1



### Draft Analytic Blueprint for Materials Provided to the Science Advisory Board Panel on the Role of Economy

- Wide Modeling in U.S. EPA Regulatory Analysis

This draft analytic blueprint is a companion to draft charge questions developed for a new Science Advisory Board (SAB) panel on the technical merits and challenges of using economy

- wide models to evaluate the social cost, benefit, and economic impacts associated with EPA air regulations. Th e purpose of th is document is to briefly describe the t ypes of references and materials that EPA could provide to the SAB to help inform the discussion and review of the charge questions

. EPA is looking for feedback from the public including specific suggestions of potential journal articles or other materials that could be developed as an input into the SAB review.

Challenges in the use of economy

- wide models to evaluate the social costs of an air regulation

GENERAL MATERIALS

- “Analyzing Costs ” chapter of EPA’s G uidelines for Preparing Economic Analyses (U.S. EPA 2010b) : This chapter defines the concept of social cost, discusses general equilibrium analysis and measurement issues related to estimating social costs, and summarizes modeling frameworks available to estimate social costs

– including computabl e general equilibrium (CGE) models

– as well as criteria to select the most appropriate approach and potential limitations of these approaches.

MATERIALS RELATED TO THE REPRESENTATION OF REGULATIONS IN ECONOMY

- WIDE MODEL S

- T able summarizing characteristics used to evaluate the application of different model ing approaches for the analysis of air regulations : Th e table will include criteria discussed in U.S. EPA ( 2010b )

- types of costs, geographic scope; sectoral scope; expected magnitude; im portance of indirect effects

- and illustrate how the characteristics from a range of a ir regulations compare to these criteria

. For example, EPA may include rules that are small in magnitude, impact few sub

- sectors, cover multiple
sectors , or are large (e.g. NAAQS) , and information on the relative magnitude of costs, timeline for implementation, industries affected, types of cost information, etc.

- White paper that document s the process required to represent an air regulation in a CGE model and summariz e s the results of illustrative CGE model runs: This paper will document the steps involved, key assumptions, and challenges that may arise when representing a regulation in a CGE model . It may also examine the sensitivity of social cost estimates to the tr eatment of a subset of issues identified in the charge questions (e.g., a small or sector specific rule). EPA intends to use one or more CGE models (e.g., EMPAX, IGEM, ADAGE) to complete these illustrative runs. The choice of issues evaluate d will be based on gaps in the existing literature or EPA analyses.

- Economy

– wide modeling resul ts and discussion from regulatory impact a nalyses for recent E PA a ir rules: EPA has used different CGE models (e.g., EMPAX, ADAGE, IGEM) to evaluate the social costs of2

proposed legislation , some recent a ir rules, and the retrospective and prospective analys e s of the Clean Air Act (U.S. EPA 1997, U.S. EPA 1999, U.S. EPA 2011) . Examples will be selected to demonstrate how abatement costs have been represented in CGE models , the types of outputs used
to characterize social costs (e.g., equivalent valuation, household consumption, GDP, etc.) , and practical challenges encountered

. A table summariz ing key assumptions, critical uncertainties, known data gaps , challenges , and model evaluation results that illustrate the differences between EPA’s compliance cost and benefit models and CGE models will be included for these examples

. K ey differences between CGE models also may be noted

.

- Appropriate sections of the p eer review report s for the ADAGE and IGEM CGE models : EPA has used ADAGE and IGEM for economy

- wide analysis of proposed greenhouse gas mitigation legislation and EPA regulations . In 2009

- 20 10 EPA undertook a formal peer review of the modeling approach by a
pan el of experts in accordance with the Office of Management and Budget Final Information Quality Bulletin for Peer Review (2004) and the U.S. EPA Peer Review Handbook (2006)

. 1

- Summary of issues and findings relevant to estimating the social costs of regulation from the literature : F or example, Hazilla and Kopp (1990) and Jorgenson and Wilcoxen (1990) provide general equilibrium analyses of the impacts of environmental regulations on regulated and non

- regulated sectors and on the economy as a whole. Ha zilla and Kopp discuss and compare partial equilibrium and general equilibrium estimates of social costs. Other literature examines the sensitivity of CGE results to underlying parameter assumptions ( e.g., Alexeeva

- Talebi et al. 2012 , U.S. EPA 2010a).

- Ene rgy Modeling Forum (EMF) 24 Special Issue of Energy Journal ( f orthcoming ) : The EMF brings together leading energy and economic modelers and model users with the goal of utilizing the collective expertise of participants to conduct model intercomparison exercises and improve understanding of important energy and environmental problems. The EMF 24 exercise engaged nine top energy

- environment

- economy models to compare economy

- wide market

- based approaches and sectoral regulatory approaches to potential U.S. climate policy; and to examine the implications of assumptions regarding technological improvement and technological availability on modeling results

. T wo overview papers explor e, respectively , the cross

- model policy and technology dimensions of the exerci se (Fawcett et al

. , forthcoming ; Clarke et al

. , forthcoming )

. Rausch and Karplus examine the efficiency and distributional implications of federal regulation s in the U.S. electric power and transportation sectors by employing a numerical simulation model w ith a unique treatment of regional, technology, and household income heterogeneity; Ross et al. link a CGE model (ADAGE) with a detailed linear optimization model of the U.S. electricity sector and examine technological and regulatory approaches to reducin g emissions.

1 The peer review report of ADAGE and IGEM and responses from the developers may be found at: http://www.epa.gov/climatechange/Downloads/EPA activities/Final_peer_review_report_for_IGEM_and_ADAGE.p df3

MATERIALS ON LINKAGES BETWEEN ENGINEERING/PARTIAL EQUILBRIUM SECTORAL MODELS AND CGE

- White paper on issues that arise when linking sector or engineering model s to CGE model s : EPA’s abatement cost estimates typically come from engineering or partial equilibrium analy ses of available technologies and are often very detailed ( e.g., what technology changes are needed for refineries with specifi c kinds of existing equipment to reduce sulfur in gasoline ). This paper will describe different metho ds for linking these types of models to CGE models ( e.g., soft v ersu s hard linkages) and key issues that may arise based on relevant EPA experience and the published literature ( e.g., Nestor and Pasurka 1995 a, 1995b ; Böhringer 1998 ; McFarland et al. 2004 ; Sue Wing 200 6 ; Böhringer and Rutherford 2008 ; Blanford et al. 2012; and Kiuila and Rutherford 2013)

. 2 Work by Nestor and Pasurka (1995a, 1995b) is particularly relevant as EPA has used data on purchases for environmental protection from these articles to allocate incremental capital and operating costs due to regulation (often estimated via an engineering or partial equilibrium model ) to capital, labor, and material inputs represented in a CGE model

.

- W hite paper outlining how EPA link s engineering an d/or economic input models such as the Integrated Planning Model (IPM) to economy

- wide models

. Alternative linkage s will also be presented along with dynamic EMPAX

- CGE modeling to illustrat e these approaches. Relevant sections of the EMPAX peer review (inc luding Appendix B) on linking to other models may also be summarized in the white paper. 3

MATERIALS ON OTHER GE MODEL FRAMEWORKS TO CONSIDER

- Summary of the literature comparing the applicability of macroeconomic and CGE models for regulatory analysis: For example, Repetto and Austin (1997) conducted a meta

- analysis and concluded that the choice of model type was a significant factor in estimates of mitigation costs. Smith (2012) also discusses a number of intersections between macroeconomics and environ mental economics. Of particul ar interest are the discussion of U.S. EPA (2011) and its incorporation of benefits into a CGE model as well as how the state of the economy influences the approach taken to evaluate the economic effects of environmental policy

.

2 Generally speaking there are two methods for linking detailed models to CGE models. “Soft

– linking” involves solving the models in sequence by drawing outputs from a partial equilibrium model and imposing those results in the general equilibrium model. A “hard

- linkage” involves incorporating the partial equilibrium model within the general equilibrium model and solving them simultaneously. 3 The EMPAX peer review and response is available at http://www.epa.gov/ttn/ecas/models/empax_peer_review_comments_responses.pdf

.4

Challenges in the use of economy

- wide models to consider the benefits of an air regulation

GENERAL MATERIALS

- Paper on how the benefits of regulation s could be incorporated in to a CGE model : Work by Dale W. Jorgenson Associates will discuss conceptual issues in incorporating monetized benefits in to a CGE model. The paper will estimate benefits and costs of the Clean Air Act Amendments for 1990

- 2020 using the IGEM CGE model , which can be compared to U.S. EPA (2011)

.

- RTI International (2007) memo on incorporating benefits of climate change into a CGE model : While the focus of this memo is the incorporation of climate impacts, health benefits are handled similarly to U.S. EPA ( 2011). That is, a number of epidemiological studies are identified and used to estimate changes in morbidity and mortality. The morbidity and mortality impacts are translated into changes in labor force participation and health care expenditures that are directly included in the ADAGE CGE model. A possible extension of the model that is suggested in the white paper is directly representing health and/or ecosystem service s in the utility function. The paper also discusses an approach to incorporating how emissions changes affect household energy demand.

- Relevant sections of the “Analyzing Benefits” chapter of EPA’s Guidelines for Preparing E conomic Analyse s (U.S. EPA 2010b) on methods to monetiz e health and other types of benefits of regulation.

MODELING MORTALITY AND MORBIDITY EFFECTS IN CGE

- Relevant sections from The Benefits and Costs of the Clean Air Act from 1990 to 2020 (U.S. EPA 2011) along with a description of the data inputs and procedures used to generate benefits estimates and incorporate them into the EMPAX CGE model. U.S. EPA (2011) modeled the macroeconomic impacts of air quality related health improvements by focusing on three specific effects: (1) the change in the household time endowment from pollution

- related mortality impacts, (2) the change in the household time endowment fro m pollution

- related morbidity, and (3) the change in medica l expenditures associated with pollution

- related morbidity. As needed, additional information may be provided to describe the BenMAP and PopSim tools and how they were used to perform benefits calc ulations, along with known shortcomings of the methodology. 4

- W hite paper that discusses alternative methods that , compared to those previously used by EPA , could be used by EPA to includ e benefits from a ir regulations in CGE models. This paper will discuss such topics as the possible use of state

- dependent utility functions, the benefits that may accrue due to changes in life expectancy, and non

- market benefits.

4 BenMAP estimates the human health impacts of air pollution in a given year, while PopSim uses these estimates to characterize the change in this risk over a multi

- year period. Together, these tools were used in U.S. EPA (2011) to estimate the changes in health care expenditures and labor productivity due to the 1990 Clean Air Act Amendm ents that are used as inputs into the CGE model.5

- Summary of the literature on incorporating he alth benefits into a CGE model: This inclu des (1) the incorporation of health benefits from reduced exposure to flow and stock air pollutants in a CGE model (Matus et al. 2008, Selin et al. 2009, Nam et al. 2010, Matus et al. 201 2 ). This line of research

assess es social benefits of air pollution r eductions by including mortality and morbidity effects in MIT ’s Emissions Prediction and Policy Analysis

– Health Effects (EPPA

- HE) CGE model and discusses how changes in human health influence labor productivity and labor

- leisure tradeoffs

. O ther relevant areas of the literature that may be summarized are: (2) h ow changes in human health may influence future preferences for reduced risks ( e.g., Murphy and Topel 2006) , and (3) how changes in human health may affect the shape of the utility function or relative preferences for other goods and services ( e.g., Viscusi and Evans 1990; Finkelstein et al

. 2009).

ADDING NON

- MARKET BENEFITS TO CGE

- Papers discussing the incorporation of non

- market benefits into CGE models: Carbone and Smith (2008, 2013) work t oward developing a framework that includes ecosystem and non

- use benefits in a CGE model. They demonstrate that the incorporation of these benefits can substantially alter estimates of changes in welfare from environmental regulations.

- Relevant sections of the “Analyzing Benefits” chapter of EPA’s Guidelines for Preparing E conomic Analyse s (U.S. EPA2010b) on challenges to monetizing non

- market benefits (e.g. ecological and other non

- use benefits) outside of a CGE modeling framework

H OW SPATIAL DIMENSION MA T TERS FOR ESTIMATION OF BENEFITS

- R elevant portion s of the final Transport Rule analysis to demonstrate that mortality effects from particulate matter vary across the country. 5 This could be supplemented by a description of how the anal ysis was performed and a discussion of the implications for including such benefits in CGE models. The spatial scale of CGE models will almost certainly be coarser than the scale of EPA benefits analyses, and this may impact how the results of CGE analyses can be interpreted.

- K ey articles or summary of the literature on spatial sorting models : Using spatially delineated sorting models, Sieg et al. (2004) and Smith et al. (2004) estimate general equilibrium benefits for improvements in air quality in the L os Angeles basin. Kuminoff et al. ( 2013 ) survey the current state of the literature on equilibrium sorting models.

5 Appendix A (Distribution of the PM2.5

- Related Benefits Among Vulnerable and Susceptible Populations) o f the Regulatory Impact Analysis for the final Transport Rule , p. 331

- 341 . Available at : http://www.epa.gov/crossstaterule/pdfs/FinalRIA.pdf

.6

Challenges in the use economy

- wide models to inform economic impacts analysis for an air regulation

GENERAL MATERIALS

- Relevant sections of the “Economic Impact Analysis” chapter of EPA’s Guidelines for Preparing E conomic Analyse s (U.S. EPA 2010b): In particular, this chapter explains the distinction between the concepts of social costs and economic impacts. It also discusses impacts on pri ces and quantities as well as plant closures, employment, productivity, and energy market impacts. This chapter also discusses the role CGE models may play in estimating economic impacts.

- White paper on economic impacts: This paper will describ e the types of economic impacts from a ir regulations that are typically of interest to policymakers and examples of the ways in which CGE frameworks have (or have not) been used to evaluate them ( e.g., legislative analyses, rules)

.

- Relevant sections of Circular A4 (Office of Management and Budget 2003) that provides guidance on how EPA and other Federal agencies should analyze the distributional impacts of regulation.

- Summary table of EMPAX, ADAGE, IGEM, and several other common ly used CGE models: The table wil l describe characteristics such as sector detail, number of US regions, treatment of and key assumptions (e.g., labor supply elasticity) related to labor and capital markets, etc. relevant for the types of economic impacts from air regulations of interest to policymakers.

CAPITAL AND LABOR MARKETS, SECTORAL DISAGGREGATION, AND ENERGY PRICE IMPACTS

- S ummary of relevant literature on the treatment of capital and labor markets in CGE models : For instance, McKibbin et al. (201 4 ) use the G

- Cubed CGE model to analyze a power

- sector

- only approach to controlling CO 2 emissions compared to economy

- wide policies. The G

- Cubed model includes several important rigidities: financial capital is perfectly mobile, but physical capital is specific to the sector and region w here it was originally installed and is subject to convex adjustment costs; and labor is assumed to be perfectly mobile among sectors within regions, but is immobile between regions, with inelastic long run labor supply, and slowly adjusting nominal wages in the short run. Boeters and Savard (2012) review alternatives for the treatment of labor markets (both labor demand and supply) in CGE models. They discuss labor market coordination, including several
wage

- forming mechanisms and inclusion of involuntary unemployment in CGE models.

- S ummar y of issues related to sectoral disaggregatio n and impacts of e nergy prices in CGE models : For instance, Alexeeva

- Talebi et al. (2012) examine sensitivity of prediction s from a CGE model to different assumptions about sectoral disaggregation

- Armington trade elasticities, how technology is represented in the production function, and energy shares

- and find that results are most sensitive to Armington elasticity assumptions. With regard to energy price impacts, Clarke et al. ( forthcoming ) compare the results of nine top energy

- environment

- economy models

. C onsistent with previous studies , they find that technology assumptions have a large influence on carbon prices7

and the economy

- wide cost of mitigation. Additionally, c ost

- effectiveness of particular energy strategies varies widely across models. U.S. EPA (2010a) offers another example where both sectoral and energy price impacts are analyzed in a CGE model

.

OTHER MODELING APPROACHES

- Literature on applicability of other economy

- wide modeling approaches for evaluating economic impacts : For example, Hahn and Hird (19 9 1) discuss and compare the appropriateness of macroeconomic and general equilibrium models for examining a wide array of federal economic and social regu lations

. Portney (1981) represents an even earlier examination of the economic impacts of environmental regulation using macroeconomic forecasting models.

Considerations for generating directly comparable estimates of social costs, benefits, and economic impacts using economy

- wide modeling

GENERAL MATERIALS

- Retrospective and Prospective Analyses of the Clean Air Act: Relevant sections of U.S. EPA (1997) and U.S. EPA (1999) reports that speak to the degree to which costs and benefits are potentially
sepa rate or interact. When the benefits and cost s from U.S. EPA ( 1999) were modeled independently by Dale W. Jorgenson Associates (2002), the quantified benefits and costs out to the year 2100 were $33.9 trillion and $1 trillion, respectively, implying net benefits of $32.9 trillion. Modeled together, quantified net ben efits were $33.0 trillion.

ADDRESSING RISK AND UNCERTAINTY IN ECONOMY

- WIDE MODELS

- Summary of the l iterature on the treatment of uncertainty in CGE models: Monte Carlo simulation has been used to conduct sensitivity analyses on calibration data and param eters in CGE models (e.g. Harrison and Vinod 1992, Elliott et al. 2 012). Procedures based on Gaussian quadrature also are used (e.g. DeVuyst and Preckel 1997). For models with parameters estimated directly from time series data, additional procedures are p ossible (Tuladhar and Wilcoxen 1998, Chapter 9 in Jorgenson et al. 2013). V alidation exercises are also used (Dixon and Rimmer 2012 , U.S. EPA 2010a ).



### - White p aper describing how EPA represents uncertainty in benefits estimates : This paper will discuss the use of Monte Carlo simulation and a report ( U.S. EPA 2009 b ) laying out a possible approach for identifying key sources of uncertainty and their impact s on results. Key from the perspective of integrating benefits into a CGE model is how uncertainty in benefits estimates interacts with structural uncertainties within the CGE models (how labor is modeled, the form of the utility function, the number of representative consumers, etc.).8

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