed for Federal Regulatory Action
Before recommending Federal regulatory action, an agency must demonstrate that the proposed action is necessary. Ifthe regulatory interventionresults from a statutory orjudicial directive, you should describe the specific authority for your action, the extent ofdiscretion available to you, and the regulatory instruments you mightuse. Executive Order 12866 states that "Federal agencies shouldpromulgate only such regulations as are required by law, are necessary to interpret the law, or are made necessary by compelling need, such as material

3failures of private markets to protect or improve the health and safety of the public, the

environment, or the well being of the American people... . " Executive Order 12866 also states that "Each agency shall identify the problem that it intends to address (including, where applicable, the failures of private markets or public institutions that warrant new agency action) as well as assess the significance of that problem." Thus, you should try to explain whether the action is intended to address a significant market failure or to meet some other compelling public need such as improving governmental processes or promoting intangible values such as distributional fairness or privacy. If the regulation is designed to correct a significant market failure, you should describe the failure both qualitatively and (where feasible) quantitatively. You should show that a government intervention is likely to do more good than harm. For other interventions, you should also provide a demonstration of compelling social purpose and the likelihood of effective action. Although intangible rationales do not need to be quantified, the analysis should present and evaluate the strengths and limitations of the relevant arguments for these intangible values. Market Failure or Other Social Purpose The major types of market failure include: externality, market power, and inadequate or asymmetric information. Correcting market failures is a reason for regulation, but it is not the only reason. Other possible justifications include improving the functioning of government, removing distributional unfairness, or promoting privacy and personal freedom. 1. Externality, common property resource and public good An externality occurs when one party's actions impose uncompensated benefits or costs on another party. Environmental problems are a classic case of externality. For example, the smoke from a factory may adversely affect the health of local residents while soiling the property in nearby neighborhoods. If bargaining were costless and all property rights were well defined, people would eliminate externalities through bargaining without the need for government regulation.3 From this perspective, externalities arise from high transactions costs and/or poorly defined property rights that prevent people from reaching efficient outcomes through market transactions. Resources that may become congested or overused, such as fisheries or the broadcast spectrum, represent common property resources. "Public goods," such as defense or basic scientific research, are goods where provision of the good to some individuals cannot occur without providing the same level of benefits free of charge to other individuals.
2. Market Power Firms exercise market power when they reduce output below what would be offered in a competitive industry in order to obtain higher prices. They may exercise market power collectively or unilaterally. Government action can be a source of market power, such as when regulatory actions exclude low-cost imports. Generally, regulations that increase market power

3 See Coase RH (1960), Journal ofLaw and Economics, 3, 1-44.

4 failures ofprivate markets to protect or improve the health and safety ofthe public, the environment, orthe well being ofthe American people

...."
Executive Order 12866 also states that "Each agency shall identify the problemthat it intends to address (including, where applicable, the failures ofprivate markets orpublic institutions that warrant new agency action) as well as assess the significance ofthatproblem." Thus, you should try to explain whether the action is intended to address a significant market failure orto meet some other compelling public need such as improving governmental processes orpromoting intangible values such as distributional fairness orprivacy. lfthe regulation is designed to correct a significant market failure, you should describe the failure both qualitatively and (where feasible) quantitatively. You should showthat a government intervention is likely to do more good than harm. For other interventions, you should also provide a demonstration of compelling social purpose and the likelihood ofeffective action. Although intangible rationales do not needto be quantified, the analysis should present and evaluate the strengths and limitations ofthe relevant arguments for these intangible values. 

### MarketFailure or OtherSocialPurpose
The major types ofmarket failure include: externality, market power, and inadequate or asymmetric information. Correcting market failures is a reason for regulation, but it is not the only reason. Otherpossiblejustifications include improving the functioning ofgovernment, removing distributional unfairness, or promotingprivacy and personal freedom.
1. Externality, commonproperty resource and public good
An externality occurs when oneparty's actions impose uncompensatedbenefits or costs on another party. Environmentalproblems are a classic case ofexternality. For example, the smoke from a factory may adversely affect the health oflocal residents while soiling the property in nearby neighborhoods. lfbargaining were costless and all property rights were well defined, people would eliminate externalities through bargaining withoutthe need for government regulation. 3 Fromthis perspective, externalities arise from high transactions costs and/orpoorly definedproperty rights thatpreventpeople from reaching efficient outcomes through market transactions.
Resources that maybecome congested or overused, such as fisheries orthe broadcast spectrum, represent commonproperty resources. "Public goods," such as defense or basic scientific research, are goods where provision ofthe good to some individuals cannot occur without providing the same level ofbenefits free ofcharge to other individuals.
2. Market Power
Firms exercise market power whenthey reduce outputbelow what would be offered in a competitive industry in order to obtain higher prices. They may exercise market power collectively orunilaterally. Government action can be a source ofmarket power, such as when regulatory actions exclude low-cost imports. Generally, regulations that increase market power

3 See Coase RH (1960), Journal of Law andEconomics, 3, 1-44.

4for selected entities should be avoided. However, there are some circumstances in which

government may choose to validate a monopoly. If a market can be served at lowest cost only when production is limited to a single producer - local gas and electricity distribution services, for example - a natural monopoly is said to exist. In such cases, the government may choose to approve the monopoly and to regulate its prices and/or production decisions. Nevertheless, you should keep in mind that technological advances often affect economies of scale. This can, in turn, transform what was once considered a natural monopoly into a market where competition can flourish. 3. Inadequate or Asymmetric Information Market failures may also result from inadequate or asymmetric information. Because information, like other goods, is costly to produce and disseminate, your evaluation will need to do more than demonstrate the possible existence of incomplete or asymmetric information. Even though the market may supply less than the full amount of information, the amount it does supply may be reasonably adequate and therefore not require government regulation. Sellers have an incentive to provide information through advertising that can increase sales by highlighting distinctive characteristics of their products. Buyers may also obtain reasonably adequate information about product characteristics through other channels, such as a seller offering a warranty or a third party providing information. Even when adequate information is available, people can make mistakes by processing it poorly. Poor information-processing often occurs in cases of low probability, high-consequence events, but it is not limited to such situations. For instance, people sometimes rely on mental rules-of-thumb that produce errors. If they have a clear mental image of an incident which makes it cognitively "available," they might overstate the probability that it will occur. Individuals sometimes process information in a biased manner, by being too optimistic or pessimistic, without taking sufficient account of the fact that the outcome is exceedingly unlikely to occur. When mistakes in information processing occur, markets may overreact. When it is time-consuming or costly for consumers to evaluate complex information about products or services (e.g., medical therapies), they may expect government to ensure that minimum quality standards are met. However, the mere possibility of poor information processing is not enough to justify regulation. If you think there is a problem of information processing that needs to be addressed, it should be carefully documented.
4. Other Social Purposes There are justifications for regulations in addition to correcting market failures. A regulation may be appropriate when you have a clearly identified measure that can make government operate more efficiently. In addition, Congress establishes some regulatory programs to redistribute resources to select groups. Such regulations should be examined to ensure that they are both effective and cost-effective. Congress also authorizes some regulations to prohibit discrimination that conflicts with generally accepted norms within our society. Rulemaking may also be appropriate to protect privacy, permit more personal freedom or promote other democratic aspirations.

5 for selected entities should be avoided. However, there are some circumstances in which government may choose to validate a monopoly. Ifa market canbe served at lowest cost only when production is limited to a single producer

- local gas and electricity distribution services, for example - a natural monopoly is said to exist. In such cases, the government may choose to approve the monopoly and to regulate its prices and/orproduction decisions. Nevertheless, you should keep inmind that technological advances often affect economies ofscale. This can, in tum, transform what was once considered a natural monopoly into a market where competition can flourish.
3. Inadequate or Asymmetric Information
Market failures may also result from inadequate or asymmetric information. Because information, like other goods, is costly to produce and disseminate, your evaluation will need to do more than demonstrate the possible existence ofincomplete or asymmetric information. Even though the market may supply less than the full amount ofinformation, the amount it does supply maybe reasonably adequate and therefore notrequire government regulation. Sellers have an incentive to provide information through advertising that can increase sales by highlighting distinctive characteristics oftheirproducts. Buyers may also obtain reasonably adequate information about product characteristics through other channels, such as a seller offering a warranty or a third party providing information.
Even when adequate information is available, people can make mistakes byprocessing it poorly. Poor information-processing often occurs in cases oflow probability, high-consequence events, but it is not limited to such situations. For instance, people sometimes rely on mental rules-of-thumb that produce errors. Ifthey have a clear mental image ofan incidentwhich makes it cognitively "available," they might overstate the probability that it will occur. Individuals sometimes process information in a biased manner, by being too optimistic or pessimistic, without taking sufficient account ofthe fact that the outcome is exceedingly unlikely to occur. When mistakes in information processing occur, markets may overreact. When it is time-consuming or costly for consumers to evaluate complex information about products or services (e.g., medical therapies), they may expect government to ensure that minimum quality standards are met. However, the mere possibility ofpoor information processing is not enough tojustifyregulation. Ifyou thinkthere is a problem ofinformation processing that needs to be addressed, it shouldbe carefully documented.
4. Other Social Purposes
There arejustifications for regulations in addition to correcting market failures. A regulation maybe appropriate when youhave a clearly identified measure that can make government operate more efficiently. In addition, Congress establishes some regulatory programs to redistribute resources to select groups. Such regulations should be examined to ensure that they are both effective and cost-effective. Congress also authorizes some regulations to prohibit discrimination that conflicts with generally accepted norms within our society. Rulemaking may also be appropriate to protect privacy, permit more personal freedom or promote other democratic aspirations.

5Showing That Regulation at the Federal Level Is the Best Way to Solve the Problem

Even where a market failure clearly exists, you should consider other means of dealing with the failure before turning to Federal regulation. Alternatives to Federal regulation include antitrust enforcement, consumer-initiated litigation in the product liability system, or administrative compensation systems. In assessing whether Federal regulation is the best solution, you should also consider the possibility of regulation at the State or local level. In some cases, the nature of the market failure may itself suggest the most appropriate governmental level of regulation. For example, problems that spill across State lines (such as acid rain whose precursors are transported widely in the atmosphere) are probably best addressed by Federal regulation. More localized problems, including those that are common to many areas, may be more efficiently addressed locally. The advantages of leaving regulatory issues to State and local authorities can be substantial. If public values and preferences differ by region, those differences can be reflected in varying State and local regulatory policies. Moreover, States and localities can serve as a testing ground for experimentation with alternative regulatory policies. One State can learn from another's experience while local jurisdictions may compete with each other to establish the best regulatory policies. You should examine the proper extent of State and local discretion in your rulemaking context. A diversity of rules may generate gains for the public as governmental units compete with each other to serve the public, but duplicative regulations can also be costly. Where Federal regulation is clearly appropriate to address interstate commerce issues, you should try to examine whether it would be more efficient to retain or reduce State and local regulation. The local benefits of State regulation may not justify the national costs of a fragmented regulatory system. For example, the increased compliance costs for firms to meet different State and local regulations may exceed any advantages associated with the diversity of State and local regulation. Your analysis should consider the possibility of reducing as well as expanding State and local rulemaking. The role of Federal regulation in facilitating U.S. participation in global markets should also be considered. Harmonization of U.S. and international rules may require a strong Federal regulatory role. Concerns that new U.S. rules could act as non-tariff barriers to imported goods should be evaluated carefully. The Presumption Against Economic Regulation Government actions can be unintentionally harmful, and even useful regulations can impede market efficiency. For this reason, there is a presumption against certain types of regulatory action. In light of both economic theory and actual experience, a particularly demanding burden of proof is required to demonstrate the need for any of the following types of regulations: ® price controls in competitive markets;

6 

### Showing ThatRegulation at the FederalLevelIs theBest Way to Solve theProblem
Even where a market failure clearly exists, you should consider other means ofdealing with the failure before turning to Federal regulation. Alternatives to Federal regulation include antitrust enforcement, consumer-initiated litigation in the product liability system, or administrative compensation systems.
In assessing whether Federal regulation is the best solution, you should also consider the possibility ofregulation at the State or local level. In some cases, the nature ofthe market failure may itselfsuggest the most appropriate governmental level ofregulation. For example, problems that spill across State lines (such as acid rain whose precursors are transported widely in the atmosphere) are probably best addressed by Federal regulation. More localized problems, including those that are common to many areas, maybe more efficiently addressed locally.
The advantages ofleavingregulatory issues to State and local authorities canbe substantial. Ifpublic values and preferences differ by region, those differences can bereflected in varying State and local regulatory policies. Moreover, States and localities can serve as a testing ground for experimentation with alternative regulatory policies. One State can learn from another's experience while localjurisdictions may compete with each other to establish the best regulatory policies. You should examine the proper extent ofState and local discretion in your rulemaking context. A diversity ofrules may generate gains for the public as governmental units compete with each other to serve the public, but duplicative regulations can also be costly. Where Federal regulation is clearly appropriate to address interstate commerce issues, you should try to examine whether it would be more efficient to retain orreduce State and local regulation. The local benefits ofState regulation may notjustifythe national costs ofa fragmented regulatory system. For example, the increased compliance costs for firms to meet different State and local regulations may exceed any advantages associated with the diversity ofState and local regulation. Your analysis should considerthe possibility ofreducing as well as expanding State and localrulemaking.
The role ofFederalregulation in facilitating U.S. participation in global markets should also be considered. Harmonization ofU.S. and international rules may require a strong Federal regulatory role. Concerns that new U.S. rules could act as non-tariffbarriers to imported goods should be evaluated carefully. 

### The PresumptionAgainstEconomicRegulation
Government actions canbeunintentionally harmful, and even useful regulations can impede market efficiency. For this reason, there is a presumption against certain types of regulatory action. In light ofboth economic theory and actual experience, a particularly demanding burden ofproofis required to demonstrate the need for any ofthe following types of regulations:

• price controls in competitive markets;

6® production or sales quotas in competitive markets;

® mandatory uniform quality standards for goods or services if the potential problem can be adequately dealt with through voluntary standards or by disclosing information of the hazard to buyers or users; or ® controls on entry into employment or production, except (a) where indispensable to protect health and safety (e.g., FAA tests for commercial pilots) or (b) to manage the use of common property resources (e.g., fisheries, airwaves, Federal lands, and offshore areas). C. Alternative Regulatory Approaches Once you have determined that Federal regulatory action is appropriate, you will need to consider alternative regulatory approaches. Ordinarily, you will be able to eliminate some alternatives through a preliminary analysis, leaving a manageable number of alternatives to be evaluated according to the formal principles of the Executive Order. The number and choice of alternatives selected for detailed analysis is a matter of judgment. There must be some balance between thoroughness and the practical limits on your analytical capacity. With this qualification in mind, you should nevertheless explore modifications of some or all of a regulation's attributes or provisions to identify appropriate alternatives. The following is a list of alternative regulatory actions that you should consider. Different Choices Defined by Statute When a statute establishes a specific regulatory requirement and the agency is considering a more stringent standard, you should examine the benefits and costs of reasonable alternatives that reflect the range of the agency's statutory discretion, including the specific statutory requirement. Different Compliance Dates The timing of a regulation may also have an important effect on its net benefits. Benefits may vary significantly with different compliance dates where a delay in implementation may result in a substantial loss in future benefits (e.g., a delay in implementation could result in a significant reduction in spawning stock and jeopardize a fishery). Similarly, the cost of a regulation may vary substantially with different compliance dates for an industry that requires a year or more to plan its production runs. In this instance, a regulation that provides sufficient lead time is likely to achieve its goals at a much lower overall cost than a regulation that is effective immediately. DifferentEnforcement Methods Compliance alternatives for Federal, State, or local enforcement include on-site inspections, periodic reporting, and noncompliance penalties structured to provide the most appropriate incentives. When alternative monitoring and reporting methods vary in their benefits and costs, you should identify the most appropriate enforcement framework. For example, in

7 @ production or sales quotas in competitive markets;

@ mandatory uniform quality standards for goods or services ifthe potential problem can be adequately dealt with through voluntary standards orby disclosing information ofthe hazard to buyers orusers; or controls on entry into employment orproduction, except (a) where indispensable to protect health and safety (e.g., FAA tests for commercial pilots) or (b) to manage the use ofcommonproperty resources (e.g., fisheries, airwaves, Federal lands, and offshore areas). 

### C. Alternative Regulatory Approaches
Once you have determined that Federal regulatory action is appropriate, you will need to consider alternative regulatory approaches. Ordinarily, you will be able to eliminate some alternatives through a preliminary analysis, leaving a manageable number ofalternatives to be evaluated according to the formal principles ofthe Executive Order. The number and choice of alternatives selected for detailed analysis is a matter of judgment. There must be some balance betweenthoroughness and the practical limits on your analytical capacity. With this qualification in mind, you should nevertheless explore modifications ofsome or all ofa regulation'S attributes orprovisions to identify appropriate alternatives. The following is a list ofalternative regulatory actions that you should consider. Different ChoicesDefinedbyStatute
When a statute establishes a specific regulatory requirement and the agency is considering a more stringent standard, you should examine the benefits and costs ofreasonable alternatives that reflect the range ofthe agency's statutory discretion, including the specific statutory requirement. Different ComplianceDates The timing ofa regulation may also have an important effect on its net benefits. Benefits may vary significantly with different compliance dates where a delay in implementation may result in a substantial loss in future benefits (e.g., a delay in implementation could result in a significantreduction in spawning stock andjeopardize a fishery). Similarly, the cost ofa regulation may vary substantially with different compliance dates for an industry that requires a year or more to plan its production runs. Inthis instance, a regulation that provides sufficient lead time is likely to achieve its goals at a much lower overall cost than a regulation that is effective immediately. DifferentEnforcementMethods Compliance alternatives for Federal, State, or local enforcement include on-site inspections, periodic reporting, and noncompliance penalties structured to provide the most appropriate incentives. When alternative monitoring andreporting methods vary in their benefits and costs, you should identify the most appropriate enforcement framework. For example, in

7some circumstances random monitoring or parametric monitoring will be less expensive and

nearly as effective as continuous monitoring. DifferentDegrees of Stringency In general, both the benefits and costs associated with a regulation will increase with the level of stringency (although marginal costs generally increase with stringency, whereas marginal benefits may decrease). You should study alternative levels of stringency to understand more fully the relationship between stringency and the size and distribution of benefits and costs among different groups. DifferentRequirementsfor Different Sized Firms You should consider setting different requirements for large and small firms, basing the requirements on estimated differences in the expected costs of compliance or in the expected benefits. The balance of benefits and costs can shift depending on the size of the firms being regulated. Small firms may find it more costly to comply with regulation, especially if there are large fixed costs required for regulatory compliance. On the other hand, it is not efficient to place a heavier burden on one segment of a regulated industry solely because it can better afford the higher cost. This has the potential to load costs on the most productive firms, costs that are disproportionate to the damages they create. You should also remember that a rule with a significant impact on a substantial number of small entities will trigger the requirements set forth in the Regulatory Flexibility Act. (5 U.S.C. 603(c), 604). DifferentRequirementsfor Different Geographic Regions Rarely do all regions of the country benefit uniformly from government regulation. It is also unlikely that costs will be uniformly distributed across the country. Where there are significant regional variations in benefits and/or costs, you should consider the possibility of setting different requirements for the different regions. Performance Standards Rather than Design Standards Performance standards express requirements in terms of outcomes rather than specifying the means to those ends. They are generally superior to engineering or design standards because performance standards give the regulated parties the flexibility to achieve regulatory objectives in the most cost-effective way. In general, you should take into account both the cost savings to the regulated parties of the greater flexibility and the costs of assuring compliance through monitoring or some other means. Market-Oriented Approaches Rather than Direct Controls Market-oriented approaches that use economic incentives should be explored. These alternatives include fees, penalties, subsidies, marketable permits or offsets, changes in liability or property rights (including policies that alter the incentives of insurers and insured parties), and required bonds, insurance or warranties. One example of a market-oriented approach is a

8 some circumstances random monitoring orparametric monitoring will be less expensive and nearly as effective as continuous monitoring. 

### DifferentDegrees of Stringency
In general, both the benefits and costs associated with a regulation will increase with the level ofstringency (although marginal costs generally increase with stringency, whereas marginal benefits may decrease). You should study alternative levels ofstringency to understand more fully the relationship between stringency and the size and distribution ofbenefits and costs among different groups. 

### DifferentRequirements forDifferentSizedFirms
You should consider setting different requirements for large and small firms, basing the requirements on estimated differences in the expected costs ofcompliance or inthe expected benefits. The balance ofbenefits and costs can shift depending onthe size ofthe firms being regulated. Small firms may find it more costly to comply withregulation, especially ifthere are large fixed costs required for regulatory compliance. Onthe otherhand, it is not efficient to place a heavierburden on one segment ofa regulated industry solelybecause it can better afford the higher cost. This has the potential to load costs on the mostproductive firms, costs that are disproportionate to the damages they create. You should also remember that a rule with a significant impact on a substantial number ofsmall entities will trigger the requirements set forth inthe Regulatory Flexibility Act. (5 U.S.c. 603(c), 604). 

### DifferentRequirements forDifferent GeographicRegions Rarely do all regions ofthe country benefituniformly from governmentregulation. Itis also unlikely that costs will be uniformly distributed across the country. Where there are significant regional variations inbenefits and/or costs, you should considerthe possibility of setting different requirements for the different regions. 

### PerformanceStandards Ratherthan Design Standards
Performance standards express requirements interms ofoutcomes rather than specifying the means to those ends. They are generally superior to engineering or design standards because performance standards give the regulated parties the flexibility to achieve regulatory objectives inthe most cost-effective way. In general, you should take into account both the cost savings to the regulated parties ofthe greater flexibility and the costs ofassuring compliance through monitoring or some othermeans. 

### Market-OrientedApproachesRatherthan Direct Controls
Market-oriented approaches that use economic incentives shouldbe explored. These alternatives include fees, penalties, subsidies, marketable permits or offsets, changes in liability orproperty rights (including policies that alter the incentives ofinsurers and insured parties), and required bonds, insurance orwarranties. One example ofa market-oriented approach is a

8program that allows for averaging, banking, and/or trading (ABT) of credits for achieving

additional emission reductions beyond the required air emission standards. ABT programs can be extremely valuable in reducing costs or achieving earlier or greater benefits, particularly when the costs of achieving compliance vary across production lines, facilities, or firms. ABT can be allowed on a plant-wide, firm-wide, or region-wide basis rather than vent by vent, provided this does not produce unacceptable local air quality outcomes (such as "hot spots" from local pollution concentration). Informational Measures Rather than Regulation If intervention is contemplated to address a market failure that arises from inadequate or asymmetric information, informational remedies will often be preferred. Measures to improve the availability of information include government establishment of a standardized testing and rating system (the use of which could be mandatory or voluntary), mandatory disclosure requirements (e.g., by advertising, labeling, or enclosures), and government provision of information (e.g., by government publications, telephone hotlines, or public interest broadcast announcements). A regulatory measure to improve the availability of information, particularly about the concealed characteristics of products, provides consumers a greater choice than a mandatory product standard or ban. Specific informational measures should be evaluated in terms of their benefits and costs. Some effects of informational measures are easily overlooked. The costs of a mandatory disclosure requirement for a consumer product will include not only the cost of gathering and communicating the required information, but also the loss of net benefits of any information displaced by the mandated information. The other costs also may include the effect of providing information that is ignored or misinterpreted, and inefficiencies arising from the incentive that mandatory disclosure may give to overinvest in a particular characteristic of a product or service.
Where information on the benefits and costs of alternative informational measures is insufficient to provide a clear choice between them, you should consider the least intrusive informational alternative sufficient to accomplish the regulatory objective. To correct an informational market failure it may be sufficient for government to establish a standardized testing and rating system without mandating its use, because competing firms that score well according to the system should thereby have an incentive to publicize the fact. D. Analytical Approaches Both benefit-cost analysis (BCA) and cost-effectiveness analysis (CEA) provide a systematic framework for identifying and evaluating the likely outcomes of alternative regulatory choices. A major rulemaking should be supported by both types of analysis wherever possible. Specifically, you should prepare a CEA for all major rulemakings for which the primary benefits are improved public health and safety to the extent that a valid effectiveness measure can be developed to represent expected health and safety outcomes. You should also perform a BCA for major health and safety rulemakings to the extent that valid monetary values can be assigned to the primary expected health and safety outcomes. In undertaking these analyses, it is important to keep in mind the larger objective of analytical consistency in

9 program that allows for averaging, banking, and/or trading (ABT) ofcredits for achieving additional emission reductions beyond the required air emission standards. ABTprograms can be extremely valuable in reducing costs or achieving earlier or greater benefits, particularly when the costs ofachieving compliance vary across production lines, facilities, or firms. ABT canbe allowed on a plant-wide, firm-wide, orregion-wide basis rather than ventby vent, provided this does notproduce unacceptable local air quality outcomes (such as "hot spots" from local pollution concentration). 

### InformationalMeasures Rather than Regulation
Ifintervention is contemplated to address a market failure that arises from inadequate or asymmetric information, informational remedies will oftenbe preferred. Measures to improve the availability ofinformation include government establishment ofa standardized testing and rating system (the use ofwhich could be mandatory orvoluntary), mandatory disclosure requirements (e.g., by advertising, labeling, or enclosures), and government provision of information (e.g., by governmentpublications, telephone hotlines, or public interestbroadcast announcements). A regulatory measure to improve the availability ofinformation, particularly about the concealed characteristics ofproducts, provides consumers a greater choice than a mandatory product standard or ban. Specific informational measures shouldbe evaluated in terms oftheir benefits and costs. Some effects ofinformational measures are easily overlooked. The costs ofa mandatory disclosure requirement for a consumer product will include not only the cost ofgathering and communicating the required information, but also the loss ofnetbenefits ofany information displaced by the mandated information. The other costs also may include the effect ofproviding information that is ignored or misinterpreted, and inefficiencies arising from the incentive that mandatory disclosure may give to overinvest in a particular characteristic ofa product or service.
Where information on the benefits and costs ofalternative informational measures is insufficient to provide a clear choice betweenthem, you should consider the least intrusive informational alternative sufficient to accomplish the regulatory objective. To correct an informational market failure it may be sufficient for government to establish a standardized testing andrating system without mandating its use, because competing firms that score well according to the system should thereby have an incentive to publicize the fact.


### D. AnalyticalApproaches
Bothbenefit-cost analysis (BCA) and cost-effectiveness analysis (CEA) provide a systematic framework for identifying and evaluating the likely outcomes ofalternative regulatory choices. A majorrulemaking shouldbe supportedby both types ofanalysis wherever possible. Specifically, you should prepare a CEA for all major rulemakings for which the primary benefits are improved public health and safety to the extent that a valid effectiveness measure canbe developed to represent expected health and safety outcomes. You should also perform a BCA for major health and safety rulemakings to the extent that valid monetary values canbe assigned to the primary expected health and safety outcomes. Inundertaking these analyses, it is important to keep in mind the larger objective ofanalytical consistency in

9estimating benefits and costs across regulations and agencies, subject to statutory limitations.

Failure to maintain such consistency may prevent achievement of the most risk reduction for a given level of resource expenditure. For all other major rulemakings, you should carry out a BCA. If some of the primary benefit categories cannot be expressed in monetary units, you should also conduct a CEA. In unusual cases where 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 distinctive feature of BCA is that both benefits and costs are expressed in monetary units, which allows you to evaluate different regulatory options with a variety of attributes using a common measure.4 By measuring incremental benefits and costs of successively more stringent regulatory alternatives, you can identify the alternative that maximizes net benefits. The size of net benefits, the absolute difference between the projected benefits and costs, indicates whether one policy is more efficient than another. The ratio of benefits to costs is not a meaningful indicator of net benefits and should not be used for that purpose. It is well known that considering such ratios alone can yield misleading results. Even when a benefit or cost cannot be expressed in monetary units, you should still try to measure it in terms of its physical units. If it is not possible to measure the physical units, you should still describe the benefit or cost qualitatively. For more information on describing qualitative information, see the section "Developing Benefit and Cost Estimates." When important benefits and costs cannot be expressed in monetary units, BCA is less useful, and it can even be misleading, because the calculation of net benefits in such cases does not provide a full evaluation of all relevant benefits and costs.You should exercise professional judgment in identifying the importance of nonquantified factors and assess as best you can how they might change the ranking of alternatives based on estimated net benefits. If the non-quantified benefits and costs are likely to be important, you should recommend which of the non-quantified factors are of sufficient importance to justify consideration in the regulatory decision. This discussion should also include a clear explanation that support designating these non-quantified factors as important. In this case, you should also consider conducting a threshold analysis to help decision makers and other users of the analysis to understand the potential significance of these factors to the overall analysis. Cost-Effectiveness Analysis5

4 Mishan EJ (1994), Cost-Benefit Analysis, fourth edition, Routledge, New York. 5 For a full discussion of CEA, see Gold, ML, Siegel, JE, Russell, LB, and Weinstein, MC (1996), Cost Effectiveness in Health and Medicine: The Report of the Panel on Cost-Effectiveness in Health and Medicine, Oxford University Press, New York.

10 estimating benefits and costs across regulations and agencies, subject to statutory limitations. Failure to maintain such consistency may prevent achievement ofthe most risk reduction for a given level ofresource expenditure. For all other major rulemakings, you should carry out a BCA. Ifsome ofthe primary benefit categories cannotbe expressed in monetary units, you should also conduct a CEA. In unusual cases where no quantified information on benefits, costs and effectiveness can beproduced, the regulatory analysis should present a qualitative discussion ofthe issues and evidence. Benefit-CostAnalysis
A distinctive feature ofBCA is that bothbenefits and costs are expressed in monetary units, which allows youto evaluate different regulatory options with a variety ofattributes using a common measure.4 Bymeasuring incremental benefits and costs ofsuccessively more stringent regulatory alternatives, you can identify the alternative that maximizes net benefits.
The size ofnetbenefits, the absolute difference betweenthe projectedbenefits and costs, indicates whether one policy is more efficient than another. The ratio ofbenefits to costs is not a meaningful indicator ofnetbenefits and should not be used for that purpose. Itis well known that considering such ratios alone canyield misleading results.
Even when a benefit or cost cannotbe expressed in monetary units, you should still try to measure it in terms ofits physical units. Ifit is notpossible to measure the physical units, you should still describe the benefit or cost qualitatively. Formore information on describing qualitative information, see the section "DevelopingBenefitandCost Estimates." When important benefits and costs cannot be expressed in monetary units, BCA is less useful, and it can even be misleading, because the calculation ofnet benefits in such cases does notprovide a full evaluation ofall relevant benefits and costs.
You should exercise professionaljudgment in identifying the importance ofnonquantified factors and assess as bestyou can how they might change the ranking ofalternatives based on estimated net benefits. Ifthe non-quantified benefits and costs are likely to be important, you should recommend which ofthe non-quantified factors are ofsufficient importance tojustify consideration in the regulatory decision. This discussion should also include a clear explanation that support designating these non-quantified factors as important. In this case, you should also consider conducting a threshold analysis to help decision makers and other users ofthe analysis to understand the potential significance ofthese factors to the overall analysis. Cost-EffectivenessAnalysis5

4 Mishan EJ (1994), Cost-BenefitAnalysis, fourth edition, Routledge, New York. S For a full discussion ofCEA, see Gold, ML, Siegel, JE, Russell, LB, and Weinstein, MC (1996), Cost Effectiveness in Health andMedicine: The Report of the Panel on Cost-Effectiveness in Health andMedicine, Oxford University Press, New York.

10Cost-effectiveness analysis can provide a rigorous way to identify options that achieve

the most effective use of the resources available without requiring monetization of all of relevant benefits or costs. Generally, cost-effectiveness analysis is designed to compare a set of regulatory actions with the same primary outcome (e.g., an increase in the acres of wetlands protected) or multiple outcomes that can be integrated into a single numerical index (e.g., units of health improvement). Cost-effectiveness results based on averages need to be treated with great care. They suffer from the same drawbacks as benefit-cost ratios. The alternative that exhibits the smallest cost-effectiveness ratio may not be the best option, just as the alternative with the highestbenefit-cost ratio is not always the one that maximizes net benefits. Incremental costeffectiveness analysis (discussed below) can help to avoid mistakes that can occur when policy choices are based on average cost-effectiveness.
CEA can also be misleading when the "effectiveness" measure does not appropriately weight the consequences of the alternatives

. For example, when effectiveness is measured in tons of reduced pollutant emissions, cost-effectiveness estimates will be misleading unless the reduced emissions of diverse pollutants result in the same health and environmental benefits. When you have identified a range of alternatives (e.g., different levels of stringency), you should determine the cost-effectiveness of each option compared with the baseline as well as its incremental cost-effectiveness compared with successively more stringent requirements. Ideally, your CEA would present an array of cost-effectiveness estimates that would allow comparison across different alternatives. However, analyzing all possible combinations is not practical when there are many options (including possible interaction effects). In these cases, you should use your judgment to choose reasonable alternatives for careful consideration. When constructing and comparing incremental cost-effectiveness ratios, you should be careful to determine whether the various alternatives are mutually exclusive or whether they can be combined. If they can be combined, you should consider which might be favored under different regulatory budget constraints (implicit or explicit). You should also make sure that inferior alternatives identified by the principles of strong and weak dominance are eliminated from consideration.6 The value of CEA is enhanced when there is consistency in the analysis across a diverse set of possible regulatory actions. To achieve consistency, you need to carefully construct the two key components of any CEA: the cost and the "effectiveness" or performance measures for the alternative policy options. With regard to measuring costs, you should be sure to include all the relevant costs to society - whether public or private. Rulemakings may also yield cost savings (e.g., energy savings associated with new technologies). The numerator in the cost-effectiveness ratio should reflect net costs, defined as the gross cost incurred to comply with the requirements (sometimes

6 Gold ML, Siegel JE, Russell LB, and Weinstein MC (1996), Cost Effectiveness in Health and Medicine: The Report ofthe Panel on Cost-Effectiveness in Health and Medicine, Oxford University Press, New York, pp. 284- 285.

11 Cost-effectiveness analysis canprovide a rigorous way to identify options that achieve the most effective use ofthe resources available withoutrequiring monetization ofall ofrelevant benefits or costs. Generally, cost-effectiveness analysis is designed to compare a set of regulatory actions with the same primary outcome (e.g., an increase in the acres ofwetlands protected) or multiple outcomes that can be integrated into a single numerical index (e.g., units ofhealth improvement).
Cost-effectiveness results based on averages need to be treated with great care. They suffer from the same drawbacks as benefit-cost ratios. The alternative that exhibits the smallest cost-effectiveness ratio may not be the best option,justas the alternative with the highest benefit-costratio is not always the one that maximizes netbenefits. Incremental costeffectiveness analysis (discussed below) can help to avoid mistakes that can occur when policy choices are based on average cost-effectiveness.
CEA can also be misleading when the "effectiveness" measure does not appropriately weight the consequences ofthe alternatives. For example, when effectiveness is measured in tons ofreduced pollutant emissions, cost-effectiveness estimates will be misleading unless the reduced emissions ofdiverse pollutants result in the same health and environmentalbenefits.
When you have identified a range ofalternatives (e.g., different levels ofstringency), you should determine the cost-effectiveness ofeach option compared with the baseline as well as its incremental cost-effectiveness compared with successively more stringentrequirements. Ideally, your CEA would present an array ofcost-effectiveness estimates that would allow comparison across different alternatives. However, analyzing all possible combinations is notpractical when there are many options (including possible interaction effects). 

### In these cases, you should use yourjudgmentto choose reasonable alternatives for careful consideration.
When constructing and comparing incremental cost-effectiveness ratios, you shouldbe careful to determine whether the various alternatives are mutually exclusive or whether they can be combined. Ifthey canbe combined, you should consider which might be favored under different regulatory budget constraints (implicit or explicit). You should also make sure that inferior alternatives identifiedby the principles ofstrong and weak dominance are eliminated from consideration. 6
The value ofCEA is enhanced when there is consistency in the analysis across a diverse set ofpossible regulatory actions. To achieve consistency, you need to carefully construct the two key components ofany CEA: the cost and the "effectiveness" orperformance measures for the alternative policy options.
With regard to measuring costs, you should be sure to include all the relevant costs to society

- whether public orprivate. Rulemakings may also yield cost savings (e.g., energy savings associated with new technologies). The numerator in the cost-effectiveness ratio should reflect net costs, defined as the gross cost incurred to comply with the requirements (sometimes

6 Gold ML, Siegel JE, Russell LB, and Weinstein Me (1996), CostEffectiveness in Health andMedicine: The Reporta/thePanel on Cost-Effectiveness in Health andMedicine, Oxford University Press, New York, pp. 284- 285.

11called "total" costs) minus any cost savings

. You should be careful to avoid double

-counting

effects in both the numerator and the denominator of the cost-effectiveness ratios. For example, it would be incorrect to reduce gross costs by an estimated monetary value on life extension if life-years are already used as the effectiveness measure in the denominator. In constructing measures of "effectiveness ", final outcomes, such as lives saved or lifeyears saved, are preferred to measures of intermediate outputs, such as tons of pollution reduced, crashes avoided, or cases of disease avoided

. Where the quality of the measured unit varies (e.g., acres of wetlands vary substantially in terms of their ecological benefits ), it is important that the measure capture the variability in the value of the selected "outcome" measure

. You should provide an explanation of your choice of effectiveness measure. Where regulation may yield several different beneficial outcomes, a cost-effectiveness comparison becomes more difficult to interpret because there is more than one measure of effectiveness to incorporate in the analysis . To arrive at a single measure you will need to weight the value of disparate benefit categories , but this computation raises some of the same difficulties you will encounter in BCA. If you can assign a reasonable monetary value to all of the regulation's different benefits, then you should do so. But in this case, you will be doing BCA, not CEA. When you can estimate the monetary value ofsome but not all of the ancillary benefits of a regulation, but cannot assign a monetary value to the primary measure of effectiveness, you should subtract the monetary estimate of the ancillary benefits from the gross cost estimate to yield an estimated net cost. (This net cost estimate for the rule may turn out to be negative - that is, the monetized benefits exceed the cost of the rule.) If you are unable to estimate the value of some of the ancillary benefits , the cost-effectiveness ratio will be overstated, and this should be acknowledged in your analysis

. CEA does not yield an unambiguous choice when there are benefits or costs that have not been incorporated in the net-cost estimates

. You also may use CEA to compare regulatory alternatives in cases where the statute specifies the level of benefits to be achieved. The Effectiveness Metric forPublic Health and Safety Rulemakings When CEA is applied to public health and safety rulemakings , one or more measures of effectiveness must be selected that permits comparison of regulatory alternatives. Agencies currently use a variety of effectiveness measures. There are relatively simple measures such as the number of lives saved, cases of cancer reduced, and cases of paraplegia prevented. Sometimes these measures account only for mortality information, such as the number of lives saved and the number of years of life saved. There are also more comprehensive, integrated measures of effectiveness such as the number of

"equivalent lives" (ELs) saved and the number of "quality-adjusted life years " (QALYs) saved. The main advantage of the integrated measures of effectiveness is that they account for a rule's impact on morbidity (nonfatal illness, injury, impairment and quality of life ) as well as premature death. The inclusion of morbidity effects is important because (a) some illnesses (e.g.,

12 called "total" costs) minus any cost savings. You shouldbe careful to avoid double-counting effects in both the numerator and the denominator ofthe cost-effectiveness ratios. For example, it wouldbe incorrect to reduce gross costs by an estimated monetary value on life extension if life-years are already used as the effectiveness measure in the denominator.
In constructing measures of"effectiveness", final outcomes, such as lives saved or lifeyears saved, are preferred to measures ofintermediate outputs, such as tons ofpollution reduced, crashes avoided, or cases ofdisease avoided. Where the quality ofthe measured unit varies (e.g., acres ofwetlands vary substantially in terms oftheir ecologicalbenefits), it is important that the measure capture the variability in the value ofthe selected "outcome" measure. You should provide an explanation ofyour choice ofeffectiveness measure. Where regulation may yield several different beneficial outcomes, a cost-effectiveness comparison becomes more difficult to interpret because there is more than one measure of effectiveness to incorporate in the analysis. To arrive at a single measure you will need to weight the value ofdisparate benefit categories, but this computationraises some ofthe same difficulties you will encounter in BCA. Ifyou can assign a reasonable monetary value to all of the regulation's different benefits, then you should do so. But inthis case, you will be doing BCA, not CEA. When you can estimate the monetary value of

### some but not all ofthe ancillary benefits of a regulation, but cannot assign a monetary value to the primary measure ofeffectiveness, you should subtract the monetary estimate ofthe ancillary benefits from the gross cost estimate to yield an estimated net cost. (This net cost estimate for the rule may tum out to be negative

- that is, the monetized benefits exceed the cost ofthe rule.) Ifyou are unable to estimate the value of some ofthe ancillary benefits, the cost-effectiveness ratio will be overstated, and this shouldbe acknowledged in your analysis. CEA does not yield anunambiguous choice when there are benefits or costs that have not been incorporated in the net-cost estimates. You also mayuse CEA to compare regulatory alternatives in cases where the statute specifies the level ofbenefits to be achieved. 

### TheEffectivenessMetric forPublicHealth andSafetyRulemakings
When CEA is applied to public health and safety rulemakings, one ormore measures of effectiveness must be selected thatpermits comparison ofregulatory alternatives. Agencies currently use a variety ofeffectiveness measures. There are relatively simple measures such as the number oflives saved, cases ofcancer reduced, and cases ofparaplegiaprevented. Sometimes these measures account only for mortality information, such as the number oflives saved and the number ofyears oflife saved. There are also more comprehensive, integrated measures ofeffectiveness such as the number of "equivalent lives" (ELs) saved and the number of"quality-adjusted life years" (QALYs) saved.
The main advantage ofthe integrated measures ofeffectiveness is that they account for a rule's impact onmorbidity (nonfatal illness, injury, impairment and quality oflife) as well as premature death. The inclusion ofmorbidity effects is importantbecause (a) some illnesses (e.g.,

12asthma) cause more instances of pain and suffering than they do premature death, (b) some

population groups are known to experience elevated rates of morbidity (e.g, the elderly and the poor) and thus have a strong interest in morbidity measurement, and (c) some regulatory alternatives may be more effective at preventing morbidity than premature death (e.g., some advanced airbag designs may diminish the nonfatal injuries caused by airbag inflation without changing the frequency of fatal injury prevented by airbags). However, the main drawback of these integrated measures is that they must meet some restrictive assumptions to represent a valid measure of individual preferences.8 For example, a QALY measure implicitly assumes that the fraction of remaining lifespan an individual would give up for an improvement in health-related quality of life does not depend on the remaining lifespan. Thus, if an individual is willing to give up 10 years of life among 50 remaining years for a given health improvement, he or she would also be willing to give up 1 year of life among 5 remaining years. To the extent that individual preferences deviate from these assumptions,analytic results from CEA using QALYs could differ from analytic results based on willingnessto-pay-measures.9 Though willingness to pay is generally the preferred economic method for evaluating preferences, the CEA method, as applied in medicine and health, does not evaluate health changes using individual willingness to pay. When performing CEA, you should consider using at least one integrated measure of effectiveness when a rule creates a significant impact on both mortality and morbidity. When CEA is performed in specific rulemaking contexts, you should be prepared to make appropriate adjustments to ensure fair treatment of all segments of the population. Fairness is important in the choice and execution of effectiveness measures. For example, if QALYs are used to evaluate a lifesaving rule aimed at a population that happens to experience a high rate of disability (i.e., where the rule is not designed to affect the disability), the number of life years saved should not necessarily be diminished simply because the rule saves the lives of people with life-shortening disabilities. Both analytic simplicity and fairness suggest that the estimated number of life years saved for the disabled population should be based on average life expectancy information for the relevant age cohorts. More generally, when numeric adjustments are made for life expectancy or quality of life, analysts should prefer use of population averages rather than information derived from subgroups dominated by a particular demographic or income group. OMB does not require agencies to use any specific measure of effectiveness. In fact, OMB encourages agencies to report results with multiple measures of effectiveness that offer different insights and perspectives. The regulatory analysis should explain which measures were selected and why, and how they were implemented. The analytic discretion provided in choice of effectiveness measure will create some inconsistency in how agencies evaluate the same injuries and diseases, and it will be difficult for

Russell LB and Sisk JE (2000), "Modeling Age Differences in Cost Effectiveness Analysis", International Journal of Technology Assessment in Health Care, 16(4), 1158-1167. 8 Pliskin JS, Shepard DS, and Weinstein MC (1980), "Utility Functions for Life Years and Health Status," Operations Research, 28(1), 206-224. 'Hammitt JK (2002), "QALYs Versus WTP," Risk Analysis, 22(5), pp. 985-1002.

13 asthma) cause more instances ofpain and suffering than they do premature death, (b) some population groups are known to experience elevated rates ofmorbidity (e.g, the elderly and the poor) and thus have a strong interest in morbidity measuremene, and (c) some regulatory alternatives may be more effective atpreventing morbidity thanpremature death (e.g., some advanced airbag designs may diminish the nonfatal injuries causedby airbag inflation without changing the frequency offatal injury preventedby airbags). However, the main drawback ofthese integrated measures is that they must meet some restrictive assumptions to represent a valid measure ofindividual preferences. 8 For example, a QALY measure implicitly assumes that the fraction ofremaining lifespan an individual would give up for an improvement in health-related quality oflife does not depend on the remaining lifespan. Thus, ifan individual is willing to give up 10 years oflife among 50 remaining years for a givenhealth improvement, he or she would also be willing to give up I year oflife among 5 remaining years. To the extent that individual preferences deviate from these assumptions, analytic results from CEAusing QALY s could differ from analytic results based on willingnessto-pay-measures. 9 Though willingness to pay is generally the preferred economic method for evaluating preferences, the CEA method, as applied in medicine and health, does not evaluate health changes using individual willingness to pay. Whenperforming CEA, you should consider using at least one integrated measure ofeffectiveness when a rule creates a significant impact on both mortality and morbidity.
When CEA is performed in specific rulemaking contexts, you should be prepared to make appropriate adjustments to ensure fair treatment ofall segments ofthe population. Fairness is important in the choice and execution ofeffectiveness measures. For example, if QALY s are used to evaluate a lifesaving rule aimed at a population that happens to experience a high rate ofdisability (i.e., where the rule is not designed to affect the disability), the number of life years saved should not necessarily be diminished simply because the rule saves the lives of people with life-shortening disabilities. Both analytic simplicity and fairness suggest that the estimated number oflife years saved for the disabled population should be based on average life expectancy information for the relevant age cohorts. More generally, when numeric adjustments are made for life expectancy or quality oflife, analysts shouldprefer use ofpopulation averages rather than information derived from subgroups dominated by a particular demographic or income group. OMB does not require agencies to use any specific measure ofeffectiveness. In fact, OMB encourages agencies to report results with multiple measures ofeffectiveness that offer different insights and perspectives. The regulatory analysis should explain which measures were selected and why, and how they were implemented.
The analytic discretion provided in choice ofeffectiveness measure will create some inconsistency in how agencies evaluate the same injuries and diseases, and it will be difficult for

7 Russell LB and SiskJE (2000), "Modeling Age Differences in Cost Effectiveness Analysis", InternationalJournal of TechnologyAssessment in Health Care, 16(4), 1158-1167. 8 Pliskin ]S, Shepard DS, and Weinstein MC (1980), "Utility Functions for Life Years and Health Status," Operations Research, 28(1), 206-224.
9 HammittJK (2002), "QALYs Versus WTP," RiskAnalysis, 22(5), pp. 985-1002.

13OMB and the public to draw meaningful comparisons between rulemakings that employ

different effectiveness measures. As a result, agencies should use their web site to provide OMB and the public with the underlying data, including mortality and morbidity data, the age distribution of the affected populations, and the severity and duration of disease conditions and trauma, so that OMB and the public can construct apples-to-apples comparisons between rulemakings that employ different measures. There are sensitive technical and ethical issues associated with choosing one or more of these integrated measures for use throughout the Federal government. The Institute of Medicine (IOM) may assemble a panel of specialists in cost-effectiveness analysis and bioethics to evaluate the advantages and disadvantages of these different measures and other measures that have been suggested in the academic literature

. OMB believes that the IOM guidance will provide Federal agencies and OMB useful insight into how to improve the measurement of effectiveness of public health and safety regulations. DistributionalEffects Those who bear the costs of a regulation and those who enjoy its benefits often are not the same people. The term "distributional effect" refers to the impact of a regulatory action across the population and economy, divided up in various ways (e.g., income groups, race, sex, industrial sector, geography). Benefits and costs of a regulation may also be distributed unevenly over time, perhaps spanning several generations

. Distributional effects may arise through "transfer payments" that stem from a regulatory action as well. For example, the revenue collected through a fee, surcharge in excess of the cost of services provided, or tax is a transfer payment. Your regulatory analysis should provide a separate description of distributional effects (i.e., how both benefits and costs are distributed among sub-populations of particular concern) so that decision makers can properly consider them along with the effects on economic efficiency. Executive Order 12866 authorizes this approach

. Where distributive effects are thought to be important, the effects of various regulatory alternatives should be described quantitatively to the extent possible, including the magnitude, likelihood, and severity of impacts on particular groups. You should be alert for situations in which regulatory alternatives result in significant changes in treatment or outcomes for different groups. Effects on the distribution of income that are transmitted through changes in market prices can be important, albeit sometimes difficult to assess. Your analysis should also present information on the streams of benefits and costs over time in order to provide a basis for assessing intertemporal distributional consequences, particularly where intergenerational effects are concerned. E. Identifying and Measuring Benefits and Costs This Section provides guidelines for your preparation of the benefit and cost estimates required by Executive Order 12866 and the "Regulatory Right-to-Know Act." The discussions in previous sections will help you identify a workable number of alternatives for consideration in your analysis and an appropriate analytical approach to use.

14 OMB and the public to draw meaningful comparisons betweenrulemakings that employ different effectiveness measures. As a result, agencies should use their web site to provide OMB and the public with the underlying data, including mortality and morbidity data, the age distribution ofthe affected populations, and the severity and duration ofdisease conditions and trauma, so that OMB and the public can construct apples-to-apples comparisons between rulemakings that employ different measures. There are sensitive technical and ethical issues associated with choosing one or more of these integrated measures for use throughout the Federal government. The Institute ofMedicine (lOM) may assemble a panel ofspecialists in cost-effectiveness analysis and bioethics to evaluate the advantages and disadvantages ofthese different measures and other measures that have been suggested inthe academic literature. OMB believes that the 10M guidance will provide Federal agencies and OMB useful insight into how to improve the measurement of effectiveness ofpublic health and safety regulations. 

### Distributional

### Effects
Those who bearthe costs ofa regulation and those who enjoy its benefits often are not the same people. The term "distributional effect" refers to the impact ofa regulatory action across the population and economy, divided up in various ways (e.g., income groups, race, sex, industrial sector, geography). Benefits and costs ofa regulation may also be distributed unevenly over time, perhaps spanning several generations. Distributional effects may arise through "transferpayments" that stem from a regulatory action as well. For example, the revenue collected through a fee, surcharge in excess ofthe cost ofservices provided, ortax is a transfer payment.
Yourregulatory analysis should provide a separate description ofdistributional effects (i.e., howboth benefits and costs are distributed among SUb-populations ofparticular concern) so that decision makers canproperly consider them along with the effects on economic efficiency. Executive Order 12866 authorizes this approach. Where distributive effects are thought to be important, the effects ofvarious regulatory alternatives shouldbe described quantitatively to the extent possible, including the magnitude, likelihood, and severity ofimpacts onparticular groups. You shouldbe alert for situations in which regulatory alternatives result in significant changes in treatment or outcomes for different groups. Effects onthe distribution ofincome that are transmitted through changes in marketprices canbe important, albeit sometimes difficult to assess. Your analysis should also present information onthe streams ofbenefits and costs over time in orderto provide a basis for assessing intertemporal distributional consequences, particularly where intergenerational effects are concerned.


### E. Identifying and MeasuringBenefits and Costs
This Sectionprovides guidelines for your preparation ofthe benefit and cost estimates required by Executive Order 12866 and the "Regulatory Right-to-Know Act." The discussions in previous sections will help you identify a workable number ofalternatives for consideration in your analysis and an appropriate analytical approach to use.

14General Issues

1. Scope of Analysis Your analysis should focus on benefits and costs that accrue to citizens and residents of the United States. Where you choose to evaluate a regulation that is likely to have effects beyond the borders of the United States, these effects should be reported separately. The time frame for your analysis should cover a period long enough to encompass all the important benefits and costs likely to result from the rule. 2. Developing a Baseline You need to measure the benefits and costs of a rule against a baseline

. This baseline should be the best assessment of the way the world would look absent the proposed action. The choice of an appropriate baseline may require consideration of a wide range of potential factors, including: ® evolution of the market, ® changes in external factors affecting expected benefits and costs, ® changes in regulations promulgated by the agency or other government entities, and ® the degree of compliance by regulated entities with other regulations. It may be reasonable to forecast that the world absent the regulation will resemble the present. If this is the case, however , your baseline should reflect the future effect of current government programs and policies

. For review of an existing regulation, a baseline assuming "no change" in the regulatory program generally provides an appropriate basis for evaluating regulatory alternatives

. When more than one baseline is reasonable and the choice of baseline will significantly affect estimated benefits and costs , you should consider measuring benefits and costs against alternative baselines

. In doing so you can analyze the effects on benefits and costs of making different assumptions about other agencies ' regulations, or the degree of compliance with your own existing rules. In all cases , you must evaluate benefits and costs against the same baseline. You should also discuss the reasonableness of the baselines used in the sensitivity analyses. For each baseline you use, you should identify the key uncertainties in your forecast.
EPA's 1998 final PCB disposal rule provides a good example of using different baselines. EPA used several alternative baselines, each reflecting a different interpretation of existing regulatory requirements

. In particular, one baseline reflected a literal interpretation of EPA's 1979 rule and another the actual implementation of that rule in the year immediately preceding the 1998 revision . The use ofmultiple baselines illustrated the substantial effect changes in EPA's implementation policy could have on the cost of a regulatory program. In the years after EPA adopted the 1979 PCB disposal rule, changes in EPA policy -- especially allowing the disposal of automobile "shredder fluff' in municipal landfills -

- reduced the cost of the program by more than $500 million per year.
In some cases, substantial portions of a rule may simply restate statutory requirements that would be self-implementing, even in the absence of the regulatory action. In these cases,

15 

### GeneralIssues
1. Scope ofAnalysis
Your analysis should focus on benefits and costs that accrue to citizens and residents of the United States. Where you choose to evaluate a regulation that is likely to have effects beyond the borders ofthe United States, these effects should be reported separately. The time frame for your analysis should cover a period long enough to encompass all the important benefits and costs likely to result from the rule.
2. Developing a Baseline
You need to measure the benefits and costs ofa rule against a baseline. This baseline shouldbe the best assessment ofthe way the world would look absent the proposed action. The choice ofan appropriate baseline may require consideration ofa wide range ofpotential factors, including:

GIl evolution ofthe market,

GIl changes in external factors affecting expectedbenefits and costs,
GIl changes inregulations promulgatedby the agency or other government entities, and

GIl the degree ofcompliance by regulated entities with otherregulations.
Itmay be reasonable to forecast that the world absent the regulation will resemble the present. Ifthis is the case, however, yourbaseline shouldreflect the future effect ofcurrent governmentprograms andpolicies. Forreview ofan existing regulation, a baseline assuming "no change" in the regulatory program generally provides an appropriate basis for evaluating regulatory alternatives. Whenmore than one baseline is reasonable andthe choice ofbaseline will significantly affect estimatedbenefits and costs, you should consider measuring benefits and costs against alternative baselines. In doing so you can analyze the effects onbenefits and costs ofmaking different assumptions about other agencies' regulations, or the degree ofcompliance with your own existing rules. In all cases, you must evaluate benefits and costs against the same baseline. You should also discuss the reasonableness ofthe baselines used in the sensitivity analyses. For each baseline you use, you should identify the key uncertainties in your forecast.
EPA's 1998 final PCB disposal rule provides a good example ofusing different baselines. EPA used several alternative baselines, each reflecting a different interpretation ofexisting regulatory requirements. Inparticular, onebaseline reflected a literal interpretation ofEPA's 1979 rule and another the actual implementation ofthatrule in the year immediatelypreceding the 1998 revision. The use ofmultiple baselines illustrated the substantial effect changes in EPA's implementation policy couldhave on the cost ofa regulatory program. Inthe years after EPA adopted the 1979 PCB disposal rule, changes in EPA policy

-- especially allowing the disposal ofautomobile "shredder fluff' in municipal landfills

-- reduced the cost ofthe program by more than $500 millionperyear. In some cases, substantial portions ofa rule may simply restate statutory requirements that wouldbe self-implementing, even in the absence ofthe regulatory action. Inthese cases,

15you should use a pre-statute baseline. If you are able to separate out those areas where the

agency has discretion, you may also use a post

-statute baseline to evaluate the discretionary elements of the action.
3. Evaluation of Alternatives You should describe the alternatives available to you and the reasons for choosing one alternative over another. As noted previously, alternatives that rely on incentives and offer increased flexibility are often more cost

-effective than more prescriptive approaches. Forinstance, user fees and information dissemination may be good alternatives to direct commandand-control regulation

. Within a command

-and-control regulatory program, performance-based standards generally offer advantages over standards specifying design, behavior, or manner of compliance. You should carefully consider all appropriate alternatives for the key attributes or provisions of the rule

. The previous discussion outlines examples of appropriate alternatives. Where there is a "continuum" of alternatives for a standard (such as the level of stringency), you generally should analyze at least three options: the preferred option; a more stringent option that achieves additional benefits (and presumably costs more) beyond those realized by the preferred option; and a less stringent option that costs less (and presumably generates fewer benefits) than the preferred option. You should choose reasonable alternatives deserving careful consideration. In some cases, a regulatory program will focus on an option that is near or at the limit of technical feasibility

. In this case, the analysis would not need to examine a more stringent option. For each of the options analyzed, you should compare the anticipated benefits to the corresponding costs. It is not adequate simply to report a comparison of the agency's preferred option to the chosen baseline. Whenever you report the benefits and costs of alternative options, you should present both total and incremental benefits and costs

. You should present incremental benefits and costs as differences from the corresponding estimates associated with the next less-stringent alternative

. 10 It is important to emphasize that incremental effects are simply differences between successively more stringent alternatives

. Results involving a comparison to a "next best" alternative may be especially useful.
In some cases, you may decide to analyze a wide array of options

. In 1998, DOE analyzed a large number of options in setting new energy efficiency standards for refrigerators and freezers and produced a rich amount of information on their relative effects. This analysis -- examining more than 20 alternative performance standards for one class of refrigerators with top-mounted freezers -- enabled DOE to select an option that produced $200 more in estimated net benefits per refrigerator than the least attractive option.
10 For the least stringent alternative , you should estimate the incremental benefits and costs relative to the baseline. Thus, for this alternative, the incremental effects would be the same as the corresponding totals . For each alternative that is more stringent than the least stringent alternative, you should estimate the incremental benefits and costs relative to the closest less-stringent alternative.

16 you shoulduse a pre-statute baseline. Ifyou are able to separate out those areas where the agency has discretion, you may also use a post-statute baseline to evaluate the discretionary elements ofthe action.
3. Evaluation ofAlternatives
You should describe the alternatives available to you and the reasons for choosing one alternative over another. As noted previously, alternatives that rely on incentives and offer increased flexibility are often more cost-effective than more prescriptive approaches. For instance, user fees and information dissemination maybe good alternatives to direct commandand-control regulation. Within a command-and-control regulatory program, performance-based standards generally offer advantages over standards specifying design, behavior, ormanner of compliance.
You should carefully consider all appropriate alternatives for the key attributes or provisions ofthe rule. The previous discussion outlines examples ofappropriate alternatives. Where there is a "continuum" ofalternatives for a standard (such as the level ofstringency), you generally should analyze at least three options: the preferred option; a more stringent option that achieves additional benefits (andpresumably costs more) beyond those realized by the preferred option; and a less stringent option that costs less (and presumably generates fewer benefits) than the preferred option.
You should choose reasonable alternatives deserving careful consideration. In some cases, a regulatory programwill focus on an option that is near or at the limit oftechnical feasibility. In this case, the analysis wouldnotneedto examine a more stringent option. For each ofthe options analyzed, you should compare the anticipatedbenefits to the corresponding costs. Itis not adequate simply to report a comparison ofthe agency's preferred option to the chosen baseline. Wheneveryoureport the benefits and costs ofalternative options, you should present both total and incremental benefits and costs. You should present incremental benefits and costs as differences from the corresponding estimates associated with the next less-stringent alternative.IO Itis importantto emphasize that incremental effects are simply differences between successively more stringent alternatives. Results involving a comparison to a "next best" alternative may be especially useful.
In some cases, youmay decide to analyze a wide array ofoptions. In 1998, DOE analyzed a large number ofoptions in setting new energy efficiency standards for refrigerators and freezers and produced a rich amount ofinformation on theirrelative effects. This analysis

-- examining more than 20 alternative performance standards for one class ofrefrigerators with top-mounted freezers

-- enabled DOE to select an option that produced $200 more in estimated net benefits perrefrigerator than the least attractive option.

10 For the least stringent aitemative, you should estimate the incremental benefits and costs relative to the baseline. Thus, for this aitemative, the incremental effects would be the same as the corresponding totals. For each altemative that is more stringent than the least stringent altemative, you should estimate the incremental benefits and costs relative to the closest less-stringent altemative.

16You should analyze the benefits and costs of different regulatory provisions separately

when a rule includes a number of distinct provisions. If the existence of one provision affects the benefits or costs arising from another provision, the analysis becomes more complicated, but the need to examine provisions separately remains. In this case, you should evaluate each specific provision by determining the net benefits of the proposed regulation with and without it. Analyzing all possible combinations of provisions is impractical if the number is large and interaction effects are widespread. You need to use judgment to select the most significant or relevant provisions for such analysis. You are expected to document all of the alternatives that were considered in a list or table and which were selected for emphasis in the main analysis. You should also discuss the statutory requirements that affect the selection of regulatory approaches. If legal constraints prevent the selection of a regulatory action that best satisfies the philosophy and principles of Executive Order 12866, you should identify these constraints and estimate their opportunity cost. Such information may be useful to Congress under the Regulatory Right-to-Know Act. 4. Transparency and Reproducibility of Results Because of its influential nature and its special role in the rulemaking process, it is appropriate to set minimum quality standards for regulatory analysis. You should provide documentation that the analysis is based on the best reasonably obtainable scientific, technical, and economic information available. To achieve this, you should rely on peer-reviewed literature, where available, and provide the source for all original information. A good analysis should be transparent and your results must be reproducible. You should clearly set out the basic assumptions, methods, and data underlying the analysis and discuss the uncertainties associated with the estimates. A qualified third party reading the analysis should be able to understand the basic elements of your analysis and the way in which you developed your estimates. To provide greater access to your analysis, you should generally post it, with all the supporting documents, on the internet so the public can review the findings. You should also disclose the use of outside consultants, their qualifications, and history of contracts and employment with the agency (e.g., in a preface to the RIA). Where other compelling interests (such as privacy, intellectual property, trade secrets, etc.) prevent the public release of data or key elements of the analysis, you should apply especially rigorous robustness checks to analytic results and document the analytical checks used. Finally, you should assure compliance with the Information Quality Guidelines for your agency and OMB's "Guidelines for Ensuring and Maximizing the Quality, Objectivity, Utility, and Integrity of Information Disseminated by Federal Agencies" ("data quality guidelines") http://www.whitehouse.gov/omb/fedreg/reproducible.html.

17 You should analyze the benefits and costs ofdifferent regulatory provisions separately when a rule includes a number ofdistinct provisions. Ifthe existence ofone provision affects the benefits or costs arising from another provision, the analysis becomes more complicated, butthe need to examine provisions separately remains. In this case, you should evaluate each specific provisionby determining the net benefits ofthe proposed regulation with and without it. Analyzing all possible combinations ofprovisions is impractical ifthe number is large and interaction effects are widespread. You need to usejudgmentto select the most significant or relevant provisions for such analysis. You are expected to document all ofthe alternatives that were considered in a list ortable and which were selected for emphasis in the main analysis.
You should also discuss the statutory requirements that affect the selection ofregulatory approaches. Iflegal constraints prevent the selection ofa regulatory action that best satisfies the philosophy and principles ofExecutive Order 12866, you should identify these constraints and estimate their opportunity cost. Such information may be useful to Congress under the Regulatory Right-to-Know Act.
4. Transparency and Reproducibility ofResults
Because ofits influential nature and its special role in the rulemaking process, it is appropriate to set minimum quality standards for regulatory analysis. You shouldprovide documentation that the analysis is based onthe best reasonably obtainable scientific, technical, and economic information available. To achieve this, you should rely onpeer-reviewed literature, where available, and provide the source for all original information.
A good analysis should be transparent and yourresults must be reproducible. You should clearly set out the basic assumptions, methods, and data underlying the analysis and discuss the uncertainties associated with the estimates. A qualified third partyreading the analysis should be able to understand the basic elements ofyour analysis and the way inwhich you developed your estimates.
To provide greater access to your analysis, you should generally post it, with all the supporting documents, on the internet so the public canreview the findings. You should also disclose the use ofoutside consultants, their qualifications, and history ofcontracts and employment with the agency (e.g., in a preface to the RIA). Where other compelling interests (such as privacy, intellectualproperty, trade secrets, etc.) prevent the public release ofdata or key elements ofthe analysis, you should apply especially rigorous robustness checks to analytic results and document the analytical checks used. Finally, you should assure compliance with the Information Quality Guidelines for your agency and OMB's "Guidelines for Ensuring and Maximizing the Quality, Objectivity, Utility, and Integrity ofInformation DisseminatedbyFederal Agencies" ("data quality guidelines") http://www.whitehouse.gov/omb/fedreg/reproducibJe.html.

17Developing Benefit and Cost Estimates

Some General Considerations The analysis document should discuss the expected 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? What are the monetized values of the potential real incremental benefits and costs to society? To present your results, you should: o include separate schedules of the monetized benefits and costs that show the type and timing of benefits and costs, and express the estimates in this table in constant, undiscounted dollars (for more on discounting see "Discount Rates" below); o list the benefits and costs you can quantify, but cannot monetize, including their timing; o describe benefits and costs you cannot quantify; and o identify or cross-reference the data or studies on which you base the benefit and cost estimates. When benefit and cost estimates are uncertain (for more on this see "Treatment of Uncertainty" below), you should report benefit and cost estimates (including benefits of risk reductions) that reflect the full probability distribution of potential consequences. Where possible, present probability distributions of benefits and costs and include the upper and lower bound estimates as complements to central tendency and other estimates. If fundamental scientific disagreement or lack of knowledge prevents construction of a scientifically defensible probability distribution, you should describe benefits or costs under plausible scenarios and characterize the evidence and assumptions underlying each alternative scenario. 2. The Key Concepts Needed to Estimate Benefits and Costs "Opportunity cost" is the appropriate concept for valuing both benefits and costs. The principle of "willingness-to-pay" (WTP) captures the notion of opportunity cost by measuring what individuals are willing to forgo to enjoy a particular benefit. In general, economists tend to view WTP as the most appropriate measure of opportunity cost, but an individual 's "willingnessto-accept" (WTA) compensation for not receiving the improvement can also provide a valid measure of opportunity cost. WTP and WTA are comparable measures under special circumstances . WTP and WTA measures may be comparable in the following situations : if a regulation affects a price change rather than a quantity change; the change being evaluated is small ; there are reasonably close substitutes available; and the income effect is small." 1 However, empirical evidence from experimental economics and psychology shows that even when income/wealth effects are "small", the measured differences between WTP and WTA can be large.12 WTP is generally

" See Hanemann WM (1991 ), American Economic Review, 81(3),635-647. 12 See Kahneman D, Knetsch JL, and Thaler RH (1991 ), "Anomalies : The Endowment Effect, Loss Aversion, and Status Quo Bias," Journal of Economic Perspectives 3(1), 192-206.

18 DevelopingBenefitand CostEstimates
1. Some General Considerations
The analysis document should discuss the expected benefits and costs ofthe selected regulatory option and any reasonable alternatives. How is the proposed action expected to provide the anticipated benefits and costs? What are the monetized values ofthe potential real incremental benefits and costs to society? To presentyour results, you should:

ED include separate schedules ofthe monetizedbenefits and costs that show the type and timing ofbenefits and costs, and express the estimates inthis table in constant, undiscounted dollars (for more on discounting see "DiscountRates" below);

ED list the benefits and costs you can quantify, but cannot monetize, including their timing;

ED describe benefits and costs you cannot quantify; and

ED identify or cross-reference the data or studies on which you base the benefit and cost estimates.
Whenbenefit and cost estimates are uncertain (for more onthis see "Treatment of Uncertainty" below), you should report benefit and cost estimates (including benefits ofrisk reductions) that reflect the full probability distribution ofpotential consequences. Where possible, presentprobability distributions ofbenefits and costs and include the upper and lower bound estimates as complements to central tendency and other estimates. Iffundamental scientific disagreement or lack ofknowledge prevents construction ofa scientifically defensible probability distribution, you should describe benefits orcosts under plausible scenarios and characterize the evidence and assumptions underlying each alternative scenano. 2. The Key Concepts Needed to Estimate Benefits and Costs "Opportunity cost" is the appropriate concept for valuingboth benefits and costs. The principle of"willingness-to-pay" (WTP) captures the notion ofopportunity costby measuring what individuals are willing to forgo to enjoy a particularbenefit. In general, economists tend to viewWTP as the most appropriate measure ofopportunity cost, but an individual's "willingnessto-accept" (WTA) compensation for not receiving the improvement can also provide a valid measure ofopportunity cost.
WTP and WTA are comparable measures under special circumstances. WTP and WTA measures maybe comparable inthe following situations: ifa regulation affects a price change rather than a quantity change; the change being evaluated is small; there are reasonably close substitutes available; andthe income effect is small. 11 However, empirical evidence from experimental economics and psychology shows that even when income/wealth effects are "small", the measured differences between WTP and WTA canbe large. 12 WTP is generally

11 See Hanemann WM (1991),American Economic Review, 81(3), 635-647. 12 See Kahneman D, Knetsch JL, and Thaler RH (1991), "Anomalies: The Endowment Effect, Loss Aversion, and Status Quo Bias," Journal of Economic Perspectives 3(1),192-206.

18considered to be more readily measurable. Adoption of WTP as the measure of value implies

that individual preferences of the affected population should be a guiding factor in the regulatory analysis.Market prices provide rich data for estimating benefits and costs based on willingness-topay if the goods and services affected by the regulation are traded in well-functioning competitive markets. The opportunity cost of an alternative includes the value of the benefits forgone as a result of choosing that alternative

. The opportunity cost of banning a product -- a drug, food additive, or hazardous chemical

-- is the forgone net benefit (i.e., lost consumer and producer surplus13 ) of that product, taking into account the mitigating effects of potential substitutes. The use of any resource has an opportunity cost regardless of whether the resource is already owned or has to be purchased

. That opportunity cost is equal to the net benefit the resource would have provided in the absence of the requirement

. For example, if regulation of an industrial plant affects the use of additional land or buildings within the existing plant boundary, the cost analysis should include the opportunity cost of using the additional land or facilities. To the extent possible, you should monetize any such forgone benefits and add them to the other costs of that alternative

. You should also try to monetize any cost savings as a result of an alternative and either add it to the benefits or subtract it from the costs of that alternative. However, you should not assume that the "avoided" costs of not doing another regulatory alternative represent the benefits of a regulatory action where there is no direct, necessary relationship between the two. You should also be careful when the costs avoided are attributable to an existing regulation

. Even when there is a direct relationship between the two regulatory actions, the use of avoided costs is problematic because the existing regulation may not maximize net benefits and thus may itself be questionable policy. (See the section, "Direct Use of Market Data," for more detail.) Estimating benefits and costs when market prices are hard to measure or markets do not exist is more difficult

. In these cases, you need to develop appropriate proxies that simulate market exchange

. Estimates of willingness

-to-pay based on revealed preference methods can be quite useful

. As one example, analysts sometimes use "hedonic price equations" based on multiple regression analysis of market behavior to simulate market prices for the commodity of interest

. The hedonic technique allows analysts to develop an estimate of the price for specific attributes associated with a product

. For instance, a house is a product characterized by a variety of attributes including the number of rooms, total floor area, and type of heating and cooling. If there are enough data on transactions in the housing market , it is possible to develop an estimate of the implicit price for specific attributes , such as the implicit price of an additional bathroom or for central air conditioning

. This technique can be extended, as well, to develop an estimate for

i3 Consumer surplus is the difference between what a consumer pays for a unit of a good and the maximum amount the consumer would be willing to pay for that unit

. It is measured by the area between the price and the demand curve for that unit

. Producer surplus is the difference between the amount a producer is paid for a unit of a good and the minimum amount the producer would accept to supply that unit

. It is measured by the area between the price and the supply curve for that unit.

19 considered to be more readily measurable. Adoption ofWTP as the measure ofvalue implies that individual preferences ofthe affected population shouldbe a guiding factor in the regulatory analysis.
Marketprices provide rich data for estimating benefits and costs based onwillingness-topay ifthe goods and services affected by the regulation are traded in well-functioning competitive markets. The opportunity cost ofan alternative includes the value ofthe benefits forgone as a result ofchoosing that alternative. The opportunity cost ofbanning a product

-- a drug, food additive, orhazardous chemica1-- is the forgone net benefit (i.e., lost consumer and producer surplus13 ) ofthatproduct, taking into account the mitigating effects ofpotential substitutes.
The use ofany resource has an opportunity costregardless ofwhether the resource is already owned orhas to be purchased. That opportunity cost is equal to the net benefitthe resource would have provided in the absence ofthe requirement. For example, ifregulation of an industrial plant affects the use ofadditiona11and or buildings within the existing plant boundary, the cost analysis should include the opportunity cost ofusing the additiona11and or facilities.
To the extent possible, you should monetize any such forgone benefits and add them to the other costs ofthat alternative. You should also try to monetize any cost savings as a result of an alternative and either add it to the benefits or subtract it from the costs ofthat alternative. However, you should not assume that the "avoided" costs ofnot doing another regulatory alternative represent the benefits ofa regulatory action where there is no direct, necessary relationship between the two. You should also be careful when the costs avoided are attributable to an existing regulation. Even whenthere is a direct relationship betweenthe two regulatory actions, the use ofavoided costs is problematic because the existing regulation may not maximize netbenefits and thus may itselfbe questionable policy. (See the section, "Direct Use ofMarketData," for more detail.) Estimatingbenefits and costs when market prices are hard to measure ormarkets do not exist is more difficult. 

### In these cases, you need to develop appropriate proxies that simulate market exchange. Estimates ofwillingness-to-pay based onrevealedpreference methods canbe quite useful. As one example, analysts sometimes use "hedonic price equations" based on multiple regression analysis ofmarket behaviorto simulate market prices for the commodity of interest. The hedonic technique allows analysts to develop an estimate ofthe price for specific attributes associated with a product. Forinstance, a house is a product characterizedby a variety ofattributes including the number ofrooms, total floor area, and type ofheating and cooling. If there are enough data ontransactions in the housing market, it is possible to develop an estimate ofthe implicit price for specific attributes, such as the implicit price ofan additional bathroom or for central air conditioning. This technique can be extended, as well, to develop an estimate for

13 Consumer surplus is the difference between what a consumer pays for aunit ofa good and the maximum amount the consumer would be willing to pay for that unit. It is measured bythe area between the price and the demand curve for that unit. Producer surplus is the difference between the amount a producer is paid for a unit ofa good and the minimum amount the producerwould accept to supply that unit. Itis measured by the area between the price and the supply curve for that unit.

19the implicit price of public goods that are not directly traded in markets. An analyst can develop

implicit price estimates for public goods like air quality and access to public parks by assessing the effects of these goods on the housing market. Going through the analytical process of deriving benefit estimates by simulating markets may also suggest alternative regulatory strategies that create such markets. You need to guard against double-counting, since some attributes are embedded in other broader measures. To illustrate, when a regulation improves the quality of the environment in a community, the value of real estate in the community generally rises to reflect the greater attractiveness of living in a better environment. Simply adding the increase in property values to the estimated value of improved public health would be double counting if the increase in property values reflects the improvement in public health. To avoid this problem you should separate the embedded effects on the value of property arising from improved public health. At the same time, an analysis that fails to incorporate the consequence of land use changes when accounting for costs will not capture the full effects of regulation. 3. Revealed Preference Methods Revealed preference methods develop estimates of the value of goods and services -- or attributes of those goods and services -- based on actual market decisions by consumers, workers and other market participants. If the market participant is well informed and confronted with a real choice, it may be feasible to determine accurately and precisely the monetary value needed for a rulemaking. There is a large and well-developed literature on revealed preference in the peer-reviewed, applied economics literature. Although these methods are well grounded in economic theory, they are sometimes difficult to implement given the complexity of market transactions and the paucity of relevant data. When designing or evaluating a revealed preference study, the following principles should be considered: ® the market should be competitive. If the market isn't competitive (e.g., monopoly, oligopoly), then you should consider making adjustments such that the price reflects the true value to society (often called the "shadow price"); ® the market should not exhibit a significant information gap or asymmetric information problem. If the market suffers from information problems, then you should discuss the divergence of the price from the underlying shadow price and consider possible adjustments to reflect the underlying shadow price; ® the market should not exhibit an externality. In this case, you should discuss the divergence of the price from the underlying shadow price and consider possible adjustments to reflect the underlying shadow price; • the specific market participants being studied should be representative of the target populations to be affected by the rulemaking under consideration; • a valid research design and framework for analysis should be adopted. Examples include using data and/or model specifications that include the markets for substitute and complementary goods and services and using reasonably unrestricted functional forms. When specifying substitute and complementary goods, the analysis should preferably be

20 the implicitprice ofpublic goods that are not directly traded in markets. An analyst can develop implicit price estimates for public goods like air quality and access to public parks by assessing the effects ofthese goods on the housing market. Going through the analytical process of deriving benefit estimates by simulating markets may also suggest alternative regulatory strategies that create such markets.
You need to guard against double-counting, since some attributes are embedded in other broader measures. To illustrate, when a regulation improves the quality ofthe environment in a community, the value ofreal estate in the community generally rises to reflect the greater attractiveness ofliving in a better environment. Simply adding the increase in property values to the estimated value ofimproved public health would be double counting ifthe increase in property values reflects the improvement in public health. To avoid this problem you should separate the embedded effects on the value ofproperty arising from improved public health. At the same time, an analysis that fails to incorporate the consequence ofland use changes when accounting for costs will not capture the full effects ofregulation.
3. Revealed Preference Methods
Revealedpreference methods develop estimates ofthe value ofgoods and services

-- or attributes ofthose goods and services

-- based on actual market decisions by consumers, workers and other market participants. Ifthe market participant is well informed and confronted with a real choice, it may be feasible to determine accurately andprecisely the monetary value needed for a rulemaking. There is a large and well-developed literature on revealed preference in the peer-reviewed, applied economics literature. Although these methods are well grounded in economic theory, they are sometimes difficult to implement given the complexity ofmarket transactions and the paucity ofrelevant data. When designing or evaluating a revealed preference study, the following principles should be considered:

e the market shouldbe competitive. Ifthe market isn't competitive (e.g., monopoly, oligopoly), then you should consider making adjustments such that the price reflects the true value to society (often calledthe "shadow price");

., the market should not exhibit a significant information gap or asymmetric information problem. Ifthe market suffers from information problems, then you should discuss the divergence ofthe price from the underlying shadowprice and considerpossible adjustments to reflect the underlying shadow price; • the market should not exhibit an externality. In this case, you should discuss the divergence ofthe price from the underlying shadowprice and considerpossible adjustments to reflectthe underlying shadow price; • the specific market participants being studied shouldbe representative ofthe target populations to be affected by the rulemaking under consideration; • a valid research design and framework for analysis shouldbe adopted. Examples include using data and/or model specifications that include the markets for substitute and complementary goods and services and using reasonably unrestricted functional forms. When specifying substitute and complementary goods, the analysis shouldpreferably be



### 20based on data about the range of alternatives perceived by market participants. If such

data are not available, you should adopt plausible assumptions and describe the limitations of the analysis. ® the statistical and econometric models employed should be appropriate for the application and the resulting estimates should be robust in response to plausible changes in model specification and estimation technique; and ® the results should be consistent with economic theory. You should also determine whether there are multiple revealed-preference studies of the same good or service and whether anything can be learned by comparing the methods, data and findings from different studies. Professional judgment is required to determine whether a particular study is of sufficient quality to justify use in regulatory analysis. When studies are used in regulatory analysis despite their technical weaknesses (e.g., due to the absence of other evidence), the regulatory analysis should discuss any biases or uncertainties that are likely to arise due to those weaknesses. If a study has major weaknesses , the study should not be used in regulatory analysis.

a. Direct Uses of Market Data Economists ordinarily consider market prices as the most accurate measure of the marginal value of goods and services to society

. In some instances, however, market prices may not reflect the true value of goods and services due to market imperfections or government intervention

. If a regulation involves changes to goods or services where the market price is not a good measure of the value to society, you should use an estimate that reflects the shadow price. Suppose a particular air pollutant damages crops

. One of the benefits of controlling that pollutant is the value of the crop yield increase as a result of the controls

. That value is typically measured by the price of the crop. However, if the price is held above the market price by a government program that affects supply , a value estimate based on this price may not reflect the true benefits of controlling the pollutant

. In this case, you should calculate the value to society of the increase in crop yields by estimating the shadow price, which reflects the value to society of the marginal use of the crop. If the marginal use is for exports, you should use the world price. If the marginal use is to add to very large surplus stockpiles, you should use the value of the last units released from storage minus storage cost. If stockpiles are large and growing, the shadow price may be low or even negative. Other goods whose market prices may not reflect their true value include those whose production or consumption results in substantial ( 1) positive or negative external effects or (2) transfer payments

. For example, the observed market price of gasoline may not reflect marginal social value due to the inclusion of taxes, other government interventions , and negative externalities (e.g., pollution). This shadow price may also be needed for goods whose market price is substantially affected by existing regulations that do not maximize net benefits. b. Indirect Uses of Market Data Many goods or attributes of goods that are affected by regulation

--such as preserving environmental or cultural amenities

--are not traded directly in markets. The value for these

21 based on data about the range ofalternatives perceived by market participants. Ifsuch data are not available, you should adopt plausible assumptions and describe the limitations ofthe analysis.

EI the statistical and econometric models employed shouldbe appropriate for the application and the resulting estimates shouldbe robust in response to plausible changes in model specification and estimation technique; and • the results should be consistent with economic theory.
You should also determine whether there are multiple revealed-preference studies ofthe same good or service and whether anything canbe learnedby comparing the methods, data and findings from different studies. Professionaljudgmentis required to determine whether a particular study is ofsufficient quality tojustify use inregulatory analysis. When studies are used in regulatory analysis despite their technical weaknesses (e.g., due to the absence ofother evidence), the regulatory analysis should discuss any biases oruncertainties that are likely to arise due to those weaknesses. Ifa studyhas major weaknesses, the study should not be used in regulatory analysis.

a. DirectUses ofMarket Data
Economists ordinarily consider market prices as the most accurate measure ofthe marginal value ofgoods and services to society. In some instances, however, marketprices may notreflect the true value ofgoods and services due to market imperfections or government intervention. Ifa regulation involves changes to goods or services where the marketprice is not a good measure ofthe value to society, you shoulduse an estimate that reflects the shadowprice. Suppose a particular airpollutant damages crops. One ofthe benefits ofcontrolling that pollutant is the value ofthe crop yield increase as a result ofthe controls. That value is typically measuredby the price ofthe crop. However, ifthe price is held above the marketprice by a governmentprogram that affects supply, a value estimatebased onthis price may notreflect the true benefits ofcontrolling the pollutant. Inthis case, you should calculate the value to society ofthe increase in crop yields by estimating the shadowprice, which reflects the value to society ofthe marginal use ofthe crop. Ifthe marginal use is for exports, you shoulduse the world price. Ifthe marginal use is to add to very large surplus stockpiles, you should use the value of the last units released from storage minus storage cost. Ifstockpiles are large and growing, the shadowprice maybe low or even negative.
Other goods whose market prices may not reflect their true value include those whose production or consumption results in substantial (1) positive ornegative external effects or (2) transfer payments. For example, the observed marketprice ofgasoline may notreflect marginal social value due to the inclusion oftaxes, other government interventions, and negative externalities (e.g., pollution). This shadowprice may also be needed for goods whose market price is substantially affected by existing regulations that do not maximize netbenefits.
b. Indirect Uses ofMarket Data Many goods or attributes ofgoods that are affected byregulation--such as preserving environmental or cultural amenities--are nottraded directly in markets. The value for these

21goods or attributes arise both from use and non-use. Estimation of these values is difficult

because of the absence of an organized market. However, overlooking or ignoring these values in your regulatory analysis may significantly understate the benefits and/or costs of regulatory action. "Use values" arise where an individual derives satisfaction from using the resource, either now or in the future. Use values are associated with activities such as swimming, hunting, and hiking where the individual makes use of the natural environment. "Non-use values" arise where an individual places value on a resource, good or service even though the individual will not use the resource, 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 may not be strictly considered a "non-use" value.14 A general concern for the welfare of others should supplement benefits and costs equally; hence, it is not necessary to measure the size of general altruism in regulatory analysis. If there is evidence of selective altruism, it needs to be considered specifically in both benefits and costs. Some goods and services are indirectly traded in markets, which means that their value is reflected in the prices of related goods and services that are directly traded in markets. Their use values are typically estimated through revealed preference methods. Examples include estimates of the values of environmental amenities derived from travel-cost studies, and hedonic price models that measure differences or changes in the value of real estate. It is important that you utilize revealed preference models that adhere to economic criteria that are consistent with utility maximizing behavior. Also, you should take particular care in designing protocols for reliably estimating the values of these attributes.
4. Stated Preference Methods Stated Preference Methods (SPM) have been developed and used in the peer-reviewed literature to estimate both "use" and "non-use" values of goods and services. They have also been widely used in regulatory analyses by Federal agencies, in part, because these methods can be creatively employed to address a wide variety of goods and services that are not easy to study through revealed preference methods.The distinguishing feature of these methods is that hypothetical questions about use or nonuse values are posed to survey respondents in order to obtain willingness-to-pay estimates relevant to benefit or cost estimation. Some examples of SPM include contingent valuation, conjoint analysis and risk-tradeoff analysis. The surveys used to obtain the health-utility values used in CEA are similar to stated-preference surveys but do not entail monetary measurement of value. Nevertheless, the principles governing quality stated-preference research, with some obvious exceptions involving monetization, are also relevant in designing quality health-utility research.

14 See McConnell KE (1997), Journal ofEnvironrnental Economics and Management , 32, 22-37.

22 goods or attributes arise both from use and non-use. Estimation ofthese values is difficult because ofthe absence ofan organized market. However, overlooking or ignoring these values in your regulatory analysis may significantly understate the benefits and/or costs ofregulatory action.
"Use values" arise where an individual derives satisfaction from using the resource, either now or in the future. Use values are associated with activities such as swimming, hunting, and hiking where the individual makes use ofthe natural environment.
"Non-use values" arise where an individual places value on a resource, good or service even though the individual will not use the resource, now or in the future. Non-use value includes bequest and existence values.
General altruism for the health and welfare ofothers is a closely related conceptbutmay not be strictly considered a "non-use" value. 14 A general concern for the welfare ofothers should supplementbenefits and costs equally; hence, it is not necessary to measure the size ofgeneral altruism in regulatory analysis. Ifthere is evidence ofselective altruism, it needs to be considered specifically in bothbenefits and costs. Some goods and services are indirectly traded in markets, which means that their value is reflected in the prices ofrelated goods and services that are directly traded in markets. Their use values are typically estimated through revealed preference methods. Examples include estimates ofthe values ofenvironmental amenities derived from travel-cost studies, and hedonic price models that measure differences or changes in the value ofreal estate. Itis important that you utilize revealed preference models that adhere to economic criteria that are consistent with utility maximizing behavior. Also, you should take particular care in designing protocols for reliably estimating the values ofthese attributes.
4. Stated Preference Methods
Stated Preference Methods (SPM) have been developed and used in the peer-reviewed literature to estimate both "use" and "non-use" values ofgoods and services. Theyhave also been widely used in regulatory analyses by Federal agencies, in part, because these methods can be creatively employed to address a wide variety ofgoods and services that are not easy to study through revealed preference methods.
The distinguishing feature ofthese methods is that hypothetical questions about use or nonuse values are posed to survey respondents in order to obtain willingness-to-pay estimates relevant to benefit or cost estimation. Some examples ofSPM include contingent valuation, conjoint analysis and risk-tradeoffanalysis. The surveys used to obtain the health-utility values used in CEA are similar to stated-preference surveys but do not entail monetary measurement of value. Nevertheless, the principles governing quality stated-preference research, with some obvious exceptions involving monetization, are also relevant in designing quality health-utility research.

14 See McConnell KE (1997), Journal of EnvironmentalEconomics andManagement, 32,22-37.


### 22When you are designing or evaluating a stated-preference study, the following principles

should be considered: ® the good or service being evaluated should be explained to the respondent in a clear, complete and objective fashion, and the survey instrument should be pre-tested; ® willingness-to-pay questions should be designed to focus the respondent on the reality of budgetary limitations and alerted to the availability of substitute goods and alternative expenditure options; ® the survey instrument should be designed to probe beyond general attitudes (e.g., a "warm glow" effect for a particular use or non-use value) and focus on the magnitude of the respondent's economic valuation; ® the analytic results should be consistent with economic theory using both "internal" (within respondent) and "external" (between respondent) scope tests such as the willingness to pay is larger (smaller) when more (less) of a good is provided; ® the subjects being interviewed should be selected/sampled in a statistically appropriate manner. The sample frame should adequately cover the target population. The sample should be drawn using probability methods in order to generalize the results 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 generalizability 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 representativeness of the sample based solely on demographic profiles. Statistical adjustments to reduce non-response bias should be undertaken whenever feasible and appropriate; ® the mode of administration of surveys (in-person, phone, mail, computer, internet or multiple modes ) should be appropriate in light of the nature of the questions being posed to respondents and the length and complexity of the instrument; ® documentation should be provided about the target population, the sampling frame used and its coverage of the target population, the design of the sample including any stratification or clustering, the cumulative response rate (including response rate at each stage of selection if applicable); the item non-response rate for critical questions; the exact wording and sequence of questions and other information provided to respondents; and the training of interviewers and techniques they employed (as appropriate); ® the statistical and econometric methods used to analyze the collected data should be transparent, well suited for the analysis, and applied with rigor and care. Professional judgment is necessary to apply these criteria to one or more studies, and thus there is no mechanical formula that can be used to determine whether a particular study is of sufficient quality to justify use in regulatory analysis. When studies are used despite having weaknesses on one or more of these criteria, those weaknesses should be acknowledged in the regulatory analysis, including any resulting biases or uncertainties that are likely to result. If a study has too many weaknesses with unknown consequences for the quality of the data, the study should not be used.

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

CII the good or service being evaluated should be explained to the respondent in a clear, complete and objective fashion, and the survey instrument should be pre-tested;

CII willingness-to-pay questions shouldbe designed to focus the respondent on the reality of budgetary limitations and alerted to the availability ofsubstitute goods and alternative expenditure options;

e the survey instrument shouldbe designed to probe beyond general attitudes (e.g., a "warm glow" effect for a particularuse ornon-use value) and focus onthe magnitude of the respondent's economic valuation;

CII the analytic results shouldbe consistent with economic theory using both "internal" (within respondent) and "external" (between respondent) scope tests such as the willingness to pay is larger (smaller) when more (less) ofa good is provided;

e the subjects being interviewed shouldbe selected/sampled in a statistically appropriate manner. The sample frame should adequately cover the target population. The sample shouldbe drawn using probability methods in order to generalize the results to the target population;

CII response rates shouldbe as high as reasonably possible. Best survey practices shouldbe followed to achieve high response rates. Lowresponse rates increase the potential for bias and raise concerns about the generalizability ofthe results. Ifresponse rates are not adequate, you should conduct an analysis ofnon-response bias or further study. Caution shouldbe used in assessing the representativeness ofthe sample based solely on demographic profiles. Statistical adjustments to reduce non-response bias shouldbe undertaken whenever feasible and appropriate;

e the mode ofadministration ofsurveys (in-person, phone, mail, computer, internet or multiple modes) shouldbe appropriate in light ofthe nature ofthe questions being posed to respondents and the length and complexity ofthe instrument;

e documentation shouldbe provided about the target population, the sampling frame used and its coverage ofthe target population, the design ofthe sample including any stratification or clustering, the cumulative response rate (including response rate at each stage ofselection ifapplicable); the item non-response rate for critical questions; the exact wording and sequence ofquestions and other informationprovided to respondents; and the training ofinterviewers and techniques they employed (as appropriate); • the statistical and econometric methods used to analyze the collected data should be transparent, well suited for the analysis, and applied with rigor and care. Professionaljudgmentis necessary to apply these criteria to one ormore studies, and thus there is no mechanical formula that canbe used to determine whether a particular study is of sufficient quality tojustifyuse in regulatory analysis. When studies are used despite having weaknesses on one ormore ofthese criteria, those weaknesses should be acknowledged in the regulatory analysis, including any resulting biases oruncertainties that are likely to result. Ifa study has too many weaknesses withunknown consequences for the quality ofthe data, the study should notbe used.

23The challenge in designing quality stated-preference studies is arguably greater for nonuse values and unfamiliar use values than for familiar goods or services that are traded (directly or indirectly) in market transactions. The good being valued may have little meaning to respondents, and respondents may be forming their valuations for the first time in response to the questions posed. Since these values are effectively constructed by the respondent during the elicitation, the instrument and mode of administration should be rigorously pre-tested to make sure that responses are not simply an artifact of specific features of instrument design and/or mode of administration. Since SPM generate data from respondents in a hypothetical setting, often on complex and unfamiliar goods, special care is demanded in the design and execution of surveys, analysis of the results, and characterization of the uncertainties. A stated-preference study may be the only way to obtain quantitative information about non-use values, though a number based on a poor quality study is not necessarily superior to no number at all. Non-use values that are not quantified should be presented as an "intangible" benefit or cost. If both revealed-preference and stated-preference studies that are directly applicable to regulatory analysis are available, you should consider both kinds of evidence and compare the findings. If the results diverge significantly, you should compare the overall size and quality of the two bodies of evidence. Other things equal, you should prefer revealed preference data over stated preference data because revealed preference data are based on actual decisions, where market participants enjoy or suffer the consequences of their decisions. This is not generally the case for respondents in stated preference surveys, where respondents may not have sufficient incentives to offer thoughtful responses that are more consistent with their preferences or may be inclined to bias their responses for one reason or another.
5. Benefit-Transfer Methods It is often preferable to collect original data on revealed preference or stated preference to support regulatory analysis. Yet conducting an original study may not be feasible due to the time and expense involved. One alternative to conducting an original study is the use of "benefit transfer" methods. (The transfer may involve cost determination as well). The practice of "benefit transfer" began with transferring existing estimates obtained from indirect market and stated preference studies to new contexts (i.e., the context posed by the rulemaking). The principles that guide transferring estimates from indirect market and stated preference studies should apply to direct market studies as well. Although benefit-transfer can provide a quick, low-cost approach for obtaining desired monetary values, the methods are often associated with uncertainties and potential biases of unknown magnitude. It should therefore be treated as a last-resort option and not used without explicit justification. In conducting benefit transfer, the first step is to specify the value to be estimated for the rulemaking. You should identify the relevant measure of the policy change at this initial stage. For instance, you can derive the relevant willingness-to-pay measure by specifying an indirect utility function. This identification allows you to "zero in" on key aspects of the benefit transfer.

24 The challenge in designing quality stated-preference studies is arguably greater for nonuse values and unfamiliaruse values than for familiar goods or services that are traded (directly or indirectly) in market transactions. The good being valued may have little meaning to respondents, and respondents may be forming their valuations for the first time in response to the questions posed. Since these values are effectively constructedby the respondent during the elicitation, the instrument and mode ofadministration should be rigorously pre-tested to make sure that responses are not simply an artifact ofspecific features ofinstrument design and/or mode ofadministration.
Since SPM generate data from respondents in a hypothetical setting, often on complex and unfamiliar goods, special care is demanded in the design and execution ofsurveys, analysis ofthe results, and characterization ofthe uncertainties. A stated-preference study maybe the only way to obtain quantitative information about non-use values, though a number based on a poor quality study is not necessarily superior to no number at all. Non-use values that are not quantified shouldbe presented as an "intangible"benefit or cost. Ifboth revealed-preference and stated-preference studies that are directly applicable to regulatory analysis are available, you should consider both kinds ofevidence and compare the findings. Ifthe results diverge significantly, you should compare the overall size and quality of the two bodies ofevidence. Other things equal, you should preferrevealed preference data over stated preference data because revealed preference data are based on actual decisions, where market participants enjoy or sufferthe consequences oftheir decisions. This is not generally the case for respondents in stated preference surveys, where respondents may not have sufficient incentives to offer thoughtful responses that are more consistent with theirpreferences or maybe inclined to bias their responses for one reason or another.
5. Benefit-TransferMethods
Itis often preferable to collect original data on revealedpreference or stated preference to support regulatory analysis. Yet conducting an original study may notbe feasible due to the time and expense involved. One alternative to conducting an original study is the use of"benefit transfer" methods. (The transfer may involve cost determination as well). The practice of "benefittransfer" began with transferring existing estimates obtained from indirect market and stated preference studies to new contexts (i.e., the contextposedby the rulemaking). The principles that guide transferring estimates from indirect market and stated preference studies should apply to direct market studies as well. Although benefit-transfer canprovide a quick, low-cost approach for obtaining desired monetary values, the methods are often associated with uncertainties and potentialbiases of unknown magnitude. It should therefore be treated as a last-resort option and not used without explicitjustification.
In conducting benefit transfer, the first step is to specify the value to be estimated for the rulemaking. You should identify the relevant measure ofthe policy change at this initial stage. For instance, you can derive the relevant willingness-to-pay measure by specifying an indirect utility function. This identification allows you to "zero in" on key aspects ofthe benefit transfer.

24The next step is to identify appropriate studies to conduct benefit transfer. In selecting

transfer studies for either point transfers or function transfers, you should base your choices on the following criteria: ® The selected studies should be based on adequate data, sound and defensible empirical methods and techniques. o The selected studies should document parameter estimates of the valuation function. o The study context and policy context should have similar populations (e.g., demographic characteristics). The market size (e.g., target population) between the study site and the policy site should be similar. For example, a study valuing water quality improvement in Rhode Island should not be used to value policy that will affect water quality throughout the United States. o The good, and the magnitude of change in that good, should be similar in the study and policy contexts. o The relevant characteristics of the study and the policy contexts should be similar. For example, the effects examined in the original study should be "reversible" or "irreversible" to a degree that is similar to the regulatory actions under consideration. o The distribution of property rights should be similar so that the analysis uses the same welfare measure. If the property rights in the study context support the use of WTA measures while the rights in the rulemaking context support the use of WTP measures, benefit transfer is not appropriate. o The availability of substitutes across study and policy contexts should be similar. If you can choose between transferring a function or a point estimate, you should transfer the entire demand function (referred to as benefit function transfer) rather than adopting a single point estimate (referred to as benefit point transfer).15 Finally, you should not use benefit transfer in estimating benefits if- • resources are unique or have unique attributes. For example, if a policy change affects snowmobile use in Yellowstone National Park, then a study valuing snowmobile use in the state of Michigan should not be used to value changes in snowmobile use in the Yellowstone National Park. o If the study examines a resource that is unique or has unique attributes, you should not transfer benefit estimates or benefit functions to value 'a different resource and vice versa. For example, if a study values visibility improvements at the Grand Canyon, these results should not be used to value visibility improvements in urban areas. o There are significant problems with applying an `ex ante "valuation estimate to an 'ex post "policy context. If a policy yields a significant change in the attributes of the good, you should not use the study estimates to value the change using a benefit transfer approach. o You also should not use a value developed from a study involving, small marginal

15 See Loomis JB (1992), Water Resources Research, 28(3), 701-705 and Kirchoff, S, Colby, BG, and LaFrance, JT (1997), Journal of Environmental Economics and Management, 33, 75-93.

25 The next step is to identify appropriate studies to conductbenefittransfer. In selecting transfer studies for eitherpointtransfers or function transfers, you shouldbase your choices on the following criteria:

o The selected studies shouldbe based on adequate data, sound and defensible empirical methods and techniques.

o The selected studies should documentparameter estimates ofthe valuation function.

o The study context and policy context shouldhave similarpopulations (e.g., demographic characteristics). The market size (e.g., target population) between the study site and the policy site shouldbe similar. For example, a study valuing water quality improvement in Rhode Island should notbe usedto value policy that will affect water quality throughout the United States.

o The good, and the magnitude ofchange in that good, shouldbe similar in the study and policy contexts.

o The relevant characteristics ofthe study and the policy contexts shouldbe similar. For example, the effects examined in the original study shouldbe "reversible" or "irreversible" to a degree that is similar to the regulatory actions under consideration.

o The distribution ofproperty rights shouldbe similar so that the analysis uses the same welfare measure. Ifthe property rights in the study context support the use ofWTA measures while the rights inthe rulemaking context support the use ofWTP measures, benefit transfer is not appropriate.

o The availability ofsubstitutes across study andpolicy contexts shouldbe similar.
Ifyou can choose betweentransferring a function or a point estimate, you shouldtransfer the entire demand function (referred to as benefit function transfer) rather than adopting a single point estimate (referred to as benefitpointtransfer). 15 Finally, you should notuse benefittransfer in estimatingbenefits if:

III resources are unique orhave unique attributes. For example, ifa policy change affects snowmobile use in Yellowstone National Park, then a study valuing snowmobileuse in the state ofMichigan should notbe used to value changes in snowmobile use in the Yellowstone National Park.

III Ifthe study examines a resource that is unique or has unique attributes, you shouldnot transfer benefit estimates orbenefit functions to value a different resource and vice versa. For example, ifa study values visibility improvements atthe Grand Canyon, these results should not be usedto value visibility improvements inurban areas.
o There are significantproblems with applying an 'hante "valuation estimate to an 'h post"policy context. Ifa policy yields a significant change in the attributes ofthe good, you should not use the study estimates to value the change using a benefittransfer approach.

III You also should notuse a value developed from a study involving, small marginal

15 See Loomis JB (1992), Water Resources Research, 28(3),701-705 and Kirchoff, S, Colby, BG, and LaFrance, JT (1997), Journal of EnvironmentalEconomics andManagement, 33, 75-93.

25changes in a policy context involving large changes in the quantity of the good. Clearly, all of these criteria are difficult to meet. However, you should attempt to satisfy as many as possible when choosing studies from the existing economic literature. Professional judgment is required in determining whether a particular transfer is too speculative to use in regulatory analysis. 6. Ancillary Benefits and Countervailing Risks Your analysis should look beyond the direct benefits and direct costs of your rulemaking and consider any important ancillary benefits and countervailing risks. An ancillary benefit is a favorable impact of the rule that is typically unrelated or secondary to the statutory purpose of the rulemaking (e.g., reduced refinery emissions due to more stringent fuel economy standards for light trucks) while a countervailing risk is an adverse economic, health, safety, or environmental consequence that occurs due to a rule and is not already accounted for in the direct cost of the rule (e.g., adverse safety impacts from more stringent fuel-economy standards for light trucks). You should begin by considering and perhaps listing the possible ancillary benefits and countervailing risks. However, highly speculative or minor consequences may not be worth further formal analysis. Analytic priority should be given to those ancillary benefits and countervailing risks that are important enough to potentially change the rank ordering of the main alternatives in the analysis. In some cases the mere consideration of these secondary effects may help in the generation of a superior regulatory alternative with strong ancillary benefits and fewer countervailing risks. For instance, a recent study suggested that weight-based, fuel-economy standards could achieve energy savings with fewer safety risks and employment losses than would occur under the current regulatory structure. Like other benefits and costs, an effort should be made to quantify and monetize ancillary benefits and countervailing risks. If monetization is not feasible, quantification should be attempted through use of informative physical units. If both monetization and quantification are not feasible, then these issues should be presented as non-quantified benefits and costs. The same standards of information and analysis quality that apply to direct benefits and costs should be applied to ancillary benefits and countervailing risks. One way to combine ancillary benefits and countervailing risks is to evaluate these effects separately and then put both of these effects on the benefits side, not on the cost side. Although it is theoretically appropriate to include disbenefits on the cost side, legal and programmatic considerations generally support subtracting the disbenefits from direct benefits. 7. Methods for Treating Non-Monetized Benefits and Costs Sound quantitative estimates of benefits and costs, where feasible, are preferable to qualitative descriptions of benefits and costs because they help decision makers understand the magnitudes of the effects of alternative actions. However, some important benefits and costs (e.g., privacy protection) may be inherently too difficult to quantify or monetize given current

26 changes in a policy context involving large changes in the quantity ofthe good. Clearly, all ofthese criteria are difficult to meet. However, you should attempt to satisfy as many as possible when choosing studies from the existing economic literature. Professional judgment is required in determining whether a particulartransfer is too speculative to use in regulatory analysis.
6. Ancillary Benefits and Countervailing Risks
Your analysis should lookbeyondthe direct benefits and direct costs ofyour rulemaking and consider any important ancillary benefits and countervailing risks. An ancillary benefit is a favorable impact ofthe rule that is typically unrelated or secondary to the statutory purpose of the rulemaking (e.g., reduced refinery emissions due to more stringent fuel economy standards for light trucks) while a countervailing risk is an adverse economic, health, safety, or environmental consequence that occurs due to a rule and is not already accounted for in the direct cost ofthe rule (e.g., adverse safety impacts from more stringent fuel-economy standards for light trucks).
You should begin by considering and perhaps listing the possible ancillary benefits and countervailing risks. However, highly speculative or minor consequences may not be worth further formal analysis. Analytic priority should be given to those ancillary benefits and countervailing risks that are important enough to potentially change the rank ordering ofthe main alternatives in the analysis. In some cases the mere consideration ofthese secondary effects may help in the generation ofa superiorregulatory alternative with strong ancillary benefits and fewer countervailing risks. For instance, a recent study suggested that weight-based, fuel-economy standards could achieve energy savings with fewer safetyrisks and employment losses than would occurunderthe current regulatory structure. Like otherbenefits and costs, an effort should be made to quantify and monetize ancillary benefits and countervailingrisks. Ifmonetization is not feasible, quantification shouldbe attempted through use ofinformative physical units. Ifboth monetization and quantification are not feasible, then these issues should be presented as non-quantified benefits and costs. The same standards ofinformation and analysis quality that apply to directbenefits and costs should be applied to ancillary benefits and countervailing risks.
One way to combine ancillary benefits and countervailing risks is to evaluate these effects separately and thenputboth ofthese effects on the benefits side, not onthe cost side. Although it is theoretically appropriate to include disbenefits onthe cost side, legal and programmatic considerations generally support subtracting the disbenefits from direct benefits.
7. Methods for Treating Non-Monetized Benefits and Costs
Sound quantitative estimates ofbenefits and costs, where feasible, are preferable to qualitative descriptions ofbenefits and costs because they help decision makers understand the magnitudes ofthe effects ofalternative actions. However, some important benefits and costs (e.g., privacyprotection) may be inherently too difficult to quantify ormonetize given current



### 26data and methods. You should carry out a careful evaluation of non-quantified benefits and

costs. Some authorities16 refer to these non-monetized and non-quantified effects as "intangible". a. Benefits and Costs that are Difficult to Monetize You should monetize quantitative estimates whenever possible. Use sound and defensible values or procedures to monetize benefits and costs, and ensure that key analytical assumptions are defensible. If monetization is impossible, explain why and present all available quantitative information. For example, if you can quantify but cannot monetize increases in water quality and fish populations resulting from water quality regulation, you can describe benefits in terms of stream miles of improved water quality for boaters and increases in game fish populations for anglers. You should describe the timing and likelihood of such effects and avoid double-counting of benefits when estimates of monetized and physical effects are mixed in the same analysis. b. Benefits and Costs that are Difficult to Quantify If you are not able to quantify the effects, you should present any relevant quantitative information along with a description of the unquantified effects, such as ecological gains, improvements in quality of life, and aesthetic beauty. You should provide a discussion of the strengths and limitations of the qualitative information. This should include information on the key reason(s) why they cannot be quantified. In one instance, you may know with certainty the magnitude of a risk to which a substantial, but unknown, number of individuals are exposed. In another instance, the existence of a risk may be based on highly speculative assumptions, and the magnitude of the risk may be unknown. For cases in which the unquantified benefits or costs affect a policy choice, you should provide a clear explanation of the rationale behind the choice. Such an explanation could include detailed information on the nature, timing, likelihood, location, and distribution of the unquantified benefits and costs. Also, please include a summary table that lists all the unquantified benefits and costs, and use your professional judgment to highlight (e.g., with categories or rank ordering) those that you believe are most important (e.g., by considering factors such as the degree of certainty, expected magnitude, and reversibility of effects). While the focus is often placed on difficult to quantify benefits of regulatory action, some costs are difficult to quantify as well. Certain permitting requirements (e.g., EPA's New Source Review program) restrict the decisions of production facilities to shift to new products and adopt innovative methods of production. While these programs may impose substantial costs on the economy, it is very difficult to quantify and monetize these effects. Similarly, regulations that establish emission standards for recreational vehicles, like motor bikes, may adversely affect the performance of the vehicles in terms of driveability and 0 to 60 miles per hour acceleration. Again, the cost associated with the loss of these attributes may be difficult to quantify and monetize. They need to be analyzed qualitatively.

16 Mishan EJ (1994), Cost-Benefit Analysis, fourth edition, Routledge, New York.

27 data and methods. You should carry out a careful evaluation ofnon-quantified benefits and costs. Some authorities 16 refer to these non-monetized and non-quantified effects as "intangible"

.

a. Benefits and Costs that are Difficult to Monetize
You should monetize quantitative estimates whenever possible. Use sound and defensible values orprocedures to monetize benefits and costs, and ensure that key analytical assumptions are defensible. Ifmonetization is impossible, explain why and present all available quantitative information. For example, ifyou can quantify but cannot monetize increases in water quality and fish populations resulting from water quality regulation, you can describe benefits in terms ofstream miles ofimproved water quality for boaters and increases in game fish populations for anglers. You should describe the timing and likelihood ofsuch effects and avoid double-counting ofbenefits when estimates ofmonetized and physical effects are mixed in the same analysis.
b. Benefits and Costs that are Difficult to Quantify
Ifyou are not able to quantify the effects, you should present any relevant quantitative information along with a description ofthe unquantified effects, such as ecological gains, improvements in quality oflife, and aesthetic beauty. You should provide a discussion ofthe strengths and limitations ofthe qualitative information. This should include information on the key reason(s) why they cannotbe quantified. In one instance, you may know with certainty the magnitude ofa risk to which a substantial, butunknown, number ofindividuals are exposed. In another instance, the existence ofa riskmaybe based onhighly speculative assumptions, and the magnitude ofthe risk maybe unknown.
For cases in which the unquantifiedbenefits or costs affect a policy choice, you should provide a clear explanation ofthe rationale behind the choice. Such an explanation could include detailed information onthe nature, timing, likelihood, location, and distribution ofthe unquantified benefits and costs. Also, please include a summary table that lists all the unquantified benefits and costs, and use yourprofessionaljudgmentto highlight (e.g., with categories or rank ordering) those that you believe are most important (e.g., by considering factors such as the degree ofcertainty, expected magnitude, and reversibility ofeffects).
While the focus is often placed on difficult to quantify benefits ofregulatory action, some costs are difficult to quantify as well. Certainpermitting requirements (e.g., EPA's New Source Review program) restrict the decisions ofproduction facilities to shift to new products and adopt innovative methods ofproduction. While these programs may impose substantial costs onthe economy, it is very difficult to quantify and monetize these effects. Similarly, regulations that establish emission standards for recreational vehicles, like motor bikes, may adversely affect the performance ofthe vehicles in terms ofdriveability and 0 to 60 miles perhour acceleration. Again, the cost associated with the loss ofthese attributes maybe difficult to quantify and monetize. They need to be analyzed qualitatively.

16 Mishan EJ (1994), Cost-BenefitAnalysis, fourth edition, Routledge, New York.

278. Monetizing Health and Safety Benefits and Costs We expect you to provide a benefit-cost analysis of major health and safety rulemakings in addition to a CEA. The BCA provides additional insight because (a) it provides some indication of what the public is willing to pay for improvements in health and safety and (b) it offers additional information on preferences for health using a different research design than is used in CEA. Since the health-preference methods used to support CEA and BCA have some different strengths and drawbacks, it is important that you provide decision makers with both perspectives. In monetizing health benefits , a WTP measure is the conceptually appropriate measure as compared to other alternatives (e.g., cost of illness or lifetime earnings), in part because it attempts to capture pain and suffering and other quality-of

-life effects

. Using the WTP measure for health and safety allows you to directly compare your results to the other benefits and costs in your analysis, which will typically be based on WTP. If well

-conducted revealed

-preference studies of relevant health and safety risks are available, you should consider using them in developing your monetary estimates. If appropriaterevealed-preference data are not available, you should use valid and relevant data from statedpreference studies. You will need to use your professional judgment when you are faced with limited information on revealed preference studies and substantial information based on stated preference studies. A key advantage of stated

-preference and health-utility methods compared to revealed preference methods is that they can be tailored to address the ranges of probabilities , types of health risks and specific populations affected by your rule. In many rulemakings there will be no relevant information from revealed-preference studies. In this situation you should consider commissioning a stated-preference study or using values from published stated-preference studies. For the reasons discussed previously, you should be cautious about using values from stated

-preference studies and describe in the analysis the drawbacks of this approach. a. Nonfatal Health and Safety Risks With regard to nonfatal health and safety risks , there is enormous diversity in the nature and severity of impaired health states. A traumatic injury that can be treated effectively in the emergency room without hospitalization or long-term care is different from a traumatic injury resulting in paraplegia

. Severity differences are also important in evaluation of chronic diseases. A severe bout of bronchitis, though perhaps less frequent, is far more painful and debilitating than the more frequent bouts of mild bronchitis

. The duration of an impaired health state, which can range from a day or two to several years or even a lifetime (e.g., birth defects inducing mental retardation), need to be considered carefully. Information on both the severity and duration of an impaired health state is necessary before the task of monetization can be performed. When monetizing nonfatal health effects, it is important to consider two components: (1) the private demand for prevention of the nonfatal health effect, to be represented by the

28 8. Monetizing Health and Safety Benefits and Costs
We expect you to provide a benefit-cost analysis ofmajorhealth and safety rulemakings in addition to a CEA. The BCA provides additional insight because (a) it provides some indication ofwhat the public is willing to pay for improvements in health and safety and (b) it offers additional information on preferences for health using a different research design than is used in CEA. Since the health-preference methods used to support CEA and BCA have some different strengths and drawbacks, it is important that youprovide decision makers with both perspectives.
In monetizing health benefits, a WTP measure is the conceptually appropriate measure as compared to other alternatives (e.g., cost ofillness or lifetime earnings), in partbecause it attempts to capture pain and suffering and other quality-of-life effects. Using the WTP measure for health and safety allows you to directly compare yourresults to the otherbenefits and costs in your analysis, which will typically be based on WTP.
Ifwell-conducted revealed-preference studies ofrelevant health and safety risks are available, you should consider using them in developing your monetary estimates. Ifappropriate revealed-preference data are not available, you should use valid and relevant data from statedpreference studies. You will need to use your professionaljudgment when you are faced with limited information on revealed preference studies and substantial informationbased on stated preference studies.
A key advantage ofstated-preference and health-utility methods compared to revealed preference methods is that they canbe tailored to address the ranges of probabilities, types of health risks and specific populations affected by yourrule. In many rulemakings there will be no relevant information from revealed-preference studies. In this situation you should consider commissioning a stated-preference study orusing values from published stated-preference studies. For the reasons discussed previously, you shouldbe cautious about using values from stated-preference studies and describe inthe analysis the drawbacks ofthis approach.

a. Nonfatal Health and Safety Risks
With regard to nonfatal health and safety risks, there is enormous diversity in the nature and severity ofimpaired health states. A traumatic injury that can be treated effectively inthe emergency room without hospitalization or long-term care is different from a traumatic injury resulting in paraplegia. Severity differences are also important in evaluation ofchronic diseases. A severe bout ofbronchitis, though perhaps less frequent, is far more painful and debilitating than the more frequent bouts ofmild bronchitis. The duration ofan impaired health state, which canrange from a day ortwo to several years or even a lifetime (e.g., birth defects inducing mental retardation), need to be considered carefully. Information onboth the severity and duration ofan impaired health state is necessary before the task ofmonetization canbe performed.
Whenmonetizing nonfatal health effects, it is important to consider two components: (1) the private demand for prevention ofthe nonfatal health effect, to be represented by the



### 28preferences of the target population at risk, and (2) the net financial externalities associated with

poor health such as net changes in public medical costs and any net changes in economicproduction that are not experienced by the target population. Revealed-preference or statedpreference studies are necessary to estimate the private demand; health economics data from published sources can typically be used to estimate the financial externalities caused by changes in health status. If you use literature values to monetize nonfatal health and safety risks, it is important to make sure that the values you have selected are appropriate for the severity and duration of health effects to be addressed by your rule. If data are not available to support monetization, you might consider an alternative approach that makes use of health-utility studies. Although the economics literature on the monetary valuation of impaired health states is growing, there is a much larger clinical literature on how patients, providers and community residents value diverse health states. This literature typically measures health utilities based on the standard gamble, the time tradeoff or the rating scale methods. This health utility information may be combined with known monetary values for well-defined health states to estimate monetary 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 assumptions and the limitations of your estimates. b. Fatality Risks Since agencies often design health and safety regulation to reduce risks to life, evaluation of these benefits can be the key part of the analysis. A good analysis must present these benefits clearly and show their importance. Agencies may choose to monetize these benefits. The willingness-to-pay approach is the best methodology to use if reductions in fatality risk are monetized. Some describe the monetized value of small changes in fatality risk as the "value of statistical life" (VSL) or, less precisely, the "value of a life." The latter phrase can be misleading because it suggests erroneously that the monetization exercise tries to place a "value" on individual lives. You should make clear that these terms refer to the measurement of willingness to pay for reductions in only small risks of premature death. They have no application to an identifiable individual or to very large reductions in individual risks. They do not suggest that any individual's life can be expressed in monetary terms. Their sole purpose is to help describe better the likely benefits of a regulatory action. Confusion about the term "statistical life" is also widespread. This term refers to the sum of risk reductions expected in a population. For example, if the annual risk of death is reduced by one in a million for each of two million people, that is said to represent two "statistical lives" extended per year (2 million people x 1/1,000,000 = 2). If the annual risk of death is reduced by one in 10 million for each of 20 million people, that also represents two statistical lives extended. The adoption of a value for the projected reduction in the risk of premature mortality is the subject of continuing discussion within the economic and public policy analysis community. A considerable body of academic literature is available on this subject. This literature involves either explicit or implicit valuation of fatality risks, and generally involves the use of estimates of

29 preferences ofthe target population at risk, and (2) the net financial externalities associated with poorhealth such as net changes in public medical costs and any net changes in economic production that are not experienced by the target population. Revealed-preference or statedpreference studies are necessary to estimate the private demand; health economics data from published sources can typically be used to estimate the financial externalities caused by changes in health status. Ifyou use literature values to monetize nonfatal health and safety risks, it is important to make sure that the values you have selected are appropriate for the severity and duration ofhealth effects to be addressed byyourrule.
Ifdata are not available to support monetization, you might consider an alternative approach that makes use ofhealth-utility studies. Although the economics literature on the monetary valuation ofimpaired health states is growing, there is a much larger clinical literature onhow patients, providers and community residents value diverse health states. This literature typically measures health utilities based on the standard gamble, the time tradeofforthe rating scale methods. This health utility information may be combined with known monetary values for well-defined health states to estimate monetary values for a wide range ofhealth states of different severity and duration. Ifyou use this approach, you should be careful to acknowledge your assumptions and the limitations ofyour estimates.
b. Fatality Risks
Since agencies often design health and safety regulation to reduce risks to life, evaluation ofthese benefits canbe the key part ofthe analysis. A good analysis mustpresent these benefits clearly and show their importance. Agencies may choose to monetize these benefits. The willingness-to-pay approach is the bestmethodology to use ifreductions in fatality risk are monetized.
Some describe the monetized value ofsmall changes in fatality risk as the "value of statistical life" (VSL) or, less precisely, the "value ofa life." The latterphrase canbe misleading because it suggests erroneously that the monetization exercise tries to place a "value" on individual lives. You should make clear that these terms refer to the measurement ofwillingness to pay for reductions in only small risks ofpremature death. They have no application to an identifiable individual orto very large reductions in individual risks. They do not suggest that any individual's life canbe expressed in monetary terms. Their sole purpose is to help describe better the likely benefits ofa regulatory action.
Confusion about the term "statistical life" is also widespread. This term refers to the sum ofrisk reductions expected in a population. For example, ifthe annual risk ofdeath is reduced by one in a million for each oftwo millionpeople, that is said to represent two "statistical lives" extended per year (2 million people x 111,000,000 2). Ifthe annual risk ofdeath is reduced by one in 10 million for each of20 million people, that also represents two statistical lives extended.
The adoption ofa value for the projectedreduction in the risk ofpremature mortality is the subject ofcontinuing discussion within the economic and public policy analysis community. A considerable body ofacademic literature is available on this subject. This literature involves either explicit or implicit valuation offatality risks, and generally involves the use ofestimates of



### 29VSL from studies on wage compensation for occupational hazards (which generally are in the

range of 10-4 annually), on consumer product purchase and use decisions, or from an emerging literature using stated preference approaches. A substantial majority of the resulting estimates of VSL vary from roughly $1 million to $10 million per statistical life." There is a continuing debate within the economic and public policy analysis community on the merits of using a single VSL for all situations versus adjusting the VSL estimates to reflect the specific rule context. A variety of factors have been identified, including whether the 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 Science Advisory Board (SAB) review of this issue was that the available literature does not support adjustments of VSL for most of these factors. The panel did conclude that it was appropriate to adjust VSL to reflect changes in income and any time lag in the occurrence of adverse health effects. The age of the affected population has also been identified as an important factor in the theoretical literature. However, the empirical evidence on age and VSL is mixed. In light of the continuing questions over the effect of age on VSL estimates, you should not use an ageadjustment factor in an analysis using VSL estimates.19 Another way that has been used to express reductions in fatality risks is to use the life expectancy method, the "value of statistical life-years (VSLY) extended." If a regulation protects individuals whose average remaining life expectancy is 40 years, a risk reduction of one fatality is expressed as "40 life-years extended." Those who favor this alternative approach emphasize that the value of a statistical life is not a single number relevant for all situations. In particular, when there are significant differences between the effect on life expectancy for the population affected by a particular health risk and the populations studied in the labor market studies, they prefer to adopt a VSLY approach to reflect those differences. You should consider providing estimates of both VSL and VSLY, while recognizing the developing state of knowledge in this area. Longevity may be only one of a number of relevant considerations pertaining to the rule. You should keep in mind that regulations with greater numbers of life-years extended are not necessarily better than regulations with fewer numbers of life-years extended. In any event, when you present estimates based on the VSLY method, you should adopt a larger VSLY estimate for senior citizens because senior citizens face larger overall health risks from all causes and they may have accumulated savings to spend on their health and safety.20 The valuation of fatality risk reduction is an evolving area in both results and methodology. Hence, you should utilize valuation methods that you consider appropriate for the

17 See Viscusi WK and Aldy JE, Journal of Risk and Uncertainty (forthcoming) and Mrozek JR and Taylor LO (2002), Journal of Policy Analysis and Management, 21(2), 253-270. 18 Distinctions between "voluntary" and "involuntary" should be treated with care. Risks are best considered to fall within a continuum from "voluntary" to "involuntary" with very few risks at either end of this range. These terms are also related to differences in the cost of avoiding risks. 19 Graham JD (2003), Memorandum to the President's Management Council, Benefit-Cost Methods and Lifesaving Rules. This memorandum can be found at http://www_whitehouse.gov/omb/inforeg/pmc benefit cost memo.pdf 20 Office of Information and Regulatory Affairs, OMB, Memorandum to the President's Management Council, ibid.

30 VSL from studies on wage compensation for occupationalhazards (which generally are in the range of 10-4 annually), on consumerproductpurchase and use decisions, or from an emerging literature using stated preference approaches. A substantial majority ofthe resulting estimates of VSL vary from roughly $1 million to $10 million per statisticallife. 17
There is a continuing debate within the economic and public policy analysis community on the merits ofusing a single VSL for all situations versus adjusting the VSL estimates to reflect the specific rule context. A variety offactors have been identified, including whether the mortality risk involves sudden death, the fear ofcancer, and the extent to which the risk is voluntarily incurred. 18 The consensus ofEPA's recent Science Advisory Board (SAB) review of this issue was that the available literature does not support adjustments ofVSL for most ofthese factors. Thepanel did conclude that it was appropriate to adjust VSL to reflect changes in income and any time lag in the occurrence ofadverse health effects.
The age ofthe affected populationhas also beenidentified as an important factor in the theoretical literature. However, the empirical evidence on age and VSL is mixed. In light ofthe continuing questions overthe effect ofage onVSL estimates, you should not use an ageadjustment factor in an analysis using VSL estimates. 19
Another way thathas been used to express reductions in fatality risks is to use the life expectancy method, the "value ofstatistical life-years (VSLY) extended." Ifa regulation protects individuals whose average remaining life expectancy is 40 years, a risk reduction ofone fatality is expressed as "40 life-years extended." Those who favor this alternative approach emphasize that the value ofa statistical life is not a single numberrelevant for all situations. Inparticular, when there are significant differences betweenthe effect on life expectancy for the population affected by a particularhealth risk and the populations studied in the labor market studies, they preferto adopt a VSL Y approach to reflect those differences. You should considerproviding estimates ofboth VSL and VSLY, while recognizing the developing state ofknowledge in this area. Longevity may be only one ofa number ofrelevant considerations pertaining to the rule. You should keep in mindthat regulations with greater numbers oflife-years extended are not necessarily betterthanregulations with fewer numbers oflife-years extended. In any event, whenyoupresent estimates based on the VSLY method, you should adopt a largerVSL Y estimate for senior citizens because senior citizens face larger overall healthrisks from all causes and they mayhave accumulated savings to spend on their health and safety?O
The valuation offatality risk reduction is an evolving area inboth results and methodology. Hence, you should utilize valuation methods that you consider appropriate for the

17 See Viscusi WK and Aldy JE, Journal of Riskand Uncertainty (forthcoming) and Mrozek JR and Taylor LO (2002), Journal of PolicyAnalysis andManagement, 21(2), 253-270. 18 Distinctions between "voluntary" and "involuntary" shouldbe treated with care. Risks are best considered to fall within a continuum from "voluntary" to "involuntary" with very few risks at either end ofthis range. These terms are also related to differences in the cost ofavoiding risks. 19 Graham JD (2003), Memorandum to the President's Management Council, Benefit-CostMethods and Lifesaving Rules. This memorandum canbe found at http://www.whitehouse.gov/omblinforegipmc benefit cost memo.pdf 20 Office ofInformation and Regulatory Affairs, OMB, Memorandum to the President's Management Council, ibid.

30regulatory circumstances. Since the literature-based VSL estimates may not be entirely

appropriate for the risk being evaluated (e.g., the use of occupational risk premia to value reductions in risks from environmental hazards), you should explain your selection of estimates and any adjustments of the estimates to reflect the nature of the risk being evaluated. You should present estimates based on alternative approaches, and if you monetize mortality risk reduction, you should do so on a consistent basis to the extent feasible. You should clearly indicate the methodology used and document your choice of a particular methodology. You should explain any significant deviations from the prevailing state of knowledge. If you use different methodologies in different rules, you should clearly disclose the fact and explain your choices. c. Valuation of Reductions in Health and Safety Risks to Children The valuation of health outcomes for children and infants poses special challenges. It is rarely feasible to measure a child's willingness to pay for health improvement and an adult's concern for his or her own health is not necessarily relevant to valuation of child health. For example, the wage premiums demanded by workers to accept hazardous jobs are not readily transferred to rules that accomplish health gains for children. There are a few studies that examine parental willingness to pay to invest in health and safety for their children. Some of these studies suggest that parents may value children's health more strongly than their own health. Although this parental perspective is a promising research strategy, it may need to be expanded to include a societal interest in child health and safety. Where the primary objective of a rule is to reduce the risk of injury, disease or mortality among children, you should conduct a cost-effectiveness analysis of the rule. You may also develop a benefit-cost analysis to the extent that valid monetary values can be assigned to the primary expected health outcomes. For rules where health gains are expected among both children and adults and you decide to perform a benefit-cost analysis, the monetary values for children should be at least as large as the values for adults (for the same probabilities and outcomes) unless there is specific and compelling evidence to suggest otherwise.21
Discount Rates Benefits and costs do not always take place in the same time period. When they do not, it is incorrect simply to add all of the expected net benefits or costs without taking account of when the actually occur. If benefits or costs are delayed or otherwise separated in time from each other, the difference in timing should be reflected in your analysis. As a first step, you should present the annual time stream of benefits and costs expected to result from the rule, clearly identifying when the benefits and costs are expected to occur. The beginning point for your stream of estimates should be the year in which the final rule will begin to have effects, even if that is expected to be some time in the future. The ending point should be far enough in the future to encompass all the significant benefits and costs likely to result from the rule.
21 For more information, see Dockins C., Jenkins RR, Owens N, Simon NB, and Wiggins LB (2002), Risk Analysis, 22(2), 335-346.

31 regulatory circumstances. Since the literature-based VSL estimates may not be entirely appropriate for the riskbeing evaluated (e.g., the use ofoccupational risk premia to value reductions inrisks from environmental hazards), you should explain your selection ofestimates and any adjustments ofthe estimates to reflect the nature ofthe riskbeing evaluated. You should present estimates based on alternative approaches, and ifyou monetize mortality risk reduction, you should do so on a consistentbasis to the extent feasible. You should clearly indicate the methodology used and document your choice ofa particular methodology. You should explain any significant deviations from the prevailing state ofknowledge. Ifyouuse different methodologies in different rules, you should clearly disclose the fact and explain your choices.

c. Valuation ofReductions in Health and Safety Risks to Children The valuation ofhealth outcomes for children and infants poses special challenges. Itis rarely feasible to measure a child's willingness to pay for health improvement and an adult's concern for his orher ownhealth is not necessarily relevant to valuation ofchild health. For example, the wage premiums demanded by workers to accept hazardousjobs are not readily transferred to rules that accomplish health gains for children.
There are a few studies that examine parental willingness to pay to invest in health and safety for their children. Some ofthese studies suggestthatparents may value children's health more strongly than their ownhealth. Although this parentalperspective is a promisingresearch strategy, it may need to be expanded to include a societal interest in child health and safety.
Where the primary objective ofa rule is to reduce the risk ofinjury, disease or mortality among children, you should conduct a cost-effectiveness analysis ofthe rule. You may also develop a benefit-cost analysis to the extentthat valid monetary values canbe assigned to the primary expected health outcomes. Forrules where health gains are expected among both children and adults and you decide to perform a benefit-cost analysis, the monetary values for children shouldbe at least as large as the values for adults (for the same probabilities and outcomes) unless there is specific and compelling evidence to suggest otherwise. 21


### DiscountRates
Benefits and costs do not always take place in the same time period. Whenthey do not, it is incorrect simply to add all ofthe expected net benefits or costs without taking account ofwhen the actually occur. Ifbenefits or costs are delayed or otherwise separated in time from each other, the difference in timing shouldbe reflected in your analysis.
As a first step, you should presentthe annual time stream ofbenefits and costs expected to result from the rule, clearly identifying when the benefits and costs are expected to occur. The beginning point for your stream ofestimates shouldbe the year in which the final rule will begin to have effects, even ifthat is expected to be some time in the future. The ending point shouldbe far enough in the future to encompass all the significantbenefits and costs likely to result from the rule.

21 For more information, see Dockins C., Jenkins RR, Owens N, Simon NB, and Wiggins LB (2002), RiskAnalysis, 22(2),335-346.

31In presenting the stream of benefits and costs, it is important to measure them in constant

dollars to avoid the misleading effects of inflation in your estimates. If the benefits and costs are initially measured in prices reflecting expected future inflation, you can convert them to constant dollars by dividing through by an appropriate inflation index, one that corresponds to the inflation rate underlying the initial estimates of benefits or costs. 1. The Rationale for Discounting Once these preliminaries are out of the way, you can begin to adjust your estimates for differences in timing. (This is a separate calculation from the adjustment needed to remove the effects of future inflation.) Benefits or costs that occur sooner are generally more valuable. The main rationales for the discounting of future impacts are: (a) Resources that are invested will normally earn a positive return, so current consumption is more expensive than future consumption, since you are giving up that expected return on investment when you consume today. (b) Postponed benefits also have a cost because people generally prefer present to future consumption. They are said to have positive time preference. (c) Also, if consumption continues to increase over time, as it has for most of U.S. history, an increment of consumption will be less valuable in the future than it would be today, because the principle of diminishing marginal utility implies that as total consumption increases, the value of a marginal unit of consumption tends to decline. There is wide agreement with point (a). Capital investment is productive, but that point is not sufficient by itself to explain positive interest rates and observed saving behavior. To understand these phenomena, points (b) and (c) are also necessary. If people are really indifferent between consumption now and later, then they should be willing to forgo current consumption in order to consume an equal or slightly greater amount in the future. That would cause saving rates and investment to rise until interest rates were driven to zero and capital was no longer productive. As long as we observe positive interest rates and saving rates below 100 percent, people must be placing a higher value on current consumption than on future consumption. To reflect this preference, a discount factor should be used to adjust the estimated benefits and costs for differences in timing. The further in the future the benefits and costs are expected to occur, the more they should be discounted. The discount factor can be calculated given a discount rate. The formula is 1/ (1+ the discount rate)` where "t" measures the number of years in the future that the benefits or costs are expected to occur. Benefits or costs that have been adjusted in this way are called "discounted present values" or simply "present values". When, and only when, the estimated benefits and costs have been discounted, they can be added to determine the overall value of net benefits.

32 Inpresenting the stream ofbenefits and costs, it is important to measure them in constant dollars to avoid the misleading effects ofinflation in your estimates. Ifthe benefits and costs are initially measured in prices reflecting expected future inflation, you can convert themto constant dollars by dividing through by an appropriate inflation index, one that corresponds to the inflation rate underlying the initial estimates ofbenefits or costs.
1. The Rationale for Discounting
Once these preliminaries are out ofthe way, you canbegin to adjust your estimates for differences in timing. (This is a separate calculation from the adjustment needed to remove the effects offuture inflation.) Benefits or costs that occur sooner are generally more valuable. The mainrationales for the discounting offuture impacts are: (a) Resources that are invested will normally earn a positive return, so current consumption is more expensive than future consumption, since you are giving up that expectedreturn on investment when you consume today. (b) Postponed benefits also have a costbecause people generally preferpresent to future consumption. They are said to havepositive timepreference. (c) Also, ifconsumption continues to increase over time, as ithas for most of

## u.s. history, an increment ofconsumption will be less valuable inthe future than it wouldbe today, because the principle ofdiminishing marginal utility implies that as total consumption increases, the value ofa marginal unit ofconsumptiontends to decline.
There is wide agreementwith point (a). Capital investment is productive, but thatpoint is not sufficientby itselfto explainpositive interest rates and observed saving behavior. To understand these phenomena, points (b) and (c) are also necessary. Ifpeople are really indifferentbetween consumptionnow and later, then they shouldbe willing to forgo current consumption in orderto consume an equal or slightly greater amount in the future. Thatwould cause saving rates and investmentto rise until interest rates were driven to zero and capital was no longerproductive. As long as we observe positive interestrates and saving rates below 100 percent, people mustbe placing a higher value on current consumptionthan on future consumption.
To reflect this preference, a discount factor shouldbe used to adjust the estimated benefits and costs for differences in timing. The further in the future the benefits and costs are expected to occur, the more they shouldbe discounted. The discount factor canbe calculated given a discount rate. The formula is 11 (1

### +the discount rate

## Y where "t" measures the number of years in the future that the benefits or costs are expectedto occur. Benefits or costs that have been adjusted inthis way are called "discounted present values" or simply "present values". When, and only when, the estimated benefits and costs havebeen discounted, they canbe added to determine the overall value ofnet 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 (httpJ/www.whitehouse.gov/omb/circulars/index.html). This Circular points out that the analytically preferred method of handling temporal differences between benefits and costs is to adjust all the benefits and costs to reflect their value in equivalent units of consumption and to discount them at the rate consumers and savers would normally use in discounting future consumption benefits. This is sometimes called the "shadow price" approach to discounting because doing such calculations requires you to value benefits and costs using shadow prices, especially for capital goods, to correct for market distortions. These shadow prices are not well established for the United States. Furthermore, the distribution of impacts from regulations on capital and consumption are not always well known. Consequently, any agency that wishes to tackle this challenging analytical task should check with OMB before proceeding. As a default position, OMB Circular A-94 states that a real discount rate of 7 percent should be used as a base-case for regulatory analysis. The 7 percent rate is an estimate of the average before-tax rate of return to private capital in the U.S. economy. It is a broad measure that reflects the returns to real estate and small business capital as well as corporate capital. It approximates the opportunity cost of capital, and it is the appropriate discount rate whenever the main effect of a regulation is to displace or alter the use of capital in the private sector. OMB revised Circular A-94 in 1992 after extensive internal review and public comment. In a recent analysis, OMB found that the average rate of return to capital remains near the 7 percent rate estimated in 1992. Circular A-94 also recommends using other discount rates to show the sensitivity of the estimates to the discount rate assumption. Economic distortions, including taxes on capital, create a divergence between the rate of return that savers earn and the private rate of return to capital. This divergence persists despite the tendency for capital to flow to where it can earn the highest rate of return. Although market forces will push after-tax rates of return in different sectors of the economy toward equality, that process will not equate pre-tax rates of return when there are differences in the tax treatment of investment. Corporate capital, in particular, pays an additional layer of taxation, the corporate income tax, which requires it to earn a higher pre-tax rate of return in order to provide investors with similar after-tax rates of return compared with non-corporate investments. The pre-tax rates of return better measure society's gains from investment. Since the rates of return on capital are higher in some sectors of the economy than others, the government needs to be sensitive to possible impacts of regulatory policy on capital allocation. The effects of regulation do not always fall exclusively or primarily on the allocation of capital. When regulation primarily and directly affects private consumption (e.g., through higher consumer prices for goods and services), a lower discount rate is appropriate. The alternative most often used is sometimes called the "social rate of time preference." This simply means the rate at which "society" discounts future consumption flows to their present value. If we take the rate that the average saver uses to discount future consumption as our measure of the social rate of time preference, then the real rate of return on long-term government debt may provide a fair approximation. Over the last thirty years, this rate has averaged around 3 percent in real terms on a pre-tax basis. For example, the yield on 10-year Treasury notes has averaged 8.1 percent since

33 2. Real Discount Rates of3 Percent and 7 Percent
OMB'sbasic guidance onthe discount rate is provided in OMB CircularA-94 (http://www.whitehousc.gov/omb/circulars/indcx.html).This Circularpoints out that the analytically preferred method ofhandling temporal differences between benefits and costs is to adjust all the benefits and costs to reflect their value in equivalent units ofconsumption and to discount them at the rate consumers and savers would normally use in discounting future consumptionbenefits. This is sometimes called the "shadowprice" approach to discounting because doing such calculations requires you to value benefits and costs using shadow prices, especially for capital goods, to correct for market distortions. These shadow prices are not well established for the United States. Furthermore, the distribution ofimpacts from regulations on capital and consumption are not always well known. Consequently, any agency that wishes to tackle this challenging analytical task should check with OMB before proceeding.
As a default position, OMB Circular A-94 states that a real discount rate of7percent shouldbe used as a base-case for regulatory analysis. The 7 percent rate is an estimate ofthe average before-tax rate ofreturn to private capital in the U.S. economy. Itis a broad measure that reflects the returns to real estate and small business capital as well as corporate capital. It approximates the opportunity cost ofcapital, and it is the appropriate discount rate whenever the main effect ofa regulation is to displace or alter the use ofcapital in the private sector. OMB revised Circular A-94 in 1992 after extensive internal review and public comment. In a recent analysis, OMB found that the average rate ofreturn to capital remains near the 7 percentrate estimated in 1992. Circular A-94 also recommends using other discount rates to show the sensitivity ofthe estimates to the discount rate assumption.
Economic distortions, including taxes on capital, create a divergence between the rate of return that savers earn and the private rate ofreturn to capital. This divergence persists despite the tendency for capital to flow to where it can earn the highest rate ofreturn. Although market forces will push after-tax rates ofretumin different sectors ofthe economy toward equality, that process will not equate pre-tax rates ofreturn when there are differences in the tax treatment of investment. Corporate capital, inparticular, pays an additional layer oftaxation, the corporate income tax, which requires it to earn a higher pre-tax rate ofreturn in order to provide investors with similar after-tax rates ofreturn compared with non-corporate investments. The pre-tax rates ofreturn better measure society's gains from investment. Since the rates ofreturn on capital are higher in some sectors ofthe economy than others, the governmentneeds to be sensitive to possible impacts ofregulatory policy on capital allocation.
The effects ofregulation do not always fall exclusively orprimarily on the allocation of capital. When regulation primarily and directly affects private consumption (e.g., through higher consumer prices for goods and services), a lower discount rate is appropriate. The alternative most oftenused is sometimes called the "social rate oftime preference." This simply means the rate at which "society" discounts future consumption flows to theirpresent value. Ifwe take the rate that the average saveruses to discount future consumption as our measure ofthe social rate oftime preference, then the real rate ofreturn on long-term government debt may provide a fair approximation. Overthe last thirty years, this rate has averaged around 3 percent in real terms on a pre-taxbasis. For example, the yield on lO-year Treasury notes has averaged 8.1 percent since

331973 while the average annual rate of change in the CPI over this period has been 5.0 percent,

implying a real 10-year rate of 3.1 percent. For regulatory analysis, you should provide estimates of net benefits using both 3 percent and 7 percent. An example of this approach is EPA's analysis of its 1998 rule setting both effluent limits for wastewater discharges and air toxic emission limits for pulp and paper mills. In this analysis, EPA developed its present-value estimates using real discount rates of 3 and 7 percent applied to benefit and cost streams that extended forward for 30 years. You should present a similar analysis in your own work. In some instances, if there is reason to expect that the regulation will cause resources to be reallocated away from private investment in the corporate sector, then the opportunity cost may lie outside the range of 3 to 7 percent. For example, the average real rate of return on corporate capital in the United States was approximately 10 percent in the 1990s, returning to the same 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 estimates using a higher discount rate as a further sensitivity analysis as well as using the 3 and 7 percent rates. 3. Time Preference for Health-Related Benefits and Costs When future benefits or costs are health-related, some have questioned whether discounting is appropriate, since the rationale for discounting money may not appear to apply to health. It is true that lives saved today cannot be invested in a bank to save more lives in the future. But the resources that would have been used to save those lives can be invested to earn a higher payoff in future lives saved. People have been observed to prefer health gains that occur immediately to identical health gains that occur in the future. Also, if future health gains are not discounted while future costs are, then the following perverse result occurs: an attractive investment today in future health improvement can always be made more attractive by delaying the investment. For such reasons, there is a professional consensus that future health effects, including both benefits and costs, should be discounted at the same rate. This consensus applies to both BCA and CEA. A common challenge in health-related analysis is to quantify the time lag between when a rule takes effect and when the resulting physical improvements in health status will be observed in the target population. In such situations, you must carefully consider the timing of health benefits before performing present-value calculations. It is not reasonable to assume that all of the benefits of reducing chronic diseases such as cancer and cardiovascular disease will occur immediately when the rule takes effect. For rules addressing traumatic injury, this lag period may be short. For chronic diseases it may take years or even decades for a rule to induce its full beneficial effects in the target population. When a delay period between exposure to a toxin and increased probability of disease is likely (a so-called latency period), a lag between exposure reduction and reduced probability of disease is also likely. This latter period has sometimes been referred to as a "cessation lag," and it may or may not be of the same duration as the latency period. As a general matter, cessation lags will only apply to populations with at least some high-level exposure (e.g., before the rule

34 1973 while the average annual rate ofchange in the CPI over this period has been 5.0 percent, implying a real 1 O-yearrate of3.1 percent.
Forregulatory analysis, you should provide estimates ofnet benefits using both 3 percent and 7 percent. An example ofthis approach is EPA's analysis ofits 1998 rule setting both effluent limits for wastewater discharges and air toxic emission limits for pulp and papermills. In this analysis, EPA developed its present-value estimates using real discount rates of3 and 7 percent applied to benefit and cost streams that extended forward for 30 years. You should present a similar analysis in your own work.
In some instances, ifthere is reason to expect thatthe regulation will cause resources to be reallocated away from private investment in the corporate sector, then the opportunity cost may lie outside the range of3 to 7 percent. For example, the average real rate ofreturn on corporate capital in the United States was approximately 10 percent inthe 1990s, returning to the same level observed in the 1950s and 1960s. Ifyou are uncertain about the nature ofthe opportunity cost, then you shouldpresentbenefit and cost estimates using a higher discount rate as a further sensitivity analysis as well as using the 3 and 7 percentrates. 3. Time Preference for Health-Related Benefits and Costs
When future benefits or costs are health-related, some have questioned whether discounting is appropriate, since the rationale for discounting money may not appear to apply to health. Itis true that lives saved today cannot be invested in a bank to save more lives in the future. Butthe resources that would have been used to save those lives canbe invested to earn a higher payoffin future lives saved. People have been observed to preferhealth gains that occur immediately to identical health gains that occur in the future. Also, iffuture health gains are not discounted while future costs are, then the following perverse result occurs: an attractive investment today in future health improvement can always be made more attractive by delaying the investment. For such reasons, there is a professional consensus that future health effects, including bothbenefits and costs, shouldbe discounted at the same rate. This consensus applies to both BCA and CEA.
A common challenge inhealth-related analysis is to quantify the time lag between when a rule takes effect and whenthe resulting physical improvements in health status will be observed in the targetpopulation. In such situations, you must carefully consider the timing ofhealth benefits before performing present-value calculations. Itis not reasonable to assume that all of the benefits ofreducing chronic diseases such as cancer and cardiovascular disease will occur immediately when the rule takes effect. Forrules addressing traumatic injury, this lag period may be short. For chronic diseases it may take years or even decades for a rule to induce its full beneficial effects in the target population.
When a delay periodbetween exposure to a toxin and increased probability ofdisease is likely (a so-called latency period), a lag between exposure reduction and reduced probability of disease is also likely. This latter periodhas sometimes been referred to as a "cessation lag," and it mayormay not be ofthe same duration as the latency period. As a general matter, cessation lags will only apply to populations with at least some high-level 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 model would allow calculation of reduced risk for each year following exposure cessation, accounting for total cumulative exposure and age at the time of exposure reduction

. The present

-value benefits estimate could then reflect an appropriate discount factor for each year's risk reduction

. Recent analyses of the cancer benefits stemming from reduction in public exposure to radon in drinking water have adopted this approach. They were supported by formal risk

-assessment models that allowed estimates of the timing of lung cancer incidence and mortality to vary in response to different radon exposure levels.22 In many cases , you will not have the benefit of such detailed risk assessment modeling. You will need to use your professional judgment as to the average cessation lag for the chronic diseases affected by your rule. In situations where information exists on latency but not on cessation lags, it may be reasonable to use latency as a proxy for the cessation lag, unless there is reason to believe that the two are different. When the average lag time between exposures and disease is unknown, a range of plausible alternative values for the time lag should be used in your analysis. 4. Intergenerational Discounting Special ethical considerations arise when comparing benefits and costs across generations

. Although most people demonstrate time preference in their own consumption behavior, it may not be appropriate for society to demonstrate a similar preference when deciding between the well-being of current and future generations

. Future citizens who are affected by such choices cannot take part in making them, and today's society must act with some consideration of their interest. One way to do this would be to follow the same discounting techniques described above and supplement the analysis with an explicit discussion of the intergenerational concerns (how future generations will be affected by the regulatory decision). Policymakers would be provided with this additional information without changing the general approach to discounting.Using the same discount rate across generations has the advantage of preventing timeinconsistency problems. For example, if one uses a lower discount rate for future generations, then the evaluation of a rule that has short-term costs and long-term benefits would become more favorable merely by waiting a year to do the analysis. Further, using the same discount rate across generations is attractive from 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 tomorrow. Some believe, however, that it is ethically impermissible to discount the utility of future generations

. That is, government should treat all generations equally. Even under this approach,
22 Committee on Risk Assessment of Exposure to Radon in Drinking Water , Board on Radiation Effects Research, Commission on Life Sciences (1996), Risk Assessment ofRadon in Drinking Water, National Research Council, National Academy Press, Washington, DC.

35 takes effect). Forpopulations 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 model would allow calculation ofreduced risk for each year following exposure cessation, accounting for total cumulative exposure and age at the time of exposure reduction. The present-value benefits estimate could then reflect an appropriate discount factor for eachyear's risk reduction. Recent analyses ofthe cancerbenefits stemming from reduction inpublic exposure to radon in drinking waterhave adopted this approach. They were supported by formal risk-assessment models that allowed estimates ofthe timing oflung cancer incidence and mortality to vary in response to different radon exposure levels. 22
In many cases, you will nothave the benefit ofsuch detailedrisk assessment modeling. You will need to use yourprofessionaljudgment as to the average cessation lag for the chronic diseases affected byyourrule. In situations where information exists on latency butnot on cessation lags, it may bereasonable to use latency as a proxy for the cessation lag, unless there is reason to believe that the two are different. When the average lag time between exposures and disease is unknown, a range ofplausible alternative values for the time lag shouldbe used in your analysis.
4. Intergenerational Discounting Special ethical considerations arise when comparingbenefits and costs across generations. Although mostpeople demonstrate time preference intheir own consumption behavior, it may notbe appropriate for society to demonstrate a similarpreference when deciding between the well-being ofcurrent and future generations. Future citizens who are affectedby such choices cannot take part in making them, and today's society must act with some consideration oftheir interest.
One way to do this would be to follow the same discounting techniques described above and supplementthe analysis with an explicit discussion ofthe intergenerational concerns (how future generations will be affected by the regulatory decision). Policymakers wouldbe provided with this additional information without changing the general approach to discounting. Using the same discount rate across generations has the advantage ofpreventing timeinconsistency problems. For example, ifone uses a lower discount rate for future generations, then the evaluation ofa rule that has short-term costs and long-termbenefits wouldbecome more favorable merely by waiting a year to do the analysis. Further, using the same discount rate across generations is attractive from an ethical standpoint. Ifone expects future generations to bebetter off, then giving them the advantage ofa lower discount rate would in effect transfer resources from poorerpeople today to richer people tomorrow.
Some believe, however, that it is ethically impermissible to discount the utility offuture generations. That is, government shouldtreat all generations equally. Evenunder this approach,

22 Committee on Risk Assessment ofExposure to Radon in Drinking Water, Board on Radiation Effects Research, Commission on Life Sciences (1996), RiskAssessment of Radon in Drinking Water, National Research Council, National Academy Press, Washington, DC.

35it would still be correct to discount future costs and consumption benefits generally (perhaps at a

lower rate than for intragenerational analysis), due to the expectation that future generations will be wealthier and thus will value a marginal dollar of benefits or costs by less than those alive today. Therefore, it is appropriate to discount future benefits and costs relative to current benefits and costs, even if the welfare of future generations is not being discounted. Estimates of the appropriate discount rate appropriate in this case, from the 1990s, ranged from 1 to 3 percent per annum.23 A second reason for discounting the benefits and costs accruing to future generations at a lower rate is increased uncertainty about the appropriate value of the discount rate, the longer the horizon for the analysis. Private market rates provide a reliable reference for determining how society values time within a generation, but for extremely long time periods no comparable private rates exist. As explained by Martin Weitzman24, in the limit for the deep future, the properly averaged certainty-equivalent discount factor (i.e., 1/[l+r]t) corresponds to the minimum discount rate having any substantial positive probability. From today's perspective, the only relevant limiting scenario is the one with the lowest discount rate - all of the other states at the far-distant time are relatively much less important because their expected present value is so severely reduced by the power of compounding at a higher rate. If your rule will have important intergenerational benefits or costs you might consider a further sensitivity analysis using a lower but positive discount rate in addition to calculating net benefits using discount rates of 3 and 7 percent.
5. Time Preference for Non-Monetized Benefits and Costs Differences in timing should be considered even for benefits and costs that are not expressed in monetary units, including health benefits. The timing differences can be handled through discounting. EPA estimated cost-effectiveness in its 1998 rule, "Control of Emissions from Nonroad Diesel Engines," by discounting both the monetary costs and the non-monetized emission reduction benefits over the expected useful life of the engines at the 7 percent real rate recommended in OMB Circular A-94. Alternatively, it may be possible in some cases to avoid discounting non-monetized benefits. If the expected flow of benefits begins as soon as the cost is incurred and is expected to be constant over time, then annualizing the cost stream is sufficient, and further discounting of benefits is unnecessary. Such an analysis might produce an estimate of the annualized cost per ton of reduced emissions 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 Portney PR and Weyant JP, eds. (1999), Discounting and Intergenerational Equity, Resources for the Future, Washington, DC. 24 Weitzman ML In Portney PR and Weyant JP, eds. (1999), Discounting and Intergenerational Equity, Resources for the Future, Washington, DC.

36 it would still be correct to discount future costs and consumptionbenefits generally (perhaps at a lowerrate than for intragenerational analysis), due to the expectation that future generations will be wealthier and thus will value a marginal dollar ofbenefits or costs by less than those alive today. Therefore, it is appropriate to discount future benefits and costs relative to current benefits and costs, even ifthe welfare offuture generations is not being discounted. Estimates of the appropriate discount rate appropriate in this case, from the 1990s, ranged from 1to 3 percent per annum.23
A second reason for discounting the benefits and costs accruing to future generations at a lowerrate is increased uncertainty about the appropriate value ofthe discount rate, the longer the horizon for the analysis. Private market rates provide a reliable reference for determining how society values time within a generation, but for extremely long time periods no comparable private rates exist. As explained by Martin Weitzman24

, in the limit for the deep future, the properly averaged certainty-equivalent discount factor (i.e., 1/[1+r]t) corresponds to the minimum discount rate having any substantial positive probability. Fromtoday's perspective, the onlyrelevant limiting scenario is the one with the lowest discount rate

- all ofthe other states at the far-distant time are relatively much less important because their expected present value is so severely reduced by the power ofcompounding at a higher rate. Ifyour rule will have important intergenerational benefits or costs you might consider a further sensitivity analysis using a lowerbutpositive discount rate in addition to calculating net benefits using discount rates of3 and 7 percent. 5. Time Preference for Non-Monetized Benefits and Costs
Differences in timing should be considered even for benefits and costs that are not expressed in monetary units, including health benefits. The timing differences canbe handled through discounting. EPA estimated cost-effectiveness in its 1998 rule, "Control ofEmissions from Nonroad Diesel Engines," by discounting both the monetary costs and the non-monetized emission reduction benefits overthe expected useful life ofthe engines at the 7 percentreal rate recommended in OMB Circular A-94. Alternatively, it may be possible in some cases to avoid discounting non-monetized benefits. Ifthe expected flow ofbenefits begins as soon as the cost is incurred and is expected to be constant over time, then annualizing the cost stream is sufficient, and further discounting of benefits is unnecessary. Such an analysis might produce an estimate ofthe annualized cost per ton ofreduced emissions ofa pollutant.
6. The Internal Rate ofReturn
The internal rate ofreturn is the discount rate that sets the net present value ofthe discounted benefits and costs equal to zero. The internal rate ofreturn does not generally

23 Portney PR and Weyant JP, eds. (1999), DiscountingandIntergenerational Equity, Resources for the Future, Washington, DC.
24 Weitzman ML In Portney PRand Weyant JP, eds. (1999), Discounting andIntergenerationalEquity, Resources for the Future, Washington, DC.


### 36provide an acceptable decision criterion, and regulations with the highest internal rate of return

are not necessarily the most beneficial

. Nevertheless, it does provide useful information and for many it will offer a meaningful indication of regulation's impact. You should consider including the internal rate of return implied by your regulatory analysis along with other information about discounted net present values. Other Key Considerations
1. Other Benefit and Cost Considerations You should include these effects in your analysis and provide estimates of their monetary values when they are significant:
® Private

-sector compliance costs and savings; ® Government administrative costs and savings; ® Gains or losses in consumers' or producers' surpluses; ® Discomfort or inconvenience costs and benefits; and

• Gains or losses of time in work, leisure and/or commuting/travel settings. Estimates of benefits and costs should be based on credible changes in technology over time. For example, retrospective studies may provide evidence that "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 "learning curve" effects) should depend on both its timeliness and direct relevance to the processes affected by the regulatory alternative under consideration

. In addition, you should take into account cost-saving innovations that result from a shift to regulatory performance standards and incentive-based policies. On the other hand, significant costs may result from a slowing in the rate of innovation or of adoption of new technology due to delays in the regulatory approval process or the setting of more stringent standards for new facilities than existing ones. In some cases agencies are limited under statute to consider only technologies that have been demonstrated to be feasible

. In these situations, it may be useful to estimate costs and cost savings assuming a wider range of technical possibilities. When characterizing technology changes over time, you should assess the likely technology changes that would have occurred in the absence of the regulatory action (technology baseline). Technologies change over time in both reasonably functioning markets and imperfect markets. If you assume that technology will remain unchanged in the absence of regulation when technology changes are likely, then your analysis will over-state both the benefits and costs attributable to the regulation. Occasionally, cost savings or other forms of benefits accrue to parties affected by a rule who also bear its costs

. For example, a requirement that engine manufacturers reduce emissions from engines may lead to technologies that improve fuel economy

. These fuel savings will normally accrue to the engine purchasers, who also bear the costs of the technologies. There is no apparent market failure with regard to the market value of fuel saved because one would expect that consumers would be willing to pay for increased fuel economy that exceeded the cost

37 provide an acceptable decision criterion, and regulations with the highest internal rate ofreturn are not necessarily the mostbeneficial. Nevertheless, it does provide useful information and for many it will offer a meaningful indication ofregulation's impact. You should consider including the internal rate ofreturn impliedbyyour regulatory analysis along with other information about discounted net present values. 

### OtherKey Considerations
1. OtherBenefit and Cost Considerations
You should include these effects inyour analysis and provide estimates oftheir monetary values when they are significant:

• Private-sector compliance costs and savings; • Government administrative costs and savings; • Gains or losses in consumers' orproducers' surpluses; • Discomfort or inconvenience costs and benefits; and • Gains or losses oftime in work, leisure and/or commuting/travel settings.
Estimates ofbenefits and costs shouldbe based on credible changes intechnology over time. For example, retrospective studies mayprovide evidence that "learning" will likelyreduce the cost ofregulation in future years. The weight you give to a study ofpast rates ofcost savings resulting from innovation (including "learning curve" effects) should depend on both its timeliness and direct relevance to the processes affectedby the regulatory alternative under consideration. In addition, you should take into account cost-saving innovations that result from a shift to regulatory performance standards and incentive-basedpolicies. Onthe otherhand, significant costs may result from a slowing in the rate ofinnovation or ofadoption ofnew technology due to delays inthe regulatory approval process orthe setting ofmore stringent standards for new facilities than existing ones. In some cases agencies are limited under statute to consider only technologies that have been demonstrated to be feasible. In these situations, it may be useful to estimate costs and cost savings assuming a widerrange oftechnical possibilities.
When characterizing technology changes over time, you should assess the likely technology changes that would have occurred inthe absence ofthe regulatory action (technology baseline). Technologies change overtime in both reasonably functioning markets and imperfect markets. Ifyou assume that technology will remainunchanged in the absence ofregulation whentechnology changes are likely, thenyour analysis will over-state both the benefits and costs attributable to the regulation. Occasionally, cost savings or other forms ofbenefits accrue to parties affected by a rule who also bear its costs. For example, a requirement that engine manufacturers reduce emissions from engines may lead to technologies that improve fuel economy. These fuel savings will normally accrue to the engine purchasers, who also bear the costs ofthe technologies. There is no apparent market failure with regard to the market value offuel savedbecause one would expectthat consumers wouldbe willing to pay for increased fuel economy that exceeded the cost

37of providing it. When these cost savings are substantial, and particularly when you estimate

them to be greater than the cost associated with achieving them, you should examine and discuss why market forces would not accomplish these gains in the absence of regulation

. As a general matter, any direct costs that are averted as a result of a regulatory action should be monetized wherever possible and either added to the benefits or subtracted from the costs of that alternative. 2. The Difference between Costs (or Benefits) and Transfer Payments Distinguishing between real costs and transfer payments is an important , but sometimes difficult, problem in cost estimation. Benefit and cost estimates should reflect real resource use. Transfer payments are monetary payments 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 transfer from buyers to sellers. The net reduction in the total surplus (consumer plus producer) is a real cost to society, but the transfer from buyers to sellers resulting from a higher price is not a real cost since the net reduction automatically accounts for the transfer from buyers to sellers. However, transfers from the United States to other nations should be included as costs, and transfers from other 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 estimates of the benefits and costs of a regulation. Instead, address them in a separate discussion of the regulation 's distributional effects. Examples of transfer payments include the following: • Scarcity rents and monopoly profits o Insurance payments o Indirect taxes and subsidies
Treatment of Uncertainty

The precise consequences (benefits and costs) of regulatory options are not always known for certain, but the probability of their occurrence can often be developed

. The important uncertainties connected with your regulatory decisions need to be analyzed and presented as part of the overall regulatory analysis. You should begin your analysis of uncertainty at the earliest possible stage in developing your analysis

. You should consider both the statistical variability of key elements underlying the estimates of benefits and costs (for example, the expected change in the distribution of automobile accidents that might result from a change in automobile safety standards) and the incomplete knowledge about the relevant relationships (for example, the uncertain knowledge of how some economic activities might affect future climate change).25 By assessing the sources of uncertainty and the way in which benefit and cost estimates may be affected under plausible assumptions, you can shape your analysis to inform decision makers and the public about the effects and the uncertainties of alternative regulatory actions.

25 In some contexts, the word "variability" is used as a synonym for statistical variation that can be described by a theoretically valid distribution function, whereas "uncertainty" refers to a more fundamental lack of knowledge. Throughout this discussion, we use the term "uncertainty" to refer to both concepts.

38 ofproviding it. When these cost savings are substantial, and particularly when you estimate them to be greater than the cost associated with achieving them, you should examine and discuss why market forces would not accomplish these gains in the absence ofregulation. As a general matter, any direct costs that are averted as a result ofa regulatory action shouldbe monetized whereverpossible and either added to the benefits or subtracted from the costs ofthat alternative.
2. The Difference between Costs (orBenefits) and TransferPayments Distinguishing betweenreal costs and transfer payments is an important, but sometimes difficult, problem in cost estimation. Benefit and cost estimates shouldreflect real resource use. Transferpayments are monetarypayments from one group to another that do not affect total resources available to society. A regulation that restricts the supply ofa good, causing its price to rise, produces a transfer from buyers to sellers. The netreduction in the total surplus (consumerplus producer) is a real cost to society, but the transfer from buyers to sellers resulting from a higherprice is not a real cost since the net reduction automatically accounts for the transfer from buyers to sellers. However, transfers from the United States to other nations shouldbe included as costs, and transfers from othernations to the United States as benefits, as long as the analysis is conducted from the United States perspective.
You should not include transfers inthe estimates ofthe benefits and costs ofa regulation. Instead, address them in a separate discussion ofthe regulation's distributional effects. Examples oftransfer payments include the following:

4> Scarcity rents and monopoly profits

4> Insurance payments
CII Indirect taxes and subsidies


### Treatment ofUncertainty
The precise consequences (benefits and costs) ofregulatory options are not always known for certain, butthe probability oftheir occurrence can oftenbe developed. The important uncertainties connected with yourregulatory decisions need to be analyzed and presented as part ofthe overall regulatory analysis. You shouldbegin your analysis ofuncertainty at the earliest possible stage in developing your analysis. You should considerboth the statistical variability of key elements underlying the estimates ofbenefits and costs (for example, the expected change in the distribution ofautomobile accidents that mightresult from a change in automobile safety standards) and the incomplete knowledge about the relevant relationships (for example, the uncertainknowledge ofhow some economic activities might affect future climate change).25 By assessing the sources ofuncertainty andthe way inwhich benefit and cost estimates may be affected under plausible assumptions, you can shape your analysis to inform decision makers and the public about the effects and the uncertainties ofalternative regulatory actions.

25 In some contexts, the word "variability" is used as a synonym for statistical variation that can be described by a theoretically valid distribution function, whereas "uncertainty" refers to a more fundamental lack ofknowledge. Throughout this discussion, we use the tenn "uncertainty" to refer to both concepts.

38The treatment of uncertainty must be guided by the same principles of full disclosure and

transparency that apply to other elements of your regulatory analysis. Your analysis should be credible, objective, realistic, and scientifically balanced.26 Any data and models that you use to analyze uncertainty should be fully identified. You should also discuss the quality of the available data used. Inferences and assumptions used in your analysis should be identified, and your analytical choices should be explicitly evaluated and adequately justified. In your presentation, you should delineate the strengths of your analysis along with any uncertainties about its conclusions. Your presentation should also explain how your analytical choices have affected your results. In some cases, the level of scientific uncertainty may be so large that you can only present discrete alternative scenarios without assessing the relative likelihood of each scenario quantitatively. For instance, in assessing the potential outcomes of an environmental effect, there may be a limited number of scientific studies with strongly divergent results. In such cases, you might present results from a range of plausible scenarios, together with any available information that might help in qualitatively determining which scenario is most likely to occur. When uncertainty has significant effects on the final conclusion about net benefits, your agency should consider additional research prior to rulemaking. The costs of being wrong may outweigh the benefits of a faster decision. This is true especially for cases with irreversible or large upfront investments. If your agency decides to proceed with rulemaking, you should explain why the costs of developing additional information-including any harm from delay in public protection-exceed the value of that information. For example, when the uncertainty is due to a lack of data, you might consider deferring the decision, as an explicit regulatory alternative, pending further study to obtain sufficient data.27 Delaying a decision will also have costs, as will further efforts at data gathering and analysis. You will need to weigh the benefits of delay against these costs in making your decision. Formal tools for assessing the value of additional information are now well developed in the applied decision sciences and can be used to help resolve this type of complex regulatory question. "Real options" methods have also formalized the valuation of the added flexibility inherent in delaying a decision. As long as taking time will lower uncertainty, either passively or actively through an investment in information gathering, and some costs are irreversible, such as the potential costs of a sunk investment, a benefit can be assigned to the option to delay a decision. That benefit should be considered a cost of taking immediate action versus thealternative of delaying that action pending more information. However, the burdens of delayincluding any harm to public health, safety, and the environment-need to be analyzed carefully. 1. Quantitative Analysis of Uncertainty

26 When disseminating information, agencies should follow their own information quality guidelines, issued in conformance with the OMB government

-wide guidelines (67 FR 8452, February 22, 2002). 27 Clemen RT (1996), Making Hard Decisions: An Introduction to Decision Analysis, second edition, Duxbury Press, Pacific Grove.

39 The treatment ofuncertainty must be guided by the sameprinciples offull disclosure and transparency that apply to other elements ofyourregulatory analysis. Your analysis should be credible, objective, realistic, and scientificallybalanced.26 Any data and models that you use to analyze uncertainty shouldbe fully identified. You should also discuss the quality ofthe available dataused. Inferences and assumptions used in your analysis shouldbe identified, and your analytical choices should be explicitly evaluated and adequatelyjustified. Inyour presentation, you should delineate the strengths ofyour analysis along with any uncertainties about its conclusions. Yourpresentation should also explainhow your analytical choices have affected your results.
In some cases, the level ofscientific uncertainty may be so large that you can only present discrete alternative scenarios without assessing the relative likelihood ofeach scenario quantitatively. Forinstance, in assessing the potential outcomes ofan environmental effect, there maybe a limited number ofscientific studies with strongly divergent results. In such cases, you mightpresent results from a range ofplausible scenarios, together with any available information that might help in qualitatively determining which scenario is most likely to occur. Whenuncertainty has significant effects onthe final conclusion about net benefits, your agency should consider additional research prior to rulemaking. The costs ofbeing wrong may outweigh the benefits ofa faster decision. This is true especially for cases with irreversible or large upfront investments. Ifyour agency decides to proceedwith rulemaking, you should explain why the costs ofdeveloping additional information-including any harm from delay in public protection-exceedthe value ofthat information.
For example, whenthe uncertainty is due to a lack ofdata, you might consider deferring the decision, as an explicitregulatory alternative, pending further study to obtain sufficient data.27 Delaying a decision will also have costs, as will further efforts at data gathering and analysis. You will needto weigh the benefits ofdelay against these costs in making your decision. Formal tools for assessing the value ofadditional information are now well developed in the applied decision sciences and can be used to help resolve this type ofcomplex regulatory question.
"Real options" methods have also formalized the valuation ofthe added flexibility inherent in delaying a decision. As long as taking time will loweruncertainty, eitherpassively or actively through an investment in information gathering, and some costs are irreversible, such as the potential costs ofa sunk investment, a benefit can be assigned to the option to delay a decision. That benefit shouldbe considered a cost oftaking immediate action versus the alternative ofdelaying that action pending more information. However, the burdens ofdelayincluding any harm to public health, safety, and the environment-needto be analyzed carefully.
1. Quantitative Analysis ofUncertainty

26 When disseminating information, agencies should follow their own information quality guidelines, issued in conformance with the OMB government-wide guidelines (67 FR 8452, February 22,2002).
27 Clemen RT (1996), Making HardDecisions:AnIntroduction to DecisionAnalysis, second edition, Duxbury Press, Pacific Grove.

39Examples of quantitative analysis, broadly defined, would include formal estimates of the

probabilities of environmental damage to soil or water, the possible loss of habitat, or risks to endangered species as well as probabilities of harm to human health and safety. There are also uncertainties associated with estimates of economic benefits and costs, such as the cost savings associated with increased energy efficiency. Thus, your analysis should include two fundamental components: a quantitative analysis characterizing the probabilities of the relevant outcomes and an assignment of economic value to the projected outcomes. It is essential that both parts be conceptually consistent. In particular, the quantitative analysis should be conducted in a way that permits it to be applied within a more general analytical framework, such as benefit-cost analysis. Similarly, the general framework needs to be flexible enough to incorporate the quantitative analysis without oversimplifying the results. For example, you should address explicitly the implications for benefits and costs of any probability distributions developed in your analysis. As with other elements of regulatory analysis, you will need to balance thoroughness with the practical limits on your analytical capabilities. Your analysis does not have to be exhaustive, nor is it necessary to evaluate each alternative at every step. Attention should be devoted to first resolving or studying the uncertainties that have the largest potential effect on decision making. Many times these will be the largest sources of uncertainties. In the absence of adequate data, you will need to make assumptions. These should be clearly identified and consistent with the relevant science. Your analysis should provide sufficient information for decision makers to grasp the degree of scientific uncertainty and the robustness of estimated probabilities, benefits, and costs to changes in key assumptions. For major rules involving annual economic effects of $1 billion or more, you should present a formal quantitative analysis of the relevant uncertainties about benefits and costs. In other words, you should try to provide some estimate of the probability distribution of regulatory benefits and costs. In summarizing the probability distributions, you should provide some estimates of the central tendency (e.g., mean and median) along with any other information you think will be useful such as ranges, variances, specified low-end and high-end percentile estimates, and other characteristics of the distribution. Your estimates cannot be more precise than their most uncertain component. Thus, your analysis should report estimates in a way that reflects the degree of uncertainty and not create a false sense of precision. Worst-case or conservative analyses are not usually adequate because they do not convey the complete probability distribution of outcomes, and they do not permit calculation of an expected value of net benefits. In many health and safety rules, economists conducting benefit-cost analyses must rely on formal risk assessments that address a variety of risk management questions such as the baseline risk for the affected population, the safe level of exposure or, the amount of risk to be reduced by various interventions. Because the answers to some of these questions are directly used in benefits analyses, the risk assessment methodology must allow for the determination of expected benefits in order to be comparable to expected costs. This means that conservative assumptions and defaults (whether motivated by science policy or by precautionary instincts), will be incompatible with benefit analyses as they will result in benefit estimates that exceed the expected value. Whenever it is possible to characterize quantitatively the probability distributions, some estimates of expected value (e.g., mean and

40 Examples ofquantitative analysis, broadly defined, would include formal estimates ofthe probabilities ofenvironmental damage to soil or water, the possible loss ofhabitat, orrisks to endangered species as well as probabilities ofharmto humanhealth and safety. There are also uncertainties associated with estimates ofeconomic benefits and costs, such as the cost savings associated with increased energy efficiency. Thus, your analysis should include two fundamental components: a quantitative analysis characterizing the probabilities ofthe relevant outcomes and an assignment ofeconomic value to the projected outcomes. Itis essential that bothparts be conceptually consistent. In particular, the quantitative analysis should be conducted in a way that permits it to be applied within a more general analytical framework, such as benefit-cost analysis. Similarly, the general framework needs to be flexible enough to incorporate the quantitative analysis without oversimplifying the results. For example, you should address explicitly the implications for benefits and costs ofany probability distributions developed in your analysis.
As with other elements ofregulatory analysis, you will need to balance thoroughness with the practical limits onyour analytical capabilities. Your analysis does not have to be exhaustive, nor is it necessary to evaluate each alternative at every step. Attention shouldbe devoted to first resolving or studying the uncertainties that have the largest potential effect on decision making. Many times these will be the largest sources ofuncertainties. In the absence ofadequate data, you will need to make assumptions. These should be clearly identified and consistent with the relevant science. Your analysis shouldprovide sufficient information for decision makers to grasp the degree ofscientific uncertainty and the robustness ofestimated probabilities, benefits, and costs to changes in key assumptions.
For major rules involving annual economic effects of$1 billion or more, you should present a formal quantitative analysis ofthe relevant uncertainties about benefits and costs. In other words, you should try to provide some estimate ofthe probability distribution ofregulatory benefits and costs. In summarizing the probability distributions, you should provide some estimates ofthe central tendency (e.g., mean and median) along with any other information you think will be useful such as ranges, variances, specified low-end and high-end percentile estimates, and other characteristics ofthe distribution.
Your estimates cannotbe more precise than their most uncertain component. Thus, your analysis should report estimates in a way that reflects the degree ofuncertainty and not create a false sense ofprecision. Worst-case orconservative analyses are not usually adequate because they do not convey the complete probability distribution ofoutcomes, and they do notpermit calculation ofan expected value ofnet benefits. In many health and safety rules, economists conducting benefit-cost analyses must rely on formal risk assessments that address a variety of risk management questions such as the baseline risk for the affected population, the safe level of exposure or, the amount ofrisk to be reduced byvarious interventions. Because the answers to some ofthese questions are directly used in benefits analyses, the risk assessment methodology must allow for the determination ofexpectedbenefits in order to be comparable to expected costs. This means that conservative assumptions and defaults (whether motivated by science policy orby precautionary instincts), will be incompatible with benefit analyses as they will result inbenefit estimates that exceed the expected value. Whenever it is possible to characterize quantitatively the probability distributions, some estimates ofexpected value (e.g., mean and

40median) must be provided in addition to ranges, variances, specified low-end and high-end

percentile estimates, and other characteristics of the distribution. Whenever possible, you should use appropriate statistical techniques to determine a probability distribution of the relevant outcomes. For rules that exceed the $1 billion annual threshold, a formal quantitative analysis of uncertainty is required. For rules with annual benefits and/or costs in the range from 100 million to $1 billion, you should seek to use more rigorous approaches with higher consequence rules. This is especially the case where net benefits are close to zero. More rigorous uncertainty analysis may not be necessary for rules in this category if simpler techniques are sufficient to show robustness. You may consider the following analytical approaches that entail increasing levels of complexity: o Disclose qualitatively the main uncertainties in each important input to the calculation of benefits and costs. These disclosures should address the uncertainties in the data as well as in the analytical results. However, major rules above the $1 billion annual threshold require a formal treatment. o Use a numerical sensitivity analysis to examine how the results of your analysis vary with plausible changes in assumptions, choices of input data, and alternative analytical approaches. Sensitivity analysis is especially valuable when the information is lacking to carry out a formal probabilistic simulation. Sensitivity analysis can be used to find "switch points" -- critical parameter values at which estimated net benefits change sign or the low cost alternative switches. Sensitivity analysis usually proceeds by changing one variable or assumption at a time, but it can also be done by varying a combination of variables simultaneously to learn more about the robustness of your results to widespread changes. Again, however, major rules above the $1 billion annual threshold require a formal treatment. ® Apply a formal probabilistic analysis of the relevant uncertainties - possibly using simulation models and/or expert judgment as revealed, for example, through Delphi methods.28 Such a formal analytical approach is appropriate for complex rules where there are large, multiple uncertainties whose analysis raises technical challenges, or where the effects cascade; it is required for rules that exceed the $1 billion annual threshold. For example, in the analysis of regulations addressing air pollution, there is uncertainty about the effects of the rule on future emissions, uncertainty about how the change in emissions will affect air quality, uncertainty about how changes in air quality will affect health, and finally uncertainty about the economic and social value of the change in health outcomes. In formal probabilistic assessments, expert solicitation is a useful way to fill key gaps in your ability to assess uncertainty.29 In general, experts can be used to quantify the probability distributions of key parameters and relationships. These solicitations, combined with other sources of data, can be combined in Monte Carlo simulations to derive a probability distribution of benefits and costs. You should

28 The purpose of Delphi methods is to generate suitable information for decision making by eliciting expect judgment. The elicitation is conducted through a survey process which eliminates the interactions between experts. See Morgan MG and Henrion M (1990), Uncertainty: A Guide to Dealing with Uncertainty in Quantitative Riskand Policy Analysis, Cambridge University Press. 29 Cooke RM (1991), Experts in Uncertainty: Opinion and Subjective Probability in Science, Oxford University Press.

41 median) must be provided in addition to ranges, variances, specified low-end and high-end percentile estimates, and other characteristics ofthe distribution.
Wheneverpossible, you should use appropriate statistical techniques to determine a probability distribution ofthe relevant outcomes. For rules that exceed the $1 billion annual threshold, a formal quantitative analysis ofuncertainty is required. Forrules with annual benefits and/or costs in the range from 100 million to $1 billion, you should seek to use more rigorous approaches with higher consequence rules. This is especially the case where net benefits are close to zero. More rigorous uncertainty analysis may notbe necessary for rules in this category ifsimpler techniques are sufficient to show robustness. You may consider the following analytical approaches that entail increasing levels ofcomplexity:

e Disclose qualitatively the main uncertainties in each important input to the calculation of benefits and costs. These disclosures should address the uncertainties in the data as well as in the analytical results. However, major rules above the $1 billion annual threshold require a formal treatment.

e Use a numerical sensitivity analysis to examine how the results ofyour analysis vary with plausible changes in assumptions, choices ofinput data, and alternative analytical approaches. Sensitivity analysis is especially valuable when the information is lacking to carry out a formal probabilistic simulation. Sensitivity analysis canbe used to find "switch points"

-- critical parameter values at which estimated net benefits change sign or the low cost alternative switches. Sensitivity analysis usuallyproceeds by changing one variable or assumption at a time, but it can also be done by varying a combination of variables simultaneously to learn more about the robustness ofyourresults to widespread changes. Again, however, major rules above the $1 billion annual threshold require a formal treatment.

e Apply a formal probabilistic analysis ofthe relevant uncertainties

- possibly using simulation models and/or expertjudgment as revealed, for example, through Delphi methods. 28 Such a formal analytical approach is appropriate for complex rules where there are large, multiple uncertainties whose analysis raises technical challenges, or where the effects cascade; it is required for rules that exceed the $1 billion annual threshold. For example, in the analysis ofregulations addressing air pollution, there is uncertainty about the effects ofthe rule on future emissions, uncertainty about how the change in emissions will affect air quality, uncertainty about how changes in air quality will affect health, and finally uncertainty about the economic and social value ofthe change in health outcomes. In formal probabilistic assessments, expert solicitation is a useful way to fill key gaps in your ability to assess uncertainty.29 In general, experts can be used to quantify the probability distributions ofkey parameters and relationships. These solicitations, combined with other sources ofdata, canbe combined in Monte Carlo simulations to derive a probability distribution ofbenefits and costs. You should

28 The purpose ofDelphi methods is to generate suitable information for decision making by eliciting expect judgment. The elicitation is conducted through a survey process which eliminates the interactions between experts. See Morgan MG and Henrion M (1990), Uncertainty: A Guide to Dealing with Uncertainty in Quantitative Riskand PolicyAnalysis, Cambridge University Press. 29 Cooke RM (1991), Experts in Uncertainty: Opinion andSubjective Probability in Science, Oxford University Press.

41pay attention to correlated inputs. Often times, the standard defaults in Monte Carlo and other similar simulation packages assume independence across distributions. Failing to correctly account for correlated distributions of inputs can cause the resultant output uncertainty intervals to be too large, although in many cases the overall effect is ambiguous. You should make a special effort to portray the probabilistic results-in graphs and/or tables-clearly and meaningfully. New methods may become available in the future. This document is not intended to discourage or inhibit their use, but rather to encourage and stimulate their development.
2. Economic Values of Uncertain Outcomes In developing benefit and cost estimates, you may find that there are probability distributions of values as well for each of the outcomes. Where this is the case, you will need to combine these probability distributions to provide estimated benefits and costs. Where there is a distribution of outcomes, you will often find it useful to emphasize summary statistics or figures that can be readily understood and compared to achieve the broadest public understanding of your findings. It is a common practice to compare the "best estimates" of both benefits and costs with those of competing alternatives. These "best estimates" are usually the average or the expected value of benefits and costs. Emphasis on these expected values is appropriate as long as society is "risk neutral" with respect to the regulatory alternatives. While this may not always be the case, you should in general assume "risk neutrality" in your analysis. If you adopt a different assumption on risk preference, you should explain your reasons for doing so. 3. Alternative Assumptions If benefit or cost estimates depend heavily on certain assumptions, you should make those assumptions explicit and carry out sensitivity analyses using plausible alternative assumptions. If the value of net benefits changes from positive to negative (or vice versa) or if the relative ranking of regulatory options changes with alternative plausible assumptions, you should conduct further analysis to determine which of the alternative assumptions is more appropriate. Because different estimation methods may have hidden assumptions, you should analyze estimation methods carefully to make any hidden assumptions explicit. F. Specialized Analytical Requirements In preparing analytical support for your rulemaking, you should be aware that there are a number of analytic requirements imposed by law and Executive Order. In addition to the regulatory analysis requirements of Executive Order 12866, you should also consider whether your rule will need specialized analysis of any of the following issues.

42 pay attention to correlated inputs. Often times, the standard defaults in Monte Carlo and other similar simulation packages assume independence across distributions. Failing to correctly account for correlated distributions ofinputs can cause the resultant output uncertainty intervals to be too large, although in many cases the overall effect is ambiguous. You should make a special effort to portray the probabilistic results-in graphs and/or tables-clearly and meaningfully.
New methods may become available in the future. This document is not intended to discourage or inhibit their use, but rather to encourage and stimulate their development.
2. Economic Values ofUncertain Outcomes
In developing benefit and cost estimates, you may find that there are probability distributions ofvalues as well for each ofthe outcomes. Where this is the case, you will need to combine these probability distributions to provide estimated benefits and costs. Where there is a distribution ofoutcomes, you will often find it useful to emphasize summary statistics or figures that can be readily understood and compared to achieve the broadestpublic understanding ofyour findings. Itis a commonpractice to compare the "best estimates" ofbothbenefits and costs with those ofcompeting alternatives. These "best estimates" are usually the average orthe expected value ofbenefits and costs. Emphasis on these expected values is appropriate as long as society is "riskneutral" with respect to the regulatory alternatives. While this may not always be the case, you should in general assume "risk neutrality" in your analysis. Ifyou adopt a different assumption on riskpreference, you should explain yourreasons for doing so. 3. Alternative Assumptions
Ifbenefit or cost estimates depend heavily on certain assumptions, you should make those assumptions explicit and carry out sensitivity analyses using plausible alternative assumptions. Ifthe value ofnet benefits changes from positive to negative (or vice versa) or if the relative ranking ofregulatory options changes with alternative plausible assumptions, you should conduct further analysis to determine which ofthe alternative assumptions is more appropriate. Because different estimation methods may have hidden assumptions, you should analyze estimation methods carefully to make any hidden assumptions explicit.


### F. Specialized AnalyticalRequirements
In preparing analytical support for your rulemaking, you should be aware that there are a number ofanalytic requirements imposed by law and Executive Order. In addition to the regulatory analysis requirements ofExecutive Order 12866, you should also consider whether yourrule will need specialized analysis ofany ofthe following issues.

42Impact on Small Businesses and Other Small Entities Under the Regulatory Flexibility Act (5 U.S.C. chapter 6), agencies must prepare a proposed and final "regulatory flexibility analysis" (RFA) if the rulemaking could "have a significant impact on a substantial number of small entities." You should consider posting your RFA on the internet so the public can review your findings. Your agency should have guidelines on how to prepare an RFA and you are encouraged to consult with the Chief Counsel for Advocacy of the Small Business Administration on expectations concerning what is an adequate RFA. Executive Order 13272 (67 FR 53461, August 16, 2002) requires you to notify the Chief Counsel for Advocacy of any draft rules that might have a significant economic impact on a substantial number of small entities. Executive Order 13272 also directs agencies to give every appropriate consideration to any comments provided by the Advocacy Office. Under SBREFA, EPA and OSHA are required to consult with small business prior to developing a proposed rule that would have a significant effect on small businesses. OMB encourages other agencies to do so as well. Analysis of Unfunded Mandates
Under the Unfunded Mandates Act (2 U.S.C. 1532), you must prepare a written statement about benefits and costs prior to issuing a proposed or final rule (for which your agency published a proposed rule) that may result in aggregate expenditure by State, local, and tribal governments, or by the private sector, of $ 100,000,000 or more in any one year (adjusted annually for inflation). Your analytical requirements under Executive Order 12866 are similar to the analytical requirements under this Act, and thus the same analysis may permit you to comply with both analytical requirements. Information Collection, Paperwork, and Recordkeeping Burdens Under the Paperwork Reduction Act (44 U.S.C. chapter 35), you will need to consider whether your rulemaking (or other actions) will create any additional information collection, paperwork or recordkeeping burdens. These burdens are permissible only if you can justify the practical utility of the information for the implementation of your rule

. OMB approval will be required of any new requirements for a collection of information imposed on 10 or more persons and a valid OMB control number must be obtained for any covered paperwork

. Your agency's CIO should be able to assist you in complying with the Paperwork Reduction Act. Information Quality Guidelines Under the Information Quality Law, agency guidelines, in conformance with the OMB government-wide guidelines (67 FR 8452, February 22, 2002), have established basic quality performance goals for all information disseminated by agencies, including information disseminated in support of proposed and final rules. The data and analysis that you use to support your rule must meet these agency and OMB quality standards. Your agency's CIO should be able to assist you in assessing information quality. The Statistical and Science Policy

43 

### Impact on SmallBusinesses and OtherSmallEntities
Under the Regulatory Flexibility Act (5 U.S.C. chapter 6), agencies must prepare a proposed and final "regulatory flexibility analysis" (RFA) ifthe rulemaking could "have a significantimpact on a substantial number ofsmall entities." You should consider posting your RFA on the internet so the public canreview your findings.
Your agency should have guidelines on how to prepare an RFA and you are encouraged to consult with the ChiefCounsel for Advocacy ofthe Small Business Administration on expectations concerning what is an adequate RFA. Executive Order 13272 (67 FR 53461, August 16, 2002) requires you to notify the ChiefCounsel for Advocacy ofany draft rules that might have a significant economic impact on a substantial number ofsmall entities. Executive Order 13272 also directs agencies to give every appropriate consideration to any comments providedby the Advocacy Office. Under SBREFA, EPA and OSHA are required to consult with small business priorto developing a proposed rule that would have a significant effect on small businesses. OMB encourages other agencies to do so as well. 

### Analysis ofUnfundedMandates
Under the Unfunded Mandates Act (2 U.S.C. 1532), you must prepare a written statement about benefits and costs prior to issuing a proposed or final rule (for which your agency published a proposed rule) that may result in aggregate expenditure by State, local, and tribal governments, orby the private sector, of$100,000,000 or more in anyone year (adjusted annually for inflation). Your analytical requirements under Executive Order 12866 are similar to the analytical requirements under this Act, and thus the same analysis may permit youto comply with both analytical requirements. 

### Information Collection, Paperwork, andRecordkeepingBurdens
Under the Paperwork Reduction Act (44 U.S.C. chapter 35), you will need to consider whether your rulemaking (or other actions) will create any additional information collection, paperwork or recordkeeping burdens. These burdens are permissible only ifyou canjustifythe practical utility ofthe information for the implementation ofyourrule. OMB approval will be required ofany newrequirements for a collection ofinformation imposed on 10 or more persons and a valid OMB control number must be obtained for any covered paperwork. Your agency's CIO should be able to assist you in complying with the Paperwork Reduction Act. 

### Information Quality Guidelines
Under the Information Quality Law, agency guidelines, in conformance with the OMB government-wide guidelines (67 FR 8452, February 22,2002), have establishedbasic quality performance goals for all information disseminated by agencies, including information disseminated in support ofproposed and final rules. The data and analysis that you use to support your rule must meetthese agency and OMB quality standards. Your agency's CIO should be able to assist you in assessing information quality. The Statistical and Science Policy

43Branch of OMB's Office of Information and Regulatory Affairs can provide you assistance. This

circular defines OMB's minimum quality standards for regulatory analysis. Environmental Impact Statements The National Environmental Policy Act (42 U.S.C. 4321-4347) and related statutes and executive orders require agencies to consider the environmental impacts of agency decisions, including rulemakings. An environmental impact statement must be prepared for "major Federal actions significantly affecting the quality of the human environment." You must complete NEPA documentation before issuing a final rule. The White House Council on Environmental Quality has issued regulations (40 C.F.R. 1500-1508) and associated guidance for implementation of NEPA, available through CEQ's website (http://www.whitehouse/,ov/ceq/). Impacts on Children Under Executive Order 13045, "Protection of Children from Environmental Health Risks and Safety Risks," each agency must, with respect to its rules, "to the extent permitted by law and appropriate, and consistent with the agency's mission," "address disproportionate risks to children that result from environmental health risks or safety risks." For any substantive rulemaking action that "is likely to result in" an economically significant rule that concerns "an environmental health risk or safety risk that an agency has reason to believe may disproportionately affect children," the agency must provide OMB/OIRA "an evaluation of the environmental health or safety effects of the planned regulation on children," as well as "an explanation of why the planned regulation is preferable to other potentially and reasonably feasible alternatives considered by the agency." Energy Impacts Under Executive Order 13211 (66 FR 28355, May 22, 2001), agencies are required to prepare and submit to OMB a Statement of Energy Effects for significant energy actions, to the extent permitted by law. This Statement is to include a detailed statement of "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 alternatives and their effects. You need to publish the Statement or a summary in the related NPRM and final rule. For further guidance, see OMB Memorandum 01-27 ("Guidance on Implementing Executive Order 13211", July 13, 2001), available on OMB's website. G. Accounting Statement You need to provide an accounting statement with tables reporting benefit and cost estimates for each major final rule for your agency. You should use the guidance outlined above to report these estimates. We have included a suggested format for your consideration.

44 Branch ofOMB's Office ofInformation and Regulatory Affairs can provide you assistance. This circular defines OMB's minimum quality standards for regulatory analysis. 

### EnvironmentalImpactStatements
The National Environmental Policy Act (42 U.S.C. 4321-4347) and related statutes and executive orders require agencies to consider the environmental impacts ofagency decisions, including rulemakings. An environmental impact statement must be prepared for "majorFederal actions significantly affecting the quality ofthe human environment." You must complete NEPA documentation before issuing a final rule. The White House Council on Environmental Quality has issued regulations (40 C.F.R. 1500-1508) and associated guidance for implementation ofNEPA, available through CEQ's website (http://www.whitehouse/gov/cegL). 

### Impacts on Children
Under Executive Order 13045, "Protection ofChildren from Environmental Health Risks and Safety Risks," each agency must, with respect to its rules, "to the extentpermittedby law and appropriate, and consistent with the agency's mission," "address disproportionate risks to children that result from environmental health risks or safety risks." For any substantive rulemaking action that "is likely to result in" an economically significant rule that concerns "an environmental health risk or safety risk that an agency has reason to believe may disproportionately affect children," the agency must provide OMB/OIRA "an evaluation ofthe environmental health or safety effects ofthe plannedregulation on children," as well as "an explanation ofwhy the plannedregulation is preferable to otherpotentially and reasonably feasible alternatives consideredby the agency." 

### EnergyImpacts Under Executive Order 13211 (66 FR 28355, May 22,2001), agencies are required to prepare and submit to OMB a Statement ofEnergy Effects for significant energy actions, to the extent permittedby law. This Statement is to include a detailed statement of"any adverse effects on energy supply, distribution, oruse (including a shortfall in supply, price increases, and increased use offoreign supplies)" for the action and reasonable alternatives and their effects. You needto publish the Statement or a summary in the relatedNPRM and final rule. For further guidance, see OMB Memorandum 01-27 ("Guidance onImplementing Executive Order 13211", July 13,2001), available on OMB's website. 

### G. Accounting Statement
You need to provide an accounting statement with tables reporting benefit and cost estimates for each major final rule for your agency. You should use the guidance outlined above to report these estimates. We have included a suggested format for your consideration.

44Categories of Benefits and Costs

To the extent feasible, you should quantify all potential incremental benefits and costs. You should report benefit and cost estimates within the following three categories: monetized quantified, but not monetized; and qualitative, but not quantified or monetized. These categories are mutually exclusive and exhaustive. Throughout the process of listing preliminary estimates of benefits and costs, agencies should avoid double-counting. This problem may arise if more than one way exists to express the same change in social welfare. Quantifying and Monetizing Benefits and Costs You should develop quantitative estimates and convert them to dollar amounts if possible. In many cases, quantified estimates are readily convertible, with a little effort, into dollar equivalents. Qualitative Benefits and Costs You should categorize or rank the qualitative effects in terms of their importance (e.g., certainty, likely magnitude, and reversibility). You should distinguish the effects that are likely to be significant enough to warrant serious consideration by decision makers from those that are likely to be minor.
Treatment of Benefits and Costs over Time You should present undiscounted streams of benefit and cost estimates (monetized and net) for each year of the analytic time horizon. You should present annualized benefits and costs using real discount rates of 3 and 7 percent. The stream of annualized estimates should begin in the year in which the final rule will begin to have effects, even if the rule does not take effect immediately. Please report all monetized effects in 2001 dollars. You should convert dollars expressed in different years to 2001 dollars using the GDP deflator.
Treatment of Risk and Uncertainty You should provide expected-value estimates as well as distributions about the estimates, where such information exists. When you provide only upper and lower bounds (in addition to best estimates), you should, if possible, use the 95 and 5 percent confidence bounds. Although we encourage you to develop estimates that capture the distribution of plausible outcomes for a particular alternative, detailed reporting of such distributions is not required, but should be available upon request. The principles of full disclosure and transparency apply to the treatment of uncertainty. Where there is significant uncertainty and the resulting inferences and/or assumptions have a critical effect on the benefit and cost estimates, you should describe the benefits and costs under plausible alternative assumptions. You may add footnotes to the table as needed to provide documentation and references, or to express important warnings.

45 

### Categories of Benefits and Costs
To the extent feasible, you should quantify all potential incremental benefits and costs. You should report benefit and cost estimates within the following three categories: monetized quantified, butnotmonetized; and qualitative, butnot quantified or monetized.
These categories are mutually exclusive and exhaustive. Throughout the process of listing preliminary estimates ofbenefits and costs, agencies should avoid double-counting. This problem may arise ifmore than one way exists to express the same change in social welfare. 

### QuantifYing andMonetizingBenefits and Costs
You should develop quantitative estimates and convert them to dollar amounts if possible. In many cases, quantified estimates are readily convertible, with a little effort, into dollar equivalents. 

### QualitativeBenefits and Costs
You should categorize or rank the qualitative effects in terms oftheir importance (e.g., certainty, likely magnitude, and reversibility). You should distinguish the effects that are likely to be significant enough to warrant serious considerationby decision makers from those that are likely to be minor.


### Treatment of Benefits and Costs over Time
You shouldpresentundiscounted streams ofbenefit and cost estimates (monetized and net) for each year ofthe analytic time horizon. You shouldpresent annualized benefits and costs using real discount rates of3 and 7 percent. The stream ofannualized estimates shouldbegin in the year in which the final rule will beginto have effects, even ifthe rule does not take effect immediately. Please report all monetized effects in 2001 dollars. You should convert dollars expressed in different years to 2001 dollars using the GDP deflator.


### Treatment of Riskand Uncertainty
You shouldprovide expected-value estimates as well as distributions about the estimates, where such information exists. Whenyouprovide only upper and lowerbounds (in addition to best estimates), you should, ifpossible, use the 95 and 5 percent confidence bounds. Although we encourage youto develop estimates that capture the distribution ofplausible outcomes for a particular alternative, detailed reporting ofsuch distributions is notrequired, but shouldbe available uponrequest. The principles offull disclosure and transparency apply to the treatment ofuncertainty. Where there is significantuncertainty and the resulting inferences and/or assumptions have a critical effect onthe benefit and cost estimates, you should describe the benefits and costs under plausible alternative assumptions. Youmay add footnotes to the table as needed to provide documentation and references, orto express important warnings.

45In a previous section, we identified some of the issues associated with developing

estimates of the value of reductions in premature mortality risk. Based on this discussion, you should present alternative primary estimates where you use different estimates for valuing reductions in premature mortality risk.
Precision of Estimates Reported estimates should reflect, to the extent feasible, the precision in the analysis. For example, an estimate of $220 million implies rounding to the nearest $10 million and thus a precision of +/-$5 million; similarly, an estimate of $222 million implies rounding to the nearest $1 million and thus, a precision of +/-$0.5 million. Separate Reporting of Transfers You should report transfers separately and avoid the misclassification of transfer payments as benefits or costs. Transfers occur when wealth or income is redistributed without any direct change in aggregate social welfare. To the extent that regulatory outputs reflect transfers rather than net welfare gains to society, you should identify them as transfers rather than benefits or costs. You should also distinguish transfers caused by Federal budget actions -- such as those stemming from a rule affecting Social Security payments -- from those that involve transfers between non-governmental parties -- such as monopoly rents a rule may confer on a private party. You should use as many categories as necessary to describe the major redistributive effects of a regulatory action. If transfers have significant efficiency effects in addition to distributional effects, you should report them. Effects on State, Local , and Tribal Governments, Small Business, Wages and Economic GrowthYou need to identity the portions of benefits, costs, and transfers received by State, local, and tribal governments. To the extent feasible, you also should identify the effects of the rule or program on small businesses, wages, and economic growth.30 Note that rules with annual costs that are less than one billion dollars are likely to have a minimal effect on economic growth.

30 The Regulatory Flexibility Act (5 U.S.C. 603(c), 604).

46 In a previous section, we identified some ofthe issues associated with developing estimates ofthe value ofreductions in premature mortality risk. Based on this discussion, you should present alternative primary estimates where youuse different estimates for valuing reductions in premature mortality risk.


### Precision of Estimates Reported estimates should reflect, to the extent feasible, the precision in the analysis. For example, an estimate of$220 million implies rounding to the nearest $10 million and thus a precision of

### +1-$5 million; similarly, an estimate of$222 million implies rounding to the nearest $1 million and thus, a precision of

### +1-$0.5 million. 

### Separate Reporting of Transfers
You shouldreport transfers separately and avoid the misclassification oftransfer payments as benefits or costs. Transfers occur when wealth orincome is redistributed without any direct change in aggregate social welfare. To the extent that regulatory outputs reflect transfers ratherthan net welfare gains to society, you should identify them as transfers rather than benefits or costs. You should also distinguish transfers caused byFederal budget actions

-- such as those stemming from a rule affecting Social Security payments

-- from those that involve transfers between non-governmental parties

-- such as monopoly rents a rule may confer on a private party. You should use as many categories as necessary to describe the major redistributive effects ofa regulatory action. Iftransfers have significant efficiency effects in addition to distributional effects, you shouldreport them. 

### Effects on State, Local, and Tribal Governments, SmallBusiness, Wages andEconomic Growth
Youneed to identity the portions ofbenefits, costs, and transfers received by State, local, and tribal governments. To the extent feasible, you also should identify the effects ofthe rule or program on small businesses, wages, and economic growth.3o Note that rules with annual costs that are less than one billion dollars are likely to have a minimal effect on economic growth.

30 The Regulatory Flexibility Act (5 U.S.c. 603(c), 604).

46OMB #:

Rule Title: RIN#: Category
BENEFITS (monetized benefits Annualized quantified, but unmonetized, benefits [unquantified) benefits

COSTS Annualized monetized costs Annualized quantified, but unmonetized, costs Qualitative (unquantified) costs TRANSFERS Annualized monetized transfers: "on budget" from whom to whom? Annualized monetized transfers: "off-budget" From whom to whom? Category Effects on State, local, and/or tribal governments Effects on small businesses Effects on wages Effects on growth Agency/Program Office:
Date: Primary Estimate Minimum Estimate

Effects

47 Maximum Estimate Source Citation RIA, preamble, etc.)

Source Citation (RIA, preamble, etc.) 

### OMB#: 

### Agency/Program Office: Rule Title: 

### RIN#: Date: Category Primary Estimate Minimum Estimate Maximum Estimate Source Citation (RIA, preamble, etc.) BENEFITS**~onetized** benefits

Annualized quantified, but unmonetized, benefits unquantified) benefits COSTS Annualized monetized costs Annualized quantified, but unmonetized, costs Qualitative (unquantified) costs TRANSFERS Annualized monetized transfers: "onbudget" from whom to whom? Annualized monetized transfers: "off-budget" From whom to whom? Category Effects Source Citation (RIA, preamble, etc.) Effects on State, local, and/or tribal governments Effects on small businesses Effects onwages Effects on growth



### 47H. Effective Date

The effective date of this Circular is January 1, 2004 for regulatory analyses received by OMB in support of proposed rules, and January 1, 2005 for regulatory analyses received by OMB in support of final rules. In other words, this Circular applies to the regulatory analyses for draft proposed rules that are formally submitted to OIRA after December 31, 2003, and for draft final rules that are formally submitted to OIRA after December 31, 2004. (However, if the draft proposed rule is subject to the Circular, then the draft final rule will also be subject to the Circular, even if it is submitted prior to January 1, 2005.) To the extent practicable, agencies should comply earlier than these effective dates. Agencies may, on a case-by-case basis, seek a waiver from OMB if these effective dates are impractical.

48 

### H. Effective Date
The effective date ofthis Circular is January 1,2004 for regulatory analyses received by OMB in support ofproposed rules, and January 1,2005 for regulatory analyses received by OMB in support offinal rules. In other words, this Circular applies to the regulatory analyses for draft proposed rules that are formally submitted to OIRA after December 31, 2003, and for draft final rules that are formally submitted to OIRA after December 31, 2004. (However, ifthe draft proposed rule is subject to the Circular, then the draft final rule will also be subject to the Circular, even ifit is submittedpriorto January 1,2005.) To the extent practicable, agencies should comply earlier than these effective dates. Agencies may, on a case-by-case basis, seek a waiver from OMB ifthese effective dates are impractical.

48