Document ID: EPA-HQ-OW-2002-0033-0145
Agency: epa
Document Type: Supporting & Related Material
Title: 
Posted Date: 2003-04-14T04:00Z

United
States
Office
of
the
EPA
240­
R­
00­
003
Environmental
Protection
Administrator
September
2000
Agency
Guidelines
for
Preparing
Economic
Analyses
Guidelines
for
Preparing
Economic
Analyses
U.
S.
Environmental
Protection
Agency
September
2000
NOTICE
The
statements
in
this
document
have
been
developed
by
the
EPA
solely
for
use
as
guidance
for
economic
analysts
in
the
Agency,
and
those
consultants,
contractors,
or
other
persons
who
perform
work
under
Agency
contract
or
sponsorship.
In
addition,
publication
of
these
Guidelines
makes
information
on
the
principles,
concepts,
and
methods
used
by
the
Agency
available
to
all
interested
members
of
the
public.
This
document
is
not
intended,
nor
can
it
be
relied
upon,
to
create
any
rights
enforceable
by
any
party
in
litigation
with
the
United
States.
The
Agency
may
decide
to
follow
the
guidance
provided
in
this
document,
or
to
act
at
variance
with
the
guidance
based
on
its
analysis
of
the
specific
facts
present.
This
guidance
may
be
revised
without
public
notice
to
reflect
changes
in
the
Agency's
approach
to
preparing
economic
analyses,
or
to
clarify
and
update
text.
i
Preface
The
U.
S.
Environmental
Protection
Agency
(
EPA),
Regulatory
Policy
Council
oversees
regulatory
planning
by
the
Agency.
In
this
capacity,
the
Council
establishes
analytical
procedures
on
risk
management
issues
to
ensure
that
high
quality
and
consistent
practices
are
followed
in
accordance
with
Federal
and
Agency
regulatory
procedures.
In
early
1996,
the
conduct
and
consistency
of
economic
analyses
prepared
in
support
of
regulatory
actions
were
identified
as
areas
in
need
of
updated
and
more
specific
guidance
than
was
presently
available
in
the
Agency.
The
Regulatory
Policy
Council
assembled
a
group
economists
and
policy
analysts
serving
in
offices
throughout
the
EPA
to
serve
on
an
Economic
Consistency
Workgroup.
The
Council
instructed
the
Workgroup
to
develop
a
series
of
issue
papers
to
assess
important
economic
analytical
issues
facing
the
Agency.
After
discussing
the
results
of
the
findings
in
the
issue
papers,
the
Council
charged
the
Workgroup
with
preparing
a
guidance
document
to
assist
in
the
preparation
of
economic
analyses
used
for
regulatory
development
and
policy
evaluation
conducted
by
the
Agency.

The
Guidelines
for
Preparing
Economic
Analyses
(
or
EA
Guidelines)
is
part
of
a
continuing
effort
by
the
EPA
to
develop
improved
guidance
on
the
preparation
and
use
of
sound
science
in
support
of
the
decision
making
process.
The
EA
Guidelines
provide
guidance
on
analyzing
the
benefits,
costs,
and
economic
impacts
of
regulations
and
policies.
The
document
draws
from
several
previously
published
sources,
including
existing
economic
guidelines
materials
prepared
by
the
EPA
in
the
mid­
1980s,
other
Agency
economic
analyses
and
handbooks,
and
materials
prepared
by
the
Office
of
Management
and
Budget
in
support
of
Executive
Order
12866
on
regulatory
planning
and
analysis.
It
seeks
to
incorporate
recent
theoretical,
empirical,
and
modeling
advances
in
environmental
economics,
drawing
upon
the
considerable
body
of
scholarly
literature.

In
an
effort
to
ensure
the
EA
Guidelines
presents
sound,
scientific
information
consistent
with
mainstream
practices
in
environmental
economics,
the
Agency's
Science
Advisory
Board
(
SAB)
was
charged
with
undertaking
an
extensive
peer
review
of
the
document.
The
review
was
performed
by
the
SAB's
Environmental
Economics
Advisory
Committee
(
EEAC),
comprising
leading
U.
S.
environmental
economists
affiliated
with
major
colleges,
universities
and
economic
research
institutions.
The
EEAC
provided
substantial
input
on
the
content
and
organization
of
the
document,
reviewing
the
materials
for
accuracy
in
both
economic
theory
and
practice.
In
their
final
review
report
to
the
Agency
(
included
as
Appendix
A
in
this
document),
the
SAB
concluded
that
the
EA
Guidelines
receive
an
overall
rating
of
"
excellent,"
saying
it
"
succeed(
s)
in
reflecting
methods
and
practices
that
enjoy
widespread
acceptance
in
the
environmental
economics
profession."

Constant
advances
in
theoretical
and
empirical
research
in
the
field
of
environmental
economics
will
require
that
the
Agency
reexamine
the
EA
Guidelines
on
a
continual
basis.
The
Agency
will
again
enlist
experts
in
the
field
of
environmental
economics
and
engage
in
an
open
review
of
the
scientific
basis
of
the
document
when
it
is
reevaluated
in
the
future.
Preface
ii
Preface
Table
of
Contents
iii
Table
of
Contents
Preface
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i
List
of
Acronyms
and
Abbreviations
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vii
Acknowledgments
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ix
Chapter
1:
Introduction
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.1
Chapter
2:
Statutory
and
Executive
Order
Requirements
for
Conducting
Economic
Analyses
.
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.5
Chapter
3:
Statement
of
Need
for
the
Proposal
3.1
Introduction
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.9
3.2
Problem
Definition
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.9
3.3
Reasons
for
Market
or
Institutional
Failure
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.9
3.4
Need
for
Federal
Action
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.10
Chapter
4:
Regulatory
and
Non­
Regulatory
Approaches
to
Consider
4.1
Introduction
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.11
4.2
Traditional
Design­
Based
Command
and
Control
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.11
4.3
Performance­
Oriented
Approaches
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.11
4.4
Market­
Oriented
Approaches
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.12
4.4.1
Descriptions
of
Market­
Based
Approaches
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.12
4.4.2
Selecting
Market­
Oriented
Approaches
.
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.13
4.5
Non­
Regulatory
Approaches
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.14
4.6
Fine­
tuning
Policy
Approaches
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.15
4.7
References
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.16
Chapter
5:
Overview
of
Economic
Analysis
of
Environmental
Policy
5.1
Introduction
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.19
5.2
Economic
Framework
and
Definition
of
Terms
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.19
5.3
Baseline
Specification
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.21
5.3.1
Guiding
Principles
for
Baseline
Specification
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.21
5.3.2
Compliance
Rate
Issues
and
Baseline
Specification
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.23
5.3.3
Multiple
Rules
or
Regulations
and
Baseline
Specification
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.25
5.3.4
Summary
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.25
5.4
Predicting
Responses
to
a
New
Environmental
Policy
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.26
5.5
Analyzing
and
Presenting
Uncertainty
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.27
5.5.1
Guiding
Principles
for
Uncertainty
Analysis
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.27
Table
of
Contents
iv
5.5.2
Performing
Sensitivity
Analysis
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.28
5.5.3
Welfare
Considerations
Related
to
Uncertainty
and
Risk
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.29
5.6
Emerging
Cross­
Cutting
Issues
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.30
5.7
References
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.31
Chapter
6:
Analysis
of
Social
Discounting
6.1
Introduction
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.33
6.2
General
Considerations
in
Social
Discounting
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.34
6.2.1
Social
and
Private
Discounting
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.34
6.2.2
Methods
for
Summarizing
Present
and
Future
Costs
and
Benefits
.
.
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.
.34
6.2.3
Sensitivity
of
Present
Value
Estimates
to
the
Discount
Rate
.
.
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.36
6.2.4
Distinguishing
Discounting
from
Other
Procedures
.
.
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.37
6.3
Approaches
to
Social
Discounting
.
.
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.38
6.3.1
Intra­
Generational
Social
Discounting
.
.
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.
.38
6.3.2
Inter­
Generational
Social
Discounting
.
.
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.48
6.4
Discounting
and
Non­
Monetized
Effects
.
.
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.52
6.4.1
Perspectives
on
Discounting
Non­
Monetized
Effects
.
.
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.
.53
6.4.2
When
Discounting
Non­
Monetized
Effects
Is
Appropriate
.
.
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.
.53
6.4.3
When
Discounting
Non­
Monetized
Effects
Might
Not
Be
Appropriate
.
.
.
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.
.54
6.5
References
.
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.
.56
Chapter
7:
Analyzing
Benefits
7.1
Introduction
to
Analyzing
Benefits
.
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.59
7.2
A
Conceptual
Framework
for
Benefits
Analysis
.
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.
.60
7.2.1
Welfare
Measures:
Willingness
to
Pay
and
Willingness
to
Accept
Compensation
.
.
.
.
.
.
.
.
.60
7.2.2
Market
Goods:
Using
Consumer
Surplus
and
Demand
Curves
.
.
.
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.
.61
7.2.3
Non­
Market
Goods
.
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.
.62
7.3
The
Benefit
Analysis
Process
.
.
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.
.62
7.3.1
A
General
"
Effect­
by­
Effect"
Approach
.
.
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.62
7.3.2
Implementation
Principles
.
.
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.
.65
7.4
Types
of
Benefits
Associated
with
Environmental
Policies
.
.
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.
.66
7.4.1
Human
Health:
Mortality
Risks
.
.
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.
.68
7.4.2
Human
Health:
Morbidity
.
.
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.
.68
7.4.3
Amenities
.
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.
.69
7.4.4
Ecological
Benefits
.
.
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.
.69
7.4.5
Reduced
Materials
Damages
.
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.
.71
7.5
Methods
for
Benefits
Valuation
.
.
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.
.71
7.5.1
Market
Methods
.
.
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.
.72
7.5.2
Revealed
Preference
Methods
.
.
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.
.73
7.5.3
Stated
Preference
Methods
.
.
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.
.83
7.5.4
Benefit
Transfer
.
.
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.
.85
7.6
Values
for
Major
Benefit
Categories
.
.
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.
.
.87
7.6.1
Human
Health:
Mortality
Risks
.
.
.
.
.
.
.
.
.
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.
.
.
.87
7.6.2
Human
Health:
Morbidity
Risks
.
.
.
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.
.
.94
7.6.3
Ecological
Benefit
Valuation
.
.
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.98
7.6.4
Materials
Damage
.
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.
.100
7.7
References
.
.
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.
.101
Chapter
8:
Analyzing
Social
Costs
8.1
Introduction
.
.
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.113
8.2
The
Theory
of
Social
Cost
Analysis
.
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.113
8.2.1
An
Illustration
of
Social
Costs
and
Externalities
.
.
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.
.114
8.3
A
General
Approach
to
Social
Cost
Analysis
.
.
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.
.115
8.3.1
Estimating
the
Supply
and
Demand
Equations
of
All
the
Affected
Markets
.
.
.
.
.
.
.
.
.
.
.
.115
8.3.2
Determining
the
Different
Types
of
Social
Costs
.
.
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.
.119
8.3.3
Other
Issues
Arising
in
Presentation
of
Social
Costs
.
.
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.123
8.4
Modeling
Tools
.
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.124
8.4.1
The
Basic
Framework
.
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.124
8.4.2
The
Direct
Compliance
Cost
Method
.
.
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.124
8.4.3
Partial
Equilibrium
Analysis
.
.
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.125
8.4.4
Multi­
Market
Models
.
.
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.126
8.4.5
General
Equilibrium
Analysis
.
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.126
8.5
Estimating
the
Social
Costs
of
Alternative
Policy
Approaches
.
.
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.130
8.5.1
Direct
(
or
Standards­
Based)
Controls
.
.
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.130
8.5.2
Incentive­
Based
Controls
.
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.131
8.5.3
Voluntary
Actions
.
.
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.135
8.6
Summary
and
Conclusions
.
.
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.135
8.7
References
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.137
Chapter
9:
Distributional
Analyses:
Economic
Impact
Analyses
and
Equity
Assessments
9.1
Introduction
.
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.139
9.1.1
A
Process
for
Economic
Impact
Analyses
and
Equity
Assessments
.
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.141
9.2
Economic
Impact
Analysis
.
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.143
9.2.1
Introduction
to
Economic
Impact
Analysis
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.143
9.2.2
Statutes
and
Policies
Requiring
Examination
of
Economic
Impacts
.
.
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.143
9.2.3
Models
for
Assessing
Economic
Impacts
.
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.145
9.2.4
Calculating
Compliance
Costs
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.147
9.2.5
Screening
for
Potentially
Significant
Impacts
.
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.148
v
Table
of
Contents
9.2.6
Profile
of
Affected
Entities
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.149
9.2.7
Impacts
on
Prices
.
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.151
9.2.8
Impacts
on
Production
and
Employment
.
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.152
9.2.9
Impacts
on
Profitability
and
Plant
Closures
.
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.153
9.2.10
Impacts
on
Related
Industries
and
Consumers
.
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.155
9.2.11
Impacts
on
Innovation,
Productivity,
and
Economic
Growth
.
.
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.155
9.2.12
Impacts
on
Industry
Competitiveness
.
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.155
9.2.13
Impacts
on
Government
Entities
and
Not­
for­
Profit
Organizations
.
.
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.156
9.3
Equity
Assessment
.
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.160
9.3.1
Introduction
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.160
9.3.2
Statutes
and
Policies
Requiring
Equity
Assessment
and
Definitions
of
Sub­
Populations
.
.
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.
.161
9.3.3
Entity
Size
.
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.161
9.3.4
Minority
Status
and
Income
Level
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.164
9.3.5
Childhood
Status
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.166
9.3.6
Case
Specific
Equity
Dimensions
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.167
9.3.7
A
Framework
for
Equity
Assessment
.
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.168
9.3.8
Data
for
Conducting
Equity
Assessments
.
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.170
9.4
References
.
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.172
Chapter
10:
Using
Economic
Analyses
in
Decision
Making
10.1
Introduction
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.
.175
10.2
Communicating
Assumptions
and
Methods
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.175
10.3
Presenting
the
Results
.
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.176
10.3.1
Results
from
Benefit­
Cost
Analysis
.
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.177
10.3.2
Results
from
Economic
Impacts
Analysis
and
Equity
Assessments
.
.
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.
.177
10.3.3
Results
from
Cost­
Effectiveness
Analysis
.
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.178
10.4
Use
of
Economic
Analyses
in
Policy
Choices
.
.
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.178
10.5
References
.
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.
.179
Appendices
A.
An
SAB
Report
on
the
EPA
Guidelines
for
Preparing
Economic
Analysis
.
.
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.
.181
B.
EPA's
Response
to
SAB
Review
.
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.205
vi
Table
of
Contents
Acronyms
and
Abbreviations
vii
AC
annualized
costs
BAT
best
available
technology
BCA
benefit­
cost
analysis
BPT
best
practicable
technology
CA
conjoint
analysis
CE
certainty
equivalent
CEQ
Council
on
Environmental
Quality
CERCLA
Comprehensive
Environmental
Response,
Compensation
and
Liability
Act
CFC
chlorofluorocarbons
CFR
Code
of
Federal
Regulations
CGE
computable
general
equilibrium
COI
cost
of
illness
CPI
Consumer
Price
Index
CR
contingent
ranking
CV
contingent
valuation
DALY
disability­
adjusted
life
year
DOE
Department
of
Energy
DOT
Department
of
Transportation
DWL
dead
weight
loss
EA
economic
analysis
EBIT
earnings
before
interest
and
taxes
EEAC
Environmental
Economics
Advisory
Committee
EIA
economic
impact
analysis
EO
Executive
Order
EPA
Environmental
Protection
Agency
FINDS
Facility
Index
Data
System
FTE
full­
time
equivalent
employment
GDP
gross
domestic
product
I/
O
input­
output
IPCC
Intergovernmental
Panel
on
Climate
Change
LP
linear
programming
MR
marginal
revenue
MPC
marginal
private
costs
MSC
marginal
social
costs
MSD
marginal
social
damages
NAICS
North
American
Industrial
Classification
System
NB
net
benefits
Acronyms
and
Abbreviations
viii
Acronyms
and
Abbreviations
NEPA
National
Environmental
Policy
Act
NESHAP
National
Emission
Standard
for
Hazardous
Air
Pollutant
NFV
net
future
value
NOAA
National
Oceanic
and
Atmospheric
Administration
OCC
opportunity
cost
of
capital
OECD
Organization
for
Economic
Cooperation
and
Development
OLS
ordinary
least
squares
OMB
Office
of
Management
and
Budget
OSHA
Occupational
Safety
and
Health
Administration
PRA
Paperwork
Reduction
Act
POTW
publicly­
owned
(
wastewater)
treatment
work
PVC
present
value
of
costs
QALY
quality­
adjusted
life
year
RAPIDS
Rule
and
Policy
Information
Development
System
RFA
Regulatory
Flexibility
Act
RIA
regulatory
impact
analysis
RUM
random
utility
model
SAB
Science
Advisory
Board
SAM
social
accounting
matrix
S&
P
Standard
&
Poors
SBA
Small
Business
Administration
SBREFA
Small
Business
Regulatory
Enforcement
Fairness
Act
SIC
Standard
Industrial
Classification
TAMM
Timber
Assessment
Market
Model
TSLS
two­
stage
least
squares
UMRA
Unfunded
Mandates
Reform
Act
USC
United
States
Code
VSL
value
of
statistical
life
VSLY
value
of
statistical
life­
year
WTA
willingness
to
accept
WTP
willingness
to
pay
Acknowledgments
ix
The
preparation
of
the
Guidelines
for
Preparing
Economic
Analyses
(
or
EA
Guidelines)
was
managed
under
the
direction
of
the
Regulatory
Policy
Council,
chaired
by
the
Deputy
Administrator
of
EPA.
Initial
work
on
the
EA
Guidelines
began
in
1996
under
the
direction
of
Deputy
Administrator,
Fred
J.
Hansen
during
his
tenure
at
the
Agency,
and
concluded
in
2000
under
Deputy
Administrator,
W.
Michael
McCabe.

The
principal
manager
of
the
Economic
Consistency
Workgroup
was
Al
McGartland,
Director,
National
Center
for
Environmental
Economics.
The
Economic
Consistency
Workgroup
consists
of
staff
economists
and
policy
analysts
from
across
the
Agency,
who
contributed
to
the
development
and
review
of
the
materials
contained
in
the
EA
Guidelines.
The
primary
writers/
editors
for
the
EA
Guidelines
were
Chris
Dockins
and
Brett
Snyder.
Additional
persons
responsible
for
final
preparation
of
the
text
include:
Liwayway
Adkins,
Kathleen
Bell,
Jennifer
Bowen,
Jared
Creason,
Richard
Garbaccio,
Richard
Iovanna,
Robin
Jenkins,
Elizabeth
McClelland,
Nicole
Owens,
Michael
Podolsky,
Keith
Sargent,
Nathalie
Simon,
Lanelle
Wiggins
and
Melonie
Williams.

Representatives
from
EPA's
many
different
program
offices
contributed
to
development
and
review
of
the
EA
Guidelines
as
members
of
the
Economic
Consistency
Workgroup.
Persons
playing
more
active
roles
in
the
review
process
included:
Ghulam
Ali,
Rebecca
K.
Allen,
Paul
Balserak,
Allen
Basala,
John
B.
Bennett,
Paul
Borst,
Nick
Bouwes,
Jennifer
Bowen,
Ed
Chu,
Matthew
Clark,
Gary
Cole,
Jim
DeMocker,
Mark
Eads,
Ron
Evans,
Sandy
Evelanko,
Glenn
Farber,
John
Faulkner,
Leslye
Fraser,
Arthur
Grube,
Patricia
Hall,
Chris
Herman,
Bryan
Hubbell,
Barnes
Johnson,
Robert
Lee,
Jonathan
Libber,
Mahesh
Podar,
John
R.
Powers,
Elliot
Rosenberg,
Jean
Schumann,
Ann
Watkins,
William
Wheeler,
David
Widawsky
and
Jan
Young.

In
addition
to
EPA
staff,
a
number
of
contractors
developed
key
materials
used
as
technical
assistance
in
preparation
of
the
EA
Guidelines
and
supporting
documents.
They
include
Frank
Arnold
and
Francis
Sussman
of
ICF
Consulting,
Inc.;
Lisa
Robinson,
Marla
Markowski,
Jim
Neumann
and
Robert
Unsworth,
of
Industrial
Economics;
Leland
Deck,
Ellen
Post
and
Penny
Schafer
of
Abt
Associates;
Robert
Raucher,
Brian
Hurd,
Lauraine
Chesnut,
David
Mills,
Greg
Pitts,
Tom
Ottom
of
Stratus
Consulting;
Richard
Bishop
of
University
of
Wisconsin­
Madison;
Michael
Hanemann
of
University
of
California­
Berkeley;
David
Burmaster
of
Alceon
Corporation;
and
Anna
Alberini
of
University
of
Colorado­
Boulder.

The
Science
Advisory
Board
(
SAB)
review
of
the
EA
Guidelines
was
supervised
by
Donald
G.
Barnes,
Director
of
the
SAB
Staff
and
by
Dr.
Joan
M.
Daisy,
Chair
of
the
SAB.
Thomas
Miller
was
the
Designated
Federal
Official
for
the
SAB­
Environmental
Economics
Advisory
Committee
(
EEAC)
charged
with
conducting
the
peer
review
of
the
EA
Guidelines.
Dorothy
Clark
provided
administrative
management
support
to
the
SAB­
EEAC.

The
SAB­
EEAC
was
chaired
by
Dr.
Robert
Stavins
of
the
John
F.
Kennedy
School
of
Government,
Harvard
University.
SAB­
EEAC
members
serving
on
the
committee
during
the
review
of
the
EA
Guidelines
included:
Dr.
Nancy
Bockstael
of
University
of
Maryland­
College
Park,
Dr.
Dallas
Burtraw
of
Resources
for
the
Future,
Dr.
Trudy
Cameron
of
University
of
California­
Los
Angeles,
Dr.
Maureen
Cropper
of
the
World
Bank,
Dr.
Herman
Daly
of
University
of
Maryland­
College
Park,
Dr.
A.
Myrick
Freeman
of
Bowdoin
College,
Dr.
Lawrence
Goulder
of
Stanford
University,
Dr.
Dale
Jorgenson
of
Harvard
University,
Dr.
Paul
Joskow
of
Massachusetts
Institute
of
Technology,
Dr.
Catherine
Kling
of
Iowa
State
University,
Dr.
Charles
Kolstad
of
University
of
California­
Santa
Barbara,
Dr.
Richard
Revesz
of
New
York
University
School
of
Law,
Dr.
Jason
Shogren
of
University
of
Wyoming,
Dr.
Hilary
Sigman
of
Rutgers
University,
Dr.
Richard
Schmalensee
of
Massachusetts
Institute
of
Technology,
and
Dr.
V.
Kip
Viscusi
of
Harvard
University.
Acknowledgments
x
Acknowledgments
Background
to
the
Guidelines
for
Performing
Economic
Analyses
In
December
of
1983,
the
U.
S.
Environmental
Protection
Agency
issued
its
Guidelines
for
Performing
Regulatory
Impact
Analysis1
(
RIA
Guidelines).

Since
their
promulgation,
the
original
RIA
Guidelines
have
remained
largely
unaltered,
experiencing
only
a
few
modifications
and
additions
to
specific
sections
during
the
1980s.

Much
has
changed
since
1983,
however,
so
EPA
has
prepared
these
revised
and
updated
Guidelines
for
Preparing
Economic
Analyses
(
EA
Guidelines).
The
revised
EA
Guidelines
reflect
the
evolution
of
environmental
policy
making
and
economic
analysis
over
the
past
decade
and
a
half.

Recent
years
have
seen
an
expansion
of
the
universe
of
economic
and
social
issues
that
are
potentially
affected
by
environmental
policies.
In
1983,
the
content
of
the
analyses
required
for
RIAs
was
driven
mostly
by
Executive
Order
12291,
which
directed
federal
agencies
to
assess
the
costs,
benefits,
and
economic
impacts
of
their
rules,
and
established
a
formal
review
process
by
the
Office
of
Management
and
Budget
(
OMB).
This
process
and
its
goals
were
reaffirmed
in
1992
with
the
issuance
of
Executive
Order
12866
on
regulatory
planning
and
review.
OMB
subsequently
released
the
document
Economic
Analysis
of
Federal
Regulations
Under
Executive
Order
128662
(
or
Best
Practices),
which
served
to
illustrate
specific
techniques
and
issues
concerning
the
conduct
of
economic
analysis
in
support
of
EO
12866.
More
recently,
OMB
released
the
document
Guidelines
to
Standardize
Measures
of
Costs
and
Benefits
and
the
Format
of
Accounting
Statements3
(
or
OMB
Guidelines)
which
currently
serves
as
guidelines
to
federal
agencies
on
economic
analysis.

In
addition
to
requirements
to
prepare
economic
analyses
set
forth
by
Executive
Order,
economic
assessments
are
also
called
for
under
various
administrative
statutes.
For
example,
agencies
are
explicitly
directed
to
examine
whether
their
policies
impose
new
"
unfunded
mandates"
on
state,
local,
and
tribal
governments,
and
to
review
economic
impacts
on
small
businesses,
governments,
and
nonprofit
enterprises
under
the
Unfunded
Mandates
Reform
Act
of
1995
(
P.
L.
104­
4)
and
the
Regulatory
Flexibility
Act,
as
amended
by
the
Small
Business
Regulatory
Enforcement
Fairness
Act
(
5
U.
S.
C.
601­
612).

Policy
makers
have
also
extended
the
scope
of
relevant
effects
to
be
considered
beyond
these
mandatory
1
Chapter
1
Chapter
1:
Introduction
1
U.
S.
Environmental
Protection
Agency,
Guidelines
for
Performing
Regulatory
Impact
Analyses.
EPA­
230­
84­
003,
December
1983.
Reprinted
with
Appendices
in
March
1991.

2
U.
S.
Office
of
Management
and
Budget,
Economic
Analysis
of
Federal
Regulations
Under
Executive
Order
12866,
January
11,
1996.
This
"
Best
Practices"
document
can
be
found
at
the
U.
S.
White
House,
Office
of
Management
and
Budget
website:
http://
www.
whitehouse.
gov/
OMB/
inforeg/
riaguide.
html
under
the
section
titled
"
Regulatory
Policy"
(
accessed
8/
28/
2000).

3
U.
S.
Office
of
Management
and
Budget,
M­
00­
08
Guidelines
to
Standardize
Measures
of
Costs
and
Benefits
and
the
Format
of
Accounting
Statements,
March
22,
2000.
The
OMB
Guidelines
serves
to
implement
Section
638(
c)
of
the
1999
Omnibus
Consolidated
and
Emergency
Supplemental
Appropriations
Act
and
Section
628(
c)
of
the
Fiscal
Year
2000
Treasury
and
General
Government
Appropriations
Act.
They
require
OMB
to
issue
guidelines
to
help
agencies
estimate
the
benefits
and
costs
of
federal
regulations
and
paperwork
and
summarize
the
results
of
the
associated
analysis.
The
OMB
Guidelines
can
be
found
at
the
U.
S.
White
House,
Office
of
Management
and
Budget
website:
http://
www.
whitehouse.
gov/
OMB/
memoranda/
index.
html
under
the
section
titled
"
Selected
Memorandum
to
Heads
of
Federal
Departments
and
Agencies"
(
accessed
8/
28/
2000).
assessments.
For
example,
the
Pollution
Prevention
Act
was
passed
in
1990
and
the
Agency
has
undertaken
new
initiatives
that
explored
voluntary,
non­
regulatory
approaches
to
address
past
and
potential
future
pollution
sources.
Economic
assessment
of
these
types
of
actions
can
provide
useful
information
on
the
economic
efficiency
of
allocating
society's
resources
in
these
ways.

The
EA
Guidelines
have
been
updated
to
keep
pace
with
the
evolving
emphases
policy
makers
place
on
different
economic
and
social
concerns
affected
by
environmental
policies.
Underlying
this
exercise
is
the
recognition
that
a
thorough
and
careful
economic
analysis
is
an
important
component
in
designing
sound
environmental
policies.
Preparing
high
quality
economic
analyses
can
greatly
enhance
the
effectiveness
of
environmental
policies
by
providing
policy
makers
with
the
ability
to
systematically
assess
the
consequences
of
regulatory
and
non­
regulatory
actions.
An
economic
analysis
can
describe
the
implications
of
policy
alternatives
not
just
for
economic
efficiency,
but
for
the
magnitude
and
distribution
of
an
array
of
impacts.
Economic
analyses
also
serve
as
a
mechanism
for
organizing
information
carefully.
Thus,
even
when
data
are
insufficient
to
support
particular
types
of
economic
analyses,
the
conceptual
scoping
exercise
may
provide
useful
insights.

The
RIA
Guidelines
focused
appropriately
not
only
on
what
was
required
for
assessing
costs,
benefits,
and
economic
impacts
of
policies,
but
also
on
the
basic
technical
procedures
for
doing
so.
Over
the
past
15
years,
however,
economic
science
has
developed
new
techniques
for
benefits
estimation,
different
economic
models
for
assessing
costs
and
other
effects,
and
greatly
expanded
data
sources
and
related
guidance
materials.
These
are
all
reflected
in
this
document.

As
a
result
of
these
modifications
and
updates,
the
new
EA
Guidelines
will
continue
to
serve,
as
always,
to
ensure
that
the
EPA's
economic
analyses
are
prepared
to
inform
its
policy
making
processes
and
satisfy
OMB's
requirements
for
regulatory
review.
The
new
EA
Guidelines
also
seek
to
establish
an
interactive
policy
development
process
between
analysts
and
decision
makers
through
an
expanded
set
of
cost,
benefit,
economic
impacts,
and
equity
effects
assessments,
an
up­
to­
date
encapsulation
of
environmental
economics
theory
and
practice,
and
an
enhanced
emphasis
on
practical
applications.
The
Scope
of
the
EA
Guidelines
The
focus
of
the
EA
Guidelines
is
on
the
economic
analyses
typically
conducted
for
environmental
policies
using
regulatory
or
non­
regulatory
management
strategies.
Other
guidance
documents
exist
for
related
analyses,
some
of
which
are
inputs
to
economic
assessments.
No
attempt
is
made
here
to
summarize
these
other
guidance
materials
Instead,
their
existence
and
content
are
noted
in
the
appropriate
sections.
The
EA
Guidelines
follow
generally
the
outline
of
OMB's
Best
Practices
and
the
OMB
Guidelines,
except
insofar
as
these
guidelines
embody
assessment
principles
and
policy
advice
developed
recently
by
EPA
for
its
economic
analyses.

As
with
the
previous
RIA
Guidelines,
the
presentation
of
economic
concepts
and
applications
in
this
document
assumes
the
reader
has
some
background
in
microeconomics
as
applied
to
environmental
and
natural
resource
policies.
Thus,
to
fully
understand
and
apply
the
approaches
and
recommendations
presented
in
the
EA
Guidelines
readers
should
be
familiar
with
basic
applied
microeconomic
analysis,
the
concepts
and
measurement
of
consumer
and
producer
surplus,
and
the
economic
foundations
of
benefit­
cost
evaluation.
Persons
lacking
these
skills,
but
seeking
to
better
understand
economics,
will
require
an
alternative
presentation
of
the
materials
contained
in
this
document.
Supplemental
written
material
will
be
prepared
to
accompany
this
document,
including
training
materials
developed
to
reach
a
wider
audience
of
individuals
responsible
for
using
the
types
of
economic
tools
and
information
described
here.

The
EA
Guidelines
are
designed
to
provide
assistance
to
analysts
in
the
economic
analysis
of
environmental
policies
but
they
do
not
provide
a
rigid
blueprint
or
a
"
cookbook
for
all
policy
assessments.
The
most
productive
and
illuminating
approaches
for
particular
situations
will
depend
on
a
variety
of
case­
specific
factors
and
will
require
professional
judgment
to
apply.
The
EA
Guidelines
should
be
viewed
as
a
summary
of
analytical
methodologies,
empirical
techniques,
and
data
sources
that
can
assist
in
performing
economic
analyses
of
environmental
policies.
When
drawing
upon
these
resources,
there
is
no
substitute
for
reviewing
the
original
source
materials.

2
Chapter
1:
Introduction
In
all
cases,
the
EA
Guidelines
recommend
adhering
to
the
following
general
principles
as
stated
by
OMB
(
EO
12866,
Introduction):

"'
Analysis
of
the
risks,
benefits,
and
costs
associated
with
regulation
must
be
guided
by
the
principles
of
full
disclosure
and
transparency.
Data,
models,
inferences,
and
assumptions
should
be
identified
and
evaluated
explicitly,
together
with
adequate
justifications
of
choices
made,
and
assessments
of
the
effects
of
these
choices
on
the
analysis.
The
existence
of
plausible
alternative
models
or
assumptions,
and
their
implications,
should
be
identified.
In
the
absence
of
adequate
valid
data,
properly
identified
assumptions
are
necessary
for
conducting
an
assessment."

"
Analysis
of
the
risks,
benefits,
and
costs
associated
with
regulation
inevitably
also
involves
uncertainties
and
requires
informed
professional
judgments.
There
should
be
balance
between
thoroughness
of
analysis
and
practical
limits
to
the
agency's
capacity
to
carry
out
analysis.
The
amount
of
analysis
(
whether
scientific,
statistical,
or
economic)
that
a
particular
issue
requires
depends
on
the
need
for
more
thorough
analysis
because
of
the
importance
and
complexity
of
the
issue,
the
need
for
expedition,
the
nature
of
the
statutory
language
and
the
extent
of
statutory
discretion
and
the
sensitivity
of
net
benefits
to
the
choice
of
regulatory
alternatives."'

Thus,
economic
analyses
should
always
acknowledge
and
characterize
important
uncertainties
that
arise
throughout
the
analysis.
Economic
analyses
should
clearly
state
the
judgments
and
decisions
associated
with
these
uncertainties
and
should
identify
the
implications
of
these
choices.
When
assumptions
are
necessary
in
order
to
carry
out
the
analysis,
the
reasons
for
those
assumptions
must
be
stated
explicitly
and
clearly.
Further,
economic
analyses
of
environmental
policies
should
be
flexible
enough
to
be
tailored
to
the
specific
circumstances
of
a
particular
policy,
and
to
incorporate
new
information
and
advances
in
the
theory
and
practice
of
environmental
policy
analysis.
Organization
of
the
EA
Guidelines
The
remainder
of
this
document
is
organized
into
nine
main
chapters
as
follows:

Chapter
2:
Statutory
and
Executive
Order
Requirements
for
Conducting
Economic
Analyses
reviews
the
major
statutes
and
other
directives
mandating
certain
assessments
of
the
consequences
of
policy
actions;

Chapter
3:
Statement
of
Need
for
the
Proposal
provides
guidance
on
procedures
and
analyses
for
clearly
identifying
the
environmental
problem
to
be
addressed
and
for
justifying
federal
intervention
to
correct
it;

Chapter
4:
Regulatory
and
Non­
Regulatory
Approaches
to
Consider
discusses
the
variety
of
regulatory
and
non­
regulatory
approaches
analysts
and
policy
makers
ought
to
consider
in
developing
strategies
for
environmental
improvement;

Chapter
5:
Overview
of
Economic
Analysis
of
Environmental
Policy
provides
a
theoretical
overview
of
environmental
economic
analyses,
as
well
as
guidance
concerning
baseline
specification
and
the
treatment
of
uncertainty;

Chapter
6:
Analysis
of
Social
Discounting
presents
a
review
of
discounting
procedures
and
provides
guidance
on
social
discounting
in
conventional
contexts
and
over
very
long
time
horizons;

Chapter
7:
Analyzing
Benefits
provides
guidance
for
assessing
the
benefits
of
environmental
policies
including
various
techniques
of
valuing
risk­
reduction
and
other
benefits;

Chapter
8:
Analyzing
Social
Costs
presents
the
basic
theoretical
approach
for
assessing
the
social
costs
of
environmental
policies
and
describes
how
this
can
be
applied
in
practice;

Chapter
9:
Distributional
Analyses
provides
guidance
for
performing
a
variety
of
different
assessments
of
the
economic
impacts
and
equity
effects
of
environmental
policies;
and
3
Chapter
1:
Introduction
Chapter
1:
Introduction
4
Chapter
10:
Using
Economic
Analyses
in
Decision
Making
concludes
the
main
body
of
the
EA
Guidelines
with
suggestions
for
evaluating
different
policy
approaches
and
options,
and
for
presenting
the
quantified
and
unquantified
results
of
the
various
economic
analyses
to
policy
makers.
Policy
makers
need
information
on
the
benefits,
costs,
and
other
effects
of
alternative
options
for
addressing
a
particular
environmental
problem
in
order
to
make
sound
policy
decisions.
In
addition,
various
statutes
specifically
require
economic
analyses
of
policy
actions.
General
mandates
may
also
direct
agencies
to
conduct
specific
types
of
economic
analyses.
In
some
cases,
agencies
have
established
their
own
requirements
for
certain
types
of
assessments
of
their
policies.
This
chapter
discusses
specific
requirements
that
apply
to
all
of
EPA's
programs.
1
OMB's
basic
requirements
for
regulatory
review,
including
their
Best
Practices
and
OMB
Guidelines
documents,
have
helped
to
shape
EPA's
methodological
and
empirical
approaches
for
conducting
economic
analyses.
Several
new
mandates
to
conduct
specific
economic
assessments
of
environmental
policies
have
also
recently
been
enacted.
Many
of
the
mandates
that
introduce
economic
analyses
requirements
of
policies
are
briefly
reviewed
here.
2
In
each
case,
citations
for
the
relevant
mandates
or
statutes
and
references
to
applicable
EPA
guidelines
are
provided
3
Executive
Order
12866,
"
Regulatory
Planning
and
Review"
requires
analysis
of
benefits
and
costs
for
all
significant
regulatory
actions.
The
Regulatory
Working
Group
has
prepared
general
guidance
for
complying
with
the
requirements
of
EO
12866.4
EO
12866
requires
a
statement
of
the
need
for
the
proposed
action,
examination
of
alternative
approaches,
and
analysis
of
social
benefits
and
costs.
Chapters
3
through
8
of
this
document
describe
methods
for
meeting
these
requirements.
EO
12866
also
states
that
the
distributional
and
equity
effects
of
a
rule
should
be
considered.
Chapter
9
describes
methods
for
analyzing
and
assessing
these
effects.

The
Unfunded
Mandates
Reform
Act
of
1995
(
P.
L.
104­
4)
directs
agencies
to
assess
the
effects
of
federal
regulatory
actions
on
state,
local,
and
tribal
governments,
and
the
private
sector.
Agencies
are
to
obtain
meaningful
input
from
state,
local,
and
tribal
governments
for
rules
containing
"
significant
federal
intergovernmental
mandates."
These
are
federal
mandates
which
may
result
in
the
expenditure
by
state,

5
Chapter
2
Chapter
2:
Statutory
and
Executive
Order
Requirements
for
Conducting
Economic
Analyses
1
EPA
personnel
seeking
information
on
EPA's
policies
and
guidelines
applicable
to
rule
development
can
be
found
at
the
following
EPA
Intranet
website
http://
intranet.
epa.
gov/
rapids
(
accessed
8/
18/
2000,
internal
EPA
document).
Many
of
the
citations
included
in
this
section
can
be
found
at
this
site.
Note,
this
website
and
other
additional
websites
referenced
in
this
document
are
located
on
EPA's
Intranet
website
and
are
limited
to
use
by
EPA
personnel.
When
cited
in
this
document,
EPA
Intranet
websites
will
be
labeled
as
"
internal
EPA
document."

2
Statutory
provisions
that
require
economic
analysis
but
that
apply
only
to
specific
EPA
programs
are
not
described
here.
However,
analysts
should
carefully
consider
the
relevant
program­
specific
statutory
requirements
when
designing
and
conducting
economic
analyses,
recognizing
that
these
requirements
may
mandate
specific
economic
analyses.

3
More
information
on
some
of
these
program­
specific
mandates
can
be
found
in
Chapter
9
of
this
document.

4
U.
S.
Office
of
Management
and
Budget,
"
Memorandum
for
Members
of
the
Regulatory
Working
Group:
Economic
Analysis
of
Federal
Regulations
Under
Executive
Order
No.
12866,"
January
11,
1996.
The
guidance
also
addresses
the
requirements
of
the
Unfunded
Mandates
Reform
Act
and
the
Regulatory
Flexibility
Act.
local,
and
tribal
governments,
in
the
aggregate,
or
by
the
private
sector,
of
$
100
million
or
more
in
any
one
year.
5
UMRA
also
directs
agencies
to
assess
the
effects
of
federal
regulatory
actions
that
will
have
a
significant
or
unique
effect
on
small
governments.
OMB
has
provided
general
guidance
on
complying
with
UMRA.
6
Executive
Order
13132,
"
Federalism"
requires
consultation
with
affected
state
and
local
governments
on
rules
that
have
federalism
implications
 
that
is
regulations
and
policy
statements
"
that
have
substantial
direct
effects
on
states
(
and
local
governments),
on
the
relationship
between
the
national
government
and
the
states,
or
on
the
distribution
of
power
and
responsibilities
among
the
various
levels
of
government
EO
13132
also
imposes
additional
consultation
obligations
on
agencies
if
they
promulgate
regulations
with
federalism
implications
that
either:
(
1)
impose
substantial
direct
compliance
costs
on
state
and
local
governments
not
required
by
statute
and
do
not
provide
funds
to
cover
these
costs,
or
(
2)
preempt
state
or
local
laws.
7
The
Regulatory
Flexibility
Act
of
1980
(
5
U.
S.
C.
610­
612)
(
RFA),
as
amended
by
The
Small
Business
Regulatory
Enforcement
Fairness
Act
of
1996
(
P.
L.
96­
354)
(
SBREFA)
requires
that
federal
agencies
determine
if
a
regulation
will
have
a
significant
economic
impact
on
a
substantial
number
of
small
entities
(
including
small
businesses,
governments
and
non­
profit
organizations.)
If
a
regulation
will
have
such
an
impact,
agencies
must
prepare
a
Regulatory
Flexibility
Analysis
and
comply
with
a
number
of
procedural
requirements
to
solicit
and
consider
flexible
regulatory
options
that
minimize
adverse
economic
impacts
on
small
entities.
EPA
has
prepared
Revised
Guidance
on
complying
with
the
RFA
and
SBREFA
requirements.
8
Chapter
1
of
that
document
provides
guidance
on
the
analytical
requirements,
including
thresholds
for
determining
"
significant
impact,"
"
substantial
number,"
and
"
small
entities,"
and
recommended
quantitative
measures
for
evaluating
economic
impacts
on
small
entities.

Executive
Order
12898,
"
Federal
Actions
to
Address
Environmental
Justice
in
Minority
Populations
and
Low­
Income
Populations"
requires
federal
agencies
to
identify
and
address,
as
appropriate,
disproportionately
high
and
adverse
human
health
or
environmental
effects
of
its
programs
policies,
and
activities
on
minority
populations
and
low
income
populations.
EO
12898
also
requires
the
same
consideration
for
Native
American
programs
EPA
and
the
Council
on
Environmental
Quality
(
CEQ)
have
prepared
guidance
for
addressing
environmental
justice
concerns
in
the
context
of
NEPA
requirements.
9
These
materials
provide
definitions
of
key
phrases
in
the
Executive
Order,
which
draw
on
draft
guidance
prepared
by
an
interagency
task
force.
10
Executive
Order
13045,
"
Protection
of
Children
from
Environmental
Health
Risks
and
Safety
Risks"
requires
agencies
to
evaluate
the
health
or
safety
effects
of
planned
regulations
on
children.
For
economically
significant
rules
that
are
subject
to
EO
13045,
agencies
are
required
to
explain
why
the
planned
regulation
is
preferable
to
other
potentially
6
Chapter
2:
Requirements
for
Conducting
Economic
Analyses
5
U.
S.
Environmental
Protection
Agency,
EPA
Guidance
­
Unfunded
Mandates
Reform
Act
of
1995,
Interim
Guidance,
March
23,
1995.

6
U.
S.
Office
of
Management
and
Budget,
"
Guidance
for
Implementing
Title
II
of
S.
1."
Memorandum
from
Sally
Katzen,
Administrator,
Office
of
Information
and
Regulatory
Affairs,
March
31,
1995.

7
U.
S.
Environmental
Protection
Agency,
Interim
Guidance
on
Executive
Order
13132:
Federalism,
February
2000.

8
U.
S.
Environmental
Protection
Agency,
EPA
Revised
Interim
Guidance
for
EPA
Rulewriters:
Regulatory
Flexibility
Act
as
amended
by
the
Small
Business
Regulatory
Enforcement
Fairness
Act,
March
29,
1999.

9
For
more
information
see
U.
S.
Environmental
Protection
Agency,
Interim
Final
Guidance
for
Incorporating
Environmental
Justice
Concerns
in
EPA's
NEPA
Compliance
Analyses,
Office
of
Federal
Activities,
April
1998,
and
Council
on
Environmental
Quality,
Guidance
for
Addressing
Environmental
Justice
under
the
National
Environmental
Policy
Act
(
NEPA),
March
1998.

10
Interagency
Working
Group
on
Environmental
Justice,
Final
Guidance
for
Federal
Agencies
on
Key
Terms
in
Executive
Order
12898,
August
8,
1995.
effective
and
reasonably
feasible
alternatives
considered
by
the
agency.
EPA
has
prepared
guidance
on
compliance
with
EO
13045.11
Materials
in
Chapter
9
provide
suggestions
for
the
types
of
questions
analysts
could
ask
to
characterize
risks
to
children,
and
refers
analysts
to
the
various
EPA
guidance
documents
on
risk
assessment
for
information
on
analytic
methodologies
While
EO
13045
primarily
addresses
risk
rather
than
economic
analyses,
economic
analyses
may
be
needed
to
determine
whether
EO
13045
requirements
apply
to
a
specific
rule.

Executive
Order
13084,
"
Consultation
and
Coordination
with
Indian
Tribal
Governments"
requires
agencies
to
recognize
the
unique
legal
relationship
with
Indian
tribal
governments
set
forth
in
the
Constitution
and
other
treaties
and
documents.
The
order
seeks
to
establish
a
regular
and
meaningful
consultation
and
collaboration
with
Indian
tribal
governments
in
the
development
of
regulations,
imposition
of
unfunded
mandates,
and
process
for
seeking
waivers
from
federal
requirements.
The
order
seeks
to
encourage
cooperation
of
tribal
governments
in
development
of
regulations
that
significantly
or
uniquely
affect
their
communities,
including
use
of
consensual
mechanisms
and
negotiated
rulemaking.

7
Chapter
2:
Requirements
for
Conducting
Economic
Analyses
11
U.
S.
Environmental
Protection
Agency,
EPA
Rule
Writer's
Guide
to
Executive
Order
13045:
Guidance
for
Considering
Risks
to
Children
During
the
Establishment
of
Public
Health­
Related
and
Risk­
Related
Standards,
Interim
Final
Guidance,
April
30,
1998.
Chapter
2:
Requirements
for
Conducting
Economic
Analyses
8
3.1
Introduction
An
appropriate
point
of
departure
for
economic
analyses
of
an
environmental
policy
is
a
clear
statement
of
the
need
for
policy
action.
Key
components
of
this
discussion
include
an
examination
of
the
nature
of
the
pollution
problem
to
be
addressed,
an
analysis
of
the
reasons
existing
legal
and
other
institutions
have
failed
to
correct
the
problem,
and
a
justification
for
federal
intervention
instead
of
other
alternatives.
Statutory
and
judicial
requirements
that
mandate
the
promulgation
of
particular
policies
or
the
evaluation
of
specific
effects
are
also
key
factors
in
motivating
certain
analyses
and
policy
actions.
In
some
instances
statutes
prohibit
the
use
of
certain
types
of
analyses
in
policy
making.
In
these
cases,
the
guidance
presented
in
this
document
should
be
applied
selectively
to
be
consistent
with
such
mandates

3.2
Problem
Definition
The
initial
problem
definition
discussion
should
briefly
review
the
nature
of
the
environmental
problem
to
be
addressed.
The
following
considerations
are
often
relevant:

primary
pollutants
causing
the
problem
and
their
magnitude;

media
through
which
exposures
or
damages
take
place;

private
and
public
sector
sources
responsible
for
creating
the
problem;

human
exposures
involved
and
the
health
effects
due
to
those
exposures;
non­
human
resources
affected
and
the
harm
that
results;

expected
evolution
of
the
pollution
problem
over
the
time
horizon
of
the
analysis;

current
control
and
mitigation
techniques;
and
the
amount
or
proportion
(
or
both)
of
the
environmental
problem
likely
to
be
corrected
by
federal
action.

3.3
Reasons
for
Market
or
Institutional
Failure
Following
this
concise
problem
definition
summary
should
be
an
examination
of
the
reasons
why
the
market
and
other
public
and
private
sector
institutions
have
failed
to
correct
the
problem.
This
component
should
be
viewed
as
a
key
part
of
the
process
of
environmental
policy
development
because
the
underlying
failure
itself
often
suggests
the
most
appropriate
remedy
for
the
problem.

Four
categories
of
"
market
failure"
are
discussed
in
OMB's
Best
Practices
in
the
sections
titled
externalities
market
power,
natural
monopoly,
and
information
asymmetry.
For
environmental
conditions,
externalities
are
the
most
likely
causes
of
the
failure
of
private
and
public
sector
institutions
to
correct
pollution
damages.
However,
information
asymmetries
and
even
pre­
existing
government­
induced
distortions
can
also
be
responsible
for
these
problems.

Externalities
can
occur
for
many
reasons.
Transactions
costs,
for
example,
can
make
it
difficult
for
injured
parties
to
use
legal
or
other
means
to
9
Chapter
3
Chapter
3:
Statement
of
Need
for
the
Proposal
cause
polluters
to
internalize
the
damages
they
cause.
A
similar
result
can
occur
when
property
rights
to
the
media
or
resources
harmed
are
held
in
common
or
are
poorly
defined.
Externalities
can
also
arise
because
tracing
the
causal
connections
from
activities
that
pose
environmental
risks
to
the
resulting
damages
can
be
very
difficult
and
often
involve
long
time
periods.

A
comprehensive
examination
of
the
market's
failure
to
address
a
specific
environmental
problem
involves
more
than
a
statement
that
harms
exist.
Economic
analyses
should
explore,
for
example,
why
transactions
costs
are
high
or
why
property
rights
are
difficult
to
assign
clearly.
Similar
analyses
are
appropriate
for
situations
in
which
other
factors
are
responsible
for
the
failure
of
the
market
or
other
public
and
private
sector
institutions
to
address
environmental
problems.

3.4
Need
for
Federal
Action
The
final
component
of
this
initial
statement
of
the
need
for
the
proposal
is
an
analysis
of
why
a
federal
remedy
is
necessary
instead
of
actions
by
private
and
other
public
sector
entities,
such
as
the
judicial
system
and
state
and
local
governments.
Federal
involvement
is
often
required
by
pollution
that
crosses
jurisdictional
boundaries,
by
international
environmental
problems,
and
by
statutory
and
other
authorities.
Economic
analyses
should
make
clear
the
basis
for
federal
involvement
by
comparing
it
with
the
performance
of
a
variety
of
realistic
alternatives
that
rely
on
other
institutions
and
arrangements.
This
discussion
should
also
verify
that
the
proposed
action
is
within
the
relevant
statutory
authorities
and
that
the
results
of
the
policy
will
be
preferable
to
no
action.
Aspects
of
the
regulations
being
proposed
and
promulgated
that
are
not
discretionary,
but
are
dictated
by
statutory
requirements,
should
be
identified,
as
this
may
have
an
influence
on
the
development
of
the
economic
analysis
and
presentation
of
the
results.
1
10
Chapter
3:
Statement
of
Need
1
The
reader
is
also
referred
to
Executive
Order
13132
on
"
Federalism"
for
the
introductory
statements
regarding
principles
of
federalism
and
the
section
describing
the
doctrines
of
preemption.
4.1
Introduction
Once
the
need
for
federal
policy
action
to
address
an
environmental
problem
has
been
established,
economic
analyses
should
define
and
evaluate
a
range
of
possible
regulatory
and
non­
regulatory
approaches.
Many
different
approaches
may
help
achieve
efficient
environmental
protection.
It
is
largely
the
analyst's
responsibility
to
consider
and
characterize
these
approaches
and
then
to
present
feasible
alternatives
for
decision
makers
to
consider
early
in
the
policy
making
process.
The
analyst
should
also
be
cognizant
of
constraints
that
may
be
placed
on
the
use
of
non­
regulatory
approaches
for
addressing
a
specific
environmental
problem.
Market­
oriented
options,
for
example,
may
not
be
consistent
with
statutory
mandates
and
the
best
response
to
an
environmental
problem
might
require
action
outside
the
authority
of
the
relevant
statute.

This
chapter
briefly
describes
several
of
these
approaches,
but
it
does
not
attempt
to
detail
the
relative
merits
of
putting
them
into
practice
for
particular
EPA
policy
initiatives.
The
goal
here
is
to
introduce
several
of
the
terms
and
concepts
to
analysts
and
to
provide
references
that
describe
the
conceptual
foundations
of
each
approach.
1
For
some
approaches,
this
chapter
provides
references
on
existing
applications
to
environmental
regulatory
programs.
Four
general
types
of
approaches
are
described
below.
The
chapter
concludes
with
some
notes
on
fine­
tuning
policy
approaches.
4.2
Traditional
Design­
Based
Command
and
Control
Design­
based
command
and
control
regulations
have
a
long
history
in
environmental
policy,
generally
taking
the
form
of
specifying
certain
technologies
or
designs.
These
regulations
usually
impose
the
same
requirements
on
all
sources,
although
new
and
existing
sources
as
groups
are
frequently
subject
to
different
standards.
2
An
advantage
of
the
approach
is
its
relative
ease
of
compliance
monitoring
and
enforcement
Nonetheless,
command
and
control
regulations
may
be
less
cost­
effective
than
other
approaches
meaning
that
the
same
environmental
protection
might
be
achieved
at
a
lower
cost
or
more
environmental
protection
might
be
secured
for
the
same
cost.
Also,
command
and
control
regulations
may
not
readily
accommodate
or
encourage
technological
innovation
or
may
fail
to
provide
incentives
to
reduce
pollution
beyond
what
would
be
undertaken
to
comply
with
the
standard.
3
4.3
Performance­
Oriented
Approaches
Rather
than
mandating
a
particular
technology
for
compliance,
performance­
based
standards
specify
a
source's
maximum
allowable
level
of
pollution
and
11
Chapter
4
Chapter
4:
Regulatory
and
Non­
Regulatory
Approaches
to
Consider
1
Baumol
and
Oates
(
1993),
particularly
Chapters
10­
14,
is
a
useful
general
reference
on
the
economic
foundations
of
many
of
these
approaches.

2
For
a
discussion
on
this
subject
and
ways
these
types
of
programs
lead
to
this
result,
see
Helfand
(
1992).

3
For
some
theoretical
analyses
of
this
point,
see
Malueg
(
1989),
Milliman
and
Prince
(
1989),
and
Jung
et
al.
(
1996).
A
recent
review
of
empirical
literature
can
be
found
in
Jaffe
and
Stavins
(
1995).
then
allows
the
source
to
meet
this
target
in
whatever
manner
it
chooses
(
e.
g.,
the
least
costly
and
most
flexible
manner
available).
This
approach
has
the
advantage
of
allowing
sources
to
effectively
tailor
pollution
control
requirements
to
their
particular
circumstances
and
encourages
and
accommodates
technological
innovation.
Often,
performance­
based
standards
provide
the
opportunity
to
achieve
the
same
goals
more
cost­
effectively
than
command
and
control
approaches.
However,
these
approaches
may
place
additional
burdens
on
monitoring
to
ensure
compliance
and
do
not
introduce
incentives
to
reduce
emissions
or
hazard
levels
beyond
prescribed
requirements.

4.4
Market­
Oriented
Approaches
A
wide
variety
of
methods
for
environmental
protection
fall
under
the
general
classification
of
market­
oriented
approaches.
In
one
manner
or
another,
each
of
these
makes
use
of
private
sector
incentives,
information,
and
decision
making
in
the
pursuit
of
environmental
improvement.
Market­
oriented
approaches
can
differ
from
more
traditional
regulatory
methods
with
regard
to
their
economic
efficiency
and
distribution
of
benefits
and
costs
within
the
economy.
These
approaches
include,
for
example:

taxes,
fees,
or
charges;

subsidies;

marketable
permit
systems;

deposit­
refund
systems;

offsets
and
bubbling;

insurance/
financial
assurance
requirements;

liability
rules;
and
information
provision.

Some
aspects
to
consider
when
choosing
among
these
approaches
as
potential
regulatory
options
are
briefly
described
below.
4
4.4.1
Descriptions
of
Market­
Based
Approaches
Taxes,
fees,
charges,
and
subsidies
generally
"
price"
pollution
and
leave
decisions
about
the
level
of
emissions
to
each
source.
For
example,
emissions
of
a
toxic
substance
might
be
subject
to
an
environmental
charge
based
on
the
damages
these
emissions
cause.
Sources
would
individually
decide
how
much
to
control
these
emissions
based
on
the
costs
of
the
control
and
the
magnitude
of
the
charge.
Taxes,
fees,
and
charges
have
some
highly
desirable
theoretic
properties,
including
encouraging
pollution
control
activities.
However,
they
also
sometimes
impose
substantially
different
burdens
on
pollution
sources
than
do
other
approaches.
One
example
is
the
potential
liability
that
taxes,
fees,
and
charges
impose
for
residual
pollution,
which
other
approaches
allow
without
charge.
Issues
surrounding
the
use
of
these
approaches
concern
the
collection
of
revenues
and
the
distribution
of
economic
"
rents"
from
these
programs,
including
deciding
who
should
collect
these
fees
(
e.
g.,
government
or
private
sector)
and
what
to
do
with
revenues
raised
by
these
mechanisms
(
e.
g.,
reduce
other
types
of
taxes
on
the
regulated
entities
or
redistribute
the
funds
to
finance
other
public
services).

Marketable
permit
systems
provide
environmental
improvements
similar
to
those
provided
by
taxes,
fees,
and
charges.
They
function
differently,
however,
in
that
the
marketable
permits
approach
sets
the
total
quantity
of
emissions,
while
taxes,
fees,
and
charges
set
the
effective
"
price"
of
emitting
pollutants.
5
If
the
permits
are
auctioned
or
otherwise
sold
to
pollution
sources,
the
12
Chapter
4:
Approaches
to
Consider
4
This
document
does
not
go
into
the
level
of
detail
necessary
to
fully
describe
and
provide
a
means
of
evaluating
the
relative
merits
of
different
regulatory
and
non­
regulatory
approaches.
Instead,
there
is
a
growing
literature
on
applied
market­
oriented
approaches
for
environmental
protection
that
should
be
reviewed
prior
to
considering
these
regulatory
approaches.
For
example,
Anderson
and
Lohof
(
1997)
and
Stavins
(
1998a,
1998b)
provide
recent
compilations
of
information
on
the
theory
behind
and
empirical
use
of
economic
incentives
systems
applied
to
environmental
protection.
Additional
sources
for
details
on
incentive
systems
include
Moore
(
1989),
Tietenberg
(
1985,
1992),
EPA
(
1991),
OECD
(
1989,
1991),
and
proceedings
published
under
the
"
Project
88"
forum
sponsored
by
the
Center
for
Science
and
International
Affairs,
Harvard
University
(
Stavins
(
1988,
1991)).
These
sources,
and
the
references
they
contain,
should
be
consulted
for
additional
information
concerning
the
design,
operation,
and
performance
of
many
of
these
instruments.

5
The
U.
S.
Acid
Rain
Program
established
under
Title
IV
of
the
1990
Clean
Air
Act
Amendments
is
a
good
example
of
a
marketable
permit
program.
For
recent
economic
analyses
of
this
program
see
Joskow
et
al
(
1998)
and
Stavins
(
1998c).
For
more
information
on
the
program
itself
visit
EPA's
Acid
Rain
website
at
http://
www.
epa.
gov/
acidrain
(
accessed
8/
28/
00).
distributional
consequences
of
this
approach
are
similar
to
those
experienced
when
using
taxes,
fees,
and
charges.
However,
if
new
entrants
must
obtain
permits
from
existing
sources,
then
the
distributional
consequences
of
permit
systems
will
differ
from
those
likely
to
arise
after
the
introduction
of
technology­
based
standards.
The
potential
to
establish
a
barrier
to
entry
on
the
basis
of
limiting
quantities
(
e.
g.,
if
"
grandfathering"
of
current
emission
sources
is
part
of
the
program)
can
affect
the
eventual
distribution
of
revenues,
expenses,
and
"
rents"
within
the
economy.
The
ultimate
distribution
of
"
rents"
under
these
programs
can
be
an
important
feature
of
market­
based
approaches
and,
therefore,
should
be
considered
when
comparing
these
with
more
traditional
regulatory
approaches.

Deposit­
refund
systems
are
like
specialized
forms
of
taxes.
The
deposit
operates
as
a
tax
and
the
refund
serves
as
an
offsetting
subsidy.
Many
good
examples
of
depositrefund
systems
exist,
most
of
which
are
geared
toward
reducing
litter
and
increasing
the
recycling
rates
of
certain
components
of
municipal
solid
waste.
6
Perhaps
the
most
prominent
examples
are
those
programs
associated
with
newspapers,
plastic,
and
glass
bottles.

Offsets
and
bubbling
allow
restricted
forms
of
emissions
trading
across
or
within
sources.
This
approach
has
seen
widespread
use,
mostly
in
controlling
air
pollution
in
nonattainment
areas.
An
offset,
for
example,
would
allow
a
new
source
of
emissions
in
an
airshed
to
negotiate
with
an
existing
source
to
secure
reduction
in
the
latter's
emissions
This
reduction
would
then
be
used
to
accommodate
the
emissions
from
the
new
source.
Bubbling
can
allow
a
facility
to
consider
all
sources
of
emissions
of
a
particular
pollutant
within
the
facility
in
achieving
an
overall
target
level
of
emission
control
or
environmental
improvement.

Insurance
and
financial
assurance
arrangements
generally
require
those
engaged
in
environmentally
risky
activities
to
ensure,
typically
through
a
third
party,
that
sufficient
resources
will
be
available
to
remedy
future
damages
This
arrangement
harnesses
the
financial
incentives
of
private
sector
companies
to
promote
and
maintain
environmentally
safer
practices.
An
example
of
this
approach
to
environmental
protection
is
the
financial
assurance
requirements
related
to
closure
and
post­
closure
care
for
hazardous
waste
treatment,
storage,
and
disposal
facilities.

Liability
rules
are
legal
tools
that
allow
victims
(
or
the
government)
to
force
polluters
that
cause
damages
to
pay
for
those
damages
after
they
occur.
7
They
are
typically
applied
to
infrequent
events
such
as
cleanup
of
hazardous
waste
sites
under
CERCLA
or
cleanup
after
oil
spills
under
the
Oil
Pollution
Control
Act.
There
are
a
variety
of
types
of
liability
rules
and
in
some
situations
these
rules
can
mimic
the
desirable
properties
of
taxes.
However,
this
is
not
the
case
in
all
situations
and
even
in
those
specific
cases
proper
functioning
of
liability
rules
depends
on
a
legal
system
which
may
not
perfectly
implement
the
rules.

Finally,
information
provision
operates
by
ensuring
that
production
and
consumption
decisions
are
adequately
informed
about
the
environmental
and
human
health
consequences
of
certain
choices.
In
some
cases,
shifts
in
these
decisions
can
encourage
environmentally
benign
activities
and
discourage
environmentally
detrimental
ones.
The
Toxics
Release
Inventory,
consumer­
based
programs
on
the
risks
of
radon
in
homes,
and
pesticide
labeling
programs
are
examples
of
efforts
by
EPA
to
implement
information­
based
policy
approaches.

4.4.2
Selecting
Market­
Oriented
Approaches
The
most
appropriate
market­
oriented
regulatory
approach
depends
on
a
wide
variety
of
factors,
such
as
the
nature
of
the
market
failure,
the
specific
circumstances
of
the
pollution
problem,
and
the
ultimate
goals
of
policy
makers.
8
The
choice
between
taxes
(
or
fees
and
charges)
and
marketable
permits,
for
example,
rests
theoretically
on
such
matters
as
the
degree
of
uncertainty
surrounding
the
estimated
benefits
and
costs
of
pollution
control
as
13
Chapter
4:
Approaches
to
Consider
6
For
example,
Arnold
(
1995)
analyses
the
merits
of
a
deposit­
refund
system
in
a
case
study
focusing
on
enhancing
used­
oil
recycling
and
Sigman
(
1995)
reviews
policy
options
to
address
lead
recycling.

7
See
Segerson
(
1995)
for
a
discussion
of
the
various
types
of
liability
rules,
the
efficiency
properties
of
each
type
of
rule,
and
an
extensive
bibliography.

8
Helpful
references
that
discuss
aspects
to
consider
when
comparing
among
different
approaches
include
EPA
(
1980),
Hahn
(
1990),
Hahn
and
Stavins
(
1992),
and
OECD
(
1994a,
1994b).
14
Chapter
4:
Approaches
to
Consider
well
as
how
marginal
benefits
and
costs
change
with
the
stringency
of
the
pollution
control
target.
This
choice
also
depends
on
distributional
considerations
and
the
extent
to
which
policy
makers
are
willing
to
allow
the
market
to
determine
exact
outcomes.
Marketable
permits,
for
example
set
the
total
level
of
pollution
control,
but
the
market
determines
which
sources
reduce
emissions
and
to
what
extent.
Taxes,
however,
leave
both
the
extent
of
control
by
individual
sources
and
the
total
level
of
control
to
market
determination.

Consideration
should
also
be
given
to
potential
differences
among
economic
instruments
that
have
implications
for
the
revenues
collected
under
alternative
mechanisms.
The
opportunities
to
direct
collected
resources
at
reductions
in
other
inefficiencies
introduced
in
markets
that
have
consequences
for
economic
welfare
will
affect
the
assessment
of
market­
oriented
approaches.
9
The
use
of
a
particular
market­
oriented
approach
is
often
suggested
directly
by
the
cause
of
the
pollution
problem
and
constraints
on
the
efficacy
of
other
traditional
policy
instruments.
For
example,
subsidies
and
deposit­
refund
systems
place
some
enforcement
burden
on
the
regulated
entities.
This
feature
makes
these
approaches
attractive
if
large
numbers
of
small
pollution
sources
exist
and
attempts
to
prohibit
their
actions
are
likely
to
fail
due
to
risk
of
widespread
noncompliance
and
costly
enforcement.
A
positive
incentive
in
these
cases
can
solve
both
the
original
market
failure
and
the
enforcement
problem.

Offsets
and
bubbles
tend
to
be
more
appropriate
when
policy
makers
seek
to
help
sources
reduce
compliance
costs,
while
still
attaining
the
environmental
improvement
embodied
in
a
more
traditional
standards­
based,
sourceby
source
approach.
Similarly,
insurance
and
financial
assurance
mechanisms
are
useful
instruments
to
supplement
existing
standards
and
rules
when
there
is
a
significant
risk
that
sources
of
future
pollution
might
be
incapable
of
financing
the
required
pollution
control
or
damage
mitigation.

Finally,
information
remedies
are
often
suggested
when
a
market
has
failed
to
provide
information
and
policy
makers
believe
that
private
and
public
sector
decisionmakers
will
act
to
address
an
environmental
problem
once
the
information
has
been
disseminated.
Voluntary
approaches
are
closely
related
to
information
remedies
and
are
most
useful
when
they
bring
to
bear
the
market's
knowledge
and
innovation
efforts
on
a
particular
environmental
problem
and
when
direct
standards­
based
methods
would
be
very
time­
consuming
and
costly
to
develop.

4.5
Non­
Regulatory
Approaches
In
addition
to
regulatory
approaches,
EPA
has
pursued
a
number
of
non­
regulatory
initiatives
that
rely
heavily
on
voluntary
approaches
to
achieve
improvements
in
emissions
controls
and
management
of
environmental
hazards.
Much
of
the
foundation
for
these
initiatives
rests
with
the
concepts
underlying
a
"
Pollution
Prevention"
approach
to
environmental
management
choices.
In
the
Pollution
Prevention
Act
of
1990,
Congress
established
as
a
national
policy
that:

pollution
should
be
prevented
or
reduced
at
the
source
whenever
feasible;

pollution
that
cannot
be
prevented
should
be
recycled
in
an
environmentally
safe
manner
whenever
feasible;

pollution
that
cannot
be
prevented
or
recycled
should
be
treated
in
an
environmentally
safe
manner
whenever
feasible;
and
disposal
or
other
release
into
the
environment
should
be
employed
as
a
last
resort
and
should
be
conducted
in
an
environmentally
safe
manner.

Working
directly
with
a
broad
array
of
institutions
that
participate
in
decisions
affecting
the
environment
(
e.
g.,
consumers
regulatory
agencies,
industry),
an
effort
is
made
to
reach
"
common
sense"
understanding
of
the
benefits
and
costs
of
management
strategies
that
prevent
damages
from
occurring,
versus
strategies
aimed
at
reacting
to
the
consequences
of
realized
environmental
hazards.
Furthermore,
some
preventive
measures
can
be
instituted
without
establishing
a
regulatory
program,
but
instead
through
a
facilitated
process
of
identifying
problems
and
9
For
useful
references
on
the
emerging
issues
concerning
the
uses
of
revenues
from
pollution
charges
(
e.
g.,
applying
environmental
tax
revenues
so
as
to
reduce
other
taxes
and
fees
in
the
economy)
and
ways
to
analyze
these
policies,
see
Bovenberg
and
de
Moojii
(
1994),
Goulder
(
1996),
Bovenberg
and
Goulder
1996),
Goulder
et.
al.
(
1997),
and
Jorgenson
(
1998a,
1998b).
solutions.
This
can
involve
sharing
information
and
experiences
among
participants
on
the
use
of
procedures,
practices,
or
processes
that
reduce
or
eliminate
the
generation
of
pollutants
and
waste
at
the
source.
Examples
within
the
manufacturing
sector
include
developing
and
distributing
information
on
input
substitution
or
modification
product
reformulation,
process
modifications,
improved
housekeeping,
and
on­
site
closed­
loop
recycling.
Further,
pollution
prevention
includes
other
practices
that
reduce
or
eliminate
pollutants
through
the
protection
of
material
resources
by
conservation
and
increased
efficiency
in
the
uses
of
raw
materials,
energy,
water,
or
other
resources.

Examples
of
voluntary
programs
include:
(
1)
the
33/
50
toxic
substances
program
under
which
many
companies
have
established
voluntary
targets
for
reducing
the
use
of
various
toxic
chemicals,
(
2)
the
"
ENERGY
STAR"
energy
efficiency
labeling
program,
and
(
3)
the
"
Design
for
the
Environment"
program.
The
last
of
these
programs
seeks
to
form
voluntary
partnerships
with
industry
and
other
stakeholders
in
order
to
develop
environmentally
safer
alternatives
to
existing
products
and
processes
that
prevent
the
need
to
cleanup
pollution
created
as
by­
products
in
manufacturing
processes.
Much
of
the
literature
developed
to
document
these
changes
can
be
found
in
public
policy
and
industrial
ecology
literature
sources.
10
4.6
Fine­
Tuning
Policy
Approaches
In
addition
to
considering
a
wide
variety
of
possible
approaches
for
environmental
protection,
analysts
and
policy
makers
should
also
examine
other
characteristics
of
regulatory
or
non­
regulatory
policies
that
affect
their
costs
and
effectiveness.
For
example,
evaluating
benefits,
costs,
and
other
effects
at
different
levels
of
stringency
for
a
given
policy
can
help
to
determine
settings
that
provide
the
greatest
net
benefits
to
society.
Similarly,
tailoring
pollution
control
requirements
to
account
for
geographical
differences
in
environmental
effects
and
source
differences
in
pollution
control
costs
will
tend
to
achieve
greater
environmental
protection
at
lower
costs.
Finally,
phasing
in
policies
over
time
to
allow
new
requirements
to
be
embedded
in
new
investments
can
often
substantially
reduce
a
policy's
costs
while
sacrificing
relatively
few
of
its
benefits,
especially
when
large­
scale
premature
retirement
of
capital
equipment
can
be
avoided.

Constraints,
such
as
statutory
provisions,
can
limit
the
number
of
available
regulatory
and
non­
regulatory
approaches
for
addressing
a
specific
environmental
problem
Market­
oriented
options,
for
example,
may
not
be
consistent
with
statutory
mandates
and
the
best
response
to
an
environmental
problem
might
require
action
outside
the
authority
of
the
relevant
statute.
Nevertheless,
the
strategy
that
best
informs
policy
makers
is
generally
one
that
adopts
an
expansive
view
of
a
problem's
possible
solutions
and
then
provides
cogent
and
detailed
economic
analysis
of
their
benefits,
costs,
and
other
effects.

15
Chapter
4:
Approaches
to
Consider
10
For
more
illustrations
of
ongoing
programs
and
policies,
the
following
websites
offer
useful
information:
http://
www.
epa.
gov/
opei/
(
accessed
8/
28/
2000)
and
http://
www.
epa.
gov/
p2/
(
accessed
8/
28/
2000).
4.7
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R.
C.
and
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Q.
Lohof.
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The
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in
Environmental
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D.
C.

Arnold,
F.
S.
1995.
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Regulation.
New
York,
NY:
John
Wiley
and
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Baumol,
W.
and
W.
Oates.
1993.
The
Theory
of
Environmental
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Third
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Englewood,
NJ:
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Bovenberg,
A.
L.
and
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de
Moojii.
1994.
Environmental
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American
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84(
5):
1085­
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Bovenberg,
A.
L.
and
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1996.
Optimal
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Taxation
in
the
Presence
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Taxes:
General
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American
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Review,
86(
5):
985­
1000.

Goulder,
L.
H.
1995.
Environmental
Taxation
and
the
Double
Dividend:
A
Reader's
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International
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and
Public
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2(
2):
157­
183.

Goulder,
L.
H.,
I.
Parry,
and
D.
Burtraw.
1997.
Revenue­
Raising
Versus
Other
Approaches
to
Environmental
Protection:
The
Critical
Significance
of
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Tax
Distortions.
RAND
Journal
of
Economics,
28(
4):
708­
731.

Hahn,
R.
W.
1990.
Regulatory
Constraints
on
Environmental
Markets.
Journal
of
Public
Economics,
42:
149­
175.

Hahn,
R.
W.
and
R.
N.
Stavins.
1992.
Economic
Incentives
for
Environmental
Protection:
Integrating
Theory
and
Practice.
American
Economic
Review,
82(
3):
464­
468.

Helfand,
G.
E.
1991.
Standards
versus
Standards:
The
Effects
of
Different
Pollution
Restriction.
American
Economic
Review.
September,
81(
4):
622­
634.

Jaffe,
A.
B.
and
R.
N.
Stavins.
1995.
Dynamic
Incentives
of
Environmental
Regulations:
The
Effects
of
Alternative
Policy
Instruments
on
Technology
Diffusion.
Journal
of
Environmental
Economics
and
Management,
29:
S43­
S63.

Jorgenson,
D.
W.
(
1998a).
Growth,
Volume
1:
Econometric
General
Equilibrium
Modeling.,
Cambridge,
MA:
MIT
Press.

Jorgenson,
D.
W.
(
1998b).
Growth,
Volume
2:
Energy,
the
Environment,
and
Economic
Growth.
Cambridge,
MA:
MIT
Press.

Joskow,
P.
L.,
R.
Schmalensee,
and
E.
M.
Bailey.
1998.
The
Market
for
Sulfur
Dioxide
Emissions.
American
Economic
Review,
September,
88(
4):
669­
85.

Jung,
C.,
K.
Krutilla,
and
R.
Boyd.
1996.
Incentives
for
Advanced
Pollution
Abatement
Technology
at
the
Industry
Level:
An
Evaluation
of
Policy
Alternatives.
Journal
of
Environmental
Economics
and
Management,
30:
95­
111.

Malueg,
D.
1989.
Emission
Credit
Trading
and
the
Incentive
to
Adopt
New
Pollution
Abatement
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Journal
of
Environmental
Economics
and
Management,
16:
52­
57.

Milliman,
S.
R.
and
R.
Prince.
1989.
Firm
Incentives
to
Promote
Technological
Change
in
Pollution
Control.
Journal
of
Environmental
Economics
and
Management,
17:
247­
265.

Moore,
J.
L.,
L.
Parker,
J.
Bodgett,
J.
McCarthy,
and
D.
Gushee.
1989.
Using
Incentives
for
Environmental
Protection:
An
Overview,
U.
S.
Congressional
Research
Service,
Washington,
D.
C.,
June
1989.

Organization
for
Economic
Cooperation
and
Development.
1989.
Economic
Incentives,
Options
for
Environmental
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Paris,
France.

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4:
Approaches
to
Consider
Organization
for
Economic
Cooperation
and
Development.
1991.
Environmental
Policy:
How
to
Apply
Economic
Instruments,
Paris,
France.

Organization
for
Economic
Cooperation
and
Development.
1994a.
Evaluating
Economic
Incentives
for
Environmental
Policy,
Paris,
France.

Organization
for
Economic
Cooperation
and
Development.
1994b.
Managing
the
Environment
­
The
Role
of
Economic
Instruments,
Paris,
France.

Segerson,
K.
1995.
Liability
and
Penalty
Structures
in
Policy
Design.
In
The
Handbook
of
Environmental
Economics,
Daniel
W.
Bromley,
Ed.,
272­
294.
Cambridge,
MA:
Blackwell
Publishers.

Sigman,
H.
A.
1995.
A
Comparison
of
Public
Policies
for
Lead
Recycling.
RAND
Journal
of
Economics,
26(
3):
452­
478.

Stavins,
R.
N.,
ed.
1988.
Project
88­
Harnessing
Market
Forces
to
Protect
Our
Environment:
Initiatives
for
the
New
President.
A
Public
Policy
Study,
Sponsored
by
Senator
Timothy
E.
Wirth,
Colorado,
and
Senator
John
Heinz,
Pennsylvania.
Washington,
D.
C.:
December
1988.

Stavins,
R.
N.,
ed.
1991.
Project
88
­
Round
II,
Incentives
for
Action:
Designing
Market­
Based
Environmental
Strategies.
A
Public
Policy
Study,
Sponsored
by
Senator
Timothy
E.
Wirth,
Colorado,
and
Senator
John
Heinz,
Pennsylvania.
Washington,
D.
C.:
May
1991.

Stavins,
R.
N.
1998a.
Market
Based
Environmental
Policies.
Faculty
Research
Working
Paper
Series.
R98­
03,
John
F.
Kennedy
School
of
Government,
Harvard
University,
Cambridge,
MA.

Stavins,
R.
N.
1998b.
"
Economic
Incentives
for
Environmental
Regulation."
The
New
Palgrave
Dictionary
of
Economics
and
the
Law,
ed.
P.
Newman.
London,
Great
Britain:
The
Macmillan
Press.

Stavins,
R.
N.
1998c.
What
Can
We
Learn
from
the
Grand
Policy
Experiment?
Lessons
from
SO2
Allowance
Trading.
Journal
of
Economic
Perspectives,
Summer
12(
3):
69­
88.

Tietenberg,
T.
1985.
Emissions
Trading:
An
Exercise
in
Reforming
Pollution
Policy,
Resources
for
the
Future,
Washington,
D.
C.

Tietenberg,
T.
1992.
Environmental
and
Natural
Resource
Economics,
Third
Edition,
New
York,
NY:
Harper
Collins
Publishers.

U.
S.
Environmental
Protection
Agency.
1980.
Checklist
of
Regulatory
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Office
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Planning
and
Management,
July
1980.

U.
S.
Environmental
Protection
Agency.
1991.
Economic
Incentives:
Options
for
Environmental
Protection,
EPA/
21P­
2001,
Office
of
Policy,
Planning
and
Evaluation,
March
1991.

17
Chapter
4:
Approaches
to
Consider
18
Chapter
4:
Approaches
to
Consider
5.1
Introduction
This
chapter
provides
a
brief
overview
of
several
different
analyses
and
assessments
that
are
normally
conducted
in
the
course
of
evaluating
environmental
policies.
It
also
presents
background
and
guidance
on
several
cross­
cutting
methodological
topics.
The
suggestions
in
this
chapter,
and
throughout
this
document
are
not
intended
to
be
rigid
rules
to
be
applied
uniformly
for
each
and
every
economic
analysis.
Instead,
they
are
intended
to
produce
a
consistent,
well­
reasoned,
and
transparent
process
for
framing
economic
analyses
regardless
of
the
specific
characteristics
and
features
of
any
given
policy.

The
next
section
outlines
a
conceptual
perspective
for
economic
analysis
and
identifies
the
component
assessments
that
together
form
an
economic
analysis
in
practice.
This
section
also
defines
certain
terms
that
are
used
throughout
this
and
the
remaining
chapters
of
the
EA
Guidelines.
The
remaining
sections
of
this
chapter
explore
some
common
methodological
elements
that
are
shared
by
virtually
all
economic
analyses
of
environmental
policies.
The
third
section
of
this
chapter
addresses
the
choice
of
analytic
baseline
and
the
fourth
discusses
predicting
responses
to
new
policies.
Treatment
of
uncertainty
is
addressed
in
the
fifth
section
and
the
final
section
addresses
some
emerging
analytical
issues.
Each
section
first
reviews
the
nature
of
the
methodological
topic
and
its
impact
on
the
economic
analyses,
and
then
provides
general
guidelines
for
incorporating
or
addressing
associated
issues
in
practice.
5.2
Economic
Framework
and
Definition
of
Terms
A
Conceptual
Perspective
for
Economic
Analysis
The
conceptually
appropriate
framework
for
assessing
all
the
impacts
of
an
environmental
regulation
is
an
economic
model
of
general
equilibrium.
The
starting
point
of
such
a
model
is
to
define
the
allocation
of
resources
and
interrelationships
for
an
entire
economy
with
all
its
diverse
components
(
households
firms,
government).
Potential
regulatory
alternatives
are
then
modeled
as
economic
changes
that
move
the
economy
from
a
state
of
equilibrium
absent
the
regulation
to
a
new
state
of
equilibrium
with
the
regulation
in
effect.
The
differences
between
the
old
and
new
states
 
measured
as
changes
in
prices,
quantities
produced
and
consumed,
income
and
other
economic
quantities
 
can
be
used
to
characterize
the
net
welfare
changes
for
each
affected
group
identified
in
the
model.

Analysts
can
rely
on
different
outputs
and
conclusions
from
the
general
equilibrium
framework
to
assess
issues
of
both
efficiency
and
distribution.
At
EPA
these
issues
often
take
the
form
of
three
distinct
questions:

Is
it
theoretically
possible
for
the
"
gainers"
from
the
policy
to
fully
compensate
the
"
losers"
and
still
remain
better
off?

Who
are
the
gainers
and
losers
from
the
policy
and
associated
economic
changes?

And
how
did
a
particular
group
 
especially
a
group
that
may
be
considered
to
be
disadvantaged
 
fare
as
a
result
of
the
policy
change?

19
Chapter
5
Chapter
5:
Overview
of
Economic
Analysis
of
Environmental
Policy
The
first
question
is
directed
at
the
measurement
of
efficiency
and
is
based
on
the
Potential
Pareto
criterion.
This
criterion
is
the
foundation
of
benefit­
cost
analysis,
requiring
that
a
policy's
net
benefits
to
society
be
positive.
Measuring
net
benefits
by
summing
all
of
the
welfare
changes
for
all
groups
provides
an
answer
to
this
question.

The
last
two
questions
are
related
to
the
distributional
consequences
of
the
policy.
Because
a
general
equilibrium
framework
provides
for
the
ability
to
estimate
welfare
changes
for
particular
groups,
these
questions
can
be
pursued
using
the
same
approach
taken
to
answer
the
efficiency
question,
provided
that
the
general
equilibrium
model
is
developed
at
an
appropriate
level
of
disaggregation.

Practical
Compromises:
Benefit
Cost
Analysis,
Economic
Impacts
Analysis,
and
Equity
Assessments
Although
a
general
equilibrium
framework
can,
in
principle
provide
the
information
needed
to
address
all
three
questions,
in
practice
analysts
have
limited
access
to
the
tools
and
resources
needed
to
adopt
a
general
equilibrium
approach1.
More
often,
EPA
must
resort
to
assembling
a
set
of
different
models
to
address
issues
of
efficiency
and
distribution
separately.
However,
the
limitations
on
employing
general
equilibrium
models
have
greatly
diminished
in
recent
years
with
advances
in
the
theory,
tools,
and
data
needed
to
use
the
approach.
Chapter
8
contains
additional
information
on
general
equilibrium
models.

The
EA
Guidelines
follow
more
traditional
practices
and
adopt
conventional
labels
to
distinguish
models
or
approaches
used
to
answer
questions
on
the
efficiency
and
distribution
of
environmental
regulations.
For
purposes
of
this
document,
the
presentation
separates
the
concepts
and
approaches
into
the
following
three
general
categories:

the
examination
of
net
social
benefits
using
a
benefitcost
analysis
(
BCA);

the
examination
of
gainers
and
losers
using
an
economic
impacts
analysis
(
EIA);
and
the
examination
of
particular
sub­
populations,
especially
those
considered
to
be
disadvantaged,
using
an
equity
assessment.

This
division
is
necessary
not
only
because
of
data
and
resource
limitations,
but
because
analysts
often
lack
models
that
are
sufficiently
comprehensive
to
address
all
of
these
dimensions
concurrently.
Within
a
BCA,
for
example
EPA
is
generally
unable
to
measure
benefits
with
the
same
models
used
for
estimating
costs,
necessitating
separate
treatment
of
costs
and
benefits.
Further,
when
estimating
social
costs
there
are
cases
in
which
some
direct
expenditures
can
be
identified,
but
data
and
models
are
unavailable
to
track
the
"
ripple"
effects
of
these
expenditures
through
the
economy.
For
most
practical
applications
therefore,
a
complete
economic
analysis
comprises
a
benefit­
cost
analysis,
an
economic
impacts
analysis,
and
an
equity
assessment.

Benefit­
cost
analysis
evaluates
the
favorable
effects
of
policy
actions
and
the
associated
opportunity
costs
of
those
actions.
The
favorable
effects
are
defined
as
benefits
and
the
opportunities
foregone
define
economic
costs.
While
conceptually
symmetric,
benefits
and
costs
must
often
be
evaluated
separately
due
to
practical
considerations.
Analysts
may
even
organize
the
analysis
of
benefits
differently
from
the
analysis
of
costs,
but
they
should
be
aware
of
the
conceptual
relationship
between
the
two.
Using
estimates
of
health
and
other
risk­
reduction
effects
provided
by
risk
assessors,
benefits
analyses
apply
a
variety
of
economic
methodologies
to
estimate
the
value
of
anticipated
health
improvements
and
other
sources
of
environmental
benefits.
Social
cost
analyses
attempt
to
estimate
the
total
welfare
costs,
net
of
any
transfers,
imposed
by
environmental
policies.
In
most
instances,
these
costs
are
measured
by
higher
costs
of
consumption
goods
for
consumers
and
lower
earnings
for
producers
and
other
factors
of
production
Some
of
the
findings
of
a
social
cost
analysis
are
inputs
for
benefits
analyses,
such
as
predicted
changes
in
the
outputs
of
goods
associated
with
a
pollution
problem.

The
assumptions
and
modeling
framework
developed
for
the
BCA,
constrain
and
limit
the
estimation
techniques
used
to
examine
gainers
and
losers
(
in
an
EIA)
or
to
examine
impacts
on
disadvantaged
sub­
populations
(
in
an
20
Chapter
5:
Overview
1
The
general
equilibrium
framework
will
at
least
capture
all
"
market"
benefits
and
costs,
but
may
not
include
non­
market
benefits,
such
as
those
associated
with
existence
value.
In
practice,
models
of
general
equilibrium
may
also
be
unable
to
analyze
relatively
small
sectors
of
the
economy
For
more
on
general
equilibrium
analysis
see
Chapter
8,
section
4.5.
equity
assessment).
To
estimate
these
two
categories
of
impacts
we
rely
on
a
multiplicity
of
estimation
techniques.
The
constraints
faced
by
these
analyses
as
well
as
details
regarding
estimation
techniques
are
given
by
Chapter
9.

5.3
Baseline
Specification
An
economic
analysis
of
a
policy
or
regulation
compares
"
the
world
with
the
policy
or
regulation"
(
the
policy
scenario
with
"
the
world
absent
the
policy
or
regulation"
(
the
baseline
scenario).
Impacts
of
policies
or
regulations
are
measured
by
the
resulting
differences
between
these
two
scenarios.
Measured
differences
may
include
changes
in
pollutant
emissions
and
ambient
concentrations,
changes
in
usage
or
production
of
toxic
substances,
and
incidence
rates
for
adverse
health
effects
associated
with
exposure
to
pollutants.

Specification
of
baseline
conditions
can
have
profound
influence
on
the
measurement
and
interpretation
of
analytic
results.
The
complexity
of
the
regulatory
and
policymaking
stipulations
may
not
yield
a
clear­
cut
decision
on
the
specification
of
baseline
conditions.
The
honesty
and
integrity
of
the
analysis
depend
on
the
ability
of
the
analyst
to
provide
well­
defined
and
defensible
choices
in
the
selection
and
estimation
of
baseline
conditions.
Analysts
uncertain
about
the
selection
of
baseline
conditions
are
advised
to
review
the
guiding
principles
listed
below.
In
the
development
of
the
rule,
the
analyst
is
responsible
for
raising
questions
about
baseline
definitions
early
within
the
regulatory
development
process,
and
should
receive
the
views
of
enforcement
and
general
counsel
staff.
Doing
so
can
facilitate
the
consistent
treatment
of
this
issue
in
EPA
analyses.

5.3.1
Guiding
Principles
for
Baseline
Specification
Baseline
specification
can
be
thought
of
as
having
two
steps
 
selection
and
quantification.
The
first
step
is
to
select
a
baseline
that
is
appropriate
to
the
question
the
analysis
is
intended
to
address.
The
second
step
is
to
estimate
the
values
of
the
relevant
factors
in
the
selected
baseline
scenario.
Several
guiding
principles
to
assist
in
the
treatment
of
baselines
in
an
analysis
are
listed
below.
Though
they
exhibit
a
common
sense
approach
to
the
issue,
the
analyst
is
advised
to
provide
explicit
statements
within
the
analysis
on
each
point.
Failure
to
do
so
may
result
in
a
confusing
analytic
presentation,
inefficient
use
of
time
and
resources,
and
misinterpretation
of
the
economic
results.

Clearly
state
the
question
the
analysis
is
addressing.
The
type
of
regulatory
question
facing
an
analyst
will
affect
the
selection
of
the
baseline
in
an
analysis.
A
baseline
definition
appropriate
to
many
analyses
will
be
"
reality
in
the
absence
of
the
regulation."
However,
to
ensure
provisions
contained
in
statutes
or
policies
precipitating
the
regulatory
action
are
appropriately
addressed,
it
is
useful
to
assume
full
compliance
with
regulatory
requirements
in
most
cases.
2
Clearly
stating
the
questions
to
be
answered
by
the
analysis
will
help
not
only
in
choosing
an
appropriate
baseline,
but
also
in
communicating
this
information
to
persons
using
the
results
of
the
analysis.

Clearly
identify
all
aspects
of
the
baseline
conditions
that
are
uncertain
and
all
assumptions
made
in
specifying
the
baseline.
If
the
analyst
had
complete
information
about
current
values
and
perfect
foresight
about
the
future,
the
appropriate
baseline
conditions
could
be
characterized
with
certainty
This,
of
course,
is
never
the
case.
Current
values
of
factors
are
often
uncertain,
and
future
values
of
factors
are
always
uncertain.
Estimates
of
uncertain
factors
should
be
based
on
actual
data,
to
the
extent
possible.
Uncertainties
underlying
the
baseline
conditions
should
be
treated
as
other
types
of
uncertainties
are
handled
throughout
the
analysis.
If,
in
the
face
of
uncertainty,
assumptions
about
baseline
components
are
made,
these
should
be
the
most
realistic
assumptions
possible.
For
example,
where
reliable
projections
of
future
economic
activity
and
21
Chapter
5:
Overview
2
Analysts
should
refer
later
sections
of
these
guidelines
(
Section
5.3.2)
and
other
cited
EPA
documents
prepared
in
support
of
implementing
these
statutes,
for
more
detailed
guidance
on
the
treatment
of
baseline
definitions
and
compliance
assumptions
used
for
economic
analyses
required
under
these
statutes.
Much
of
the
information
on
EPA's
policies
and
guidelines
applicable
to
rule
development
can
be
found
at
the
following
EPA
Intranet
website
http://
intranet.
epa.
gov/
rapids
(
accessed
8/
02/
2000,
internal
EPA
document).
demographics
are
available,
this
information
should
be
accounted
for
in
defining
the
baseline.
All
assumptions
should
be
clearly
stated,
with
particular
attention
given
to
situations
calling
for
more
than
one
baseline
to
be
included
in
the
analysis.

Be
consistent
throughout
the
analysis
in
the
use
of
baselines.
The
same
baseline
should
be
carried
through
for
all
components
of
the
analysis.
For
example,
the
comparison
of
costs
and
benefits
in
a
benefit­
cost
analysis
should
draw
upon
estimates
derived
using
the
same
baseline,
so
that
the
calculation
of
net
economic
benefits
yields
a
meaningful
economic
measure.
Likewise,
when
comparing
and
ranking
alternative
regulatory
options,
the
same
baseline
should
be
used
for
all
options
under
consideration
When
use
of
more
than
one
baseline
scenario
is
warranted,
the
analyst
must
avoid
the
mistake
of
combining
analytic
results
obtained
from
different
baseline
scenarios.
To
limit
confusion
on
this
point,
if
multiple
baseline
scenarios
are
included
in
an
analysis,
presentations
of
economic
information
should
clearly
describe
and
refer
to
which
baseline
scenario
is
being
used.

Determine
the
appropriate
level
of
effort
for
baseline
specification.
Every
analysis
is
limited
by
finite
resources.
Analytical
efforts
should
be
concentrated
on
those
components
of
the
baseline
that
are
most
important
to
the
analysis.
If
several
components
of
the
baseline
are
uncertain,
the
analysis
should
concentrate
its
limited
resources
on
refining
the
estimates
of
those
components
that
have
the
greatest
effect
on
interpretation
of
the
results.

Clearly
state
the
"
starting
point"
of
baseline
and
policy
scenarios.
A
starting
point
of
an
analysis
is
the
point
in
time
at
which
the
comparison
between
the
baseline
and
policy
scenarios
begins.
This
is
conceptually
a
point
in
time
when
the
two
scenarios
are
believed
to
diverge.
For
example,
one
approach
is
to
organize
the
analysis
presuming
that
the
policy
scenario
conditions
diverge
from
those
in
the
baseline
at
the
time
an
enforceable
requirement
becomes
effective
Another
convenient
approach
is
to
set
the
starting
point
to
be
coincident
with
promulgation
of
the
final
rule.
These
dates
may
be
appropriate
to
use,
as
they
are
clearly
defined
under
monitored
administrative
procedures,
or
represent
deadlines
that
compliance
progress
can
be
measured
against.

However,
where
behavioral
changes
are
motivated
by
the
expected
outcome
of
the
regulatory
process,
the
actual
timing
of
the
formal
issuance
of
an
enforceable
requirement
should
not
be
used
to
define
differences
between
the
baseline
and
policy
scenarios.
Earlier
starting
points,
such
as
the
date
authorizing
legislation
is
signed
into
law,
the
date
the
rule
is
first
published
in
a
Notice
of
Proposed
Rule
Making,
or
other
regulatory
development
process
milestones,
may
be
supported
if
divergence
from
the
baseline
occurs
due
to
anticipation
of
promulgation.
In
some
instances,
parties
anticipating
the
outcome
of
a
regulatory
initiative
may
change
their
economic
behavior,
including
spending
resources
to
meet
expected
emission
or
hazard
reductions
prior
to
the
compliance
deadline
set
by
enforceable
requirements.
The
same
issues
arise
in
the
treatment
of
non­
regulatory
programs,
in
which
voluntary
or
negotiated
environmental
goals
may
be
established,
leading
parties
to
take
steps
to
achieve
these
goals
at
rates
different
from
those
expected
in
the
absence
of
the
program.
In
these
cases,
it
may
be
appropriate
to
include
these
costs
and
benefits
into
the
analysis
of
the
policy
action,
and
not
subsume
these
into
the
baseline
scenario.
The
dynamic
aspects
of
market
and
consumer
behavior,
and
the
many
motivations
leading
to
change,
can
make
it
more
difficult
to
attribute
economic
costs
and
benefits
to
specific
regulations.
Looking
at
the
sensitivity
of
the
outcome
of
the
analysis
to
these
conditions
and
assumptions
will
be
useful.

Let
the
duration
of
important
effects
of
a
policy
dictate
the
structure
of
the
analysis
and
baseline
To
consider
how
the
benefits
of
a
proposed
policy
compare
with
the
costs
of
the
policy,
the
analyst
will
assemble
estimates
of
the
present
discounted
values
of
the
total
costs
and
benefits
attributable
to
the
policy.
How
one
defines
the
baseline
is
particularly
important
in
situations
in
which
the
accrual
of
costs
and/
or
benefits
do
not
coincide
due
to
lagged
effects,
or
occur
over
an
extended
period
of
time.
For
example
the
human
health
benefits
of
a
policy
that
reduces
leachate
from
landfills
may
not
be
manifest
for
many
years,
if
the
potential
for
human
exposure
through
contaminated
groundwater
may
occur
22
Chapter
5:
Overview
decades
after
closure
of
the
landfill.
In
theory,
then,
the
longer
the
time
frame,
the
more
likely
the
analysis
will
depict
all
the
benefits
and
costs
of
the
policy
that
are
expected
to
occur.
However,
forecasts
of
economic
demographic,
and
technological
trends
necessary
for
baseline
specification
must
also
span
the
entire
period
of
the
analysis.
Because
the
reliability
of
many
forecasts
diminishes
into
the
future,
the
analyst
must
balance
the
advantages
of
structuring
the
analysis
to
include
a
longer
time
span
against
the
disadvantages
of
the
decreasing
reliability
of
the
analytic
results.

Defining
the
baseline
and
policy
scenarios
will
often
require
information
and
assumptions
on
trends
in
behavior,
and
how
these
trends
may
be
affected
by
regulatory
management
options.
For
example,
the
analyst
may
observe
trends
in
economic
activity
or
pollution
control
technologies
that
occur
for
reasons
other
than
direct
environmental
regulations.
For
example,
as
the
purchasing
power
of
consumer
income
increases
over
time,
demand
for
different
commodities
can
change.
Demand
for
some
commodities
may
grow
at
rates
faster
than
the
rate
of
change
in
income,
while
demand
for
other
goods
may
decrease.
Therefore,
where
these
trends
are
highly
uncertain
or
are
expected
to
have
significant
influence
on
the
evaluation
of
regulatory
alternatives
(
including
a
"
no­
regulatory
control"
alternative),
the
analyst
should
clearly
explain
and
identify
their
choices
in
the
analysis.

Lastly,
in
some
cases
the
benefits
of
a
policy
will
be
expected
to
increase
over
time.
Some
analyses
must
therefore
look
far
enough
into
the
future
to
assure
that
benefits
are
not
substantially
underestimated.
For
example,
suppose
a
policy
that
would
greatly
reduce
greenhouse
gas
emissions
were
being
proposed.
In
the
baseline
scenario,
the
level
of
greenhouse
gases
in
the
atmosphere
would
steadily
increase
over
time,
with
a
corresponding
increase
in
expected
human
health
and
welfare
and
ecological
changes.
A
benefitcost
analysis
limited
to
the
first
decade
after
initiation
of
the
policy
would
be
likely
to
distort
the
relationship
of
benefits
and
costs
associated
with
the
policy.
In
this
case,
the
conflict
between
the
need
to
consider
a
long
time
frame
and
the
decreasing
reliability
of
forecasting
far
into
the
future
may
be
substantial.
In
most
cases,
primary
considerations
in
determining
the
time
horizon
of
the
analysis
will
be
the
time
span
of
the
physical
effects
that
drive
the
benefits
estimates
and
capital
investment
cycles
associated
with
environmental
expenditures.

5.3.2
Compliance
Rate
Issues
and
Baseline
Specification
One
aspect
of
baseline
specification
that
is
particularly
complex,
and
for
which
assumptions
are
typically
necessary
is
that
of
compliance
rates.
The
treatment
of
compliance
in
the
baseline
scenario
can
significantly
affect
the
results
of
the
analysis.
Therefore,
it
is
important
to
be
clear
to
persons
using
the
analysis
how
assumptions
about
compliance
behavior
are
incorporated
into
the
analysis,
and
how
sensitive
the
results
are
to
the
handling
of
compliance
rates.

It
can
be
challenging
to
clearly
demonstrate
the
economic
effects
attributable
to
a
new
regulation
or
policy,
while
avoiding
the
potential
for
double­
counting
of
benefits,
costs,
and
impacts
associated
with
separate
existing
regulations
To
aid
in
preparation
of
the
economic
analysis
and
presentation
of
results,
it
is
common
to
establish
baseline
conditions
so
that
the
affected
regulated
entities
are
in
full
compliance
with
other
separate
existing
regulations.
Assuming
full
compliance
with
existing
regulations
will
enable
the
analysis
to
focus
on
the
incremental
economic
effects
of
the
new
rule
or
policy,
the
results
of
which
are
used
to
evaluate
the
predicted
economic
changes.
This
information
also
meets
the
requirements
contained
in
many
of
the
statutes
and
administrative
orders
that
use
economic
information
as
evidence
that
further
steps
need
to
be
taken
to
address
the
effects
on
regulated
parties
(
described
in
Chapters
2
and
9).

Defining
the
baseline
in
this
fashion
may
pose
some
challenges
to
the
analyst,
since
current
observed
or
reported
economic
behavior
may
represent
the
consequences
of
either
under­
compliance
or
overcompliance
with
existing
regulations.
For
example,
it
is
possible
to
observe
over­
compliance
by
regulated
entities
with
enforceable
standards.
One
can
find
industries
whose
current
effluent
discharge
concentrations
for
regulated
pollutants
are
measured
below
concentrations
legally
required
by
existing
effluent
guideline
regulations.
On
the
23
Chapter
5:
Overview
Chapter
5:
Overview
24
other
hand,
evidence
for
under­
compliance
is
evident
in
the
resources
devoted
by
EPA
and
other
state
and
local
regulatory
agencies
to
enforce
rules
through
orders,
fines,
and
negotiated
settlements.
As
a
result,
it
will
be
important
that
the
analysis
separates
the
changes
associated
with
a
new
regulation
from
actions
taken
to
meet
existing
requirements.
This
is
of
particular
importance
if
actions
taken
to
meet
existing
requirements
are
coincident
with,
but
not
caused
by,
changes
introduced
by
the
new
regulation.
3
For
some
types
of
analyses
it
is
sensible
to
establish
a
baseline
of
"
current
practice"
(
i.
e.,
what
is
believed
to
be
the
actual
degree
of
compliance,
rather
than
assumed
full
compliance).
For
example,
when
a
new
action
under
review
is
intended
to
address
or
"
fix­
up"
compliance
problems
associated
with
existing
policies,
information
on
current
practices
belongs
in
the
baseline.
Otherwise,
defining
the
baseline
in
a
manner
that
disregards
this
behavior
will
obscure
the
value
of
investigating
whether
further
or
alternative
regulatory
actions
are
necessary
(
e.
g.,
as
was
the
case
in
a
review
of
banning
lead
from
gasoline,
which
was
precipitated
in
part
by
the
noncompliance
of
consumers
misfueling
their
non­
leaded
gasoline
automobiles
(
EPA,
1985)).
For
a
deregulatory
rule
(
e.
g.,
a
rule
designed
to
address
potential
changes
in
or
clarify
definitions
of
regulatory
performance
that
frees
entities
from
enforceable
requirements
contained
in
an
existing
rule),
it
may
be
sensible
to
perform
the
analysis
using
both
a
full
compliance
and
"
current
practices"
baseline.
A
full
compliance
scenario
in
this
instance
introduces
some
added
complications
to
the
analysis,
but
it
may
be
important
to
report
on
the
economic
effects
of
failing
to
take
the
deregulatory
action.

In
cases
of
over­
compliance
with
existing
policies,
or
actions
already
taken
in
the
economic
interests
of
the
affected
parties,
current
practices
can
be
used
to
define
baseline
conditions
unless
these
practices
are
expected
to
change
or
are
highly
uncertain
in
ways
that
are
directly
associated
with
the
rule
being
analyzed.
For
example,
observed
over­
compliance
by
a
regulated
entity
may
be
the
result
of
choices
it
has
made
to
anticipate
forthcoming
more
stringent
federal
regulatory
requirements.
If
there
should
be
a
decision
not
to
follow
through
with
the
anticipated
federal
regulation,
the
analysis
will
need
to
establish
whether
the
current
observed
over­
compliance
behavior
by
the
regulated
entity
may
be
curtailed
to
meet
existing
(
i.
e.,
relatively
less
stringent)
requirements.
If
the
regulated
entity
in
this
example
is
expected
to
continue
to
over­
comply
despite
the
absence
of
the
more
stringent
regulation,
then
the
policy
scenario
should
not
contain
the
costs
and
benefits
attributable
to
this
behavior,
and
it
is
appropriate
to
account
for
them
in
the
baseline
scenario
that
describes
the
"
world
without
the
regulation."
However,
if
the
regulated
entity
will
relax
its
pollution
control
practices
to
meet
current
requirements
after
the
stricter
regulation
fails
to
emerge,
then
the
costs
and
benefits
of
the
over­
compliance
behavior
should
be
attributed
to
the
policy
scenario.
In
these
situations,
it
may
be
useful
to
consider
performing
the
analysis
with
alternative
baseline
scenarios,
and
demonstrate
the
potential
economic
consequences
of
different
assumptions
associated
with
the
expected
changes
in
this
type
of
behavior.

Analysts
may
also
elect
to
incorporate
predicted
differences
in
compliance
rates
within
policy
options
considered
for
new
rules,
in
cases
where
compliance
behavior
is
known
to
vary
systematically
with
the
regulatory
options
being
considered
(
e.
g.,
if
the
expected
compliance
rate
with
a
rule
may
differ
if
entities
are
regulated
using
economic
incentives
as
compared
with
prescribed
control
technologies).

Despite
the
above
possible
complexities,
it
is
prudent
for
most
analyses
of
regulations
to
develop
baseline
and
policy
scenarios
that
assume
full
compliance
with
existing
and
newly
enacted
regulations.
One
rationale
for
adopting
these
assumptions
is
that
the
analytic
results
will
provide
information
on
the
unique
role
the
action
under
consideration
is
expected
to
have
on
the
economy,
which
may
be
required
under
the
authorizing
statute,
or
administrative
laws
and
policies.
As
a
practical
matter,
noncompliant
behavior
will
need
to
be
known,
estimable,
and
occurring
at
rates
that
can
affect
the
evaluation
of
policy
options
before
totally
rejecting
assumptions
of
"
full
3
For
example,
assigning
costs
between
an
existing
and
new
regulation
could
be
further
complicated,
if,
as
a
result
of
under­
compliance
with
the
existing
regulation,
the
estimated
"
joint"
cost
of
meeting
both
regulations
differs
from
the
summed
marginal
costs
of
first
meeting
the
existing
regulation,
followed
by
implementing
the
new
regulation.
The
same
concern
equally
applies
to
the
attribution
of
benefits
and
economic
impacts
to
each
regulation.
Under
these
circumstances,
the
analyst
should
seek
further
directions
provided
by
the
authorizing
legislation
for
the
regulation,
or
instructions
contained
in
other
operative
laws
and
policies.
compliance"
for
existing
and
new
policies.
In
the
end,
assumptions
on
compliance
behavior
for
current
and
new
requirements
should
be
clearly
presented
in
the
description
of
the
analytic
approach
and
assumption
used
for
the
analysis.
Care
should
be
taken
to
describe
the
importance
of
these
assumptions
when
comparing
regulatory
options
for
which
social
costs
and
benefits,
and
economic
impacts
have
been
estimated.

5.3.3
Multiple
Rules
or
Regulations
and
Baseline
Specification
If
conditions
exist
where
there
are
no
other
relevant
regulations,
specifying
a
baseline
is
not
complicated
by
questions
of
whether
other
regulations
are
being
implemented
and,
if
so,
which
regulations
are
responsible
for
environmental
improvements
and
can
"
take
credit"
for
reductions
in
risks.
That
is,
there
is
no
need
to
be
concerned
with
which
environmental
improvements
are
in
the
baseline.
Nor
is
it
necessary
to
try
to
determine
how
these
other
regulations
affect
market
conditions
that
directly
influence
the
costs
or
the
benefits
associated
with
the
policy
of
interest.

But
actual
conditions
in
the
regulation
of
environmental
risks
are
much
more
complex,
and
it
is
an
unusual
case
where
the
above
holds
true.
There
are
many
regulatory
agencies
(
i.
e.,
federal,
state,
local)
affecting
environmental
behavior,
and
several
forms
of
consumer
and
industrial
behavior
are
regulated
by
agencies
whose
agendas
can
overlap
with
EPA's
(
e.
g.,
OSHA,
DOT,
DOE).
Absent
an
orderly
sequence
of
events
that
allows
attributing
changes
in
behavior
to
a
unique
regulatory
source,
in
practice,
there
is
no
non­
arbitrary
way
to
allocate
the
costs
and
the
benefits
of
a
package
of
overlapping
policies
to
each
individual
policy.
Whether
any
one
of
these
policies
is
"
in
the
baseline"
of
the
benefit­
cost
analysis
of
another
policy
is,
to
a
large
degree,
a
matter
of
choice.
There
is
no
theoretically
correct
order
for
conducting
a
sequential
analysis
of
multiple
overlapping
policies
that
are
promulgated
simultaneously.

An
idealized
approach
would
attempt
to
analyze
all
of
the
policies
together
when
assessing
the
total
costs
and
benefits
resulting
from
the
package
of
policies.
However,
this
kind
of
comprehensive
analysis
is
usually
not
feasible.
A
practical
alternative
may
be
to
consider
the
actual
or
statutory
timing
of
the
promulgation
and/
or
implementation
of
the
policies,
and
use
this
to
establish
a
sequence
with
which
to
analyze
related
rules.
But
even
when
the
temporal
order
of
policies
makes
it
clearer
which
policies
are
"
in
the
baseline"
and
which
are
not,
different
depictions
of
the
timing
and
impacts
of
pre­
existing
or
overlapping
policies
can
still
have
a
substantial
effect
on
the
outcome
of
a
benefit­
cost
analysis.
An
example
of
this,
offered
by
Arnold
(
1995),
concerns
regulations
designed
to
reduce
the
production
of
chlorofluorocarbons
(
CFCs)
and
other
ozone­
depleting
substances.
In
this
case,
the
impacts
of
multiple
regulations
on
production
decisions
were
not
separable
or
independent
of
the
order
of
their
issuance,
so
that
the
costs
and
benefits
of
requirements
estimated
for
each
regulation
were
dependent
on
which
preexisting
rules
were
considered
binding
in
the
analysis.
A
similar
illustration
concerning
hazardous
waste
regulations
is
also
provided
by
Arnold
(
1995),
wherein
an
assessment
of
the
costs
and
benefits
associated
with
several
regulations
is
performed,
demonstrating
that
the
result
of
evaluating
each
individual
regulation
varies
significantly
depending
on
which
of
the
other
regulations
are
included
in
the
baseline.

Therefore,
the
best
practice
is
to
be
clear
as
to
the
baseline
selected
for
the
analysis,
and
to
present
a
justification
for
making
this
choice.
This
can
include
providing
information
on
the
status
of
other
regulatory
actions
that
may
have
some
effect
on
the
baseline,
and
conducting
sensitivity
analyses
that
test
for
the
implications
of
including
or
omitting
other
regulations.
Some
regulatory
actions
have
attempted
to
directly
link
rules
together
that
affect
the
same
industrial
category
(
e.
g.,
the
pulp
and
paper
effluent
guidelines
and
NESHAP
rules
(
EPA,
1997)).
While
statutory
and
judicial
deadlines
may
inhibit
the
linking
of
rules
that
fall
on
the
same
regulated
entities
(
e.
g.,
UMRA
and
RFA
require
analyses
be
performed
for
each
rule),
coordination
between
rulemaking
groups
is
advocated
in
EPA's
regulatory
development
process,
and
sharing
of
data,
models
and
joint
decisions
on
analytic
approaches
is
strongly
recommended.

5.3.4
Summary
The
specification
of
the
baseline
for
an
economic
analysis
can
have
a
profound
influence
on
the
outcome
of
the
25
Chapter
5:
Overview
analysis.
The
estimated
costs
and/
or
benefits
of
a
proposed
policy
can
change
by
an
order
of
magnitude
under
different
baseline
assumptions.
Careful
thought
in
specifying
the
baseline
is
therefore
crucial
to
a
defensible
analysis.

The
first
step
is
to
be
clear
about
the
question
being
asked
and
therefore
what
baseline
the
analyst
would
like
to
specify
The
second
step
is
to
characterize
that
baseline
as
well
as
possible
within
the
constraints
of
the
analysis.
This
involves
determining
which
baseline
parameters
are
most
important
to
the
analysis,
assessing
the
advisability
of
expending
resources
to
improve
the
estimates
of
those
parameters,
and
making
reasonable
assumptions
when
necessary.
In
all
cases,
assumptions
and
uncertainties
should
be
clearly
stated
as
part
of
the
analysis,
along
with
a
discussion
of
how
alternative,
plausible
assumptions
would
be
likely
to
affect
the
outcome
of
the
analysis.
Within
the
resources
available,
sensitivity
analysis
and
uncertainty
analysis
are
valuable
tools
for
illustrating
the
potential
impacts
of
assumptions
made
and
quantifying,
to
the
degree
possible,
the
extent
of
the
uncertainty
underlying
the
specified
baseline.
Finally,
the
estimation
of
the
costs
and
benefits
attributable
to
individual
policies
in
a
package
of
policies
is
a
problem
for
which
there
simply
is
no
"
correct
answer."

Many
factors
will
affect
the
configuration
of
the
baseline
in
EPA's
economic
analyses.
This
means
that
even
though
analytical
choices
are
well­
constructed
and
logical,
the
consequences
of
these
differences
may
frustrate
efforts
to
attain
comparability
of
baselines
across
different
regulatory
activities.
Still,
in
any
effort
to
evaluate
regulatory
options
and
assess
benefits,
costs,
and
economic
impacts
attributable
to
an
individual
rule,
the
analysis
should
be
internally
consistent
in
its
definition
and
use
of
baseline
assumptions
This
is
imperative
when
more
than
one
baseline
scenario
is
introduced,
since
this
provides
more
possibilities
to
erroneously
compare
costs
and
benefits
across
different
baselines.
A
decision
to
include
multiple
baselines
into
an
analysis
can
result
in
a
complex
set
of
modeling
choices,
and
an
abundance
of
analytic
results
to
interpret
and
communicate
to
decision
makers.
Therefore,
analysts
are
advised
to
seek
clear
direction
from
management
about
baseline
definitions
early
during
the
development
of
a
rule.

5.4
Predicting
Responses
to
a
New
Environmental
Policy
It
is
impossible
to
measure
an
environmental
policy's
costs
and
benefits
without
a
clear
characterization
of
actions
taken
in
response
to
the
policy.
Some
policies
are
prescriptive
in
specifying
what
actions
are
required
 
for
example,
mandating
the
use
of
a
specific
type
of
pollution
control
equipment.
It
can
be
difficult,
however,
to
predict
responses
to
less­
direct
performance
standards,
such
as
bans
on
the
production
or
use
of
certain
products
or
processes,
and
market­
based
incentive
programs.
Analysts
should
make
explicit
all
assumptions
about
responses,
and
should
consider
plausible
alternative
compliance
options.
Alternatively,
when
the
number
of
conceivable
options
is
essentially
infinite,
the
analysis
should
at
least
span
the
range
of
possibilities.
Cost­
effectiveness
analysis
can
often
be
used
to
identify
and
map
out
dominant
regulatory
options
and
responses.
When
it
is
not
possible
to
characterize
compliance
responses
with
a
high
degree
of
certainty,
the
analysis
should
include
a
description
of
the
likely
direction
of
bias
in
the
estimates
 
whether
costs
and
benefits
are
over­
or
understated
 
if
this
is
known.

Predicting
responses
starts
with
a
comprehensive
list
of
possible
response
options.
These
may
include
the
use
of
different
compliance
technologies
(
if
the
technology
is
not
specified
by
the
policy
itself)
or
waste
management
methods;
changes
in
operations
to
avoid
or
reduce
the
need
for
new
controls
or
the
utilization
of
materials
whose
use
is
restricted
by
a
policy
(
including
various
types
of
pollution
prevention);
shutting
down
a
production
line
or
plant
to
avoid
the
investments
required
to
achieve
compliance;
or
even
noncompliance.
4
Typically,
parties
affected
by
a
policy
are
assumed
to
choose
the
compliance
option
that
minimizes
their
costs.
In
some
cases,
however,
it
may
be
reasonable
to
select
a
more
costly
option
as
the
most
likely
response.
Sometimes
a
higher
26
Chapter
5:
Overview
4
As
in
the
case
of
baseline
specification,
most
analyses
will
assume
full
compliance
by
all
entities
that
continue
to
operate.
For
some
policies
that
present
significant
enforcement
challenges,
or
for
options
that
differ
in
ways
that
are
likely
to
affect
compliance
rates,
it
may
be
useful
to
calculate
how
costs
and
benefits
compare
when
using
estimates
of
compliance
rates
less
than
100
percent.
cost
option
may
significantly
reduce
future
legal
liabilities,
or
achieve
compliance
with
other
rules
being
implemented
at
either
the
same
time,
or
those
expected
to
be
promulgated
in
the
future.
However,
the
additional
costs
of
compliance
responses
in
excess
of
least­
cost
strategy
costs
should
be
attributed
to
these
other
causes.

Estimating
responses
is
often
the
most
difficult
for
pollution
prevention
policies
because
these
options
are
generally
more
site­
and
process­
specific
than
end­
of­
pipe
control
technologies.
Predicting
the
costs
and
environmental
effects
of
pollution
prevention
policies
may
require
detailed
information
on
industrial
processes.
As
a
result,
the
costs
of
a
pollution
prevention
policy
may
be
overstated
and
the
benefits
either
over­
or
understated
(
depending
on
the
nature
of
the
process
changes
involved).
Nevertheless,
economic
analyses
should
at
least
include
qualitative
discussion
of
potential
pollution
prevention
responses
and
their
effects
on
costs
and
benefits.

Predicting
reductions
in
output
(
e.
g.,
production
line
or
plant
closures)
in
response
to
a
policy
requires
analysis
of
market
characteristics
that
determine
the
allocation
of
cost
increases
among
directly
affected
entities
and
their
suppliers
customers,
and
competitors.
This
subject
is
discussed
in
the
economic
impact
analysis
section
of
Chapter
9.

5.5
Analyzing
and
Presenting
Uncertainty
This
section
contains
guidance
on
dealing
with
uncertainty
in
regulatory
economic
analyses,
focusing
on
characterizing
the
precision
of
estimated
economic
outcomes
such
as
net
benefits.
It
provides
specific
recommendations
for
describing
and
presenting
problems
arising
from
uncertainty
and
suggestions
for
carrying
out
sensitivity
analyses.

This
section
concludes
with
a
discussion
of
the
welfare
considerations
related
to
risk
and
uncertainty.
5
These
considerations
are
largely
distinct
from
those
associated
with
characterizing
precision.
The
use
of
certainty
equivalents
for
addressing
these
problems
is
addressed
briefly,
but
detailed
treatment
is
beyond
the
scope
of
this
discussion.
6
Issues
related
to
differences
in
risk
perceptions
and
the
provision
of
information
are
described,
and
the
role
of
quasi­
option
values
in
decisions
characterized
by
irreversible
consequences
is
addressed
briefly.

5.5.1
Guiding
Principles
for
Uncertainty
Analysis
Uncertainty
is
inherent
in
economic
analyses,
particularly
those
associated
with
environmental
benefits
for
which
there
are
no
existing
markets.
The
issue
for
the
analyst
is
not
how
to
avoid
uncertainty,
but
how
to
account
for
it
and
present
useful
conclusions
to
those
making
policy
decisions
Treatment
of
uncertainty,
therefore,
should
be
considered
part
of
the
communication
process
between
analysts
and
policy
makers.

Transparency
and
clarity
of
presentation
are
the
guiding
principles
for
assessing
and
describing
uncertainty
in
economic
analyses.
Although
the
extent
to
which
uncertainty
is
treated
and
presented
will
vary
according
to
the
specific
needs
of
the
economic
analysis,
some
general
minimum
requirements
apply
to
most
economic
analyses.
In
assessing
and
presenting
uncertainty
the
analyst
should,
if
feasible:

present
outcomes
or
conclusions
based
on
expected
or
most
plausible
values;

provide
descriptions
of
all
known
key
assumptions,
biases,
and
omissions;

perform
sensitivity
analysis
on
key
assumptions;
and
justify
the
assumptions
used
in
the
sensitivity
analysis.

The
outcome
of
the
initial
assessment
of
uncertainty
may
be
sufficient
to
support
the
policy
decisions.
If,
however,
the
implications
of
uncertainty
are
not
adequately
captured
in
the
initial
assessment
then
a
more
sophisticated
27
Chapter
5:
Overview
5
Stemming
from
definitions
given
in
Knight
(
1921)
economists
have
distinguished
risk
and
uncertainty
according
to
how
well
one
can
characterize
the
probabilities
associated
with
potential
outcomes.
Risk
applies
to
situations
or
circumstances
in
which
a
probability
distribution
is
known
or
assumed,
while
uncertainty
applies
to
cases
where
knowledge
of
probabilities
is
absent.
Note
that
the
economic
definitions
for
these
terms
may
differ
from
those
used
in
other
disciplines.

6
Several
other
issues
associated
with
uncertainty
are
also
beyond
the
scope
of
this
brief
discussion,
including
verification,
validation,
and
plausibility
checks.
Analysts
will
need
to
consult
other
sources
for
additional
information
on
these
topics.
analysis
should
be
undertaken.
The
need
for
additional
analysis
should
be
clearly
stated,
along
with
a
description
of
the
other
methods
used
for
assessing
uncertainty.
These
methods
include
decision
trees,
Delphi­
type
methods7
and
meta­
analysis.
Probabilistic
methods,
including
Monte
Carlo
analysis,
can
be
particularly
useful
because
they
explicitly
characterize
analytical
uncertainty
and
variability
However,
these
methods
can
be
difficult
to
implement
often
requiring
more
data
than
are
available
to
the
analyst.
8
Confidence
intervals
are
generally
useful
to
describe
the
uncertainty
associated
with
particular
variables.
When
data
are
available
to
estimate
confidence
intervals
they
can
serve
to
characterize
the
precision
of
estimates
and
to
bound
the
values
used
in
sensitivity
analysis.

5.5.2
Performing
Sensitivity
Analysis
Most
analytical
base
cases,
or
primary
analyses,
generally
do
not
address
uncertainty
and
present
expected
or
most
plausible
outcomes.
Regardless
of
the
basis
for
the
primary
analysis,
point
estimates
alone
do
not
provide
policy
makers
with
information
about
the
full
range
of
potential
outcomes.
Additional
information
is
needed
if
the
decision­
maker
is
to
have
a
more
complete
view
of
the
potential
impacts
of
the
policy
alternatives.
It
is
always
useful
to
see
how
net
benefit
estimates
or
other
outputs
of
the
economic
analysis
change
with
assumptions
about
input
parameters.
Sensitivity
analysis
provides
a
systematic
method
for
making
these
determinations.
Keeping
in
mind
some
basic
principles
can
enhance
sensitivity
analysis.

Focus
on
key
variables.
For
most
applied
economic
analyses,
a
full
sensitivity
analysis
that
includes
every
variable
is
not
feasible.
Instead
the
analyst
must
limit
the
sensitivity
analysis
to
those
input
parameters
that
are
considered
to
be
key
or
particularly
important.
In
determining
which
parameters
are
key,
the
analyst
should
carefully
consider
both
the
range
of
possible
values
for
input
parameters
and
each
one's
functional
relationship
to
the
output
of
analysis.
The
analyst
should
specify
a
plausible
range
of
values
for
each
key
variable,
including
the
rationale
for
the
range
of
values
tested.

Present
the
results
clearly.
Results
of
the
sensitivity
analysis
should
be
presented
clearly
and
accompanied
with
descriptive
text.
The
most
common
approach
to
this
sort
of
partial
sensitivity
analysis
is
to
estimate
the
change
in
net
benefits
(
for
a
benefit­
cost
analysis)
or
other
economic
outcome
while
varying
a
single
parameter,
leaving
other
parameters
at
their
base
value.
A
more
complete
analysis
will
present
the
marginal
changes
in
the
economic
outcome
as
the
input
parameter
takes
on
progressively
higher
or
lower
values.
Varying
two
parameters
simultaneously
can
often
provide
a
richer
picture
of
the
implications
of
base
values
and
the
robustness
of
the
analysis.
Analysts
should
consider
using
graphs
to
present
these
combined
sensitivity
analyses
by
plotting
one
parameter
on
the
x­
axis,
the
economic
outcome
on
the
y­
axis,
and
treating
the
second
parameter
as
a
shift
variable.
9
Identify
switch
points.
"
Switch
point"
values
for
key
input
parameters
can
be
very
informative,
especially
in
benefit­
cost
analyses.
Switch
points
are
defined
as
those
conditions
at
which
the
recommended
policy
decision
changes
(
e.
g.,
when
the
estimation
of
net
benefits
changes
sign).
While
switch
points
are
not
tests
of
confidence
in
the
statistical
sense,
they
can
help
provide
decision­
makers
with
an
understanding
of
how
robust
the
analysis
is.

Assess
the
need
for
more
detailed
analysis.
Finally,
sensitivity
analyses
can
also
be
useful
as
a
screening
device
to
determine
where
more
extensive
treatment
of
uncertainty
may
be
needed.
In
some
cases
the
plausible
range
of
values
for
the
parameter
may
be
narrowed
with
further
research
or
data
gathering
or
the
analyst
may
be
able
to
better
characterize
the
parameter's
uncertainty.
If
several
parameters
28
Chapter
5:
Overview
7
There
a
number
of
such
techniques,
but
all
of
these
methods
focus
on
the
use
of
eliciting
and
combining
expert
judgment
to
inform
analysis.
See
Chapter
7
of
Morgan
and
Henrion
(
1990)
for
more
detail
on
the
use
of
these
methods.

8
Morgan
and
Henrion
(
1990)
is
a
useful
general
reference
that
includes
descriptions
of
many
methods
to
assess
uncertainty.

9
When
the
analysis
contains
many
highly
uncertain
variables,
presentation
may
be
facilitated
by
noting
the
uncertainty
of
each
in
footnotes
and
carrying
through
the
central
analysis
using
best
point
estimates.
appear
to
have
a
large
impact
on
the
results
of
the
analysis
then
a
more
sophisticated
treatment
of
uncertainty
may
be
necessary.

5.5.3
Welfare
Considerations
Related
to
Uncertainty
and
Risk
So
far
this
discussion
has
focused
upon
uncertainty
as
it
must
be
accommodated
by
the
analyst
charged
with
performing
an
economic
assessment
and
the
decision­
maker
who
receives
this
information.
A
separate
but
related
issue
is
how
individuals
affected
by
environmental
policies
respond
to
uncertainty
in
outcomes
and
imperfect
information
These
responses
may
have
an
impact
on
how
individuals
respond
to
policy
alternatives
and
how
they
value
policy
outcomes.
Some
of
these
considerations
are
noted
here,
but
this
treatment
is
not
detailed
or
exhaustive
It
is
important
to
note
that
analytical
precision
and
welfare
effects
are
distinct
concepts.
Certainty
equivalents,
for
example,
address
welfare
effects
and
are
appropriate
for
assessing
efficiency
in
a
benefit­
cost
analysis,
but
they
do
not
assess
analytical
precision
or
mitigate
the
usefulness
of
sensitivity
analyses
and
bounding
cases.

Risk
attitudes
and
certainty
equivalents:
Individuals
and
other
entities
are
generally
not
neutral
when
faced
with
situations
of
uncertainty
or
risk.
In
most
cases
related
to
environment
and
health
they
are
considered
to
be
risk
averse,
favoring
a
certain
outcome
to
one
that
is
uncertain
even
if
the
expected
value
of
the
risky
outcome
is
equal
to
the
value
of
the
certain
one.
The
theoretically
preferred
manner
of
incorporating
risk
attitudes
is
to
use
certainty
equivalents
sometimes
termed
certain
monetary
equivalents
Certainty
equivalents
are
defined
as
the
minimum
amount
that
an
individual
would
be
willing
to
accept
with
certainty
instead
of
facing
the
uncertain
outcomes.
10
While
certainty
equivalents
have
theoretic
appeal,
they
are
difficult
to
put
into
practice
for
economic
analyses
of
environmental
policies.
Estimation
of
certainty
equivalents
requires
detailed
knowledge
of
(
or
assumptions
about)
risk
preferences,
and
analysts
are
unlikely
to
have
these
data.
To
estimate
certainty
equivalents
one
must
also
be
able
to
assign
probabilities
to
the
set
of
potential
outcomes.
It
is
often
very
difficult
or
impossible
to
make
these
assignments.

Lay
and
expert
risk
perceptions:
Lay
perceptions
of
risk
may
differ
significantly
from
scientific
assessments
of
the
same
risk,
and
an
extensive
literature
has
developed
on
the
topic.
11
Because
individuals
respond
according
to
their
own
risk
perceptions,
it
is
important
for
the
analyst
to
be
attentive
to
situations
where
there
is
an
obvious
divergence
in
these
two
measures.
In
such
cases,
analysts
should
consider
evaluating
policy
options
under
both
sets
of
information
clearly
stating
the
basis
for
economic
value
estimates
used
or
developed
in
their
analysis.
Because
providing
information
to
the
public
may
reduce
differences
between
lay
and
expert
perceptions
of
risk,
and
may
allay
public
concerns,
analysts
should
consider
including
these
strategies
in
their
analysis
of
potential
policy
options.

Provision
of
information:
Some
policy
actions
focus
on
providing
information
on
risks
to
health
and
welfare.
Inasmuch
as
this
information
allows
consumers
to
make
better
decisions
regarding
their
households'
welfare
there
is
an
economic
benefit
to
providing
this
information.
Revealed
preference
benefit
analyses,
however,
can
make
new
information
appear
to
have
a
net
negative
effect
on
household
welfare
because
households
may
undertake
new
(
and
costly)
activities
in
response.
An
appropriate
framework
for
evaluating
the
benefits
of
information
provision
under
these
circumstances
is
to
assess
the
costs
of
sub­
optimal
household
decisions
under
the
lesscomplete
information.
12
Analysts
should
carefully
consider
these
issues
when
they
evaluate
policies
that
focus
on
information
provision.

29
Chapter
5:
Overview
10
Some
researchers
have
suggested
risk­
adjusted
discount
rates
as
an
alternative
device
for
incorporating
information
on
the
uncertainty
future
benefits
and
costs.
Most
economists
now
conclude,
however,
that
the
discount
rate
should
not
be
adjusted
to
account
for
uncertainty
in
benefit
cost
analysis.

11
Useful
general
sources
include
Slovic
(
1987)
and
Fischhoff
et
al.
(
1978).

12
Foster
and
Just
(
1989)
describes
this
approach
more
fully,
demonstrating
that
compensating
surplus
is
an
appropriate
measure
of
willingness
to­
pay
under
these
conditions.
The
authors
illustrate
this
with
an
empirical
application
to
food
safety.
Quasi­
option
value:
Another
relevant
issue
in
decision
making
under
uncertainty
is
that
of
quasi­
option
value
as
identified
by
Arrow
and
Fisher
(
1974).
Some
environmental
policies
involve
irreversible
decisions
that
must
be
made
in
the
face
of
uncertainty.
If
information
that
reduces
this
uncertainty
can
be
expected
to
develop
over
time,
then
there
is
a
positive
"
quasioption
value
to
waiting
until
this
information
is
available
In
this
case,
the
value
originates
from
possessing
the
option
to
hold
off
on
making
the
decision
until
uncertainties
are
resolved.
Generally,
it
is
difficult
to
quantitatively
include
quasi­
option
values
in
an
economic
analysis
of
environmental
policy,
but
the
concept
is
useful
and
may
be
highlighted
qualitatively
if
circumstances
warrant.
For
more
on
this
issue
see
Freeman
(
1984,
1993),
Fisher
and
Hanemann
(
1987),
and
Cochrane
and
Cutler
(
1990).

5.6
Emerging
Cross­
Cutting
Issues
Many
other
cross­
cutting
issues
are
not
detailed
in
the
EA
Guidelines.
Some
of
these
issues
are
difficult
or
impossible
to
incorporate
fully
into
economic
analyses
at
this
time,
but
may
become
either
more
important
or
more
tractable
as
the
economic
literature
develops.
Although
the
relevance
of
these
considerations
depends
on
the
specifics
of
the
policy
being
considered,
analysts
may
want
to
at
least
consider
these
issues
qualitatively.
Three
emerging
issues
are
identified
here:
tax
interaction
effects,
the
pace
of
exogenous
technological
change,
and
the
effects
of
regulation
on
innovation.

Tax
Interaction
effects:
Although
evaluations
of
environmental
policies
typically
assume
a
first­
best
regulatory
setting,
preexisting
taxes
such
as
those
on
labor
income
create
a
second­
best
setting.
This
difference
can
affect
the
estimated
costs
of
policy
actions.
Recent
advances
in
applied
general
equilibrium
analysis
have
led
to
generally
replicable
qualitative
results.
These
studies
indicate
that
ignoring
these
effects
may
result
in
underestimating
the
cost
of
compliance
from
a
social
perspective.
13
However,
the
magnitude
of
the
effect
 
and
perhaps
the
direction
 
will
vary
across
policies.
Although
the
analytical
emphasis
on
this
issue
has
been
on
estimating
costs,
benefits
analysis
can
conceivably
suffer
a
similar
bias.

Pace
of
exogenous
technological
change:
Economic
analysis
of
environmental
policies
may
be
affected
by
the
pace
of
exogenous
technological
change.
In
principal,
accounting
for
this
can
either
increase
or
decrease
marginal
and
total
abatement
costs,
depending
on
the
direction
of
change.
Generally,
however,
the
expectation
is
that
accounting
for
exogenous
technological
change
would
decrease
estimated
abatement
costs.
Recent
analyses
have
indicated
that
even
for
mature
technologies
the
magnitude
of
this
effect
can
be
large.
14
Regulation
and
innovation:
More
extensive
research
is
being
developed
to
examine
the
impact
of
various
regulatory
approaches
on
firms'
research
and
development
decisions
for
abatement
technology.
15
As
suggested
in
the
descriptions
of
alternative
regulatory
approaches
in
Chapter
4,
this
impact
may
be
positive
or
negative
depending
on
the
regulatory
approach
and
setting.
Generally,
economists
expect
that
incentivebased
instruments
will
provide
greater
incentive
for
cost­
reducing
innovations
than
will
command
and
control
regulatory
approaches.
Policies
that
provide
information
to
firms
and
consumers
may
also
affect
technological
innovation.
Chapter
8
provides
some
additional
information
on
the
subject
of
regulation,
innovation,
and
the
implications
for
estimating
social
costs.

30
Chapter
5:
Overview
13
For
an
example
see
Bovenberg
and
Goulder
(
1997).

14
See,
for
example,
Ellerman
and
Montero
(
1998)
and
Carlson
et
al
(
1998).

15
See,
for
example,
Milliman
and
Prince
(
1989)
and
Biglaiser
and
Horowitz
(
1995).
5.7
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31
Chapter
5:
Overview
32
Chapter
5:
Overview
6.1
Introduction
The
costs
and
benefits
of
many
environmental
policies
are
frequently
paid
and
received
at
different
points
over
the
course
of
sometimes
long
time
horizons
As
a
result,
benefit­
cost
and
related
analyses
that
are
key
components
of
EPA's
policy
development
and
evaluation
process
must
describe
future
effects
in
terms
that
help
present
day
policy
makers
choose
appropriate
approaches
for
environmental
protection.

One
common
method
for
doing
so
is
called
discounting
which
is
the
process
whereby
the
values
of
future
effects
are
adjusted
to
render
them
comparable
to
the
values
placed
on
current
consumption,
costs,
and
benefits,
reflecting
the
fact
that
a
given
amount
of
future
consumption
is
worth
less
than
the
same
amount
of
consumption
today.
Time
discounting
is
accomplished
by
multiplying
the
future
values
of
a
policy's
effects
by
discount
factors
that
reflect
both
the
amount
of
time
between
the
present
and
the
point
at
which
these
events
occur
and
the
degree
to
which
current
consumption
is
more
highly
valued
than
future
consumption.

Despite
the
relative
simplicity
of
the
discounting
concept
choosing
a
discount
rate
has
been
one
of
the
most
contentious
and
controversial
aspects
of
EPA's
economic
analyses
of
environmental
policies.
While
there
are
several
plausible
explanations
for
why
discounting
in
environmental
policy
evaluation
has
been
unsettled
for
many
years,
the
most
important
is
that
the
theoretical
and
applied
economics
literature
on
discounting
from
a
social
perspective
is
voluminous
and
technically
complex.
This
makes
it
difficult
to
distill
precise
advice
on
appropriate
discounting
procedures
for
policy
analysis.
Moreover,
in
some
cases
the
economics
literature
by
itself
does
not
yield
simple
and
robust
discounting
rules
for
practical
applications
because
making
such
important
social
decisions
requires
inputs
from
disciplines
other
than
economics.

Nonetheless,
it
is
important
to
consider
the
uncertainties
surrounding
social
discounting
in
the
broader
context
of
applied
economic
analysis.
Benefit­
cost
analysis
is
not
a
precise
tool
that
yields
firm
numerical
results,
rather,
it
is
a
general
framework
for
more
carefully
accounting
for
the
potential
and
varied
effects
of
government
programs.
Some
of
these
effects
can
be
quantified,
whereas
others
can
only
be
assessed
qualitatively.
Some
may
be
relatively
certain
whereas
others
may
be
quite
speculative.

The
imprecision
connected
with
assessing
benefits
and
costs
suggests
that
the
controversy
surrounding
the
discount
rate,
in
many
circumstances,
may
have
more
theoretical
than
practical
significance.
For
example,
the
effects
on
net
benefits
of
alternative
assumptions
made
for
measuring
and
valuing
uncertain
effects
of
environmental
policies
can
overwhelm
the
effects
of
changes
in
the
discount
rate.
Additionally,
for
some
government
projects,
benefits
and
costs
may
have
similar
time
profiles,
or
benefits
may
so
outweigh
costs
(
or
vice
versa),
that
changes
in
the
discount
rate
will
not
influence
the
policy
implications
of
the
analysis.

This
review
of
the
basics
of
social
discounting
begins
in
Section
6.2
with
a
discussion
of
some
general
considerations
in
social
discounting.
In
Section
6.3,
various
discounting
procedures
for
environmental
policy
assessment
are
presented
and
evaluated.
This
detailed
discussion
is
divided
into
social
discounting
as
applied
in
intra­
generational
contexts,
where
very
long
time
horizons
involving
multiple
generations
do
not
apply,
and
discounting
for
inter­
generational
33
Chapter
6
Chapter
6:
Analysis
of
Social
Discounting
circumstances
involving
long
time
horizons
and
unborn
generations.
EPA
guidance
for
intra­
generational
social
discounting
is
presented
in
Section
6.3.1.5.
EPA
guidance
on
inter­
generational
social
discounting
follows
in
Section
6.3.2.4.
Finally,
discounting
and
related
procedures
for
situations
in
which
some
effects
are
not
monetized
are
addressed
in
Section
6.4.

6.2
General
Considerations
in
Social
Discounting
This
section
reviews
a
few
basic
concepts
and
considerations
central
to
understanding
the
role
and
importance
of
discounting
in
public
policy
evaluation.
The
focus
is
mainly
on
describing
social
discounting
and
on
distinguishing
discounting
per
se
from
other
aspects
of
measuring
and
summarizing
the
costs,
benefits,
impacts,
and
other
consequences
of
environmental
policies.
It
also
discusses
the
circumstances
in
which
discounting
has
a
large
impact
on
the
net
social
benefits
of
an
environmental
policy.

6.2.1
Social
and
Private
Discounting
Discounting
in
public
policy
evaluation
is
normally
referred
to
as
social
discounting
or
discounting
using
the
social
rate
of
interest.
The
process
itself
 
applying
discount
factors
to
future
flows
of
costs,
benefits,
and
other
consequences
of
environmental
and
other
policies
 
is
mechanically
the
same
as
the
discounting
process
in
private
individuals'
economic
and
financial
calculations.
What
makes
it
"
social"
discounting
is
that
it
is
being
applied
in
the
context
of
evaluating
a
policy's
effects
from
an
overall
social
perspective.
Clearly,
private
and
social
perspectives
can
yield
very
different
conclusions
concerning
for
example,
the
cost
of
engaging
in
an
activity
that
also
generates
environmental
harms.

Whether
social
discounting
also
departs
significantly
from
private
discounting,
however,
is
less
clear.
Some
approaches
to
social
discounting
suggest
that
the
procedures
and
rates
should
be
the
same
as
those
used
in
private
sector
discounting.
Other
perspectives,
however,
suggest
that
social
discounting
is
a
very
different
process
than
a
single
individual's
discounting.
In
any
event,
at
a
minimum
the
term
"
social
discounting"
refers
to
the
broad
society­
as­
a­
whole
point
of
view
embodied
in
benefit­
cost
and
other
analyses
of
public
policies.
Whether
it
also
connotes
procedures
and
rates
different
from
private
discounting
is
a
central
question
explored
in
this
chapter.

6.2.2
Methods
for
Summarizing
Present
and
Future
Costs
and
Benefits
Most
applications
of
social
discounting
in
environmental
policy
evaluation
involve
translating
future
values
into
present
ones.
The
conceptual
foundation
of
discounting
is
based
on
the
fact
that
present
consumption
is
valued
differently
from
future
consumption.
Discounting
renders
costs
and
benefits
that
occur
in
different
time
periods
comparable
by
stating
them
all
in
present
day
terms.
The
resulting
net
present
value
is
at
least
one
measure
of
social
value
that
might
be
used
in
evaluating
environmental
policies.

6.2.2.1
Net
Present
Value
In
formal
terms,
the
net
present
value
of
a
projected
stream
of
current
and
future
benefits
and
costs
is
found
by
multiplying
the
benefits
and
costs
in
each
year
by
a
timedependent
weight,
dt,
and
adding
all
of
the
weighted
values
as
follows:

NPV
=
NB0
+
d1NB1
+
d2NB2
+
...
+
dnNBn
NBt
is
the
net
difference
between
benefits
and
costs
(
Bt­
Ct)
that
accrue
at
the
end
of
period,
t,
and
the
discounting
weights
are
given
by:

dt
=
l/(
l+
r)
t
where
r
is
the
discount
rate
and
n
is
the
final
period
in
the
future
in
which
the
policy's
effects
are
felt.

To
account
for
inflation,
either
real
or
nominal
values
may
be
used,
as
long
as
they
are
used
consistently.
In
other
words,
nominal
costs
and
benefits
require
nominal
discount
rates,
and
real
costs
and
benefits
require
real
discount
rates.
Moreover,
consistent
decision
making
requires
that
the
same
discount
rate
be
used
for
both
34
Chapter
6:
Social
Discounting
benefits
and
costs.
Otherwise,
any
policy
can
be
justified
by
choosing
a
sufficiently
low
discount
rate
for
benefits,
by
choosing
a
sufficiently
high
discount
rates
for
costs,
or
by
choosing
a
sufficiently
long
time
horizon.

It
is
important
to
be
explicit
about
how
time
periods
are
designated
and
when,
within
each
time
period,
costs
and
benefits
accrue.
Typically,
time
periods
are
years,
but
alternative
time
periods
may
prove
desirable
or
necessary
if
costs
or
benefits
accrue
at
irregular
or
non­
annual
intervals
The
preceding
formula
assumes
that
t=
0
designates
the
beginning
of
the
first
period.
Therefore,
C0
represents
startup
costs
such
as
capital
costs
that
occur
immediately
upon
implementation
of
the
regulation.
The
formula
further
assumes
that
no
additional
costs
are
incurred
until
the
end
of
the
first
year
of
regulatory
compliance.
1
Benefits,
if
any,
also
accrue
at
the
end
of
each
time
period.
Therefore,
the
following
diagram
illustrates
how
net
benefits
(
measured
in
dollars)
are
distributed
over
time.

6.2.2.2
Annualized
Values
In
addition
to
net
present
value,
there
are
other
procedures
for
rendering
costs
and
benefits
that
occur
in
more
than
one
time
period
comparable.
One
method
is
to
annualize
the
costs
and
benefits
over
the
duration
of
the
policy.
For
example,
in
the
absence
of
discount
rates
(
r=
0),
a
regulation
that
costs
$
100,000
at
the
end
of
the
first
year,
$
200,000
at
the
end
of
the
second
year,
and
$
300,000
at
the
end
of
the
third
year
can
be
said
to
cost
$
200,000
a
year
in
annualized
costs
over
the
three
year
period.
Comparing
annualized
costs
to
annualized
benefits
is
equivalent
to
comparing
the
present
values
of
costs
and
benefits.

Costs
and
benefits
each
may
be
annualized
separately
by
using
a
two­
step
procedure.
To
annualize
the
costs,
for
example,
the
present
value
of
costs
is
calculated
using
the
NPV
formula
in
Section
6.2.2.1,
except
that
the
stream
of
costs
alone,
not
the
net
benefits,
is
used
in
the
calculation.
This
present
value
is
then
annualized
(
as
in
calculating
mortgage
payments)
according
to
the
following
formula:

where,

AC
=
annualized
cost
accrued
at
the
end
of
each
of
n
periods;

PVC
=
present
value
of
costs;

r
=
the
discount
rate
per
period;
and
n
=
the
duration
of
the
policy.

Note
that
the
annualized
cost
is
the
amount
one
would
have
to
pay
at
the
end
of
each
period
t
to
add
up
to
the
same
cost
in
present
value
terms
as
the
stream
of
costs
being
annualized.
There
is
no
initial
cost
at
t=
0
in
this
annualization.
Such
an
initial
cost
can
be
incorporated
into
the
annualization
using
the
slightly
different
formula:

This
approach
is
also
useful
when
analyzing
non­
monetized
benefits,
such
as
reductions
in
emissions
or
reductions
in
health
risks,
when
benefits
are
constant
over
time.
The
average
cost­
effectiveness
of
a
policy
can
be
calculated
by
dividing
the
annualized
cost
by
the
annual
benefit
to
produce
measures
of
program
effectiveness,
such
as
the
cost
per
ton
of
emissions
avoided.

6.2.2.3
Net
Future
Value
Finally,
there
is
yet
another
way
of
rendering
costs
and
benefits
that
occur
in
more
than
one
time
period
comparable
Instead
of
discounting
all
future
values
back
to
the
present,
it
is
possible
to
accumulate
them
forward
to
some
future
time
period
 
for
example,
to
the
end
of
the
last
year
of
the
policy's
effects,
n.
Here,
the
net
benefit
test
is
whether
the
accumulated
net
future
value
(
NFV)
is
positive.

NFV
=
d0NB0
+
d1NB1
+
d2NB2
+
...
+
dn­
1NBn­
1
+
NBn
35
Chapter
6:
Social
Discounting
1
See
EPA
(
1995)
for
an
example
in
which
operating
and
monitoring
costs
were
assumed
to
be
spread
out
evenly
throughout
each
year
of
compliance.
While
the
exponential
function
above
is
the
most
accurate
way
of
modeling
the
relationship
between
present
value
and
a
continuous
stream
of
benefits
and
costs,
simple
adjustments
to
the
equations
above
can
sometimes
adapt
them
for
use
under
alternative
assumptions
about
how
dollar
flows
are
distributed
over
time.
TIME
Year
t
0
1
2
3
4
...
n
$
NB0
NB1
NB2
NB3
NB4
...
NBn
AC
=
PVC
×
r
×
(
1
+
r)
n
(
1+
r)
n
­
1
AC
=
PVC
×
r
×
(
1
+
r)
n
(
1+
r)(
n+
1)
­
1
Chapter
6:
Social
Discounting
36
NBt
is
the
net
difference
between
benefits
and
costs
(
Bt­
Ct)
that
accrue
in
year
t
and
the
accumulation
weights,
dt,
are
given
by
dt
=
(
l+
r)(
n­
t)

where
r
is
the
discount
rate.

Each
of
these
methods
employs
an
interest
rate
to
translate
values
through
or
across
time,
so
the
methods
are
not
really
different
ways
to
determine
the
benefits
and
costs
of
a
policy.
Instead,
they
are
different
ways
to
express
and
compare
costs
and
benefits
that
occur
in
multiple
time
periods
on
a
consistent
basis.
Discounting
places
all
costs
and
benefits
in
the
present
time
period,
annualization
spreads
them
smoothly
through
time,
and
accumulation
states
them
all
in
the
future.
But
each
procedure
uses
the
same
discount
(
interest)
rate,
so
they
are
different
ways
to
describe
the
same
underlying
phenomenon.

Depending
on
the
circumstances,
one
method
might
have
advantages
over
the
others.
For
example,
annualizing
the
costs
of
two
machines
with
different
service
lifetimes
might
reveal
that
the
one
with
the
higher
total
cost
actually
has
a
lower
annual
cost
because
of
its
longer
lifetime.
Similarly,
discounting
to
the
present
is
likely
to
be
the
most
informative
procedure
when
analyzing
a
policy
that
requires
an
immediate
investment
and
offers
a
stream
of
highly
variable
future
benefits.

In
general,
however,
these
are
alternative
ways
of
translating
costs
and
benefits
through
time
using
an
interest
rate.
Therefore,
the
analysis,
discussion,
and
conclusions
presented
in
this
chapter
apply
to
all
methods
of
translating
costs,
benefits,
and
effects
through
time,
even
though
the
focus
is
mostly
on
discounting.

6.2.3
Sensitivity
of
Present
Value
Estimates
to
the
Discount
Rate
The
impact
of
discounting
streams
of
costs
and
benefits
in
public
policy
evaluation
is
sometimes
large
and
sometimes
not,
depending
on
the
circumstances.
When
all
effects
occur
in
the
same
period,
discounting
may
be
unnecessary
or
superfluous:
net
benefits
are
positive
or
negative
regardless
of
the
discount
rate
used
or
the
procedure
for
translating
them
through
time.
Similarly,
when
costs
and
benefits
of
a
policy
are
largely
constant
over
the
relevant
time
frame,
discounting
costs
and
benefits
will
produce
the
same
conclusion
concerning
the
policy
as
would
examination
of
a
single
year's
costs
and
benefits.
Of
course,
higher
discount
rates
will
reduce
the
present
value
of
any
future
cost
or
benefit.
But
if
costs
and
benefits
of
a
policy
occur
simultaneously
and
if
their
relative
values
do
not
change
over
time,
whether
the
net
present
value
of
such
a
policy
is
positive
does
not
depend
on
the
discount
rate.

Discounting
can
substantially
affect
the
present
value
net
benefits
estimates
for
public
policies
when
there
is
a
significant
difference
in
the
timing
of
costs
and
benefits.
For
example,
if
the
costs
of
a
policy
are
incurred
today,
they
are
not
discounted
at
all.
But
if
the
benefits
will
occur
30
years
from
now,
the
present
value
of
the
benefits,
and,
hence,
the
net
present
value
of
the
policy's
effects,
depends
critically
on
the
discount
rate
used.

Suppose
the
cost
of
some
environmental
policy
that
is
incurred
entirely
in
the
present
is
$
1
billion
and
that
after
30
years
a
benefit
results
that
is
estimated
to
be
worth
$
5
billion
in
the
future.
Without
discounting,
a
policy
that
offers
benefits
five
times
its
cost
appears
to
be
a
very
worthwhile
social
investment.
Discounting
the
$
5
billion
future
benefits,
however,
can
radically
alter
the
economic
assessment
of
the
net
present
value
of
the
policy.
Five
billion
dollars,
30
years
in
the
future,
discounted
at
one
percent
is
$
3.71
billion,
at
three
percent
it
is
worth
$
2.06
billion
at
seven
percent
it
is
worth
$
657
million,
and
at
10
percent
it
is
worth
only
$
287
million.
In
this
case,
the
range
of
discount
rates
generates
over
an
order
of
magnitude
difference
in
the
present
value
of
benefits.
And,
longer
time
horizons
will
produce
even
more
dramatic
effects
on
a
policy's
net
present
value.
Hence,
the
choice
of
the
discount
rate
largely
determines
whether
this
policy
is
considered,
at
least
on
economic
efficiency
grounds,
to
offer
society
positive
or
negative
net
benefits.

Thus,
for
government
projects
and
policies
that
require
large
initial
outlays
or
that
have
long
delays
before
benefits
are
realized,
the
selection
of
the
discount
rate
can
be
a
major
factor
in
determining
whether
the
net
present
value
is
positive.
Many
of
EPA's
policies
fit
these
profiles.
Large
investments
by
public
or
private
parties
are
usually
required
early
on,
whereas
the
benefits
of
those
investments
either
accrue
for
many
years
thereafter,
such
as
improvements
in
health
and
environmental
quality,
or
will
not
begin
for
many
years,
such
as
reductions
in
the
contamination
of
environmental
systems
from
hazardous
waste,
landfill
facilities,
and
the
protection
of
the
earth's
atmosphere
and
climate.

6.2.4
Distinguishing
Discounting
from
Other
Procedures
Discounting
is
only
one
of
several
components
that
are
necessary
in
order
to
produce
comparable
estimates
of
a
policy's
costs
and
benefits
that
accrue
over
more
than
one
time
period.
Discounting
is
a
technique
for
translating
values
from
one
time
period
to
another
in
order
to
express
the
values
of
a
policy's
consequences
in
consistent
terms.
It
is
not,
however,
a
method
for
actually
determining
the
future
values
of
future
costs
and
benefits.
Two
considerations
related
to
determining
these
future
values
 
projecting
future
values
based
on
present
ones
and
accounting
for
risk
 
are
closely
related
to
discounting.

6.2.4.1
Future
Values
of
Costs
and
Benefits
The
future
value
of
one
of
an
environmental
policy's
effects
may
hinge
critically
on
the
assumed
rate
of
growth
of
wealth
over
time.
There
may
also
be
a
connection
between
increasing
wealth
and
the
discount
rate
for
expressing
future
values
in
present
day
terms.
Nevertheless,
the
process
of
determining
the
values
of
future
costs
and
benefits
and
then
translating
them
into
present
terms
are
two
conceptually
distinct
procedures.

It
is
generally
appropriate
to
conduct
each
of
these
tasks
separately.
And,
it
is
prudent
to
avoid
attempting
to
"
correct
for
errors
in
one
procedure
by
"
adjusting"
the
other.
For
example,
it
is
technically
possible
to
use
a
current
valuation
for
a
future
benefit
whose
future
value
is
expected
to
increase,
but
then
reduce
the
discount
rate
to
reflect
that
assumed
rising
valuation
through
time.
Nevertheless,
this
is
usually
unwise
because
the
values
of
other
consequences
of
a
policy
might
not
follow
the
same
rate
of
increase
over
time.
Thus,
these
might
be
over­
or
undercorrected
by
the
adjusted
discount
rate.
The
only
way
to
avoid
that
result
would
be
to
use
a
different
adjusted
discount
rate
for
each
cost
and
benefit
stream,
which
is
generally
inappropriate.

6.2.4.2
Risk
and
the
Social
Discount
Rate
The
relationship
between
risk
and
the
rate
of
return
on
assets
has
been
an
important
subject
in
modern
finance.
Risk
considerations
also
have
played
a
role
in
the
controversy
surrounding
the
selection
of
an
appropriate
discount
rate
for
benefit­
cost
analysis.
For
example,
one
recommendation
is
that
public
projects
with
risky
or
uncertain
future
costs
and
benefits
should
be
discounted
at
a
higher
rate
reflecting
those
risks,
just
as
it
is
in
the
private
sector.

The
concept
of
risk
is
often
interpreted
narrowly
as
being
measured
by
the
variability
or
range
of
possible
outcomes
of
a
project.
Greater
variation
implies
more
risk
according
to
this
view.
But
the
notion
of
risk
should
be
conceptualized
more
broadly.
Rather
than
being
taken
in
isolation,
the
risk
of
a
project
is
measured
by
its
effect
on
the
variability
in
outcomes
of
the
entire
portfolio
of
assets.
In
general,
the
degree
of
risk
associated
with
an
asset
is
measured
in
terms
of
the
covariance
of
its
returns
with
those
of
the
portfolio
of
assets
to
which
it
is
added.
2
When
viewed
from
this
broader
perspective,
most
environmental
projects
are
either
riskless
or
reduce
risk.
This
is
because
most
environmental
projects
have
benefits
and
costs
that
are
widely
dispersed
and
that
are
uncorrelated
or
negatively
correlated
with
future
measured
income
and
other
aspects
of
economic
welfare.

Nevertheless,
the
costs
and
benefits
of
some
environmental
policies
can
be
risky
in
this
broader
sense.
In
these
cases,
it
is
commonly
argued
that
the
discount
rate
should
be
adjusted
upward
by
a
risk
premium
to
value
future
uncertain
returns.
However,
this
is
generally
not
the
correct
procedure
because
it
requires
the
discount
rate
to
reflect
both
the
risk
of
future
returns
as
well
as
the
length
of
time
until
they
materialize.
That
is,
if
the
goal
is
to
reduce
the
present
value
of
a
project's
returns
to
reflect
their
risk,
the
same
decrease
in
present
value
will
be
37
Chapter
6:
Social
Discounting
2
An
assumption
underlying
this
analysis
is
that
the
asset
being
acquired
is
a
very
small
fraction
of
the
portfolio
of
assets
already
held.
If
this
assumption
is
violated,
the
variability
in
returns
of
the
asset
can
directly
affect
the
variability
of
returns
to
the
entire
portfolio.
The
potential
costs
and
benefits
of
environmental
policies
generally
are
spread
among
large
numbers
of
people,
however,
which
satisfies
the
condition
that
the
asset
acquired
be
a
small
portion
of
the
portfolio
of
assets
already
held.
produced
by
a
smaller
increase
in
the
discount
rate
the
longer
the
delay
until
the
returns
are
received.
3
Economic
theory
suggests
using
two
different
"
instruments
to
accomplish
the
two
different
goals.
One
such
procedure
to
account
for
risk
is
to
value
a
project's
uncertain
returns
using
the
certain
monetary
equivalent
or
certainty
equivalent.
As
discussed
in
Chapter
5
of
this
document,
this
is
the
amount
risk
averse
individuals
would
be
willing
to
pay
with
certainty
for
the
risky
prospect.
The
certainty
equivalent
should
then
be
discounted
using
the
rate
of
interest
individuals
use
to
discount
other
perfectly
certain
flows.

Hence,
to
properly
account
for
risk
in
benefit­
cost
analyses
the
first
step
should
be
to
evaluate
whether
a
project
is
actually
risky
from
the
broader
perspective
of
society's
larger
portfolio
of
assets.
Many
government
policies
are
not
risky
at
all,
so
that
their
expected
values
of
costs
and
benefits
can
be
discounted
directly
using
a
risk­
free
interest
rate.
For
projects
that
offer
truly
risky
prospects,
however
certain
monetary
equivalents
for
these
returns
should
be
derived
and
then
discounted
to
the
present
using
a
risk­
free
rate.
The
discount
rate
should
not
be
"
adjusted"
to
account
for
risky
costs
and
benefits.

6.3
Approaches
to
Social
Discounting
This
review
of
the
basics
of
social
discounting
and
the
new
EPA
guidance
on
the
subject
begins
with
discounting
in
conventional
or
intra­
generational
contexts,
where
very
long
time
horizons
involving
multiple
generations
do
not
apply.
Next,
approaches
for
inter­
generational
social
discounting
involving
very
long
time
horizons
and
unborn
generations,
are
presented
and
evaluated.

The
main
purpose
of
this
discussion
is
to
provide
a
broad
overview
of
the
extensive
literature
on
social
discounting
in
order
to
distill
from
it
practical
guidelines
for
environmental
policy
evaluation.
It
is
not,
however,
a
detailed
review
of
the
literature
on
discounting
in
public
project
evaluation
which
is
vast
in
scope
and
volume.
Excellent
sources
for
summaries
of
the
social
discounting
literature
are
Lind
(
1982a),
Lind
(
1982b),
Lind
(
1990),
Lind
(
1994),
Lyon
(
1990),
Lyon
(
1994),
Kolb
and
Scheraga
(
1990),
Scheraga
(
1990),
IPCC
(
1996),
Pearce
and
Turner
(
1990),
and
Pearce
and
Ulph
(
1994).

6.3.1
Intra­
Generational
Social
Discounting
This
section
explores
social
discounting
in
conventional
or
intra­
generational
contexts,
specifically
those
in
which
very­
long­
time­
horizon
issues
are
not
important
features.
Most
of
the
traditional
discounting
literature
focuses
on
these
circumstances.
Intra­
generational
contexts
may
well
have
decades­
long
time
frames,
but
they
do
not
explicitly
confront
the
extremely
long
time
horizons
and
impacts
on
unborn
generations
that
are
central
to
the
extensions
of
social
discounting
research
into
climate
change,
nuclear
waste
disposal,
and
other
such
policy
issues.
The
division
of
the
problem
into
intra­
generational
and
inter­
generational
social
discounting
helps
to
understand
the
substantially
different
contribution
economic
approaches
can
offer
in
each
area.

The
discussion
begins
with
a
brief
review
of
the
analytical
foundations
of
conventional
social
discounting.
It
next
outlines
the
major
social
discounting
approaches
suggested
in
the
literature.
The
section
concludes
with
a
review
of
the
concrete
conclusions
and
advice
offered
by
the
traditional
discounting
literature
and
the
new
guidance
developed
by
EPA
for
use
in
social
discounting
in
intra­
generational
contexts.

6.3.1.1
Analytical
Foundation
of
Intra­
Generational
Social
Discounting
Conventional
social
discounting
is
rooted
firmly
in
the
view
that
the
government
is
acting
on
behalf
of
its
citizens
in
undertaking
public
projects
and
promulgating
environmental
and
other
policies.
Therefore,
benefit­
cost
analysis
of
these
actions
should
seek
to
estimate
the
costs
and
benefits
experienced
by
all
of
the
affected
parties,
and
in
so
38
Chapter
6:
Social
Discounting
3
Note
that
if
discount
rates
are
adjusted
to
incorporate
risk,
the
adjustment
is
not
always
upward.
Risky
benefits
are
worth
less
than
their
expected
value,
so
an
upward
adjustment
of
the
discount
rate
will
reduce
the
present
value.
But
uncertain
costs
would
require
a
downward
adjustment
of
the
discount
rate
to
increase
the
present
value
to
reflect
the
fact
that
risk
averse
individuals
would
pay
more
than
the
expected
value
of
the
costs
to
avoid
bearing
the
uncertain
prospect.
doing
determine
whether,
in
aggregate,
the
gainers
under
a
policy
would
be
able
to
compensate
the
losers.

This
foundation
for
social
discounting
has
an
important
implication
for
the
choice
of
a
social
discounting
method.
Just
as
consumer
sovereignty
dictates
that
the
government
should
incorporate
the
specific
values
that
particular
individuals
place
on
outcomes
that
affect
them
in
assessing
its
actions,
the
government
should
also
discount
future
costs
and
benefits
in
the
same
way
that
the
affected
individuals
do.
Strict
adherence
to
the
principles
of
consumer
sovereignty
is
necessary
in
order
to
determine
how
much
each
person
would
agree
he
or
she
is
made
better
or
worse
off
by
a
given
policy
in
present
value
terms.

The
analytical
and
ethical
foundation
of
the
intra­
generational
social
discounting
literature
thus
rests
on
the
traditional
test
of
a
"
potential"
Pareto
improvement
in
social
welfare
 
whether
gainers
could
compensate
the
losers.
This
framework
fundamentally
casts
the
consequences
of
government
policies
in
terms
of
collections
of
individuals
contemplating
changes
in
their
own
consumption
(
broadly
defined)
over
time.
Thus,
social
discounting
in
this
context
should
seek
to
mimic
the
discounting
practices
of
the
affected
individuals.

The
Paretian
economics
point
of
view,
however,
is
not
the
only
ethical
perspective
possible
in
this
context.
As
discussed
in
the
section
on
inter­
generational
discounting,
another
approach
is
to
cast
the
problem
in
terms
of
maximizing
a
social
welfare
function
that
includes
utilities
of
present
and
future
individuals
and
is
maximized
according
to
an
alternative
set
of
objectives
and
constraints.
While
alternative
social
welfare
functions
could
apply
to
intragenerational
circumstances,
it
is
generally
confined
to
inter­
generational
contexts.
Hence,
although
there
is
nothing
inherent
in
a
short­
time­
horizon
policy
that
dictates
that
only
the
Paretian
perspective
is
appropriate
for
intragenerational
situations,
this
is
the
most
commonly
accepted
point
of
departure
in
the
social
discounting
literature
for
these
circumstances.
It
is
also
worth
considering
the
two
very
distinct
foundations
for
social
discounting
separately
because
their
implications
for
determining
the
social
discount
rate
are
quite
different.
The
Paretian
economic
approach
suggests
that
the
social
discount
rate
is
to
be
found
by
examining
the
preferences
of
affected
parties,
while
the
discount
rate
under
alternative
social
welfare
functions
is
not
necessarily
based
on
the
preferences
of
existing
individuals.
4
6.3.1.2
Fundamental
Procedures
for
Intra­
Generational
Social
Discounting
Given
the
reasonably
precise
and
circumscribed
objective
of
social
discounting
as
described
above,
the
volume
of
literature
on
the
topic
is
surprisingly
diverse
and
complex.
This
section
briefly
reviews
the
major
approaches
suggested
in
the
literature
and
evaluates
their
implications
for
practical
social
discounting
in
environmental
policy
assessments
The
section
concludes
with
a
summary
of
recommended
practices
for
social
discounting
in
intra­
generational
contexts.

Consumption
Rate
of
Interest
Approach
for
Social
Discounting
The
economic
literature
begins
by
pointing
out
that
under
a
variety
of
restrictive
assumptions
 
no
taxes,
no
risk,
perfect
capital
markets
 
the
task
of
discounting
effects
experienced
by
individuals
would
be
straightforward.
Analysts
should
simply
use
the
observable
market
rate
of
interest
that
underlies
the
intertemporal
consumption
allocation
decisions
of
those
same
individuals.
The
rate
at
which
individuals
are
willing
to
exchange
consumption
over
time
is
normally
referred
to
as
the
"
consumption
rate
of
interest."

The
simplifying
assumptions
(
especially
the
absence
of
taxes
on
investment
returns)
imply
that
the
consumption
rate
of
interest
equals
the
market
interest
rate,
which
also
equals
the
rate
of
return
on
private
sector
investments.
In
this
case,
individuals
discount
future
consumption
at
the
market
rate
of
interest,
which
is
also
the
rate
at
which
consumption
can
be
translated
through
time
via
private
sector
investments.
Hence,
if
the
government
seeks
to
value
costs
and
benefits
in
present
day
terms
in
the
same
way
as
the
affected
individuals,
it
also
should
discount
using
the
market
rate
of
interest.

One
of
the
simplifying
assumptions
underlying
this
result
 
that
the
consumption
rate
of
investment
at
which
consumers
discount
future
consumption
equals
the
rate
of
39
Chapter
6:
Social
Discounting
4
This
concept
is
also
treated
in
Chapter
10
in
the
discussion
of
ways
to
jointly
consider
efficiency
and
equity
within
a
single
analytical
framework.
return
on
private
sector
investment
 
probably
does
not
hold
in
practice.
Taxes
on
private
sector
investment
returns
can
cause
the
social
rate
at
which
consumption
can
be
traded
through
time
(
the
pre­
tax
rate
of
return)
to
exceed
the
rate
at
which
individuals
can
trade
consumption
over
time
(
the
post­
tax
consumption
rate
of
interest).

For
example,
suppose
the
market
rate
of
interest,
net
of
inflation,
is
five
percent,
and
that
taxes
on
capital
income
amount
to
40
percent
of
the
net
return.
In
this
case,
private
investments
will
yield
five
percent,
of
which
two
percent
is
paid
in
taxes
to
the
government,
with
individuals
receiving
the
remaining
three
percent.
From
a
social
perspective
consumption
can
be
traded
from
the
present
to
the
future
at
a
rate
of
five
percent.
But
individuals
effectively
trade
consumption
through
time
at
a
rate
of
three
percent
because
they
owe
taxes
on
investment
earnings.
As
a
result,
the
consumption
rate
of
interest
is
three
percent
which
is
substantially
less
than
the
five
percent
social
rate
of
return
on
private
sector
investments
(
also
known
as
the
social
opportunity
cost
of
private
capital).

Over
several
decades,
a
very
large
body
of
economic
literature
developed,
analyzing
the
implications
for
social
discounting
of
divergences
between
the
consumption
rate
of
interest
and
the
social
rate
of
return
on
private
sector
investment.
The
dominant
approaches
in
this
literature
are
briefly
outlined
here.

Consumption
Rate
of
Interest­
Shadow
Price
of
Capital:
The
Traditional
View
One
approach
that
enjoys
widespread
support
among
economists
recommends
that
social
discounting
in
intragenerational
contexts
should
use
the
consumption
rate
of
interest
to
discount
future
costs
and
benefits
that
have
been
valued
in
terms
of
future
consumption.
Intuitively,
this
procedure
makes
sense
because
the
government
is
assumed
to
be
valuing
future
consequences
of
its
policies
just
as
the
affected
citizens
would.
If
individuals
discount
future
consumption
(
and
the
costs
and
benefits
of
a
public
policy)
using
the
consumption
rate
of
interest,
then
so
should
the
government.
So,
the
social
rate
of
discount
should
equal
the
consumption
rate
of
interest.

But,
if
the
costs
of
financing
a
public
project
or
the
costs
of
regulatory
compliance
displace
private
investments,
society
loses
the
total
pre­
tax
returns
from
those
foregone
investments
Private
capital
investments
might
be
displaced
if,
for
example,
public
projects
are
financed
with
government
debt
and
the
supply
of
investment
capital
is
relatively
fixed.
This
is
the
"
closed
economy"
condition.
In
this
case,
discounting
costs
and
benefits
using
the
consumption
rate
of
interest
(
the
post­
tax
rate
of
interest)
does
not
seem
to
capture
the
fact
that
society
loses
the
higher,
social
(
pretax
rate
of
return
on
foregone
investments.

Under
the
consumption
rate
of
interest­
shadow
price
of
capital
approach
for
social
discounting,
the
social
value
of
displacing
private
capital
investments
is
taken
into
account
prior
to
discounting.
Under
this
approach,
when
a
public
project
displaces
private
sector
investments,
the
correct
method
for
measuring
the
social
costs
and
benefits
requires
an
adjustment
of
the
estimated
costs
(
and
perhaps
benefits
as
well)
prior
to
discounting
using
the
consumption
rate
of
interest.
This
adjustment
factor
is
referred
to
as
the
"
shadow
price
of
capital."
5
The
shadow
(
social)
price
(
value)
of
private
capital
is
intended
to
capture
the
fact
that
a
unit
of
private
capital
produces
a
stream
of
social
returns
at
a
rate
greater
than
the
rate
at
which
they
are
discounted
by
individuals.
If
the
social
rate
of
discount
is
the
consumption
rate
of
interest,
then
the
social
value
of
a
$
1
private
sector
investment
will
be
greater
than
$
1.
The
investment
produces
a
rate
of
return
for
its
owners
equal
to
the
post­
tax
consumption
rate
of
interest,
plus
a
stream
of
tax
revenues
(
considered
to
be
consumption)
for
the
government.

To
illustrate
this
simply,
suppose
that
the
consumption
rate
of
interest
is
three
percent,
that
the
pre­
tax
rate
of
return
on
private
investments
is
five
percent,
that
the
netof
tax
earnings
from
these
investments
are
consumed
in
each
period,
and
that
the
investment
exists
in
perpetuity
(
amortization
payments
from
the
gross
returns
of
the
investment
are
devoted
to
preserving
the
value
of
the
capital
intact).
A
$
1
private
investment
with
these
characteristics
will
produce
a
stream
of
private
consumption
of
$
0.03
per
year
and
tax
revenues
of
$
0.02
per
year.
Discounting
the
private
post­
tax
stream
of
consumption
at
the
three
percent
consumption
rate
of
interest
yields
a
present
value
of
$
1.
Discounting
the
stream
of
tax
revenues
at
the
same
rate
yields
a
present
value
of
about
$
0.67.
The
social
value
40
Chapter
6:
Social
Discounting
5
Lind
(
1982a)
remains
the
seminal
source
for
this
approach
in
the
social
discounting
literature.
of
this
$
1
private
investment
 
the
shadow
price
of
capital
 
is
thus
$
1.67,
substantially
greater
than
the
$
1
private
value
that
individuals
place
on
it.

Therefore,
if
financing
a
public
project
displaces
private
investments,
this
"
consumption
rate
of
interest­
shadow
price
of
capital"
approach
suggests
adjusting
the
project's
costs
upward
by
the
shadow
price
of
capital
and
then
discounting
all
costs
and
benefits
using
a
social
rate
of
discount
equal
to
the
consumption
rate
of
interest.
To
apply
this
approach,
the
first
step
is
to
determine
whether
private
investment
flows
will
be
altered
by
a
policy.
Typically,
project
costs
are
thought
to
displace
private
capital,
at
least
in
part,
although
project
benefits
could
encourage
additional
private
sector
investments.
Next,
all
of
the
altered
private
investment
flows
(
positive
and
negative)
are
multiplied
by
the
shadow
price
of
capital
to
convert
them
into
consumption­
equivalent
units.
All
flows
of
consumption
and
consumption­
equivalents
are
then
discounted
using
the
consumption
rate
of
interest.

A
simple
example
of
this
method
is
as
follows.
Suppose
the
pre­
tax
rate
of
return
from
private
investments
is
five
percent
and
the
post­
tax
rate
is
three
percent,
with
the
difference
attributable
to
taxation
of
capital
income.
Assume
as
well
that
increases
in
government
debt
displace
private
investments
dollar­
for­
dollar,
and
that
increased
taxes
reduce
individuals'
current
consumption
also
on
a
onefor
one
basis.
6
Finally,
assume
that
the
$
1
current
cost
of
a
public
project
is
financed
75
percent
with
government
debt
and
25
percent
with
current
taxes
and
that
this
project
produces
a
benefit
40
years
from
now
that
is
estimated
to
be
worth
$
5
in
the
future.

Using
the
consumption
rate
of
interest­
shadow
price
of
capital
approach,
first
multiply
75
percent
of
the
$
1
current
cost
(
which
is
the
amount
of
displaced
private
investment
by
the
shadow
price
of
capital
(
assume
this
is
the
$
1.67
figure
from
above).
This
yields
$
1.2525,
to
which
is
added
the
$
0.25
amount
by
which
the
project's
costs
displace
current
consumption.
The
total
social
cost
is
therefore
$
1.5025.
This
results
in
a
net
social
present
value
of
about
$
0.03,
which
is
the
present
value
of
the
future
$
5
benefit
discounted
at
the
three
percent
consumption
rate
of
interest
($
1.5328)
minus
the
$
1.5025
social
cost.

Thus,
under
the
consumption
rate
of
interest­
shadow
price
of
capital
approach,
costs
are
adjusted
upward
to
reflect
the
higher
social
costs
of
displacing
private
investments,
but
discounting
for
time
itself
is
accomplished
using
the
consumption
rate
of
interest
 
consistent
with
how
individuals
trade
and
value
consumption
over
time.

Variants
of
this
approach
exist.
For
example,
the
Kolb­
Scheraga
(
1988)
approach
recommends
annualizing
capital
expenditures
using
the
pre­
tax
rate
and
then
discounting
all
cost
and
benefits
using
the
consumption
rate
of
interest.

Other
Social
Discounting
Approaches
Other
approaches
for
social
discounting
in
the
literature
have
been
recommended
on
and
off
over
the
years.
These
alternatives
focus
on
different
methods
than
the
shadow
price
of
capital
approach
for
evaluating
policies
that
displace
private
sector
investments.
However,
the
procedures
these
approaches
use
will
not
generally
produce
a
correct
estimate
of
the
social
present
value
of
a
policy's
costs
and
benefits.
Some
of
these
other
methods
for
social
discounting
are
reviewed
and
evaluated
below.

Weighted
average
of
pre­
and
post­
tax
rates
of
return:
A
major
alternative
approach
for
addressing
the
divergence
between
the
higher
social
rate
of
return
on
private
investments
and
lower
consumption
rate
of
interest
is
to
set
the
discount
rate
for
public
projects
equal
to
a
weighted
average
of
the
two.
The
weights
would
equal
the
proportions
of
project
financing
that
displace
private
investment
and
consumption,
respectively.
Intuitively,
this
approach
would
set
an
overall
project
discount
according
to
the
amount
lost
by
displacing
consumption
(
using
the
lower
consumption
rate
of
interest)
and
the
amount
lost
by
displacing
investments
(
using
the
higher
social
rate
of
return
on
private
capital).

For
example,
suppose
the
social
rate
of
return
from
private
investments
is
five
percent
and
the
consumption
rate
of
interest
is
three
percent,
as
above.
Suppose
further
that
75
percent
of
a
public
project's
costs
are
financed
using
41
Chapter
6:
Social
Discounting
6
The
assumption
that
additional
government
borrowing
crowds
out
private
investment
dollar­
for­
dollar
is
not
critical
to
the
example.
If
crowding
out
is
less
than
dollar­
for­
dollar,
then
the
75
percent
of
the
project's
cost
that
is
financed
by
additional
debt
would
be
further
divided
into
the
proportion
of
that
percentage
of
the
cost
that
displaces
private
investment,
which
should
then
be
adjusted
using
the
shadow
price
of
capital,
and
the
remainder
of
the
cost,
which
is
drawn
from
consumption
and
therefore
does
not
need
to
be
adjusted.
government
debt,
with
the
remaining
25
percent
of
the
costs
raised
through
taxation.
Finally,
assume
that
government
debt
crowds
out
private
investment
on
a
dollar­
for­
dollar
basis
and
that
increased
taxes
reduce
individuals'
current
consumption
also
on
a
one­
for­
one
basis.
The
weighted
average
approach
then
suggests
that
the
social
rate
of
discount
should
be
75
percent
of
five
percent
plus
25
percent
of
three
percent,
or
four
and
a
half
percent.
If
the
proportions
of
the
project's
financing
from
each
revenue
source
were
reversed,
however,
the
weighted
average
discount
rate
would
instead
be
25
percent
of
five
percent
plus
75
percent
of
three
percent,
or
three
and
a
half
percent.

This
approach
has
enjoyed
considerable
popularity
over
the
years,
and
is
probably
acceptable
for
similarly
timed
cost
and
benefit
flows.
7
As
presented
above,
however,
it
is
technically
incorrect
and
can
produce
net
present
value
results
substantially
different
from
the
correct
result
(
where
"
correct"
is
defined
by
the
consumption
rate
of
interest­
shadow
price
of
capital
approach).
The
problem
with
the
simple
weighted
average
approach
is
that
it
seeks
to
accomplish
two
tasks
using
the
social
discount
rate
 
pure
time
discounting
and
adjusting
for
the
displacement
of
private
investments
that
yield
pre­
tax
social
returns
higher
than
the
consumption
rate
of
interest.

In
general,
the
"
synthesized"
discount
rate
based
on
the
social
rate
of
return
from
private
investments
and
the
consumption
rate
of
interest
that
accomplishes
both
objectives
 
and
so
arrives
the
correct
present
value
 
depends
on
the
timing
of
the
cost
and
benefits
flows.
A
simple
weighted
average
based
only
on
project
cost
components
will
not
in
general
produce
the
correct
result.

To
understand
this,
consider
how
the
weighted
average
discount
rate
approach
performs
for
the
simple
numerical
example
discussed
above.
Assume
that
the
social
rate
of
return
on
private
investments
is
five
percent,
that
the
consumption
rate
of
interest
is
three
percent,
that
increases
in
government
debt
displace
private
investments
dollar­
fordollar
that
the
$
1
current
cost
of
a
public
project
is
financed
75
percent
with
government
debt
and
25
percent
with
current
taxes,
and
that
the
project
produces
a
benefit
40
years
from
now
that
is
estimated
to
be
worth
$
5
in
the
future.

The
weighted
average
social
discount
rate
approach
would
suggest
discounting
the
future
benefit
at
a
four
and
a
half
percent
rate
(
0.75
times
five
percent
plus
0.25
times
three
percent).
This
produces
an
estimated
net
social
present
value
of
­$
0.14,
which
is
the
present
value
of
the
future
$
5
benefit
discounted
using
a
four
and
a
half
percent
rate
($
0.86)
minus
the
current
year
$
1
cost.
In
this
case,
the
weighted
average
social
discount
rate
approach
suggests
that
the
project's
net
social
present
value
is
negative.
But
earlier,
the
consumption
rate
of
interest­
shadow
price
of
capital
approach
was
applied
to
exactly
this
scenario,
concluding
that
the
net
social
present
value
is
positive.

The
problem
with
the
weighted
average
approach
is
that
its
method
for
accounting
for
the
higher
social
cost
of
displaced
private
investments
is
to
"
over
discount"
the
benefits
But
the
amount
of
"
over
discounting"
necessary
in
this
example
to
adjust
for
the
actual
social
costs
of
the
project's
costs
depends
on
the
time
profile
of
the
benefit
stream
 
the
farther
in
the
future
the
benefits
occur,
the
less
"
over
discounting"
is
needed.
The
source
of
the
project's
financing
is
therefore
insufficient
to
define
a
single
rate
of
social
discount
that
will
produce
correct
net
social
present
value
results
for
any
given
policy.

Accordingly,
to
derive
the
weighted
average
discount
rate
that
will
produce
the
correct
net
present
value
requires
that
the
consumption
rate
of
interest­
shadow
price
of
capital
method
be
used
first
to
compute
the
net
present
value.
The
discount
rate
that
produces
this
correct
present
value
based
on
discounting
costs
and
benefits,
but
not
adjusting
for
the
shadow
price
of
capital,
can
then
be
calculated.
There
seems
to
be
little
purpose
to
this
exercise
because
it
requires
the
net
present
value
of
a
policy
to
be
computed
using
accurate
procedures
first
before
the
adjusted
discount
rate
can
be
derived.

Opportunity
cost
of
capital:
Another
approach
for
social
discounting
argues
that
the
government
should
not
invest
(
or
compel
investment
through
its
policies)
in
any
project
that
offers
a
rate
of
return
less
than
the
social
rate
of
return
on
private
investments.
Stated
another
way,
because
the
citizens
collectively
enjoy
the
benefits
of
all
42
Chapter
6:
Social
Discounting
7
Lind
(
1982b)
provides
a
clear
exposition
of
the
weighted
average
approach
for
estimating
the
social
discount
rate.
The
large
literature
on
this
topic,
spanning
the
1960s
through
the
early
1980s,
has
been
summarized
well
by
Lind
and
others.
public
and
private
investments,
welfare
will
be
higher
overall
if
the
government
invests
in
projects
with
the
highest
rates
of
return.
8
Critics
of
this
social
investment
rule
argue
that
the
government
cannot
realistically
tax
citizens
and
then
invest
in
private
sector
projects.
Therefore,
the
issue
is
not
what
"
could"
be
done
with
the
funds,
but
rather
what
"
would"
be
done
with
them.
Thus,
if
the
government
obtains
funds
for
a
project
through
taxation
and
this
displaces
only
private
consumption,
then
relative
to
consuming
the
resources
today,
welfare
is
increased
as
long
as
the
project
generates
future
benefits
that
exceed
those
costs
when
discounted
at
the
consumption
rate
of
interest.
Of
course,
it
remains
true
that
welfare
would
be
further
increased
if
the
funds
were
devoted
to
an
even
more
valuable
project.

A
closely
related
opportunity
cost­
based
observation
is
that
the
government
faces
a
menu
of
projects
and,
for
whatever
reason,
is
not
able
to
undertake
all
projects
that
have
positive
net
social
benefits
when
computed
using
a
social
rate
of
discount
equal
to
the
consumption
rate
of
interest.
In
this
event,
the
opportunity
costs
of
funding
one
program
are
the
benefits
of
other
programs
not
funded.
Proponents
of
this
view
typically
conclude
that
the
"
hurdle
discount
rate
for
a
particular
project
should
be
equal
to
the
rate
of
return
offered
by
other
projects
foregone.

Regardless
of
the
particular
point
of
departure,
the
central
point
of
the
opportunity
cost
strand
of
the
social
discounting
literature
is
valid.
Social
welfare
will
be
improved
if
the
government
invests
in
projects
that
have
higher
values
than
if
it
invests
in
lower
value
ones.
Hence,
if
the
net
present
value
of
benefits
of
all
courses
of
action
are
examined
using
the
consumption
rate
of
interest
and
the
set
with
the
highest
net
benefits
are
pursued,
social
welfare
will
be
higher
than
otherwise.
9
So
stated,
this
advice
is
correct.

However,
it
does
not
follow
that
rates
of
return
offered
by
alternative
private
or
public
projects
define
the
level
of
the
social
discount
rate.
An
alternative
project
might
produce
large
benefits
over
the
future
and
thus
offer
a
large
"
rate
of
return."
But
if
individuals
discount
these
future
benefits
using
the
consumption
rate
of
interest,
the
correct
way
to
describe
this
project
is
that
it
offers
substantial
present
value
net
benefits.
In
general,
the
opportunity
cost
argument
is
not
about
the
social
discount
rate
per
se,
but
about
correctly
and
consistently
examining
the
social
values
of
all
alternatives.
As
was
the
case
for
the
shadow
price
of
capital,
an
alternative
project
with
a
high
rate
of
return
will
have
a
high
social
net
present
value.
But
this
does
not
imply
that
its
rate
of
return
should
become
the
social
rate
of
discount
to
be
used
for
pure
time
discounting
for
other
projects.

Consumption
Rate
of
Interest­
Shadow
Price
of
Capital:
The
New
View
Over
the
years,
the
consumption
rate
of
interest­
shadow
price
of
capital
approach
to
social
discounting
has
gained
increasingly
wide
acceptance
among
economists.
Recently,
however,
a
key
assumption
in
that
analysis
has
been
questioned
 
the
assumption
that
the
economy
is
"
closed"
to
foreign
capital
flows
 
and
an
alternative
hypothesis
concerning
government
crowding
out
of
private
investment
has
been
put
forward.
10
According
to
this
new
view,
earlier
analyses
implicitly
assumed
that
capital
flows
into
the
nation
were
either
nonexistent
or
very
insensitive
to
interest
rates,
a
"
closed
economy"
assumption.
Empirical
evidence
suggests,
however,
that
international
capital
flows
are
quite
large
and
very
sensitive
to
interest
rate
changes.
In
this
case,
the
supply
of
investment
funds
to
the
U.
S.
equity
and
debt
markets
is
likely
to
be
highly
elastic
(
the
"
open
economy"
condition)
and,
thus,
private
capital
displacement
is
much
less
important
than
it
was
previously
thought
to
be.

Under
this
new
view,
it
is
inappropriate
to
assume
that
financing
a
public
project
through
borrowing
will
result
in
dollar­
for­
dollar
crowding
out
of
private
investment.
If,
instead,
financing
public
projects
results
in
no
crowding
out
of
private
investment,
then
no
adjustments
using
the
shadow
price
of
capital
are
necessary.
Benefits
and
costs
should
be
discounted
using
the
consumption
rate
of
interest
alone.
However,
the
literature
to
date
does
not
adequately
support
the
assumption
of
zero
crowding
out.
It
is
more
likely
that
there
exists
some
degree
of
private
capital
43
Chapter
6:
Social
Discounting
8
Many
authors
cite
high
opportunity
costs
of
public
investments.
Among
these
are
Birdsall
and
Steer
(
1993),
Schelling
(
1995),
and
Lyon
(
1994).
On
the
technical
issue
of
rates
of
return
vs.
net
present
values,
see
Lind
(
1990)
and
Cowen
and
Parfit
(
1992).

9
Clearly,
such
an
approach
cannot
be
followed
when
a
particular
action
is
mandated.

10
See
Lind
(
1990)
for
this
revision
of
the
consumption
rate
of
interest­
shadow
price
of
capital
approach.
displacement
within
the
spectrum
between
zero
and
dollar
for­
dollar
displacement.
The
degree
of
crowding
out
will
depend
on
the
magnitude
of
the
policy
or
program
being
analyzed.
Unfortunately,
while
the
shadow
price
of
capital
adjustment
requires
an
assessment
of
the
proportion
of
costs
that
displace
investment,
11
the
literature
provides
little
empirical
evidence
as
to
the
relationship
between
project
size
and
capital
displacement.
12
6.3.1.3
Applying
the
Consumption
Rate
of
Interest
Approach
to
Environmental
Policies
The
extension
of
the
consumption
rate
of
interest­
shadow
price
of
capital
approach
to
the
case
of
an
economy
"
open"
to
substantial
capital
flows
is
relatively
recent.
And,
as
is
true
for
most
of
the
discounting
literature,
virtually
all
of
the
discussion
focuses
on
public
project
financing,
rather
than
on
environmental
policies
that
largely
mandate
that
private
parties
undertake
certain
actions
or
expenditures
in
pursuit
of
social
objectives.
Finally,
while
it
is
intuitive
to
argue
that
private
investments
are
not
displaced
by
either
additional
government
borrowing
or
mandatory
private
investments
for
environmental
protection,
it
is
often
the
gross
gains
and
losses
of
the
affected
parties
in
the
economy
that
are
the
focus
of
economic
impact
analyses.
How
the
change
in
the
assumption
concerning
the
availability
of
investment
funds
to
the
economy
translates
into
these
gross
gains
and
losses
is
critical
for
conducting
accurate
environmental
policy
assessments.

For
all
of
these
reasons,
it
is
worth
clarifying
the
capital
displacement
and
adjustment
issue
for
environmental
policies
that
mandate
capital
investments
in
the
context
of
both
the
"
open"
and
"
closed"
economy
assumptions
regarding
capital
flows.

Environmentally­
Mandated
Private
Investments
in
a
"
Closed"
Economy
To
focus
closely
and
exclusively
on
the
shadow
price
of
capital
adjustment
issue,
some
simplifying
assumptions
are
helpful.
Assume
that
there
is
no
risk
and
uncertainty,
that
all
firms
and
the
government
borrow
at
the
interest
rate
i,
that
taxes
on
investment
income
are
levied
on
all
sources
of
such
income
at
a
rate
of
t,
and
that
the
resulting
post­
tax
interest
rate,
r
(=
i
×
(
1­
t)),
is
the
rate
at
which
individuals
discount
future
consumption.
13
Further,
assume
that
the
net­
of­
tax
returns
from
all
investments
are
consumed
in
each
year
(
to
assist
in
making
this
illustration
as
simple
as
possible).
Assume,
finally,
that
the
supply
of
investment
funds
is
perfectly
inelastic
with
respect
to
their
price,
the
interest
rate.

Consider,
first,
a
public
project
that
costs
$
1,
is
financed
through
taxes
on
labor
and
other
factors
of
production
(
but
not
capital),
and
offers
future
environmental
benefits.
Assuming
that
increased
current
taxation
only
reduces
consumption,
the
cost
of
the
project
is
this
amount
of
reduced
current
consumption.
Future
benefits,
once
valued
in
terms
of
future
consumption,
can
be
discounted
to
the
present
using
a
social
rate
of
discount
equal
to
the
consumption
rate
of
interest.
For
the
remainder
of
this
discussion,
the
benefits
side
of
the
calculations
will
be
ignored
to
focus
on
the
cost
calculation
considerations.

Now,
consider
exactly
the
same
project,
but
assume
that
it
is
financed
only
through
government
borrowing,
which
crowds
out
an
equal
amount
of
private
sector
investment.
To
calculate
the
costs
of
this
project
financing,
it
is
helpful
to
analyze
the
impacts
on
the
different
entities
affected.
First,
the
private
sector
investors
who
lend
$
1
to
the
government
instead
of
to
private
firms
are
indifferent.
They
receive
the
interest
rate
i
from
either
source
and,
therefore
continue
to
receive
a
stream
of
returns
net­
of­
tax
equal
to
$
1
×
r.

Next,
consider
the
government,
which
can
be
thought
of
as
representing
the
interests
of
citizens
in
future
years.
The
foregone
private
investments
would
have
generated
a
stream
of
tax
revenues
of
$
1
×
t
×
i
each
year,
which
is
lost.
But
the
increased
public
debt
is
taxable,
so
the
government
regains
this
$
1
×
t
×
i
each
year
and
the
streams
of
gained
and
lost
tax
revenues
offset
each
other.
Nevertheless,
the
government
must
service
this
new
debt
44
Chapter
6:
Social
Discounting
11
See
footnote
5
for
a
description
of
this
adjustment.

12
See
Lind
(
1990)
for
a
summary
of
the
empirical
literature
in
this
area.

13
The
relevant
tax
rate
t
is
the
effective
marginal
tax
rate.
It
is
difficult
to
determine
this
rate
in
the
aggregate
with
any
reasonable
degree
of
accuracy.
by
raising
future
taxes
each
year
by
the
amount
$
1
×
i
(
assuming,
for
simplicity,
that
the
debt
is
a
perpetuity).

As
a
result,
the
cost
of
financing
this
public
project
through
government
debt
in
a
closed
economy
context
is
a
stream
of
decreased
consumption
experienced
in
the
future
of
$
1
×
i
per
year
forever.
The
present
value
of
this
stream
of
foregone
consumption
computed
using
the
consumption
rate
of
interest,
r,
exceeds
$
1.
This
is
the
essence
of
the
shadow
price
of
capital
adjustment
rationale
The
value
of
i
exceeds
r
in
this
example
because
of
the
tax
wedge
between
the
social
(
pre­
tax)
rate
of
return
on
investments
and
the
(
post­
tax)
consumption
rate
of
interest.
This
is
the
equivalent
of
observing
that
a
taxable
investment
yields
a
private
return
of
r
per
year
to
the
investor
and
a
"
return"
of
t
×
i
to
the
government
in
the
form
of
tax
revenues.

Assume
now
that
the
relevant
investment
is
a
private
sector
capital
project
that
must
be
undertaken
in
order
to
comply
with
an
environmental
policy.
To
estimate
the
social
costs
of
this
requirement
under
the
closed
economy
assumption,
two
polar
cases
are
useful
to
examine:
no
cost
shifting
to
consumers
or
other
factors
of
production
and
full
cost
shifting
to
consumers
through
higher
product
prices.

In
the
case
of
no
cost
shifting
to
consumers,
the
owners
of
the
firms
required
to
make
these
investments
either
must
obtain
debt
or
equity
funds
or
reduce
their
other
investment
and
lending
activities,
to
comply.
Wherever
the
required
funds
originate,
two
facts
are
clear.
One
is
that
other
taxable
investments
of
$
1
will
not
be
undertaken.
The
second
is
that,
because
the
price
of
the
products
or
services
into
which
this
environmental
investment
flows
does
not
rise,
the
mandated
investment
will
produce
no
"
return"
for
their
owners
or
for
the
government
in
the
form
of
future
tax
revenues.
The
result
is
that
the
owners
of
the
affected
firms
lose
a
stream
of
investment
income,
$
1
×
r,
and
the
government
loses
a
stream
of
tax
revenues
of
$
1
×
t
×
i,
because
of
the
displaced
private
investment.
But
since
r=
i
×
(
1­
t),
this
adds
up
to
a
stream
of
costs
of
$
1
×
i
per
year.
Once
again,
this
is
essentially
the
shadow
price
of
capital
adjustment.

Now
assume
that
the
cost
of
the
mandated
environmental
investment
is
shifted
to
consumers
through
higher
prices,
which
rise
by
enough
to
provide
the
full
social
pre­
tax
return
of
i.
In
this
case,
the
owners
of
the
firms
required
to
make
these
investments
are
indifferent.
Similarly,
the
government
is
indifferent
 
it
still
receives
a
stream
of
tax
revenues
from
the
$
1
investment.
Here,
however,
it
is
consumers
of
the
affected
product
or
service
who
are
not
indifferent.
In
fact,
the
product
price
increases
they
face
are
precisely
enough
to
provide
the
$
1
×
i
pre­
tax
social
return
on
the
mandated
investment.
Here
again,
this
is
essentially
the
shadow
price
of
capital
adjustment.

Environmentally­
Mandated
Private
Investments
in
an
"
Open"
Economy
The
central
difference
between
the
closed
and
open
economy
contexts
concerns
the
conditions
of
supply
of
investment
funds.
In
the
closed
economy
case,
the
amount
of
these
funds
is
fixed,
so
the
total
available
for
all
projects,
private
and
public,
is
constant.
Hence,
the
key
to
analyzing
that
case
lies
in
tracing
the
implications
of
altering
the
composition
of
the
investments
undertaken
with
and
without
a
new
public
project
or
a
new
environmental
policy
mandating
private
investments.

In
the
open
economy
context,
however,
what
is
fixed
is
not
the
supply
of
investment
funds,
but
the
price
at
which
they
may
be
obtained.
In
this
case,
all
investments
worth
undertaking
without
a
new
public
project
or
a
new
environmental
policy
requiring
investments
will
still
be
worth
undertaking
with
those
new
policies
 
so
that
there
will
be
no
impact
on
capital
availability
and
the
level
of
private
sector
investments.
This
suggests
that
measuring
the
costs
of
these
policies
in
this
open
economy
context
may
be
slightly
different
than
in
the
closed
economy
case.

Purely
tax­
financed
public
projects
are
not
discussed
here
because
the
results
for
that
case
do
not
depend
on
the
assumption
concerning
the
supply
of
capital.
For
debt­
financed
public
projects,
however,
the
results
under
the
closed
and
open
economy
assumptions
are
very
different
In
this
open
economy
case,
the
government's
increased
$
1
of
borrowing
does
not
change
the
level
of
U.
S.
private
sector
investment.
Hence,
the
government
must
service
the
debt
at
a
cost
of
$
1
×
i
per
year,
but
also
gains
from
that
$
1
×
i
×
t
of
tax
revenues
from
these
new
45
Chapter
6:
Social
Discounting
taxable
interest
payments.
14
The
net
cost
is
only
$
1
×
i
×
(
1­
t),
which
is
the
stream
of
future
reduced
consumption
citizens
will
experience
as
the
net
cost
of
the
new
public
project.
But
because
i
×
(
1­
t)=
r,
this
stream
of
reduced
consumption
is
equal
to
$
1
×
r.
Discounted
at
the
consumption
rate
of
interest,
r,
the
present
value
cost
is
$
1.
This
is
the
rationale
for
not
using
the
shadow
price
of
capital
adjustment.

To
analyze
the
implications
of
the
open
economy
assumption
for
mandated
private
investments,
the
no­
and
fullcost
pass­
through
polar
cases
continue
to
be
helpful.
In
the
case
of
no­
cost
pass­
through,
the
results
are
very
simple
The
owners
of
the
firms
required
to
make
the
investments
to
comply
with
an
environmental
policy
will
obtain
the
necessary
funds
either
from
their
own
resources
that
would
have
been
invested
elsewhere,
or
from
other
sources,
and
undertake
the
required
investments.
Because
the
price
of
the
services
or
products
subject
to
the
new
policy
do
not
rise
to
compensate
for
these
costs,
no
return
to
these
owners
or
to
the
government
in
the
form
of
tax
revenues
will
result.
But,
because
the
supply
of
investment
funds
to
the
economy
is
perfectly
elastic,
no
other
private
sector
investments
will
be
foregone.

The
result
in
this
case
is
that
the
owners
of
the
entities
required
to
make
these
investments
will
lose
a
stream
of
private
investment
returns
of
$
1
×
r
(
their
net­
of­
tax
return
on
production
investments)
if
the
mandatory
investment
causes
them
to
reduce
investment
elsewhere.
Alternatively,
the
owners
of
the
affected
firms
may
increase
their
demands
for
investment
funds
in
the
market
and
continue
with
their
pre­
policy
investment
plans.
Nevertheless,
because
i
is
constant,
all
investment
projects
that
were
profitable
before
the
policy
is
imposed
will
still
be
profitable
and
these
investments
will
be
undertaken
as
if
the
policy
did
not
exist.
Hence,
the
government
loses
no
tax
revenue
as
a
result
and
no
shadow
price
of
capital
adjustment
is
appropriate
here.

Finally,
if
the
costs
of
the
mandated
private
investments
are
fully
passed
through
to
consumers,
the
owners
of
the
affected
firms
are
now
indifferent.
The
government
and
the
consumers
of
the
relevant
services
or
products,
however
are
not.
First,
the
consumers
of
the
affected
sector's
output
face
price
increases
equivalent
to
$
1
×
i,
which
is
the
amount
necessary
to
fully
recoup
the
full
pre­
tax
social
return
on
the
invested
capital.
But
the
government
gains
a
stream
of
tax
revenues
associated
with
this
mandated
investment,
amounting
to
$
1
×
i
×
t
per
year.
Again,
all
other
investments
are
still
undertaken
because
of
the
assumption
regarding
the
supply
of
investment
funds.

As
a
result,
the
net
cost
to
society
is
the
price
increase
borne
by
consumers,
equal
to
$
1
×
i
per
year,
minus
the
increase
government
tax
revenues
 
which
represents
future
reduced
taxation
 
of
$
1
×
i
×
t
per
year,
for
a
net
cost
of
only
$
1
×
i(
1­
t)=$
1
×
r.
Thus,
the
shadow
price
of
capital
adjustment
is
not
necessary
here.
But,
note
that
the
cost
increase
for
the
firm
and
its
consumers
is
measured
by
the
pre­
tax
amount
per
year,
$
1
×
i,
not
the
net
social
cost
of
$
1
×
r
per
year.
The
former
is
the
relevant
measure
for
modeling
private
sector
"
economic
impacts"
and
for
assessing
the
gross
gains
and
losses
of
a
policy,
while
the
latter
represents
the
social
perspective.

6.3.1.4
Summary
of
Advice
from
the
Economics
Literature
The
vast
majority
of
the
traditional
social
discounting
literature
has
focused
on
exploring
the
implications
for
public
project
evaluation
of
a
few,
probably
very
important,
departures
from
the
idealized
no­
other­
distortions
simplified
economy
for
which
unambiguous
social
discounting
recommendations
can
be
made.
Yet,
in
the
development
of
that
literature,
many
matters
have
been
addressed
and
are
considered
by
many
contributors
to
this
literature
to
be
somewhat
settled,
some
of
which
are
discussed
above,
and
others
not
(
largely
because
they
are
not
directly
social
discounting
issues).
In
particular,
for
intra­
generational
social
discounting:

There
is
reasonable
agreement
that
the
social
rate
of
discount
ought
to
reflect
the
private
rates
of
consumption
discount
of
the
citizens
affected.

If
social
and
private
returns
from
private
investments
are
different,
then
adjustments
should
be
introduced
46
Chapter
6:
Social
Discounting
14
The
taxability
of
the
interest
payments
on
the
increased
amount
of
government
debt
in
an
open
economy
context
is
complex
because
of
the
international
nature
of
capital
markets.
Generally
speaking,
taxes
are
owed
on
interest
earnings
from
government
obligations
to
the
country
that
pays
the
interest,
although
there
are
exceptions
to
this
rule.
Hence,
if
U.
S.
citizens
increase
their
lending
to
the
U.
S.
government,
the
interest
earnings
would
clearly
be
taxable.
If
foreign
investors
purchase
the
increased
U.
S.
government
debt,
normally
these
interest
payments
are
taxable
as
U.
S.
income.
to
reflect
this
when
and
if
policies
alter
private
investment
flows.

Uncertainty
and
risk
should
largely
be
addressed
through
appropriate
valuation
of
costs
and
benefits
(
e.
g.,
certain
monetary
equivalents)
rather
than
through
modifications
of
the
discount
rate.

Changes
in
the
values
of
environmental
goods
and
other
such
factors
should
likewise
be
reflected
in
direct
cost
and
benefit
measurements,
not
through
adjustments
to
the
social
discount
rate.

Irreversibility
of
consequences
is
an
option
value
concept
and
requires
separate
treatment
in
benefit­
cost
analyses,
but
it
does
not
provide
a
reason
to
adjust
the
discount
rate.

Opportunity
costs
of
other
public
and
private
uses
for
funds
should
be
considered
in
evaluating
the
desirability
of
undertaking
a
particular
public
investment
or
policy.
That
a
project
offers
a
positive
present
value
of
net
benefits
when
discounted
using
the
consumption
rate
of
interest
does
not
by
itself
imply
that
the
policy
should
be
undertaken.

These
conclusions
demonstrate
the
significant
progress
made
in
the
theoretical
social
discounting
literature,
especially
regarding
the
implications
of
divergences
between
social
and
private
rates
of
returns
on
investments.
However,
exactly
what
numerical
rate
of
interest
to
use
for
social
discounting
in
practical
policy
evaluations
remains
somewhat
unsettled.

Moreover,
some
recent
literature
questions
some
of
the
most
basic
premises
underlying
the
conventional
social
discounting
analysis.
For
example,
recent
studies
of
individuals
financial
and
other
decision
making
suggest
that
even
a
single
person
may
appear
to
value
and
discount
different
actions,
goods,
and
wealth
components
differently.
This
"
mental
accounts"
or
"
self­
control"
approach
suggests
that
individuals
may
well
evaluate
some
aspects
of
the
future
quite
differently
from
other
consequences.
The
discount
rate
an
individual
might
apply
to
a
given
future
benefit
or
cost,
as
a
result,
may
not
be
observable
from
market
prices,
interest
rates,
or
other
phenomena.
This
may
be
especially
the
case
if
the
future
consequences
in
question
are
not
tradable
commodities.
Some
recent
evidence
from
experimental
economics
also
indicates
that
discount
rates
appear
to
be
lower
the
larger
the
magnitude
of
the
underlying
effect
being
valued,
higher
for
gains
than
for
losses,
and
tend
to
decline
as
the
length
of
time
to
the
event
increases.
15
Despite
all
of
these
limitations,
practical
economic
analyses
must
use
social
discounting
to
assist
in
evaluating
environmental
policies.
Hence,
even
limited
guidance
is
helpful
in
developing
recommendations
for
practical
analyses.
What
is
offered
in
the
empirical
literature
for
choosing
a
social
discount
rate
focuses
on
estimating
the
consumption
rate
of
interest
at
which
individuals
translate
consumption
through
time
with
reasonable
certainty.

For
this,
historical
rates
of
return,
post­
tax
and
after
inflation
on
"
safe"
assets,
such
as
U.
S.
Treasury
securities,
are
normally
used,
typically
resulting
in
rates
in
the
range
of
one
to
three
percent.
16
Some
studies
have
expanded
this
portfolio
to
include
other
bonds,
stocks,
and
even
housing
and
this
generally
raises
the
range
of
rates
slightly.
It
should
be
noted
that
these
rates
are
ex
post
rates
of
return,
not
anticipated,
and
they
are
somewhat
sensitive
to
the
time
periods
selected
and
the
classes
of
assets
considered
17
A
recent
study
of
the
social
discount
rate
for
the
United
Kingdom
places
the
consumption
rate
of
interest
at
two
to
four
percent,
with
the
balance
of
the
evidence
pointing
toward
the
lower
end
of
the
range.
18
47
Chapter
6:
Social
Discounting
15
Shefrin
and
Thaler
(
1988)
and
Thaler
(
1985)
are
central
sources
for
the
mental
accounts
idea
and
Lowenstein
and
Thaler
(
1989)
report
numerous
examples
of
various
inconsistencies
and
other
aspects
of
individual
intertemporal
choices.

16
Estimates
of
the
consumption
rate
of
interest
(
an
individual's
marginal
rate
of
time
preference)
could
be
based
on
either
after­
tax
lending
or
borrowing
rates.
Because
individuals
may
be
in
different
marginal
tax
brackets,
have
different
levels
of
assets,
and
have
different
opportunities
to
borrow
and
invest,
the
type
of
interest
rate
that
best
reflects
marginal
time
preference
will
differ
among
individuals.
Additionally,
individuals
routinely
are
observed
to
have
several
different
types
of
savings,
each
possibly
yielding
different
returns,
while
simultaneously
borrowing
at
different
rates
of
interest.
Thus,
discerning
an
average
marginal
rate
of
time
preference
from
observed
interest
rates
is
very
difficult.
However,
the
fact
that,
on
net,
individuals
generally
accumulate
assets
over
their
working
lives
suggests
that
the
after­
tax
returns
on
savings
instruments
generally
available
to
the
public
will
provide
a
reasonable
estimate
of
the
consumption
rate
of
interest.

17
Ibbotson
and
Sinquefield
(
1984
and
annual
updates)
provide
historical
rates
of
return
for
various
assets
and
for
different
holding
periods.

18
Lind
(
1982b)
offers
some
empirical
estimates
of
the
consumption
rate
of
interest.
Pearce
and
Ulph
(
1994)
provide
the
estimates
of
the
consumption
rate
of
interest
for
the
United
Kingdom.
Lyon
(
1994)
provides
estimates
of
the
shadow
price
of
capital
under
a
variety
of
assumptions.
Finally,
for
the
shadow
price
of
capital,
even
less
concrete
empirical
guidance
is
available.
This
parameter
depends
on
the
consumption
rate
of
interest,
the
gross­
of­
tax
rate
of
return
on
private
investment,
and
the
rate
of
consumption
out
of
net
investment
returns,
among
other
factors.
Depending
on
the
magnitudes
of
these
factors,
shadow
prices
from
close
to
one
to
three,
20,
100,
and
infinity
can
result.
Lyon
(
1990)
has
an
excellent
review
of
how
to
calculate
the
shadow
price
of
capital
and
possible
settings
for
the
various
parameters
that
determine
its
magnitude.
Moreover,
the
shadow
price
of
capital
adjustment
will
require
an
assessment
of
the
proportion
of
project
costs
that
displace
private
investment.
Whether
or
not
this
adjustment
is
necessary
appears
to
depend
largely
on
whether
the
economy
in
question
is
assumed
to
be
open
or
closed
and
on
the
magnitude
of
the
intervention
or
program
considered
relative
to
the
flow
of
investment
capital
from
abroad.
19
6.3.1.5
Guidance
for
Intra­
Generational
Social
Discounting
For
economic
analyses
of
intra­
generational
policies
analysts
should
apply
the
consumption
rate
of
interest
approach.
There
should
be
no
adjustments
using
the
shadow
price
of
capital
unless
there
are
strong
reasons
to
believe
that
a
particular
policy
will
affect
the
level
of
U.
S.
private
sector
investment.
20
Based
on
historical
rates
of
return
on
relatively
risk­
free
investments,
adjusted
for
taxes
and
inflation,
a
consumption
rate
of
interest
measured
at
two
to
three
percent
is
justified.

OMB's
own
guidance
on
discounting21
currently
recommends
discounting
using
a
rate
of
seven
percent,
an
estimate
of
the
average
real
pre­
tax
rate
of
return
generated
by
private
sector
investments.
EPA
economic
analyses
therefore
should
provide
estimates
of
the
present
values
of
costs
and
benefits
using
both
a
two
to
three
percent
rate
and
OMB's
guidance
on
discounting.
In
some
cases,
a
sensitivity
analysis
at
discount
rates
within
this
range
may
provide
useful
information
to
decision
makers.

In
addition,
all
analyses
should
present
the
undiscounted
streams
of
benefits
and
costs.
This
is
not
equivalent
to
calculating
a
present
value
using
a
discount
rate
of
zero.
In
other
words,
the
flow
of
benefits
and
costs
should
be
displayed
rather
than
a
summation
of
values.

6.3.2
Inter­
Generational
Social
Discounting
This
section
focuses
on
social
discounting
in
the
context
of
policies
with
very
long
time
horizons
involving
multiple
generations.
Policies
with
potential
inter­
generational
impacts
include
global
climate
change,
radioactive
waste
disposal,
groundwater
pollution,
and
biodiversity.
Because
of
potentially
large
or
catastrophic
impacts
on
unborn
generations
and
because
policies
with
very
long
time
horizons
often
involve
high
costs
imposed
by
current
generations,
there
is
less
agreement
in
the
literature
on
the
appropriate
approach
to
discounting
over
very
long
time
horizons.
This
section
attempts
to
present
a
balanced
discussion
of
alternative
points
of
view.
The
discussion
first
focuses
on
how
the
point
of
departure
for
inter­
generational
discounting
differs
in
some
very
fundamental
ways
from
that
of
intra­
generational
social
discounting.
Next,
various
approaches
for
deciding
whether
and
how
to
discount
when
evaluating
inter­
generational
policies
are
reviewed.
Finally,
the
section
concludes
by
summarizing
the
advice
offered
by
the
economics
literature
and
EPA's
new
guidelines
for
inter­
generational
social
discounting.

48
Chapter
6:
Social
Discounting
19
Studies
suggesting
that
increased
U.
S.
government
borrowing
does
not
crowd
out
U.
S.
private
investment
generally
examine
the
impact
of
changes
in
the
level
of
government
borrowing
on
interest
rates.
The
lack
of
a
significant
positive
correlation
of
government
borrowing
and
interest
rates
is
the
foundation
of
this
conclusion.
Because
changes
in
yearly
U.
S.
government
borrowing
during
the
past
several
decades
have
been
in
the
many
billions
of
dollars,
it
is
reasonable
to
conclude
that
EPA
programs
and
policies
costing
a
fraction
of
these
amounts
are
not
likely
to
result
in
significant
crowding
out
of
U.
S.
private
investments.

20
As
the
estimation
of
the
shadow
price
of
capital
can
be
a
costly
exercise,
analysts
should
use
a
value­
of­
information
approach
to
determine
whether
it
is
worthwhile
to
pursue
a
quantitative
assessment
of
the
effects
of
private
capital
displacement.
Should
a
quantitative
assessment
be
undertaken,
the
analysis
should
include
a
sensitivity
analysis
of
alternative
assumptions
regarding
the
degree
of
crowding
out.

21
OMB
Circular
A­
94,
"
Guidelines
and
Discount
Rates
for
Benefit­
Cost
Analysis
of
Federal
Programs,"
October
29,
1992
(
note:
see
updates
to
cost­
effectiveness
rates
 
most
recent
released
in
January
2000,
http://
www.
whitehouse.
gov/
OMB/
circulars/
a094/
a094.
html
(
accessed
8/
28/
2000))
and
U.
S.
Office
of
Management
and
Budget,
Guidelines
to
Standardize
Measures
of
Costs
and
Benefits
and
the
Format
of
Accounting
Statements,
report
M­
00­
08,
March
22,
2000,.
http://
www.
whitehouse.
gov/
media/
pdf/
m00­
08.
pdf
(
accessed
8/
28/
2000).
6.3.2.1
Analytical
Foundation
of
Inter­
Generational
Social
Discounting
One
obvious
problem
with
long­
time­
horizon
policies
is
that
many
of
the
people
affected
are
not
alive.
Hence,
while
the
preferences
of
each
affected
individual
are
knowable
(
if
probably
unknown
in
practice)
for
intra­
generational
social
discounting
problems,
they
are
essentially
unknowable
for
those
involving
future
generations
not
yet
born.
This
is
not
always
a
severe
problem
for
practical
policymaking,
especially
when
policies
impose
relatively
modest
costs
and
benefits,
or
when
the
benefits
begin
immediately,
or
in
the
not
too
distant
future.
And
most
of
the
time,
it
suffices
to
assume
that
future
generations
will
have
preferences
much
like
those
of
present
generations.

The
more
serious
challenge
posed
by
long­
time­
horizon
situations
arises
primarily
when
costs
and
benefits
of
an
action
or
inaction
are
very
large
and
are
distributed
asymmetrically
over
vast
expanses
of
time.
Here,
the
crux
of
the
problem
is
that
future
generations
are
not
present
to
participate
in
making
the
relevant
social
choices.
Instead,
these
decisions
will
be
made
only
by
existing
generations.
Social
discounting
in
these
cases
can
no
longer
be
thought
of
as
a
process
of
consulting
the
preferences
of
all
affected
parties
concerning
their
valuation
today
of
effects
they
will
experience
in
different
time
periods.

Moreover,
compounding
interest
over
very
long
time
horizons
can
have
profound
impacts
on
the
inter­
generational
distribution
of
welfare.
An
extremely
large
cost
far
enough
in
the
future
has
essentially
zero
present
value
when
discounted
at
even
a
low
rate.
But
a
modest
sum
invested
today
at
the
same
low
interest
rate
also
can
grow
to
a
staggering
amount
given
enough
time.
Therefore,
mechanically
discounting
very
large
distant
future
effects
of
a
policy
without
thinking
carefully
about
the
ethical
implications
is
not
advised.

6.3.2.2
Perspectives
on
Inter­
Generational
Social
Discounting
The
social
discounting
literature
contains
many
different
perspectives
on
social
discounting
in
inter­
generational
contexts.
This
section
briefly
describes
the
major
approaches
and
their
theoretical
motivations.
The
focus
in
this
discussion
is
on
the
social
discount
rate
itself,
so
such
other
issues
as
the
shadow
price
of
capital
adjustments,
while
clearly
still
relevant
under
certain
assumptions,
are
kept
in
the
background.

Social
Welfare
Planner
Approach
One
popular
recommendation
is
that
social
discounting
for
inter­
generational
policies
should
be
based
upon
methods
economists
have
used
for
many
years
in
optimal
growth
analyses.
In
these
models,
the
policy
maker
is
understood
to
be
maximizing
the
utilities
of
all
present
and
future
generations
using
a
well­
defined
social
welfare
function.
22
In
optimal
growth
models,
the
social
rate
of
discount
generally
equals
the
sum
of
two
factors.
One
is
a
discount
rate
for
pure
time
preference,
which
measures
the
degree
to
which
the
social
planner
favors
the
utility
of
current
and
near
future
members
of
society
over
that
of
individuals
in
the
more
distant
future.
The
other
is
an
adjustment
reflecting
the
fact
that
the
marginal
utility
of
consumption
will
decline
over
time
as
consumption
per
capita
increases
(
equal
to
the
elasticity
of
marginal
utility
multiplied
by
the
rate
of
increase
of
consumption
over
time).

If
the
world
actually
corresponded
to
the
theoretical
construct
of
an
optimal
growth
model
and
there
were
no
taxes
or
other
distortions,
the
social
discount
rate
as
defined
in
these
models
would
be
equal
to
the
market
interest
rate.
And,
the
market
rate
of
interest,
in
turn,
would
also
be
equal
to
the
social
rate
of
return
on
private
investments
and
the
consumption
rate
of
interest.
But
because
the
world
contains
many
distortions,
and
is
not
likely
to
conform
to
the
conditions
that
characterize
optimal
growth
models,
the
social
rate
of
discount
is
not
observable
in
the
economy.

Recent
practical
applications
of
this
approach
to
very­
longtime
horizon
analyses
have
therefore
attempted
to
estimate
the
social
discount
rate
by
constructing
it
from
its
components.
Most
assume
that
the
rate
of
pure
time
discount
is
zero,
adhering
to
the
ethical
precept
that
the
policy
maker
ought
not
to
inherently
favor
present
generations'
consumption
over
that
of
future
generations.
For
the
other
component
of
the
social
discount
rate,

49
Chapter
6:
Social
Discounting
22
Key
literature
on
this
topic
includes
Arrow
et
al.
(
1996),
Lind
(
1994),
Schelling
(
1995),
Solow
(
1992),
Manne
(
1994),
Toth
(
1994),
Sen
(
1982),
Dasgupta
(
1982),
and
Pearce
and
Ulph
(
1994).
hypothetical,
but
perhaps
plausible,
estimates
of
the
elasticity
of
marginal
utility
and
the
rate
of
growth
of
consumption
over
time
are
introduced.
The
product
of
these
two
factors
is
the
implied
social
discount
rate.
This
computational
procedure
in
essence
derives
an
implied
social
rate
of
discount
under
the
assumption
that
future
generations
will
be
richer
than
current
generations,
so
that
the
marginal
utility
of
consumption
is
projected
to
fall
over
time.
Rates
developed
using
this
technique
generally
range
from
one­
half
percent
to
three
percent.
23
Optimal
growth
modeling,
however,
is
only
one
strand
of
the
substantial
body
of
research
and
writing
on
intertemporal
social
welfare
maximization
and
optimal
growth.
This
literature
extends
from
the
economics
and
ethics
of
inter­
personal
and
inter­
generational
wealth
distribution,
to
the
more
specific
environment­
growth
issues
raised
in
the
"
sustainability"
literature,
and
even
to
the
appropriate
form
of
the
social
welfare
function,
e.
g.,
utilitarianism
or
Rawls'
maxi­
min
criterion.

Clearly,
economics
alone
cannot
provide
definitive
guidance
for
selecting
the
"
correct"
social
welfare
function
or
the
social
rate
of
time
preference.
Nevertheless,
economics
can
offer
a
few
insights
concerning
the
implications
and
consequences
of
alternative
choices
and
some
advice
on
the
appropriate
and
consistent
use
of
the
social
welfare
function
approach
as
a
policy
evaluation
tool.

Approaches
Based
on
Existing
Individuals'
Preferences
The
major
alternative
to
the
social
welfare
planner
approach
for
inter­
generational
discounting
is
to
rely
on
the
preferences
of
current
individuals
for
an
appropriate
discount
rate.
At
its
core,
this
perspective
rejects
the
view
that
the
problem
is
one
of
balancing
the
interests
of
all
humans
who
will
live
now
and
in
the
future.
Instead,
according
to
this
perspective,
it
is
fundamentally
about
individuals
alive
today
allocating
their
scarce
resources
to
competing
ends,
one
of
which
happens
to
be
the
welfare
of
future
generations.
Several
specific
approaches
fall
into
this
category.
Consumption
rate
of
interest/
infinitely­
lived
individuals:
Although
not
popular
in
theoretical
terms,
in
practice
it
is
common
to
adopt
the
approach
of
simply
making
no
great
distinction
between
intergenerational
and
intra­
generational
social
discounting
Models
of
infinitely­
lived
individuals,
for
example
suggest
the
consumption
rate
of
interest
as
the
social
discount
rate.
But
the
assumption
that
people
live
forever
is
contrary
to
the
fact
that
individuals
actually
do
not
live
long
enough
to
experience
distant
future
consequences
of
a
policy
and
to
report
today
the
present
values
they
place
on
those
effects.
As
such,
models
of
infinitely­
lived
individuals
essentially
ignore
the
fundamental
problem
posed
in
evaluations
of
policies
that
affect
distant
future
generations.

Inter­
generational
discounting
vs.
time
discounting
Another
suggestion
for
social
discounting
in
inter­
generational
contexts
is
to
examine
possible
differences
between
how
current
individuals
evaluate
the
welfare
of
their
descendants
versus
how
they
discount
their
own
future
consumption.
24
It
is
possible
that
the
year­
by­
year
exponential
time
discounting
25
that
underlies
an
individual's
allocation
of
his
or
her
own
consumption
in
the
present
and
the
future
does
not
apply
to
this
individual's
valuation
of
his
or
her
descendant's
welfare.
That
is,
a
person
might
indeed
value
future
generations'
consumption
less
than
his
or
her
own
current
and
future
consumption,
but
not
as
low
as
would
be
implied
by
standard
discounting
techniques.
An
individual's
present
valuation
of
the
consumption
of
successive
future
generations
might
decline
gradually
and
approach
some
constant
positive
value,
so
that
the
value
of
a
unit
of
consumption
by
a
person
10
generations
from
the
present
might
be
considered
to
be
the
same
as
a
unit
of
consumption
by
a
person
11
generations
from
now.

A
related
line
of
reasoning
suggests
that
large­
scale
catastrophic
consequences
in
the
future
are
viewed
differently
than
marginal
changes
in
welfare,
so
that
it
matters
little
whether
these
possibilities
are
100
years
50
Chapter
6:
Social
Discounting
23
See
IPCC
(
1996),
pp.
131­
132.

24
Sources
discussing
this
approach
include
Rothenberg
(
1993),
Cropper
et
al.
(
1992),
Shefrin
and
Thaler
(
1988),
Thaler
(
1985),
and
Cowen
and
Parfit
(
1992).

25
Exponential
time
discounting
applies
discounting
factors
to
future
values
that
increase
as
the
time
between
the
present
and
the
future
when
those
values
will
be
experienced
increases.
As
a
result,
the
present
value
of
a
benefit
to
be
enjoyed
50
years
from
now
is
much
higher
than
the
present
value
of
the
same
benefit
if
it
accrues
100
years
from
now.
or
1,000
years
in
the
future.
If
so,
applying
exponential
or
year­
by­
year,
time
discounting
to
such
future
consequences
is
inappropriate.

Revealed/
stated
preferences
for
altruism:
According
to
this
view,
environmental
policies
that
affect
distant
future
generations
are
considered
to
be
altruistic
acts.
26
As
such,
they
should
be
valued
by
current
generations
exactly
the
same
as
other
acts
of
altruism.
Hence,
the
discount
rate
in
question
is
not
that
applied
to
an
individual's
consumption,
but
instead
that
applicable
for
an
individual's
valuation
of
the
consumption
or
welfare
of
someone
else.

At
least
some
altruism
is
apparent
from
international
aid
programs,
private
charitable
giving,
and
bequests
within
overlapping
generations
of
families.
But
the
evidence
suggests
that
the
importance
of
other
people's
welfare
to
an
individual
appears
to
grow
weaker
with
temporal,
cultural,
geographic,
and
other
measures
of
"
distance."
The
implied
discount
rates
that
survey
respondents
appear
to
apply
in
trading
off
present
and
future
lives
are
also
relevant
under
this
approach.
One
such
survey
(
Cropper,
et
al.,
1992)
suggests
that
these
rates
are
positive
on
average,
consistent
with
the
rates
at
which
people
discount
monetary
outcomes,
and
decline
as
the
time
horizon
involved
lengthens.

Opportunity
cost
of
alternatives:
A
variety
of
perspectives
in
the
inter­
generational
discounting
literature
converge
on
the
broad
notion
that
devoting
resources
to
long­
time­
horizon
environmental
projects
 
largely
because
low
discount
rates
appear
to
make
these
attractive
in
present
value
terms
 
neglects
numerous
other
social
investment
opportunities
with
higher
values.
27
Advocates
of
this
point
of
view
point
to
numerous
alternative
social
investments
that
would
generate
far
larger
benefits
now
and
in
the
future,
such
as
basic
infrastructure,
education,
medical
assistance,
and
other
projects
in
developing
nations.

Depending
on
the
context,
this
point
of
view
is
often
expressed
in
two
different
ways:
(
1)
many
other
investments
would
be
more
beneficial
to
society
and
so
long­
time­
horizon
environmental
programs
face
very
high
opportunity
costs,
and
(
2)
the
rates
of
return
offered
by
these
alternative
investments
are
high
and
these
rates
ought
to
be
used
as
the
social
rate
of
discount.

As
noted
earlier
in
the
context
of
intra­
generational
social
discounting,
the
first
statement
of
this
opportunity
cost
argument
is
the
correct
one,
the
second
is
somewhat
problematic.
The
opportunity
costs
of
alternative
government
or
private
investment
programs
are
appropriately
measured
by
calculating
their
present
values
using
the
social
rate
of
discount.
If
these
projects
have
higher
rates
of
return
than
the
social
discount
rate,
their
social
present
values
will
also
be
high.
But
this
does
not
imply
that
the
social
rate
of
discount
itself
ought
to
be
set
equal
to
some
alternative
project's
rate
of
return.
For
example,
an
alternative
project
might
offer
a
very
large
rate
of
return
for
only
one
year,
but
this
should
not
become
the
social
rate
of
discount
for
very­
long­
time­
horizon
projects
and
policies.

Paretian
compensation
tests:
One
final
approach
for
social
discounting
in
an
inter­
generational
context
returns
to
the
theoretical
motivation
and
ethical
underpinnings
of
intra­
generational
social
discounting
This
approach
views
social
discounting
in
intergenerational
contexts
as
a
question
of
whether
the
distribution
of
wealth
among
many
different
generations
could
be
adjusted
in
order
to
compensate
the
losers
under
an
environmental
policy
and
still
leave
the
gainers
better
off.
Whether
gainers
could
compensate
losers
hinges
on
the
rate
of
interest
at
which
society
(
the
U.
S.
presumably
or
perhaps
the
entire
world)
can
transfer
wealth
across
hundreds
of
years.
Some
argue
that
in
the
U.
S.
context,
a
good
candidate
for
this
rate
is
the
federal
government's
borrowing
rate.

What
lies
at
the
foundation
of
this
approach
is
the
goal
of
maintaining
overall
inter­
generational
equity.
The
implicit
assumption
is
that
society
starts
from
a
position
at
which
the
distribution
of
wealth
across
present
and
future
generations
is
"
acceptable."
Then
51
Chapter
6:
Social
Discounting
26
Schelling
(
1995)
and
Birdsall
and
Steer
(
1993)
are
good
references
for
these
arguments.

27
Many
authors
cite
high
opportunity
costs
of
public
investments.
Among
these
are
Birdsall
and
Steer
(
1993),
Nordhaus
(
1993),
Schelling
(
1995),
and
Lyon
(
1994).
it
is
discovered
that
some
current
environmental
action
or
inaction
will
impose
large
burdens
on
future
generations.
To
maintain
inter­
generational
equity,
some
sort
of
accumulation
fund
is
necessary
to
provide
compensation
for
those
harms.

While
this
approach
offers
solid
advice
for
selecting
a
social
discount
rate
for
inter­
generational
policy
evaluation,
its
resolution
of
the
many
difficult
social
choice
problems
posed
by
such
policies
rests
on
two
critical
assumptions.
One
is
that
the
initial
distribution
of
inter­
generational
wealth
is
socially
acceptable.
If
this
is
not
the
case,
it
is
not
clear
that
attempting
to
maintain
that
distribution
after
discovering
the
long­
term
environmental
problem
is
an
appropriate
goal.

Second,
if
the
compensation
fund
is
not
accumulated,
then
the
decision
not
to
remedy
this
environmental
problem
is
once
again
recast
as
an
inter­
generational
equity
problem,
not
a
question
purely
of
economic
efficiency.
There
is
considerable
skepticism
regarding
the
willingness
of
the
current
generation
to
provide
these
compensation
funds
and
a
significant
concern
that
intervening
generations
might
not
continue
the
accumulation
process.
Thus,
actually
undertaking
the
process
of
locking
away
sufficient
savings
for
distant
future
generations
to
compensate
them
for
environmental
harms
is
a
very
different
matter
than
determining
the
rates
of
interest
at
which
such
a
fund
might
grow.

6.3.2.3
Summary
of
Advice
from
the
Economics
Literature
There
is
little
consensus
in
the
economic
literature
on
social
discounting
for
inter­
generational
policies.
In
particular,
the
fundamental
choice
of
what
moral
perspective
should
guide
inter­
generational
social
discounting
 
a
social
planner
who
weighs
the
utilities
of
present
and
future
generations,
the
preferences
of
the
current
generations
regarding
future
generations
or
perhaps
other
approaches
 
cannot
be
made
on
economic
grounds
alone.
It
is
important,
however,
to
view
this
result
in
the
proper
context.
In
fact,
the
practical
effect
of
this
lack
of
consensus
concerning
social
discounting
for
inter­
generational
policies
is
not
as
profound
as
it
at
first
appears.
The
major
problems
with
discounting
in
long­
time­
horizon
contexts
occur
in
probably
a
few
cases
out
of
a
vastly
larger
set,
particularly
where
costs
and
benefits
are
inherently
high
and
are
substantially
divorced
in
time.
But
the
environmental
policies
that
fit
this
description
are
uncommon
because
most
environmental
programs
are
relatively
short
in
duration
and
reversible,
with
their
time
frames
determined
largely
by
capital
investments.

6.3.2.4
Guidance
for
Inter­
Generational
Social
Discounting
Based
on
the
theoretical
social
discounting
literature
and
other
considerations,
economic
analyses
of
policies
with
inter­
generational
effects
should
generally
include
a
"
no
discounting"
scenario
by
displaying
the
streams
of
costs
and
benefits
over
time.
This
is
not
equivalent
to
calculating
a
present
value
using
a
discount
rate
of
zero
(
i.
e.,
the
flow
of
benefits
and
costs
should
be
displayed
rather
than
a
summation
of
values).

Economic
analyses
should
present
a
sensitivity
analysis
of
alternative
discount
rates,
including
discounting
at
two
to
three
percent
and
seven
percent
as
in
the
intra­
generational
case,
as
well
as
scenarios
using
rates
in
the
interval
one­
half
to
three
percent
as
prescribed
by
optimal
growth
models.
The
discussion
of
the
sensitivity
analysis
should
include
appropriate
caveats
regarding
the
state
of
the
literature
with
respect
to
discounting
for
very
long
time
horizons.

6.4
Discounting
and
Non­
Monetized
Effects
Despite
analysts'
best
efforts
to
assign
monetary
values
to
all
of
the
consequences
of
an
environmental
policy,
there
are
instances
in
which
monetization
is
not
feasible.
This
section
briefly
explores
social
discounting
when
some
elements
are
not
expressed
in
monetary
terms.
28
52
Chapter
6:
Social
Discounting
28
Although
this
discussion
focuses
exclusively
on
non­
monetized
benefits,
many
cost
categories
are
often
not
monetized
as
well.
The
time
costs
consumers
experience
as
a
result
of
some
policies,
the
financial
costs
of
business
delays
that
result
from
others,
and
the
quality
and
performance
impairments
caused
by
yet
other
policies
often
are
not
monetized
in
economic
analyses.
Discounting
policy
regarding
these
non­
monetized
effects
should
largely
track
discounting
practices
for
monetized
costs
unless
there
are
reasons
for
not
doing
so,
similar
to
those
described
in
this
section
for
leaving
some
non­
monetized
benefits
undiscounted.
6.4.1
Perspectives
on
Discounting
Non­
Monetized
Effects
One
strategy
for
addressing
future
non­
monetized
effects
is
to
discount
them
as
though
they
had
been
monetized.
Some
argue,
however,
that
environmental
benefits
that
have
not
been
monetized
cannot
 
or
should
not
 
be
discounted
and
summarized
together
with
costs
in
a
costeffectiveness
or
benefit­
cost
summary.
Two
basic
lines
of
reasoning
are
normally
offered.
One
is
that
because
discounting
is
essentially
a
financial
process
designed
to
evaluate
investment
decisions,
it
is
only
relevant
to
dollardenominated
streams,
and
so
benefits
that
are
in
physical
rather
than
dollar
terms
cannot
be
discounted.
Discounting
some
types
of
benefits,
such
as
avoided
damages
to
human
lives
or
natural
resources,
treats
these
tangible
risk­
related
benefits
as
monetary
outcomes,
when
they
are
not
in
fact
financial
consequences.

The
other
line
of
reasoning
for
not
discounting
non­
monetized
benefits
is
that
it
is
ethically
unacceptable
to
discount
physical
units.
If,
for
example,
cancer
cases
that
occur
in
the
future
are
discounted
to
the
present,
this
effectively
asserts
that
a
future
cancer
case
is
not
really
a
cancer
case,
but
rather
is
only
80
percent,
20
percent,
or
some
other
fraction
of
a
"
full"
current
cancer
case.
Discounting
therefore
somehow
cheapens
the
future
effect's
value
or
reduces
its
importance
and
is
unfair
to
future
individuals
or
generations
whose
lives
or
natural
resources
are
at
stake.
This
argument
is
often
applied
not
only
to
human
health
and
environmental
effects
that
are
simply
enumerated
but
also
to
those
that
are
monetized.

Evaluating
these
arguments
requires
a
clear
understanding
of
the
various
reasons
why
benefits
might
not
be
monetized
in
any
given
analysis.
In
some
cases,
benefits
are
not
monetized
because
the
environmental
and
health
impacts
may
be
unknown,
so
that
only
changes
in
emissions,
production
exposure,
or
other
imperfect
proxies
for
benefits,
damages,
or
harms,
are
available.
Sometimes
there
may
be
an
estimated
time
stream
of
human
health
and
environmental
impacts,
but
the
needed
valuation
tools
and
information
on
how
to
monetize
the
benefits
are
not
 
or
are
only
partially
 
available.
Finally,
in
still
other
cases,
physical
effects
have
been
estimated
and
could
be
monetized
but
this
last
step
 
converting
measured
physical
effects
into
dollar
values
of
benefits
 
has
simply
not
been
taken.

6.4.2
When
Discounting
Non­
Monetized
Effects
Is
Appropriate
In
many
cases,
quantitative
information
on
the
time
streams
of
physical
effects
is
available
and
these
effects
are
measured
in
terms
of
human
health
consequences
and
ecosystem
damages
that
correspond
to
endpoints
that
are
normally
monetized.
If
so,
then
these
non­
monetized
benefits
ought
to
be
discounted
if
monetized
costs
and
benefits
are
discounted.
Discounting
non­
monetary
effects
in
these
cases
is
not
inherently
different
from
discounting
these
units
after
attaching
a
unit
value
in
dollar
terms.
What
is
being
conveyed
is
the
notion
that
effects
felt
farther
in
the
future
are
worth
less
in
today's
terms
than
those
that
occured
earlier
in
time.
Thus,
if
two
policies
have
identical
current
costs
and
the
same
amount
of
benefits
in
the
future
except
that
one
produces
these
benefits
earlier
in
time,
the
policy
that
offers
earlier
benefits
will
have
a
higher
social
value.

Choosing
not
to
discount
non­
monetized
benefits
can
have
perverse
consequences.
First,
to
the
extent
that
the
act
of
discounting
and
the
choice
of
discount
rate
embody
a
rational
investment
criterion,
failing
to
discount
non­
monetized
benefits
may
produce
results
that
appear
to
be
irrational
or
intrinsically
unappealing.
Suppose,
for
example,
there
is
a
policy
that
is
estimated
to
save
five
lives
in
the
year
it
is
implemented.
This
policy
can
either
be
implemented
today
(
Option
A)
or
20
years
from
now
(
Option
B),
and
the
undiscounted
costs
in
current
dollars
are
the
same
for
both
options.
If
the
discounted
costs
are
compared
with
undiscounted
benefits,
a
cost­
effectiveness
evaluation
will
clearly
favor
Option
B.
Thus,
failing
to
discount
benefits
can
produce
a
situation
in
which
society
has
little
motive
to
pursue
current
environmental
benefits
because
by
investing
instead,
larger
net
environmental
benefits
can
be
gained
in
the
more
distant
future.

Finally,
surveys
that
examine
individuals'
attitudes
toward
public
policies
with
non­
monetized
benefits
suggest
that
people
do
appear
to
apply
a
positive
discount
rate
to
these
future
effects.
For
example,
contingent
valuation
studies
(
Cropper
et
al.,
1992;
Carson
et
al.,
1987;
Horowitz
and
Carson,
1990)
that
look
at
individuals'
preferences
for
53
Chapter
6:
Social
Discounting
saving
lives
find
that
individuals
prefer
projects
that
save
lives
in
the
near
term
over
equivalent
cost
projects
that
save
lives
in
the
future.

6.4.3
When
Discounting
Non­
Monetized
Effects
Might
Not
Be
Appropriate
While
there
are
many
cases
in
which
non­
monetized
benefits
can
and
should
be
discounted
along
with
all
of
the
other
costs
and
benefits
of
environmental
policies,
there
are
others
in
which
benefits
are
not
monetized
for
reasons
that
pose
more
significant
problems
for
discounting.
Specifically,
sometimes
the
available
measures
of
benefits
are
very
poor
proxies
for
ultimate
damages,
making
it
difficult
to
discount
them
correctly.

When
an
analysis
stops
far
short
of
the
physical
effects
that
are
good
proxies
for
damages,
the
relationship
between
harms
and
emissions
 
or
other
relevant
physical
measures
 
might
be
poorly
understood.
In
the
case
of
the
greenhouse
effect,
for
example,
the
ultimate
impact
of
a
ton
of
greenhouse
gas
emitted
in
a
given
year
depends
on
the
subsequent
change
in
the
time
paths
of
temperature,
sea
level,
and
other
variables,
and
on
the
physical
effects
and
economic
impacts
accompanying
these
changes.
Changes
in
temperature
depend,
in
turn,
on
the
magnitude
of
emissions
of
all
greenhouse
gases
over
time
and
their
radiative
forcing.
Further,
the
impacts
of
climate
change
may
depend
not
only
on
the
absolute
levels
of
these
effects,
but
on
the
rate
at
which
they
occur.
Because
linking
quantified
physical
harms
to
a
unit
of
emissions
is
a
difficult
task,
discounting
greenhouse
gas
emissions
would
be
a
premature
and
problematic
step
in
determining
the
cost­
effectiveness
of
two
alternative
emission
reduction
strategies.

Similarly,
even
when
benefit
estimates
are
based
on
linkages
from
emissions
to
other
physical
and
biological
endpoints
often
these
benefit
measures
are
still
not
close
enough
to
the
endpoints
of
ultimate
concern
to
allow
discounting
For
example,
although
pollution
damages
can
be
measured
in
terms
of
species
diversity,
ecosystem
health,
and
forest
productivity,
the
further
detailed
linkages
from
those
damages
to
current
and
future
recreation,
production
non­
use,
or
other
values
identified
by
economists
and
ecologists
often
do
not
exist.
Discounting
non­
monetized
effects
is
also
not
warranted
when
doing
so
actually
conceals
information
of
value
to
policy
makers.
For
example,
suppose
a
policy
reduces
current
and
future
effluent
discharges
to
a
river.
Suppose
further
that
this
river
has
a
complex
chemistry,
so
that
interactions
between
the
effluent
reduced
by
this
environmental
policy
and
other
natural
and
human
inputs
to
the
river
are
unknown
and/
or
the
relationship
between
effluent
discharges
and
damages
is
nonlinear
(
e.
g.,
the
river
is
subject
to
degradation
only
after
passing
some
threshold).
Here,
the
same
quantities
of
effluent
reduction
in
different
time
periods
are
not
necessarily
identical
in
their
effects,
so
not
only
is
there
a
time
element
to
contend
with,
but
also
possible
differences
in
ultimate
environmental
benefits
In
this
case
it
might
be
far
more
useful
to
display
the
stream
of
effluent
reduction
and
probabilities
of
exceeding
thresholds
each
year,
rather
than
to
discount
all
of
the
future
effluent
reduction.

In
all
of
these
examples,
the
problem
is
that
analysts
have
an
incomplete
understanding
of
the
relationship
between
emissions
 
and
production
or
other
physical
units
that
are
potentially
subject
to
control
 
and
the
actual
harm
to
human
health
or
the
environment
that
result.
However,
a
general
preference
for
earlier
benefits
over
later
ones
still
applies.
The
problem
is
that
discounting
in
these
cases
masks
important
information
by
implicitly
assuming
that
a
unit
of
benefits
in
one
period
has
an
identical
effect
on
the
ultimate
benefit
consequences
of
concern
as
a
unit
of
the
same
benefit
in
another
period.
When
non­
monetized
benefits
measures
are
far
from
the
human
health
and
other
benefit
categories
of
true
concern,
this
assumption
often
is
contrary
to
reality.

When
it
is
not
appropriate
to
discount
certain
non­
monetized
benefits,
comparisons
of
costs
and
benefits
can
still
be
made
without
directly
discounting
the
benefits.
For
example,
if
costs
and
benefits
occur
in
each
time
period
over
the
course
of
a
policy,
and
these
do
not
change
significantly
over
time,
net
social
benefits
can
be
explored
without
discounting
by
examining
a
representative
year's
costs
and
benefits.
Similarly,
if
the
benefits
are
relatively
constant
through
time,
but
the
costs
are
not,
the
costs
can
be
annualized
and
compared
to
the
annual
benefits
using
cost
effectiveness
analysis.
Another
approach
is
to
cumulate
costs
forward
with
interest
to
compare
this
future
value
to
the
benefits,
a
method
that
is
particularly
suitable
when
the
benefits
occur
in
only
one
future
year.
If
none
of
54
Chapter
6:
Social
Discounting
these
methods
applies,
simply
presenting
the
streams
of
costs
and
monetized
and
non­
monetized
benefits
to
policy
makers
is
often
sufficient.

55
Chapter
6:
Social
Discounting
6.5
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1994.
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1993.
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1982.
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1994.
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57
Chapter
6:
Social
Discounting
58
Chapter
6:
Social
Discounting
7.1
Introduction
to
Analyzing
Benefits
At
its
roots,
benefits
analysis
develops
monetary
values
to
inform
the
policy
making
process.
These
values
are
important
because
they
allow
decision
makers
to
directly
compare
costs
and
benefits
using
the
same
measure
(
i.
e.,
dollars).
A
complete
benefits
analysis
is
also
useful
because
it
makes
explicit
the
assumptions
about
the
value
of
benefits
embedded
in
different
policy
choices.
This
chapter
focuses
on
those
benefits
that
can
be
expressed
in
terms
of
dollars
Chapter
10
discusses
the
presentation
of
nonmonetized
benefits,
those
that
cannot
be
expressed
in
dollar
terms.

This
chapter
presents
information
on
the
theory
and
practice
of
benefits
assessment
for
environmental
policies.
The
discussion
focuses
on
the
benefits
possible
from
a
"
typical"
EPA
policy
or
regulation
that
reduces
emissions
of
contaminants
into
the
environment
However,
the
principles
discussed
here
apply
to
other
types
of
EPA
policies,
such
as
those
that
provide
information
or
regulatory
relief.

Most
EPA
benefits
analyses
face
two
serious
challenges
First,
a
given
policy
may
produce
many
different
benefits,
but
it
is
seldom
possible
to
obtain
a
single,
comprehensive
value
estimate
for
the
collection
of
effects.
This
will
often
leave
analysts
with
no
alternative
but
to
address
these
effects
individually,
aggregating
values
to
generate
an
estimate
of
the
total
benefits
of
a
policy
alternative.
Although
there
are
exceptions
to
this
"
effect
by
effect"
process
for
benefits
analysis,
much
of
the
discussion
in
this
chapter
assumes
that
analysts
will
be
forced
to
adopt
this
approach.
The
second
major
challenge
faced
by
analysts
is
the
difficulty
of
conducting
original
valuation
research
in
support
of
specific
policy
actions.
Because
it
is
often
too
expensive
or
time
consuming
to
perform
original
research,
analysts
will
need
to
draw
upon
existing
valuation
estimates
for
use
in
benefits
analysis.
The
process
of
applying
these
estimates
to
value
the
consequences
of
policy
actions
is
called
benefits
transfer.
Although
the
benefit
transfer
method
is
detailed
in
only
one
section,
this
chapter
is
generally
written
with
benefit
transfer
in
mind.
For
example,
the
descriptions
of
valuation
methods
in
Section
7.5
include
recommendations
for
assessing
the
quality
of
published
studies.
This
is
done
to
help
analysts
determine
which
studies
deserve
consideration
for
use
in
benefit
transfers.

While
analysts
should
always
seek
precision,
they
must
make
assumptions
and
exercise
professional
judgment
to
face
the
challenges
noted
above,
as
well
as
numerous
others
that
arise
in
a
benefits
analysis.
Existing
value
estimates,
for
example,
are
often
subject
to
large
uncertainty
bounds
due
to
measurement
error,
model
uncertainty,
and
the
inherent
variability
of
individual
preferences.
When
drawing
from
these
studies
 
and
when
using
quantitative
estimates
of
any
kind
 
analysts
should
carefully
assess
the
quality
of
the
data
and
should
clearly
state
the
reasons
for
their
analytical
choices.
As
with
any
analytical
exercise
the
maxim
"
garbage
in,
garbage
out"
always
applies.

The
next
section
briefly
summarizes
the
conceptual
economic
framework
for
benefits
analysis.
Section
7.3
outlines
the
effect­
by­
effect
process
for
benefits
analysis,
including
some
general
implementation
principles.
The
fourth
section
defines
and
describes
the
types
of
benefits
associated
with
environmental
policies,
followed
by
a
review
of
available
economic
valuation
methods
in
Section
7.5.
This
chapter
59
Chapter
7
Chapter
7:
Analyzing
Benefits
concludes
with
specific
recommendations
for
valuing
types
of
benefits
that
are
common
to
many
EPA
policies.

7.2
A
Conceptual
Framework
for
Benefits
Analysis
This
section
describes
the
theoretical
economic
foundation
for
valuing
benefits.
The
theoretical
discussion
here
serves
as
a
conceptual
starting
point
for
benefits
estimation
 
it
is
not
a
full
and
comprehensive
treatment
of
welfare
economics.
The
section
includes
a
discussion
of
willingness
to
pay,
consumer
surplus,
and
analytical
problems
arising
from
the
lack
of
markets
for
environmental
improvements.
References
are
provided
for
further
reading
on
the
specific
topics
introduced
in
this
section,
but
useful
texts
for
general
reference
include
Just
et
al.
(
1982),
Braden
and
Kolstad
(
1991),
and
Freeman
(
1993).
Boardman
et
al.
(
1996),
Brent
(
1995)
and
Hanley
and
Spash
(
1993)
are
useful,
general
references
for
benefitcost
analysis.

7.2.1
Welfare
Measures:
Willingness
to
Pay
and
Willingness
to
Accept
Compensation
Economists
define
benefits
by
focusing
on
measures
of
individual
satisfaction
or
well­
being,
referred
to
as
measures
of
welfare
or
utility.
Economic
theory
assumes
that
individuals
can
maintain
the
same
level
of
utility
while
trading­
off
different
"
bundles"
of
goods,
services,
and
money.
For
example,
one
may
be
equally
satisfied
by
going
fishing
or
viewing
a
movie.
The
tradeoffs
individuals
make
reveal
information
about
the
value
they
place
on
these
goods
and
services.

The
willingness
to
trade
off
compensation
for
goods
or
services
can
be
measured
either
as
willingness
to
pay
(
WTP)
or
as
willingness
to
accept
compensation
(
WTA).
Economists
generally
express
WTP
and
WTA
in
monetary
terms.
In
the
case
of
an
environmental
policy,
willingness
to
pay
is
the
maximum
amount
of
money
an
individual
would
voluntarily
exchange
to
obtain
an
improvement
(
or
avoid
a
decrement)
in
the
environmental
effects
of
concern
Conversely,
willingness
to
accept
compensation
is
the
least
amount
of
money
an
individual
would
accept
to
forego
the
improvement
(
or
endure
the
decrement).
1
WTP
and
WTA
are
not
necessarily
equal.
The
amount
an
individual
would
be
willing
to
pay
to
obtain
an
environmental
improvement
is
not
necessarily
identical
to
the
amount
he
or
she
would
be
willing
to
accept
to
forego
the
improvement.
One
reason
for
this
difference
is
that
the
starting
points
of
the
two
measures
differ.
For
environmental
improvements,
WTP
uses
the
level
of
utility
without
the
improvement
as
a
reference
point.
WTA,
on
the
other
hand,
uses
as
its
reference
point
the
level
of
utility
with
the
improvement.
Although
these
two
measures
are
distinct
and
sometimes
differ
in
practice,
under
conventional
assumptions
economists
expect
that
the
difference
between
them
will
be
small
in
most
cases.
This
result
generally
holds
as
long
as
the
amounts
in
question
are
a
relatively
small
proportion
of
the
individual's
income.
Nonetheless,
in
the
case
of
environmental
goods,
some
additional
considerations
modify
this
general
result.
Hanemann
(
1991)
shows
that
while
this
result
holds
for
price
changes,
it
does
not
strictly
hold
for
changes
in
quantity
or
quality.
Also,
if
a
good
has
no
close
substitutes,
differences
in
WTP
and
WTA
may
be
large
even
if
the
effect
on
income
is
small.

WTP
and
WTA
can
also
be
identified
with
what
they
imply
about
property
rights
 
whether
entities
have
a
right
to
pollute,
so
the
public
must
pay
them
not
to,
or
whether
the
public
has
a
right
to
a
clean
environment
and
must
be
compensated
for
pollution
For
example,
in
the
case
of
a
policy
that
would
reduce
existing
pollution
levels,
the
use
of
WTP
measures
to
value
benefits
implicitly
assumes
that
the
property
right
rests
with
the
polluting
firm.

60
Chapter
7:
Benefits
1
In
the
case
of
environmental
improvements,
WTP
is
identified
as
the
compensating
variation
measure
of
welfare
change,
while
WTA
in
this
case
is
identified
as
the
equivalent
variation
measure.
For
environmental
decrements,
these
associations
are
reversed.
For
a
more
detailed
treatment
of
welfare
measures
that
includes
these
issues
see
Just
et
al.
(
1982),
Freeman
(
1993),
and
Hanley
and
Spash
(
1993).
In
practice,
WTP
is
generally
used
to
value
benefits
because
it
is
often
easier
to
measure
and
estimate.
To
simplify
the
presentation,
we
use
the
term
"
willingness
to
pay"
(
or
WTP)
throughout
this
chapter
to
refer
to
the
underlying
economic
principles
behind
both
WTA
and
WTP.

Aggregating
Individual
Willingness
to
Pay
Measures
The
benefits
of
a
policy
are
the
sum
total
of
each
affected
individual's
WTP
for
the
policy.
Because
benefit­
cost
analysis
assesses
only
the
efficiency
of
policy
choices,
each
individual's
WTP
must
be
given
the
same
weight
in
the
summation
This
means
that
no
individual
or
group
of
individuals
is
given
preferential
treatment
in
assessing
the
efficiency
of
the
program
except
to
the
degree
that
they
are
willing
to
pay
for
it.
As
described
in
Chapter
9,
equity
assessments
and
impact
analyses
can
be
used
to
describe
the
effects
of
policies
on
populations
of
concern.

Altruism
While
benefits
are
generally
calculated
by
summing
each
individual's
WTP
for
his
or
her
own
welfare,
there
are
conditions
under
which
it
is
appropriate
to
include
altruistic
values,
or
individuals'
WTP
for
the
welfare
of
others.
Economic
theory
concludes
that
if
one
cares
about
a
neighbor
but
respects
the
neighbor's
preferences,
and
if
the
neighbor
would
have
to
pay
for
the
policy
action
being
analyzed,
then
altruistic
benefits
should
not
be
counted
in
a
benefit­
cost
analysis.
The
intuition
behind
this
result
is
that,
if
one
respects
the
neighbor's
preferences,
one
cares
about
both
the
benefits
and
the
costs
the
neighbor
faces.
It
is
therefore
inappropriate
to
add
the
value
one
attaches
to
the
neighbor's
benefits
without
considering
the
cost
implications
of
doing
so.
Comparing
individual
benefits
and
costs
in
this
case
is
the
appropriate
decision
rule.

Altruistic
benefits
may
be
counted
either
when
altruism
toward
one's
neighbor
is
paternalistic
or
when
one
will
in
fact
bear
the
costs
of
the
project
but
the
neighbor
will
not.
In
the
first
case
(
paternalistic
altruism),
one
cares
about
the
benefits
the
neighbor
will
enjoy,
e.
g.,
from
a
health
or
safety
project,
but
not
about
the
costs
the
project
will
impose
on
him.
An
example
of
the
second
case
would
be
a
project
whose
costs
are
borne
entirely
by
the
current
generation;
i.
e.,
the
project
imposes
no
costs
on
future
generations.
In
this
case,
altruism
toward
future
generations
by
the
current
generation
could
legitimately
be
counted
as
a
benefit.

7.2.2
Market
Goods:
Using
Consumer
Surplus
and
Demand
Curves
Willingness
to
pay
is
closely
related
to
the
concept
of
consumer
surplus,
which
is
both
an
individual
and
an
aggregate
concept.
An
individual
demand
curve
indicates
the
maximum
amount
an
individual
would
be
willing
to
pay
to
acquire
an
additional
unit
of
good.
These
individual
demand
curves
can
then
be
aggregated
into
a
market
demand
curve
that
provides
the
cumulative
WTP
for
additional
units.
Consumer
surplus
is
derived
from
market
estimates
of
how
much
of
the
good
is
demanded
in
the
aggregate
at
each
price
and
can
be
easier
to
estimate
than
individual
WTP.

A
market
demand
curve
for
a
given
good
or
service
traces
out
the
amounts
that
consumers
will
purchase
at
different
price
levels;
i.
e.,
their
collective
WTP
for
the
good
or
service
Consumer
surplus
is
the
excess
amount
that
purchasers
are
willing
to
spend
on
a
good
or
service
over
and
above
that
required
by
the
market
price
(
i.
e.,
the
area
under
the
demand
curve
but
above
the
price
line).
This
surplus
serves
as
a
measure
of
the
social
benefits
of
producing
the
good.
Policies
that
affect
market
conditions
in
ways
that
decrease
prices
will
generally
increase
consumer
surplus.
This
increase
can
be
used
to
measure
the
benefits
of
the
policy.
2
The
use
of
demand
curves
and
consumer
surplus
highlights
the
importance
of
assessing
how
individuals
will
respond
to
changes
in
market
conditions.
For
example,
if
a
policy
affects
the
price
or
availability
of
a
commodity
traded
in
a
market
(
e.
g.,
if
it
leads
to
increases
in
the
commercial
fish
harvest),
multiplying
the
increased
quantity
by
current
prices
generally
will
not
provide
an
accurate
61
Chapter
7:
Benefits
2
Technically,
consumer
surplus
serves
as
a
precise
measure
of
benefits
only
if
the
demand
curve
represents
a
compensated
or
Hicksian,
demand
function.
However,
Willig
(
1976)
shows
that
ordinary,
or
Marshallian,
demand
curves
can
often
be
used
to
derive
an
approximate
measure
of
welfare.
The
difference
in
these
two
types
of
demand
curves
is
that
the
former
holds
utility
constant,
while
the
latter
holds
income
constant.
More
background
on
the
theoretic
basis
for
welfare
measures
can
be
found
in
several
texts
including
Freeman
(
1993),
Johansson
(
1993),
Just
et
al.
(
1982),
and
Varian
(
1992).
Chapter
7:
Benefits
62
measure
of
benefits.
Depending
on
the
elasticity
of
the
demand
curve,
a
one
percent
price
increase
may
lead
to
more
(
or
less)
than
a
one
percent
increase
in
the
quantity
demanded,
affecting
the
change
in
consumer
surplus.
3
While
not
detailed
here,
supply
curves
also
vary
in
elasticity
and
have
an
analogous
effect
on
producer
surplus.
Information
on
the
elasticity
of
the
supply
and
demand
curves
is
needed
to
estimate
benefits
in
the
form
of
increases
in
consumer
(
and/
or
producer)
surplus.
4
7.2.3
Non­
Market
Goods
One
challenge
facing
analysts
of
environmental
policies
is
the
lack
of
a
market
for
most
environmental
improvements
Because
"
cleaner
air"
or
"
cleaner
water"
is
not
normally
bought
or
sold,
market
data
are
generally
not
available
for
benefit
valuation.
Economists
have
therefore
developed
other
methods
for
eliciting
values
for
these
types
of
effects.
These
methods
rely
either
on
information
from
the
markets
for
related
goods
(
revealed
preference
methods)
or
on
direct
information
on
people's
preferences
(
stated
preference
methods).
Individual
WTP
values
estimated
in
these
studies
can
be
aggregated
(
or
an
average
value
multiplied
by
the
total
number
of
affected
individuals
to
produce
an
estimate
of
the
total
benefit
for
a
good
or
policy.
Section
7.5
provides
more
information
on
the
economic
foundations
of
specific
methods,
and
Section
7.6
details
how
these
methods
have
been
 
or
can
be
 
applied
in
benefits
analysis.

7.3
The
Benefits
Analysis
Process
From
the
perspective
of
economic
theory,
an
appropriate
measure
of
a
policy's
benefits
is
the
sum
of
individual
WTP
estimates
for
that
policy.
While
it
may
be
possible
in
some
circumstances
to
obtain
individual
WTP
estimates
for
the
entirety
of
a
policy
decision,
in
practice,
analysts
must
often
use
an
"
effect­
by­
effect"
approach
for
benefit
valuation
This
section
discusses
this
approach
to
benefits
analysis,
concluding
with
some
general
principles
to
keep
in
mind
when
implementing
this
approach.

7.3.1
A
General
"
Effect­
by­
Effect"
Approach
The
most
widely
used
approach
for
estimating
the
benefits
of
a
policy
option
is
to
evaluate
separately
the
major
effects
of
a
given
policy
and
then
sum
these
individual
measures
to
arrive
at
total
benefits.
This
general
approach
usually
involves
describing
the
physical
effects
of
the
pollutants
(
e.
g.,
various
types
of
damages
to
human
health
and
ecological
systems)
and
assessing
each
type
of
effect
separately
In
some
cases,
it
may
be
desirable
and
feasible
to
diverge
from
this
approach.
For
example,
contingent
valuation
or
other
methods
could
be
used
to
develop
estimates
of
WTP
for
the
combined
effects
of
the
policy
change,
reducing
the
need
to
identify,
quantify,
and
value
each
effect
separately.
A
comprehensive
value
estimate
for
the
entire
set
of
effects
from
a
policy
change
can
also
be
useful
as
an
indication
of
the
upper
bound
expected
from
the
sum
of
values
developed
with
the
effect­
by­
effect
approach.
5
However,
because
it
is
difficult
to
develop
estimates
of
the
total
value
of
the
pollution
reduction
and
decision
makers
are
often
interested
in
information
on
individual
benefit
categories,
an
effect­
by­
effect
valuation
approach
is
most
often
used
by
EPA
in
economic
analyses
of
regulations.

The
general
effect­
by­
effect
approach
for
assessing
the
benefits
of
environmental
policies
includes
three
components:

Identify
potentially
affected
benefit
categories
by
developing
an
inventory
of
the
physical
effects
that
may
be
averted
by
the
policies.

3
Elasticity
is
a
measure
of
relative
change.
For
a
given
demand
curve,
price
elasticity
is
defined
as
the
percentage
change
in
quantity
demanded
divided
by
the
percentage
change
in
price.
Where
this
value
is
less
than
one
in
absolute
value,
demand
is
considered
to
be
"
inelastic."
Elasticity
values
greater
than
one
(
in
absolute
value)
indicate
that
demand
is
"
elastic."

4
It
is
important
to
keep
in
mind
that
elasticity
is
a
local
concept.
Generally,
one
can
expect
the
elasticity
of
supply
and
demand
curves
to
vary
along
their
respective
lengths.
This
means
that
elasticities
measured
at
a
particular
point
on
these
curves
may
not
be
appropriate
for
estimating
large
changes
or
changes
elsewhere
on
the
curve.
In
these
cases,
it
may
be
necessary
to
characterize
the
demand
and
supply
functions
in
the
relevant
range
of
prices
and
quantities.

5
Randall
(
1991)
presents
a
framework
for
comparing
total
value
and
"
independent
valuation
and
summation"
and
reviews
many
issues
associated
with
estimating
total
values.
Quantify
significant
physical
effects
to
the
extent
possible
working
with
managers,
risk
assessors,
ecologists
physical
scientists,
and
other
experts.

Estimate
the
values
of
these
effects
using
studies
that
focus
on
the
effects
of
concern
or
transferring
estimates
from
studies
of
similar
impacts.

These
steps
may
be
implemented
using
an
iterative
process.
For
example,
analysts
can
begin
by
conducting
screening
analyses
using
available
data
and
relatively
simple
assumptions,
then
collect
additional
data
and
refine
the
analysis
as
needed
to
better
inform
decision­
making.

Each
step
in
this
approach
is
discussed
in
more
detail
below,
focusing
on
the
actions
that
are
generally
undertaken
when
conducting
benefits
analyses
for
typical
EPA
policies
However,
this
guidance
is
intended
to
be
flexible.
Analysts
will
need
to
determine
on
a
case­
by­
case
basis
whether
this
framework
is
appropriate
for
assessing
a
specific
policy,
given
the
effects
particular
to
that
policy
and
the
information
needed
for
related
decision­
making.

Step1:
Identify
Potentially
Affected
Benefit
Categories
The
first
step
in
the
benefits
assessment
is
to
determine
the
types
of
benefits
most
likely
to
be
associated
with
the
particular
policy.
Section
4
of
this
chapter
contains
a
detailed
presentation
of
the
categories
of
benefits
typically
associated
with
environmental
policies
and
regulations.
To
identify
benefit
categories,
analysts
should,
to
the
extent
feasible,
do
several
things:

Develop
an
initial
understanding
of
policy
options
of
interest
by
working
with
cost
analysts
and
policy
makers.
Information
should
also
be
collected
on
the
likely
range
of
emissions
levels
associated
with
the
baseline
and
with
implementation
of
each
of
the
policy
options.
At
the
outset
of
the
analysis,
the
range
of
options
and
associated
emissions
levels
considered
may
be
very
broad
because
emissions
levels
and
preferred
policy
options
can
change
significantly
in
the
course
of
the
policy
making
process.

Research
the
physical
effects
of
the
pollutants
on
human
health,
welfare,
and
the
environment.
This
can
be
done
by
reviewing
the
literature
and,
if
necessary,
meeting
with
other
experts.
This
step
requires
considering
the
transport
of
the
pollutant
through
the
environment
along
a
variety
of
pathways,
including
movement
through
the
air,
surface
water
and
groundwater,
deposition
in
soils,
and
ingestion
or
uptake
by
plants
and
animals
(
including
humans).
Along
these
pathways,
the
pollutant
may
have
detrimental
effects
on
natural
resources
(
e.
g.,
affecting
oxygen
availability
in
surface
water
or
reducing
crop
yields)
as
well
as
direct
or
indirect
effects
on
human
health
(
e.
g.,
affecting
cancer
incidence
through
direct
inhalation
or
through
ingestion
of
contaminated
food).

Consider
the
potential
change
in
these
effects
as
a
result
of
possible
policy
options.
If
policy
options
differ
only
in
their
level
of
stringency,
then
each
option
may
have
an
impact
on
all
identified
physical
effects.
In
other
cases,
however,
some
effects
may
be
reduced
while
others
remain
unchanged
under
a
specific
policy
option.
Evaluating
how
physical
effects
change
under
each
policy
option
requires
evaluation
of
how
the
pathways
differ
in
the
"
post­
policy"
world.

Evaluate
which
effects
are
likely
to
be
significant
in
the
overall
benefit
analysis
according
to
at
least
three
criteria:

 
whether
there
are
likely
to
be
observable
changes
in
the
benefits
category
when
comparing
the
policy
options
to
each
other
and
to
the
baseline;

 
whether
the
benefits
category
is
likely
to
account
for
a
major
proportion
of
the
total
benefits
of
the
policy;
and
 
whether
stakeholders
or
decision
makers
are
likely
to
need
information
on
the
benefits
category
even
if
its
magnitude
is
relatively
small.
6
The
outcome
of
this
initial
step
in
the
benefits
analysis
can
be
summarized
in
a
list
or
matrix
that
describes
the
physical
effects
of
the
pollutant,
identifies
the
benefits
categories
associated
with
these
effects,
and
an
initial
ranking
of
which
effects
may
be
significant
enough
to
warrant
further
investigation.

Initially,
the
list
of
benefit
categories
may
be
lengthy
and
include
all
effects
that
reasonably
can
be
associated
with
63
Chapter
7:
Benefits
6
This
criteria
relates
to
equity
considerations
detailed
in
Chapter
9.
the
policy
options
under
consideration.
Analysts
should
preserve
and
refine
this
list
of
benefit
categories
as
the
analysis
proceeds,
and
the
effects
that
are
not
assessed
in
detail
should
be
discussed
qualitatively
when
presenting
analytic
results.
In
some
cases,
it
may
not
be
feasible
to
assess
some
of
the
more
significant
impacts,
either
because
of
insufficient
scientific
data
(
e.
g.,
data
are
lacking
on
the
effects
of
changes
in
pollution
levels
on
the
benefit
category
of
concern)
or
because
the
time
or
resources
needed
to
assess
the
effect
are
high
compared
to
the
significance
of
the
benefits
category
in
the
decision­
making
process.
These
issues
should
be
discussed
when
presenting
the
results
of
the
benefits
analysis.
The
discussion
should
address
(
1)
the
criteria
used
to
exclude
selected
benefit
categories
from
detailed
quantitative
analysis,
(
2)
the
likely
magnitude
of
the
non­
quantified
benefits,
and
(
3)
the
extent
to
which
these
effects
are
or
are
not
important
considerations
for
the
decision­
making
process.

Step
2:
Quantify
Significant
Physical
Effects
The
second
step
is
to
quantify
the
physical
impacts
related
to
each
category.
Data
are
usually
needed
on
the
extent,
timing,
age
distribution
of
the
affected
population,
and
severity
of
the
effects.
The
focus
should
be
on
the
changes
attributable
to
each
policy
option
in
comparison
to
the
baseline.
For
example,
if
the
risk
of
lung
cancer
is
one
of
the
effects
of
concern,
data
may
be
needed
on
the
changes
in
risk
associated
with
each
option,
the
timing
of
the
risk
reductions,
the
age
distribution
of
those
experiencing
the
risk
reductions,
and
the
percentage
of
cases
likely
to
be
fatal.
If
visibility
is
a
concern,
data
may
be
needed
on
the
geographical
areas
affected
and
the
change
in
visibility
levels
attributable
to
each
policy
option.

Work
closely
with
analysts
in
other
fields.
Estimating
these
impacts
is
largely,
but
not
completely
the
domain
of
other
scientists,
including
risk
assessors
ecologists,
and
other
experts.
These
experts
are
generally
responsible
for
evaluating
the
likely
transport
of
the
pollutant
through
the
environment
and
its
potential
effects
on
humans,
ecological
systems,
and
manufactured
materials
under
the
baseline
and
each
policy
option.
The
principal
role
of
the
economist
is
to
communicate
with
these
experts
in
order
to
ensure
that
the
information
provided
is
adequate
to
support
the
benefits
analysis,
including
information
on
the
uncertainty
associated
with
the
estimates
of
physical
impacts.
However,
economists
may
also
be
able
to
provide
insights,
information,
and
analysis
on
behavioral
changes
that
can
affect
the
results
of
the
risk
assessment.

Try
to
match
the
risk
assessment
and
economic
endpoints.
A
key
consideration
in
this
interaction
is
that
the
endpoints
quantified
and
described
in
the
risk
assessment
match
well
the
effects
for
which
economic
valuation
is
feasible.
Effects
that
are
described
too
broadly
or
that
cannot
be
associated
with
economic
welfare
will
limit
the
ability
of
the
analysis
to
capture
the
full
range
of
benefits
associated
with
policy
options.
It
is
difficult,
for
example,
to
produce
an
economic
measure
of
the
benefits
associated
with
a
reduction
in
the
number
of
persons
exposed
to
a
contaminant
at
a
particular
level.
If,
however,
the
risk
assessment
can
produce
an
estimate
of
the
reduction
in
the
number
and
type
of
adverse
health
effects
from
exposure,
then
the
economic
valuation
exercise
is
much
more
feasible.
This
means
that
the
analyst
must
be
aware
of
the
available
economic
data
and
tools
when
working
with
risk
assessors
and
other
scientists.

Describe
qualitatively
effects
that
cannot
be
quantified.
It
will
not
be
possible
to
quantify
all
of
the
significant
physical
impacts
for
all
policies.
For
example,
animal
studies
may
suggest
that
a
contaminant
causes
severe
illnesses
in
humans,
but
the
data
available
may
not
be
adequate
to
determine
the
number
of
expected
cases
associated
with
different
human
exposure
levels.
Likewise,
it
is
often
not
possible
to
quantify
all
the
ways
in
which
an
ecosystem
may
change
as
a
result
of
an
environmental
policy.
In
these
situations,
the
effect
should
be
described
qualitatively
when
presenting
the
results
of
the
benefits
analysis.
Analysts
should
also
assess
the
implications
of
not
being
able
to
include
this
effect
in
quantitative
benefits
estimates.

EPA
has
developed
extensive
guidance
on
the
assessment
of
human
health
and
ecological
risks
and
analysts
should
refer
to
those
documents
and
the
offices
responsible
for
their
production
and
implementation
for
further
64
Chapter
7:
Benefits
guidance.
7
No
specific
guidance
exists
for
assessing
changes
in
materials
damages
or
amenity
effects.
Analysts
should
consult
relevant
experts
and
existing
literature
to
determine
the
"
best
practices"
appropriate
for
this
type
of
analysis.

Step
3:
Estimate
the
Values
of
the
Effects
Once
information
on
the
physical
effects
of
the
pollutant
is
available,
the
next
step
is
to
assess
the
value
of
related
benefits
based
on
estimates
of
individual
WTP.
As
discussed
earlier,
no
market
exists
for
many
of
the
types
of
benefits
anticipated
from
environmental
regulation.
In
most
cases,
analysts
will
need
to
rely
upon
the
results
of
other
methods
for
estimating
economic
values.
Details
on
these
methods
and
examples
of
how
they
may
be
applied
can
be
found
in
Sections
7.5
and
7.6,
respectively.

Consider
using
more
than
one
method
to
estimate
benefits.
Different
methods
often
address
different
subsets
of
total
benefits
and
the
use
of
multiple
methods
allows
for
comparison
of
alternative
measure
of
value.
Double­
counting
is
a
significant
concern
when
applying
more
than
one
method,
however,
and
any
overlap
should
be
noted
in
presenting
the
results.
In
addition,
some
components
of
the
total
value
of
benefits
may
not
be
amenable
to
valuation
and
will
need
to
be
described
in
other
terms
when
presenting
the
analytic
results.
The
discussion
of
benefit
transfer
in
Section
7.5
describes
many
of
the
issues
involved
in
applying
values
from
one
study
to
another
situation.

Describe
the
source
of
estimates
and
confidence
in
those
sources.
Valuation
estimates
always
contain
a
degree
of
uncertainty.
Using
them
in
a
context
other
than
the
one
in
which
they
were
initially
estimated
can
only
increase
that
uncertainty.
If
many
high­
quality
studies
of
the
same
effect
have
produced
comparable
values,
analysts
can
have
more
confidence
in
using
these
estimates
in
their
benefits
calculations
Some
specific
benefit
transfer
methods
described
in
Section
7.5
provide
a
systematic
manner
of
combining
multiple
estimates.
In
other
cases,
analysts
may
have
only
a
single
study
 
or
even
no
directly
comparable
study
 
to
draw
from.
In
all
cases,
the
presentation
of
the
benefits
analysis
should
clearly
describe
the
sources
of
any
values
used,
along
with
some
assessment
of
the
confidence
associated
with
those
sources.

7.3.2
Implementation
Principles
When
applying
this
framework
to
assess
the
benefits
of
specific
policies,
analysts
should
keep
in
mind
the
following
general
principles:

Focus
on
key
issues.
Resources
should
be
focused
on
benefit
categories
that
are
likely
to
influence
policy
decisions.
To
use
time
and
resources
effectively,
analysts
must
weigh
the
costs
of
conducting
additional
analysis
against
the
usefulness
of
the
additional
information
provided
for
decision­
making.
The
analysis
should
devote
significant
time
and
resources
to
carefully
assessing
those
benefits
categories
that
are
likely
to
influence
the
selection
among
policy
options.
In
some
cases,
relatively
simple
screening
analyses
may
provide
adequate
information
on
these
benefits.
Additional
data
collection
may
not
be
warranted
because
it
is
unlikely
to
lead
to
significant
changes
in
the
conclusions
of
the
analysis.
For
example,
screening
using
a
broad
range
of
values
for
selected
effects
may
indicate
that
a
policy
is
clearly
worth
pursuing
and
analysts
may
conclude
that
any
possible
refinements
to
the
analysis
are
likely
to
simply
reinforce
this
conclusion.
In
this
case,
the
analyst
should
discuss
the
approach
taken
and
note
that
the
benefits
estimate
may
represent
a
lower
bound.
Likewise,
some
categories
of
benefits
may
not
be
assessed
either
because
they
are
expected
to
be
small
or
because
the
costs
or
time
needed
to
quantify
them
far
exceed
the
time
or
resource
levels
appropriate
for
analysis
of
the
particular
policy.

Applying
this
approach
to
benefits
assessment
involves
first
conducting
scoping
analyses
to
collect
available
information
on
the
potential
benefits
of
the
policies
and
using
this
information
to
develop
65
Chapter
7:
Benefits
7
In
September
1986,
EPA
published
final
risk
assessment
guidelines
for
a
number
of
health
effects,
including
Guidelines
for
Carcinogen
Risk
Assessment,
which
are
currently
under
revision.
Many
other
risk­
related
guidelines
have
been
published,
revised,
and
updated
since
1986.
Recent
additions
include
Guidelines
for
Exposure
Assessment
(
EPA,
1992)
and
Guidelines
for
Reproductive
Toxicity
Risk
Assessment
(
EPA,
1996).
More
information
on
these
and
other
guidelines,
as
well
as
electronic
copies
of
the
documents
themselves,
can
be
found
on
the
home
page
of
EPA's
National
Center
for
Environmental
Assessment
at
http://
www.
epa.
gov/
nceawww1/
raf/
rafguid.
htm
(
accessed
8/
28/
2000).
preliminary
estimates
(
see,
for
example,
Morgan
and
Henrion,
1990).
The
results
from
this
initial
screening
analysis
can
then
be
used
to
inform
the
early
stages
of
the
policy
development
process
and
to
focus
future
research
on
those
areas
most
in
need
of
further
assessment.
In
many
cases,
it
may
be
useful
to
use
benefits
transfer
techniques
in
the
initial
stages
of
the
analysis,
as
discussed
later
in
this
chapter.

Coordinate
frequently
with
others
involved
in
developing
the
policies.
Ongoing
coordination
with
the
analysts
responsible
for
assessing
costs
and
economic
impacts,
and
with
the
work
group
considering
policy
options
is
crucial
to
ensure
consistency
as
the
policy
options
and
analyses
evolve.
This
coordination
should
begin
in
the
planning
stages
of
the
analysis,
and
should
continue
throughout
the
development
process.
Successful
efforts
often
involve
informal
conversations
among
lead
analysts
several
times
each
week,
supplemented
by
larger
and
more
formal
periodic
meetings
to
report
on
progress
and
discuss
next
steps.

Coordination
will
help
ensure
that
the
cost
and
benefit
results
are
comparable
and
based
on
consistent
baseline
and
policy
assumptions.
In
addition,
information
from
the
cost
analysis
is
often
needed
for
the
analysis
of
benefits
and
vice
versa.
For
example,
if
a
policy
requires
firms
to
install
new
pollution
controls,
benefits
analysis
requires
information
on
the
number
of
facilities
likely
to
install
each
type
of
control
and
the
associated
reduction
in
emissions.
On
the
other
hand,
where
a
performance
standard
is
being
considered
the
cost
analysis
may
need
data
from
the
risk
models
in
considering
which
controls
are
likely
to
meet
the
standard.

Consider
changes
in
behavior.
The
use
of
an
effect­
by­
effect
approach
does
not
necessarily
mean
that
one
should
simply
value
benefits
by
estimating
the
physical
changes
attributable
to
changes
in
pollution
emission
levels
(
e.
g.,
increases
in
the
fish
population
then
assigning
a
unit
value
to
these
changes
(
e.
g.,
the
price
of
the
fish).
Such
a
limited
analysis
will
be
inappropriate
in
many
cases
because
it
leaves
out
the
effects
of
changes
in
behavior
attributable
to
changes
in
environmental
quality.
For
example,
increased
fish
populations
may
cause
commercial
prices
to
drop,
in
which
case
consumers
may
increase
their
purchases.
Commercial
fisheries
may
also
respond
to
changes
in
pollution
levels
by
altering
their
production
processes.
While
it
may
not
be
possible
in
practice
to
capture
all
of
these
types
of
responses
in
the
analysis,
those
that
are
likely
to
be
significant
should
be
addressed.

Guard
against
double­
counting
benefits.
If
there
is
significant
overlap
across
the
values
used
for
estimating
the
benefits
of
different
effects,
summing
values
across
these
effects
could
substantially
overstate
expected
benefits.
For
example,
property
value
studies
may
estimate
people's
WTP
for
all
perceived
effects.
This
would
overlap
with
values
estimated
separately
for
any
one
of
these
effects,
such
as
reduced
risk,
so
simply
adding
these
two
values
to
estimate
benefits
would
be
inappropriate.
Analysts
should
also
take
care
to
ensure
that
important
effects
of
the
policy
have
not
been
omitted
in
the
benefits
analysis,
as
this
will
lead
to
significant
underestimates
of
total
benefits.

Explicitly
address
uncertainty
and
non­
monetized
effects.
Benefits
assessments
for
environmental
policies
often
involve
significant
uncertainty.
Sometimes
this
uncertainty
cannot
be
reduced
(
or
better
characterized)
given
the
need
to
regulate
in
a
timely
manner
and
the
resources
available
for
the
analysis.
These
uncertainties
should
be
clearly
communicated
when
presenting
the
results
of
the
analysis
focusing
on
the
implications
for
decision­
making.
For
example,
if
benefits
may
be
significantly
overstated
due
to
the
conservatism
inherent
in
the
risk
estimates
then
the
materials
summarizing
the
analysis
should
state
this
explicitly.
Guiding
principles
for
addressing
and
presenting
uncertainty
are
presented
in
Chapter
5
of
this
guidance.
The
relative
significance
of
benefits
categories
that
are
not
quantified,
or
quantified
but
not
monetized,
should
also
be
described,
as
discussed
in
Chapter
10.

7.4
Types
of
Benefits
Associated
with
Environmental
Policies
This
section
describes
the
types
of
benefits
that
are
typically
associated
with
environmental
policies.
These
66
Chapter
7:
Benefits
descriptions
are
provided
with
an
understanding
that
it
is
desirable
to
quantify
and
monetize
these
benefits.
Available
valuation
techniques
are
described
in
Section
7.5.

Benefits
from
environmental
policies
can
be
broadly
classified
into
those
that
directly
affect
humans
and
human
welfare
and
those
that
affect
human
welfare
through
systems
or
processes.
The
former
category
includes
human
health
improvements
such
as
reduced
mortality
rates,
decreased
incidence
of
nonfatal
cancers,
chronic
conditions
and
other
illnesses
and
reduced
adverse
reproductive
or
developmental
effects.
Improved
amenities
are
another
type
of
benefit
experienced
directly
by
humans.
Improved
taste
and
odor
of
tap
water
resulting
from
treatment
requirements
are
an
example
of
direct
amenity
benefits.
Benefits
that
affect
human
welfare
through
systems
or
processes
include
reduced
materials
damages
and
numerous
other
effects
collectively
termed
ecological
benefits.
EPA
policies
may
result
in
ecological
impacts
that
affect
the
human
use
of
natural
resources
(
e.
g.,
improving
commercial
fishing,
increasing
agricultural
yields,
enhancing
recreational
opportunities.)
Ecological
effects
may
also
provide
passive
use
(
or
"
non­
use")
benefits
that
arise
from
a
variety
of
motives
including,
for
example,
one's
own
utility
in
knowing
that
clean
resources
exist
or
the
desire
to
preserve
clean
resources
for
future
generations.
In
some
cases,
environmental
policies
also
reduce
damages
to
manufactured
materials
or
improve
a
resource's
aesthetic
qualities.
Reducing
air
pollution
may
decrease
damages
to
building
exteriors
or
improve
visibility.
Exhibit
7­
1
illustrates
this
categorization
scheme
67
Chapter
7:
Benefits
Benefit
Category
Examples
of
Service
Flows
Commonly­
Used
Valuation
Methods
Human
Health
Mortality
Risks
Reduced
risk
of
°
Averting
behaviors
°
Cancer
fatality
°
Hedonics
°
Acute
fatality
°
Stated
preference
Morbidity
Risks
Reduced
risk
of
°
Averting
behaviors
°
Cancer
°
Cost
of
illness
°
Asthma
°
Hedonics
°
Nausea
°
Stated
preference
Amenities
°
Taste
°
Averting
behaviors
°
Odor
°
Hedonics
°
Visibility
°
Stated
preference
Ecological
Benefits
Market:
products
Provision
of
°
Food
°
Market
°
Market
°
Fuel
°
Timber
°
Fiber
°
Fur,
eather
Non­
market:
Provision
of
°
Production
function
recreation
and
°
Recreational
opportunities,
°
Averting
behaviors
aesthetics
e.
g.,
viewing,
fishing,
boating,
°
Hedonics
swimming,
hiking
°
Recreation
demand
°
Scenic
vistas
°
Stated
preference
Indirect:
ecosystem
°
Climate
moderation
°
Pollination
by
wild
species
°
Production
function
services
°
Flood
moderation
°
Biodiversity,
genetic
library
°
Averting
behaviors
°
Groundwater
recharge
°
Water
filtration
°
Stated
preference
°
Sediment
trapping
°
Soil
fertilization
°
Soil
retention
°
Pest
control
°
Nutrient
cycling
Non­
use:
existence
No
associated
services
°
Stated
preference
and
bequest
values
Materials
Damage
­­
°
Averting
behaviors
°
Market
Exhibit
7­
1
Examples
of
Benefit
Categories,
Service
Flows,
and
Commonly­
Used
Valuation
Methods
and
suggests
commonly­
used
techniques
for
estimating
their
values,
although
the
list
is
not
exhaustive.
8
A
detailed
discussion
of
valuation
techniques
is
presented
in
the
next
section
of
this
chapter.
The
remainder
of
this
section
describes
each
of
these
categories
briefly
and
notes
issues
associated
with
quantification.

7.4.1
Human
Health:
Mortality
Risks
Some
EPA
policies
are
designed
to
decrease
the
risks
of
contracting
potentially
fatal
health
effects,
such
as
some
cancers.
Reducing
these
risks
of
premature
fatality
provides
welfare
increases
to
those
individuals
affected
by
the
policy.
It
is
important
to
keep
in
mind
that
policies
generally
provide
marginal
changes
in
relatively
small
risks.
That
is,
most
policies
do
not
provide
assurance
that
one
will
not
prematurely
die
of
environmental
causes,
they
only
marginally
reduce
the
probability
of
such
an
event.

Reduced
mortality
risks
are
often
measured
in
terms
of
"
statistical
lives."
This
measure
is
the
aggregation
of
many
small
risks
over
an
exposed
population
Suppose,
for
example,
that
a
policy
affects
100,000
people
and
reduces
the
risk
of
premature
mortality
by
one
in
10,000
for
each
individual.
Summing
these
individual
risk
reductions
across
the
entire
affected
population
results
in
the
policy
saving
10
statistical
lives.
It
is
unknown
who
these
ten
people
might
be
 
everyone
faces
some
risk
of
being
affected
 
but
the
policy
can
be
expected
to
prevent
premature
fatality
for
10
individuals
in
the
population.

Alternative
measurements
may
include
"
statistical
life
years."
A
somewhat
more
refined
approach
to
measuring
reduced
mortality
risks
includes
the
degree
of
life
extension
in
the
estimate.
This
is
usually
done
by
looking
not
just
at
the
reduced
probability
of
a
premature
fatality,
but
also
at
the
expected
life
span
of
those
enjoying
the
risk
reduction.
A
risk
reduction
of
one
in
10,000
experienced
by
a
population
of
100,000
people
with
an
expected
remaining
life
span
of
50
years
each,
for
example,
would
save
10
"
statistical
lives"
or
500
"
statistical
life
years."
Measuring
mortality
risk
reduction
in
terms
of
statistical
life
years
provides
more
information
about
the
expected
benefits
of
a
policy,
but
requires
risk
estimates
for
specific
age
groups.
9
Often
these
risk
estimates
are
not
available.

7.4.2
Human
Health:
Morbidity
Effects
This
benefits
category
consists
of
reductions
in
the
risk
of
non­
fatal
health
effects
ranging
from
mild
illnesses
such
as
headache
and
nausea
to
very
serious
illnesses
such
as
cancer.
A
complete
list
of
morbidity
effects
is
beyond
the
scope
of
this
document,
but
the
presumption
for
all
of
these
effects
is
that
the
illness
will
not
generally
result
in
premature
fatality.

Morbidity
effects
can
generally
be
characterized
by
their
duration
and
severity.
For
duration
of
illness
the
primary
distinction
is
between
acute
effects
and
chronic
effects.
Acute
effects
are
discrete
episodes
usually
lasting
only
a
few
days,
while
chronic
effects
last
much
longer
and
are
generally
associated
with
long­
term
illness.
Severity
defines
the
degree
of
impairment
associated
with
the
illness
and
may
be
measured
in
terms
of
"
restricted
activity
days,"
"
bed
disability
days,"
or
"
lost
work
days."
10
Severity
may
also
be
described
in
terms
of
health
state
indices
that
may
combine
multiple
dimensions
of
health
into
a
single
quantity,
or
index.
The
difference
in
the
index
68
Chapter
7:
Benefits
8
This
classification
scheme
is
offered
here
to
facilitate
discussion
in
this
document.
It
is
similar
in
many
respects
to
one
offered
in
Freeman
(
1993),
but
other
researchers
have
offered
alternatives.
Freeman
(
1993)
describes
some
general
characteristics
of
these
alternatives.
The
list
of
techniques
for
each
benefit
category
is
not
intended
to
be
comprehensive
or
exclusive
9
Additional
refinements
to
account
for
quality
of
life
or
health
status
are
often
employed
in
the
public
health
and
health
economics.
Existing
measures
include
"
quality
adjusted
life
years"
(
QALYs)
and
"
disability
adjusted
life
years."
These
measures
have
not
been
fully
integrated
with
the
literature
on
benefits
analysis
for
environmental
policies.
More
information
on
QALYs
can
be
found
in
Gold
et
al.
(
1996)
and
additional
information
on
DALYs
can
be
found
in
Murray
(
1994).

10
As
Cropper
and
Freeman
(
1991)
note,
these
descriptions
are
essentially
characterizations
of
a
behavioral
response
to
the
illness.
Lost
workdays,
for
example,
in
some
cases
requires
a
decision
on
an
individual's
part
not
to
go
to
work
due
to
illness.
Such
a
response
may
depend
upon
various
socioeconomic
factors
as
well
as
the
physical
effect
of
the
illness.
value
reflects
the
relative
difference
in
disutility
associated
with
symptoms
or
illnesses.
11
Morbidity
effects
can
be
further
characterized
by
the
set
of
symptoms
associated
with
an
illness.

Morbidity
effects
are
usually
quantified
in
terms
of
the
number
of
expected
cases
of
a
particular
illness.
Given
the
risks
faced
by
each
individual
and
the
number
of
persons
exposed
to
this
risk,
an
estimate
of
"
statistical
cases"
can
be
defined
analogously
to
"
statistical
lives"
described
above.
Alternatively,
morbidity
effects
may
be
described
according
to
the
expected
number
and
duration
of
particular
symptoms
associated
with
the
illness.
These
estimates
of
"
symptom
days"
may
be
used
in
benefits
analysis
when
appropriate
estimates
of
economic
value
are
available.

7.4.3
Amenities
Direct
amenities
include
improvements
in
aesthetic
attributes
associated
with
environmental
commodities.
This
includes
improvements
in
taste,
odor,
appearance,
or
visibility
In
short,
these
benefits
are
determined
by
how
the
senses
are
affected
and
how
individual's
welfare
is
changed
as
a
result.
This
class
of
benefits
is
unique
in
that
the
focus
is
on
the
sensory
experience
and
not
on
a
physical
or
material
effect.

Despite
this
conceptual
distinction,
aesthetic
benefits
are
often
intertwined
with
other
benefit
categories
such
as
health
and
recreation.
A
policy
that
improves
air
quality,
for
example,
might
simultaneously
improve
visibility
and
reduce
mortality
risks
associated
with
airborne
contaminants.
New
treatments
for
drinking
water
might
reduce
health
risks
as
well
as
alter
the
taste
and
odor
of
tap
water.
These
relationships
may
make
it
extremely
difficult
to
separately
quantify
and
value
improvements
in
aesthetic
qualities.

Many
types
of
policies
can
be
expected
to
have
some
impact
on
these
kinds
of
amenities
and
they
may
be
the
focus
of
a
given
policy.
Amenity
improvements
may
be
major
component
of
total
expected
benefits.
Improved
visibility
from
better
air
quality
is
one
example
that
has
been
the
subject
of
several
empirical
studies.
12
7.4.4
Ecological
Benefits
Ecosystems
provide
services
that
benefit
humans.
For
example,
a
freshwater
lake
may
provide
recreational
and
boating
sites;
a
wetland
provides
a
service
by
being
a
breeding
ground
for
fish
and
fowl.
Although
ecosystems
have
a
profound
impact
upon
human
well­
being,
the
quantitative
assessment
of
ecological
benefits
presents
a
formidable
challenge
for
several
reasons.
First,
natural
systems
are
inherently
complex.
The
many
services
they
provide
and
how
they
provide
them
may
be
poorly
understood
by
even
the
scientific
community.
Second,
ecological
risks
vary
widely
in
terms
of
persistence
(
e.
g.,
eutrophication
versus
species
extinction),
geographic
extent
(
e.
g.,
toxic
contamination
versus
global
climate
change),
and
the
degree
to
which
the
overall
threat
can
be
predicted
(
e.
g.,
effects
of
ozone
on
crops
versus
developmental
and
behavioral
effects
of
chemicals
on
wildlife
populations).
Third,
many
of
the
less
tangible
benefits
are
not
readily
amenable
to
monetary
valuation.

Section
7.3
discussed
generally
the
three
steps
involved
in
assessing
the
benefits
of
environmental
policies.
However,
some
issues
associated
with
identifying
and
quantifying
ecological
benefits
are
particularly
complex
and
warrant
more
detailed
treatment.

Identifying
Ecological
Benefits
The
first
step
in
assessing
ecological
benefits
is
to
identify
those
relevant
to
policy
options
under
consideration,
focusing
on
service
flows
that
are
likely
to
change
as
a
consequence
of
guidance
or
regulatory
action.
In
general,
these
ecological
benefits
may
be
thought
of
as
flows
of
services
from
the
natural
asset
in
question.
These
can
be
categorized
by
how
directly
they
are
experienced
and
where
they
fall
along
a
private
good/
public
good
continuum
Exhibit
7­
2
illustrates
how
the
categories
relate
to
one
another.
Not
only
is
it
useful
as
a
conceptual
tool,
this
69
Chapter
7:
Benefits
11
These
indices
may
be
constructed
in
a
number
of
ways,
but
consistency
with
welfare
economics
requires
affected
individuals
to
define
these
relative
tradeoffs
for
themselves
rather
than
having
them
determined
by
health
experts.
Several
economic
analyses
have
employed
some
form
of
health
state
index.
Recent
examples
include
Desvousges
et
al.
(
1998)
and
Magat
et
al.
(
1996).

12
Examples
of
these
studies
include
Rae
(
1983),
Johnson
et.
al.
(
1983),
Schulze
et
al.
(
1983),
Chestnut
and
Rowe
(
1990),
Crocker
and
Shogren
(
1991),
and
McClelland
et
al.
(
1993).
categorization
helps
direct
analysts
to
suitable
valuation
methods.
13
Market
benefits:
Direct
market
benefits
are
some
of
the
most
readily
identified
service
flows
provided
by
ecosystems.
These
typically
relate
to
primary
products
that
can
be
bought
and
sold
competitively
as
factors
of
production
or
final
consumption
products.
Although
they
may
be
managed
to
a
high
degree,
agricultural
systems
are
nevertheless
predicated
on
ecological
processes.
As
a
consequence,
increased
productivity
of
farmland
and
rangeland
may
provide
significant
market
benefits.
Other
products
include
commercial
fish
species
and
timber.
When
access
is
controlled
and
appropriate
user
charges
levied,
recreational
opportunities
may
also
be
considered
direct,
market
benefits.

Non­
market
benefits:
Recreational
opportunities
and
aesthetic
qualities
provided
by
ecosystems
are
also
experienced
directly
by
individuals,
albeit
in
a
non­
market
setting.
Non­
market
benefits
include
both
consumptive
uses
(
e.
g.,
recreational
fishing
and
hunting)
and
non­
consumptive
uses
(
e.
g.,
scenic
vistas
wildlife
viewing,
hiking,
and
boating).
These
services
are
typically
provided
by
natural
assets
held
in
common
(
e.
g.,
public
lands).
They
have
public
goods
characteristics
 
since
access
is
not
or
cannot
be
controlled
consumption
is
not
exclusive.
On
the
other
hand,
like
private
goods,
they
are
rival
in
consumption
because
excessive
use
by
others
(
i.
e.,
congestion)
tends
to
diminish
one's
own
enjoyment
of
these
services.

Indirect
benefits:
Ecosystem
services
that
do
not
directly
provide
some
good
or
opportunity
to
individuals
may
be
valued
because
they
support
off­
site
ecological
resources
or
maintain
the
biological
and
biochemical
processes
required
for
life
support.
These
indirect
benefits
tend
to
be
purely
public
in
nature
 
access
to
or
use
of
the
service
is
not
exclusive
and
a
virtually
unlimited
number
of
individuals
can
share
in
the
benefits
without
reducing
the
average
benefit
accruing
to
each.
Each
type
of
ecosystem
provides
various
indirect
benefits.
Wetlands
recharge
groundwater
mitigate
flooding,
and
trap
sediments.
Forests
sequester
carbon,
anchor
soil,
and
maintain
microclimates
Estuaries
protect
adolescent
fish.
Terrestrial
ecosystems
provide
habitat
for
natural
pollinators.
All
of
these
systems
support
biodiversity.

Non­
use
benefits:
Some
benefits
are
not
associated
with
any
direct
use
by
either
individuals
or
mankind.

70
Chapter
7:
Benefits
Ecological
Benefits
Use
Non­
Use
Direct
Indirect
Market
Non­
Market
Public
Goods
Private
Goods
Exhibit
7­
2
Ecological
Benefits
Classification
Scheme
13
A
more
detailed
discussion
of
these
concepts
is
also
found
in
EPA's
Conceptual
Framework
for
Assessing
Ecological
Costs
or
Benefits
(
EPA,
1999b).
A
draft
is
available
at
http://
intranet.
epa.
gov/
oerrinet/
ecoweb/
index2.
htm
(
accessed
8/
29/
2000).
Rather,
they
result
because
individuals
might
value
an
ecological
resource
without
using
or
even
intending
to
use
it.
Non­
use
values,
also
referred
to
as
passive
use
values,
are
those
associated
with
the
knowledge
the
resource
exists
in
an
improved
state,
bequest
values
for
future
generations
and
altruistic
values
for
others'
enjoyment
of
the
resource.
An
individual's
commitment
to
environmental
stewardship
may
also
be
the
source
of
existence
value.
The
commitment
of
some
groups
to
particular
animals
or
ecosystems
provides
an
example
of
this.
14
Quantifying
Ecological
Risk
The
second
step
in
the
analysis
of
ecological
benefits
is
to
estimate
the
physical
effects
of
each
policy
option,
comparing
the
flow
of
services
with
and
without
the
policy.
It
falls
upon
ecologists
and
environmental
toxicologists
to
conduct
the
ecological
risk
assessments
to
estimate
the
expected
adverse
ecological
effect
of
a
particular
stressor.
15
Ecological
risk
assessments
can
be
either
narrow
in
scope,
with
inquiry
limited
to
a
single
species
or
population
(
e.
g.,
the
effect
of
chemical
exposure
on
an
endangered
bird
species)
or
focus
broadly
on
an
entire
ecosystem.
Further
information
on
ecological
risk
assessment
can
be
found
in
Ecological
Risk
Assessment
Guidelines
(
EPA,
1998).

The
results
of
an
ecological
risk
assessment
generally
include
the
effect's
magnitude
(
expressed
in
such
metrics
as
hazard
quotients
or
percent
change
in
population),
duration,
spatial
distribution,
and
time
period
of
recovery.
The
analysis
of
ecological
risks
may
be
highly
uncertain.
Limited
availability
of
data
and
models,
and
imperfect
understanding
of
key
issues,
hampers
our
ability
to
describe
ecological
effects.

7.4.5
Reduced
Materials
Damages
The
materials
damages
benefit
category
includes
welfare
impacts
that
arise
from
changes
in
the
provision
of
service
flows
from
the
"
material"
environment.
The
"
material"
environment
is
distinguished
from
the
natural
environment
discussed
in
the
ecological
benefits
section
and
includes
constructed
or
highly­
managed
physical
systems.
Changes
in
the
stock
and
quality
of
these
material
environmental
resources
are
assessed
in
a
similar
fashion
to
their
natural
environment
counterparts.
Analytically,
benefits
assessment
for
materials
improvements
parallels
that
for
managed
ecosystems
such
as
agriculture
or
forestry,
with
most
benefits
arising
from
direct,
market
effects
or
use
values.
For
example,
effects
from
changes
in
air
quality
on
the
provision
of
the
service
flows
from
physical
resources
such
as
buildings,
bridges,
or
roads
are
handled
in
a
similar
fashion
to
the
effects
from
changes
in
air
quality
on
crops
or
commercial
timber
stocks.
The
most
common
empirical
applications
involve
air
pollution
damages
and
the
soiling
of
structures
and
other
property.

7.5
Methods
for
Benefits
Valuation
Economists
have
developed
a
number
of
methodologies
to
measure
the
benefits
of
environmental
improvements.

Market
methods
can
be
used
when
direct
markets
for
environmental
goods
and
services
exist.
The
benefits
of
a
change
in
quantity
of
a
good
are
estimated
using
data
on
these
market
transactions.
By
knowing
how
the
good
was
bought
and
sold,
economists
can
infer
directly
how
people
appear
to
value
that
good.

Unfortunately,
direct
markets
for
environmental
goods
and
services
do
not
often
exist.
In
the
absence
of
these
markets,
environmental
and
natural
resource
economists
must
rely
upon
alternative
methodologies
to
measure
the
benefits
of
environmental
improvements.

Revealed
preference
methods
(
or
indirect
approaches)
allow
economists
to
infer
the
value
placed
on
environmental
goods
using
data
on
actual
choices
made
by
individuals
in
related
markets.
Revealed
preference
methods
include
recreational
demand
models,
hedonic
wage
and
hedonic
property
models,
and
averting
behavior
models.

71
Chapter
7:
Benefits
14
Even
though
it
does
not
involve
use,
non­
use
value
still
falls
under
the
rubric
of
welfare
economics.
It
emanates
from
human
interest,
alone,
and
does
not
encompass
any
rights
or
ethics­
based
justification
for
preservation
(
see
Kopp,
1992
and
Mazzotta
and
Kline,
1995).

15
Other
types
of
frameworks
for
ecological
assessment
include
injury
assessments
undertaken
as
part
of
natural
resource
damage
assessments
(
IEC,
1995
and
Huguenin
et
al.,
1996)
and
environmental
assessments
undertaken
to
meet
the
requirements
of
NEPA.
Stated
preference
methods
(
or
direct
approaches)
allow
economists
to
estimate
the
value
placed
on
environmental
goods
using
data
on
hypothetical
choices
made
by
individuals
responding
to
a
survey.
Stated
preference
methods
include
contingent
valuation
conjoint
analysis,
and
contingent
ranking.

Specific
approaches
that
fall
under
these
two
broad
categories
are
presented
below.
This
presentation
includes
an
overview
of
each
method,
a
description
of
its
general
application
to
environmental
benefits
assessment,
and
a
discussion
of
issues
involved
in
interpreting
and
understanding
studies
using
the
method.
This
information
is
primarily
designed
to
help
analysts
evaluate
existing
studies
being
considered
for
benefit
transfer,
but
it
can
also
assist
analysts
in
assessing
the
feasibility
of
employing
these
methods
The
discussion
below
concludes
with
a
separate
overview
of
benefit
transfer
methodology
in
general.
It
is
important
to
keep
in
mind
that
research
on
all
of
these
methods
is
ongoing,
sometimes
at
a
rapid
pace.
The
limitations
and
qualifications
described
here
are
meant
to
characterize
the
state
of
the
science
at
the
time
these
guidelines
are
published.
Analysts
should
consult
additional
resources
as
they
become
available.

7.5.1
Market
Methods
Economic
Foundation
of
Market
Methods
Market
methods
are
used
to
value
environmental
goods
and
services
that
are
directly
traded
as
market
commodities
Market
methods
are
used,
for
example,
to
examine
the
effects
of
air
quality
improvements
on
agriculture
and
commercial
timber
industries
and
the
effects
of
water
quality
improvements
on
commercial
fisheries.

Market
methods
apply
when
environmental
goods
are
factor
inputs.
Changes
in
the
quality
or
stock
of
an
environmental
good
can
affect
production
costs,
which
can
then
alter
the
price
and
quantity
of
output
and
the
returns
to
other
factor
inputs.
In
turn,
these
market
responses
affect
the
decisions
and
welfare
of
consumers
and
producers.
Changes
in
the
prices
of
marketed
goods
consumers
face
and
changes
in
the
income
of
the
owners
of
the
factor
inputs
reveal
information
about
the
welfare
of
consumers
and
producers.
For
example,
the
benefits
of
an
environmental
improvement
are
often
realized
as
increases
in
consumer
and
producer
surplus
that
arise
from
lower
costs
and
prices
and
increases
in
the
quantity
of
the
marketed
good.
For
more
detailed
discussion
of
the
economic
foundation
of
market
methods,
see
Just
et
al.(
1982)
or
Freeman
(
1993).

General
Application
to
Benefits
Assessment
When
applying
market
methods
to
assess
the
benefits
of
environmental
improvements,
two
types
of
market
responses
are
important:
the
impacts
of
the
environmental
change
on
the
relevant
marketed
good
(
e.
g.,
factor)
and
the
response
of
producers
and
consumers
to
this
change.
When
examining
these
responses,
it
is
important
to
consider
the
range
of
market
responses
available
to
producers
and
consumers.
Overlooking
market
adjustments
can
bias
benefits
assessment.
For
instance,
the
damage
function
approach,
which
derives
benefits
by
applying
a
unit
price
to
a
physical
measure
of
damage
or
loss,
ignores
consumer
responses
to
market
adjustments.
16
Measures
of
price­
elasticities,
cross­
price
elasticities,
and
substitution
possibilities
indicate
the
extent
to
which
market
adjustments
are
likely
to
occur.

In
practice,
characterizing
the
market
response
to
a
change
in
environmental
quality
can
be
difficult.
Two
techniques
that
rely
on
observations
of
direct
market
behavior,
cost
and
production
function
approaches,
facilitate
the
measurement
of
consumer
and
producer
surplus
changes,
but
one
must
assume
optimizing
behavior
on
the
part
of
producers
and
consumers.
A
different
approach
for
benefits
assessment
is
to
use
optimization
models
that
simulate
behavior.
All
three
of
these
approaches
require
considerable
information
and
data
on
the
relevant
market
participants.

Benefits
estimation
using
market
methods
varies
with
the
types
of
markets
affected
by
the
environmental
improvement
The
nature
of
firms
affected
on
the
producer
side
(
e.
g.,
single­
product
firms
or
multi­
product
firms),
the
market
structure
(
e.
g.,
vertically
linked
markets),
and
the
presence
of
market
distortions
(
e.
g.,
monopoly
power,
price
supports)
influence
the
complexity
of
benefits
assessment.
Freeman
(
1993)
singles
out
two
cases
where
72
Chapter
7:
Benefits
16
Although
the
damage
function
approach
does
not
account
for
market
adjustments,
it
may
be
a
useful
screening
tool
when
time
and
resources
are
limited.
benefits
assessment
is
relatively
straightforward.
The
first
case
is
one
in
which
the
environmental
good
or
quality
is
a
perfect
substitute
for
another
input.
Here,
the
benefits
of
an
environmental
improvement
can
be
calculated
by
estimating
the
reduction
in
input
costs
caused
by
substituting
away
from
the
other
input,
as
long
as
the
change
in
total
costs
does
not
affect
marginal
costs
or
output.
The
second
case
is
where
observable
market
data
(
e.
g.,
cost,
demand,
and
market
structure)
imply
that
benefits
from
an
environmental
improvement
will
accrue
to
owners
of
fixed
factors
Here,
benefits
can
take
the
form
of
increased
productivity
and
are
realized
as
profit
or
quasi­
rents.
One
such
case
would
be
where
the
producer
affected
by
the
environmental
improvement
is
small
relative
to
the
market
and
variable
prices
for
factors
and
products
are
not
affected
by
the
environmental
improvement.

Empirical
applications
of
market
methods
are
diverse.
Among
other
topics,
the
empirical
literature
has
addressed
the
effects
of
air
quality
changes
on
agriculture
and
commercial
timber
industries.
It
has
also
assessed
the
effects
of
water
quality
changes
on
water
supply
treatment
costs
and
on
the
production
costs
of
industry
processors,
irrigation
operations,
and
commercial
fisheries.
Refer
to
Adams
et
al.
(
1986),
Kopp
and
Krupnick
(
1987),
Taylor
(
1993),
and
EPA
(
1997)
for
empirical
examples.

Considerations
in
evaluating
and
understanding
market
studies
Issues
to
consider
when
interpreting
the
results
of
market
studies
include:

Data
requirements
and
implications:
Employing
market
methods
requires
information
on
the
effect
of
the
environmental
resource
on
production
costs,
supply
conditions
for
output,
demand
curve
for
final
good,
and
factor
supplies.

The
model
for
estimation:
Data
availability
plays
a
large
role
in
the
selection
of
a
modeling
approach
and
the
structure
of
the
model.
Production
function,
cost
function,
and
simulation
optimization
models
are
all
options
for
understanding
the
market
response
to
environmental
improvements.
7.5.2
Revealed
Preference
Methods
In
the
absence
of
market
data
on
the
value
of
environmental
improvements,
WTP
may
be
estimated
by
looking
at
related
goods
that
are
traded
in
markets.
Methods
that
employ
this
general
approach
are
referred
to
as
"
revealed
preference"
methods
because
people's
behavior
in
associated
markets
reveals
the
value
they
place
on
the
environmental
improvements.
For
example,
if
pollution
levels
affect
the
use
of
a
lake
for
recreational
fishing,
individual
WTP
to
travel
to
a
substitute
site
can
be
used
to
estimate
the
value
of
averting
the
damages
to
the
lake
of
concern.
Four
distinct
revealed
preference
methods
have
been
widely
used
by
economists:
recreation
demand
models
(
including
travel
cost
and
discrete
choice
models),
hedonic
pricing
models,
averting
behavior
models,
and
cost­
of­
illness
studies.

7.5.2.1
Recreation
Demand
Models
Improvements
in
environmental
quality
may
enhance
recreation
opportunities
at
one
or
more
sites
in
a
region.
For
example,
policies
that
control
the
level
of
toxics
in
surface
water
bodies
might
result
in
a
reduction
in
the
number
of
lakes
and
streams
subject
to
fish
consumption
advisories
thereby
enhancing
recreational
angling
opportunities
Recreation
improvements
constitute
a
potentially
large
class
of
environmental
benefits,
but
measurement
of
these
values
is
complicated
by
the
fact
that
access
to
recreation
activities
are
only
partially
regulated
by
observable
market
mechanisms.
Recreation
demand
models,
including
the
travel
cost
model,
the
random
utility
model
(
RUM),
and
other
approaches,
may
be
used
to
assess
nonmarket
benefits
associated
with
recreation
activities.

Economic
Foundation
of
Recreation
Demand
Models
Recreation
demand
models
focus
on
the
choice
of
trips
or
visits
to
sites
for
recreational
purposes.
The
basic
trade
off
to
be
considered
is
between
the
satisfaction
gained
from
participating
in
an
activity
at
a
site
and
the
value
of
money
and
time
given
up.
The
fundamental
assumption
is
that
people
may
weigh
the
money
and
time
costs
of
travel
to
a
site
in
the
same
way
as
an
admission
fee.
Thus,
by
examining
the
patterns
of
travel
to
particular
sites,
one
may
73
Chapter
7:
Benefits
infer
how
individuals
value
the
site
or
particular
aspects
of
the
site
such
as
environmental
quality.

As
with
other
economic
studies,
recreation
demand
models
rely
on
individual
perceptions.
While
it
is
possible
to
value
changes
in
environmental
quality
that
have
an
obvious
effect
on
popular
recreation
activities,
recreation
demand
methods
may
not
be
appropriate
for
valuing
changes
in
environmental
quality
that
are
difficult
for
people
to
observe
or
only
indirectly
affect
well­
known
species.

Travel
cost
models:
The
simplest
recreation
demand
model
involves
trips
to
a
single
site.
User
surveys
provide
data
on
visitors
and
trip
origins
and
the
data
is
organized
by
distance
to
the
site.
Generally,
an
inverse
relation
between
distance
traveled
and
the
number
of
visits
emerges.
The
distance
variable
may
be
converted
to
cost
by
including
factors
for
the
dollar
per
mile
cost
of
vehicle
travel
as
well
as
the
cost
of
travel
times
and,
the
relationship
among
the
variables
may
be
interpreted
as
a
demand
function
with
the
number
of
trips
from
a
particular
area
as
a
function
of
the
travel
costs
of
reaching
the
site.

The
single­
site
travel
cost
model
may
be
extended
to
multiple
sites,
usually
by
estimating
a
system
of
demand
equations,
with
the
number
of
trips
to
a
given
site
taken
to
be
a
function
of
the
cost
of
visiting
that
site
as
well
as
the
costs
of
visiting
other
available
sites.
A
number
of
extensions
to
the
simple
travel
cost
model
are
described
in
Freeman
(
1993).

Travel
cost
models
are
most
appropriate
for
estimating
changes
in
the
number
of
trips
over
a
given
period
of
time,
also
known
as
participation.
They
are
limited
however,
in
their
ability
to
model
the
recreationist's
choice
among
competing
sites.
A
separate
but
related
body
of
literature
has
developed
around
models
that
directly
address
the
decision
of
"
where
to
go"
and
estimate
welfare
changes
associated
with
this
alternative
theoretical
framework.

Discrete
choice
models:
For
analyses
focusing
on
the
role
of
environmental
quality
variables,
changes
in
social
welfare
may
best
be
estimated
through
discrete
choice
models
(
also
referred
to
as
RUMs).
Discrete
choice
models
focus
on
the
decision
to
recreate
at
a
specific
site
as
compared
to
alternative
substitute
sites.
The
model
considers
travel
cost
and
environmental
quality
variables
associated
with
all
competing
sites.
Detailed
treatments
of
the
discrete
choice
model
include
Bockstael
et
al.
(
1986)
and
Bockstael
et
al.
(
1991).

Although
well
suited
for
analyzing
welfare
effects
of
changes
in
site
quality
per
visit,
the
discrete
choice
model
is
less
useful
for
predicting
the
number
of
trips
over
a
period
and
measuring
seasonal
welfare
changes.
Most
recreation
demand
studies
use
either
variations
on
the
discrete
choice
model
or
combinations
of
travel
cost
and
discrete
choice
approaches
to
estimate
changes
in
social
welfare.

Considerations
in
Evaluating
and
Understanding
Recreation
Demand
Studies
There
are
several
issues
that
must
be
confronted
in
a
recreation
demand
model:

Definition
of
a
site:
Ideally,
one
could
estimate
a
recreation
demand
model
in
which
sites
are
defined
as
specific
points,
such
as
launch
ramps,
campsites,
etc.,
but
the
data
requirements
of
detailed
models
are
large.
Similarly,
for
a
given
site,
the
range
of
alternative
sites
may
vary
by
individual.
Ultimately,
every
recreation
demand
study
strikes
a
compromise
in
defining
sites,
balancing
data
needs
and
availability,
costs,
and
time.

Opportunity
cost
of
time:
Part
of
the
cost
of
taking
a
recreation
trip
is
the
value
of
recreation
time,
which
varies
with
respondent's
income
and
work
schedules.
Recreation
demand
models
typically
use
some
fraction
of
the
wage
rate
in
calculating
travel
costs,
but
the
tradeoffs
between
work
hours
and
leisure
time
involve
complex
theoretical
and
methodological
issues.
Furthermore,
it
is
presupposed
that
travel
time
detracts
from
the
overall
satisfaction
of
a
recreation
trip,
but
this
assumption
may
not
always
hold.
Other
time­
related
issues
include
the
treatment
of
onsite
time,
which
varies
from
case
to
case
but
is
often
ignored
altogether.

Multiple
site
or
multipurpose
trips:
Recreation
demand
models
assume
that
the
particular
recreation
activity
being
studied
is
the
sole
purpose
for
a
given
trip.
Visits
to
multiple
sites
or
multipurpose
trips
confound
attempts
to
measure
social
welfare
changes.

74
Chapter
7:
Benefits
7.5.2.2
Hedonic
Wage
Studies
(
Wage­
Risk
studies)

Hedonic
wage
studies
draw
on
the
framework
of
hedonic
pricing
methods.
This
section
describes
the
hedonic
wage
method,
but
first
provides
some
general
background
on
hedonic
pricing
methods
in
general.
Property
value
studies
another
large
area
of
research
based
upon
this
framework
is
described
in
Section
7.5.2.3.

Background
on
Hedonic
Pricing
Methods
in
General
Hedonic
pricing
methods
apply
to
heterogeneous
goods
and
services.
Heterogeneous
goods
and
services
consist
of
"
bundles"
of
attributes
and
are
differentiated
from
each
other
by
the
quantity
and
quality
of
these
attributes.
Job
opportunities,
housing
units,
computers,
and
cars
are
common
examples
of
heterogeneous
goods.
Hedonic
pricing
methods
explain
variations
in
price
using
information
on
attributes.
For
example,
determinants
of
wages
are
expected
to
include
worker
characteristics
(
e.
g.,
level
of
education,
tenure,
age)
and
job
characteristics
(
e.
g.,
risk
of
fatal
injury).
Determinants
of
housing
prices
may
include
structural
attributes
(
e.
g.,
number
of
bedrooms
and
age
of
house),
neighborhood
attributes
(
e.
g.,
population
demographics
crime,
and
school
quality),
and
environmental
attributes
(
e.
g.,
air
quality
and
proximity
to
hazardous
waste
sites).

The
economic
theory
underlying
hedonic
pricing
methods
extends
from
a
model
of
market
equilibrium,
where
suppliers
and
demanders
of
heterogeneous
goods
interact
under
conditions
of
perfect
information
and
zero
transactions
costs.
Consumers
derive
utility
from
the
attributes
of
the
heterogeneous
goods
and
adjust
purchases
in
response
to
differences
in
these
attributes.
Producers
or
sellers
of
goods
and
services
incur
costs
that
vary
with
the
range
of
attributes
offered.
An
equilibrium
price
schedule
develops
from
the
market
interactions
of
consumers
and
suppliers.
The
foundation
of
the
hedonic
pricing
method
as
it
relates
to
job
opportunities
is
analogous,
with
workers
and
employers
interacting
in
the
labor
market.
The
equilibrium
price
schedule
is
termed
the
hedonic
price
function
and
forms
the
basis
for
benefits
assessment
using
hedonic
pricing
methods.
Rosen
(
1974)
is
the
seminal
article
on
the
economic
theory
of
hedonic
methods.

Empirical
hedonic
pricing
research
typically
concentrates
on
the
hedonic
price
function
and
the
decisions
of
consumers
or
workers.
The
hedonic
price
function
is
approximated
by
regressing
price
on
measures
of
attributes
and
the
estimated
coefficients
represent
the
marginal
WTP
for
the
associated
attribute.
Applications
of
hedonic
methods
to
labor
wages
and
property
values
have
been
used
to
characterize
the
benefits
of
environmental
improvements
17
These
are
known
as
hedonic
wage
studies
and
hedonic
property
value
studies,
respectively.
Each
is
considered
separately
below.

Economic
Foundation
of
Hedonic
Wage
Studies
(
Wage­
Risk
Studies)

Hedonic
wage
studies,
sometimes
known
as
wage­
risk
or
compensating
wage
studies,
are
based
on
the
premise
that
individuals
make
tradeoffs
between
higher
wages
and
increased
occupational
risks
of
death
or
injury.
Essentially,
higher
risk
jobs
are
expected
to
pay
higher
wages,
all
else
held
constant.
Hedonic
wage
studies
use
statistical
regression
and
data
from
labor
markets
to
isolate
the
increment
in
wages
associated
with
higher
job
risks.
The
outcome
of
these
models
is
an
estimated
value
of
small
changes
in
mortality
risks.
Some
models
also
attempt
to
estimate
the
value
of
small
changes
in
morbidity,
or
non­
fatal
risks.

The
key
to
an
effective
hedonic
wage
study
lies
in
separating
the
portion
of
compensation
associated
with
occupational
health
risks
from
other
job
characteristics,
including
supervisory
responsibility,
job
security,
and
similar
factors.
The
wage
rate
is
also
affected
by
the
industry
in
which
the
individual
is
employed,
characteristics
of
the
location
and
the
personal
characteristics
of
the
workers
(
e.
g.,
age,
education
experience).
All
of
these
data
are
needed
to
disentangle
the
effects
of
worker
characteristics
from
those
of
job
attributes
in
determining
wages
paid.

In
hedonic
wage
studies,
workers'
perceptions
of
risk
levels
across
jobs
are
assumed
to
match
actual
risk
levels.
If
perceived
risks
do
not
match
actual
risks
faced
by
the
workers,
then
the
resulting
estimates
of
compensation
required
to
accept
additional
risk
will
be
biased.
Most
75
Chapter
7:
Benefits
17
Palmquist
(
1991)
and
Freeman
(
1993)
contain
current
discussions
of
the
use
of
hedonic
methods
for
characterizing
the
demand
for
environmental
quality
and
benefits
assessment.
See
Palmquist
(
1982)
for
a
discussion
of
a
benefits
assessment
method
related
to
hedonic
property
value
studies
known
as
repeat
sales
analysis.
analysts
believe
that
this
potential
bias
is
small,
but
others
argue
that
workers
generally
underestimate
on­
the­
job
risks.
If
the
latter
is
true,
hedonic
wage
studies
will
understate
the
additional
compensation
required
for
bearing
risks.
Some
studies
attempt
to
account
for
workers'
perceived
risks,
but
the
results
of
these
studies
are
not
markedly
different
from
those
that
do
not.

Another
assumption
employed
in
hedonic
wage
studies
is
the
existence
of
perfect
labor
markets
in
which
workers
are
freely
mobile
and
there
is
perfect
information
about
jobs
and
job
risks.
Hedonic
wage
studies
will
not
produce
accurate
estimates
of
the
wage­
risk
tradeoff
in
imperfect
markets
where
workers
are
unable
to
move
freely
between
jobs
or
in
which
only
union
members
have
sufficient
information
and
market
power
to
receive
higher
wages
for
higher
risk
jobs.
Since
in
reality
labor
markets
are
somewhat
imperfect,
many
studies
attempt
to
control
for
union
membership
and
similar
factors
that
might
influence
wage
rates.

Hedonic
wage
models
are
limited
to
estimating
values
for
relatively
small
risk
changes.
The
observed
wage
and
the
estimated
increment,
or
"
premium,"
to
accept
higher
risks
represents
the
market
equilibrium
price
for
the
entire
set
of
workers
in
the
study.
This
estimate
is
not
necessarily
the
value
that
any
particular
worker
would
require
to
accept
a
risk
increase,
but
for
small
changes
in
risk,
it
is
very
close.

A
thorough
treatment
of
the
hedonic
wage
model
that
includes
all
of
these
considerations
can
be
found
in
Viscusi
(
1992,
1993).

General
Application
of
Hedonic
Wage
Studies
to
Benefits
Assessment
Because
they
are
narrowly
focused
on
labor
market
tradeoffs
hedonic
wage
studies
are
not
generally
well­
suited
to
measure
the
benefits
of
environmental
regulation
directly.
That
is,
it
is
not
usually
feasible
to
perform
a
hedonic
wage
study
to
estimate
the
benefits
that
would
accrue
from
a
specific
environmental
policy
action.
Nonetheless,
these
studies
have
yielded
consistent
estimates
of
how
groups
of
workers
appear
to
value
small
risk
changes.
Environmental
benefits
assessments
can
draw
upon
these
studies
to
estimate
the
value
of
reductions
in
environmental
mortality
risks.
18
Such
an
application
is
essentially
an
exercise
in
benefits
transfer,
which
is
described
in
greater
detail
later
in
this
chapter.

Analysts
should
be
aware
that,
although
hedonic
wage
studies
currently
provide
the
most
reliable
and
consistent
estimates
of
the
value
of
mortality
risks,
there
are
important
differences
in
the
types
of
risks
captured
in
an
hedonic
wage
study
and
the
types
of
risks
that
are
affected
by
environmental
regulation.
For
instance,
hedonic
wage
studies
tend
to
focus
on
accidental
deaths
occurring
among
prime­
aged
males
while
deaths
associated
with
environmental
risk
often
occur
among
the
elderly
and
may
involve
an
extended
latency
period.
Furthermore,
elevated
risks
in
hedonic
wage
studies
are
voluntarily
accepted
while
environmental
risks
are
often
involuntarily
borne.
The
nature
and
importance
of
these
and
other
differences
are
detailed
in
Section
6
of
this
chapter.

Estimates
of
the
value
of
changes
in
fatal
risks
are
generally
more
relevant
for
environmental
benefits
assessment
than
are
those
for
job­
related
non­
fatal
injuries.
This
is
because
these
injuries
are
usually
quite
different
from
the
non­
fatal
health
risks
associated
with
environmental
policy
actions.

Hedonic
wage
models
have
also
used
wage
differentials
across
geographic
areas
to
estimate
values
for
environmental
quality
differences.
19
Theoretically,
jobs
in
areas
with
poor
environmental
quality
should
pay
less
than
identical
jobs
in
areas
with
high
environmental
quality,
again
holding
all
else
equal.
There
are
a
number
of
difficulties
with
employing
hedonic
wage
models
in
this
manner,
including
integrating
wage
and
housing
choices,
and
the
need
to
assess
intra­
city
variation
in
amenities.
The
majority
of
hedonic
wage
studies
relevant
for
most
EPA
policies
have
focused
on
estimating
values
for
health
risks.

Considerations
in
Evaluating
and
Understanding
Hedonic
Wage
Studies
Data
requirements
and
implications:
Hedonic
wage
studies
require
large
sets
of
data
on
labor
76
Chapter
7:
Benefits
18
Values
of
mortality
risk
have
also
been
estimated
using
hedonic
studies
of
automobile
prices.
While
these
studies
produce
values
of
life
in
a
similar
range,
most
environmental
risk
assessments
rely
on
hedonic
wage
studies.
For
information
on
the
automobile
price
literature,
see
Dreyfus
and
Viscusi
(
1996)
and
Viscusi
(
1992).

19
This
should
not
be
confused
with
attempts
to
control
for
wage
differentials
across
broad
regions
found
in
most
existing
wage­
risk
studies.
market
behavior.
Data
on
worker
and
job
characteristics
are
generally
collected
using
survey
techniques.
Risk
information,
however,
is
frequently
retrieved
from
published
sources
reported
at
the
occupation
or
industry
level.
These
risk
measures
are
then
matched
to
the
worker
in
the
sample
using
information
provided
by
the
respondent
on
his
or
her
job.
The
risk
data
used
in
most
studies,
however,
are
not
complete.
For
example,
although
accidental,
onthe
job
(
and
almost
immediate)
deaths
are
generally
reported,
occupational
diseases
such
as
cancer
are
not
accurately
captured
in
most
data.

The
estimated
wage­
risk
tradeoff
can
vary
considerably
across
data
sets
and
across
methodologies.
In
particular,
studies
that
draw
upon
data
from
high­
risk
jobs
will
generally
provide
valuations
of
risk
that
are
lower
than
those
that
rely
upon
data
from
lower­
risk
jobs.
This
is
due
to
a
sample
selection
problem.
Study
results
reflect
the
value
to
the
sample
population
High
risk
jobs
tend
to
attract
those
who
are
less
averse
to
taking
risks
and
therefore
require
less
compensation
to
face
them.

Controlling
for
other
risks:
If
the
study
seeks
to
estimate
values
for
fatal
risks,
it
is
important
that
the
study
control
adequately
for
non­
fatal
risks
in
order
to
obtain
an
unbiased
wage­
risk
estimate
for
mortality.
Conversely,
when
values
for
non­
fatal
risk
are
being
estimated,
mortality
risks
should
be
considered
in
the
wage­
risk
equation.

The
scope
of
the
risk
measures:
Some
labor
market
studies
use
actuarial
data
to
determine
the
risk
levels
faced
by
workers.
However,
these
data
are
not
limited
to
occupational
risks.
They
include
all
types
of
fatality
risks
faced
by
the
individual
both
on
and
off
the
job.
The
degree
to
which
these
risks
are
correlated
with
job
risks
is
unclear,
but
they
would
not
be
reflected
in
job­
related
compensation.
These
studies
generally
should
be
excluded
from
use
in
policy
analysis
since
this
problem
will
cause
the
tradeoffs
they
estimate
to
be
biased
downwards
by
an
unknown
amount.

The
model
for
estimation:
Some
labor
market
studies
attempt
to
determine
the
value
of
a
life
year
and
the
implicit
discount
rate
workers
apply
to
this
value.
While
attractive
in
theory,
the
complexity
of
the
structural
models
used
in
these
studies
leads
to
less
robust
estimates
of
the
value
of
risk
reduction
than
studies
using
conventional
wage­
risk
estimation
procedures
Such
studies
should
be
viewed
as
less
reliable
for
use
in
valuing
lifesaving
programs.

7.5.2.3
Hedonic
Property
Value
Studies
Hedonic
property
value
studies
are
applications
of
the
hedonic
pricing
method.
The
introduction
to
Section
7.5.2.2
(
Hedonic
Wage
Studies)
provides
background
on
hedonic
pricing
methods
in
general.

Economic
Foundation
of
Property
Value
Studies
Hedonic
property
value
studies
assert
that
individuals
perceive
housing
units
as
bundles
of
attributes
and
derive
different
levels
of
utility
from
different
combinations
of
these
attributes.
When
transaction
decisions
are
made,
individuals
make
tradeoffs
between
money
and
attributes.
These
tradeoffs
reveal
the
marginal
values
of
these
attributes
and
are
central
to
hedonic
property
value
studies.
Hedonic
property
value
studies
use
statistical
regression
methods
and
data
from
real
estate
markets
to
examine
the
increments
in
property
values
associated
with
different
attributes.
20
Structural
attributes
(
e.
g.,
number
of
bedrooms
and
age
of
house),
neighborhood
attributes
(
e.
g.,
population
demographics,
crime,
and
school
quality),
and
environmental
attributes
(
e.
g.,
air
quality
and
proximity
to
hazardous
waste
sites)
may
influence
property
values.
When
assessing
an
environmental
improvement,
it
is
essential
to
separate
the
effect
of
the
relevant
environmental
attribute
on
the
price
of
a
housing
unit
from
the
effects
of
other
attributes.
While
deriving
measures
of
marginal
WTP
using
hedonic
methods
is
straightforward,
estimating
measures
of
WTP
for
substantial
or
discrete
(
non­
marginal)
improvements
in
environmental
quality
is
difficult.
The
use
of
hedonic
property
value
studies
for
benefits
assessment
rests
on
careful
interpretation
of
the
hedonic
price
function
and
its
relevance
to
the
policy
scenario
being
considered.
Bartik
77
Chapter
7:
Benefits
20
To
simplify
the
discussion,
housing
units
are
consistently
used
as
examples.
Hedonic
property
value
studies
are
also
completed
on
vacant
land
parcels.
(
1988b)
and
Palmquist
(
1991,
1988)
provide
excellent,
detailed
discussions
of
benefits
assessment
using
hedonic
methods.

When
using
hedonic
property
value
studies
for
benefits
assessment,
the
measurement
of
the
environmental
attribute
is
central
to
the
analysis.
If
the
measurement
of
the
environmental
attribute
does
not
match
individuals'
perceptions
then
the
results
of
the
analysis
may
be
biased.

The
hedonic
price
function
for
housing
units
represents
an
equilibrium
that
results
from
the
interaction
of
suppliers
and
demanders
of
housing
in
a
market
with
full
information
When
this
assumption
is
not
met,
the
results
of
an
hedonic
analysis
will
not
provide
an
exact
representation
of
the
tradeoffs
individuals
make
across
housing
attributes
and
the
marginal
values
associated
with
these
different
attributes.

General
Application
of
Hedonic
Property
Value
Studies
to
Benefits
Assessment
Benefits
assessment
applications
of
hedonic
property
value
studies
focus
on
the
relationship
between
property
values
and
environmental
attributes
such
as
air
quality,
water
quality,
proximity
to
hazardous
waste
sites,
and
landscape
characteristics.
Hedonic
property
value
studies
are
not
widely
used
in
environmental
benefits
assessments
because
of
the
limited
transferability
of
hedonic
results
and
the
difficulties
of
using
hedonic
methods
to
describe
the
benefits
associated
with
discrete
(
non­
marginal)
environmental
improvements.

Using
data
on
a
sample
of
transactions,
price
is
regressed
on
measures
of
the
observable
attributes
and
an
hedonic
price
function
is
estimated.
The
coefficient
on
the
environmental
attribute
reveals
the
marginal
WTP
for
that
attribute.
Therefore,
if
the
policy
scenario
considered
results
in
a
marginal
environmental
improvement,
the
estimated
hedonic
is
well­
suited
to
measure
benefits.
However,
if
the
policy
scenario
considered
results
in
a
discrete
improvement
that
affects
numerous
properties,
additional
information
on
preferences
and
the
hedonic
price
function
is
required
for
assessing
the
true
benefits
of
the
environmental
improvement.
21
When
larger
changes
in
environmental
quality
are
considered,
the
analytical
requirements
increase
because
the
hedonic
price
function
and
the
level
of
utility
of
individuals
may
change.

The
hedonic
price
function
does
not
typically
provide
general
information
on
individuals'
WTP
for
the
different
attributes.
Methods
for
identifying
demand
(
or
WTP)
functions
for
the
different
attributes
(
e.
g.,
using
data
from
multiple
markets
or
imposing
assumptions
about
the
functional
form
of
the
hedonic
and/
or
the
utility
functions
of
individuals)
exist,
but
they
often
rely
on
restrictive
assumptions.
22
Furthermore,
identifying
WTP
functions
does
not
ensure
the
ability
to
measure
the
welfare
gain
from
a
discrete
environmental
improvement
because
markets
intervene
and
prices
change.
As
a
result
of
these
difficulties
approximations
of
welfare
gains
based
on
the
hedonic
price
function
are
sometimes
employed
to
assess
benefits.
See
Palmquist
(
1991,
1988)
and
Bartik
(
1988b)
for
a
detailed
discussion
of
benefits
assessment
using
hedonic
methods,
including
guidance
on
developing
lower
and
upper
bound
measures
of
benefits.

Considerations
in
Evaluating
and
Understanding
Property
Value
Studies
Data
requirements
and
implications:
Property
value
studies
require
large
amounts
of
disaggregated
data.
Market
transaction
prices
on
individual
parcels
or
housing
units
are
preferred
to
aggregated
data
such
as
census
tract
information
on
average
housing
units
because
aggregation
problems
can
be
avoided.
Data
on
attributes
may
include
housing
characteristics
sale
dates,
neighborhood
amenities
such
as
schools
and
parks,
neighborhood
demographic
characteristics
such
as
income,
age,
and
race,
and
environmental
quality.

Errors
in
variables:
Problems
may
arise
from
error
in
measuring
prices
(
aggregated
data)
and
errors
in
measuring
product
characteristics
(
particularly
those
related
to
the
neighborhood
and
the
environment).
In
addition,
omitted
variable
bias
problems
may
occur
if
relevant
data
are
not
available.

The
measurement
of
environmental
attributes:
The
measurement
of
the
environmental
attribute
included
in
the
hedonic
price
function
is
central
to
78
Chapter
7:
Benefits
21
There
are
cases
when
the
hedonic
price
function
can
alone
be
used
to
measure
welfare
effects
from
a
non­
marginal
change
in
the
environmental
attribute.
For
example,
this
holds
if
few
properties
are
affected
and
the
hedonic
price
function
is
not
expected
to
shift.

22
See
Palmquist
(
1991)
for
a
detailed
discussion
of
identification
issues.
the
assessment
of
benefits.
Researchers
often
use
information
available
from
the
scientific
community
such
as
air
or
water
quality
monitoring
data
and
then
must
determine
how
to
assign
the
data
to
the
individual
houses
in
the
data
set.
However,
there
may
be
differences
between
how
these
attributes
are
measured
by
scientists
and
how
they
are
perceived
by
individuals
If
this
difference
is
large,
the
hedonic
price
function
will
not
accurately
represent
the
values
of
these
attributes.
Individual
perceptions
of
environmental
attributes
are
central
to
this
type
of
analysis.
23
Another
issue
to
consider
is
the
timing
of
the
effect
from
the
environmental
improvement.
Some
effects
from
environmental
improvements
change
over
time.
Others
may
be
understood
differently
over
time
depending
on
available
information
(
e.
g.,
hazardous
waste
sites).
The
choice
of
when
and
how
to
measure
the
environmental
attribute
for
a
given
transaction
price
is
complicated.
Refer
to
Kiel
and
McClain
(
1995)
for
a
discussion
of
price
responses
over
time.

The
model
for
estimation:
There
are
numerous
statistical
or
econometric
issues
associated
with
applying
hedonic
methods
to
property
value
studies.
These
include
the
choice
of
functional
form,
the
definition
of
the
extent
of
the
market,
identification,
and
endogeneity.
A
brief
overview
of
the
first
two
estimation
issues
is
presented
below.
Refer
to
Palmquist
(
1991)
for
a
thorough
treatment
of
the
econometric
issues
associated
with
hedonic
property
value
studies.

Because
economic
theory
offers
limited
guidance
on
the
functional
form
of
an
hedonic
price
function,
researchers
often
try
several
forms
when
estimating
hedonic
functions
(
e.
g.,
semilogarithmic,
inverse
semilogarithmic,
log­
linear,
or
quadratic
Box
Cox).
However,
it
is
important
to
note
that
the
choice
of
functional
form
has
implications
for
benefits
assessment
See
Graves
et
al.
(
1988)
and
Cropper,
Deck,
and
McConnell
(
1988)
for
discussions
of
issues
related
to
the
choice
of
functional
form.

The
choice
of
data
also
has
an
effect
on
estimation.
The
extent
of
the
market
is
defined
by
the
scope
of
housing
market
data
collected.
Questions
have
been
raised
about
how
to
define
the
extent
of
housing
markets
Empirically,
it
is
important
to
note
that
if
the
market
is
defined
to
be
too
big,
the
resulting
coefficients
of
the
hedonic
price
function
may
be
biased.
Conversely,
if
the
market
is
defined
too
narrowly,
the
coefficients
of
the
hedonic
price
function
are
less
efficient
Refer
to
Michaels
and
Smith
(
1990)
for
information
on
defining
the
extent
of
the
market.

Assessing
the
results
an
empirical
study:
Two
simple
ways
to
assess
the
quality
of
a
property
value
study
are
noted
here.
First,
a
review
of
the
empirical
work
is
informative.
This
involves
assessing
the
quality
of
the
data
collected,
the
framing
of
the
policy
problem,
the
measurement
of
environmental
attributes
and
the
statistical
regression
analysis.
Second,
the
existing
literature
on
hedonic
methods
is
a
valuable
resource.
Comparing
data,
modeling
assumptions
and
results
across
studies
is
a
useful
exercise.
While
variation
is
expected
across
studies,
especially
between
those
completed
on
different
areas,
some
factors
such
as
the
signs
of
particular
coefficients
may
be
consistently
reported.

7.5.2.4
Averting
Behavior
Method
The
averting
behavior
method
infers
values
from
observations
of
how
people
change
defensive
behavior
in
response
to
changes
in
environmental
quality.
Defensive
behaviors
are
usually
defined
as
actions
taken
to
reduce
the
risk
of
suffering
environmental
damages,
as
well
as
actions
taken
to
mitigate
the
impact
of
environmental
damages.
The
former
category
includes
behaviors
such
as
the
use
of
air
filters
or
boiling
water
prior
to
drinking
it,
while
the
latter
includes
the
purchase
of
medical
care
or
treatment.
Faced
with
a
given
level
of
environmental
risk,
the
averting
behavior
method
assumes
that
individuals
engage
in
these
defensive
behaviors
to
achieve
an
optimal
level
of
health.
By
analyzing
the
expenditures
associated
with
these
defensive
behaviors
economists
can
attempt
to
estimate
the
value
individuals
place
on
small
changes
in
risk.
24
79
Chapter
7:
Benefits
23
For
example,
hedonic
property
value
studies
that
address
water
quality
often
use
measures
such
as
water
clarity
because
these
are
observable
characteristics.
In
contrast,
standard
scientific
measures
such
as
BOD
or
pH
may
not
be
readily
perceived
by
individuals.

24
As
Desvousges
et
al.
(
1998)
note,
the
term
"
averting
behavior
study"
has
been
used
to
describe
at
least
three
somewhat
different
approaches:
attempts
to
estimate
WTP
for
environmental
quality;
attempts
to
estimate
WTP
for
health
effects
or
other
specific
impacts;
and
simple
summation
of
observed
expenses.
Economic
Foundation
of
Averting
Behavior
Method
The
economic
theory
underlying
the
averting
behavior
method
rests
on
a
model
of
household
production.
In
these
models,
households
produce
health
benefits
by
combining
an
exogenous
level
of
environmental
quality
with
inputs
such
as
defensive
behaviors.
The
underlying
theory
predicts
that
a
person
will
continue
to
take
protective
action
as
long
as
the
perceived
benefit
exceeds
the
cost
of
doing
so.
If
there
is
a
continuous
relationship
between
defensive
actions
and
reductions
in
health
risks,
then
the
individual
will
continue
to
avert
until
the
cost
just
equals
his
or
her
WTP
for
these
reductions.
Thus,
the
benefit
for
a
small
reduction
in
health,
or
health
risk,
is
estimated
from
two
primary
pieces
of
information
(
1)
the
cost
of
the
averting
behavior
or
good
and
(
2)
its
effectiveness,
as
perceived
by
the
individual,
in
offsetting
the
loss
in
environmental
quality.

Averting
behaviors
methods
can
provide
theoretically
correct
measures
of
WTP
to
avoid
a
decline
in
environmental
quality
or
an
increase
in
environmental
risks.
To
do
so,
however,
they
require
a
great
deal
of
data
and
particular
assumptions
about
consumer
preferences.
In
practice,
it
has
proven
difficult
to
meet
these
requirements.
More
detail
on
the
difficulties
inherent
in
applying
the
averting
behavior
model
can
be
found
in
Cropper
and
Freeman
(
1991).

One
approach
to
estimation
is
to
use
observable
expenditures
on
averting
and
mitigating
activities
to
generate
values
that
may
be
interpreted
as
a
lower
bound
on
WTP.
Harrington
and
Portney
(
1987)
demonstrate
this
by
showing
that
WTP
for
small
changes
in
environmental
quality
can
be
expressed
as
the
sum
of
the
values
of
four
components
lost
time,
changes
in
averting
expenditures,
changes
in
mitigating
expenditures,
and
the
loss
of
utility
from
pain
and
suffering.
The
first
three
terms
of
this
expression
are
observable,
in
principle,
and
can
be
approximated
by
using
changes
in
these
expenditures
observed
after
a
change
in
environmental
quality.
The
resulting
estimate
can
be
interpreted
as
a
lower
bound
on
WTP
that
may
be
used
in
benefits
analysis.
These
estimates
can
be
an
improvement
over
cost­
of­
illness
estimates
alone,
because
the
latter
usually
captures
only
mitigating
expenditures
and
lost
time.
25
Averting
behavior
results
cannot
always
be
interpreted
as
lower
bounds
on
WTP,
however,
because
conclusions
may
depend
critically
upon
modeling
conditions.
For
example,
Shogren
and
Crocker
(
1991)
use
a
theoretical
model
to
show
that
the
impact
of
changes
in
risk
on
defensive
expenditures
is
ambiguous
and
that
these
expenditures
need
not
be
a
lower
bound
value.
Using
the
same
model
Quiggin
(
1992)
imposes
restrictions
under
which
defensive
expenditures
will
increase
in
response
to
increases
in
risk,
providing
support
for
self­
protection
expenditures
as
a
method
for
benefits
valuation.
Recently,
Shogren
and
Crocker
(
1999)
show
that
averting
behavior
need
not
be
a
lower
bound
on
value
when
both
private
and
collective
risk
reduction
strategies
are
considered.

Large,
or
non­
marginal,
changes
in
environmental
quality
require
a
somewhat
different
valuation
strategy.
Generally,
it
is
not
possible
to
obtain
exact
estimates
of
WTP
for
these
changes.
However,
Bartik
(
1988a)
details
the
conditions
under
which
upper
and
lower
bounds
on
WTP
may
be
estimated
in
this
circumstance.
These
bounds
effectively
bracket
WTP.

Finally,
analysts
should
remember
that
consumers
base
their
actions
on
perceived
benefits
from
defensive
behaviors
If
these
perceptions
differ
from
objective
estimates
of,
for
example,
risk
changes,
the
analysis
will
produce
biased
WTP
estimates
for
a
given
change
in
objective
risk.
Surveys
may
be
necessary
in
order
to
determine
the
benefits
individuals
perceive
they
are
receiving
when
engaging
in
defensive
activities.
These
perceived
benefits
can
then
be
used
as
the
object
of
the
valuation
estimates.

General
Application
of
Averting
Behavior
Method
to
Benefits
Assessment
The
averting
behavior
method
can,
in
theory,
provide
WTP
estimates
for
a
wide
range
of
environmental
benefits,
including
changes
in
mortality
risks,
morbidity
risks,
and
damage
to
materials.
Most
recent
research,
however,
has
focused
on
health
risk
changes.

Mortality
risks
can
be
estimated
with
the
averting
behavior
method
by
observing
purchases
of
items
that
reduce
the
80
Chapter
7:
Benefits
25
Cropper
and
Freeman
(
1991)
note
that
the
full
costs
of
medical
expenditures
and
lost
work
time
may
not
be
borne
by
individuals
making
these
decisions
due
to
insurance
and
paid
sick
leave.
An
analysis
of
social
benefits
would
need
to
include
the
costs
that
have
been
shifted
from
the
consumer
to
others.
risks
of
dying
in
an
accident.
These
applications
are
sometimes
known
as
consumer
market
studies.
One
of
the
difficulties
with
the
use
of
averting
behavior
methods
in
this
context
is
that
many
of
the
risk
reduction
actions
are
discrete
rather
than
continuous,
leading
to
estimates
that
are
likely
to
understate
the
value
of
risk
reduction
to
the
average
purchaser.
These
studies
can
also
be
sensitive
to
assumptions
about
unobserved
costs
such
as
the
time
required
for
employing
or
maintaining
the
risk­
reducing
good.

The
most
common
focus
of
averting
behavior
models
has
been
the
estimation
of
values
for
non­
fatal
health
(
morbidity
risk
changes.
There
have
been
many
analyses
of
observable
averting
and
mitigating
expenditures.
Some
of
these
studies
focus
on
behaviors
that
prevent
or
mitigate
the
impact
of
particular
symptoms
(
e.
g.,
shortness
of
breath,
headaches),
while
others
have
examined
averting
expenditures
in
response
to
specific
episodes
of
contamination
(
e.
g.,
groundwater
contamination).
The
difference
in
these
endpoints
is
important.
Because
many
contaminants
can
produce
similar
symptoms,
studies
that
estimate
values
for
symptoms
may
be
more
amenable
to
benefit
transfer
than
those
that
are
episode­
specific.
The
latter
may
be
more
useful,
however,
if
assessing
the
benefits
of
a
regulation
expected
to
reduce
the
probability
of
similar
contamination
episodes.

Considerations
in
Evaluating
and
Understanding
Averting
Behaviors
Studies
Data
requirements
and
implications:
Cropper
and
Freeman
(
1991)
describe
the
data
required
for
estimating
WTP
using
the
averting
behavior
method.
These
requirements
are
quite
burdensome
and
include
information
detailing
the
severity,
frequency,
and
duration
of
symptoms;
exposure
to
environmental
contaminants;
actions
taken
to
avert
or
mitigate
damages;
the
costs
of
those
behaviors
and
activities;
and
other
variables
that
affect
health
outcomes
(
e.
g.,
age,
health
status,
chronic
conditions).

Often,
data
availability
will
limit
the
analysis
to
an
examination
of
observed
defensive
expenditures.
These
results
can
be
cautiously
interpreted
as
a
lower
bound
on
WTP.
Analysts
should
note
that
costs
associated
with
pain
and
suffering
will
not
be
included
in
the
estimate.
Separability
of
other
benefits:
Many
defensive
behaviors
not
only
avert
or
mitigate
against
environmental
damages,
but
also
provide
other
benefits.
For
example,
air
conditioners
obviously
provide
cooling
in
addition
to
air
filtering,
and
bottled
water
may
not
only
reduce
health
risks,
but
may
also
be
better
tasting
The
degree
to
which
individuals
engage
in
averting
behaviors
to
obtain
these
benefits
provides
evidence
of
the
value
of
these
qualities,
but
disentangling
the
value
of
different
components
is
not
an
easy
task.
In
order
to
accurately
produce
estimates
of
WTP
for
a
risk
change,
for
example,
averting
behaviors
studies
must
isolate
the
value
for
the
effect
of
interest
from
the
value
of
the
other
benefits
conferred
by
the
defensive
activity.
It
is
also
possible
that
the
averting
behavior
may
have
negative
effects
on
utility.
For
example,
wearing
helmets
when
riding
bicycles
or
motorcycles
may
be
uncomfortable.
Failure
to
account
for
"
other"
benefits
and
disutilities
associated
with
averting
behaviors
will
result
in
biased
estimates
of
WTP.
Analysts
should
exercise
caution
in
interpreting
the
results
of
studies
that
focus
on
goods
in
which
there
may
be
significant
interrelated
costs
and
benefits.

Modeling
assumptions:
As
noted
above,
restrictive
assumptions
are
sometimes
needed
to
make
averting
behavior
models
tractable.
For
example,
assuming
that
the
economy
and
the
environment
are
additively
separable
may
lead
to
unambiguous
results,
but
it
may
be
plausible
only
in
particular
circumstances.
Shogren
and
Crocker
(
1999)
note
this
fact
and
suggest
that
this
assumption
be
justified
whenever
invoked.
Analysts
drawing
upon
averting
behavior
studies
will
need
to
review
and
assess
the
implications
of
these
assumptions
for
the
valuation
estimates.

7.5.2.5
Cost­
of­
Illness
Method
The
health
economics
literature
relies
heavily
upon
the
cost­
of­
illness
method
to
value
morbidity
changes.
The
cost­
of­
illness
method
does
not
estimate
WTP,
but
rather
estimates
the
change
in
explicit
market
costs
resulting
from
a
change
in
the
incidence
of
a
given
illness.
Two
types
of
costs
measured
in
a
typical
cost­
of­
illness
study
are
direct
costs
(
such
as
diagnosis,
treatment,
rehabilitation
and
accommodation)
and
indirect
costs
(
including
loss
of
work
time).

81
Chapter
7:
Benefits
Economic
Foundation
of
Cost­
of­
Illness
The
theoretical
basis
for
the
cost­
of­
illness
method
relies
on
two
major
assumptions
(
1)
direct
costs
of
morbidity
reflect
the
economic
value
of
goods
and
services
used
to
treat
illness
and
(
2)
a
person's
earnings
reflect
the
economic
value
of
lost
production.
Because
of
distortions
in
medical
and
labor
markets,
an
argument
could
be
made
about
whether
these
assumptions
hold,
but
they
are
broadly
consistent
with
neoclassical
economics.

It
is
important
to
note
that
the
cost
of
illness
is
not
a
measure
of
WTP.
The
cost­
of­
illness
approach
simply
measures
ex
post
costs
and
does
not
attempt
to
measure
the
loss
in
utility
due
to
pain
and
suffering
or
the
costs
of
any
averting
behaviors
that
individuals
have
taken
to
avoid
the
illness
altogether
(
see
Section
7.5.2.3
on
averting
behaviors).
However,
the
cost­
of­
illness
estimate
may
be
considered
a
lower
bound
estimate
of
WTP
(
Harrington
and
Portney,
1987;
Berger
et
al.,
1987).
The
main
reason
that
the
cost
of
illness
understates
total
WTP
is
the
failure
to
account
for
many
effects
of
disease.
It
ignores
pain
and
suffering,
defensive
expenditures,
lost
leisure
time,
and
any
potential
altruistic
benefits.
As
a
simple
hypothetical
example,
if
an
individual
spends
five
dollars
on
pain
medication
to
treat
a
headache,
and
does
not
miss
any
time
from
work
due
to
the
headache,
his
or
her
cost
of
illness
is
five
dollars.
The
individual's
actual
WTP
to
avoid
the
headache
is
likely
to
be
greater
than
five
dollars,
assuming
he
experiences
disutility
from
the
pain
the
headache
causes
prior
to
taking
the
pain
medication.
Available
comparisons
of
cost­
of­
illness
and
total
WTP
estimates
suggest
that
the
difference
can
be
large
(
Rowe
et
al.,
1995).
However,
this
difference
varies
greatly
across
health
effects
and
across
individuals.

Most
existing
cost­
of­
illness
studies
estimate
indirect
costs
based
on
the
typical
hours
lost
from
a
work
schedule
or
home
production,
evaluated
at
an
average
hourly
wage.
The
direct
medical
costs
of
illness
are
generally
derived
in
one
of
two
ways.
The
empirical
approach
uses
a
database
of
actual
costs
incurred
for
patients
with
the
illness
to
estimate
the
total
medical
costs
of
the
disease.
The
theoretical
approach
uses
a
panel
of
physicians
to
develop
a
generic
treatment
profile
for
the
illness.
Illness
costs
are
estimated
by
multiplying
the
probability
of
a
patient
receiving
a
treatment
by
the
cost
of
the
treatment.
For
any
particular
application,
the
preferred
approach
will
depend
on
availability
of
reliable
actual
cost
data
as
well
as
characteristics
of
the
illness
under
study.

Detailed
descriptions
of
the
cost­
of­
illness
approach
can
be
found
in
Cooper
and
Rice
(
1976),
Hartunian
et
al.
(
1981),
Hu
and
Sandifer
(
1981),
Rice
(
1966),
Rice
et
al.
(
1985)
and
EPA's
Cost
of
Illness
Handbook
(
EPA,
forthcoming).

General
Application
of
Cost­
of­
Illness
Method
to
Benefits
Assessment
Because
the
cost­
of­
illness
approach
does
not
rely
on
elaborate
econometric
models,
and
data
are
often
readily
available
implementation
of
this
approach
is
relatively
straightforward
For
these
same
reasons,
the
approach
is
easy
to
explain
to
policy
makers
and
the
general
public
and
tends
to
be
less
resource
intensive
than
other
approaches
to
health
valuation.
The
method
is
generally
suited
for
illnesses
such
as
non­
fatal
cancers
and
other
incidents
of
morbidity.

Cost­
of­
illness
measures
will
understate
WTP
because
they
do
not
capture
the
disutility
associated
with
anxiety,
pain
and
suffering,
or
averting
costs.
On
the
other
hand,
some
WTP
estimates
may
understate
social
costs
because
they
are
unlikely
to
account
for
health
care
costs
passed
on
to
third
parties
(
e.
g.,
health
insurance
companies
or
hospitals
in
the
case
of
direct
medical
expenses,
and
employers
who
offer
sick
leave
in
the
case
of
time/
productivity
loss).

Considerations
in
Evaluating
and
Understanding
Cost­
of­
Illness
Studies
Ex
post
vs.
ex
ante
measure:
As
noted
above,
the
cost­
of­
illness
measures
ex
post
costs
of
an
illness
rather
than
WTP
to
avoid
the
illness.
Although
the
approach
may
account
for
costs
shifted
from
the
individual
experiencing
the
illness
to
third
parties,
it
fails
to
account
for
the
disutility
of
pain
and
suffering,
or
any
costs
that
may
have
been
incurred
in
order
to
avoid
the
illness.
Also,
ex
post
measures
cannot
capture
any
value
associated
with
risk
attitudes.
These
attitudes
may
have
a
significant
effect
on
WTP
to
reduce
risks
of
more
severe
illnesses.

It
is
also
important
to
keep
in
mind
that
this
measure
captures
the
costs
of
choices
that
individuals
make.
Individuals
generally
choose
when
and
how
often
to
go
to
the
doctor
and
when
and
for
how
long
to
stay
home
from
work.
These
choices
may
be
affected
by
82
Chapter
7:
Benefits
the
existence
of
health
insurance,
sick
leave,
and
socioeconomic
status.

Technological
change:
Medical
treatment
technologies
and
methods
are
constantly
changing,
and
this
could
push
the
true
cost
estimate
for
a
given
illness
either
higher
or
lower.
When
using
previous
cost­
ofillness
studies,
the
analyst
should
be
sure
to
research
whether
and
how
the
generally
accepted
treatment
has
changed
from
the
time
of
the
study.

Measuring
the
value
of
lost
productivity:
Several
issues
arise
in
the
indirect
cost
portion
of
a
cost­
of­
illness
study.
Simply
valuing
the
actual
lost
work
time
due
to
an
illness
may
not
capture
the
full
loss
of
an
individual's
productivity
in
the
case
of
a
long­
term
chronic
illness.
Chronic
illness
may
force
an
individual
to
work
less
than
a
full­
time
schedule,
take
a
job
at
a
lower
pay
rate
than
he
or
she
would
otherwise
qualify
for
as
a
healthy
person,
or
drop
out
of
the
labor
force
altogether.
A
second
issue
involved
with
estimating
the
value
of
lost
productivity
is
the
choice
of
wage
rate.
Even
if
the
direct
medical
costs
are
estimated
using
individual
actual
cost
data,
it
is
highly
unlikely
that
the
individual
data
will
include
wages.
Therefore,
the
wage
rate
chosen
should
reflect
the
demographic
distribution
of
the
illness
under
study.
Furthermore,
the
value
of
lost
time
should
include
the
productivity
of
those
persons
not
involved
in
paid
jobs.
Homemakers'
household
upkeep
and
childcare
services,
retired
persons'
volunteering
efforts,
and
students'
time
in
school
all
directly
or
indirectly
contribute
to
the
productivity
of
society.
Finally,
the
value
of
lost
leisure
time
to
an
individual
and
his
family
is
not
included
in
most
cost­
of­
illness
studies.

7.5.3
Stated
Preference
Methods
Stated
preference
approaches
attempt
to
measure
WTP
values
directly.
Unlike
the
revealed
preference
methods
that
infer
values
for
environmental
goods
and
services
from
observed
behavior,
stated
preference
methods
rely
on
data
from
surveys
that
directly
question
respondents
about
their
preferences
to
measure
the
value
of
environmental
goods
and
services.
This
class
of
methods
comprises
several
related
techniques,
including
contingent
valuation
(
CV),
stated
choice
or
conjoint
analysis
(
CA),
and
less
frequently
contingent
ranking
(
CR).
The
common
feature
of
these
methods
is
direct
questioning
of
members
of
a
population
about
their
likely
choices
in
a
hypothetical
market.
These
three
techniques
are
discussed
below.

Economic
Foundation
of
Stated
Preference
Methods
There
are
some
situations
in
which
data
on
actual
behavior
and
choices
cannot
be
used
to
derive
estimates
of
the
value
of
environmental
goods
and
services.
Stated
preference
methods
rely
on
survey
data
rather
than
on
data
on
observed
behavior,
therefore,
they
can
be
used
to
measure
the
value
of
environmental
goods
and
services
in
most
situations
The
responses
elicited
from
the
surveys,
if
truthful
are
either
direct
expressions
of
WTP
or
can
be
used
to
estimate
WTP
for
the
good
in
question.

Contingent
Valuation:
Contingent
valuation
(
CV)
is
the
most
well
developed
of
the
stated
preference
methods.
CV
surveys
either
ask
respondents
if
they
would
pay
a
specified
amount
for
a
described
hypothetical
commodity
or
ask
their
highest
WTP
for
it
(
for
a
good
overview
of
the
method
see
Hanemann,
1991;
Mitchell
and
Carson,
1989;
Carson,
2000;
or
Kopp
et
al.
1997).
Concerns
about
the
reliability
of
value
estimates
that
come
from
CV
studies
have
dominated
debates
about
the
methodology,
since
research
has
shown
that
bias
can
be
introduced
easily
into
these
studies,
especially
if
they
are
not
carefully
done.
In
particular,
the
concern
that
CV
surveys
do
not
require
respondents
to
make
actual
payments
has
led
critics
to
argue
that
responses
to
CV
surveys
are
biased
because
of
the
hypothetical
nature
of
the
good.
Reliability
tests
on
the
data
that
conform
to
expectations
from
both
economic
and
psychological
theory
can
enhance
the
credibility
of
a
CV
survey.
Surveys
without
these
tests
should
be
suspect;
surveys
whose
results
fail
the
tests
may
be
discredited.

The
result
of
the
debates
about
the
reliability
of
the
CV
method
has
been
an
infusion
of
methods
and
theory
particularly
from
the
disciplines
of
psychology
and
survey
research,
to
enhance
questionnaire
design
to
mitigate
these
concerns
(
Krosnick,
1991;
Fischhoff,
1997).
In
addition,
the
National
Oceanic
and
Atmospheric
Administration
(
NOAA)
convened
a
panel
of
well­
known
economists
to
review
and
evaluate
the
83
Chapter
7:
Benefits
methodology
in
1993.
The
panel
devised
a
set
of
"
best
practices"
recommendations
for
the
method,
particularly
as
it
relates
to
natural
resource
damage
assessments
(
NOAA,
1993).
EPA
subsequently
prepared
comments
on
the
panel
recommendations
and
regulations
NOAA
proposed
that
drew
upon
the
panel's
report
(
EPA,
1994).

Conjoint
Analysis
and
Contingent
Ranking:
Conjoint
analysis
(
CA)
and
contingent
ranking
(
CR)
studies
ask
respondents
to
make
choices
between
two
or
more
(
in
the
case
of
CA),
or
rank
several
(
in
the
case
of
CR),
similar
commodities
with
different
attributes
and
prices,
in
order
to
tease
out
the
marginal
value
of
particular
attributes
of
the
commodity
of
interest
(
Johnson
et
al.,
1994).
These
methods
are
a
variation
on
stated
preference
methods
that
aim
to
evaluate
marginal
tradeoffs
rather
than
the
total
value
for
a
described
change
that
is
evaluated
in
CV
studies.
Arising
out
of
the
marketing
discipline,
these
methods
rely
on
respondents'
ability
to
make
choices
between
commodities
whose
attributes
differ
in
relation
to
one
another.
These
methods
often
present
respondents
with
a
series
of
binary
choice
questions
(
e.
g.,
"
Given
the
descriptions
of
A
and
B,
would
you
prefer
A
or
B?")
or
multiple
choice
questions
that
ask
respondents
to
make
tradeoffs
between
prices
and
other
features
of
commodities
that
are
presented
to
them.

General
Application
of
Stated
Preference
Methods
to
Benefits
Assessment
More
than
2,000
stated
preference
studies
have
been
undertaken
since
the
early
1970'
s.
Among
other
things,
these
have
been
used
to
value
changes
in
visibility
(
Chestnut
and
Rowe,
1990;
Tolley
et
al.
1985),
changes
in
surface
water
quality
(
Mitchell
and
Carson,
1984,
1986b),
groundwater
protection
(
McClelland
et
al.,
1992),
recreation
services
(
Cameron
and
James,
1987;
Bishop
and
Heberlien,
1979)
and
changes
in
health
effects
attributable
to
pollution
(
Krupnick
and
Cropper,
1989;
Mitchell
and
Carson,
1986a;
Viscusi
et
al.,
1991).

Currently,
contingent
valuation
is
the
only
established
method
capable
of
estimating
non­
use
values;
however,
most
CV
studies
are
designed
to
elicit
respondents'
total
value
for
a
given
commodity.
A
number
of
researchers
have
attempted
to
disaggregate
WTP
values
into
"
use"
and
"
non­
use"
components.
Examples
of
studies
where
nonuse
values
have
been
specifically
evaluated
include
McClelland
et
al.
(
1992)
and
Schulze
et
al.
(
1993).
A
more
practical
approach
is
to
represent
non­
use
values
by
employing
the
total
WTP
amounts
given
by
persons
who
do
not
use
the
resource.
The
downside
to
this
convenience
is
that
there
might
be
significant
differences
between
those
who
use
the
resource
and
those
who
do
not.
Applying
non­
use
values
from
the
latter
population
to
the
former
one
may
result
in
biased
estimates.

In
the
context
of
environmental
valuation,
the
commodity
being
purchased
is
usually
a
described
change
in
environmental
quality.
This
is
a
Hicksian
measure,
since
it
asks
respondents
to
state
the
amount
of
income
that
they
would
be
willing
to
forgo
in
order
to
have
the
described
commodity,
while
making
them
as
well
off
as
they
were
without
it
and
the
payment.
Similarly,
they
might
be
asked
how
much
they
would
be
willing
to
accept
to
put
up
with
a
nuisance
or
a
loss.
However,
willingness
to
accept
applications
of
CV
are
much
more
problematic
because,
unlike
the
case
of
WTP,
there
is
no
upper
limit
on
the
size
of
the
opportunity
set
available
to
the
respondent.
This
results
in
a
strong
potential
for
respondents
to
overstate
the
amount
they
would
need
to
receive
to
compensate
them
for
a
loss.

While
conjoint
analysis
(
CA)
has
been
used
in
marketing
for
some
time,
its
application
to
environmental
valuation
began
in
the
late
1980'
s.
To
date,
it
has
not
been
subject
to
the
level
of
testing
and
scrutiny
that
CV
has
had,
so
much
less
is
known
about
the
reliability
(
and
how
to
enhance
it)
of
these
studies.
The
main
methodological
concerns
that
arise
with
CA
studies
are
the
viability
of
disaggregating
the
good
in
question
into
attributes
that
can
be
separately
traded
off
in
respondents'
minds,
and
the
problem
that
many
respondents
display
intransitive
preferences
over
the
numerous,
and
often
complex,
set
of
choices.
As
a
result
of
this
complexity,
heteroskedasticity
is
a
pervasive
problem
with
these
methods.

An
important
limitation
to
using
contingent
valuation
and
other
stated
preference
techniques
is
that
it
is
expensive
and
time­
consuming
to
survey
the
public
about
their
preferences.
Samples
must
be
drawn,
questionnaires
developed,
surveys
administered
either
by
mail,
telephone
or
in
person,
and
results
coded
and
analyzed.
In­
person
interviews
are
most
expensive,
but
in
some
contexts
are
unavoidable
due
to
the
need
to
present
complicated
information
to
respondents
or
when
they
are
required
as
84
Chapter
7:
Benefits
criterion
for
legal
evidence.
Mail
and
phone
surveys
carry
much
lower
costs
and
are
often
sufficient
for
use
in
the
analysis
of
EPA
policies.

Considerations
in
Evaluating
Contingent
Valuation
Studies
Accurately
measuring
WTP
for
environmental
goods
and
services
using
contingent
valuation
depends
on
the
reliability
and
validity
of
the
data
collected.
There
are
several
issues
to
consider
when
evaluating
study
quality.

Content
validity:
To
evaluate
a
survey
instrument
itself,
the
analyst
should
look
for
a
number
of
features
that
the
researchers
should
have
incorporated
into
the
survey
scenario.
First,
the
commodity
being
valued
must
be
clearly
and
concisely
defined.
A
detailed
explanation
of
the
salient
features
of
the
environmental
change
being
valued
(
the
"
commodity")
begins
with
a
careful
exposition
of
the
conditions
in
the
baseline
case
and
how
these
would
be
expected
to
change
over
time
if
no
action
were
taken.
Next,
the
action
(
policy
change)
should
be
described,
including
an
illustration
of
how
and
when
the
policy
action
would
affect
aspects
of
the
environment
that
people
might
care
about.
Finally,
the
way
the
payment
will
be
made
(
e.
g.,
through
taxes,
user
fees,
etc.)
may
have
large
implications
for
the
outcome,
so
careful
attention
should
be
paid
to
the
rationale
given
for
the
choice
of
payment
mechanism.
Respondent
attitudes
about
the
provider
and
the
implied
property
rights
of
the
survey
scenario
can
be
used
to
evaluate
the
appropriateness
of
these
features
of
the
commodity
description
(
Fischhoff
and
Furby,
1988).
Questions
that
probe
for
respondent
comprehension
and
acceptance
of
the
commodity
scenario
can
offer
important
indications
about
the
potential
for
the
study
to
be
reliable.

Construct
validity:
In
CV
studies,
the
main
indicators
of
study
quality
are
tests
of
internal
validity
that
can
be
incorporated
into
study
design.
Internal
validity
is
supported
when
variables
that
are
expected
by
theory
to
be
important
determinants
of
preferences
actually
are
statistically
significant
with
the
correct
sign.
For
example,
with
normal
goods,
price
is
expected
to
have
a
negative
effect
on
demand
for
a
good,
while
household
income
is
expected
to
have
a
positive
effect,
all
else
equal.
Thus,
respondents
with
higher
income
are
expected
to
demand
more
of
the
good
than
respondents
with
low
income.
Familiarity
with
the
good
or
its
context
can
also
be
an
important
indicator
of
internal
validity.
One
would
intuitively
expect
that
someone
who
fishes
would
know
more
about,
and
be
willing
to
pay
more
for,
a
commodity
that
improves
conditions
for
fishing
than
someone
who
never
engages
in
outdoor
recreation.
Tests
of
sensitivity
to
scope,
where
the
amount
of
the
commodity
is
varied
randomly
over
different
sub­
samples
of
survey
respondents,
can
increase
confidence
in
the
results
where
the
findings
are
consistent
with
theoretical
expectations
(
Carson
et
al.,
1993).

Criterion
validity:
In
order
to
assess
criterion
validity
the
analyst
needs
to
have
an
indicator
of
true
value
against
which
to
evaluate
values
from
contingent
valuation
studies.
Given
the
lack
of
actual
market
prices,
it
is
often
impossible
to
conduct
criterion
validity
tests.
However,
the
quality
of
a
CV
study
can
also
be
gauged
by
comparing
valuation
estimates
obtained
using
CV
with
those
obtained
using
other
techniques.
At
least
one
study
that
has
compared
CV
valuation
estimates
with
estimates
derived
using
other
valuation
techniques
has
shown
that,
where
the
CV
study
was
carefully
designed,
CV
estimates
are
not
inflated
relative
to
the
other
estimates
for
the
same
commodity
(
Carson,
1996).

In
conclusion,
because
of
the
issues
raised
here,
among
other
factors,
there
is
a
divergence
of
views
within
the
economic
profession
concerning
whether
stated
preference
methods
can
provide
useful
information
on
economic
values
and
on
validity
of
individuals'
responses
to
hypothetical
questions.
Nonetheless,
for
goods
providing
non­
use
value,
stated
preference
methods
may
provide
the
only
analytic
method
currently
available
for
benefits
estimation.

7.5.4
Benefit
Transfer
Benefit
transfer
can
be
a
feasible
alternative
to
using
one
of
the
primary
stated
or
revealed
preference
research
methods
described
in
previous
sections.
Rather
than
collecting
primary
data,
the
benefit
transfer
approach
relies
on
information
from
existing
studies
that
have
applied
other
methods.
More
precisely,
Boyle
and
Bergstrom
(
1992)
define
benefit
transfer
as
"
the
transfer
of
existing
estimates
of
nonmarket
values
to
a
new
study
85
Chapter
7:
Benefits
which
is
different
from
the
study
for
which
the
values
were
originally
estimated."
The
case
for
which
the
existing
estimates
were
obtained
is
often
referred
to
as
the
"
study
case,"
while
the
case
under
consideration
for
a
new
policy
is
termed
the
"
policy
case."

Existing
applications
of
benefit
transfer
often
focus
on
recreation
demand.
For
an
example
of
such
a
study,
see
Walsh
et
al.
(
1992).
Applications
of
benefit
transfer
to
value
health
effects
have
also
been
completed.
See,
for
example,
EPA's
retrospective
and
prospective
reports
on
the
benefits
and
costs
of
the
Clean
Air
Act
(
EPA,
1997a;
EPA
1999a).
Here,
ranges
of
values
for
multiple­
symptom
health
effects
were
calculated
by
combining
results
of
studies
that
valued
individual
health
effects.
More
information
on
benefit
transfer
in
general
and
some
of
the
issues
discussed
below
can
be
found
in
EPA
(
1993)
and
a
special
issue
of
Water
Resources
Research
(
1992,
Volume
28,
Number
3)
dedicated
to
the
topic.
More
recently,
Desvousges
et
al.
(
1998)
discusses
transfer
studies
in
general
not
only
for
valuation
purposes.
The
authors
illustrate
the
transfer
method
with
a
case­
study
estimating
externalities
associated
with
electric
utility
generation.

Is
Benefit
Transfer
the
Appropriate
Technique?

The
advantages
to
benefit
transfer
are
clear.
Original
studies
are
time
consuming
and
expensive;
benefit
transfer
can
reduce
both
the
time
and
financial
resources
needed
to
develop
benefits
estimates
of
a
proposed
policy.
Given
the
demands
of
the
regulatory
process,
these
considerations
may
be
extremely
important.
Additionally,
while
the
quality
of
primary
research
is
unknown
in
advance,
the
analyst
performing
a
benefit
transfer
is
able
to
gauge
the
quality
of
existing
studies
prior
to
conducting
the
transfer
exercise.

However,
benefit
transfer
is
not
without
drawbacks.
Most
important,
estimates
derived
using
benefit
transfer
techniques
are
unlikely
to
be
as
accurate
as
primary
research
tailored
specifically
to
the
new
policy
case.
Of
concern
to
the
analyst
is
whether
more
accurate
benefits
information
make
a
difference
in
the
decision­
making
process.
There
are
many
situations
in
which
a
benefit
transfer
may
provide
adequate
information.
For
example,
if
the
entire
range
of
benefits
estimates
from
the
transfer
exercise
falls
well
above
or
below
the
costs
of
the
policy
being
considered
more
accurate
estimates
will
probably
not
alter
the
efficiency
conclusion.
Other
factors
to
consider
when
deciding
whether
to
conduct
a
benefit
transfer
include
the
availability
of
relevant,
high­
quality
existing
studies
and
the
degree
to
which
additional
primary
research
would
reduce
the
uncertainty
of
the
current
benefits
estimate.

Considerations
in
Evaluating
and
Understanding
Benefit
Transfer
Studies
Currently,
a
systematic
process
for
conducting
benefit
transfer
does
not
exist.
There
are,
however,
well­
accepted
steps
involved
in
the
process.
When
conducting
a
benefit
transfer,
one
should
make
certain
that
each
of
the
following
steps
are
carried
out
carefully:

Describe
the
policy
case.
The
first
step
in
a
benefit
transfer
is
to
describe
the
policy
case
so
that
its
characteristics
and
consequences
are
understood.
It
is
equally
important
to
describe
the
population
impacted
by
the
proposed
policy.
As
part
of
this
step,
it
is
important
to
determine
whether
effects
of
the
policy
will
be
felt
by
the
general
population
or
by
specific
subsets
of
individuals
(
e.
g.,
users
of
a
particular
recreation
site
or
children).
Information
on
the
affected
population
will
generally
be
used
to
convert
per
person
(
or
household)
values
to
an
aggregate
benefits
estimate.

Identify
existing,
relevant
studies.
Existing,
relevant
studies
are
identified
by
conducting
a
literature
search.
This
literature
search
should,
ideally,
include
searches
of
published
literature,
reviews
of
survey
articles,
examination
of
databases,
and
consultation
with
researchers
to
identify
government
publications,
unpublished
research,
works
in
progress,
and
other
"
gray
literature."

Review
available
studies
for
quality
and
applicability
In
the
third
step,
the
analyst
should
review
and
assess
the
studies
identified
in
the
literature
review
for
their
quality
and
applicability
to
the
policy
case.
The
quality
of
the
study
case
estimates
will,
in
part,
determine
the
quality
of
the
benefit
transfer.
Indicators
of
quality
will
generally
depend
on
the
method
used.
See
the
previous
discussions
on
each
of
the
primary
research
methods
for
more
information
on
assessing
the
quality
of
studies.
Assessing
studies
for
applicability
involves
determining
whether
86
Chapter
7:
Benefits
available
studies
are
comparable
to
the
policy
case.
Specifically:

 
the
basic
commodities
must
be
essentially
equivalent;

 
the
baseline
and
extent
of
the
change
should
be
similar;
and
 
the
affected
populations
should
be
similar.

The
analyst
should
also
determine
whether
adjustments
can
be
made
for
important
differences
between
the
policy
case
and
the
study
case.
In
some
cases,
it
may
prove
enlightening
to
discuss
your
interpretation
and
intended
use
of
the
study
case
with
the
original
authors.
See
Desvousges
et
al.
(
1992)
for
additional
information
on
criteria
used
to
determine
quality
and
applicability.
For
more
information
on
applicability
as
related
to
specific
benefit
categories,
see
the
draft
Handbook
for
Non­
Cancer
Valuation
(
EPA,
1999c),
the
Children's
Health
Valuation
Handbook
(
EPA,
forthcoming),
and
Desvousges
et
al.
(
1998).

Transfer
the
benefit
estimates.
This
step
involves
the
actual
transfer.
There
are
four
types
of
benefit
transfer
studies:
point
estimate,
benefit
function,
meta­
analysis,
and
Bayesian
techniques.
The
point
estimate
approach
involves
taking
the
mean
value
(
or
range
of
values)
from
the
study
case
and
applying
it
directly
to
the
policy
case.
As
it
is
rare
that
a
policy
case
and
study
case
will
be
identical,
this
approach
is
not
generally
recommended.
Rather
than
directly
using
existing
values,
analysts
will
often
adjust
point
estimates
based
on
judged
differences
between
the
study
and
policy
cases.
Judgments
of
this
type
should
be
based
on
economic
theory,
empirical
evidence,
and
experience
(
Brookshire
and
Neill,
1992).
The
benefit
function
transfer
approach
is
more
refined
but
also
more
complex.
If
the
study
case
provides
a
WTP
function,
valuation
estimates
can
be
updated
by
substituting
applicable
values
of
key
variables,
such
as
baseline
risk
and
population
characteristics
(
e.
g.,
mean
or
median
income,
racial
or
age
distribution)
from
the
policy
case
into
the
benefit
function.
The
most
rigorous
benefit
transfer
exercise
uses
metaanalysis
Meta­
analysis
is
a
statistical
method
of
combining
a
number
of
valuation
estimates
that
allows
the
analyst
to
systematically
explore
variation
in
existing
value
estimates
across
studies.
As
with
the
benefit
function
transfer
approach,
key
variables
from
the
policy
case
are
inserted
into
the
resulting
benefit
function.
An
alternative
to
the
meta­
analytic
approach
is
the
Bayesian
approach.
These
techniques
provide
a
systematic
way
of
incorporating
study
case
information
with
policy
case
information.
Studies
that
have
explored
these
concepts
include
Atkinson
et
al.
(
1992)
and
Boyle
et
al.
(
1994).
A
discussion
of
Bayesian
approaches
appears
in
Desvousges
et
al.
(
1998).
Regardless
of
the
procedure
used,
estimates
are
generally
aggregated
over
the
affected
population
to
compute
an
overall
benefits
estimate.

Address
uncertainty.
Benefit
transfer
involves
judgements
and
assumptions.
Throughout
the
analysis
the
researcher
should
clearly
describe
all
judgements
and
assumptions
and
their
potential
impact
on
final
estimates,
as
well
as
any
other
sources
of
uncertainty
inherent
in
the
analysis.

7.6
Values
for
Major
Benefit
Categories
As
noted
earlier,
EPA
policies
may
reduce
the
risk
of
premature
death,
typically
measured
as
the
number
of
statistical
lives
"
saved"
as
a
result
of
the
policy
action.
The
benefits
of
these
risk
reductions
are
usually
measured
using
the
concept
of
the
"
value
of
a
statistical
life"
(
VSL).
VSL
estimates
are
derived
from
aggregated
estimates
of
individual
values
for
small
changes
in
mortality
risks.
If
10,000
individuals
are
each
willing
to
pay,
for
example,
$
500
for
a
reduction
in
risk
of
1/
10,000,
then
the
value
of
saving
one
statistical
life
equals
$
500
times
10,000
 
or
$
5
million.
This
does
not
mean
that
any
identifiable
life
is
valued
at
this
amount,
but
rather
that
the
aggregate
value
of
reducing
a
collection
of
small
individual
risks
is
worth
$
5
million
in
this
case.

7.6.1
Human
Health:
Mortality
Risks
EPA
policies
reduce
a
wide
array
of
mortality
risks.
Some
risks
are
experienced
by
young
persons
and
others
by
older
persons.
Some
risks
result
in
death
shortly
after
exposure,
while
others
take
years
to
manifest.
For
benefits
87
Chapter
7:
Benefits
analysis,
mortality
risks
can
generally
be
classified
across
two
broad
dimensions:
the
characteristics
of
the
affected
population
and
the
characteristics
of
the
risk
itself,
such
as
timing.
These
dimensions
can
be
expected
to
affect
the
value
of
reducing
mortality
risks.

An
ideal
value
estimate
for
fatal
risk
reduction
would
account
for
all
of
these
demographic
and
risk
characteristics
It
would
be
derived
from
the
preferences
of
the
population
affected
by
the
policy,
based
on
the
type
of
risk
that
the
policy
is
expected
to
reduce.
For
example,
if
a
policy
were
designed
to
remove
carcinogens
at
a
suburban
hazardous
waste
site,
the
ideal
measure
would
represent
the
preferences
for
reduced
cancer
risks
for
the
typical
suburban
dweller
in
the
area.
Unfortunately,
it
is
simply
too
expensive
and
time­
consuming
to
obtain
such
unique
risk
value
estimates
for
each
EPA
policy.

Because
original
research
is
usually
infeasible,
analysts
at
EPA
will
need
to
draw
from
existing
VSL
estimates
that
have
been
obtained
using
well­
established
methods.
However,
virtually
all
available
applications
of
these
methods
focus
on
risks
that
differ
from
environmental
risks
in
a
number
of
ways.
Applying
existing
VSL
estimates
found
in
the
economics
literature
is
an
exercise
in
benefit
transfer
and
raises
a
number
of
issues
associated
with
this
technique.

This
section
characterizes
and
assesses
these
issues,
recognizing
that
there
are
limitations
to
how
effectively
analysts
can
make
adjustments
in
the
benefit
transfer
process.
The
discussion
is
sometimes
necessarily
broad,
given
that
there
are
a
variety
of
different
types
of
mortality
risks
affected
by
EPA
policies.
First,
this
section
briefly
reviews
relevant
economic
valuation
methods
and
the
VSL
estimates
they
provide.
Then
the
bulk
of
this
section
highlights
key
considerations
when
considering
and
transferring
these
values
for
use
in
EPA
benefits
analysis.
In
order
to
focus
the
discussion,
this
section
emphasizes
those
considerations
that
may
be
unique
to
benefit
transfer
in
the
context
of
mortality
risk
changes.
Benefit
transfer
considerations
that
are
common
to
all
applications,
including
most
demographic
characteristics
of
the
study
and
policy
populations,
are
described
in
the
section
of
the
benefit
transfer
method
itself.
7.6.1.1
Available
Methods
for
Estimating
Mortality
Risk
Values
The
value
of
small
changes
in
mortality
risk
is
well­
studied
although
researchers
generally
acknowledge
that
there
are
formidable
difficulties
in
measuring
risk­
dollar
tradeoffs
Economists
have
developed
three
broad
methods
to
estimate
a
value
of
mortality
risk
reduction,
each
of
which
is
described
below.
When
using
any
of
these
methods,
researchers
encounter
uncertainties
not
only
in
isolating
the
amount
of
compensation
received
for
assuming
higher
mortality
risk,
but
also
in
estimating
the
actual
and
perceived
risk
increment
inherent
in
the
transaction.

Wage­
risk
analysis:
This
method
is
well­
established
and
the
economics
literature
contains
at
least
twenty
high­
quality
wage­
risk
studies.
The
resulting
VSL
estimates
range
from
about
$
0.7
million
to
more
than
$
16
million
(
1997$)
and
are
included
in
Exhibit
7­
3.
Wage­
risk
studies
have
been
performed
in
a
number
of
different
industries
and
countries
and
their
estimates
appear
to
be
somewhat
sensitive
to
the
data
and
econometric
model
used.
26
Workplace
mortality
risks,
which
tend
to
be
dominated
by
deaths
associated
with
accidents
or
other
immediate
causes,
form
the
basis
for
VSL
estimates
from
these
studies.
Environmental
risks
affected
by
EPA
policies
often
differ
from
these
types
of
risk
in
a
number
of
ways.

Contingent
valuation:
There
are
at
least
five
highquality
published
estimates
of
VSL
based
on
the
contingent
valuation
method.
These
estimates
are
broadly
consistent
with
those
generated
by
the
wage­
risk
method
and
are
included
in
Exhibit
7­
3.
These
studies
have
not
employed
a
fatal
risk
scenario
involving
an
environmental
cause
and,
therefore,
suffer
from
some
of
the
same
"
risk
context"
differences
as
wagerisk
studies
when
transferred
for
use
in
EPA
policy
analyses.
Recently,
however,
researchers
have
exhibited
renewed
interest
in
using
the
contingent
valuation
method
to
explore
how
particular
factors
affect
WTP
to
reduce
risks.
27
Averting
behavior
studies:
The
published
literature
contains
several
examples
of
averting
behavior
88
Chapter
7:
Benefits
26
Viscusi
(
1992,
1993)
discusses
the
implications
of
different
specifications
and
data
sets.

27
Johannesson
and
Johansson
(
1996),
for
example,
attempt
to
value
extensions
to
life
expectancy.
The
design
of
this
study
has,
however,
received
some
criticism
(
Krupnick
et
al.,
1999).
studies,
also
known
as
"
consumer
market
studies."
Consumer
market
studies
have
examined
risk­
dollar
tradeoffs
associated
with
highway
speed
(
Ghosh
et
al.,
1975),
seatbelt
use
(
Blomquist,
1979),
use
of
smoke
detectors
(
Dardis,
1980;
Garbacz,
1989),
and
the
use
of
child
safety
seats
(
Carlin
and
Sandy,
1991).
All
of
these
studies
suffer
from
problems
in
estimating
the
full
costs
of
consumer
actions
to
reduce
risks.
For
example,
it
is
difficult
to
quantify
the
added
expense
and
"
cost
of
time"
involved
in
purchasing,
installing,
and
maintaining
a
smoke
detector.
Further,
these
studies
cannot
generally
control
for
reductions
in
non­
fatal
risks
that
are
associated
with
the
averting
action.
Some
researchers
argue
that
these
and
other
limitations
lead
consumer
market
studies
to
produce
downwardly
biased
VSL
estimates.
28
89
Chapter
7:
Benefits
Study
Method
Value
of
Statistical
Life
Kneisner
and
Leeth
(
1991
­
U.
S.)
Labor
Market
$
0.7
million
Smith
and
Gilbert
(
1984)
Labor
Market
$
0.8
million
Dillingham
(
1985)
Labor
Market
$
1.1
million
Butler
(
1983)
Labor
Market
$
1.3
million
Miller
and
Guria
(
1991)
Contingent
Valuation
$
1.5
million
Moore
and
Viscusi
(
1988)
Labor
Market
$
3.0
million
Viscusi,
Magat
and
Huber
(
1991)
Contingent
Valuation
$
3.3
million
Marin
and
Psacharopoulos
(
1982)
Labor
Market
$
3.4
million
Gegax
et
al.
(
1985)
Contingent
Valuation
$
4.0
million
Kneisner
and
Leeth
(
1991
­
Australia)
Labor
Market
$
4.0
million
Gerking,
de
Haan
and
Schulze
(
1988)
Contingent
Valuation
$
4.1
million
Cousineau,
Lecroix
and
Girard
(
1988)
Labor
Market
$
4.4
million
Jones­
Lee
(
1989)
Contingent
Valuation
$
4.6
million
Dillingham
(
1985)
Labor
Market
$
4.7
million
Viscusi
(
1978,
1979)
Labor
Market
$
5.0
million
R.
S.
Smith
(
1976)
Labor
Market
$
5.6
million
V.
K.
Smith
(
1976)
Labor
Market
$
5.7
million
Olson
(
1981)
Labor
Market
$
6.3
million
Viscusi
(
1981)
Labor
Market
$
7.9
million
R.
S.
Smith
(
1974)
Labor
Market
$
8.7
million
Moore
and
Viscusi
(
1988)
Labor
Market
$
8.8
million
Kneisner
and
Leeth
(
1991
­
Japan)
Labor
Market
$
9.2
million
Herzog
and
Schlottman
(
1987)
Labor
Market
$
11.0
million
Leigh
and
Folsom
(
1984)
Labor
Market
$
11.7
million
Leigh
(
1987)
Labor
Market
$
12.6
million
Garen
(
1988)
Labor
Market
$
16.3
million
Derived
from
EPA
(
1997)
and
Viscusi
(
1992).

28
These
criticisms
include
Fisher
et
al.
(
1989)
and
Viscusi
(
1992).
Exhibit
7­
3
Value
of
Statistcal
Life
Estimates
(
mean
values
in
1997
dollars)
No
clear
consensus
establishes
one
of
these
three
methods
or
any
particular
study
as
exhibiting
superior
features
for
use
in
regulatory
analyses.
However,
the
relative
abundance
of
available
VSL
estimates
from
wage­
risk
studies
provides
a
range
of
broadly
applicable
values
for
reduced
mortality
risk.
As
in
other
benefit
transfer
exercises,
a
range
or
distribution
of
values
serves
as
a
starting
point
when
seeking
to
identify
values
appropriated
for
a
particular
policy
context.

7.6.1.2
Existing
Reviews
of
Value
of
Statistical
Life
Estimates
Literature
surveys
found
in
Viscusi
(
1993)
and
Fisher
(
1989)
represent
the
best
starting
points
for
VSL
estimates.
In
both
cases,
the
authors'
goals
included
presenting
a
broadly
applicable
range
of
values
rather
than
a
point
estimate
Viscusi
(
1993)
is
more
recent
and
includes
some
studies
not
considered
by
Fisher.
29
Drawing
from
these
reviews,
EPA
identified
26
policy­
relevant
risk
VSL
studies
as
part
of
an
extensive
assessment
titled
The
Benefits
and
Costs
of
the
Clean
Air
Act,
1970
to
1990
(
EPA,
1997a).
30
These
are
summarized
in
Exhibit
7­
3
(
IEc
1992,
1993a,
1993b).
Five
of
the
26
studies
are
contingent
valuation
studies,
the
rest
are
wage­
risk
studies.
To
allow
for
probabilistic
modeling
of
mortality
risk
reduction
benefits,
the
analysts
reviewed
a
number
of
common
distributions
to
determine
which
best
fit
the
distribution
of
mean
values
from
the
studies.
A
Weibull
distribution
was
selected
with
a
central
tendency
(
or
mean)
of
$
5.8
million
(
1997$).

Although
these
studies
are
generally
of
high­
quality,
the
$
5.8
million
measure
of
central
tendency
does
not
account
for
variation
in
study­
specific
factors
underlying
these
VSL
estimates.
Further
research
on
synthesizing
the
results
of
these
and
other
studies,
including
the
use
of
meta­
analysis
may
provide
estimates
better
suited
for
benefit
transfer
to
environmental
policies.

7.6.1.3
Benefit
Transfer
Considerations
for
Using
Existing
VSL
Estimates
Exhibit
7­
3
contains
the
best
range
of
estimates
available
at
this
time.
For
use
in
benefits
analyses,
EPA
recommends
a
central
estimate
of
$
4.8
million
(
1990$),
updated
to
the
base
year
of
the
analysis.
For
example,
updating
this
figure
for
inflation
produces
an
estimate
of
$
6.1
million
in
1999
dollars.
31
However,
as
with
any
benefit
transfer
exercise,
it
is
important
to
consider
differences
in
the
nature
of
the
base
and
policy
cases.
As
noted
earlier,
for
fatal
risks
these
differences
fall
into
two
major
categories:

differences
in
the
characteristics
of
the
population;
and
differences
in
the
characteristics
of
the
risks
being
valued.

Particular
differences
in
these
categories
are
detailed
below.
Following
this
presentation
is
a
summary
assessment
of
how
analysts
might
assess
the
impact
of
these
population
and
risk
dimensions.
Generally,
policy
analysts
considering
mortality­
related
benefits
should
include
at
least
a
qualitative
discussion
of
the
potential
impact
of
these
factors
on
the
overall
results.
It
is
important
to
recognize
that
the
ultimate
objective
of
the
benefit
transfer
exercise
is
to
adjust
or
correct
for
all
of
the
factors
that
significantly
affect
the
value
of
mortality
risk
reduction
in
the
context
of
the
policy.
Analysts
should
carefully
consider
the
implications
of
making
adjustments
for
some
relevant
factors,
but
not
for
others.

90
Chapter
7:
Benefits
29
A
third
literature
survey,
Miller
(
1990),
reviews
a
broad
range
of
value
of
life
studies,
including
estimates
from
averting
behavior
studies
that
others
forcefully
argue
are
not
appropriate
for
environmental
policy
purposes.
In
addition,
Miller's
results
are
dependent
on
adjustments
he
makes
to
wage­
risk
data.
These
adjustments
are
the
subject
of
debate
among
economists
and
may
be
difficult
to
defend
in
environmental
contexts.

30
This
approach
for
valuing
mortality
risks
was
subject
to
extensive
external
peer
review
during
the
development
process
of
this
report.
Since
the
report's
release,
this
approach
has
been
adopted
in
other
EPA
benefit
analyses.
Peer
reviewers
have
recently
confirmed
the
approach
for
use
in
a
prospective
analysis
of
the
Clean
Air
Act
(
EPA,
1999a).

31
This
was
estimated
using
the
Consumer
Price
Index
(
CPI)
for
all
goods
and
services.
Many
economists
prefer
to
use
the
Gross
Domestic
Product
(
GDP)
Deflator
inflation
index
in
some
applications.
The
key
issue
for
EPA
analysts
is
that
the
chosen
index
be
used
consistently
throughout
the
analysis.
Factors
Associated
with
Demographic
Characteristics
Age
(
longevity):
Several
authors
have
attempted
to
address
potential
differences
in
the
value
of
statistical
life
due
to
differences
in
the
average
age
of
the
affected
population
or
the
average
age
at
which
an
effect
is
experienced.
32
In
the
case
of
reductions
in
mortality
risks,
a
young
person
is
assumed
to
experience
a
greater
expected
benefit
in
total
lifetime
utility
than
an
older
person.
This
hypothesis
may
be
confounded
by
the
finding
that
older
persons
reveal
a
greater
demand
for
reducing
mortality
risks
and
hence
have
a
greater
implicit
value
of
a
life
year
(
Ehrlich
and
Chuma,
1990).
Though
few
in
number,
empirical
studies
and
theoretic
models
suggest
that
the
value
of
a
life
follows
a
consistent
"
inverted­
U"
life­
cycle,
peaking
in
the
region
of
mean
age.
33
Two
alternative
adjustment
techniques
have
been
derived
from
this
literature.
The
first,
valuation
of
statistical
life­
years,
is
based
on
the
concept
of
statistical
life
years
introduced
in
Section
7.4.1.
The
most
common
application
of
this
approach
is
illustrated
in
Moore
and
Viscusi
(
1988)
and
presumes
that
1)
the
value
of
statistical
life
equals
the
sum
of
discounted
values
for
each
life
year
and
2)
each
life
year
has
the
same
value.
This
method
was
applied
as
an
alternative
case
in
an
effort
to
evaluate
the
sensitivity
of
the
benefits
estimates
prepared
for
EPA's
retrospective
study
of
the
costs
and
benefits
of
the
Clean
Air
Act
(
EPA
1997).
A
second
technique
is
to
apply
a
distinct
value
or
suite
of
values
for
mortality
risk
reduction
depending
on
the
age
of
incidence.
However,
there
is
relatively
little
available
literature
upon
which
to
base
such
adjustments.
34
Health
status:
Individual
health
status
also
appears
to
affect
WTP
for
mortality
risk
reduction.
This
is
a
relevant
factor
for
valuation
of
environmental
risks
because
individuals
with
impaired
health
are
often
the
most
vulnerable
to
mortality
risks
from
environmental
causes
(
for
example,
particulate
air
pollution
appears
to
disproportionately
affect
individuals
in
an
already
impaired
state
of
health).
Health
status
is
distinct
from
age
(
a
"
quality
versus
quantity"
distinction)
but
the
two
factors
are
clearly
correlated
and
therefore
must
be
addressed
jointly
when
considering
the
need
for
an
adjustment.
At
least
one
pilot
study
has
found
that
WTP
for
increased
longevity
decreases
with
a
declining
baseline
health
state
(
Desvousges
et
al.,
1996).
35
Factors
Associated
with
Characteristics
of
Risk
and
Other
Considerations
Risk
characteristics
appear
to
affect
the
value
that
people
place
on
risk
reduction.
A
large
body
of
work
identifies
eight
dimensions
of
risk
that
affect
human
risk
perception:
36
 
voluntary/
involuntary;

 
ordinary/
catastrophic;

 
delayed/
immediate;

 
natural/
man­
made;

 
old/
new;

 
controllable/
uncontrollable;

 
necessary/
unnecessary;
and
 
occasional/
continuous.

91
Chapter
7:
Benefits
32
See,
for
example,
Cropper
and
Sussman
(
1990)
and
Moore
and
Viscusi
(
1988).

33
Jones­
Lee
et
al.
(
1985)
reach
this
conclusion
empirically,
considering
both
remaining
years
of
life
and
the
value
of
a
life
year.
This
conclusion
supports
theoretical
predictions
by
Shepard
and
Zeckhauser
(
1982).

34
This
second
approach
was
illustrated
in
one
EPA
study
(
EPA,
1995)
for
valuation
of
air
pollution
mortality
risks,
drawing
upon
adjustments
measured
in
Jones­
Lee
et
al.
(
1985).

35
The
fields
of
health
economics
and
public
health
often
account
for
health
status
through
the
use
of
quality
adjusted
life
years
(
QALYs)
or
disability
adjusted
life
years
(
DALYs).
These
measures
have
their
place
in
evaluating
the
cost
effectiveness
of
medical
interventions
and
other
policy
contexts,
but
have
not
been
fully
integrated
into
the
welfare
economic
literature
on
risk
valuation.
More
information
on
QALYs
can
be
found
in
Gold
et
al.
(
1996)
and
additional
information
on
DALYs
can
be
found
in
Murray
(
1994).

36
A
review
of
issues
in
risk
perception
is
found
in
Slovic
(
1987).
Other
informative
sources
include
Rowe
(
1977),
Otway
(
1977),
and
Fischhoff
et
al.
(
1978).
Transferring
VSL
estimates
between
these
categories
may
introduce
bias.
37
There
have
been
some
recent
efforts
attempting
to
quantitatively
assess
these
sources
of
bias.
These
studies
generally
conclude
that
voluntariness,
control,
and
responsibility
affect
individual
values
for
safety,
although
the
direction
and
magnitude
of
these
effects
are
somewhat
uncertain.

Environmental
risks
may
differ
from
those
that
form
the
basis
of
VSL
estimates
in
many
of
these
dimensions
Occupational
risks,
for
example,
are
generally
considered
to
be
more
voluntary
in
nature
than
are
environmental
risks,
and
may
be
more
controllable.

Latency
periods:
Many
environmental
policies
are
targeted
at
reducing
the
risk
of
effects
such
as
cancer,
where
there
may
be
an
extended
period
of
latency
between
the
time
of
exposure
and
eventual
death
from
the
disease.
38
While
the
benefit
of
a
reduction
in
exposure
is
an
immediate
reduction
in
the
risk
of
the
associated
health
endpoint,
latency
periods
between
exposure
and
manifestation
may
affect
the
value
of
that
risk
reduction.
Existing
VSL
estimates
are
based
upon
risks
of
relatively
immediate
fatalities,
making
them
an
imperfect
fit
for
a
benefits
analysis
of
many
policies.
Economic
theory
suggests
that
reducing
the
risk
of
a
delayed
health
effect
will
be
valued
less
than
reducing
the
risk
of
a
more
immediate
one,
when
controlling
for
other
factors.

A
simple
ad
hoc
approach
to
adjusting
existing
VSL
estimates
is
to
apply
a
financial
discount
rate
over
the
expected
latency
period.
However,
defining
latency
periods
with
existing
risk
assessment
methods
may
be
difficult
and
empirical
estimates
may
be
highly
uncertain.
Further,
the
underlying
assumptions
supporting
this
procedure
may
oversimplify
how
individuals
appear
to
consider
delayed
health
effects.
39
Cropper
and
Sussman
(
1990)
develop
an
alternative
procedure
to
account
for
the
influence
of
time
on
fatal
risk
reduction
values,
but
their
demonstration
is
data­
intensive,
requiring
detailed
life
tables
and
agespecific
VSL
estimates.

Altruism:
The
existing
VSL
literature
focuses
on
individual
risk
tradeoffs,
but
there
is
evidence
that
people
are
willing
to
pay
to
reduce
risks
incurred
by
others.
Although
the
literature
on
altruism
is
limited,
several
studies
suggest
that
these
values
may
be
significant
40
Other
analysts
advocate
caution
in
attempting
to
inflate
value
of
life
estimates
to
reflect
altruism,
primarily
because
of
concerns
over
the
potential
for
double­
counting.
41
7.6.1.4
Summary
of
Advice
from
the
Economics
Literature
It
is
important
to
recognize
the
limitations
of
a
single
VSL
point
estimate
and
to
consider
whether
any
of
the
factors
discussed
above
may
have
a
significant
impact
on
the
benefits
estimated
for
mortality
risk
reductions
from
environmental
policies.
In
any
given
policy
context,
there
may
be
several
components
that
are
both
relevant
and
important
and
that
could
act
to
increase
or
decrease
the
appropriate
risk
reduction
value
used
to
estimate
benefits.
Adjustments
for
each
these
factors
may
offset
one
another
to
some
extent.
42
Analysts
should
exercise
caution
in
accounting
for
some
important
risk
and
population
characteristics
when
unable
to
account
for
others.

92
Chapter
7:
Benefits
37
Examples
include
Mendeloff
and
Kaplan
(
1990),
McDaniels
et
al.
(
1992),
Savage
(
1993),
Jones­
Lee
and
Loomes
(
1994,
1995,
1996),
and
Covey
et
al.
(
1995).

38
Although
latency
is
defined
here
as
the
time
between
exposure
and
fatality
from
illness,
alternative
definitions
may
be
used
in
other
contexts
For
example,
"
latency"
may
refer
to
the
time
between
exposure
and
the
onset
of
symptoms.
These
symptoms
may
be
experienced
for
an
extended
period
of
time
before
ultimately
resulting
in
fatality.

39
See,
for
example,
the
choice
of
discount
rate
discussion
in
Horowitz
et
al.
(
1990)
and
Rowlatt
et
al.
(
1998).

40
In
a
study
that
included
willingness
to
pay
to
reduce
others'
risk
of
illness
from
insecticides,
Viscusi
et
al.
(
1988)
found
evidence
of
significant
altruistic
values.
Jones­
Lee
et
al.
(
1985)
suggests
an
adjustment
to
value
of
statistical
life
estimates
of
about
one­
third
to
account
for
people's
concern
for
the
safety
of
others.

41
Examples
include
Bergstrom
(
1982)
and
Viscusi
(
1992).

42
Sometimes
this
might
mean
that
very
different
risks
will
be
valued
similarly.
There
are
relatively
few
studies
that
assess
responses
to
different
types
of
risk
in
an
individual
choice
framework.
A
notable
exception
is
Magat
et
al.
(
1996),
which
finds
individuals
indifferent
between
mortality
risks
from
an
automobile
accident
and
those
from
fatal
lymph
cancer.
Because
of
the
inherent
uncertainty
in
any
analysis,
however
analysts
should
consider
qualitative
evaluations
of
these
factors
and
explore
where
sensitivity
analysis
can
satisfactorily
address
some
of
these
concerns.
The
importance
and
relevance
of
each
of
the
risk
and
demographic
characteristics
need
to
be
considered.
Depending
upon
specific
policy
context,
there
may
be
multiple
alternatives
for
supplemental
analysis.

For
example,
when
policies
do
not
affect
the
entire
population
equally,
a
sensitivity
analysis
may
show
the
cost
per
life
saved.
In
some
contexts
these
values
may
provide
useful
information
to
decision
makers
on
the
relative
merits
of
alternative
policy
options.
However,
cost­
per­
life­
saved
measures
implicitly
assume
that
all
costs
are
associated
with
mortality
reduction.
For
policies
that
provide
other
types
of
benefits,
cost­
per­
life­
saved
measures
may
be
misleading
unless
the
value
of
those
benefits
are
first
deducted
from
cost
estimates,
but
it
is
impossible
to
make
these
deductions
when
some
benefits
are
either
non­
quantified
or
non­
monetized.
Because
of
these
shortcomings,
analysts
will
need
to
assess
the
usefulness
of
cost­
per­
lifesaved
measures
on
a
case­
by­
case
basis.

In
general,
the
decision
to
perform
sensitivity
analysis
will
also
depend
upon
the
relative
importance
of
mortality
values
in
the
overall
benefits
estimates
and
upon
having
sound
theoretical
and
empirical
economic
literature
upon
which
to
structure
the
analysis.
Parameter
values
used
to
formulate
the
sensitivity
analyses
must
also
be
supported
by
the
underlying
risk
assessment
data.

What
support
does
the
economics
literature
currently
offer
for
making
these
potential
adjustments?
Existing,
feasible
methods
for
age
(
or
longevity)
adjustments
have
significant
limitations.
Age
adjustments
may
be
desirable
from
a
theoretical
standpoint,
but
the
relationship
between
the
value
of
risk
reductions
and
expected
remaining
life
span
is
complex.
Application
of
existing
valuation
of
statistical
life
years
approaches
implicitly
assumes
a
linear
relationship
in
which
each
discounted
life
year
is
valued
equally.
As
OMB
(
1996)
notes,
although
"
there
are
theoretical
advantages
to
using
a
value
of
statistical
life­
year­
extended
(
VSLY)
approach,
current
research
does
not
provide
a
definitive
way
of
developing
estimates
of
VSLY
that
are
sensitive
to
such
factors
as
current
age,
latency
of
effect,
life
years
remaining,
and
social
valuation
of
different
risk
reductions."
The
second
alternative,
applying
a
suite
of
values
for
these
risks,
lacks
broad
empirical
support
in
the
economics
literature.
However,
the
potential
importance
of
this
benefit
transfer
factor
suggests
that
analysts
consider
sensitivity
analysis
when
risk
data
 
essentially
risk
estimates
for
specific
age
groups
 
are
available.
Emerging
literature
on
the
value
of
life
expectancy
extensions,
based
primarily
on
stated
preference
techniques,
is
beginning
to
help
establish
a
basis
for
valuation
in
cases
where
the
mortality
risk
reduction
involves
relatively
short
extensions
of
life.
43
A
small
body
of
literature
on
the
quantitative
impact
of
risk
characteristics
on
risk
valuation
exists.
Although
there
is
some
qualitative
consistency
in
the
results
of
these
studies,
the
risk
valuation
literature
is
not
sufficiently
robust
to
support
quantitative
adjustments
for
these
factors
at
this
time.
Considerations
associated
with
risk
characteristics
may
deserve
qualitative
discussion
in
some
policy
contexts.

Both
of
the
procedures
available
for
accounting
for
latency
have
potentially
serious
shortcomings.
For
example,
neither
procedure
addresses
the
dread
of
death
or
the
morbidity
that
occurs
prior
to
fatality
from
protracted
diseases,
such
as
that
experienced
with
many
cancers.
As
noted
earlier,
the
simple
"
discounted
VSL"
approach
may
also
oversimplify
how
individuals
consider
latency
in
their
expressed
WTP
for
reduced
mortality
risks.
This
literature
does,
however,
suggest
one
alternative
for
conducting
sensitivity
analysis
on
this
benefit
transfer
component.

7.6.1.5
Conclusion
In
summary,
these
guidelines
recognize
the
theoretically
ideal
measure
of
mortality
risk
reduction
benefits
and
this
section
has
discussed
the
many
variables
affecting
such
a
measure.
Due
to
current
limitations
in
the
existing
economic
literature,
these
guidelines
conclude
that
an
appropriate
default
approach
for
valuing
these
benefits
is
93
Chapter
7:
Benefits
43
It
should
be
noted
that
many
observers
have
expressed
reservations
over
adjusting
the
value
of
mortality
risk
reduction
on
the
basis
of
population
characteristics
such
as
age.
One
of
the
ethical
bases
for
these
reservations
is
a
concern
that
adjustments
for
population
characteristics
may
imply
support
for
variation
in
protection
from
environmental
risks.
Another
consideration
is
that
existing
economic
methods
may
not
capture
social
willingness
to
pay
to
reduce
health
risks.
Chapter
9
details
how
some
these
considerations
may
be
informed
by
a
separate
assessment
of
equity.
Chapter
10
describes
the
potential
for
efficiency
and
equity
considerations
to
be
considered
together
in
a
social
welfare
function.
provided
by
the
central
VSL
estimate
described
earlier.
However,
analysts
should
carefully
present
the
limitations
of
this
estimate.
Economic
analyses
should
also
fully
characterize
the
nature
of
the
risk
and
populations
affected
by
the
policy
action
and
should
confirm
that
these
parameters
are
within
the
scope
of
the
situations
considered
in
these
guidelines.
While
a
qualitative
discussion
of
these
issues
is
generally
warranted
in
EPA
economic
analyses,
analysts
should
also
consider
a
variety
of
quantitative
sensitivity
analyses
on
a
case­
by­
case
basis
as
data
allow.
The
analytical
goal
is
to
characterize
the
impact
of
key
attributes
that
differ
between
the
policy
and
study
cases.
These
attributes,
and
the
degree
to
which
they
affect
the
value
of
risk
reduction,
may
vary
with
each
benefit
transfer
exercise,
but
analysts
should
consider
the
characteristics
described
above
(
e.
g.,
age,
health
status,
voluntariness
of
risk,
latency)
and
values
arising
from
altruism.

As
the
economic
literature
in
this
area
evolves,
WTP
estimates
for
mortality
risk
reductions
that
more
closely
resemble
those
from
environmental
hazards
may
support
more
precise
benefit
transfers.
Literature
on
the
specific
methods
available
to
account
for
individual
benefit
transfer
considerations
will
also
continue
to
develop.
EPA
will
continue
to
conduct
annual
reviews
of
the
risk
valuation
literature
and
will
reconsider
and
revise
the
recommendations
in
these
guidelines
accordingly.
EPA
will
seek
advice
from
the
Science
Advisory
Board
as
guidance
recommendations
are
revised.
44
Despite
the
limitations
described
in
this
section,
analysts
should
remember
that
mortality
risk
valuation
remains
one
of
the
most
studied
benefit
categories
for
environmental
policies.
Wage­
risk
studies,
while
not
without
limitations
nonetheless
provide
revealed
preference
estimates
based
on
a
well­
tested
method.
Estimating
mortality
related
benefits
will
often
be
relatively
straightforward
to
implement
while
other
benefit
categories
will
require
more
time
and
attention.
7.6.2
Human
Health:
Morbidity
Risks
Morbidity
valuation,
or
the
valuation
of
non­
fatal
health
effects,
often
requires
addressing
a
more
diverse
set
of
issues
than
mortality
valuation.
First,
there
is
a
tremendous
variety
in
the
health
endpoints
considered
for
valuation
These
endpoints
vary
with
respect
to
their
severity,
including
the
degree
to
which
other
activities
can
be
pursued
and
the
degree
of
discomfort
or
pain
associated
with
the
ailment.
The
duration
of
the
effect
also
varies
considerably
from
short
term
effects
to
those
that
may
be
permanently
debilitating.
Non­
fatal
health
effects
differ
considerably
with
respect
to
the
availability
of
existing
value
estimates.
Some
of
these
health
effects
have
been
valued
multiple
times
with
different
methods,
while
others
have
not
been
the
subject
of
any
valuation
studies.

Willingness
to
pay
to
reduce
the
risk
of
experiencing
an
illness
is
the
preferred
measure
of
value
for
morbidity
effects.
This
measure
includes
several
components.
Illness
imposes
direct
costs,
such
as
expenses
for
medical
care
and
medication,
and
indirect
costs,
such
as
lost
time
from
paid
work,
maintaining
a
home,
and
pursuing
leisure
activities.
Illness
also
imposes
less
easily
measured,
but
equally
real
costs
of
discomfort,
anxiety,
pain,
and
suffering
Methods
used
to
estimate
WTP
vary
in
the
extent
to
which
they
capture
these
components.

A
commonly
used
alternative
to
WTP
is
the
avoided
costs
of
illness
(
COI).
For
a
given
health
effect,
the
COI
approach
will
generally
understate
true
WTP.
By
focusing
on
market
measures
of
the
value
of
health
effects,
it
leaves
out
important
components
such
as
the
value
of
avoiding
pain
and
suffering.
By
focusing
on
ex
post
costs,
it
also
does
not
capture
the
risk
attitudes
associated
with
ex
ante
WTP
measures.
However,
for
many
effects,
estimates
of
WTP
are
not
currently
available
or
are
highly
uncertain.
Where
estimates
of
WTP
are
not
available,
the
potential
94
Chapter
7:
Benefits
44
A
second
review
on
this
subject
was
recently
completed
by
the
Science
Advisory
Board
(
SAB),
the
results
of
which
can
be
found
in
"
An
SAB
Report
on
EPA's
White
Paper
Valuing
the
Benefits
of
Fatal
Cancer
Risk
Reductions,"
EPA­
SAB­
EEAC­
00­
013,
July
27,
2000
(
website
address
http://
www.
epa.
gov/
sab/
eeacf013.
pdf,
accessed
8/
28/
00).
The
SAB
review
elaborates
further
on
using
the
wage­
risk
literature
for
valuing
mortality
risk
reductions,
concluding
that
among
the
demographic
and
risk
factors
that
might
affect
VSL
estimates,
the
current
literature
can
only
support
empirical
adjustments
related
to
the
timing
of
the
risk.
First,
the
review
supports
adjusting
willingness­
to­
pay
estimates
to
account
for
higher
future
income
levels,
though
not
for
cross­
sectional
differences
in
income.
The
second
time­
related
adjustment
recommended
is
to
discount
for
risk
reductions
that
are
brought
about
in
the
future
by
current
policy
initiatives
(
that
is,
after
a
latency
period),
using
the
same
rates
used
to
discount
other
future
benefits
and
costs.
More
information
on
the
SAB
review
and
its
implications
for
the
Guidelines
will
be
released
in
a
forthcoming
supplement
to
this
document.
bias
inherent
in
relying
on
cost­
of­
illness
estimates
should,
at
minimum,
be
discussed
qualitatively.

Time
and
resources
will
often
not
allow
for
original
morbidity
valuation
research
to
support
specific
benefit
analyses
As
with
other
types
of
benefits,
analysts
will
then
need
to
look
for
estimates
available
from
existing
sources,
and
apply
these
values
to
the
policy
case
using
benefit
transfer
techniques.
The
discussion
here
is
presented
with
this
benefit
transfer
exercise
in
mind.
The
remaining
parts
of
this
section
present
a
summary
of
methods
commonly
used
to
value
reductions
in
morbidity,
useful
references
for
obtaining
existing
values,
and
issues
that
arise
in
transferring
existing
values
to
the
analysis
of
EPA
policies.

7.6.2.1
Available
Methods
for
Estimating
Morbidity
Values
Researchers
use
a
wide
range
of
methods
to
value
changes
in
morbidity
risks.
Some
available
methods
measure
the
theoretically­
preferred
value
of
individual
WTP
to
avoid
a
health
effect,
while
others
provide
useful
data
but
are
less
well­
grounded
in
economic
theory.
Methods
also
differ
in
the
perspective
from
which
valuation
is
measured
(
e.
g.,
before
or
after
the
incidence
of
morbidity)
and
the
degree
to
which
they
account
for
all
of
the
components
of
total
WTP.

The
three
primary
research
methods
used
most
often
to
value
environmental
morbidity
are
cost
of
illness,
contingent
valuation,
and
averting
behavior,
as
described
earlier.
Several
other
primary
valuation
methods
have
been
used
less
frequently
to
value
morbidity
from
environmental
causes:
hedonic
methods,
risk­
risk
tradeoffs,
health­
state
indexes,
and
studies
of
jury
awards.
However,
these
methods
often
do
not
provide
monetary
estimates
of
WTP
or
suffer
from
other
methodological
flaws,
and
are
generally
less
useful
for
policy
analysis.

Cost­
of­
illness:
The
cost­
of­
illness
method
is
straightforward
to
implement
and
explain
to
policy
makers
and
has
a
number
of
other
advantages.
It
has
been
applied
for
many
years,
is
well­
developed,
and
measures
of
direct
and
indirect
costs
are
easily
explained
without
reference
to
complex
economic
theory.
Collection
of
additional
data
is
often
less
expensive
than
for
other
methods,
perhaps
making
it
feasible
to
develop
original
cost­
of­
illness
estimates
in
support
of
a
specific
policy
or
set
of
policies.
Estimates
for
many
illnesses
are
available
from
existing
studies
and
span
a
wide
range
of
health
effects.
EPA's
Cost
of
Illness
Handbook
(
EPA,
forthcoming)
contains
an
extensive
collection
of
cost­
of­
illness
estimates
As
noted
earlier,
however,
the
cost­
of­
illness
method
has
several
shortcomings
and
its
theoretical
basis
is
quite
limited.
Generally,
cost­
of­
illness
estimates
should
be
considered
lower
bounds
on
WTP.

Averting
behavior:
In
the
case
of
morbidity
valuation
the
averting
behavior
method
can
provide
WTP
estimates
based
on
actual
behavior.
These
measures
can
account
for
all
of
the
effects
of
health
on
individual
well­
being,
including
altruism
toward
other
household
members
if
averting
actions
are
taken
jointly
(
e.
g.,
if
everyone
in
the
household
drinks
bottled
water).
However,
the
method
has
several
weaknesses
as
described
in
Section
7.5.
Existing
studies
vary
in
their
analytical
approach.
Some
existing
studies
have
attempted
to
estimate
WTP
for
particular
sets
of
illnesses
(
Gerking
and
Stanley,
1986;
Dickie
and
Gerking,
1991;
Bresnahan
and
Dickie,
1995).
Others
do
not
attempt
to
estimate
ex
ante
WTP,
but
focus
instead
on
actual
household
expenditures
in
response
to
a
particular
contamination
episode
or
event
(
Harrington
et
al.,
1989;
Abdallah,
1990).
In
practice
most
averting
behavior
estimates
should
be
interpreted
cautiously
as
a
lower­
bound
estimate
on
WTP.
Also,
because
behaviors
generally
avert
a
range
of
symptoms
(
e.
g.,
a
water
filter
removes
contaminants
with
several
potential
health
effects),
it
is
difficult
to
isolate
the
value
of
avoiding
those
individual
health
effects
that
may
be
attributable
to
a
particular
EPA
policy.
Indiscriminate
use
of
this
method
may
raise
significant
problems
with
double
counting
or
overestimation.

Stated
preference
methods:
Contingent
valuation
and
other
stated
preference
methods
can
be
used
to
account
for
all
the
effects
of
illness
on
individual
wellbeing
including
pain
and
suffering.
These
methods
appear
to
be
the
only
ones
capable
of
eliciting
dollar
values
for
altruism
toward
persons
outside
the
household
Unlike
the
averting
behavior
or
cost­
of­
illness
methods,
these
can
be
applied
to
value
the
risks
of
illness
lacking
any
connection
to
market
transactions.
Stated
preference
methods
have
been
used
to
value
a
95
Chapter
7:
Benefits
number
of
different
health
outcomes
including
accidental
poisoning
(
Viscusi
and
Magat,
1987;
Viscusi
et
al.,
1988);
coughing,
congestion,
and
other
minor
symptoms
(
Berger
et
al.,
1987);
chronic
bronchitis
(
Viscusi
et
al.,
1991;
Krupnick
and
Cropper,
1992);
and
nonfatal
nerve
disease
(
Magat
et
al.,
1996).
Some
economists,
however,
express
concerns
about
the
hypothetical
nature
of
the
transaction
and
the
difficulties
inherent
in
ensuring
that
respondents
understand
the
change
in
health
status
they
are
being
asked
to
value.
45
7.6.2.2
Existing
References
for
Morbidity
Values
Analysts
have
a
number
of
resources
available
for
obtaining
information
on
morbidity
values.
While
these
references
provide
valuable
information,
they
are
not
substitutes
for
careful
evaluation
of
original
studies
when
considering
a
benefit
transfer.
Useful
general
references
for
valuing
non­
fatal
health
effects
include
Tolley
et
al.
(
1994
)
and
Johanneson
(
1995).
Both
of
these
books
provide
references
to
many
existing
health
valuation
studies
and
discuss
issues
associated
with
using
these
estimates
for
policy
valuation.
Desvousges
et
al.
(
1998)
assess
a
number
of
existing
studies
in
the
context
of
performing
a
benefit
transfer
for
a
benefits
analysis
of
improved
air
quality.
Another
good
starting
point
for
reviewing
available
estimates
is
EPA's
Handbook
for
Non­
Cancer
Valuation
(
EPA,
1999c).
This
report
will
provide
available,
published
estimates
for
many
illnesses
and
reproductive
and
developmental
effects.

Because
estimates
of
WTP
will
not
always
be
available
for
particular
health
effects,
another
useful
resource
is
EPA's
Cost
of
Illness
Handbook
(
EPA,
forthcoming).
This
handbook
includes
cost­
of­
illness
estimates
for
many
cancers,
developmental
illnesses
and
disabilities,
and
other
illnesses
Work
on
the
handbook
is
ongoing
and
new
estimates
will
be
included
as
they
become
available.
46
Existing
EPA
economic
analyses
may
also
provide
useful
insights.
For
example,
the
Benefits
and
Costs
of
the
Clean
Air
Act
(
EPA,
1997a)
draws
upon
a
number
of
existing
studies
to
obtain
values
for
reductions
of
a
variety
of
health
effects.
The
report
describes
the
central
estimates
used
in
the
analysis,
how
these
estimates
were
derived,
and
attempts
to
quantify
the
uncertainty
associated
with
using
the
estimates.

7.6.2.3
Benefit
Transfer
Using
Existing
Morbidity
Value
Estimates
Benefit
transfer
was
detailed
earlier
in
this
chapter;
however
there
are
issues
associated
with
benefit
transfer
particular
to
morbidity
valuation.
As
with
any
benefit
transfer,
analysts
should:

carefully
describe
the
policy
case;

assess
the
quality
of
the
studies
and
their
applicability
to
the
policy
case;

evaluate
the
plausibility
of
the
findings;

consider
possible
adjustments
for
differences
between
the
subject
of
the
study
and
the
policy
case;
and
explicitly
address
uncertainty.

EPA's
Handbook
for
Non­
Cancer
Valuation
(
EPA,
1999c)
contains
additional
information
on
this
subject.

Matching
the
Study
Case
to
the
Policy
Case
Assessing
applicability:
A
key
element
in
evaluating
the
applicability
of
a
study
is
the
correspondence
between
the
health
effect
valued
in
the
study
and
the
health
effect
influenced
by
the
policy.
An
assessment
of
this
correspondence
must
consider
the
set
of
symptoms
covered
in
the
study.
The
analyst
should
consider
whether
the
study
case
consists
of
a
larger
or
smaller
set
of
symptoms
than
the
policy
case.
The
severity
of
the
symptoms
should
also
be
commensurate
including
the
degree
to
which
the
illness
limits
activities
and
the
extent
of
any
discomfort,
pain
and
suffering.
Analysts
should
also
assess
whether
the
duration
of
the
base
and
policy
cases
are
similar.

A
second
key
factor
is
the
similarity
between
the
population
examined
in
the
study
and
the
population
affected
by
the
policy.
Key
considerations
include
the
96
Chapter
7:
Benefits
45
See,
for
example,
Mitchell
and
Carson,
1989;
Cummings
et
al.,
1986;
NOAA,
1993;
Bjornstad
and
Kahn,
1996;
NRDA,
1994;
Diamond
and
Hausman,
1994.

46
The
Cost
of
Illness
Handbook
will
be
available
online.
The
website
will
be
continuously
updated
as
additional
COI
estimates
are
completed.
baseline
health
status
of
the
populations,
the
age
of
the
populations,
and
other
demographic
characteristics.

Evaluating
plausibility:
The
analyst
should
conduct
some
initial
checks
to
evaluate
whether
the
study
case
values
are
plausible
or
reasonable.
For
example,
if
the
estimated
value
of
avoiding
an
acute,
reversible
effect
exceeds
other
reasonable
estimated
values
for
avoiding
long­
term,
chronic
effects,
then
the
value
for
the
acute
effect
is
probably
too
large
and
will
be
difficult
to
defend.
On
the
other
hand,
WTP
values
that
are
less
than
cost­
of­
illness
values
for
the
same
effect
are
probably
too
low,
particularly
if
the
effect
clearly
results
in
pain
or
otherwise
impairs
activity.

Using
the
results
of
multiple
studies:
After
reviewing
the
quality
and
applicability
of
available
studies,
the
analyst
can
apply
the
valuation
estimates
to
the
data
on
cases
averted
by
each
policy
option.
Because
the
value
of
morbidity
avoidance
is
difficult
to
quantify
precisely,
it
is
useful
where
possible
to
apply
estimates
from
more
than
one
valuation
technique
Where
multiple
studies
are
available
that
provide
differing
estimates,
the
range
of
values
should
be
presented
with
a
discussion
of
the
advantages
and
limitations
of
the
studies
used.
Estimates
based
solely
on
cost­
of­
illness
values
should
be
flagged
as
potentially
understating
total
values.
WTP
studies
of
health
effects
that
are
similar
in
severity
and
duration
may
be
used
as
a
point
of
comparison.

Addressing
Uncertainty
and
Related
Concerns
Available
estimates
of
non­
fatal
effects
may
suffer
from
several
limitations.
They
may
be
derived
from
cost­
of­
illness
methods
that
do
not
fully
measure
WTP
to
avoid
the
effect
or
may
be
transferred
from
studies
of
effects
that
are
similar,
but
not
identical
to,
the
effect
of
concern.
The
extent
to
which
adjustments
or
new
research
are
needed
to
address
these
concerns
will
depend
largely
on
the
value
of
new
information
to
the
decision­
making
process.
If
morbidity
values
are
a
small
component
of
total
benefits
and
unlikely
to
influence
the
choice
among
policy
options,
then
a
qualitative
discussion
of
uncertainty
may
be
appropriate
Where
morbidity
values
are
a
significant
concern,
quantified
sensitivity
analysis
and
additional
data
collection
may
be
desired.

Some
of
the
major
sources
of
uncertainty
are
described
below.
Because
of
the
diversity
of
the
health
effects
of
concern
and
of
the
studies
used
to
value
morbidity
effects,
this
discussion
is
relatively
general.
The
limitations
and
potential
adjustments
or
analyses
of
uncertainty
that
are
appropriate
will
vary
greatly
depending
on
the
approach
used
for
a
particular
policy
analysis.
More
information
on
these
issues
is
provided
in
EPA's
Non­
Cancer
Valuation
Handbook
(
EPA,
1999c).

Ex
ante
and
ex
post
valuation
estimates:
Environmental
contamination
will
generally
not
cause
an
adverse
health
effect
with
certainty,
but
rather
will
increase
the
probability
that
the
effect
occurs,
increase
its
severity
given
that
it
occurs,
or
both.
People
are
likely
to
value
these
changes
in
risk
differently
than
they
would
value
certain
changes
in
health
status.
While
contingent
valuation
and
other
methods
can
adopt
an
ex
ante
perspective
and
obtain
estimates
for
risk
changes,
many
available
studies
provide
ex
post
value
estimates
for
morbidity
effects.
For
minor
health
effects
this
difference
in
perspective
may
not
be
important,
but
for
severe
health
effects
the
difference
may
be
significant
and
ex
post
estimates
may
understate
the
benefits
of
a
policy
action.
Analysts
should
address
this
issue
at
least
qualitatively
in
these
cases.

Incomplete
estimates
of
willingness
to
pay:
The
widespread
availability
of
health
insurance
and
paid
sick
leave
shift
the
costs
of
illness
from
individuals
to
others.
While
this
cost­
shifting
can
be
addressed
explicitly
in
cost­
of­
illness
studies,
it
may
lead
to
problems
in
estimating
total
WTP
through
contingent
valuation
surveys.
If
the
researcher
does
not
adequately
address
these
concerns,
respondents
may
understate
their
WTP,
assuming
that
some
related
costs
will
be
borne
by
others.

Timing
of
health
effects:
Environmental
contamination
may
cause
immediate
or
delayed
health
effects
and
the
value
of
avoiding
a
given
health
effect
likely
depends
on
whether
it
occurs
now
or
in
the
future.
Recent
empirical
research
confirms
that
workers
discount
future
risks
of
fatal
injuries
on
the
job;
that
is,
they
are
willing
to
pay
less
to
reduce
a
future
risk
than
a
present
risk
of
equal
magnitude
(
Viscusi
and
Moore,
1989).
In
addition,
a
separate
study
concluded
that
individuals
value
policies
that
yield
health
benefits
in
the
present
more
highly
than
policies
that
97
Chapter
7:
Benefits
yield
the
same
benefits
in
the
future
(
Cropper
et
al.,
1994).

7.6.2.4
Summary
Morbidity
benefits
valuation
can
be
a
difficult
process,
often
requiring
careful
judgment
decisions
by
the
analyst.
Whether
the
analyst
is
conducting
original
research
that
supports
the
policy
action
or
is
drawing
upon
existing
studies,
clarity
and
transparency
in
the
analysis
is
vital.
When
employing
benefits
transfer,
some
shortcomings
in
the
"
fit"
of
the
study
case
to
the
policy
case
is
to
be
expected
Addressing
these
shortcomings
explicitly,
conducting
appropriate
sensitivity
analysis,
and
clearly
stating
assumptions
can
greatly
enhance
the
credibility
of
the
benefits
analysis.

7.6.3
Ecological
Benefit
Valuation
In
estimating
ecological
benefits,
one
is
generally
forced
to
value
individual
ecological
service
flows
separately
and
then
sum
these
estimates
rather
than
constructing
prices
for
changes
in
the
structure
and
function
of
entire
ecosystems
Alternative
approaches
that
estimate
the
total
value
of
ecosystems
based
on
the
replacement
cost
of
the
entire
ecosystem
or
its
embodied
energy
(
e.
g.,
Costanza
et
al.,
1997;
Ehrlich
and
Ehrlich,
1997;
Pearce,
1998;
Pimentel
et
al.,
1997)
have
received
considerable
attention
as
of
late.
However,
the
results
of
these
studies
should
not
be
incorporated
into
benefit
assessments.
The
methods
adopted
in
these
studies
are
not
well
grounded
in
economic
theory
nor
are
they
typically
applicable
to
policy
analysis.
Pearce
(
1998)
contains
a
critical
review
of
the
total
value
approach,
as
does
Bockstael
et
al.
(
2000).

Although
the
economics
literature
is
replete
with
benefit
studies,
the
coverage
is
patchy
considering
the
broad
range
of
services
and
stressors
addressed
by
EPA
programs.
Especially
rare
in
the
literature
are
examples
of
wide­
scale
changes,
very
small
changes,
or
the
consequences
of
long
term
ecological
and
economic
change.
Ongoing
research
has
begun
to
address
these
data
limitations.
Examples
include
recent
contingent
valuation
studies
undertaken
for
purposes
of
natural
resource
damage
assessments
that
attempt
to
elicit
WTP
for
marginal
changes
in
long­
term
environmental
quality
(
Kopp
et
al.,
1994).
In
addition,
Layton
and
Brown
(
1997)
attempt
to
elicit
from
respondents
the
value
of
one
attribute
of
the
long­
term
ecological
changes
expected
to
be
associated
with
climate
change.

Available
Methods
for
Estimating
Ecological
Benefits
Economists
have
employed
a
variety
of
methods
to
estimate
the
benefits
of
improved
ecological
conditions.
Issues
particular
to
their
implementation
for
this
benefit
category
are
discussed
below.

Market
models:
The
benefit
of
changes
in
commercial
crop,
timber,
or
fish
harvests
can
be
estimated
using
a
variety
of
available
market
models.
Several
studies
have
assessed
the
social
welfare
implications
of
changes
in
yields
for
a
number
of
crop
species.
For
example,
Taylor
et
al.
(
1993)
apply
the
Agricultural
Sector
Model
and
Kopp
et
al.
(
1985)
apply
the
Regional
Model
Farm
Agricultural
Benefits
Assessment
Model
to
estimate
welfare
impacts
of
agricultural
yield
changes.
Adams
et
al.
(
1997)
use
the
Agricultural
Simulation
Model
to
estimate
the
economic
effects
associated
with
yield
changes
resulting
from
climate
change.

When
dealing
with
timber
or
fisheries,
bioeconomic
models
are
designed
to
deal
explicitly
with
time
to
account
for
the
fact
that
environmental
and
market
changes
are
not
coincident.
EPA
has
used
the
Timber
Assessment
Market
Model
(
TAMM)
to
estimate
ozone
effects
on
commercial
timber
harvesting.
The
welfare
impacts
of
changes
in
commercial
fish
harvests
have
also
been
examined,
e.
g.,
Alaskan
king
crab
in
Greenberg
et
al.
(
1994);
herring
in
Mendelsohn
(
1993);
and
lobster
in
Wang
and
Kellogg
(
1988).

If
changes
in
service
flows
are
small,
current
market
prices
can
be
used
as
a
proxy
for
expected
benefit.
For
example,
a
change
in
the
commercial
fish
catch
might
be
valued
using
the
market
price
for
the
affected
species.
This
approach
can
only
be
used
in
cases
where
fishing
effort
and
price
are
unlikely
to
be
affected
by
the
policies.
If
these
conditions
do
not
hold,
a
market
model
should
be
applied
to
assess
the
effects
of
increased
catch
rates
on
supply
conditions
and
market
price,
as
discussed
earlier
in
the
section
on
consumer
and
producer
surplus.

98
Chapter
7:
Benefits
Production
function
approach:
Values
for
indirect,
non­
market
benefits
can
be
estimated
when
their
contribution
to
production
processes
are
expressed
explicitly
in
a
production
function.
As
service
flows
increase,
the
welfare
gain
is
essentially
the
marginal
product
of
the
service
for
small
changes
or
is
reflected
by
the
shift
in
the
marginal
cost
curve.
Several
studies
have
examined
the
relationship
between
environmental
quality
and
crop
production,
such
as
measurement
of
ozone
impacts
by
Heck
et
al.
(
1983).
Moreover,
researchers
have
applied
this
approach
using
household
production
functions
to
examine
ecosystem
services
that
benefit
individuals
directly
or
to
establish
the
link
between
some
services
and
their
off­
site
benefits.
Bell
(
1997)
values
wetland
contributions
to
recreational
fishing
and
Barbier
(
1994)
values
a
range
of
indirect
wetland
benefits.
Smith
et
al.
(
1993)
estimate
the
impact
of
nitrogen
and
pesticide
loadings
on
coastal
water
recreational
fishing.

Averting
behaviors
approaches:
One
such
approach,
the
replacement
cost
method,
uses
purchases
of
market
goods
to
infer
the
value
of
indirect,
non­
market
services.
Willingness
to
pay
is
revealed
by
efforts
made
to
substitute
for
services
provided
by
ecosystems.
For
example,
since
water
treatment
infrastructure
replaces
wetland
functions,
investment
and
operations
and
maintenance
costs
provide
an
estimate
of
the
value
of
the
water
filtration
service
provided
by
wetlands.
This
method
is
justified
only
when
individuals
are
proven
willing
to
incur
such
replacement
costs,
through
either
their
voluntary
purchases
or
their
support
for
public
works
projects.
If
so,
the
value
of
the
service
is
at
least
as
much
as
the
replacement
cost.

Another
variation
on
this
theme
applies
to
actions
that
reduce
the
cost
of
complying
with
existing
policies
For
example,
a
reduction
in
atmospheric
nitrogen
deposition
in
the
watershed
of
an
estuary
may
ultimately
reduce
the
costs
incurred
in
reducing
other
sources
of
nitrogen
to
the
system,
such
as
added
controls
on
POTWs.
This
approach
is
generally
useful
in
situations
satisfying
two
criteria:
alternative
pollution
control
methods
are
prescribed
through
existing
policies
and
the
new
policies
under
consideration
would
provide
a
lower
cost
method
for
achieving
the
desired
level
of
environmental
protection.
Hedonic
methods:
Hedonic
property
models
can
isolate
the
relationship
between
environmental
quality
and
housing
prices
from
the
effects
of
variation
in
other
attributes
such
as
size,
location,
and
security.
This
method
is
often
used
to
use
to
value
regional
difference
in
air
quality.
Smith
and
Huang
(
1995)
conduct
a
meta­
analysis
to
examine
how
well
the
models
perform
in
this
context
and
discern
a
statistically
significant
relationship
between
housing
prices
and
air
quality
measures
in
general.
Hedonic
models
have
also
been
used
to
estimate
the
impact
of
landfill
closure
(
Kohlhase,
1991),
nuisances
from
odors
(
Palmquist
et
al.,
1997),
and
the
existence
and
remediation
of
toxic
contaminated
sites
(
Kiel,
1995)
on
nearby
property
values.
Other
applications
have
addressed
the
costs
of
land­
use
restrictions
(
Parsons,
1992)
and
the
benefits
of
water
quality
improvements
(
Rich
and
Moffitt,
1982).
A
promising
development
involves
the
application
of
hedonic
methods
in
a
model
of
land­
use
change
to
explore
the
ecological
and
economic
consequences
of
landscape
alteration
(
Bockstael,
1996).
In
addition,
Geoghegan
et
al.
(
1997)
estimate
the
impact
of
land
uses
adjacent
to
and
near
one's
home.

Recreation
demand
models:
Recreation
demand
models
are
discussed
in
detail
in
Section
5.2.1
of
this
chapter.
Recreation
demand
models
are
based
on
the
tradeoff
between
travel
expense
and
environmental
quality.
While
early
travel
cost
models
dealt
with
single
sites,
did
not
consider
environmental
quality,
and
suffered
from
a
range
of
limitations
and
biases,
more
recent
efforts
overcome
these
problems.
For
example
a
travel
cost
model
was
used
to
estimate
the
WTP
by
Chesapeake
Bay
beach
users
for
a
20
percent
improvement
in
water
quality
as
measured
by
nitrogen
and
phosphorous
loadings
(
Bockstael
et
al.,
1989).

Random
utility
models
have
been
used
in
a
wide
variety
of
studies
to
estimate
the
recreational
fishing
benefit
of
fresh
water
quality
improvements.
Montgomery
and
Needelman
(
1997)
apply
a
random
utility
model
to
fishing
behavior
and
estimate
the
benefits
of
eliminating
toxic
contamination
from
New
York
lakes
and
ponds.
Recreation
demand
models
also
have
been
used
in
the
context
of
forest
management
(
Englin
and
Mendelsohn,
1991;
Dwyer
et
al.,
1983),
the
ecological
effects
of
natural
resource
99
Chapter
7:
Benefits
damages
(
Hausman
et
al.,
1995;
Morey
and
Rowe,
1995),
health
risks
associated
with
fish
advisories
(
Jakus
et.
al.,
1997),
and
non­
point
source
pollution
controls
in
estuaries
(
Kaoru
et
al.,
1995).

Stated
preference
approaches:
As
discussed
earlier
stated
preference
methods
represent
the
only
means
of
obtaining
a
value
for
non­
use
benefits.
For
instance,
research
has
tried
to
measure
how
much
better
people
feel
that
various
wildlife
species
are
alive
and
well
(
Stevens
et
al.,
1991).
Individuals
have
also
expressed
a
willingness
to
pay
to
protect
visibility
in
national
parks,
whether
or
not
they
plan
to
visit
these
parks
(
Crocker
and
Shogren,
1991).
Contingent
valuation
has
been
applied
to
the
other
ecological
benefit
categories
as
well.
EPA
has
regularly
used
the
results
of
one
such
study
to
value
water
quality
improvements
in
fresh
water
(
Mitchell
and
Carson,
1986b).

7.6.4
Materials
Damage
Market
methods
are
the
primary
technique
used
to
quantify
benefits
falling
in
this
category.
Materials
damages
can
include
changes
in
both
the
quantity
of
the
materials
and
in
the
quality.
Linking
changes
in
environmental
quality
with
the
provision
of
service
flows
from
materials
can
be
difficult
because
of
the
limited
understanding
of
the
physical
effects
(
e.
g.,
scientific
information),
the
timing
of
some
effects
(
e.
g.,
long­
term),
and
risk
responses
of
producers
and
consumers
of
these
service
flows.
When
feasible,
assessment
typically
involves
combining
the
output
of
an
environmental
model
with
stressor­
response
function
and/
or
price
information
to
estimate
the
impact
of
the
change
in
environmental
quality
on
production
(
inputs)
or
consumption
(
output)
of
the
material
service
flows.
The
market
response
to
this
impact
serves
as
the
basis
for
the
welfare
change
and
benefits
assessment.
In
practice,
these
market
methods
may
be
implemented
as
reduced
from
economic
models
that
relate
averting
or
mitigating
expenditures
to
ambient
pollutant
levels.
The
degree
to
which
behavioral
adjustments
are
considered
when
measuring
the
market
response
are
important
and
models
that
incorporate
behavioral
responses
are
preferred
to
those
that
do
not.
Refer
to
Adams
and
Crocker
(
1991)
for
a
detailed
discussion
of
this
and
other
features
of
materials­
damagesbenefits
assessment.
See
the
analysis
of
household
soiling
in
EPA
(
1997b)
for
an
example
that
employs
a
reduced
form
economic
model
relating
defensive
expenditures
to
ambient
pollutant
levels.

100
Chapter
7:
Benefits
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297­
317.

Viscusi,
W.
K.
and
C.
J.
O'Connor.
1984.
Adaptive
Responses
to
Chemical
Labeling:
Are
Workers
Bayesian
Decision
Makers?
The
American
Economic
Review
74(
5):
942­
956.

Walsh,
R.,
D.
Johnson,
and
J.
McKean.
1992.
Benefit
Transfer
of
Outdoor
Recreation
Demand
Studies,
1968­
1988.
Water
Resources
Research
28(
3):
707­
713.

Wang,
S.
D.
H.
and
C.
Kellogg.
1988.
An
Econometric
Model
for
American
Lobster.
Marine
Resource
Economics
5:
61­
70.

Water
Resources
Research.
March,
1992.
(
Entire
issue
devoted
to
benefit
transfer)
28(
3).

Willig,
R.
1976.
Consumer's
Surplus
Without
Apology.
American
Economic
Review,
September.
66(
4):
589­
597.

112
Chapter
7:
Benefits
8.1
Introduction
The
goal
of
a
benefit­
cost
analysis
is
to
determine
the
net
change
in
social
welfare
brought
about
by
a
new
environmental
policy,
as
measured
by
changes
in
the
producer
and
consumer
surpluses.
In
general,
the
economic
effects
of
a
new
environmental
policy
result
in
many
different
people
and
firms
being
affected,
both
positively
and
negatively.
The
previous
chapter
looked
at
the
positive
effects
(
or
social
benefits
This
chapter
considers
the
negative
effects
(
or
social
costs).
It
is
the
sum
of
these
changes,
when
combined
with
the
social
benefits,
that
yield
a
measure
of
the
net
changes
in
social
welfare.

As
with
social
benefits,
when
computing
the
social
cost
of
a
policy
(
i.
e.,
the
negative
impact
on
social
welfare),
monetary
sums
that
measure
changes
in
individuals'
welfare
are
all
weighted
equally
in
benefit
cost
analysis.
Other
methods
for
evaluating
the
welfare
consequences
of
policies
on
particular
individuals
groups,
or
sectors
should
be
examined
using
either
economic
impact
analysis,
equity
assessment
techniques,
or
social
welfare
functions
(
all
described
in
Chapter
9).

This
chapter
is
organized
into
four
major
sections
followed
by
a
concluding
section.
Section
8.2
reviews
the
theoretical
foundations
of
social
cost
estimation
for
environmental
policies.
Section
8.3
discusses
how
to
estimate
and
model
total
social
cost.
1
Next,
four
types
of
models
for
estimating
social
cost
are
examined
in
Section
8.4.
Then
the
estimation
of
the
costs
of
specific
regulatory
approaches
is
reviewed
in
Section
8.5.
Finally,
Section
8.6
provides
a
discussion
of
the
choice
of
tools
for
each
type
of
policy
.
8.2
The
Theory
of
Social
Cost
Analysis
The
total
social
cost
is
the
sum
of
the
opportunity
costs
incurred
by
society
because
of
a
new
regulatory
policy;
the
opportunity
costs
are
the
value
of
the
goods
and
services
lost
by
society
resulting
from
the
use
of
resources
to
comply
with
and
implement
the
regulation,
and
from
reductions
in
output.
These
costs,
however,
do
not
take
into
account
any
of
the
health,
environmental,
safety,
or
other
benefits
which
offset
the
social
welfare
costs.

The
five
basic
components
of
total
social
costs
are
listed
here
in
the
general
order
of
relative
ease
of
estimation,
and
hence
inclusion,
in
most
social
cost
analyses
of
environmental
policies.
They
include:

Real­
resource
compliance
costs:
These
direct
costs
are
the
principal
component
of
total
social
costs
and
are
associated
with:
(
1)
purchasing
installing,
and
operating
new
pollution
control
equipment,
(
2)
changing
the
production
process
by
using
different
inputs
or
different
mixtures
of
inputs,
or
(
3)
capturing
the
waste
products
and
selling
or
reusing
them.
(
The
last
two
options
can
actually
result
in
negative
compliance
costs.)

These
real­
resource
costs
should
also
include
unpriced
resources
that
have
opportunity
costs
associated
with
them,
such
as
unpaid
labor
diverted
from
other
productive
uses,
and
extra
administrative
costs
associated
with
compliance.
However,
the
pre­
tax
compliance
costs
do
not
include
any
transfers,
such
as
emissions
taxes,
licensing
fees,
or
subsidies
(
which
are
included
in
the
firm's
private
costs).

113
Chapter
8
Chapter
8:
Analyzing
Social
Costs
1
Several
texts
on
applied
microeconomics
and
policy
evaluation
provide
substantially
more
theoretical
depth
and
examples
than
the
overview
presented
in
this
chapter,
such
as
Arnold
(
1995),
Gramlich
(
1981),
and
Just
et
al.
(
1982).
Government
regulatory
costs:
These
include
the
monitoring,
administrative,
and
enforcement
costs
associated
with
new
regulations.
This
also
includes
the
cost
of
setting
up
a
new
market
when
incentivebased
regulations
are
established,
such
as
tradable
permits.

Social
welfare
losses:
These
are
the
losses
in
consumer
and
producer
surpluses
associated
with
the
rise
in
the
price
(
or
decreases
in
the
output)
of
goods
and
services
that
occurs
as
a
result
of
an
environmental
policy.

Transitional
costs:
These
include
the
value
of
resources
that
are
displaced
because
of
regulationinduced
reductions
in
production,
and
the
private
real­
resource
costs
of
reallocating
those
resources.
Offsetting
these
costs,
in
theory,
are
regulationinduced
increases
in
resource
use
in
both
primary
and
related
markets
(
e.
g.,
more
workers
and
equipment
are
needed
for
pollution
control).

Indirect
costs:
These
other
costs
include
the
adverse
effects
policies
may
have
on
product
quality,
productivity,
innovation,
and
changes
in
markets
indirectly
affected
by
the
environmental
policy,
all
of
which
may
have
impacts
on
net
levels
of
measured
consumer
and
producer
surplus.
8.2.1
An
Illustration
of
Social
Costs
and
Externalities
Exhibit
8­
1
illustrates
an
externality
(
pollution)
associated
with
the
production
of
a
good
or
service
(
Q).
In
this
figure:

MR
is
marginal
revenue
from
selling
the
good;

MPC
is
the
marginal
private
real­
resource
cost
of
production;

MSD
is
the
marginal
social
damage
from
pollution
associated
with
production;
and
MSC
is
the
total
marginal
social
cost
of
supplying
the
good.

The
producer
operates
where
marginal
revenue
(
MR)
equals
marginal
private
real­
resource
costs
(
MPC),
so
it
produces
Q1
items
at
a
price
of
P1
per
item.
In
this
example
the
producer
also
is
assumed
to
impose
a
social
cost
on
society
due
to
pollution
associated
with
its
production
of
Q.
Here
the
actual
pre­
policy
total
social
cost
of
supplying
the
good
is
measured
by
the
marginal
private
realresource
cost
(
MPC)
plus
the
marginal
social
damage
(
MSD,
also
known
as
an
externality)
caused
by
pollution.
Together
the
MPC
plus
the
MSD
gives
the
true
marginal
social
cost
(
MSC)
of
supplying
the
good.

114
Chapter
8:
Social
Costs
Price
P4
P*

P1
P2
P3
0
Q*
Q
1
Quantity
DWL
MSD
MPC
MSC
F
E
G
H
MR
Exhibit
8­
1
Producer
and
Consumer
Surplus
with
an
External
Cost
The
producer
surplus
is
indicated
by
the
area
of
triangle
P1GP3
and
the
consumer
surplus
is
measured
as
the
area
of
triangle
P1GP4,
but
the
total
social
damage
is
indicated
by
the
area
of
P3GF
P2.
Therefore,
the
deadweight
loss
to
society
(
DWL)
is
equal
to
the
area
of
triangle
EFG.
If
producers
have
to
pay
for
the
damage
caused
by
the
pollution,
their
producer
surplus
is
reduced
to
area
of
triangle
P2HP1
minus
the
area
of
triangle
HGF.
In
this
case
the
firm
would
be
making
negative
profits
since
the
area
of
triangle
HGF
is
larger
than
their
producer
surplus.
Net
social
welfare
in
this
case
would
be
the
area
of
triangle
P2EP4
less
the
area
of
triangle
EFG
(
the
deadweight
loss).

If,
however,
the
optimal
amount
of
the
product
is
produced
(
i.
e.,
where
MR
equals
MSC),
then
the
firm's
output
is
Q*
at
a
price
of
P*.
In
this
case,
consumer
surplus
is
equal
to
the
area
of
triangle
P4EP*
and
producer
surplus
is
the
area
of
triangle
P2EP*.
Since
there
is
no
deadweight
loss
to
society,
net
social
welfare
has
increased
and
is
equal
to
the
area
of
triangle
P2EP4.

Suppose
that
producers
can
do
nothing
to
reduce
the
pollution
damages
other
than
decrease
the
amount
of
output
supplied.
If
the
government
places
a
tax
equal
to
the
MSD
on
each
unit
of
pollution,
this
would
increase
private
production
costs
(
but
not
private
real­
resource
costs)
by
the
amount
of
the
MSD,
which
would
cause
a
rise
in
consumer
(
taxpayer)
welfare.
This
occurs
because
of
the
reduction
in
adverse
health
effects.
Depending
on
the
revenue
policy
of
the
government,
it
could
lead
to
a
possible
reduction
in
consumer
taxes,
since
producers
are
now
paying
an
additional
tax
(
the
double­
dividend
hypothesis,
which
is
described
in
greater
detail
later
in
this
chapter).
Although
there
is
a
decrease
in
the
producer
surplus
(
and
the
obvious
consumer
surplus),
the
overall
social
welfare
has
increased
because
of
the
reduction
in
the
externality
costs.
2
Adding
all
of
these
surplus
changes
together,
and
subtracting
the
transfers
to
the
government
(
i.
e.,
taxes),
yields
the
net
social
cost
of
the
policy.

If
instead
of
an
emissions
tax,
a
firm
is
required
to
install
pollution
control
devices,
the
private
compliance
costs
will
raise
the
firm's
supply
curve
(
or
MPC)
up
by
the
amount
spent
on
the
new
equipment.
Under
a
permit
system,
where
a
set
number
of
permits
are
issued
for
each
unit
of
pollution,
and
firms
are
allowed
to
buy
and
sell
these
permits
then
each
firm
will
consider
buying
permits
if
the
private
cost
of
a
permit
is
less
than
the
unit
cost
of
reducing
pollution.
Conversely,
a
firm
that
can
reduce
its
pollution
by
less
than
the
cost
of
a
permit
will
consider
selling
its
"
extra"
permits.
In
both
cases,
the
firms'
MPC
curves
will
shift
up
by
the
price
of
the
permits,
just
as
it
did
in
the
case
of
an
emissions
tax.

8.3
A
General
Approach
to
Social
Cost
Analysis
The
challenge
in
developing
an
estimate
of
the
social
cost
of
an
environmental
policy
is
to
consider
the
market(
s)
being
affected
by
the
policy,
assess
the
available
data
and
analytic
methods,
and
adopt
an
analytic
approach
that
will
yield
an
estimate
suitable
for
use
in
the
benefit­
cost
analysis
An
important
requirement
in
measuring
social
costs
is
to
characterize
the
supply
and
demand
equations
of
the
regulated
market
or
behavior.
This
section
briefly
reviews
the
estimation
of
supply
and
demand
equations
and
their
relevance
to
social
cost,
but
concentrates
on
the
variety
of
social
costs
that
may
be
encountered
from
different
types
of
environmental
policies:
(
1)
direct
social
costs,
(
2)
transitional
costs,
and
(
3)
indirect
costs.
Finally,
some
other
issues
that
arise
in
characterizing
and
presenting
social
costs
are
examined,
including
discounting,
difficulties
in
monetizing
costs,
consideration
of
sensitivity
analyses,
and
simplifying
market
effects.

8.3.1
Estimating
the
Supply
and
Demand
Equations
of
All
the
Affected
Markets
Empirical
estimates
of
the
supply
and
demand
curves
for
each
market
are
usually
needed
to
calculate
the
social
costs
of
proposed
regulations
and
policies.
In
addition
to
private
sources,
government
reports
and
academic
studies
can
provide
useful
information
needed
to
estimate
the
115
Chapter
8:
Social
Costs
2
If
the
regulation
causes
social
costs
to
be
greater
than
the
MSD,
then
net
social
welfare
may
actually
fall
because
of
the
new
regulation;
one
cause
being
the
diversion
of
investment
capital
to
excess
pollution
control
and
away
from
its
highest
valued
use.
Chapter
8:
Social
Costs
116
supply
and
demand
equations.
3
Solving
these
equations
will
yield
equilibrium
quantities
and
prices
in
each
market
that
approximate
the
baseline
figures.

In
most
situations,
the
supply
and
demand
functions
can
be
derived
based
on
engineering
cost
estimates.
For
example
a
step­
function
demand
curve
for
a
particular
good
can
be
computed
based
on
the
prices
at
which
various
segments
of
the
market
will
turn
to
substitute
goods.
This
technique
is
relatively
more
successful
for
products
that
are
used
as
inputs
to
other
processes
and
consumer
goods
that
have
well­
defined
alternatives.
Similarly,
an
estimate
of
producer
surplus
can
be
derived
based
on
the
value
of
plant
and
equipment
dedicated
to
supplying
a
particular
good,
and
the
ease
or
difficulty
with
which
this
capital
can
be
deployed
in
other
markets
to
supply
different
goods.
In
the
long
run,
the
supply
curve
is
often
assumed
to
be
horizontal

Information
on
the
elasticity
of
demand
is
available
for
the
aggregate
output
of
most
industries.
When
such
information
is
unavailable,
as
is
often
the
case
for
intermediate
goods,
the
elasticity
of
demand
may
be
quantitatively
or
qualitatively
assessed.
Econometric
techniques,
such
as
multiple
regression,
can
be
used
to
estimate
a
demand
curve
when
sufficient
data
are
available.
For
example,
when
dealing
with
intermediate
products,
econometric
models
can
be
constructed
using
engineering
cost
data
to
estimate
both
the
supply
and
demand
curves.
In
general,
econometric
tools
are
frequently
used
to
estimate
supply
and
demand
equations
and
the
factors
that
influence
them.

Information
on
the
availability
of
product
or
service
substitutes
the
impact
of
price
increases
on
final
goods
(
where
the
product
or
service
is
an
intermediate
good),
the
amount
of
a
person's
income
devoted
to
the
good
or
service
and
the
necessity
of
the
final
product
or
service
can
be
used
to
qualitatively
assess
demand
elasticities.
The
estimate
selected
for
the
point
elasticity
should
be
consistent
with
the
equilibrium
point
(
the
time
allowed
for
adjustments
to
occur)
used
in
the
analysis.
Estimating
the
equations
that
govern
market
supply
and
demand
may
be
time
and
resource
intensive,
in
addition
to
the
formidable
tasks
of
developing
the
means
to
structure
and
compute
the
considered
models.
While
many
types
of
markets
have
been
researched
in
detail
by
the
academic
community,
others
may
be
too
new
to
have
much
information
available.
It
may
be
difficult
to
obtain
data
from
the
affected
firms
or
industries
because
of
confidentiality
provisions
or
the
proprietary
nature
of
some
data
and
models.
Achieving
sufficiently
reliable
results
will
often
depend
on
the
quality
of
the
data,
and
overcoming
problems
with
data
will
be
a
primary
hurdle
in
many
social
cost
analyses.

8.3.1.1
Definition
of
Elasticities
In
general,
economists
use
the
term
"
elasticity"
to
refer
to
the
sensitivity
of
one
variable
to
changes
in
another
variable
4
The
price
elasticity
of
demand
(
or
supply)
refers
to
changes
in
the
quantity
demanded
(
or
supplied)
that
would
result
from
a
change
in
the
price
of
a
good
or
service
Changes
are
measured
assuming
all
other
things,
such
as
incomes
and
tastes,
remain
constant.
Demand
and
supply
elasticities
are
rarely
constant
and
often
change
depending
on
the
quantity
of
the
good.
Therefore,
when
calculating
elasticities,
it
is
important
to
state
the
price
and
quantity
of
the
good.

"
Elastic"
demand
(
or
supply)
indicates
that
a
small
percentage
increase
in
price
results
in
a
larger
percentage
decrease
in
quantity
demanded
(
or
supplied).
How
much
of
the
price
increase
that
will
be
passed
on
to
consumers
is
determined
by
the
elasticity
of
demand
relative
to
supply
(
as
well
as
the
degree
of
competition
within
the
industry
and
existing
price
controls).
All
other
things
equal,
an
industry
facing
a
relatively
elastic
demand
is
less
likely
to
pass
on
costs
to
the
consumer
because
increasing
prices
will
result
in
reduced
revenues.

3
Sources
can
include
trade
publications,
financial
studies,
and
data
collected
through
surveys
administered
in
support
of
the
regulation
(
e.
g.,
Section
308
surveys
administered
under
the
Clean
Water
Act
for
promulgation
of
effluent
discharge
limitations).
Government
agencies
and
the
private
sector
also
publish
data
and
studies
on
the
economic
activity
of
the
public
and
private
sector
and
households.
A
more
complete
listing
of
examples
is
provided
in
Exhibit
9­
3
on
sources
used
to
prepare
economic
profiles
of
industries.
Additional
illustrations
can
be
found
in
existing
EPA
economic
reports,
several
of
which
are
referenced
later
in
this
chapter.

4
Own
price
elasticity
of
demand
is
defined
as
the
percentage
change
in
quantity
demanded
divided
by
the
percentage
change
in
price.
Own
price
elasticity
of
supply
is
defined
as
the
ratio
of
the
percentage
change
in
quantity
supplied
divided
by
the
percentage
change
in
price.
8.3.1.2
Determinants
of
Demand
Elasticity
Among
the
many
variables
that
affect
the
elasticity
of
demand
are:
(
1)
the
availability
of
close
substitutes,
(
2)
the
percentage
of
income
a
consumer
spends
on
the
good,
(
3)
how
necessary
the
good
is
for
the
consumer,
(
4)
the
amount
of
time
available
to
the
consumer
to
locate
substitutes
(
5)
the
level
of
aggregation
used
in
the
study,
and
(
6)
the
expected
future
price
of
the
good.
In
this
section,
only
the
first
four
will
be
discussed.

The
availability
of
close
substitutes
is
one
of
the
most
important
factors
that
determine
demand
elasticities.
A
product
with
close
substitutes
tends
to
have
an
elastic
demand,
because
consumers
can
readily
switch
to
substitutes
rather
than
paying
a
higher
price.
Therefore,
a
company
is
less
likely
to
be
able
to
pass
through
costs
if
there
are
many
close
substitutes
for
its
product.

Whether
the
affected
product
represents
a
substantial
or
necessary
portion
of
customers'
costs
or
budgets
is
another
factor
that
affects
demand
elasticities.
When
price
increases
occur
for
products
that
represent
a
substantial
portion
of
downstream
producers'
costs
or
consumers'
budgets,
these
producers
or
consumers
may
be
more
likely
to
seek
alternatives.
Where
the
product
subject
to
the
price
increase
is
less
important
in
customers'
budgets,
customers
may
be
less
motivated
to
use
substitutes
(
even
if
they
are
available)
or
to
forego
consumption
entirely.
A
similar
issue
concerns
the
type
of
final
good
involved.
Reductions
in
demand
may
be
more
likely
to
occur
when
prices
increase
for
"
luxuries"
or
optional
purchases
than
for
basic
requirements.

The
time
frame
considered
is
a
third
important
factor
in
determining
elasticity.
Elasticities
tend
to
increase
over
time,
as
firms
and
customers
have
more
time
to
respond
to
changes
in
prices.
A
company
facing
an
inelastic
demand
curve
in
the
short
run
may
experience
greater
losses
in
demand
in
the
long
run,
as
customers
have
time
to
make
adjustments
that
allow
use
of
substitutes
or
as
new
substitutes
are
developed.
It
is
important
to
keep
in
mind
that
elasticities
differ
at
the
firm
versus
the
industry
level.
For
example,
if
twenty
companies
are
producing
pesticide
formulations
that
are
equally
effective,
each
firm
may
face
an
elastic
demand
curve
because
of
competition
within
the
industry,
although
the
industry
as
a
whole
may
face
an
inelastic
demand
curve
for
its
products
as
a
group.
In
this
example,
it
would
not
be
appropriate
to
use
an
industry­
level
elasticity
to
estimate
the
ability
of
only
one
firm
to
pass
on
compliance
costs
when
its
competitors
are
not
subject
to
the
same
costs.

8.3.1.3
Determinants
of
Supply
Elasticities
The
elasticity
of
supply
depends,
in
part,
on
how
quickly
costs
per
unit
rise
as
firms
increase
their
output.
Among
the
many
variables
that
influence
this
rise
in
cost
are:

the
availability
of
close
input
substitutes;

the
amount
of
time
available
to
adjust
production
to
changing
conditions;

the
degree
of
market
concentration
among
producers;

the
expected
future
price
of
the
product;

the
price
of
related
inputs
and
related
outputs;
and
the
speed
of
technological
advances
in
production
that
can
lower
costs.

Supply
elasticities
will
tend
to
increase
over
time
as
firms
have
more
opportunities
to
renegotiate
contracts
and
change
production
technologies.

Characteristics
of
supply
in
the
industries
affected
by
a
regulation
can
be
as
important
as
demand
characteristics
in
determining
the
economic
impacts
of
a
rule.
For
highly
elastic
supply
curves,
it
is
likely
that
costs
will
be
passed
through
to
consumers.
The
main
determinants
of
industry
supply
curves
are
the
structure
of
costs
and
the
time
period
of
the
analysis.
Industry
supply
curves
are
defined
as
the
aggregation
of
the
supply
curves
of
individual
firms
within
an
industry.

If
detailed
financial
profiles
of
individual
establishments
or
categories
of
establishments
and
production
data
are
available
they
can
be
used
to
define
an
industry
supply
curve.
Explicit
information
on
the
cost
structure
of
an
industry
is
117
Chapter
8:
Social
Costs
very
useful
in
predicting
impacts
more
precisely
than
is
possible
using
industry
average
data.
A
given
firm
may
experience
significant
impacts
if
it
is
already
a
relatively
high
cost
producer.
Such
firms
would
be
more
vulnerable
to
closure
if
subjected
to
high
compliance
costs.

8.3.1.4
Obtaining
Supply
and
Demand
Elasticities
Elasticity
estimates
may
be
obtained
from
existing
literature
or
from
original
research.
The
use
of
published
estimates
avoids
the
time
and
expense
of
gathering
the
necessary
data.
Sources
for
published
estimates
include
previous
agency
rule
makings
or
relevant
studies
found
in
the
economics
literature.
The
analyst
will
have
to
employ
careful
judgement
in
deciding
whether
and
how
to
use
elasticity
estimates
from
previous
studies.
Estimates
should
be
drawn
from
studies
based
on:

similar
market
structure
and
level
of
aggregation;

sensitivity
to
potential
differences
in
regional
elasticity
estimates;

current
economic
conditions;
and
appropriate
time
horizon
(
i.
e.,
short
or
long
run).

This
is
not
an
exhaustive
list
of
issues
which
must
be
considered
in
applying
existing
estimates
to
new
analyses.
There
are
a
number
of
statistical
and
technical
issues
that
may
influence
the
quality
of
elasticity
estimates.
Relevant
texts
cited
below
should
be
consulted
and
technical
assistance
sought
when
necessary.

New
or
original
estimates
of
elasticities
are
derived
from
demand
and
supply
functions
for
goods
or
services
that
have
been
estimated
using
econometric
methods.
Econometrics
is
the
use
of
statistical
analysis
in
applied
economic
research.
For
example,
the
demand
for
a
good
or
service
is
often
estimated
as
a
function
of
its
price,
the
price
of
related
goods
(
substitutes
and
complements),
consumer
demographic
characteristics,
as
well
as
variables
that
may
represent
institutional
or
technological
characteristics
of
a
market.
Supply
and
demand
elasticities
may
be
derived
from
a
variety
of
functional
forms
that
embody
various
assumptions
about
the
relationships
between
the
data.
Methods
of
calculating
elasticity
estimates
differ
according
to
the
specification
of
the
function.
The
analyst
should
consult
relevant
texts
and
seek
technical
assistance.

The
availability
of
sufficient
data,
both
in
terms
of
quantity
and
quality,
is
the
first
threshold
that
determines
whether
econometric
tools
can
be
used.
Only
with
sufficient
data
can
elasticity
estimates
be
considered
reliable.
The
analyst
should
carefully
document
data
sources.
Once
the
decision
to
employ
econometrics
is
made,
there
are
a
number
of
issues
which
the
analyst
must
address,
including
the
choice
of
an
appropriate
modeling
technique,
proper
functional
form,
and
ensuring
that
the
mathematical
properties
required
for
the
chosen
technique
to
yield
proper
results
are
achieved.
For
example,
ordinary
least
squares
(
OLS)
requires
that:

values
of
independent
variables
are
non­
stochastic
or
fixed;

expected
mean
value
of
the
error
term
is
zero;

expected
value
of
the
variance
of
the
error
term
is
constant;

no
correlation
exists
between
error
terms;
and
no
correlation
exists
between
error
terms
and
independent
variables.

If
any
of
these
conditions
are
violated,
the
analyst
will
have
to
make
a
corrective
adjustment
to
the
OLS
or
consider
an
alternative
econometric
technique.
For
example,
if
one
of
the
independent
variables
is
endogenous,
the
first
and
last
condition
will
be
violated,
resulting
in
a
biased
and
inefficient
coefficient
estimate.
In
the
context
of
estimating
a
demand
function,
the
price
variable
is
likely
to
be
endogenous
which
would
render
the
coefficient
estimate
and
derived
elasticity
incorrect.
A
method
known
as
two­
stage
least
squares
(
TSLS)
represents
one
means
of
accounting
for
endogeneity.
The
number
of
potential
econometric
approaches,
mathematical
requirements,
and
corrective
measures
is
beyond
the
scope
of
this
guidance
document.
Analysts
should
consult
relevant
texts
for
a
more
thorough
discussion
of
all
of
these
issues.
5
118
Chapter
8:
Social
Costs
5
For
detailed
review
of
econometric
modeling
and
technical
issues
see
Greene
(
1996),
Maddala
(
1992),
or
Pindyck
and
Rubinfeld
(
1991).
Kennedy
(
1998)
provides
a
more
intuitive
discussion
in
the
main
text
with
detailed
technical
notes
provided
in
appendices.
8.3.1.5
Uses
and
Substitutes
Analysis
A
"
Uses
and
Substitutes
Analysis"
may
provide
useful
information
on
the
characteristics
of
demand
as
a
supplement
to
or
substitute
for
elasticity
estimates.
6
This
is
"...
an
indepth
examination
of
each
significant
use
of
the
substance
in
question,
and
an
assessment
of
the
costs,
performance,
and
useful
life
of
substitutes,
on
a
product­
by­
product
basis."
7
A
"
Uses
and
Substitutes
Analysis"
includes
four
steps:

1)
define
markets
and
segments
of
markets
that
are
relatively
homogeneous;

2)
assess
the
cost
and
performance
characteristics
of
the
products
in
question;

3)
identify
the
most
appropriate
substitutes;
and
4)
estimate
the
incremental
costs
and
performance
characteristics
of
the
substitutes
in
each
specific
application.

The
results
of
the
analysis
can
then
be
used
to
generate
demand
functions,
based
on
the
price
at
which
substitute
products
become
economical
for
different
uses.
This
analysis
can
be
time
and
information
intensive
and
may
produce
relatively
crude
results.
It
is
nonetheless
a
useful
alternative
to
estimating
demand
functions
when
elasticities
are
not
available.

8.3.2
Determining
the
Different
Types
of
Social
Costs
Having
established
measures
of
supply
and
demand,
the
analysis
then
considers
how
equilibrium
price
and
quantities
will
change
from
measured
baseline
conditions.
Social
cost
changes
in
each
of
the
affected
markets
are
assessed
by
examining
the
direct,
indirect,
and
transitional
effects
that
occur
as
a
result
of
the
new
policy.
The
types
of
social
costs
that
need
to
be
examined
to
determine
how
the
supply
and
demand
equations
change
are
summarized
with
examples
in
Exhibit
8­
2.
A
short
description
of
direct
costs,
which
include
private
and
public
compliance
costs,
government
regulatory
costs,
and
other
types
of
social
costs,
is
presented.
Other
social
costs
less
routinely
included
in
empirical
analyses
of
social
costs,
including
indirect
costs
and
the
transitional
costs,
are
then
reviewed.

8.3.2.1
Direct
Social
Costs
The
direct
social
costs
of
a
new
environmental
policy
arise
from:
(
1)
changes
in
the
private
real­
resource
compliance
costs,
(
2)
additional
government
regulatory
costs,
(
3)
social
welfare
losses,
and
(
4)
transitional
social
costs.
The
largest
fraction
of
direct
social
costs
arises
from
the
realresource
compliance
costs
due
to
the
new
regulation.
These
new
compliance
costs
arise
from
the
installation,
operation,
and
maintenance
of
new
capital
equipment,
or
are
a
result
of
changes
in
the
production
process
that
raise
the
price
of
producing
the
good.

The
additional
compliance
costs
can
be
used
to
estimate
the
new
equilibrium
price
and
quantity
in
the
affected
markets
which
will
change
social
welfare.
However,
these
changes
will
affect
other
markets,
resulting
in
further
price
and
quantity
changes
in
other
goods,
giving
rise
to
additional
changes
in
social
welfare.
The
significance
of
the
changes
in
other
markets
will
influence
the
type
of
model
necessary
for
the
economic
analysis
(
see
Section
8.4,
"
Modeling
Tools").
Changes
in
social
welfare
also
result
from
increased
government
regulatory
costs
and
transitional
costs
from
plant
closures
and
unemployment.

Private
real­
resource
compliance
costs
can
arise
from:
(
1)
the
capital
costs
associated
with
the
purchase,
installation,
operation,
and
maintenance
of
new
pollution
control
equipment,
(
2)
changes
in
the
inputs
or
mixtures
used
in
the
production
process,
or
(
3)
the
capture
of
waste
products
that
can
either
be
disposed
of,
sold,
or
reused.

Real­
resource
costs
are
theoretically
straightforward
to
calculate
if
they
arise
from
the
purchase
of
new
pollution
control
equipment.
For
example,
having
information
on
the
number
of
factories
and
the
price
of
purchasing
and
operating
new
equipment
required
to
meet
a
policy
would
provide
a
means
of
estimating
the
compliance
costs
for
the
industry.
However,
since
all
factories
are
not
identical,
costs
may
be
estimated
based
on
cost
studies
of
representative
factories
119
Chapter
8:
Social
Costs
6
Uses
and
substitutes
analysis
is
described
in
Arnold
(
1995).

7
Ibid.,
p.
21.
chosen
by
random
sampling
procedures,
which
can
be
extrapolated
to
the
universe
of
affected
factories.

Additional
costs
involve
the
operating
expenses,
maintenance
and
training
associated
with
the
new
equipment
Further
costs
may
occur
from
maintenance
changes
in
other
equipment.
Also,
additional
administrative
costs
may
be
associated
with
obtaining
permits
and
preparing
required
monitoring
reports.
8
In
the
two
other
methods
of
compliance,
the
private
costs
may
actually
be
negative
and
thus
need
to
be
included
for
an
accurate
estimate
of
social
costs.
When
waste
products
are
captured
and
then
disposed
of,
sold,
or
reused,
the
cost
calculation
is
also
straightforward.
Disposal
charges
are
easily
determined
and
the
selling
price
of
the
waste
product
(
if
it
is
used
as
an
input
for
other
goods)
can
also
be
obtained.
However,
if
the
production
process
is
changed
so
that
different
inputs
are
used
or
the
mixture
of
the
inputs
is
altered,
the
costs
involved
will
be
difficult
to
determine
before
the
change
takes
place.
In
addition,
the
changes
may
be
considered
proprietary
information.

Government
regulatory
costs
are
incurred
by
federal,
state,
or
local
governments
to
administer
and
enforce
new
policies.
Government
regulatory
costs
include:
administration,
training,
monitoring/
reporting
(
if
they
are
not
included
in
compliance
costs),
enforcement,
litigation,
and
the
cost
of
developing
and
distributing
permits.
These
incremental
costs
must
be
financed
through
additional
taxation
or
other
governmental
financing
mechanisms.

Because
they
are
hard
to
translate
into
producer
and
consumer
surplus
terms,
governmental
administration
and
enforcement
costs
are
typically
examined
in
terms
of
their
dollar
costs
and
staffing
requirements
(
expressed
as
full­
time
equivalent
employment
(
FTEs)).
Ultimately,
these
costs
are
borne
by
taxpayers
unless
other
administrative
costs
are
reduced
to
accommodate
a
new
policy.
Since
government
costs
are
usually
small
compared
to
the
explicit
compliance
costs,
they
are
not
usually
included
in
partial
120
Chapter
8:
Social
Costs
8
A
good
recent
illustration
of
the
measurement
of
compliance
costs
can
be
found
in
EPA
(
1997),
Economic
Analysis
for
the
NESHAPS
for
Source
Categories:
Pulp
&
Paper
Production;
Effluent
Limitations
Guidelines,
Pretreatment
Standards:
Pulp,
Paper,
and
Paperboard
Category,
Phase
I.
For
useful
empirical
presentations
on
engineering
approaches,
see
Vatavuk
(
1990)
for
air
pollution
controls
and
EPA
(
1984)
for
a
wider
variety
of
pollution
control
technologies.
Social
Cost
Category
Examples
Real­
resource
Compliance
Costs
°
Capital
costs
of
new
equipment
°
Operation
and
maintenance
of
new
equipment
°
Waste
capture
and
disposal,
selling,
or
reuse
°
Change
in
production
processes
or
inputs
°
Maintenance
changes
in
other
equipment
Government
Sector
Regulatory
Costs
°
Training/
administration
°
Monitoring/
reporting
°
Enforcement/
litigation
°
Permitting
Social
Welfare
Losses
°
Higher
consumer
and
producer
prices
°
Legal/
administrative
costs
Transitional
Social
Costs
°
Unemployment
°
Firm
closings
°
Resource
shifts
to
other
markets
°
Transaction
costs
°
Disrupted
production
Source:
Adapted
from
Harrington
et
al.
(
1999).
Exhibit
8­
2
Examples
of
Social
Cost
Categories
equilibrium
models.
However,
if
they
are
significant,
they
should
be
estimated
separately
and
added
to
the
surplus­
based
social
cost
estimates.

Monitoring
and
enforcement
costs,
incurred
by
the
government,
can
be
either
(
1)
the
opportunity
costs
of
other
activities
that
are
discontinued
because
of
fixed
government
budgets,
or
(
2)
the
private
costs
imposed
on
taxpayers
to
support
the
increased
government
expenditure
necessary
for
the
program.
The
costs
of
government
monitoring
and
enforcement
efforts
are
normally
based
on
the
cost
of
necessary
administrative
activities.
9
Social
welfare
losses
occur
when
real­
resource
compliance
costs
result
in
higher
prices
for
the
good
or
service
and
when
additional
government
regulatory
costs
result
in
higher
taxes
passed
on
to
the
consumer.
New
regulations
may
lead
to
increased
legal
and
administrative
costs
for
the
government,
as
well
as
for
the
regulated
entities.
The
change
in
social
welfare
resulting
from
an
increase
in
taxes
or
fees
assessed
in
order
to
pay
for
government
regulatory
costs
will
typically
be
small
relative
to
social
welfare
losses
attributable
to
the
real­
resource
compliance
costs.

If
the
imposition
of
real­
resource
compliance
costs
leads
to
an
increase
in
the
price
of
the
good,
this
will
lead
consumers
to
either
buy
less
or
switch
to
substitutes
thereby
leading
to
a
fall
in
the
consumer
surplus
The
amount
of
the
private
costs
passed
through
to
the
consumer
is
determined
by
the
market
structure
and
the
elasticities
of
demand,
supply,
and
income.
Once
the
prices,
quantities,
and
elasticities
are
known,
the
process
of
calculating
changes
in
producer
and
consumer
surpluses
is
also
theoretically
straightforward.
10
Transitional
effects
vary
depending
on
the
length
of
the
time
period
examined;
therefore,
social
cost
analyses
should
be
explicit
about
the
time
frame
being
studied.
In
the
short
run,
the
private
annualized
costs
of
compliance,
both
for
consumers
and
producers,
will
be
higher
relative
to
the
annualized
long­
run
costs.
This
is
because
the
shortrun
analysis
will
not
provide
for
possible
adjustments
in
the
production
process,
or
allow
consumers
to
find
substitutes.
Some
workers
may
become
unemployed
in
the
short
run,
but
will
almost
certainly
find
other
jobs
in
the
long
run.

However,
over
time
the
impact
of
a
policy
can
easily
spread
out
to
a
variety
of
markets
and
result
in
a
number
of
unanticipated
adverse
effects.
Therefore,
it
is
not
always
appropriate
to
assume
that
social
costs
arising
in
the
short
run
as
a
consequence
of
transitional
effects
will
be
resolved
in
the
long
run.
For
EPA
economic
analyses,
the
four
transitional
effects
most
frequently
considered
include:
(
1)
plant
closings
and
resultant
unemployment,
(
2)
resources
shifting
to
other
markets,
(
3)
transactions
costs
associated
with
setting
up
incentive­
based
programs,
and
(
4)
disruptions
in
production.

Firm
closings
and
unemployment:
In
the
simplest
static
models,
the
time
frame
is
assumed
to
be
a
period
of
time
in
the
near
future
(
e.
g.,
the
first
year
after
a
new
policy
is
promulgated).
Surplus­
based
measures
of
social
cost
are
therefore
short­
run
estimates.
But
as
time
passes,
adjustments
are
likely
to
occur.
Workers
who
suffer
transitional
unemployment
will
usually
find
new
jobs,
and
new
plant
and
equipment
installed
in
the
future
might
require
relatively
less
costly
pollution
control.
These
long­
run
changes
should
be
considered
as
the
yearly
social
costs
of
a
policy
are
calculated
into
the
future.

In
most
cases,
involuntary
unemployment
and
plant
closings
are
consequences
that
are
difficult
to
model
using
a
conventional
partial
equilibrium
framework
(
which
will
be
discussed
in
the
following
section
on
modeling
tools).
Predicting
these
specific
consequences
would
require
far
more
detailed
analysis
and
data
than
are
usually
available
for
practical
assessments
Unemployment
rates
for
each
group
of
workers
the
duration
of
unemployment,
and
the
cost
of
job
training
programs
are
just
some
of
the
factors
that
121
Chapter
8:
Social
Costs
9
A
useful
illustration
of
the
measure
of
government
regulatory
costs
for
a
rule
can
by
found
in
EPA
(
1995a),
Economic
Analysis
of
the
Title
IV
Requirements
of
the
Clean
Air
Act
Amendments.

10
An
example
of
the
steps
taken
to
estimate
the
measurement
of
social
welfare
losses
from
a
rule
is
EPA
(
1998),
Economic
Analysis
of
Effluent
Limitation
Guidelines
and
Standards
for
the
Centralized
Waste
Treatment
Industry.
need
to
be
taken
into
account
when
estimating
how
the
transitional
costs
decline
over
time.

These
temporary
effects
are
typically
assessed
and
reported
as
part
of
an
"
economic
impact"
of
the
policy
and
are
incorporated
into
the
development
of
the
social
cost
section
of
an
economic
analysis.
Chapter
9
of
this
document
reviews
such
methods
to
assist
in
detecting
situations
in
which
a
policy's
private
costs
are
sufficiently
large
to
induce
social
costs
from
occurring
as
a
consequence
of
business
closures,
reduced
employment,
or
other
such
impacts.

Shifts
of
resources
to
other
markets:
These
shifts
occur
when
the
payments
to
factors
of
production
(
labor,
land,
and
capital)
are
reduced.
These
shifts
are
partly
responsible
for
the
decreased
output
level
of
the
product
or
service.
Those
that
remain
earn
less
than
before,
at
least
in
the
short
run,
which
is
reflected
in
the
lower
net
price
received
by
producers
for
the
good
or
service.
Some
of
the
resources
no
longer
employed
in
producing
this
good
or
service
might
even
become
unemployed
for
a
while,
such
as
labor,
or
be
permanently
and
prematurely
scrapped,
such
as
plant
and
equipment.
These
and
other
realworld
phenomena
can
change
the
position
and
slope
of
the
supply
functions
in
other
markets.
Likewise,
consumers
of
the
product
either
pay
more
for
the
same
good
or
purchase
substitutes
that
are
less
suitable
or
more
costly,
which
can
change
the
position
and
slope
of
several
demand
functions.
The
analysis
of
these
types
of
effects
is
also
treated
more
fully
in
Chapter
9.

Transaction
costs:
These
costs
are
encountered
with
incentive­
based
policies,
such
as
with
a
tradable
permits
program.
A
market
must
be
established
so
that
the
efficiency
gains
from
trading
permits
are
maximized
and
rules
for
trading
are
developed
that
enable
the
market
to
function
under
the
rules
of
perfect
competition.
Therefore,
initial
short­
run
costs
associated
with
setting
up
the
market
will
be
high,
but
are
expected
to
diminish
over
time
as
the
created
market
begins
to
function
with
less
government
oversight
The
private
cost
of
buying
and
selling
permits
will
then
become
similar
to
the
purchase
of
any
other
resource
needed
to
produce
a
good
or
service.
Disruptions
in
production:
This
may
take
place
when
new
equipment
is
installed
or
new
production
processes
or
inputs
are
applied.
These
costs
can
be
estimated
as
the
amount
of
time
the
production
line
is
stopped
or
slowed
down
to
allow
for
the
necessary
changes
to
comply
with
the
new
policy
regulations.
However,
if
the
changes
are
made
during
previously
scheduled
down­
time
or
required
maintenance,
then
downward
adjustments
should
be
made
to
the
estimated
costs
to
reflect
this.

To
conclude,
in
many
cases
transitional
costs
are
considered
to
be
small
enough
that
their
inclusion
in
the
overall
social
cost
estimate
would
not
appreciably
alter
the
quantitative
conclusions.
However,
when
these
are
expected
to
be
significant,
the
costs
should
be
estimated.
For
example,
lost
wages
and
job
search
costs
during
the
time
workers
are
unemployed
can
be
used
as
a
proxy
for
this
transitional
social
cost.
Similarly,
the
value
of
prematurely
retired
plant
and
equipment
can
be
calculated
and
added
to
the
surplus­
based
social
cost
estimates
to
capture
this
transitional
effect,
as
long
as
this
is
not
reflected
already
in
the
supply
and
demand
framework.

8.3.2.2
General
Equilibrium
(
Indirect)
Effects
Other
possible
components
of
social
costs,
such
as
effects
on
product
quality,
productivity,
innovation,
and
market
structure,
can
require
fairly
complex
dynamic
models
to
quantify.
Although
most
individual
regulatory
policies
will
not
have
such
dramatic
effects,
these
costs
can
be
quite
significant
in
certain
instances,
such
as
when
a
policy's
requirements
delay
industrial
projects
or
affect
new
product
development.
Such
policy
effects
have
implications
for
future
social
costs
but
are
difficult
to
measure
and
express
in
social
cost
terms.
However,
an
effort
should
be
made
to
qualitatively
describe
these
factors
and
look
at
approaches
that
can
quantify
these
effects
when
data
and
resources
can
support
this
level
of
detailed
analysis
of
social
costs.

Changes
in
market
structure
may
occur
if
the
expense
of
pollution
control
is
sufficiently
high
that
it
drives
out
enough
firms
to
cause
changes
in
the
market
concentration
and
competitiveness
of
firms
remaining
in
the
industry.
Such
a
change
often
results
in
shifts
of
both
firm
and
industry
supply
curves,
which
can
lead
to
changes
in
output
and
122
Chapter
8:
Social
Costs
prices
in
several
markets
affecting
both
producer
and
consumer
surpluses.

Labor
and
capital
productivity
may
decrease
under
new
regulations.
For
example,
the
administrative
costs
of
monitoring
emissions
and
filing
reports
with
regulatory
agencies
may
require
firms
to
hire
more
workers
whose
labor
does
not
increase
productivity
(
as
measured
by
labor
employed
relative
to
produced
output).
Pollution
control
devices
or
restrictions
on
the
use
of
products
may
cause
lower
levels
of
output
relative
to
unconstrained
production
processes.
For
example,
placing
restrictions
on
pesticide
use
may
reduce
the
yield
of
crops
susceptible
to
pest
damage,
holding
other
factors
of
production
(
e.
g.,
labor,
fertilizer)
constant.
In
each
case,
however,
private
costs
are
captured
by
changes
in
the
supply
and
demand
curves
of
the
product,
and
therefore
care
should
be
taken
to
insure
that
social
costs
associated
with
productivity
losses
are
not
double
counted
with
other
social
cost
estimates.

Discouraged
investment
may
occur
if
research
and
development
funds
are
reallocated
to
meet
additional
compliance
costs.
This
may
result
in
decreases
in
technological
innovation
and
product
quality.
The
latter
can
be
modeled
as
the
reduced
amount
consumers
are
willing
to
pay
for
the
low
quality
good,
relative
to
what
they
were
willing
to
pay
for
the
original,
higher
quality
good.
In
practice,
changes
in
technological
innovations
are
not
commonly
analyzed
in
most
economic
models
used
in
benefit­
cost
analyses
of
individual
regulations
and
policies.

8.3.3
Other
Issues
Arising
in
Presentation
of
Social
Costs
Four
additional
issues
to
note
arise
in
the
organization
and
presentation
of
social
costs,
several
of
which
have
also
been
raised
earlier
in
this
document
in
connection
with
the
measurement
of
social
benefits.
These
issues
discussed
here
on
social
costs
include:
(
1)
discounting,
(
2)
difficulties
valuing
some
social
cost
categories,
(
3)
conducting
sensitivity
analyses,
and
(
4)
simplifying
market
effects.

Discounting:
Social
discounting
procedures
for
economic
analyses
are
reviewed
in
considerable
detail
in
Chapter
6.
For
purposes
of
computing
the
social
costs
of
environmental
policies,
costs
should
be
discounted
using
the
methods
and
social
discount
rates
discussed
in
that
chapter.
This
is
the
case
regardless
of
the
methods
used
to
estimate
social
costs.
Social
costs
can
be
estimated
in
detail
year­
byyear
or
estimated
using
growth
rates,
or
merely
assumed
to
be
constant.
These
streams
of
social
costs
can
then
be
adjusted
to
yield:
(
1)
discounted
present
value,
(
2)
future
value,
or
(
3)
the
annualized
cost
of
the
policy.
All
three
approaches
are
different
ways
to
express
the
same
concept
and
choosing
which
method
to
present
the
results
will
depend
on
the
method
that
most
effectively
allows
comparisons
among
the
options
and
the
measurement
of
net
benefits.
11
Difficulties
of
valuing
social
costs:
Some
consequences
of
environmental
policies
are
difficult
to
represent
in
the
definitive,
quantitative
terms
of
conventional
social
cost
analysis.
Irreversible
environmental
impacts,
substantial
changes
in
economic
opportunities
for
certain
segments
of
the
population,
social
costs
that
span
very
long
time
horizons,
socioeconomic
effects
on
communities,
and
poorly
understood
effects
on
large­
scale
ecosystems
are
difficult
to
summarize
in
a
quantitative
benefitcost
analysis.
Some
alternative
techniques
for
measuring
and
presenting
these
effects
to
policy
makers
are
reviewed
in
section
7.6.3
of
the
benefits
chapter
that
discusses
measuring
ecological
benefits.
The
relative
significance
of
social
cost
categories
that
are
not
quantified
 
or
are
quantified
but
not
valued
 
should
be
described
in
the
analysis.

Sensitivity
analysis:
The
estimates
in
the
social
cost
analysis
will
not
be
known
with
certainty.
In
fact,
some
data
and
models
will
likely
introduce
substantial
uncertainties
into
the
estimations
of
social
costs.
Numerous
assumptions
are
made
in
regard
to
123
Chapter
8:
Social
Costs
11
Many
EPA
analyses
typically
prepare
an
annualized
cost
estimate,
since
this
measure
is
one
of
several
used
to
determine
whether
rules
require
additional
review
and
oversight,
and
is
used
to
help
establish
the
scope
of
the
economic
analysis
to
be
conducted
(
e.
g.,
the
social
cost
threshold
of
$
100
million
in
annual
costs
is
used
to
identify
rules
that
require
a
benefit­
cost
analysis
under
the
provisions
of
EO
12866).
the
baseline,
predicting
responses
to
policy,
and
the
number
of
affected
markets.
Therefore,
the
conclusions
drawn
in
the
benefit­
cost
analysis
will
be
sensitive
to
the
degree
of
uncertainty
present
and
the
assumptions
that
were
made.
Reporting
the
uncertainty
of
the
data,
the
assumptions
used,
and
how
the
uncertainty
and
assumptions
affect
the
results
are
important
components
of
the
presentation
of
social
cost.
Section
5.5
outlines
the
process
of
analyzing
and
presenting
uncertainty.

Simplifying
market
effects:
Given
the
complexity
of
modern
economies,
measuring
and
predicting
all
of
the
consequences
of
a
particular
action
would
involve
a
significant
effort.
The
central
question
explored
in
this
section
is
whether
some
or
all
markets
indirectly
affected
by
a
policy
must
be
analyzed
to
obtain
a
measure
of
social
costs
suitable
for
a
benefit­
cost
analysis,
or
whether
the
calculation
of
social
costs
can
be
limited
to
an
assessment
of
the
directly
affected
markets
without
introducing
unacceptable
biases
and
errors
into
the
analysis.

In
general,
the
social
cost
of
a
policy
can
be
measured
exclusively
by
changes
that
occur
in
the
markets
directly
targeted
by
a
policy,
as
long
as
significant
net
changes
in
social
welfare
are
not
generated
in
indirectly
affected
markets
If
price
changes
in
other
markets
generate
both
gainers
and
losers
among
the
producers
and
consumers,
then
they
may
offset
each
other
in
a
social
cost
analysis
as
transfers.
12
However,
if
there
are
strong
reasons
to
believe
that
conditions
in
other
related
markets
might
generate
important
net
social
welfare
consequences,
these
should
be
examined.
If
a
policy
indirectly
increases
or
decreases
the
quantity
of
a
good
that
is
consumed,
whose
production
or
consumption
involves
an
externality,
then
this
results
in
net
social
welfare
effects
that
may
be
worth
considering
when
calculating
total
social
costs
(
and
benefits).

8.4
Modeling
Tools
The
following
section
first
focuses
on
the
basic
framework
common
to
all
models
used
to
estimate
social
costs,
while
the
remaining
sections
examine
the
models
commonly
used:
(
1)
direct
compliance
cost
methods,
(
2)
partial
equilibrium
models,
(
3)
multi­
market
models,
and
(
4)
computable
general
equilibrium
models.

8.4.1
The
Basic
Framework
Benefit­
cost
models
must
predict
what
actions
firms
are
likely
to
choose
when
attempting
to
comply
with
a
new
policy
and
what
the
compliance
costs
of
those
actions
will
be.
Normally,
these
are
based
on
engineering
or
process
cost
models
that
examine
firms'
alternative
compliance
methods.
Engineering
cost
estimates
typically
specify
the
capital,
operating,
and
maintenance
costs
that
are
likely
to
occur
in
adopting
different
pollution
control
strategies.
When
possible,
these
initial
engineering
cost
estimates
should
include
the
expected
level
of
compliance
costs,
as
well
as
reasonable
lower
and
upper
bounds
for
purposes
of
sensitivity
analysis.

In
addition
to
the
preliminary
engineering
or
other
estimates
of
the
social
costs
of
various
compliance
strategies,
other
costs
may
be
significant.
As
noted
earlier,
for
some
market­
based
approaches,
transaction
costs
can
often
be
substantial.
For
example,
when
setting
up
the
market
for
a
permit
trading
system,
determining
how
many
permits
to
purchase
or
sell
can
involve
detailed
cost
modeling
and
forecasting,
in
addition
to
the
social
costs
associated
with
operating
the
trading
system.
When
these
costs
are
likely
to
be
significant,
they
should
be
estimated
in
addition
to
the
basic
private
real­
resource
costs
of
capital
and
the
operating
costs
of
alternative
compliance
methods.

8.4.2
The
Direct
Compliance
Cost
Method
In
some
cases,
social
costs
are
estimated
using
the
direct
compliance
cost
method.
This
is
the
simplest
approach
used
in
estimating
social
costs.
Under
this
approach,
the
social
cost
for
a
policy
is
simply
set
equal
to
the
initial
engineering
or
other
compliance
cost
estimates
for
the
compliance
options
the
firms
are
likely
to
adopt;
no
additional
modeling
is
undertaken.
If
only
compliance
costs
are
calculated,
the
private
(
compliance)
costs
are
likely
to
124
Chapter
8:
Social
Costs
12
This
conclusion
regarding
the
net
social
welfare
implications
of
price
changes
in
related
markets
requires
some
qualification.
Even
when
non­
zero
welfare
effects
are
produced
by
price
changes
in
related
markets,
they
are
likely
to
be
small
relative
to
the
estimated
producer
and
consumer
welfare
effects
in
the
directly
affected
markets.
See
Arnold
(
1995)
for
more
discussion
of
related
markets
and
welfare
measurement.
be
overestimated.
This
is
because
private
costs
are
computed
for
the
pre­
policy
level
of
output
under
the
implicit
assumption
that
there
is
no
substitution
away
from
the
affected
products
or
activities
into
other
relatively
less
expensive
ones.
That
is,
firms
do
not
make
any
capital
or
labor
adjustments
in
their
production
processes.
In
addition
when
the
resulting
changes
in
consumer
surplus
are
calculated
at
the
new
higher
prices,
consumer
welfare
losses
are
also
likely
to
be
overestimated
since
changes
in
consumer
behavior
will
not
be
taken
into
account.

Nevertheless,
using
direct
compliance
costs
as
an
approximation
of
actual
social
costs
may
be
reasonable
for
a
policy
when
price
and
quantity
changes
are
small,
and
there
are
few
indirect
effects.
However,
if
consumers
can
easily
switch
to
substitute
goods,
this
adjustment
will
make
the
actual
social
cost
of
the
policy
significantly
less
than
indicated
by
the
direct
compliance
cost
estimates.
Likewise,
if
firms
can
find
less
costly
substitutes
for
their
inputs
or
production
processes,
which
have
been
made
more
expensive
by
the
new
regulations,
then
compliance
costs
will
be
an
overestimate
of
the
actual
social
costs.

8.4.3
Partial
Equilibrium
Analysis
Because
of
the
limitations
of
using
direct
compliance
costs
as
a
measure
of
social
costs,
an
alternative
approach
is
to
model
the
economic
effects
of
these
compliance
costs
on
producers
and
consumers
using
a
partial
equilibrium
supply
and
demand
model
of
the
affected
markets.
This
allows
for
a
more
complete
analysis
of
social
costs
and
their
incidence.
"
Partial"
equilibrium
refers
to
the
fact
that
the
supply
and
demand
functions
are
modeled
for
just
one
or
a
few
isolated
markets
and
that
conditions
in
other
markets
are
assumed
either
to
be
unaffected
by
a
policy
or
unimportant
for
social
cost
estimation.

For
example,
if
using
a
partial
equilibrium
supply
and
demand
framework,
a
new
environmental
policy
that
increases
production
costs
will
cause
a
change
in
the
supply
function.
The
demand
function,
the
old
and
new
supply
functions,
prices,
and
quantities
can
then
be
used
to
compute
changes
in
producer
and
consumer
surpluses.
If
the
relevant
markets
are
evolving
over
time,
this
technique
can
be
applied
in
each
future
time
period
using
new
supply
and
demand
functions.
This
makes
it
possible
to
estimate
the
changing
distribution
of
social
costs
over
time.

The
practical
difference
between
the
results
of
the
partial
equilibrium
supply
and
demand­
based
modeling
and
the
direct
compliance
costs
approach
depends
on
the
nature
of
the
policy
and
the
magnitude
of
its
effects.
For
small
compliance
costs,
price
and
quantity
movements
are
likely
to
be
minimal,
so
the
social
cost
estimates
derived
from
the
partial
equilibrium
model
framework
will
not
be
significantly
different
from
the
results
obtained
from
the
direct
compliance
cost
method.

For
policies
with
larger
compliance
costs,
price
and
quantity
movements
could
be
more
substantial.
The
estimated
social
costs
using
the
supply
and
demand
framework
in
these
cases
may
be
considerably
less
than
those
suggested
by
the
simpler
direct
compliance
cost
approach.
Moreover,
policies
that
effectively
ban
products
or
activities
cause
the
loss
of
all
producer
and
consumer
surpluses
in
these
markets.
Therefore,
it
is
difficult
to
calculate
social
costs
of
these
policies
without
an
explicit
supply
and
demand
framework.

Analyzing
the
effects
of
a
policy
using
a
partial
equilibrium
model
of
the
directly
affected
markets
is
appropriate
when
the
ramifications
in
indirectly
affected
markets
do
not
generate
net
social
costs.
It
is
also
a
reasonable
framework
as
long
as
the
social
costs
imposed
by
a
policy
are
small
and
do
not
significantly
alter
other
markets
or
produce
measurable
macroeconomic
effects
(
e.
g.,
changes
in
national
unemployment
levels).

In
most
cases,
a
conventional
partial
equilibrium
framework
comparing
the
pre­
policy
baseline
with
the
expected
results
of
a
new
environmental
policy
will
suffice
for
an
economic
analysis.
For
analyzing
environmental
policies
that
pose
very
large
consequences
for
the
economy,
computable
general
equilibrium
modeling
is
an
alternative
technique
that
is
particularly
useful
and
is
discussed
later
in
this
chapter.
13
The
partial
equilibrium
framework
is
a
commonly
used
theoretical
tool
for
modeling
and
measuring
the
social
costs
of
environmental
policies.
In
theory,
a
variety
of
125
Chapter
8:
Social
Costs
13
Useful
recent
illustrations
of
partial
equilibrium
analyses
prepared
in
support
of
environmental
policies
include
EPA
(
1998)
Economic
Analysis
of
Effluent
Guidelines
and
Standards
for
the
Centralized
Waste
Treatment
Industry,
and
EPA
(
1996)
Economic
Impact
Analysis
of
Proposed
NESHAP
for
Flexible
Polyurethane
Foam.
social
costs
can
be
observed
and
calculated
using
this
technique.
Even
transitional
effects
that
result
in
shortrun
social
costs,
such
as
premature
capital
equipment
retirement
and
relatively
brief
spells
of
involuntary
unemployment
can
be
modeled
and
estimated
using
this
framework.
Thus,
the
approach
offers
a
theoretically
sound,
if
limited,
method
for
conceptualizing
the
consequences
of
an
environmental
policy
and
measuring
their
social
costs.

Deriving
the
supply
and
demand
functions
is
the
foundation
of
benefit­
cost
analysis
and
is
necessary
in
all
economic
models
used
to
analyze
social
costs
and
benefits.
However,
because
of
its
importance
and
the
uncertainties
associated
with
estimating
supply
and
demand
functions,
it
may
be
useful
to
evaluate
key
assumptions
with
sensitivity
analyses
and
develop
a
range
of
estimated
social
costs.

The
typical
analysis
is
performed
assuming
a
competitive
market,
although
unusual
circumstances
may
require
relaxing
this
assumption.
Even
should
competitive
market
conditions
fail
to
hold,
partial
equilibrium
analysis
can
be
adapted
to
analyze
varying
market
conditions
that
may
more
closely
reflect
real­
world
conditions.
It
is
useful
to
indicate
when
social
benefits
or
social
costs
have
been
overestimated
or
underestimated
because
of
biases
caused
by
market
distortions.
However,
the
principles
underlying
partial
equilibrium
analysis
can
serve
as
a
useful
model
to
evaluate
the
real­
resource
costs
of
many
of
EPA's
regulations
and
policies.

As
previously
discussed
in
Section
5.6,
"
Emerging
Cross­
Cutting
Issues,"
environmental
policies
usually
can
be
analyzed
assuming
a
first­
best
regulatory
setting,
although
actual
conditions
reflect
a
second­
best
world
in
light
of
taxes
placed
on
a
variety
of
goods
and
services.
Therefore,
it
is
conceivable
that
a
regulatory
policy
in
one
sector
may
have
effects
in
labor
markets
and
other
sectors
of
the
economy.
Thus,
examining
costs
in
only
the
final
goods
market
may
cause
costs
(
or
even
benefits)
to
be
underestimated.

The
scope
of
the
regulatory
program
is
likely
to
be
proportional
to
the
effects
experienced
in
other
sectors
of
the
economy.
Therefore,
the
larger
the
program,
the
more
important
it
is
to
examine
several
markets
to
accurately
estimate
costs
and
determine
(
1)
tax
interaction
effects,
(
2)
changes
in
technology,
and
(
3)
the
effects
on
firms'
research
and
development
decisions.
Thus,
multi­
market
models
are
needed
for
regulatory
policies
that
may
have
large
economic
effects
on
several
sectors
of
the
economy.

8.4.4
Multi­
Market
Models
Multi­
market
models
go
beyond
partial
equilibrium
analysis
by
extending
the
inquiry
to
more
than
just
a
single
market.
Multi­
market
analysis
attempts
to
capture
at
least
some
of
the
interactions
between
markets.
However,
unlike
the
general
equilibrium
models
discussed
in
the
next
section,
multi­
market
models
do
not
attempt
to
incorporate
a
representation
of
the
entire
economy.

An
example
of
the
use
of
a
multi­
market
model
for
environmental
policy
analysis
is
contained
in
a
report
prepared
for
EPA
on
the
regulatory
impact
of
controls
on
asbestos
and
asbestos
products
(
EPA
1989).
The
model
developed
for
the
study
describes
the
interactions
between
the
asbestos
fiber
market
and
markets
for
the
goods
that
use
the
fiber
as
an
intermediate
input.
The
collective
demands
for
final
goods
that
use
asbestos
create
a
derived
demand
for
asbestos
fiber.
The
price
of
the
fiber
is
determined
through
the
interaction
between
the
demand
and
supply
schedules
for
asbestos.
Changes
in
this
price
in
turn
influence
the
prices
and
demands
for
the
downstream
goods.
The
specification
of
the
links
between
the
input
and
output
markets
is
especially
important
for
simulating
alternative
regulatory
policies,
including
interventions
in
both
the
input
market
(
caps
on
the
usage
of
asbestos
fiber)
and
in
the
output
market
(
bans
on
some
of
the
goods
that
use
asbestos
as
an
input),
as
well
as
combinations
of
the
two.
The
model
was
then
used
to
compare
the
efficiency
losses
under
various
regulatory
scenarios.

8.4.5
General
Equilibrium
Analysis
Although
the
use
of
a
partial
equilibrium
or
multi­
market
model
may
be
appropriate
when
policies
are
likely
to
affect
a
limited
number
of
markets,
they
are
not
able
to
capture
interactions
between
a
large
number
of
sectors.
Many
environmental
policies,
such
as
energy
taxes,
can
be
expected
to
impact
a
large
number
of
sectors
both
directly
where
the
policy
is
applied,
and
indirectly
through
spillover
and
feedback
effects
on
those
and
other
sectors.
A
strength
of
general
equilibrium
models
is
their
ability
to
126
Chapter
8:
Social
Costs
account
consistently
for
the
linkages
between
all
sectors
of
the
economy.
Three
types
of
general
equilibrium
models
that
have
been
used
for
the
analysis
of
social
costs
are
input­
output
models,
linear
programming
models,
and
computable
general
equilibrium
(
CGE)
models.

8.4.5.1
Input­
Output
(
I/
O)
Models
The
central
idea
underlying
I/
O
analysis
is
that
in
modern
economies,
production
activities
are
closely
interrelated.
An
input­
output
table
represents
the
flow
of
goods
and
services
through
the
economy,
usually
measured
as
transactions
occurring
over
the
course
of
a
year.
In
addition
to
the
primary
factors
of
capital,
labor,
and
land,
most
productive
sectors
use
many
different
intermediate
inputs.
In
an
I/
O
table,
the
column
associated
with
a
particular
sector
lists
the
value
of
the
individual
intermediate
and
primary
inputs
consumed
by
that
sector.
The
row
associated
with
an
individual
sector
lists
the
value
of
that
sector's
output
purchased
as
both
intermediate
inputs
and
final
demand.
For
each
sector
in
a
table,
the
column
sum
represents
the
total
costs
of
production
and
the
row
sum
represents
total
expenditure
on
that
sector's
output.
A
key
feature
of
I/
O
tables
is
that,
by
definition,
for
every
sector,
total
costs
must
equal
total
expenditures
during
the
year.
14
An
I/
O
table
can
be
turned
into
a
simple
linear
model
through
a
series
of
matrix
operations.
The
intermediate
inputs
matrix
defines
a
matrix
of
technical
coefficients,
based
on
the
assumption
that
inputs
to
production
are
consumed
in
fixed
proportions
to
output
and
that
there
are
constant
returns
to
scale.
The
model
is
manipulated
by
making
exogenous
changes
to
the
vector
of
final
demands.
The
model
will
then
calculate
how
much
of
each
of
the
intermediate
goods
is
required
to
produce
the
new
final
demand
vector.
The
sum
of
the
intermediate
inputs
required
plus
final
demand
is
equal
to
total
output
for
the
year.

I/
O
models
have
a
long
history
in
environmental
policy
analysis.
Leontief
(
1970)
showed
how
it
was
possible
to
augment
the
basic
I/
O
model
with
an
additional
set
of
coefficients
for
pollution
generation
and/
or
abatement.
When
a
set
of
pollution
coefficients
has
been
defined,
an
I/
O
model
can
then
produce
an
estimate
of
the
quantity
of
pollution
that
would
be
generated
along
with
a
given
amount
of
final
demand
or
total
output.
The
quantity
of
pollution
generated
may
be
specified
in
either
monetary
terms
(
as
damages)
or
in
physical
units.

Some
economic
research
firms
use
I/
O
models
to
provide
upper
bound
estimates
on
price
effects.
Others
use
I/
O
models
to
look
at
the
related
markets
and
their
potential
significance
prior
to
adopting
a
partial
or
general
equilibrium
model.
The
I/
O
approach
has
also
been
extended
further
to
include
non­
market,
ecological
commodities
such
as
ecosystem
services.
15
Although
I/
O
models
can
be
a
useful
as
a
consistency
check
or
a
first­
order
approximation,
they
have
a
number
of
shortcomings
that
limit
their
applicability
as
a
predictive
tool:

Given
that
prices
are
normally
assumed
to
be
fixed
and
do
not
adjust
to
indicate
scarcity,
there
is
nothing
to
ensure
that
the
total
demands
generated
by
manipulation
of
the
model
are
consistent
with
the
actual
productive
capacity
of
the
economy.

The
fixed
coefficients
assumption
leaves
no
scope
for
substitution
of
inputs
in
production.

Since
there
is
no
producer
or
consumer
behavior
built
into
I/
O
models,
simulation
of
policy
interventions
that
would
affect
those
agents
is
of
limited
value.

Because
the
construction
of
an
input­
output
table
is
a
costly
and
time­
consuming
process,
usually
requiring
a
specialized
survey,
the
application
of
input­
output
analysis
to
environmental
policy
making
will
normally
only
be
possible
when
an
appropriate
table
already
exists.
More
importantly,
since
input­
output
tables
are
used
in
linear
programming
and
computable
general
equilibrium
models,
this
last
shortcoming
is
shared
by
these
models
as
well.

127
Chapter
8:
Social
Costs
14
A
general
reference
on
input­
output
models
is
Miller
and
Blair
(
1985).

15
A
discussion
of
the
application
of
input­
output
models
to
environmental
policy
analysis,
with
a
number
of
examples,
is
provided
in
Chapter
7
of
Miller
and
Blair
(
1985).
Another
example
applied
to
the
environmental
protection
industry
is
EPA
(
1995b),
The
U.
S.
Environmental
Protection
Industry:
A
Proposed
Framework
for
Assessment.
8.4.5.2
Linear
Programming
(
LP)
Models
I/
O
models
are
driven
by
exogenous
changes
in
final
demand.
Since
they
do
not
contain
an
objective
function,
I/
O
models
are
difficult
to
use
for
decision
making
among
multiple
alternatives.
However,
it
is
possible
to
extend
the
basic
I/
O
model
into
a
LP
model
by
incorporating
an
explicit
objective
function
and
a
set
of
inequality
constraints
16
In
addition
to
the
usual
economic
variables,
the
objective
function
may
be
specified
to
include
a
number
of
environmental
variables,
such
as
the
discharge
of
air
or
water
pollutants
The
specification
of
multiple
inequality
constraints
allows
for
a
great
deal
of
flexibility
in
the
application
of
LP
model
(
because
of
this
flexibility,
EPA's
Office
of
Air
and
Radiation
has
used
linear
programming
models
for
many
years).
Shadow
prices
generated
in
the
dual
form
of
LP
models
have
a
limited
relationship
to
market
prices
and
may
sometimes
be
useful
as
indicators
of
the
importance
of
the
individual
constraints.
Sensitivity
analysis
can
be
conducted
by
varying
key
parameters
in
the
model.
17
The
flexibility
in
the
specification
of
LP
models
is
also
something
of
a
liability
of
the
approach.
The
problem
is
that
the
selection
of
the
constraints
used
is
often
ad
hoc
and
may
influence
the
model
solution.
As
with
many
linear
models,
there
is
often
a
tendency
towards
unrealistic
solutions,
such
as
excessive
specialization
in
production
or
trade.
Finally,
the
lack
of
realistic
consumer
and
producer
behavior
is
carried
over
from
I/
O
models.

8.4.5.3
Computable
General
Equilibrium
(
CGE)
Models
As
discussed
in
the
previous
sections
on
I/
O
and
LP
models
these
approaches
have
shortcomings
that
make
them
less
than
ideal
tools
for
policy
analysis
in
modern
market
economies.
In
particular,
in
both
I/
O
and
LP
models,
the
behavior
of
producers
and
consumers
does
not
reflect
the
independent
optimizing
behavior
that
is
usually
assumed
to
be
a
characteristic
of
agents
in
a
market
economy.
Without
the
specification
of
realistic
producer
and
consumer
behavior,
model­
based
policy
simulations
will
be
unable
to
correctly
account
for
the
reactions
agents
may
have
to
policies
that
impact
them.
Computable
general
equilibrium
(
CGE)
models
incorporate
more
realistic
behavioral
specifications
of
the
agents
into
the
model
and
are
thus
able
to
provide
a
better
laboratory
for
many
types
of
policy
analysis.
CGE
models
have
been
used
to
analyze
a
wide
variety
of
policy
interventions,
including
issues
in
public
finance,
international
trade,
development,
and
increasingly,
the
environment.
18
Most
policies
meant
to
protect
the
environment,
ranging
from
those
relying
on
market­
based
instruments,
such
as
effluent
taxes,
to
command
and
control
regulations,
induce
changes
in
the
behavior
of
consumers
and
producers
These
changes
may
occur
directly
where
the
intervention
takes
place
or
indirectly
as
the
effects
of
the
intervention
are
passed
through
the
economy.
Because
they
focus
on
both
trying
to
model
more
accurately
the
expected
reactions
of
consumers
and
producers
to
policy
interventions
and
on
the
interactions
between
various
actors
in
the
economy,
for
some
problems
CGE
models
may
be
the
most
appropriate
tool
for
the
analysis
of
social
costs.
CGE
models
are
particularly
good
at
examining
questions
of
static
resource
allocation,
such
as
the
effects
the
imposition
of
a
tax
may
have
on
sectoral
output,
income,
and
employment.
Under
certain
specifications,
CGE
models
may
also
be
useful
for
assessing
impacts
on
overall
measures
of
economic
performance,
such
as
aggregate
output,
employment,
and
various
measures
of
welfare.

In
almost
all
cases,
CGE
models
start
from
the
framework
and
data
of
an
input­
output
table,
which
provides
a
basic
set
of
accounting
identities
for
the
production
sectors.
Producers
are
assumed
to
maximize
their
profits
through
their
choice
of
productive
inputs,
typically
labor,
capital,
and
intermediate
goods,
and
sometimes
land.
Consumers,

128
Chapter
8:
Social
Costs
16
The
term
linear
programming
actually
refers
to
any
applied
mathematical
programming
exercise
where
an
objective
function
is
either
maximized
or
minimized
subject
to
a
set
of
inequality
constraints
and
where
all
of
the
equations
are
linear.
In
this
section,
only
general
equilibrium
applications
(
i.
e.,
those
based
on
an
input­
output
table)
are
discussed.

17
Linear
programming
models
are
discussed
in
Dervis
et
al.
(
1982).
A
number
of
examples
of
the
application
of
linear
programming
models
to
environmental
problems
are
given
in
Hufschmidt
et
al.
(
1983).

18
General
references
on
CGE
models
include
Dervis
et
al.
(
1982)
and
Ginsburgh
and
Keyser
(
1997).
Applications
to
environmental
policy
are
discussed
in
Wajsman
(
1995).
or
in
many
cases
a
representative
consumer,
are
assumed
to
maximize
their
utility
by
choosing
their
consumption
bundles,
subject
to
a
budget
constraint.
Although
not
usually
specified
as
an
optimizing
agent,
most
CGE
models
also
include
a
government
sector
that
collects
a
variety
of
taxes
to
pay
for
its
purchases
of
goods
and
services.
The
domestic
demand
for
imports
and
the
supply
of
exports
are
determined
based
on
the
relative
prices
of
domestic
and
foreign
goods.

CGE
models
may
be
categorized
across
a
number
of
dimensions.
These
can
include
(
1)
the
method
by
which
the
parameters
of
the
model
are
specified
(
through
calibration
or
econometric
estimation),
(
2)
the
time
horizon
of
the
model
(
static
or
dynamic),
and
(
3)
the
scope
of
the
model
(
single­
or
multi­
country).
Most
CGE
models
are
calibrated
to
a
single
base
year,
which
is
assumed
to
be
in
equilibrium.
After
the
specification
of
a
subset
of
elasticities
and
other
data
obtained
through
a
literature
search
(
or
using
informed
judgments)
the
rest
of
the
parameters
can
be
determined
by
working
backward
from
a
social
accounting
matrix
(
SAM)
for
the
base
year.
19
An
alternative
to
the
calibration
approach
is
econometric
estimation.
20
General
equilibrium
econometric
estimation
allows
models
to
incorporate
the
representation
of
more
sophisticated
producer
and
consumer
behavior
than
would
normally
be
possible
through
calibration.
However,
econometric
estimation
requires
a
consistent
set
of
multi­
sector
timeseries
data
and
this
data
is
usually
not
available
for
developing
countries.

CGE
models
can
also
be
differentiated
by
the
time
horizon
of
the
analysis.
The
majority
of
CGE
models
are
"
static,"
meaning
that
no
explicit
dynamics
are
incorporated
and
the
time
frame
for
the
attainment
of
a
new
equilibrium
following
a
policy
or
external
shock
is
indeterminate.
In
conducting
simulations,
an
exogenous
shock
is
introduced
or
a
variable,
such
as
a
tax
rate,
is
altered.
The
model
is
then
allowed
to
search
for
a
solution
until
a
new
set
of
prices
is
found
which
again
equilibrates
the
system.
The
new
prices
in
turn
determine
a
new
set
of
factor
demands,
outputs,
and
incomes.
The
values
from
this
new
solution
are
then
compared
with
the
values
from
the
original
equilibrium
Dynamic
models,
on
the
other
hand,
incorporate
an
explicit
updating
of
time
dependent
variables,
such
as
the
labor
supply,
capital
stock,
technology,
and
demand
patterns.
In
conducting
a
simulation,
a
baseline
case
is
first
run
with
a
given
set
of
assumptions
about
the
timedependent
variables.
Next,
an
alternative
or
counterfactual
simulation
is
run
with
the
same
set
of
assumptions,
but
with
a
policy
or
external
shock.
The
values
resulting
from
the
alternative
solution
are
then
compared
with
the
original
baseline.
These
values
may
be
compared
at
different
points
in
time
or
discounted
to
estimate
present
values,
or
to
evaluate
changes
in
welfare.

Another
dimension
along
which
CGE
models
may
be
classified
is
by
scope:
(
1)
single
country
or
single
region
models
(
2)
multi­
country
or
multi­
region
models,
and
(
3)
global
models
encompassing
all
countries
and
regions.
Although
models
representing
a
single
country
or
region
are
the
most
common,
multi­
country
or
multi­
region
models
are
being
developed
in
increasing
numbers.
Because
trade
is
inherently
a
multi­
country
phenomenon,
multi­
country
models
are
generally
the
best
suited
for
examining
issues
that
involve
the
flow
of
goods,
services,
and
capital
across
national
boundaries.

CGE
models
have
been
applied
to
an
expanding
array
of
environmental
policy
issues.
Most
recently,
they
have
been
used
for
the
analysis
of
policies
designed
to
avert
or
slow
global
climate
change,
such
as
those
proposed
in
the
Kyoto
Protocol.
Both
single
country
and
multi­
country
CGE
models
have
been
used
for
these
simulations,
with
multicountry
models
able
to
assess
policies
like
global
emissions
trading.
Because
they
are
able
to
incorporate
taxes
and
other
existing
distortions,
CGE
models
have
been
used
to
explore
the
potential
for
a
"
double
dividend"
 
a
reduction
in
pollution
plus
a
reduction
in
the
inefficiencies
of
the
tax
system
 
from
substituting
taxes
on
pollutants
for
pre­
existing
taxes
on
output,
income,
or
wages.
In
addition
CGE
models
have
been
used
to
perform
retrospective
analyses
of
the
economic
costs
of
a
number
of
environmental
regulations.
21
129
Chapter
8:
Social
Costs
19
References
on
social
accounting
matrices
include
Pyatt
and
Round
(
1985)
and
Chapter
10
of
Sadoulet
and
de
Janvry
(
1995).

20
This
approach
has
been
pioneered
by
Dale
Jorgenson
and
a
number
of
his
collaborators.
See
in
particular
the
papers
collected
in
Jorgenson
(
1998a,
1998b).
Another
example
of
the
use
of
the
econometric
approach
is
Hazilla
and
Kopp
(
1990).

21
For
example,
the
Jorgenson­
Wilcoxen
dynamic
CGE
model
of
the
U.
S.
was
used
to
estimate
compliance
costs
between
1970
and
1990
for
EPA's
retrospective
study
of
the
benefits
and
costs
of
the
Clean
Air
Act
(
EPA,
1997b).
A
previous
CGE­
based
study
by
Hazilla
and
Kopp
(
1990)
looked
at
the
costs
of
both
the
Clean
Air
and
Clean
Water
Acts.
While
CGE
models
have
a
number
of
advantages
as
tools
for
policy
analysis,
they
also
have
serious
drawbacks:

Although
the
costs
have
been
reduced
in
recent
years,
the
construction
of
a
CGE
model
can
be
still
be
time
consuming
and
expensive.

In
addition
to
an
appropriate
input­
output
table,
a
considerable
amount
of
data
on
national
accounts,
trade,
elasticities,
and
environmental
externalities
must
be
collected
and
made
consistent
with
the
sectors
chosen
to
be
part
of
the
analysis.

Dynamic
models
also
require
that
forecasts
be
made
for
many
exogenous
variables.

Many
environmental
policies
only
affect
a
small
part
of
what
may
be
a
highly
aggregated
sector
in
an
inputoutput
table.
Sometimes
it
will
be
possible
to
separate
these
smaller
sectors
out,
but
sufficient
data
is
often
not
available
at
that
level
of
detail.

8.5
Estimating
the
Social
Costs
of
Alternative
Policy
Approaches
This
section
discusses
the
methods
of
estimating
the
social
costs
for
several
alternative
regulatory
and
nonregulatory
policy
approaches,
which
are
divided
into
three
categories:
(
1)
direct
controls,
(
2)
incentive­
based
controls,
and
(
3)
voluntary
actions
taken
to
reduce
environmental
risks.
The
discussion
focuses
on
the
significant
features
of
each
regulatory
approach
that
must
be
examined
in
either
partial
equilibrium,
multi­
market,
or
CGE
models.
In
addition
to
the
private
compliance
costs,
transactions
costs
may
be
significant.
Therefore,
the
associated
changes
in
the
prices
of
goods
and
services
will
alter
producer
and
consumer
surplus
and
must
be
calculated
to
estimate
the
total
social
costs.

Independent
of
the
method
used,
the
social
cost
analysis
should
explain
how
the
uncertainties
and
assumptions
in
the
data
and
models
affect
the
results.
Since
much
of
the
data
used
is
not
known
with
certainty
and
many
assumptions
must
be
made
to
develop
the
necessary
analytical
models,
social
cost
estimates
can
never
be
known
with
total
certainty.
Another
difficulty
is
that
private
(
compliance
cost
bounds
in
one
project
may
be
based
on
the
intuition
of
a
single
engineer,
but
the
private
cost
bounds
in
another
sector
may
be
developed
based
on
adequate
data
permitting
the
estimation
of
confidence
intervals.
Aggregating
these
into
a
single
study
may
conceal
important
uncertainties
rather
than
enlightening
the
decision
making
process.
22
8.5.1
Direct
(
or
Standards­
Based)
Controls
In
general,
direct
or
standards­
based
controls
rely
on
different
types
of
standards
that
mandate
a
level
of
performance
intended
to
acheive
an
environmental
objective.

8.5.1.1
Technology
Standards
Estimating
the
private
compliance
costs
of
standards­
based
regulations
is
relatively
straightforward
compared
to
incentive
based
approaches.
Technology
standards
often
require
Best
Available
Technology
(
BAT)
or
Best
Practicable
Technology
(
BPT).
Since
these
technologies
already
exist,
their
costs
and
the
number
of
firms
required
to
use
them
are
often
well
documented.
Additional
compliance
costs
include
expenditures
on
maintenance
and
training
costs
associated
with
installing
and
operating
the
equipment.
However,
estimating
the
private
compliance
costs
is
not
always
simple,
especially
for
proposed
regulations.
For
example,
unanticipated
scaling
effects,
as
well
as
unforeseen
bottlenecks
in
construction
and
implementation
may
occur,
resulting
in
differences
between
the
anticipated
bids
for
a
project,
the
bids
received,
and
the
actual
construction
cost.

The
private
real­
resource
costs,
when
discounted
over
time,
correspond
to
the
sum
of
investment
costs
and
discounted
annual
costs
(
operating
and
maintenance
and
other
annual
regulatory
costs)
that
will
be
incurred
by
firms
to
comply
with
the
regulation.
Thus,
the
realresource
costs
of
regulation
can
be
approximated,
in
most
instances,
by
methodologies
routinely
used
by
other
EPA
130
Chapter
8:
Social
Costs
22
Another
reason
for
variability
of
the
compliance
cost
estimates
for
pollution
control
may
be
due
to
the
way
emission
rates
are
characterized
their
method
of
transport,
and
chemical
transformation
rather
than
variations
in
the
price
of
pollution
control
equipment
and
labor
costs.
program
offices
to
evaluate
compliance
costs.
Furthermore,
the
supply
and
demand
curves
that
implicitly
lie
behind
such
calculations
need
not
be
formally
estimated
unless
the
effects
of
the
regulation
on
price
and
output
are
expected
to
be
significant.

8.5.1.2
Emission
Standards
Regulations
that
limit
emissions
are
usually
targeted
at
particular
point
sources
or
geographic
regions,
but
there
also
exist
national
standards
such
as
ambient
air
and
water
quality
standards.
For
point
sources,
private
compliance
cost
estimates
are
usually
based
on
the
cost
to
purchase
and
operate
regulatory
equipment
needed
to
comply
with
the
regulations.
This
equipment
will
be
similar
to
that
needed
to
meet
technology
standards.
Since
it
may
be
prohibitive
to
examine
in
detail
each
area
and
all
its
pollution
sources,
private
social
and
compliance
cost
estimates
can
be
based
upon
random
samples
of
representative
areas
and
industries.
The
survey
should
accurately
reflect
the
expected
compliance
costs
for
different
categories
and
sizes
of
industries
in
each
area.
In
each
of
the
three
cases,
additional
social
costs
are
involved
with
monitoring
and
enforcement
of
the
regulations.

8.5.1.3
Production
Bans
The
prohibition
of
a
product
or
service
results
in
shutdowns
causing
short­
and,
sometimes,
long­
term
unemployment
as
well
as
the
loss
or
premature
retirement
of
capital
equipment.
Therefore,
adjustment
costs
should
include:
(
1)
the
value
of
wages
temporarily
or
permanently
foregone
because
of
reductions
in
production
levels
in
the
directly
affected
markets23
and
(
2)
the
social
cost
of
reemploying
displaced
workers
(
including
the
administrative
cost
for
transfer
payment
programs,
but
excluding
the
payment
itself).
Moreover,
policies
that
effectively
ban
products
or
activities
cause
the
loss
of
all
producer
and
consumer
surpluses
in
these
markets.
Regulations
also
may
substantially
affect
secondary
or
linked
markets.
CGE
and
multi­
market
models
will
account
for
these
effects,
but
partial
equilibrium
models
will
not
do
so
unless
a
separate
model
is
used.

Some
policies,
although
not
explicitly
banning
production,
may
be
so
stringent
that
the
effect
on
production
is
the
same.
In
this
case,
the
concept
of
compliance
cost
is
less
applicable.
For
example,
if
the
mandated
environmental
protection
controls
would
be
so
costly
that
the
new
equilibrium
level
of
output
is
zero
(
because
the
consumers
of
the
good
shift
completely
to
substitutes
and
producers
of
the
good
exit
this
market
to
produce
other
outputs),
then
it
is
not
possible
to
use
compliance
costs
as
an
estimate
of
social
costs.
A
ban
on
producing
this
good
would
produce
a
similar
result.

In
the
case
of
an
effective
ban
on
production,
the
social
cost
of
the
new
policy
is
measured
by
the
complete
loss
of
all
producer
and
consumer
surpluses
in
this
market.
The
real­
resource
cost
in
this
case
might
be
conceptualized
as
the
welfare
change
associated
with
the
additional
expense
and
lower
quality
of
the
other
goods
that
consumers
purchase
as
substitutes
for
their
previous
use
of
the
product.

8.5.2
Incentive­
Based
Controls
The
appeal
of
incentive­
based
approaches
is
their
potential
ability
to
achieve
environmental
improvement
goals
more
cost
effectively
than
traditional
standards­
based
methods.
The
approaches
examined
here
include:
marketable
permits
emission
taxes,
bubbles
and
offsets,
user
charges,
product
charges,
subsidies
for
pollution
reduction,
government
cost
sharing,
refundable
deposits,
pollution
indemnity
and
information
and
labeling
rules.
In
many
cases,
significant
transfers
will
occur
between
private
parties
and
the
government,
but
in
most
cases,
these
policies
achieve
their
greater
economic
efficiency
through
mechanisms
that
encourage
private
parties
to
use
information
known
to
them
but
not
to
the
environmental
authorities.
Such
information
may
include
differences
in
emission
control
costs
among
different
firms.
Analyses
of
the
social
costs
of
incentive­
based
approaches
may
require
different
information
and
tools
than
those
used
to
analyze
more
traditional
131
Chapter
8:
Social
Costs
23
Lost
wages,
rather
than
lost
production,
is
suggested
as
a
proxy
for
the
value
of
displaced
resources.
In
most
cases,
lost
wages
will
capture
most
of
the
value
of
displaced
resources
because
it
is
likely
that
inputs
other
than
labor
will
be
reallocated
to
other
sectors
of
the
economy
fairly
quickly
and
at
little
cost.
policies.
The
task
of
calculating
the
exact
compliance
costs
of
these
policies
is
therefore
more
difficult.
24
8.5.2.1
Marketable
Permits
Permits
are
usually
denominated
in
the
amount
of
emissions
allowed
and
the
number
and
denomination
of
permits
issued
determines
the
aggregate
amount
of
emissions
25
Marketable
permits
establish
the
aggregate
quantity
of
pollution
allowed
and
allow
the
price
of
those
entitlements
to
vary.
Since
different
polluters
incur
different
private
costs
to
control
emissions,
they
will
be
willing
to
pay
different
amounts
for
permits.
The
price
of
permits,
in
theory,
will
be
established
by
the
unit
cost
of
control
of
the
marginal
polluter.
Marketable
permits
are
traded
between
emission
sources,
giving
rise
to
a
transfer
among
private
parties
but
not
social
costs.

In
contrast
to
technology
standards,
incentive­
based
approaches
(
taxes
or
permits)
do
not
require
any
particular
firm
to
install
particular
pollution
control
devices.
Therefore,
it
is
usually
necessary
to
predict
what
technology
will
be
used
by
the
firms
to
meet
the
new
regulations
to
estimate
costs.
Under
a
marketable
permit
system,
the
private
costs
of
pollution
control
are
estimated
following
a
three­
step
process:

Calculate
the
demand
and
supply
functions
for
the
permits
(
these
demand
and
supply
functions
are
based
on
the
costs
of
different
sources'
pollution
control
options).
Polluters
will
be
willing
to
pay
prices
for
the
permits
up
to
the
unit
cost
of
reducing
emissions.

Estimate
the
equilibrium
price
for
permits.
This
price
will
determine
which
firms
will
install
pollution
control
measures
and
those
which
will
purchase
additional
permits.

Calculate
the
real­
resource
cost
of
the
regulation
by
summing
the
investment
costs
and
the
present
value
of
operating
and
maintenance
costs
incurred
to
reduce
emissions.
(
The
cost
of
the
permits
purchased
by
firms
is
classified
as
an
income
transfer
between
firms,
not
a
social
cost.)

Marketable
permits
may
be
sold
at
auction
initially,
in
which
case
the
prices
bid
for
the
newly
issued
permits
again
represent
income
transfers
to
the
government.
Alternatively,
permits
may
be
allocated
to
sources
by
some
rule,
in
which
case
no
private
costs
are
imposed
at
the
outset.
In
neither
case
is
the
private
cost
of
a
permit
counted
as
part
of
the
social
cost,
since
it
is
not
a
realresource
cost,
but
rather
a
transfer
from
one
firm
to
another
or
a
transfer
from
a
firm
to
the
government.
The
act
of
establishing
the
permit
system
and
assigning
property
rights
to
the
distributed
permits
may
result
in
some
type
of
"
wealth
transfer"
taking
place,
which
should
be
accounted
for
in
the
equity
assessment
of
the
benefit­
cost
analysis.

As
described
earlier,
the
marketable
permit
systems
requires
the
creation
of
a
functioning
market.
This
results
in
administrative
costs
and
also
additional
enforcement
costs
since
it
is
necessary
to
ensure
that
emissions
do
not
exceed
the
levels
for
which
permits
are
held.
Both
need
to
be
added
to
the
social
cost
estimate.

8.5.2.2
Emission
Taxes
Estimates
of
the
social
costs
of
pollution
control
under
emissions
taxes
are
virtually
the
same
as
those
under
marketable
permits.
Here
however,
the
unit
price
of
pollution
will
be
known
(
since
it
is
set
by
the
regulation)
and
does
not
have
to
be
calculated.
Because
the
private
cost
of
pollution
control
varies
among
firms,
firms
with
the
highest
private
costs
of
pollution
control
are
expected
to
cut
back
production
and
pay
the
tax
on
the
remaining
emissions,
rather
than
install
required
pollution
control
equipment.
Most
often,
firms
will
choose
some
combination
of
cutbacks
in
production,
installation
of
pollution
control
equipment,
and
payment
of
the
tax.
However,
as
in
the
case
of
most
regulations,
real­
world
limitations
may
reduce
the
possible
selection
of
cost­
minimizing
alternatives
chosen
or
firms
may
simply
decide
to
engage
in
litigation
to
delay
the
regulation,
which
adds
an
additional
cost.

132
Chapter
8:
Social
Costs
24
However,
after
the
policy
is
passed,
compliance
costs
are
much
easier
to
calculate.
In
the
case
of
emission
taxes,
cost­
minimizing
polluters
in
theory,
will
reduce
emissions
up
to
the
point
where
the
marginal
cost
of
control
equals
the
tax.
Of
course,
these
conclusions
rest
upon
the
assumptions
of
perfectly
competitive
markets,
low
transactions
costs,
and
complete
information.

25
Permits
may
also
be
weighted
based
on
the
impact
the
pollutant
has
on
air
or
water
quality.
After
the
supply
(
or
abatement
cost)
function
for
each
firm
is
estimated,
then
the
equilibrium
amount
of
pollution
generated
can
be
determined.
The
new
production
levels
can
then
be
calculated
for
each
firm
along
with
how
much
pollution
control
equipment
will
be
installed.
Finally,
the
real­
resource
costs
and
private
costs
are
calculated
as
is
done
above
for
marketable
permits.
However,
here
the
pollution
taxes
or
charges
may
involve
transfers
of
tax
revenues
from
the
private
sector
to
the
government,
but
because
such
fees
accrue
to
the
government,
they
are
again
income
transfers
and
should
not
be
included
in
total
social
costs.

8.5.2.3
Bubbles
and
Offsets
Bubbles
and
offsets
allow
emissions
to
be
averaged
among
specific
regions
or
among
different
sources
within
a
particular
facility.
The
resulting
level
of
emission
control
must
be
equivalent
to
or
better
than
that
required
by
existing
regulations.
If
"
banking"
is
allowed,
pollution
credits
can
be
traded
across
time
 
with
potential
offsets
created
in
one
period
to
be
used
in
later
periods.
Bubbles
and
offsets
create
incentives
to
reduce
emissions
in
firms
where
the
private
costs
of
control
are
relatively
low.
Compared
with
direct
controls,
bubbles
and
offsets
usually
result
in
lower
compliance
costs
(
relative
to
costs
incurred
under
technology
and
emission
standards).

Additional
social
costs
associated
with
bubbles
and
offsets
are
similar
to
those
encountered
with
marketable
permits.
Initial
administrative
costs
may
be
significant
and
some
additional
enforcement
costs
for
monitoring
emission
levels
also
may
be
incurred.
The
private
cost
of
the
offsets
traded
in
a
formal
market
are
transfers
between
the
creator
and
the
user
of
the
offset
and
are
not
social
costs.
However,
the
transactions
costs
incurred
to
arrange
the
trade,
both
private
and
public,
are
part
of
total
social
costs.

8.5.2.4
User
Charges
Charges
may
be
imposed
directly
on
users
of
publicly
operated
facilities.
Such
charges
have
been
imposed
on
firms
that
discharge
waste
to
municipal
wastewater
treatment
facilities
and
on
non­
hazardous
solid
wastes
disposed
of
in
publicly
operated
landfills.
User
charges
are
usually
set
at
a
level
sufficient
to
recover
the
private
costs
of
operating
the
public
system,
rather
than
to
create
incentives
for
reducing
pollution.
Measuring
the
total
social
cost
imposed
by
user
charges
is
similar
in
concept
to
measuring
the
social
costs
of
emission
charges,
but
is
not
always
based
on
a
per
unit
charge
of
the
pollutant.

8.5.2.5
Product
Charges
Charges
may
be
imposed
on
intermediate
or
final
products
whose
use
or
disposal
pollutes
the
environment.
The
private
and
social
costs
imposed
by
product
charges
depend
on
the
extent
to
which
users
switch
to
substitutes,
reduce
the
rate
at
which
the
product
is
used
by
recycling
or
other
process
changes,
or
continue
to
use
the
regulated
products
Predicting
responses
and
estimating
compliance
costs
is
difficult
and
requires
analysis
of
the
social
costs
and
effectiveness
of
substitute
products
as
well
as
the
social
costs
of
recycling
and
reuse.
Any
charges
paid
as
a
result
of
continuing
use
represent
private
costs,
but
are
not
social
costs
because
these
are
borne
by
the
consumer
who
buys
less
of
the
more
expensive
product.

8.5.2.6
Subsidies
for
Pollution
Reduction
Subsidies
paid
to
polluters
based
on
their
reductions
in
pollution
have
the
same
general
effect
on
behavior
as
charges
on
pollution.
Sources
may
reduce
pollution
up
to
the
point
where
the
private
costs
of
control
equal
the
subsidy
Using
subsidies
instead
of
charges
shifts
private
costs
to
the
government.
This
may
result
in
more
sources
continuing
to
operate
than
if
a
charge
system
were
used.
Thus,
subsidies
and
charges
may
not
have
the
same
aggregate
social
costs
or
the
same
degree
of
pollution
control.

Measuring
the
social
costs
resulting
from
a
system
of
pollution
subsidies
is
similar
in
concept
to
measuring
the
social
costs
resulting
from
pollution
charges,
except
that
private
costs
are
reduced
by
the
amount
of
the
subsidy,
rather
than
being
increased
by
the
amount
of
the
fee.
Again,
the
subsidies
themselves
are
income
transfers
and
do
not
constitute
a
social
cost.
Therefore,
private
real­
resource
costs
should
be
computed
excluding
the
subsidies.

8.5.2.7
Government
Cost­
Sharing
In
addition
to
issuing
the
regulations
described
above,
the
government
may
take
actions
to
lower
the
private
costs
of
133
Chapter
8:
Social
Costs
specific
actions
 
most
notably,
by
subsidizing
investments
in
pollution
control
equipment.
These
subsidies
may
take
the
form
of
reduced
interest
rates,
accelerated
depreciation
direct
capital
grants,
and
loan
assistance
or
guarantees
for
pollution
control
investments.
Such
policies
may
not
by
themselves
induce
changes
in
private
behavior.
However,
in
conjunction
with
direct
controls,
pollution
fees,
or
other
regulatory
mechanisms,
they
may
influence
the
nature
of
private
responses
and
the
distribution
of
the
cost
burden.
In
particular,
such
subsidies
may
encourage
investment
in
pollution
control
equipment,
rather
than
other
responses
that
do
not
require
capital
investments
(
e.
g.,
changes
in
operating
practices
or
recycling
and
reuse).

Government
cost­
sharing
subsidies
reduce
the
private
costs
associated
with
the
resulting
private
investments.
However,
social
costs
may
arise
if
cost­
sharing
programs
lead
to
resource
misallocations.
Additional
social
costs
will
result
from
administration
of
the
subsidy
program,
but
are
likely
to
be
minor
if
the
incentives
are
provided
through
the
existing
tax
system.
However,
they
may
be
significant
if
new
administrative
structures
are
required.

8.5.2.8
Refundable
Deposits
Refundable
deposits
create
economic
incentives
to
return
a
product
for
reuse
or
for
proper
disposal,
providing
that
the
deposit
exceeds
the
private
cost
of
returning
the
product
Therefore,
to
predict
the
rates
of
return,
the
private
cost
of
returning
products
must
be
estimated.

Under
a
refundable
deposit
system,
compliance
costs
consist
of
the
resources
(
labor,
equipment,
and
transportation
required
to
return
the
regulated
product,
and
the
private
cost
of
preparing
products
for
reuse
(
if
required),
less
the
cost
of
new
products
replaced
by
recycled
products.
The
private
administrative
costs
of
a
deposit
system
vary,
depending
on
where
in
the
production­
consumption
cycle
they
occur
and
from
whom
the
deposits
are
collected.
Record­
keeping
requirements
may
also
be
a
cost
component
For
those
that
participate
in
a
recycling/
refund
program
the
opportunity
cost
of
the
time
spent
sorting
trash
is
an
important
component,
and
the
analysis
must
address
whether
other
behavior
changes
may
be
expected
to
take
place
(
e.
g.,
whether
consumers
may
adjust
their
consumption
of
products
marketed
in
recyclable
containers).
The
deposits
themselves
represent
transfers
from
one
point
in
the
production­
consumption
cycle
to
another
and,
hence,
are
not
social
costs.
These
transfers
are
temporary
if
the
deposit
is
reclaimed,
but
permanent
if
it
is
not.
Enforcement
costs
are
minimal
since
no
standards
have
been
set
and
no
laws
are
broken
if
the
product
is
not
returned.

A
government
"
buy­
back"
constitutes
another
type
of
refundable
deposit.
Under
this
system,
the
government
either
directly
pays
a
fee
for
the
return
of
a
product
or
subsidizes
firms
that
purchase
recycled
materials.
They
are
equivalent
to
product
deposits,
except
that
the
government
rather
than
the
purchaser,
provides
the
deposit.
The
government
subsidy
represents
a
transfer
from
the
government
to
the
private
sector,
which
offsets
the
private
costs
of
recycling
products.

8.5.2.9
Pollution
Indemnity
Regulations
that
impose
stricter
liability
on
polluters
for
the
health
and
environmental
damage
caused
by
their
pollution
may
reduce
the
transaction
costs
of
legal
actions
brought
by
affected
parties.
Such
regulations
do
not
impose
additional
social
costs,
but
only
shift
the
costs
from
one
party
to
another.
However,
this
may
induce
polluters
to
alter
their
behavior
and
expend
real
resources
to
reduce
their
probability
of
being
required
to
reimburse
other
parties
for
pollution
damages.
For
example,
they
may
reduce
pollution,
dispose
of
waste
products
more
safely,
install
pollution
control
devices,
reduce
output,
or
invest
in
added
legal
counsel.

Other
regulations
may
require
firms
to
demonstrate
financial
ability
to
compensate
damaged
parties
by
posting
performance
bonds
that
are
forfeited
in
the
event
of
damages,
by
obtaining
liability
insurance,
or
by
contributing
to
a
pool
of
funds
to
compensate
victims.
The
administrative
and
enforcement
costs
imposed
by
such
requirements
represent
the
use
of
economic
resources
but
are
not
counted
as
part
of
the
social
costs
because
the
funds
used
to
pay
damages
do
not
represent
a
use
of
resources,
but
are
transfers
among
private
parties
(
between
polluters,
insurers,
and
victims
of
pollution).
Again,
however,
these
requirements
are
likely
to
alter
private
behavior
and
lead
to
increased
outlays
of
real
resources
to
reduce
the
probability
of
accidents,
or
reduce
the
probability
of
having
to
pay
using
any
of
the
methods
cited
above.

134
Chapter
8:
Social
Costs
8.5.2.10
Information
and
Labeling
Rules
Information
or
labeling
rules
may
be
applied
to
specific
substances
or
to
certain
contaminated
locations.
For
example,
warning
labels
may
be
required
for
hazardous
substances
that
describe
safe­
handling
procedures
or
describe
the
risks
posed
by
the
product.
Purchasers
may
then
switch
to
less
damaging
substitutes
for
some
or
all
uses
or
handlers
of
hazardous
substances
may
be
better
able
to
prevent
damages.
Posting
information
on
contaminated
locations
gives
potentially
exposed
parties
the
opportunity
to
avoid
hazards
 
for
example,
contaminated
dump
sites
or
drinking
water
aquifers.

Calculating
the
private
costs
of
complying
with
information
and
labeling
requirements
for
particular
cases
is
straightforward
Compliance
costs
include
the
cost
of
developing
the
required
information
(
analyzing
the
composition
of
substances,
monitoring
and
testing
of
sites,
testing
for
health
damages,
etc.)
and
the
cost
of
disseminating
information
(
printing
and
applying
labels,
maintaining
and
publishing
information
on
sites).

Similarly,
the
direct
costs
of
enforcing
and
administering
the
requirements
(
including
government
review
and
approval
of
labels)
can
be
calculated
directly.
Calculating
aggregate
private
costs
may
be
more
difficult,
however,
if
the
number
of
containers
requiring
labels
or
the
number
of
facilities
affected
is
unknown.
In
addition,
it
is
difficult
to
predict
responses
by
the
recipients
of
the
information
and,
hence,
the
social
cost
of
avoidance.

8.5.3
Voluntary
Actions
While
there
can
be
social
costs
associated
with
voluntary
actions
taken
to
mitigate
environmental
polluting
behavior,
it
may
be
difficult
to
establish
the
relation
between
decisions
made
by
firms
or
individuals
and
the
role
EPA
and
other
regulatory
agencies
may
play
in
inducing
or
contributing
to
the
adoption
of
these
practices.
EPA
and
other
regulatory
agencies
are
looking
to
alternative
nonregulatory
approaches
in
an
effort
to
change
behavior
that
contributes
to
health
and
environmental
risks.
Examples
of
EPA
programs
of
this
type
include
the
33/
50
program
for
reduction
of
toxic
pollutant
discharges
and
energy
conservation
and
greenhouse
gas
mitigation
measures,
such
as
ENERGY
STAR
and
Climate
Wise
programs.
26
A
basic
premise
underlying
social
cost
analyses
is
the
assumption
that
profit­
maximizing
firms
undertake
investment
decisions,
voluntary
or
otherwise,
when
it
is
in
their
private
interests
to
do
so
(
i.
e.,
where
private
benefits
are
greater
than
private
costs).
If
actions
would
not
have
occurred
absent
EPA's
involvement
in
these
programs,
then
there
may
be
social
costs
(
beyond
those
costs
incurred
by
EPA)
that
are
associated
with
actions
taken
by
participants
in
the
programs.
Social
costs
may
arise,
for
example,
from
firms
exhibiting
strategic
behavior
in
their
investment
decision
that
incorporates
expectations
that
voluntarily
participating
in
nonregulatory
programs
may
serve
to
reduce
or
delay
promulgation
of
future,
potentially
more
stringent
enforceable
compliance
standards.
Without
some
assessment
of
costs,
it
is
difficult
to
establish
whether
a
particular
voluntary
program
is
cost­
effective
in
comparison
with
other
policy
actions.
As
a
consequence
it
is
useful
to
investigate
the
social
costs
associated
with
nonregulatory
programs
 
quantifying
how
they
affect
economic
markets,
and
evaluating
the
relative
economic
efficiency
of
these
approaches
as
compared
with
regulatory
policies.

8.6
Summary
and
Conclusions
This
chapter
has
reviewed
the
theoretical
foundations
of
social
cost
assessments
as
well
as
practical
methods
for
measuring
the
social
costs
of
environmental
policies.
Several
key
conclusions
reached
in
this
discussion
are
worth
reiterating.

First,
in
most
cases,
the
social
costs
of
an
environmental
policy
or
other
action
can
be
measured
with
sufficient
accuracy
by
limiting
the
analysis
to
the
directly
affected
markets.
This
allows
the
analysis
to
focus
on
the
sectors
that
must
comply
with
a
policy.
In
these
cases,
the
disturbances
that
ripple
outward
from
the
directly
affected
markets
to
numerous
other
markets
should
have
a
minimal
effect
on
the
estimation
of
social
costs.

135
Chapter
8:
Social
Costs
26
More
information
on
the
operations
and
objectives
of
these
types
of
programs
can
be
found
in
publications
prepared
by
EPA's
Office
of
Reinvention
and
at
the
following
website
http://
www.
epa.
gov/
reinvent/
(
accessed
8/
28/
2000).
Second,
a
conventional
partial
equilibrium
depiction
and
modeling
of
the
directly
affected
markets
will
often
be
sufficient
to
measure
social
costs.
The
detail
and
precision
of
applying
this
approach
in
practice
will
depend
on
the
availability
of
information,
the
resources
devoted
to
the
evaluation
and
the
value
to
policy
makers
of
improved
accuracy
of
the
results.

Finally,
other
modeling
techniques,
such
as
CGE,
are
often
used
to
measure
a
variety
of
indirect
costs,
the
many
transitional
effects
of
environmental
policies,
and,
when
they
are
significant,
transactions
costs
borne
by
private
sector
entities.
Nevertheless,
the
majority
of
the
economic
analysis
of
environmental
policies
can
employ
the
conventional
partial
equilibrium
modeling
approach
to
evaluate
social
costs
of
EPA
policies
and
programs.

136
Chapter
8:
Social
Costs
8.7
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138
Chapter
8:
Social
Costs
139
9.1
Introduction
In
an
effort
to
fully
understand
a
regulation's
impact
and
make
an
informed
judgement
regarding
its
desirability,
policy
makers
study
many
different
regulatory
consequences.
Economic
information
is
important
to
the
evaluation
of
at
least
two
consequences
 
a
regulation's
efficiency
and
its
distributional
consequences.
In
principle,
both
types
of
consequences
could
be
estimated
simultaneously
by
a
general
equilibrium
model.
In
practice,
for
reasons
discussed
in
Chapter
5,
they
are
usually
estimated
separately.

A
benefit­
cost
analysis
(
BCA)
calculates
the
social
benefits
and
costs
of
an
environmental
policy
and
answers
the
question
of
whether
the
benefits
are
sufficient
for
the
gainers
to
potentially
compensate
the
losers,
leaving
everyone
at
least
as
well
off
as
before
the
policy.
Its
calculation
of
net
benefits
helps
ascertain
the
economic
efficiency
of
a
regulation.
Two
other
ways
to
express
economic
information
 
an
economic
impact
analysis
(
EIA)
and
an
equity
assessment
 
assess
changes
in
social
welfare
by
examining
the
distributive
effects
of
a
regulation.
An
EIA
focuses
on
traditional
classifications
of
affected
populations1
(
e.
g.,
industrial
sector
classifications).
Under
the
heading
of
equity
assessment
analysts
can
address
broad
concerns
such
as
changes
in
the
national
distribution
of
income
or
wealth.
In
addition,
an
equity
assessment
can
provide
information
to
decision
makers
on
how
policies
affect
specific
sub­
populations.
Disadvantaged
or
vulnerable
sub­
populations
(
e.
g.,
low
income
households)
may
be
of
particular
concern.

Economic
Impact
Analysis
(
EIA)

An
EIA
helps
answer
the
questions,
"
Who
are
the
losers
and
gainers
from
a
policy?"
and
"
By
how
much
do
they
lose
or
gain?"
Traditionally,
EIAs
have
focused
on
the
losers
and
the
negative
impacts
of
an
environmental
regulation.
This
focus
is
in
response
to
existing
legislative
and
administrative
statutes
and
policies
which
direct
analysts
to
examine
the
distribution
of
negative
regulatory
impacts
or
costs.
Currently,
several
of
these
same
statutes
and
policies
call
for
a
similar
examination
of
the
positive
impacts
of
a
regulation.

Unlike
a
BCA
which
rests
its
conclusions
exclusively
on
comparisons
of
social
benefits
and
costs,
an
EIA
examines
the
distribution
of
many
different
economic
impacts.
Conventional
impacts
include
monetized
effects
such
as
changes
in
profitability
or
in
government
revenues,
as
well
as
non­
monetized
effects
such
as
increases
in
unemployment
rates
or
numbers
of
plant
closures.
An
EIA
will
often
examine
and
report
on
regulatory
outcomes
that
a
BCA
would
not.
For
example,
when
measuring
impacts
on
private
Chapter
9
Chapter
9:
Distributional
Analyses:
Economic
Impact
Analyses
and
Equity
Assessments
1
The
term
"
affected"
is
applied
throughout
the
chapter
in
its
most
general
use
as
an
economic
term.
Analysts
should
be
aware
of
how
the
authorizing
statute
for
the
rule,
as
well
as
other
applicable
statutes
and
administrative
orders
noted
in
this
chapter,
make
more
specific
use
of
this
term.
For
example,
the
Regulatory
Flexibility
Act
includes
the
clause
"
subject
to
the
requirements
of
the
rule"
when
quantifying
economic
impacts.
This
results
in
analyzing
entities
that
are
directly
affected,
so
that
conclusions
can
be
drawn
as
to
the
significance
of
impacts
of
the
rule.
Alternatively,
provisions
in
UMRA
and
EO
12866
address
both
direct
and
indirect
impacts,
so
that
the
affected
population
of
entities
may
be
more
inclusive
than
only
those
"
subject
to
the
requirements
of
the
rule."
For
more
information
Chapter
8,
Section
3
on
"
Social
Cost
Analysis"
covers
the
economic
concepts
and
terminology
relevant
to
direct
and
indirect
impacts.
businesses,
an
EIA
will
include
changes
in
transfer
payments
from
firms
to
the
public
sector
whereas
a
BCA
would
not.
Transfer
payments
become
important
when
analyzing
the
distributional
consequences
of
a
regulation.
To
achieve
the
objective
of
an
EIA
and
educate
policy
makers
about
who
will
lose
or
gain
as
a
result
of
a
particular
regulation,
analysts
have
traditionally
relied
upon
the
assortment
of
impacts
described
in
Section
9.2
below.

Equity
Assessment
Generally,
assessments
of
equity
examine
a
regulation's
impact
on
the
distribution
of
national
income
or
wealth.
Decision
makers
may
use
this
information
in
conjunction
with
economic
efficiency
measures
as
captured
in
a
benefit
cost
analysis
to
evaluate
tradeoffs
between
equity
and
efficiency.
For
the
most
unified
treatment,
both
equity
and
efficiency
issues
can
be
addressed
in
a
computable
general
equilibrium
model.
2
In
practice,
data
constraints
will
limit
analysts
to
undertake
distributional
analyses
independently
from
benefit­
cost
analyses.

As
is
true
for
an
EIA,
an
equity
assessment
is
generally
more
concerned
with
sub­
populations
who
experience
net
costs
or
other
negative
impacts
than
with
those
who
experience
net
benefits
or
positive
impacts.
An
equity
assessment
may
consider
effects
on
any
sub­
population,
but
it
should
always
consider
the
economic
effects
of
a
regulation
on
disadvantaged
or
vulnerable
sub­
populations;
specifically,
sub­
populations
who
are
physically
susceptible
to
environmental
contamination,
are
less
than
fully
capable
of
representing
their
own
interests,
or
are
economically
disadvantaged
or
vulnerable.
Examples
include
children,
low­
income
or
minority
communities,
and
small
businesses
governments,
and
not­
for­
profit
organizations.
For
many
of
these
sub­
populations,
EPA
has
been
directed
by
statute
or
policy
to
examine
the
effects
of
its
rules
when
they
are
expected
to
have
a
"
disproportionate,"
"
significant
and
substantial,"
or
other
such
impact.

An
equity
assessment
draws
on
information
and
analytic
tools
used
in
BCA
and
may
report
on
impacts
using
measures
found
in
an
EIA.
Therefore,
an
early
step
in
an
equity
assessment
is
to
identify
sub­
populations
likely
to
be
affected
by
a
regulation.
Once
identified,
if
data
permits,
the
social
costs
and
benefits
estimated
for
the
BCA
can
be
disaggregated
and
net
benefits
for
the
sub­
population(
s)
or
the
distribution
of
net
benefits
among
sub­
populations,
can
be
examined.
An
equity
assessment
may
also
examine
economic
impacts,
such
as
increases
in
rates
of
unemployment
or
other
traditional
impact
measures,
for
the
identified
sub­
population(
s).

Consistency
Between
BCA
and
Distributional
Analyses
Ensuring
consistency
in
analytic
design
and
interpretation
of
results
for
the
BCA,
EIA
and
equity
assessment
supporting
a
particular
regulation
is
essential.
All
three
examine
impacts
that,
in
principle,
could
be
estimated
by
a
single
general
equilibrium
model
(
see
Section
5.2).
Both
an
EIA
and
an
equity
assessment
must
be
conducted
following
the
principles
that
frame
a
BCA,
even
if
the
formal
preparation
of
BCA
is
not
undertaken.
When
a
BCA
is
undertaken,
to
the
extent
possible,
both
distributive
analyses
should
adopt
the
same
set
of
assumptions
used
in
the
BCA.
For
example
all
three
should
rely
upon
the
same
set
of
baseline
assumptions
and
all
three
should
assume
the
same
values
for
relevant
elasticities.
However,
because
all
the
information
needed
to
estimate
distributive
outcomes
is
often
not
integral
to
the
calculations
performed
in
a
BCA,
in
many
cases
further
assumptions
must
be
developed
specifically
for
the
EIA
or
the
equity
assessment.
For
example,
new
assumptions
regarding
definitions
of
sub­
populations
must
be
developed
and
there
might
be
good
reason
to
assume
different
elasticities
for
different
sub­
populations.
Even
in
these
cases,
analysts
should
ensure
that
the
implications,
if
any,
of
the
added
assumptions
for
the
outcome
of
the
BCA
are
understood
and
made
manifest
to
policy
makers.

Using
a
Social
Welfare
Function
to
Evaluate
Efficiency­
Equity
Tradeoffs
Potentially,
a
regulation's
effects
on
distribution,
analyzed
by
its
EIA
and/
or
equity
assessment,
and
its
effects
on
efficiency,
analyzed
by
its
BCA,
can
be
incorporated
into
a
single
social
welfare
function.
A
social
welfare
function
establishes
criteria
under
which
efficiency
and
equity
outcomes
are
transformed
into
a
single
metric,
making
them
directly
comparable.
A
potential
output
of
such
a
function
is
a
ranking
of
policy
outcomes
that
have
different
aggregate
levels
and
distributions
of
net
benefits.
A
social
welfare
function
can
provide
empirical
evidence
that
a
policy
alternative
yielding
higher
net
benefits,
but
a
less
140
Chapter
9:
Distributional
Analyses
2
Computable
general
equilibrium
models
are
discussed
in
section
8.4.5.
equitable
distribution
of
wealth,
is
better
or
worse
than
a
less
efficient
alternative
with
more
egalitarian
distributional
consequences.
3
In
practice,
developing
a
universally
acceptable
social
welfare
function
is
difficult
because
it
requires
explicit
decisions
to
be
made
about
society's
preferences
for
the
distribution
of
resources.
Nonetheless,
future
research
may
result
in
some
feasible
practical
alternatives.
4
These
guidelines
do
not
suggest
a
particular
social
welfare
function
or
that
analysts
attempt
to
use
this
approach
at
this
time,
but
the
approach
may
merit
further
consideration
as
additional
research
and
applications
develop.

Chapter
Summary
This
chapter
begins
with
a
brief
discussion
of
an
iterative
process
between
analysts
and
management
to
facilitate
thorough
consideration
of
the
output
from
distributional
analyses.
The
bulk
of
the
chapter
occurs
in
Section
9.2
on
Economic
Impact
Analysis
which,
after
reviewing
statutes
and
policies
that
require
examination
of
economic
impacts,
describes
methods
for
estimating
economic
impacts
that
are
relevant
for
both
EIAs
and
equity
assessments
The
final
section
of
this
chapter
discusses
the
relatively
new
distributional
analysis,
equity
assessment.
Statutes
and
policies
that
require
equity
assessment,
definitions
of
sub­
populations,
and
a
general
framework
for
conducting
an
equity
assessment,
including
possible
data
sources,
are
reviewed.

9.1.1
A
Process
for
Economic
Impact
Analyses
and
Equity
Assessments
This
section
describes
an
iterative
process
between
EPA
analysts
and
senior
management5
as
an
integral
part
of
an
EIA
and
an
equity
assessment.
At
several
points
of
the
regulatory
development
process,
senior
analysts
should
report
the
results
of
distributional
analyses
to
senior
management
and
receive
feedback.
Only
through
such
ongoing
communication
can
senior
management
remain
sufficiently
informed
so
that
potential
economic
effects
of
proposed
environmental
regulations
receive
proper
attention
within
the
regulatory
development
process.

As
discussed
above,
ensuring
consistency
between
the
EIA,
equity
assessment,
and
BCA
is
critical.
The
methods
and
results
of
an
EIA
and
an
equity
assessment
are
inherently
linked
to
their
corresponding
BCA.
Consequently,
concerns
regarding
distributional
outcomes
that
arise
through
the
iterative
process
that
necessitate
a
change
in
the
regulatory
approach
will
also
require
adjustments
to
the
assessment
of
social
benefits
and
costs.

This
iterative
process
is
not
expected
to
add
significant
additional
administrative
procedures
to
the
current
EPA
regulatory
development
process.
Rather,
its
objective
is
to
bring
greater
attention
to
opportunities
for
the
workgroup
and
senior
management
to
have
ongoing
communication
related
to
potential
economic
impacts
and
equity
dimensions
of
proposed
environmental
regulations.
Frequent
and
timely
exchanges
of
information
between
senior
management
and
the
workgroup
will
focus
greater
attention
on
affected
sectors
of
the
economy
as
well
as
affected
subpopulations
and
may
influence
the
final
regulatory
alternative
selected.

Information
contained
in
Exhibit
9­
1
illustrates
such
a
process.
Its
contents
are
consistent
with
the
procedures
outlined
in
the
document,
Regulation
Development
in
EPA
(
EPA,
1997)
and
with
the
process
for
promulgating
a
regulation
illustrated
by
the
flow
chart
in
Guidance
for
Analytic
Blueprints
(
EPA,
1994).
There
are
two
key
components
of
Exhibit
9­
1
that
are
designed
to
institutionalize
the
iterative
process
between
the
workgroup
and
senior
management
for
EIAs
and
equity
assessments.
The
first
component
is
an
explicit
incorporation
of
the
identification
and
analysis
of
economic
impacts
and
equity
dimensions
such
as
those
listed
in
Exhibits
9­
2
and
9­
5
into
the
regulatory
development
process.
The
second
component,
depicted
by
the
arrows,
is
a
process
for
initiating
multiple
141
Chapter
9:
Distributional
Analyses
3
For
more
on
the
use
of
social
welfare
functions
in
policy
analysis
see
Sen
(
1970),
Arrow
(
1977),
and
Jorgenson
(
1997).
An
empirical
application
of
this
approach
can
be
found
in
Norland
and
Ninassi
(
1998).

4
For
a
recent
description
of
potential
alternatives
see
Farrow
(
1998).

5
Senior
management
is
used
as
shorthand
for
persons
responsible
for
authorizing
and
using
these
forms
of
analysis.
Most
often,
these
persons
will
include
the
Assistant
or
Regional
Administrator
of
the
lead
office
or
region
that
is
considering
the
regulation
or
other
upper
management
within
that
office
or
region.
Chapter
9:
Distributional
Analyses
142
re­
evaluations
of
a
regulation
during
the
development
process.
This
process
includes
three
key
tasks.

Identify
potentially
important
economic
impacts
and
equity
dimensions
for
senior
management
to
help
determine
which
may
be
of
concern.
This
should
be
done
as
part
of
the
analytical
blueprint
process.
The
analytic
blueprint
provides
an
opportunity
for
early
identification
of
important
issues
in
order
to
enhance
the
quality
of
information
provided
to
senior
management
to
assist
in
decisions
for
a
particular
regulation
or
policy.
While
required
for
Tier
1
and
2
regulations,
analytic
blueprints
are
encouraged
for
Tier
3
regulations
as
well.

Conduct
a
preliminary
analysis
of
these
economic
impacts
and
equity
dimensions
once
senior
management
has
approved
the
analytic
blueprint.
This
is
the
second
point
where
the
iterative
process
affects
a
regulation's
development.
Analysts
should
share
the
results
with
senior
management
who
should
then
determine
whether
to
proceed
to
a
more
detailed
analysis
or
to
revisit
the
preliminary
analysis.
Senior
management
may
even
decide
to
alter
the
overall
regulatory
approach
being
considered
which
could
require
revising
the
BCA
as
well
as
the
analytic
blueprint.
The
potential
need
to
revise
the
analytic
blueprint
is
consistent
with
the
idea
that
it
is
a
living
document.
6
Develop
options
and
prepare
detailed
economic
analysis
after
the
preliminary
analysis
is
complete.
Data
and
information
developed
as
part
of
this
effort
will
provide
input
for
conducting
distributional
analyses
for
the
impacts
and
dimensions
identified
earlier.
Here
is
the
third
point
where
the
iterative
process
comes
into
play.
It
is
recommended
that
input
from
senior
management
be
sought
once
more
before
proceeding
to
closure.
Additional
economic
impact
and
6
For
a
detailed
discussion
of
the
concept
of
the
analytic
blueprint
as
a
living
document
and
more
information
on
the
"
Tiering"
of
rules,
see
pp.
12­
13
Guidance
for
Analytic
Blueprints
(
EPA,
1994)
and
see
section
5,
p.
31
Regulation
Development
in
EPA
(
EPA,
1997).
Tier
Assigned
&
Workgroup
Members
Identified
Early
Guidance
from
Senior
Management
Workgroup
Prepares
Analytic
Blueprint
and
Identifies
Potential
Economic
Impacts
and
Equity
Dimensions
Senior
Management
Reviews
Analytic
Blueprint
Approval
Workgroup
Conducts
Preliminary
Analysis
and
Analyzes
Economic
Impacts
and
Equity
Dimensions
Senior
Management
Reviews
Preliminary
Analysis
Non­
approval
Approval
Workgroup
Develops
Regulatory
Options
and
Analyzes
Economic
Impacts
and
Equity
Dimensions
Senior
Management
Reviews
Detailed
Analyses
Non­
approval
Approval
Workgroup
Prepares
Rule,
Draft
Policy,
etc.
Alternatives
Selection
OMB
Review
Workgroup
Closure
Administrator's
Signature
Federal
Register
Publication
Non­
approval
Exhibit
9­
1
Flow
Chart:
A
Process
for
Economic
Impact
Analyses
and
Equity
Assessments
equity
analysis
may
be
warranted
for
a
variety
of
reasons
including
new
insights
gathered
from
the
regulatory
review
process.

9.2
Economic
Impact
Analysis
9.2.1
Introduction
to
Economic
Impact
Analysis
As
discussed
in
Chapter
5
above,
a
BCA
calculates
the
total
social
benefits
and
total
social
costs
associated
with
an
environmental
policy
and
measures
the
change
in
overall
economic
efficiency.
As
part
of
the
effort
to
inform
policy
makers,
it
is
important
to
not
only
understand
the
change
in
economic
efficiency,
but
to
understand
the
distribution
of
negative
and
positive
impacts
associated
with
this
change.
An
EIA
contributes
to
this
understanding.
It
identifies
losers
and
gainers
from
a
policy
and
estimates
the
magnitude
of
their
gains
and
losses.
An
EIA
does
this
by
studying
the
economic
changes
occurring
across
broadly
defined
economic
sectors
of
society
such
as
industry,
government
not­
for­
profit
organizations,
and
consumers.
In
addition
to
these
broad
categories,
an
EIA
will
examine
more
narrowly
defined
sectors
within
these
broad
categories
such
as
the
solid
waste
industry
or
an
individual
solid
waste
company.
Traditionally,
EIAs
have
focused
on
the
losers
and
the
negative
impacts
of
an
environmental
regulation,
although
at
least
two
general
directives
(
see
Exhibit
9­
2)
suggest
that
the
positive
impacts
be
examined
as
well.

EIAs
measure
impacts
in
different
ways,
from
direct
impacts
on
private
business
 
including
individual
plants,
whole
firms,
and
industrial
sectors
 
to
indirect
impacts
on
customers
and
suppliers.
EIAs
also
measure
direct
and
indirect
impacts
on
governments
and
not­
for­
profit
entities
such
as
schools
or
hospitals.
Impacts
include
changes
in
profitability,
employment,
prices
paid
by
consumers,
government
revenues
or
expenditures,
trade
balances,
and
other
changes
of
interest
to
policy
makers.

Ensuring
consistency
of
the
EIA
with
the
BCA
for
a
particular
regulation
is
essential.
For
consistency,
an
EIA
must
be
conducted
within
the
analytical
bounds
of
its
corresponding
BCA.
To
the
extent
possible,
the
EIA
should
adopt
the
same
set
of
assumptions
used
by
the
BCA.
Adjustments
or
additions
to
these
assumptions
or
to
the
overall
modeling
framework
used
for
the
BCA
should
be
made
only
when
they
help
bridge
the
difference
between
social
and
private
perspectives,
such
as
the
difference
between
the
social
cost
of
a
regulation
and
private
compliance
costs.

EPA's
programs
and
regulations
vary
greatly
in
the
types
of
parties
affected
and
the
nature
of
economic
impacts
that
may
be
important.
The
data
available
for
analysis
vary
widely
as
well.
Thus,
while
specific
methods
for
estimating
impacts
are
reviewed,
it
is
expected
that
every
EIA
will
focus
on
the
particular
issues
associated
with
the
set
of
regulations
under
review.
The
general
methods
outlined
here
should
be
adapted
to
fit
the
needs
of
a
particular
analysis.

The
remainder
of
this
section
is
divided
into
twelve
subsections
The
first
outlines
the
statutes
and
policies
that
direct
EPA,
and
other
government
agencies,
to
study
the
distribution
of
positive
and
negative
impacts.
The
second
gives
a
broad
overview
of
models
for
estimating
social
costs
and
how
such
models
might
relate
to
distributional
analyses.
In
the
third
section,
we
begin
explaining
how
to
assess
economic
impacts.
We
begin
with
the
first
step,
which
is
to
calculate
compliance
costs.
The
next
steps
 
how
to
screen
for
significant
impacts
and
how
to
profile
affected
entities
 
are
outlined
in
the
fourth
and
fifth
sections
Finally,
beginning
in
Section
9.2.7,
we
review
methods
for
estimating
specific
impacts,
in
the
following
order:
impacts
on
prices;
impacts
on
production
and
employment
impacts
on
profitability
and
plant
closures;
impacts
on
related
industries
and
consumers;
aggregate
impacts
on
innovation,
productivity,
and
economic
growth;
impacts
on
industry
competitiveness;
and
impacts
on
governments
and
not­
for­
profit
organizations.

9.2.2
Statutes
and
Policies
Requiring
Examination
of
Economic
Impacts
There
are
at
least
two
general
administrative
laws
or
orders
that
direct
analysts
to
examine
economic
impacts;
each
is
reviewed
below.
Some
parts
of
environmental
statutes
also
require
consideration
of
economic
impacts.
Relevant
quotations
from
a
selection
of
these
are
presented.

143
Chapter
9:
Distributional
Analyses
9.2.2.1
General
Administrative
Laws
or
Orders
At
least
one
statute
 
The
Unfunded
Mandates
Reform
Act
of
1995
(
UMRA)
 
and
one
executive
order
 
EO
12866,
"
Regulatory
Planning
and
Review"
 
require
agencies
to
analyze
various
economic
impacts
of
regulatory
actions.
7
These
directives
require
analysts
to
report
on
economic
information
that
does
not
directly
concern
the
net
benefits
tests
for
efficiency
in
a
BCA.
The
first
calls
for
analysts
to
examine
the
distribution
of
benefits
and
costs
across
different
sectors
of
the
economy.
The
second
directs
that
certain
outcomes
be
examined,
such
as
changes
in
unemployment
rates.
For
each
policy,
Exhibit
9­
2
gives
the
dimensions
for
which
impacts
are
to
be
analyzed
and
the
corresponding
analytical
requirements.
A
discussion
of
these
requirements
follow
the
table.

As
outlined
by
Exhibit
9­
2,
UMRA
requires
analysts
to
examine
the
costs,
benefits,
and
budgetary
effects
of
regulatory
actions
as
experienced
by
state,
local,
and
tribal
governments
regions;
urban
or
rural
or
other
types
of
communities
or
particular
segments
of
the
private
sector.
For
the
national
economy,
UMRA
suggests
many
impacts
that
must
be
examined,
including
effects
on
productivity,
economic
growth,
full
employment,
creation
of
jobs,
and
international
competitiveness.
These
requirements
apply
only
to
rules
that
include
federal
mandates
"
which
may
result
in
the
expenditure
by
state,
local,
and
tribal
governments
in
the
aggregate,
or
by
the
private
sector,
of
$
100
million
or
more
in
any
one
year."
8
Exhibit
9­
2
also
briefly
summarizes
relevant
parts
of
guidance
from
the
Office
of
Management
and
Budget
for
EO
128669
(
OMB,
1996
or
Best
Practices)
and
Guidelines
to
Standardize
Measures
of
Costs
and
Benefits
and
the
Format
of
Accounting
Statements10
(
OMB,
2000
or
OMB
Guidelines).
The
Best
Practices
suggests
that
analysts
examine
the
distribution
of
impacts
across
various
sectors
of
the
economy:
"
Information
on
distributional
impacts
related
to
the
(
regulatory)
alternatives
should
accompany
the
analysis
of
aggregate
benefits
and
costs."
11
In
the
OMB
Guidelines,
the
focus
for
a
distributional
analysis
is
placed
on
those
sectors
that
are
likely
to
feel
substantial
impacts:
"
If
these
distributive
effects
are
important,
you
should
describe
the
effects
of
various
regulatory
alternatives
quantitatively
to
the
extent
possible,
including
their
magnitude,
likelihood,
and
incidence
of
effects
on
particular
groups."
12
The
Best
Practices
also
states,
"
The
term
'
distributional
effects'
refers
to
the
description
of
the
net
effects
of
a
regulatory
alternative
across
the
population
and
economy,
divided
up
in
various
ways
.
.
."
13
This
clearly
suggests
that
both
positive
and
negative
impacts
are
relevant.

OMB
cautions
analysts
conducting
distributional
analyses
to
recognize
that
transfer
payments
will
become
relevant,
to
avoid
double­
counting
even
when
mixing
monetized
and
physical
effects,
and
to
describe
distributional
effects
without
judging
their
fairness.

"
Since
generally
accepted
principles
do
not
exist
for
determining
when
one
distribution
of
net
benefits
is
more
equitable
than
another,
you
should
describe
distributional
effects
without
144
Chapter
9:
Distributional
Analyses
7
EO
13132,
Federalism
which
took
effect
on
November
2,
1999,
and
EO
13084,
Consultation
and
Coordination
With
Indian
Tribal
Governments
which
took
effect
on
August
12,
1998,
both
support
the
objectives
of
UMRA.

8
UMRA
§
202.

9
U.
S.
Office
of
Management
and
Budget's
Economic
Analysis
of
Federal
Regulations
Under
Executive
Order
12866,
January
11,
1996.
This
"
Best
Practices"
document
can
be
found
at
the
U.
S.
White
House,
Office
of
Management
and
Budget
website:
http://
www.
whitehouse.
gov/
OMB/
inforeg/
riaguide.
html
under
the
section
titled
"
Regulatory
Policy"
(
accessed
8/
28/
2000).

10
U.
S.
Office
of
Management
and
Budget's
M­
00­
08
Guidelines
to
Standardize
Measures
of
Costs
and
Benefits
and
the
Format
of
Accounting
Statements,
March
22,
2000.
The
OMB
Guidelines
serves
to
implement
Section
638(
c)
of
the
1999
Omnibus
Consolidated
and
Emergency
Supplemental
Appropriations
Act
and
Section
628(
c)
of
the
Fiscal
Year
2000
Treasury
and
General
Government
Appropriations
Act.
They
require
OMB
to
issue
guidelines
to
help
agencies
estimate
the
benefits
and
costs
of
Federal
regulations
and
paperwork
and
summarize
the
results
of
the
associated
analysis.
The
OMB
Guidelines
can
be
found
at
the
U.
S.
White
House,
Office
of
Management
and
Budget
website:
http://
www.
whitehouse
gov/
OMB/
memoranda/
index.
html
under
the
section
titled
"
Selected
Memorandum
to
Heads
of
Federal
Departments
and
Agencies"
(
accessed
8/
28/
2000).

11
Best
Practices,
p.
10.

12
OMB
Guidelines,
p.
16.

13
Best
Practices,
p.
23.
judging
their
fairness.
You
should
describe
these
effects
broadly,
focusing
on
large
groups
with
small
effects
per
capita,
as
well
as
on
small
groups
experiencing
large
effects
per
capita.
You
should
also
note
any
equity
issues
not
related
to
the
distribution
of
policy
effects
if
they
are
important
and
describe
them
quantitatively
to
the
extent
you
can."
17
9.2.3
Models
for
Assessing
Economic
Impacts
As
noted
above,
the
analytic
methods
used
for
a
distributional
analysis
of
a
particular
regulation
should
be
consistent
with
those
used
for
the
corresponding
BCA.
This
section
returns
to
the
four
methods
for
estimating
social
costs
covered
in
Chapter
8,
adding
more
insights
on
their
application
to
distributional
impacts.
18
The
most
sophisticated
method
 
computable
general
equilibrium
(
CGE)
 
is
145
Chapter
9:
Distributional
Analyses
General
Administrative
Dimension
Analytical
Requirements
Law
or
Order
UMRA
State,
local,
and
tribal
Qualitative
and
quantitative
assessment
of
anticipated
governments;
the
costs
and
benefits
of
the
federal
mandate,
including
costs
private
sector
and
benefits
to
state,
local,
and
tribal
governments
or
the
private
sector.

Geographic
location
Estimates
of
any
disproportionate
budgetary
effects
of
the
Federal
mandate
upon
any
particular
regions
of
the
nation
or
particular
state,
local,
or
tribal
governments;
urban
or
rural
or
other
types
of
communities;
or
particular
segments
of
the
private
sector.

National
economy
Estimates
of
the
effect
of
the
federal
mandate
on
the
national
economy,
such
as
the
effect
on
productivity,
economic
growth,
full
employment,
creation
of
productive
jobs,
and
international
competitiveness
of
U.
S.
goods
and
services.

OMB
Guidance
for
Population
and
An
economic
analysis
(
EA)
should
describe
the
net
effects
EO
12866
and
economy,
divided
of
a
regulatory
alternative
across
the
population
and
Accounting
Statements
up
in
various
ways
economy.
(
e.
g.,
income
groups,
"
Irrespective
of
the
presentation
of
monetized
race,
sex,
industrial
benefits
and
costs,
the
EA
should
present
available
sector)
physical
or
other
quantitative
measure
of
the
effects
of
the
alternative
actions
to
help
decision
makers
understand
the
full
effects
of
alternative
actions."
16
14
Exhibit
9­
2
does
not
include
a
discussion
of
The
Regulatory
Flexibility
Act
of
1980
(
RFA),
as
amended
by
the
Small
Business
Regulatory
Enforcement
Fairness
Act
of
1996
(
SBREFA),
as
they
are
discussed
below
in
Section
9.3,
"
Equity
Assessment."

15
The
Office
of
Regulatory
Management
and
Information's
Rule
and
Policy
Information
Development
System
(
RAPIDS)
http://
intranet.
epa.
gov/
rapids
(
accessed
8/
18/
2000,
internal
EPA
document)
is
a
resource
for
EPA
personnel
who
wish
to
read
relevant
statutes,
executive
orders
or
Agency
policy
documents
in
their
entirety
or
to
acquire
copies.

16
Best
Practices,
p.
23.

17
OMB
Guidelines,
p.
16.

18
For
additional
information
regarding
the
four
methods
for
estimating
social
costs
see
Section
3
of
Chapter
8.
Exhibit
9­
2
Economic
Impacts
Required
by
General
Administrative
Law
or
Order14,15
treated
first
and
moves
to
less
complex
approaches,
concluding
with
direct
compliance
costs.

9.2.3.1
Computable
General
Equilibrium
Models
A
CGE
framework
can
be
used
to
describe
the
effect
of
a
particular
policy
on
overall
measures
of
economic
performance
such
as
aggregate
output,
welfare,
and
the
level
of
employment.
CGE
models
are
particularly
effective
in
assessing
static
resource
allocation
and
welfare
distribution
effects.
These
include
the
allocation
of
resources
across
sectors
(
e.
g.,
employment
by
sector),
the
distribution
of
sectoral
output,
the
distribution
of
income
among
factors,
and
the
distribution
of
welfare
across
different
consumer
groups,
whole
regions,
and
countries.
By
construction
the
basic
capacity
to
describe
and
evaluate
these
sorts
of
distributional
impacts
exists
to
some
extent
within
every
CGE
model.
More
detailed
impacts,
or
impacts
of
a
particular
kind,
will
require
a
more
complex
and/
or
tailored
model
formulation
(
and
the
data
to
support
it).

The
simplest
CGE
models
generally
include
a
single,
representative
consumer,
a
few
production
sectors,
and
a
government
sector,
all
within
a
single­
country,
static
framework
Complexities
may
be
specified
for
the
model
in
a
variety
of
ways.
Consumers
may
be
divided
into
different
groups
along
the
lines
of
income,
occupation,
or
other
socioeconomic
criteria.
Producers
may
be
disaggregated
into
dozens,
or
even
hundreds,
of
sectors,
each
producing
a
unique
commodity.
The
government,
in
addition
to
implementing
a
variety
of
taxes
and
other
policy
instruments
may
produce
public
sector
outputs,
provide
a
public
good,
or
run
a
deficit.
CGE
models
may
be
international
in
scope,
consisting
of
many
countries
or
regions
linked
by
international
flows
of
goods
and
capital.
The
behavioral
equations
that
characterize
economic
decisions
may
take
on
simple
or
complex
functional
forms.
The
model
may
be
solved
dynamically
over
a
long
time
horizon,
incorporating
inter­
temporal
decision­
making
on
the
part
of
consumers
or
firms.
This
will
have
implications
for
the
treatment
of
savings,
investment,
and
the
long­
term
profile
of
consumption
and
capital
accumulation.
9.2.3.2
Multi­
Market
Models
CGE
modeling
captures
multiple
effects
of
a
given
policy
change
throughout
an
entire
economy
and
can
provide
comprehensive
distributional
information
across
economic
sectors
(
e.
g.,
employment
by
sector).
A
CGE
model
may
not
be
feasible
or
practical
to
use
as
a
consequence
of
limited
data
and
resources
or
when
the
scope
of
expected
significant
market
interactions
is
limited
to
a
subset
of
economic
sectors.
In
such
instances
a
multi­
market
analysis
can
be
adopted
as
an
alternative
to
a
CGE
model.
19
Multimarket
analysis
considers
the
interactions
between
a
regulated
market
and
other
important
related
markets
(
outputs
and
inputs),
requiring
estimates
of
elasticities
of
demand
and
supply
for
these
markets
as
well
as
crossprice
elasticities
also
found
in
CGE
models.
Multi­
market
models
are
best
used
when
potential
economic
impacts
and
equity
effects
on
related
markets
might
be
considerable
but
more
complete
modeling
using
a
CGE
framework
would
offer
a
negligible
improvement
on
the
quality
of
information
produced.

9.2.3.3
Partial
Equilibrium
Models
Unlike
multi­
market
and
CGE
models,
a
partial
equilibrium
framework
limits
a
distributional
analysis
to
considering
impacts
on
entities
associated
with
the
directly
affected
output
markets
only.
Distributional
consequences
for
other
output
markets
and
input
markets
are
not
estimated
using
these
models.
As
discussed
in
Chapter
8,
a
partial
equilibrium
framework
requires
knowledge
of
demand
and
supply
functions
for
directly
affected
markets
only.

If
information
is
required
for
distributional
outcomes
that
this
method
is
not
designed
to
address,
it
may
be
possible
to
adopt
further
assumptions
and
acquire
additional
data
to
approximate
distributional
consequences
of
concern.
These
new
assumptions
should
be
consistent
with
those
used
for
the
corresponding
BCA.

9.2.3.4
Direct
Costs
of
Compliance
A
relatively
unsophisticated
distributional
analysis
examines
the
direct
costs
of
compliance
paid
by
regulated
entities
Often
these
analyses
simply
assume
that
the
quantity
of
output
and
state
of
technology
in
the
regulated
industry
146
Chapter
9:
Distributional
Analyses
19
For
a
detailed
discussion
of
multi­
market
analysis
see
Chapter
9
in
Just
et
al.
(
1982).
remain
unchanged
after
the
regulation
becomes
effective.
An
analyst
could
disaggregate
compliance
costs
for
regulated
industries
or
sectors
or
geographic
regions.

9.2.4
Calculating
Compliance
Costs
The
first
step
in
assessing
impacts
is
to
estimate
and
verify
the
costs
of
compliance.
This
step
is
necessary
regardless
of
whether
the
entities
affected
are
for­
profit,
governmental
communities,
or
not­
for­
profit
entities.
Compliance
costs
include
annual
costs
(
such
as
operation
and
maintenance
of
pollution
control
equipment
or
increased
production
cost)
and
any
capital
costs.
In
certain
situations
it
may
be
appropriate
to
estimate
the
costs
year
by
year,
especially
in
cases
where
the
costs
are
expected
to
vary
over
time.
Depending
on
the
nature
of
the
analysis,
these
costs
may
be
annualized,
so
that
they
can
be
compared
to
average
annual
income
and
other
measures
of
financial
strength.
20
Verifying
the
compliance
cost
estimates
entails
two
steps.
First,
the
full
range
of
responses
to
the
rule
needs
to
be
identified,
including
pollution
prevention
alternatives.
Second,
the
costs
for
each
response
need
to
be
checked
to
determine
if
all
elements
are
included
and
the
costs
are
consistent
with
a
given
base
year.
Either
a
general
inflation
factor,
such
as
the
Gross
Domestic
Product
(
GDP)
implicit
price
deflator,
or
various
cost
indices
specific
to
the
type
of
project
can
be
used.
21
The
base
year
and
indexing
procedure
should
be
stated
clearly.
Implicit
costs
that
do
not
represent
direct
outlays
may
be
important.
The
cost
estimates
should
include
such
elements
as
production
lost
during
installation,
training
of
operators,
and
education
of
users
and
citizens
(
for
example,
for
programs
involving
recycling
of
household
wastes).
The
cost
of
acquiring
a
permit
is
not
so
much
the
permit
fee
as
it
is
the
lost
opportunities
during
the
approval
process.
Likewise,
the
cost
of
having
a
car's
emissions
inspected
is
not
so
much
the
fee
as
it
is
the
value
of
registrant's
time.

EIAs
and
BCAs
use
different
concepts
of
cost.
BCA
relies
on
estimates
of
the
social
costs
of
a
regulation.
EIA
costs
are
the
private
costs
needed
to
predict
compliance
responses
and
assess
economic
impacts
in
several
ways.
Social
costs
represent
costs
to
society
as
a
whole,
whereas
private
costs
reflect
costs
as
they
are
experienced
by
the
affected
parties.
Often,
the
same
basic
engineering
compliance
cost
estimates
are
used
as
the
basis
for
developing
both
social
and
private
cost
estimates
and
are
adjusted
to
provide
the
required
costs.

There
are
several
issues
analysts
must
consider
when
estimating
the
private
costs
of
environmental
polices.
These
include:

Before­
versus
after­
tax
costs:
The
costs
of
complying
with
regulations
are
generally
deductible
as
expenses
for
income
tax
purposes.
The
effective
burden
of
compliance
costs
is
reduced
for
taxable
entities
because
they
can
reduce
their
taxable
income
by
the
amount
of
the
compliance
costs.
The
effect
of
a
regulation
on
profits
is
therefore
measured
by
after­
tax
compliance
costs.
Different
components
of
engineering
cost
estimates
should
be
adjusted
based
on
their
specific
impact
on
taxes,
to
provide
the
inputs
needed
for
an
EIA.
22
Operating
costs
are
generally
fully
deductible
as
expenses
in
the
year
incurred.
Capital
investments
associated
with
compliance
must
generally
be
depreciated
over
some
number
of
years.
23
In
most
cases,
communities,
not­
for­
profits,
and
governments
do
not
benefit
from
reduced
income
taxes
that
can
offset
compliance
costs.
Therefore,
adjustments
to
cost
estimates,
annualization
formulas,
and
cost
of
capital
calculations
required
to
calculate
aftertax
costs
should
not
be
used
in
analyses
of
impacts
on
governments
and
not­
for­
profits.

147
Chapter
9:
Distributional
Analyses
20
As
previously
discussed,
the
discount
rate
used
should
be
specific
to
the
task.
The
rate
used
to
annualize
costs
is
dependent
on
the
entity's
cost
of
capital
and,
thus,
the
sources
of
financing
used
as
well
as
the
credit
rating
of
the
borrower.
When
calculating
the
present
value
of
a
stream
of
future
social
costs
(
or
benefits),
the
social
rate
of
time
preference
is
the
appropriate
discount
rate.
See
Chapter
6
for
a
complete
discussion
of
discount
rates.

21
The
GDP
implicit
price
deflator
is
reported
by
the
U.
S.
Department
of
Commerce,
Bureau
of
Economic
Analysis
in
its
Survey
of
Current
Business.
The
annual
Economic
Report
of
the
President,
Office
of
the
President,
is
another
convenient
source
for
the
GDP
deflator
time
series.

22
Engineering
costs
can
often
be
used
in
their
before­
tax
form
to
calculate
social
costs.
Adjustments
may
be
required,
however,
if
the
available
compliance
cost
estimates
do
not
reflect
the
social
cost
of
the
resources
used.
Transfers:
Social
costs
reflect
the
real
value
of
economic
resources
 
labor,
equipment,
supplies
 
used
to
achieve
compliance.
However,
some
types
of
compliance
costs
incurred
by
the
regulated
parties
may
represent
transfers
among
parties.
Transfers,
such
as
payments
for
insurance
or
payments
for
marketable
permits
do
not
reflect
use
of
economic
resources.
Private
cost
estimates
used
in
the
EIA
should
include
such
transfers,
but
these
transfers
should
be
excluded
when
calculating
social
costs
for
the
benefit­
cost
analysis.

Discounting:
Compliance
costs
often
vary
over
time,
perhaps
requiring
initial
capital
investments
and
then
annual
operating
costs.
To
estimate
impacts,
the
stream
of
costs
is
generally
discounted
to
provide
a
Present
Value
of
Costs
(
PVC)
that
reflects
the
time
value
of
money.
24
In
contrast
to
social
costs
and
benefits
which
are
discounted
using
a
social
discount
rate,
private
costs
are
discounted
using
a
rate
that
reflects
the
regulated
entity's
cost
of
capital.
25
The
private
discount
rate
used
will
generally
exceed
the
social
discount
rate
by
an
amount
that
reflects
the
risk
associated
with
the
regulated
entity
in
question.
26
For
firms,
their
cost
of
capital
may
also
be
determined
by
their
ability
to
deduct
debt
from
their
tax
liability.

Annualized
costs:
Annualizing
costs
involves
calculating
the
annualized
equivalent
of
the
stream
of
cash
flows
associated
with
compliance.
It
provides
a
single
annual
cost
number
that
reflects
the
various
components
of
compliance
costs
incurred
over
some
selected
time
period
(
e.
g.,
15
or
30
years).
27
The
annual
value
is
the
amount
that,
if
incurred
each
year
over
the
selected
time
period,
would
have
the
same
present
value
as
the
actual
stream
of
compliance
expenditures
Annualized
costs
are
therefore
a
convenient
compliance
cost
metric
that
can
be
compared
with
annual
revenues
and
profits.
It
is
important
to
remember
that
using
annualized
costs
masks
the
timing
of
actual
compliance
outlays.
For
some
purposes,
using
the
underlying
compliance
costs
may
be
more
appropriate.
For
example,
when
assessing
the
availability
of
financing
for
capital
investments,
it
is
important
to
consider
the
actual
timing
of
capital
outlays.

Fixed
versus
variable
costs:
Some
types
of
compliance
costs
vary
with
the
size
of
the
regulated
enterprise
(
e.
g.,
in
proportion
to
production).
Other
components
of
cost
may
be
fixed
with
respect
to
production
such
as
the
costs
involved
in
reading
and
understanding
regulatory
requirements.
28
Requirements
that
impose
high
fixed
costs
will
impose
a
higher
cost
per
unit
of
production
on
smaller
firms
than
on
larger
firms.
It
is
important
that
the
effects
of
any
"
economies
of
scale"
be
reflected
in
the
compliance
costs
used
to
analyze
economic
impacts.
29
Using
the
same
average
annualized
cost
per
unit
of
production
may
mask
the
importance
of
such
fixed
costs
and
understate
impacts
on
small
entities.

9.2.5
Screening
for
Potentially
Significant
Impacts
A
comprehensive
analysis
of
all
aspects
of
economic
impacts
associated
with
a
rule
can
be
highly
resource
intensive.
Detailed
and
explicit
analysis
of
impacts
may
not
be
justified
in
all
cases,
if
a
preliminary
analysis
148
Chapter
9:
Distributional
Analyses
23
Current
federal
and
state
income
tax
rates
can
be
obtained
from
the
Federation
of
Tax
Administrators
in
Washington,
D.
C.
FTA,
State
Tax
Rates
&
Structure,
available
from
http://
www.
taxadmin.
org/
fta/
rate/
tax_
stru.
html
(
accessed
8/
28/
2000).

24
This
Present
Value
of
Costs
may
then
be
annualized
to
provide
an
annual
equivalent
of
the
uneven
compliance
cost
stream,
as
described
below.

25
While
the
discount
rate
differs,
the
formula
used
to
discount
private
costs
is
the
same
as
used
for
social
costs.
See
Chapter
6.

26
Risk
adjusted
rates
for
different
industries
can
be
obtained
from
the
Ibbotsen
Associates
Handbook
or
for
specific
firms
from
the
Value
Line
Investment
Survey.

27
Annualized
costs
are
also
discussed
in
Chapter
6
on
social
discounting.
The
formula
for
calculating
annualized
costs
is
presented
in
Section
6.2.

28
Note
that
fixed
versus
variable
costs
is
not
the
same
thing
as
capital
versus
operating
costs.
Capital
costs
may
be
fixed
or
variable
with
respect
to
the
size
of
the
operation,
as
may
operating
costs.
This
distinction
between
capital
and
operating
costs
is
important
for
calculating
after­
tax
costs.

29
Economies
of
scale
characterize
costs
that
decline
on
a
per
unit
basis
as
the
scale
of
an
operation
increases.
suggests
that
economic
impacts
will
be
minor.
Screening
analyses
provide
a
way
to
focus
attention
and
analytic
resources
on
the
areas
where
economic
impacts
are
most
likely
to
be
significant.
These
screening
analyses
generally
use
simplifying
assumptions
about
market
outcomes
(
e.
g.,
the
alternative
no­
cost­
pass­
through
and
full­
cost­
passthrough
assumptions)
or
simple
tests
of
financial
impacts
(
e.
g.,
a
ratio
of
compliance
costs
to
sales
or
to
profits)
to
screen
for
potentially
significant
impacts.

It
is
important
to
keep
in
mind
the
limitations
in
screening
analyses
when
interpreting
and
presenting
their
results.
They
typically
identify
cases
of
potentially
significant
impacts.
More
detailed
investigation
beyond
the
screening
analysis
is
usually
needed
to
reach
a
reliable
conclusion
about
the
likelihood
of
significant
impacts.

In
addition,
screening
analysis
criteria
should
be
chosen
to
balance
the
risk
of
identifying
"
false
positives"
versus
"
false
negatives."
That
is
to
say,
using
too
low
a
threshold
will
do
little
to
distinguish
true
differences
in
potential
impacts
(
false
positives),
while
using
too
high
a
threshold
runs
the
risk
of
missing
some
sectors
that
may
be
significantly
affected
(
false
negatives).

Finally,
when
screening
analyses
are
based
on
alternative
assumptions
about
market
responses,
it
is
important
to
note
in
presenting
the
results
that
they
represent
extreme
assumptions
that
in
practice
cannot
occur
simultaneously.
For
example,
worst
case
impacts
on
profits
cannot
occur
simultaneously
with
worst
case
impacts
on
prices.
30
9.2.6
Profile
of
Affected
Entities
9.2.6.1
Compiling
an
Industry
Profile
and
Projected
Baseline
The
impact
of
a
regulation
on
business
profitability
and
other
economic
outcomes
depends
on
the
magnitude
of
the
compliance
costs
associated
with
the
rule,
on
the
distribution
of
compliance
costs
across
firms,
and
on
the
economic
and
financial
characteristics
of
the
affected
firms
and
industries.
31
A
substantial
portion
of
an
EIA
involves
characterizing
the
affected
firms
and
industries
as
a
basis
for
evaluating
economic
impacts.
The
following
are
important
inputs
to
an
EIA:

Standard
Industrial
Classification
(
SIC)
and
North
American
Industrial
Classification
System
(
NAICS)
industry
codes:
These
definitions
can
be
developed
by
working
with
engineering
analysts,
the
EPA
project
team
and
workgroups,
industry
roundtables
and
industry
specialists
at
the
Department
of
Commerce.
The
SIC
codes
and
their
definitions
appear
in
the
Standard
Industrial
Classification
Manual:
1987,
available
from
the
Government
Printing
Office
(
OMB,
1987).
This
industry
classification
system
is
being
replaced
by
the
North
American
Industry
Classification
System
(
NAICS),
which
will
be
reflected
in
the
forthcoming
data
series
(
OMB,
1998).
A
regulated
entity
that
is
a
small
part
of
a
larger
industry
may
require
fractional
multipliers
in
order
to
estimate
the
regulated
category's
share
of
the
larger
industry.

Compilation
of
summary
statistics:
Data
regarding
total
employment,
revenue,
number
of
establishments
and
number
of
firms
are
available
from
the
economic
censuses
and
interim
updates
(
e.
g.,
Department
of
Commerce
Annual
Survey
of
Manufactures,
for
non­
manufacturers,
the
Department
of
Commerce
County
Business
Patterns,
and
Agricultural
Statistics
from
the
Department
of
Agriculture).
The
profile
should
also
define
the
industry
and
its
products,
describe
major
production
technologies,
and
discuss
important
business
and
regulatory
trends.

The
level
and
distribution
of
compliance
costs:
Estimates
of
compliance
costs
reflect
predicted
responses
to
the
rule
and
are
often
developed
based
on
engineering
estimates.
It
is
important
to
know
how
costs
are
distributed
among
plants
and
firms
in
the
same
industry,
since
firms
that
are
not
affected
by
the
rule
or
that
incur
lower
compliance
costs
than
their
competitors
may
gain
competitive
advantage
as
a
result
of
the
rule.
If
only
a
few
producers
in
an
industry
incur
added
costs,
they
are
less
likely
to
be
149
Chapter
9:
Distributional
Analyses
30
A
more
detailed
treatment
of
the
considerations
in
the
conduct
of
sensitivity
analysis
is
presented
in
Chapter
5.

31
Generally,
analysts
should
presume
a
perfectly
competitive
market
structure.
The
purpose
of
developing
an
industry
profile
is
to
confirm
this
presumption
or
discover
evidence
to
the
contrary.
able
to
raise
their
prices
to
recover
costs.
In
contrast,
a
rule
that
affects
all
industry
participants
equally
is
more
likely
to
result
in
price
increases
and
less
likely
to
change
the
competitive
structure
of
the
industry.
In
addition,
some
rules
impose
different
requirements
and
costs
on
new
versus
existing
sources.
Such
rules
may
affect
industry
competition,
growth,
and
innovation
by
raising
barriers
to
new
entry.

Baseline
industry
growth
and
financial
condition:
Industries
and
firms
that
are
relatively
profitable
in
the
baseline
will
be
better
able
to
absorb
new
compliance
costs
without
experiencing
financial
distress.
Industries
that
are
enjoying
strong
growth
may
be
better
able
to
recover
increased
costs
through
price
increases
than
they
would
have
been
had
there
been
no
demand
growth.
Section
9.2.9
provides
suggestions
for
using
specific
ratios
to
assess
the
significance
of
economic
impacts
on
a
firm's
financial
condition.

Baseline
industry
structure:
Industry­
level
impacts
depend
on
the
competitive
structure
and
organization
of
the
industry
and
the
industry's
relationship
to
other
economic
entities.
In
addition,
the
number
and
size
distribution
of
firms
and
facilities
and
the
degree
of
vertical
integration
are
important
aspects
of
industry
structure
that
affect
the
economic
impacts
of
regulations.

Characteristics
of
supply
and
demand:
Assessing
the
likelihood
of
changes
in
production
and
prices
requires
information
on
the
characteristics
of
supply
and
demand
in
the
affected
industries.
The
relevant
characteristics
are
reflected
in
price
elasticities
of
supply
and
demand,
which,
if
available,
allow
direct
quantitative
analysis
of
changes
in
prices
and
production
Often,
reliable
estimates
of
elasticities
are
not
available,
and
the
analysis
of
industry­
level
adjustments
must
rely
on
simplifying
assumptions
and
qualitative
assessments.

The
industry
profile
provides
a
general
understanding
of
an
industry
or
industries
affected
by
a
regulatory
action
and
characterizes
their
ability
to
absorb
compliance
costs.
This
information
provides
the
basis
for
assumptions
central
to
the
impact
analysis,
as
well
as
information
needed
for
some
of
the
special
analyses
such
as
Regulatory
Flexibility
Analyses.

9.2.6.2
Profile
of
Other
Affected
Entities
Careful
consideration
needs
to
be
given
to
the
question
of
whether
or
not
a
particular
rule
will
affect
government
entities,
32
not­
for­
profit
organizations,
33
or
households.
For
example,
air
pollution
regulations
that
apply
to
power
plants
may
affect
municipally
owned
electric
companies;
air
regulations
that
apply
to
vehicles
may
affect
municipal
bus
companies,
as
well
as
other
municipal
vehicles
such
as
police
cars
and
public
works
vehicles;
effluent
guidelines
for
machinery
repairing
activities
may
affect
municipal
garages.
Thus,
the
first
step
is
to
identify
all
the
government
entities
that
may
be
affected.

Relevant
characteristics
of
government
entities
may
include:

the
community's
size
(
number
of
people
living
in
the
community);

household
income
levels
(
both
median
and
some
measure
of
the
income
range);

number
of
children
(
since
education
is
frequently
the
major
service
provided
by
local
governments);

number
of
elderly
residents
(
who
frequently
have
fixed
incomes);

unemployment
rate;

revenue
amounts
by
source;
and
the
credit
or
bond
rating
of
the
community.

If
the
property
tax
is
the
major
revenue
source,
then
the
assessed
value
of
property
in
the
community
and
the
percentage
of
this
assessed
value
represented
by
residential
versus
commercial
and
industrial
property
should
be
determined.
If
the
government
entity
serves
multiple
communities,
such
as
a
regional
water
or
sewer
authority,

150
Chapter
9:
Distributional
Analyses
32
Government
entities
that
may
be
affected
by
a
program
include
states,
cities,
counties,
towns,
townships,
water
authorities,
villages,
Indian
Tribes,
special
districts,
military
bases,
etc.

33
Examples
of
not­
for­
profits
include
non­
profit
hospitals,
colleges,
universities,
and
research
institutions.
then
this
information
needs
to
be
collected
for
all
the
communities
covered
by
the
entity.

Data
on
community
size,
income,
number
of
children
and
elderly,
and
unemployment
levels
are
available
from
the
U.
S.
Bureau
of
Census.
Data
on
property
values,
amount
of
revenue
collected
from
each
revenue
source,
and
credit
rating
will
need
to
be
collected
directly
from
the
community
or
state
finance
agencies.
If
the
regulated
activity
is
provided
by
an
"
Enterprise
Fund"
then
revenue
and
cost
information
will
need
to
be
obtained
directly
from
the
fund.
34
Depending
on
the
number
of
communities
affected
and
the
level
of
detail
warranted,
the
analysis
may
rely
on
generally
available
data
only.
In
other
cases,
a
survey
of
affected
communities
may
be
necessary.
However,
in
cases
where
a
survey
is
needed,
there
will
be
a
need
to
comply
with
the
requirements
of
the
Paperwork
Reduction
Act
(
PRA).

Relevant
characteristics
of
not­
for­
profit
entities
include
their
size,
the
goods
or
services
they
provide,
their
operating
costs,
and
the
amount
and
sources
of
their
revenue.
If
the
entity
is
raising
its
revenues
through
user
fees
or
in
other
ways
charging
a
price
for
its
goods/
services
(
such
as
university
tuition),
then
the
income
levels
of
its
clientele
are
relevant.
If
the
entity
relies
on
contributions,
then
it
would
be
helpful
to
know
the
financial
and
demographic
characteristics
of
its
contributors.
If
it
relies
on
government
funding
(
such
as
Medicaid)
then
possible
future
changes
in
these
programs
should
be
identified.

Relevant
features
of
households
are
standard
socioeconomic
and
demographic
characteristics.
These
characteristics
include,
for
example,
their
income
level,
size,
age
distribution,
education
level,
and
ethnic
group.

9.2.6.3
Profile
Data
Sources
Profiles
generally
draw
from
at
least
two
types
of
information
1)
literature
from
economic
journals,
dissertations,
and
industry
trade
publications,
and
2)
quantitative
data
describing
the
characteristics
of
the
industry.
The
relevant
literature
can
be
useful
in
characterizing
the
industry
activities
and
markets
as
well
as
regulations
affecting
the
industry.
Identification
of
relevant
literature
is
most
efficiently
performed
through
a
computerized
search
using
on­
line
services
such
as
Dialog,
BRS/
Search
Services,
or
Dow
Jones
News/
Retrieval.
These
on­
line
services
contain
more
than
800
databases
covering
business,
economic,
and
scientific
topic
areas.
Exhibit
9­
3
lists
some
commonly
used
sources.

The
industry
profile
may
also
identify
those
situations
where
sufficient
data
for
an
EIA
cannot
be
obtained
through
published
and
commercial
sources.
These
situations
arise
particularly
when
the
affected
industry
is
one
of
many
product
lines
or
other
activities
of
identified
facilities
in
addition,
for
some
industries,
identification
of
the
appropriate
SIC
or
NAICS
code
for
all
the
firms
or
facilities
included
in
the
industry
may
be
difficult
if
the
industry
can
be
categorized
in
a
variety
of
ways.
In
these
cases,
and
particularly
if
facility­
level
data
are
required
to
estimate
economic
impacts,
a
survey
of
either
a
statistical
sample
or
a
census
of
affected
facilities
may
be
required
to
provide
sufficient
data
for
analysis.

9.2.7
Impacts
on
Prices
Predicting
impacts
on
prices
is
the
basis
for
determining
how
the
burden
of
compliance
costs
will
be
shared
between
the
directly­
affected
firms
and
their
customers
and
suppliers
in
a
typical
market.
At
one
extreme,
regulated
firms
may
not
be
able
to
raise
their
prices
at
all
and
they
will
bear
the
entire
burden
of
the
added
costs
in
the
form
of
reduced
profits.
Reduced
profits
may
result
from
reduced
earnings
on
continuing
production,
lost
profits
on
products
or
services
that
are
no
longer
produced,
or
some
combination
of
the
two.
At
another
extreme,
firms
may
be
able
to
raise
prices
enough
to
recover
costs
fully.
In
this
case,
there
will
be
no
impacts
on
the
profitability
of
the
directly­
affected
firms
but
their
customers
will
bear
the
burden
of
increased
prices.
Another
possible
outcome
is
that
suppliers
to
the
directly­
affected
firms
will
bear
some
of
the
burden
in
lost
earnings
if
the
regulation
results
in
a
decline
in
demand
for
particular
products.
35
151
Chapter
9:
Distributional
Analyses
34
Public
services
that
are
funded
entirely
by
fees
charged
to
users
are
referred
to
as
"
enterprises"
and
their
revenues
are
referred
to
as
"
Enterprise
Funds."

35
Regulations
limiting
sulfur
emissions
may
result
in
reduced
demand
for
high­
sulfur
coal,
for
example,
which
will
result
in
a
fall
in
the
price
of
such
coal
and
lost
profits
for
its
producers.
In
general,
the
likelihood
that
price
increases
will
occur
can
be
evaluated
by
considering
whether
competitive
conditions
will
allow
the
affected
facilities
to
pass
on
their
costs.
The
methods
used
to
conduct
the
analysis
of
the
directly­
affected
markets
will
depend
on
the
availability
of
appropriate
estimates
of
supply
and
demand
elasticities.
In
many
cases,
reliable
estimates
of
elasticities
will
not
be
available.
37
In
these
cases,
the
analyst
will
need
to
rely
on
a
more
basic
investigation
of
the
characteristics
of
supply
and
demand
in
the
affected
market
to
reach
a
judgment
about
the
likelihood
of
full
or
partial
pass­
through
of
costs
via
price
increases.
9.2.8
Impacts
on
Production
and
Employment
Regulations
may
raise
the
cost
of
doing
business
sufficiently
to
make
some
or
all
production
unprofitable
or
may
reduce
the
quantity
demanded
as
producers
raise
their
prices
to
maintain
profitability.
The
associated
reductions
in
output
may
result
from
lower
operating
rates
at
existing
plants,
closure
of
some
plants,
or
reduced
future
growth
in
production
relative
to
what
would
have
occurred
in
the
baseline.
Losses
in
employment
are
typically
associated
with
reductions
in
output.

152
Chapter
9:
Distributional
Analyses
36
Economic
Censuses
include:
Census
of
Manufacturers,
Census
of
Construction
Industries,
Census
of
Mineral
Industries,
Census
of
Retail
Trade,
Census
of
Service
Industries,
Census
of
Transportation,
and
Census
of
Wholesale
Trade.

37
See
Chapter
8
for
a
more
complete
discussion
of
costs
and
elasticity.
Source
Data
Trade
Publications
Market
and
technological
trends,
sales,
location,
regulatory
events,
ownership
changes.

U.
S.
Department
of
Commerce,
Total
revenue
by
4­
SIC
(
generally);
payroll;
quantity
and
value
of
products
shipped
Economic
Censuses36
and
materials
consumed;
value
added;
capital
expenditures,
assets,
inventories,
employment,
and
geographic
area,
distribution
by
size,
kind
of
business.

U.
S.
Department
of
Commerce,
Description
of
industry,
trends,
international
competitiveness,
regulatory
events.
U.
S.
Industry
&
Trade
Outlook
United
Nations,
Foreign
trade
volumes
for
selected
commodities,
major
trading
partners
International
Trade
Statistics
Yearbook
Robert
Morris
Associates,
Income
statement
and
balance
sheet
summaries,
profitability,
debt
burden
and
Annual
Statement
Studies
other
financial
ratios,
all
expressed
in
quartiles
and
available
for
recent
years.
Based
on
loan
applicants
only.

Dun
&
Bradstreet,
Type
of
establishment,
SIC
code,
address,
facility
and
parent
firm
revenues
and
Information
Services
employment.

Standard
&
Poor's
Publicly
held
firms,
at
4­
digit
SIC
level.
Prices,
dividends,
and
earnings,
line­
of­
business
and
geographic
segment
information,
S&
P's
ratings.
Quarterly
History
(
10
years):
income
statement,
ratio,
cash
flow,
and
balance
sheet
analyses
and
trends.

Standard
&
Poor's,
Industry
profiles,
competitors
for
selected
firms.
Firm
Level
Data:
Research
Reports
(
publicly
traded
companies)
company
background,
stock
prices,
major
competitors,
description
of
business
organization,
summary
financial
data.

Securities
and
Exchange
Income
statement
and
balance
sheet,
working
capital,
cost
of
capital,
Commission
10k
Filings,
employment,
outlook,
regulatory
history,
foreign
competition,
lines
of
business,
EDGAR
System
Database
ownership
and
subsidiaries,
mergers
and
acquisitions.

Value
Line
Industry
Reports
Industry
overviews,
company
descriptions
and
outlook,
performance
measures.

FINDS
database
Facility
SIC,
latitude
and
longitude,
zip
code,
size,
ownership
structure.
Exhibit
9­
3
Frequently
Used
Profile
Sources
EPA
has
used
a
variety
of
methods
to
assess
reductions
in
production
and
employment.
In
some
cases,
demand
and
supply
elasticities
are
used
directly
to
calculate
changes
in
output
and
prices
that
would
result
from
a
shift
upward
in
the
supply
curve
associated
with
compliance
costs.
Often
estimates
of
the
shape
of
the
supply
curve
are
not
available
and
assumptions
are
made
about
its
shape
in
the
region
of
interest
to
allow
use
of
demand
elasticity
estimates
to
predict
output
and
price
adjustments.

In
other
cases,
analysts
may
assess
the
impacts
of
rules
on
the
profitability
of
specific
firms
or
industry
segments,
and
identify
potential
line
or
plant
closures
based
on
a
financial
analysis.
38
If
partial
or
full
plant
closures
are
projected
it
is
important
to
consider
whether
the
production
lost
at
the
affected
facilities
will
be
shifted
to
other
existing
plants
or
to
new
sources
or
will
simply
no
longer
be
produced
If
there
is
excess
capacity
in
the
industry
in
the
baseline
and
some
plants
with
excess
capacity
can
operate
profitably
in
compliance
with
the
rule,
they
may
expand
production
to
meet
the
demand
for
products
no
longer
produced
at
plants
that
can
no
longer
operate
profitably.
39
Even
if
total
production
does
not
decline
but
is
simply
shifted
from
higher­
cost
plants
to
more
efficient
competitors
and
even
if
total
employment
does
not
change,
localized
changes
in
employment
may
interest
policy
makers.
This
is
especially
the
case
for
rules
that
may
have
a
strong
regional
impact.
For
example,
UMRA
§
202
requires
such
an
analysis
as
an
element
of
the
UMRA
cost
analysis.
Data
on
the
ratio
of
production
or
sales
to
employment
can
help
predict
the
number
of
jobs
lost
as
a
result
of
reductions
in
production.
The
regional
distribution
of
job
losses
can
be
calculated
based
on
plant
locations.

9.2.9
Impacts
on
Profitability
and
Plant
Closures
The
availability
of
financial
information
used
to
assess
profitability
varies
greatly,
depending
on
the
industry
in
question
and
the
extent
to
which
EPA
is
able
to
collect
new
information
by
surveying
the
affected
entities.
With
limited
exceptions,
detailed
financial
information
is
not
generally
available
for
individual
plants
or
for
privately­
held
companies
from
published
sources.
Financial
data
for
publicly­
held
companies
may
be
too
aggregated
to
allow
analysis
of
the
specific
business
practices
affected
by
the
rule.
In
the
absence
of
new
data
collection
by
EPA,
analysts
may
need
to
rely
on
financial
profiles
constructed
for
model
plants,
or
on
industry­
average
data
provided
by
the
Census
Bureau
and
other
sources.
40
In
some
cases,
financial
profiles
used
in
the
analysis
of
a
previous
rule­
making
might
be
adapted
and
updated
to
analyze
the
impacts
of
the
rule
in
question.

Analysis
is
conducted
by
determining
how
the
added
costs
of
compliance
will
affect
the
financial
strength
of
the
firm.
As
with
predicting
price
increases,
it
may
be
worthwhile
to
start
with
a
screening
analysis
based
on
an
extreme
assumption
about
the
incidence
of
costs
 
in
this
case,
that
no
costs
can
be
recovered
through
price
increases.
This
assumption
provides
a
worst
case
estimate
of
impacts
on
profits,
potential
closures,
and
employment
reductions
in
the
directly­
affected
market.
Where
firms
in
an
industry
do
not
appear
to
experience
financial
distress
under
the
no­
cost­
pass­
through
scenario,
more
detailed
analyses
to
predict
actual
market
adjustments
and
price
increases
are
not
needed.

The
severity
of
financial
impacts
to
firms
from
a
rule
can
range
from
no
impact
(
if
all
costs
are
recovered
through
price
increases,
for
example)
to
a
modest
reduction
in
profits,
closure
of
a
production
line
or
plant,
to
bankruptcy
of
the
firm.
Criteria
for
assessing
the
degree
of
financial
distress
and
for
predicting
when
a
production
line
or
plant
would
be
shut­
down
are
not
clear­
cut.
41
If
detailed
financial
profiles
can
be
developed,
including
revenues,
costs,
income
statements,
and
balance
sheets,
a
variety
of
financial
tests
can
be
used
to
assess
the
likelihood
of
financial
distress
or
closure.
These
tests
address
the
following
issues:

153
Chapter
9:
Distributional
Analyses
38
Analysis
of
impacts
on
profitability
and
plant
closures
are
discussed
later
in
this
section.

39
Some
surviving
plants
could
experience
increases
in
production,
capacity
utilization,
and
profits
even
though
subjected
to
regulatory
requirements,
if
their
competitors
face
even
greater
cost
increases.

40
Sources
of
financial
data
are
listed
in
Exhibit
9­
3.

41
This
section
assumes
a
perfectly
competitive
market,
which
in
practice
does
not
always
correctly
characterize
the
market
structure
being
analyzed.
In
these
cases,
this
section
should
be
adapted
to
the
relevant
market
structure.
Do
the
costs
of
the
regulation
result
in
a
negative
discounted
after­
tax
cash
flow?
42
Does
the
facility
or
firm's
profitability
fall
below
acceptable
levels?

Is
the
facility
or
firm's
ability
to
finance
its
operations
and
pay
its
obligations
jeopardized?

Establishments
that
fail
the
first
test
are
potentially
at
risk
for
closure.
43
Closure
Decisions
A
variety
of
considerations
affect
a
firm's
decision
to
close
a
production
line
or
a
plant.

The
profitability
of
the
plant
itself
provides
insight
into
whether
the
operation
will
be
contined
if
the
plant
represents
a
stand­
alone
business.
This
also
assumes
that
it
is
possible
to
construct
a
financial
profile
of
that
business.

The
role
the
plant
plays
in
a
larger
operation
may
influence
closure
decisions.
For
example,
some
plants
may
be
part
of
a
vertically
or
horizontally
integrated
operation.
Such
plants
might
not
be
viable
as
a
stand­
alone
operation
but
may
continue
to
operate
based
on
its
contribution
to
the
business
line
as
a
whole.
In
general,
however,
the
analysis
should
assume
that
an
operation
will
be
closed
if
compliance
with
the
rule
would
increase
costs
to
the
point
where
continued
operation
is
no
longer
profitable.

A
negative
discounted
cash
flow
indicates
that
returns
are
below
the
rate
of
return
required
to
provide
the
required
return
on
equity
and
payment
of
interest.
Closures
in
the
short
run
are
likely
to
occur
if
earnings
do
not
cover
variable
costs
plus
the
cost
of
compliance.
Disinvestment
and
closures
will
occur
over
the
longer
term
if
earnings
are
not
sufficient
to
justify
investment
in
plant
and
equipment
as
well.
Where
closures
and
reduced
production
are
likely
for
some
but
not
all
plants,
firms
may
face
complex
decisions
about
which
plants
to
close.
These
decisions
reflect
relative
operating
costs,
age
of
equipment,
tax
and
other
incentives
offered
by
local
communities
and
states
to
retain
business,
and
logistical
considerations.
Analyses
of
plant
closures
should
include
caveats
stating
that
the
analysis
identifies
candidates
for
closure,
rather
than
providing
reliable
predictions
of
which
specific
plants
will
close.
The
available
information
on
plant­
level
operating
costs
and
contributions
to
earnings
is
generally
too
uncertain
to
allow
more
precise
prediction
of
plant
closures.

Financial
Distress
Short
of
Closure
Short
of
closure,
financial
distress
may
occur.
Financial
distress
measures
a
continuum
from
mild
to
severe
financial
weakness
and
may
result
in
difficulties
obtaining
financing
and
attracting
capital.
44
Although
in
practice,
analysts
may
use
a
variety
of
measures
of
financial
distress
use
of
specific
financial
ratios
has
the
advantage
that
it
mirrors
analyses
that
investment
and
lending
institutions
perform
to
evaluate
industries
and
businesses.
Particular
measures
include:

Measures
of
impacts
on
profitability,
e.
g.,
pre­
tax
return
on
assets
(
net
operating
income
divided
by
total
assets)
or
return
on
equity.
These
measures
reflect
the
profit
performance
of
a
firm's
capital
assets.
If
returns
are
reduced
to
unacceptable
levels
when
compliance
costs
are
included,
the
firm
may
have
difficulty
financing
new
investment
or
attracting
capital
even
if
it
is
not
earning
negative
returns.

Measures
of
impacts
on
liquidity,
e.
g.,
interest
coverage
ratio
(
cash
operating
income
divided
by
interest
expense),
times­
interest­
earned
(
earnings
before
interest
and
taxes
divided
by
interest
expense),
and
the
current
ratio
(
current
assets
divided
by
current
liabilities.)
These
measures
reflect
the
firm's
154
Chapter
9:
Distributional
Analyses
42
If
after­
tax
cash
flow
is
negative
under
baseline
conditions
(
before
considering
compliance
costs),
the
facility
is
a
likely
candidate
for
closure
even
in
the
absence
of
additional
compliance
costs.
These
closures
should
not
be
attributed
to
the
rule,
but
rather
should
be
classified
as
baseline
closures.

43
If
it
is
possible
to
estimate
plant
liquidation
values,
another
test
can
be
added
to
assess
the
likelihood
of
closure.
Plants
may
be
predicted
to
close
if
the
value
of
continuing
to
operate
is
less
than
the
liquidation
value.

44
Researchers
have
developed
various
composite
measures
that
are
designed
to
assess
the
potential
for
bankruptcy.
The
most
commonly
cited
is
the
ZETA
model
or
"
Z­
score"
developed
by
Altman
et
al.
(
1993).
This
model
uses
a
weighted
average
of
five
variables
to
predict
potential
for
bankruptcy.
The
ratios
include
working
capital/
total
assets,
retained
earnings/
total
assets,
earnings
before
interest
and
taxes
(
EBIT)/
total
assets,
market
value
of
equity/
par
value
of
debt,
and
sales/
total
assets.
The
model
includes
levels
for
this
composite
score
that
represent
clear
potential
for
bankruptcy
low
or
no
potential
for
bankruptcy,
and
an
uncertain
grey
area.
ability
to
meet
its
financial
obligations
out
of
current,
on­
going
operations.
If
operating
cash
flow
does
not
comfortably
exceed
its
payment
obligations,
the
firm
may
have
to
use
resources
required
for
on­
going
operations
to
pay
contractual
obligations
and
its
creditworthiness
will
suffer.

9.2.10
Impacts
on
Related
Industries
and
Consumers
The
economic
and
financial
impacts
of
regulatory
actions
propagate
to
industries
and
communities
that
are
linked
to
the
regulated
industries,
resulting
in
indirect
business
impacts.
These
indirect
impacts
may
include
employment
and
income
losses,
as
well
as
changes
in
the
competitiveness
and
efficiency
of
related
markets.
Compliance­
related
industries,
on
the
other
hand,
may
yield
offsetting
gains
in
employment
and
income
when
a
regulated
industry
purchases
equipment,
facilities
or
labor
in
order
to
comply
with
a
regulation.

Although,
in
principle,
every
economic
entity
can
be
thought
of
as
having
a
connection
with
every
other
entity,
practical
considerations
usually
require
an
analysis
of
indirect
impacts
to
be
performed
or
presented
for
a
manageable
subset
of
economic
entities
that
are
most
strongly
linked
to
the
regulated
entity.
In
addition
to
considering
major
customers
and
specialized
suppliers
of
the
affected
industry,
it
is
also
important
to
consider
less
obvious
but
potentially
significant
links,
for
example,
basic
suppliers
such
as
electricity
generators.

For
this
reason,
the
analysis
of
linkages
should
use
a
framework
that
thoroughly
measures
indirect
as
well
as
direct
linkages.
Whatever
the
approach,
the
goal
of
the
analysis
is
to
measure
 
given
a
certain
amount
of
employment
and
income
change
in
a
regulated
market
 
how
employment
and
income
will
likely
change
in
related
entities.
9.2.11
Impacts
on
Innovation,
Productivity,
and
Economic
Growth
While
regulatory
interventions
can
theoretically
lead
to
macroeconomic
impacts,
such
as
growth
and
technical
efficiency,
such
impacts
may
be
impossible
to
measure
or
observe.
45
In
some
cases,
however,
it
may
be
feasible
to
use
macroeconomic
models
to
evaluate
the
regulatory
impact
on
gross
national
product
(
i.
e.,
including
trade
effects
and
plant
location
decisions),
factor
payments,
inflation,
and
aggregate
employment.

For
programs
or
rules
that
are
expected
to
have
significant
impacts
in
a
particular
region,
use
of
regional
models
 
either
general
equilibrium
or
more
limited
models
 
may
be
valuable.

Some
macroeconomic
regulatory
effects
are
beyond
the
capacity
of
the
typical
regulatory
impact
analysis
to
quantify
For
example,
price
changes
induced
by
a
regulation
can
lead
to
technical
inefficiency
because
firms
are
not
choosing
the
production
techniques
that
minimize
the
use
of
labor
and
other
resources
in
the
long
run.
Instead,
firms
will
tend
to
overuse
resources
whose
prices
are
artificially
depressed
by
the
regulation
compared
to
the
resources'
true
cost
to
society.

Additional
anecdotal,
theoretical
and
limited
empirical
literature
are
available
that
point
to
possible
macroeconomic
impacts.
46
9.2.12
Impacts
on
Industry
Competitiveness
Regulatory
actions
that
substantially
change
the
structure
or
conduct
of
firms
can
produce
indirect
impacts
by
changing
the
competitiveness
of
the
regulated
industry,
as
well
as
that
of
linked
industries.
An
analysis
of
impacts
on
competitiveness
begins
by
examining
barriers
to
entry
and
market
concentration
and
by
answering
two
key
questions.

155
Chapter
9:
Distributional
Analyses
45
OMB
states
that
macroeconomic
effects
are
likely
to
be
measurable
only
if
the
impact
of
the
regulation
exceeds
0.25
to
0.5
percent
of
GDP.
See
OMB
(
1995).

46
See
Jaffe
et
al.
(
1995)
and
Gray
and
Shadbegian
(
1997).
Will
the
regulation
erect
entry
barriers
that
might
reduce
innovation
by
impeding
new
entrants
into
the
market?
High
sunk
costs
associated
with
capital
costs
of
compliance
or
compliance
determination
and
familiarization
would
be
an
entry
barrier
attributable
to
the
regulation.
Sunk
costs
are
fixed
costs
that
cannot
be
recovered
in
liquidation;
they
can
be
calculated
by
subtracting
the
liquidation
value
of
assets
from
the
acquisition
cost
of
assets
facing
a
new
entrant,
on
an
after­
tax
basis.
47
Lack
of
access
to
debt
or
equity
markets
to
finance
fixed
costs
of
entering
the
market
can
also
present
entry
barriers
even
if
none
of
the
fixed
costs
are
sunk
costs.
However,
if
financing
is
available
and
fixed
costs
are
recoverable
in
liquidation,
the
magnitude
of
fixed
costs
alone
should
not
present
any
barrier
to
entry.

Will
the
regulation
tend
to
create
or
enhance
market
power
and
reduce
the
economic
efficiency
of
the
market?
The
tools
presented
in
the
section
describing
how
to
create
an
economic
profile
also
address
this
question.
The
most
important
of
these
tools
include
measures
of
horizontal
and
vertical
integration
(
i.
e.,
concentration),
among
both
buyers
and
sellers,
in
the
baseline
compared
to
post­
compliance
cases.
Closely
related
to
concentration,
product
differentiation
may
occasionally
be
either
increased
or
decreased
by
a
regulatory
action.
For
a
hypothetical
example,
certain
labeling
restrictions
might
reduce
the
ability
of
firms
to
segment
their
market
by
differentiating
an
essentially
uniform
product
with
packaging
In
such
a
hypothetical
baseline,
firms
might
enjoy
effectively
higher
concentration
ratios
and
less
competition
after
imposition
of
a
uniform
labeling
policy.

9.2.13
Impacts
on
Government
Entities
and
Not­
for­
Profit
Organizations
Section
9.2.9
of
this
chapter
discussed
ways
of
measuring
the
impact
of
regulations
and
requirements
on
private
entities,
such
as
firms
and
manufacturing
facilities.
When
dealing
with
private
entities,
the
primary
focus
is
on
measures
that
assess
changes
in
profits.
This
section
describes
impact
measures
for
situations
where
profits
and
profitability
are
not
relevant
 
where
the
regulations
affect
government
entities
and/
or
not­
for­
profit
organizations.
Many
of
the
same
questions,
however,
apply:

Which
entities
are
affected
and
what
are
their
characteristics

How
much
will
the
regulation
increase
operating
costs?

What
impact
will
the
regulation
have
on
operating
procedures?

Will
this
change
the
amount
and/
or
quality
of
the
goods
and
services
provided?

Can
the
entity
raise
the
necessary
capital
and
will
this
change
its
ability
to
raise
capital
for
other
projects?

The
major
difference
is
that
instead
of
ultimately
measuring
the
regulation's
impact
on
profit
levels,
when
government
entities
are
involved,
the
ultimate
measure
is
the
ability
of
its
citizens
to
pay
for
the
requirements.
Likewise,
in
the
case
of
a
not­
for­
profit,
the
measure
is
the
reduction
in
the
organization's
ability
to
provide
its
goods
and
services.

9.2.13.1
Measures
of
Government
Impacts
EPA
regulations
can
affect
governments
in
at
least
three
ways.
They
can
directly
impose
requirements
on
the
governmental
entity,
such
as
water
pollution
requirements
for
publicly­
owned
wastewater
treatment
works
(
POTWs)
or
air
pollution
restrictions
that
affect
municipal
bus
systems
or
power
plants.
Second,
they
can
involve
costs
for
governments
to
implement
and
enforce
regulations
imposed
on
other
parties.
Finally,
they
can
impose
indirect
costs
on
government
entities,
such
as
increased
unemployment
in
a
community
because
an
EPA
regulation
has
resulted
in
reduced
production
(
or
even
closure)
at
a
factory
in
the
community.
Keep
in
mind
that
some
of
the
impacts
may
reduce
the
community's
financial
resources
and
thus
its
ability
to
pay
for
the
requirements.
For
example,
the
156
Chapter
9:
Distributional
Analyses
47
Sunk
costs
are
sometimes
referred
to
as
exit
barriers.
Without
exit
barriers,
there
can
be
no
entry
barriers,
as
long
as
there
are
no
liquidity
constraints.
closure
of
a
facility
may
increase
the
drain
on
social
services
at
the
same
time
that
tax
revenues
are
declining.

Impacts
of
Programs
That
Directly
Affect
Government
and
Not­
for­
Profit
Entities
The
direct
impact
measures
can
be
divided
into
two
categories
(
1)
those
that
measure
the
impact
itself
in
terms
of
the
relative
size
of
the
costs
and
the
burden
they
place
on
citizens
and
(
2)
those
that
measure
the
economic
and
financial
conditions
of
the
entity
that
affect
its
ability
to
pay
for
the
requirements.
For
each
category,
there
are
several
types
of
measures
that
can
be
used
either
as
alternatives,
or
jointly,
to
illuminate
various
aspects
of
the
question.

Measuring
the
relative
cost
and
burden
of
the
regulations
There
are
three
commonly
used
approaches
to
measuring
the
burden
of
the
rule;
all
involve
calculating
the
annualized
costs
of
complying
with
the
regulation.
For
government
entities,
the
three
approaches
are:

Annualized
compliance
costs
as
a
percentage
of
annual
costs
for
the
service
included:
This
measure
tries
to
define
the
impact
as
narrowly
as
possible
and
is
particularly
appropriate
when
the
service
or
activity
to
be
regulated
is
provided
by
a
single­
purpose
entity.
For
example,
if
the
regulated
activity
is
sewage
treatment,
the
POTW
may
not
be
able
to
draw
on
general
government
revenues
to
cover
its
increased
cost.
Thus
the
appropriate
comparison
would
be
to
estimate
the
resulting
increase
in
its
costs.
Even
if
the
affected
entities
are
not
able
to
draw
on
general
government
revenues,
it
is
useful
to
know
how
the
rule
affects
the
cost
of
the
activity
in
question.
In
practice,
EPA
has
often
used
the
condition
that
if
compliance
costs
are
less
than
one
percent
of
the
current
annual
costs
of
the
activity,
it
is
usually
assumed
that
the
compliance
costs
are
placing
a
small
burden
on
the
entity.

Annualized
compliance
costs
as
a
percentage
of
annual
revenues
of
the
governmental
unit:
The
second
measure
corresponds
to
the
commonly
used
private­
sector
measure
of
annualized
compliance
costs
as
a
percentage
of
sales.
Referred
to
as
the
"
Revenue
Test,"
it
is
one
of
the
measures
suggested
in
EPA
Revised
Interim
Guidance
for
EPA
Rulewriters:
Regulatory
Flexibility
Act
as
amended
by
the
Small
Business
Regulatory
Enforcement
Fairness
Act
(
EPA,
1999).
48
This
differs
from
the
prior
measure
in
that
it
compares
annualized
compliance
costs
to
the
total
revenues
of
the
entity
(
which
usually
is
multi­
purpose
in
nature).
If
compliance
costs
are
less
than
one
percent
of
revenues,
then
the
requirements
are
usually
considered
to
be
affordable.
Compliance
costs
in
the
range
of
one
to
three
percent
of
government
revenues
are
less
easily
interpreted.
If
all
affected
communities
fall
in
this
range,
then
further
thought
should
be
given
to
lowering
annual
compliance
costs,
if
only
a
small
percentage
of
communities
fall
into
this
range
and
the
rest
fall
below
one
percent,
then
the
requirements
can
probably
be
considered
affordable.
Compliance­
cost­
to­
revenue
ratios
of
greater
than
three
percent
indicate
that
the
requirements
are
placing
a
heavy
burden
on
the
community.

Per
household
(
or
per
capita)
annualized
compliance
costs
as
a
percentage
of
median
household
(
or
per
capita)
income:
The
third
measure
compares
the
annualized
costs
to
the
ability
of
residents
to
pay
for
the
cost
increase.
Commonly
referred
to
as
the
"
Income
Test,"
it
is
described
in
the
Revised
Interim
Guidance
(
EPA,
1999)
and
EPA's
Office
of
Water
Interim
Economic
Guidance
for
Water
Quality
Standards.
Workbook
(
EPA,
1995a).
49
Costs
can
be
compared
to
either
median
household
or
median
per
capita
income.
In
calculating
the
per
household
or
per
person
costs,
the
actual
allocation
of
costs
needs
to
be
considered.
If
the
costs
are
entirely
paid
through
property
taxes,
and
the
community
is
predominately
residential,
then
an
average
per
household
cost
is
probably
appropriate.
If,
however,
some
or
all
of
the
costs
are
allocated
to
users
(
e.
g.,
fares
paid
by
bus
riders
or
fees
paid
by
users
for
sewer,
water,
or
electricity
supplied
by
municipal
utilities
then
this
needs
to
be
taken
into
account.
In
addition,
if
some
of
the
costs
are
borne
by
local
firms,

157
Chapter
9:
Distributional
Analyses
48
See
Section
9.3
for
a
discussion
of
the
analytic
and
procedural
requirements
under
SBREFA.

49
For
example,
materials
presented
in
the
water
guidance
and
other
EPA
Office
of
Water
analyses
are:
less
than
one
percent
indicates
little
impact,
over
two
percent
indicates
a
large
impact,
with
the
range
from
one
to
two
percent
being
a
gray
area
of
indeterminate
impact.
then
that
portion
of
the
costs
needs
to
be
handled
separately.

Two
commonly
used
impact
measures
for
not­
for­
profit
entities
are:
(
1)
annualized
compliance
costs
as
a
percentage
of
annual
operating
costs
and
(
2)
annualized
compliance
costs
as
a
percentage
of
total
assets.
The
first
is
equivalent
to
the
first
of
the
impact
measures
described
for
government
entities,
measuring
the
percentage
increase
in
costs
that
would
result
from
the
regulation
being
analyzed.
The
second
is
a
more
severe
test,
measuring
the
impacts
if
the
annualized
costs
were
paid
for
out
of
the
assets
of
the
institution.
As
presented
in
EPA's
Revised
Interim
Guidelines,
the
guidelines
for
annualized
compliance
costs
as
a
percentage
of
annual
operating
costs
are:
annualized
compliance
costs
less
than
1
percent
of
operating
costs
indicate
that
the
rule
does
not
represent
a
burden
annualized
compliance
costs
between
one
and
three
percent
of
operating
costs
indicates
that
the
rule
may
impose
a
burden,
and
annualized
compliance
costs
that
are
more
than
three
percent
of
operating
costs
indicates
that
the
rule
may
impose
a
heavy
burden.

Measuring
the
economic
and
financial
health
of
the
community:
This
second
category
of
impact
measures
looks
at
the
economic
and
financial
health
of
the
community
involved,
since
these
will
affect
its
ability
to
finance
expenditures
required
by
a
program
or
rule.
A
given
cost
may
place
a
much
heavier
burden
on
a
poor
community
than
on
a
wealthy
one
of
the
same
size.
As
with
the
impact
measures
described
above,
there
are
three
categories
of
economic
and
financial
condition
measures:

Indicators
of
the
community's
debt
situation:
Debt
indicators
are
important
because
they
measure
both
the
ability
of
the
community
to
absorb
additional
debt
(
to
pay
for
any
capital
requirements
of
the
rule)
and
the
general
financial
condition
of
the
community.
While
several
indicators
have
been
developed
and
used,
this
section
describes
two.
One
measure
is
the
governmental
entity's
bond
rating.
Awarded
by
companies
such
as
Moody's
and
Standard
&
Poor's,
bond
ratings
summarize
their
assessment
of
a
community's
credit
capacity
and
thus
reflect
the
current
financial
conditions
of
the
governmental
body.
A
second
frequently
used
measure
is
the
ratio
of
overall
net
debt
(
the
debt
to
be
repaid
by
property
taxes)
to
the
full
market
value
of
taxable
property
in
the
community.
Overall
net
debt
should
include
the
debt
of
overlapping
districts.
For
example,
a
household
may
be
part
of
a
town,
a
regional
school
district,
and
a
county
sewer
and
water
district,
all
of
which
have
debt
that
the
household
is
helping
to
pay
off.
50
See
Exhibit
9­
4
for
interpretations
of
the
values
for
these
measures.
Neither
of
these
two
debt
measures
will
always
be
appropriate.
Some
communities,
especially
small
ones,
may
not
have
a
bond
rating.
This
does
not
necessarily
mean
that
they
are
not
creditworthy,
it
may
only
mean
that
they
have
not
had
an
occasion
recently
to
borrow
money
in
the
bond
market.
Second,
if
the
government
entity
does
not
rely
on
property
taxes,
as
may
be
the
case
for
a
state
government
or
an
enterprise
district,
then
the
ratio
of
debt
to
full
market
value
may
not
be
relevant.
Information
on
debt
and
assessed
property
values
are
available
from
the
financial
statement
of
each
community.
The
state's
auditor's
office
is
likely
to
have
this
information
for
all
communities
within
the
state.

Indicators
of
the
economic/
financial
condition
of
the
households
in
the
community:
There
are
a
wide
variety
of
household
economic
and
financial
indicators.
Two
commonly
used
ones
are:
the
unemployment
rate
and
median
household
income.
Both
measure
the
financial
well­
being
of
households.
Unemployment
rates
are
available
from
the
U.
S.
Bureau
of
Labor
Statistics.
Median
household
income
is
available
from
the
U.
S.
Census
and
some
states
maintain
more
up­
to­
date
databases
on
income
levels.
Benchmark
values
for
these
two
measures
are
presented
in
Exhibit
9­
4.

Financial
management
indicators:
This
category
consists
of
indicators
measuring
the
general
financial
health
of
the
community
as
an
entity,
as
opposed
to
the
general
financial
health
of
the
residents.
Since
158
Chapter
9:
Distributional
Analyses
50
An
alternative
to
the
net
debt
as
percent
of
full
market
value
of
taxable
property
is
the
net
debt
per
capita.
Commonly
used
benchmarks
for
this
measure
are:
Net
debt
per
capita:
less
than
$
1,000
=
strong
financial
condition
Net
debt
per
capita:
$
1,000
and
$
3,000
=
mid­
range
or
gray
area
Net
debt
per
capita:
greater
than
$
3,000
=
weak
financial
condition
most
local
communities
rely
on
the
property
tax
as
their
major
source
of
revenues,
two
indicators
of
property
tax
health
are
presented
here.
One
measures
the
burden
property
taxes
are
placing
on
the
community
in
terms
of
property
tax
revenues
as
a
percent
of
full
market
value
of
taxable
property.
The
second
indicator
measures
the
efficiency
with
which
the
community's
finances
are
managed,
and
indirectly
whether
the
tax
burden
may
already
be
excessive,
in
terms
of
the
property
tax
collection
rate.
As
the
property
tax
burden
on
tax
payers
increases,
they
are
more
likely
to
not
pay
their
taxes
or
pay
them
late.

Measuring
the
financial
strength
of
not­
for­
profit
entities
includes
assessing
(
1)
how
much
reserve
the
entity
has,
(
2)
how
much
debt
the
entity
already
has
and
how
its
annual
debt
service
compares
to
its
annual
revenues,
and
(
3)
how
the
entity's
fees
or
user
charges
compare
with
the
fees
and
user
charges
of
similar
institutions.
Again,
this
part
of
the
analysis
is
meant
to
judge
whether
the
entity
is
in
a
strong
or
weak
financial
position
to
absorb
additional
costs.
Impacts
of
Programs
That
Place
Administrative
and
Enforcement
Burdens
on
Governments
Many
EPA
programs
require
effort
on
the
part
of
different
levels
of
government
for
administration
and/
or
enforcement
These
costs
must
be
considered
to
comply
with
UMRA
and
to
calculate
the
full
social
costs
of
a
program
or
rule.
EPA
is
currently
investigating
methods
for
estimating
and
evaluating
the
impacts
of
such
costs.
Revisions
to
this
guidance
document
will
be
made
in
the
future
to
incorporate
the
results
of
that
work.

Impacts
of
Programs
That
Indirectly
Affect
Government
Entities
The
previous
section
describes
how
to
measure
the
impact
of
regulations
that
directly
affect
the
provision
of
goods
or
services
by
government
or
not­
for­
profit
entities.
This
section
addresses
the
indirect
or
induced
impacts
on
government
entities.
For
example,
a
manufacturing
facility
may
reduce
or
suspend
production
in
response
to
an
EPA
regulation
thus
reducing
the
income
levels
of
its
employees.
In
turn,
these
reductions
will
propagate
through
the
economy
by
means
of
changes
in
household
expenditures.
These
induced
impacts
include
the
familiar
multiplier
159
Chapter
9:
Distributional
Analyses
Indicator
Weak
Mid­
Range
Strong
Below
BBB
(
S&
P)
BBB
(
S&
P)
Above
BBB
(
S&
P)
Below
Baa
(
Moody's)
Baa
(
Moody's)
Above
Baa
(
Moody's)

Overall
Net
Debt
as
Percent
of
Full
Market
Above
5%
2%
to
5%
Below
2%
Value
of
Taxable
Property
More
than
1
percentage
Within
1
percentage
More
than
1
percentage
Unemployment
Rate
point
above
national
point
of
national
point
below
national
average
average
average
Median
Household
More
than
10%
Within
10%
of
the
More
than
10%
Income
below
the
state
median
state
median
above
the
state
median
Property
Tax
as
Percent
of
Full
Market
Value
of
Above
4%
2%
to
4%
Below
2%
Taxable
Property
Property
Tax
Collection
Rate
Less
than
94%
94%
to
98%
More
than
98%
Bond
Rating
Exhibit
9­
4
Indicators
of
Economic
and
Financial
Well­
Being
of
Government
Entities
effect,
in
which
loss
of
income
in
one
household
results
in
less
spending
by
that
household
and,
therefore,
less
income
in
households
and
firms
associated
with
goods
previously
purchased
by
the
first
household.
Unlike
production
based
linkages,
income­
based
linkages
tend
to
be
more
geographically
localized,
with
the
strength
of
the
linkage
typically
decreasing
as
geographic
distance
increases
(
although
the
number
of
linked
economic
entities
increases
with
distance).

Decreased
household
and
business
income
can
affect
the
government
sector
by
reducing
tax
revenues
and
increasing
expenditures
on
income
security
programs
(
the
automatic
stabilizer
effect),
employment
training,
food
and
housing
subsidies,
and
other
fiscal
line
items.
Due
to
wide
variation
in
these
programs
and
in
tax
structures,
estimating
public
sector
impacts
for
a
large
number
of
government
jurisdictions
can
be
prohibitively
difficult.

On
the
other
hand,
compliance
expenditures
increase
income
for
businesses
and
employees
that
provide
compliance
related
goods
and
services.
These
income
gains
also
have
a
multiplier
effect,
offsetting
some
of
the
induced
losses
in
tax
revenue
and
increases
in
government
expenditures
identified
above.

9.3
Equity
Assessment
9.3.1
Introduction
In
the
context
of
an
EPA
economic
analysis,
an
equity
assessment
is
an
important
type
of
distribution
analysis.
An
equity
assessment
examines
the
accrual
of
a
regulation's
net
costs,
net
benefits,
or
other
economic
impacts
to
a
specific
sub­
population(
s)
and/
or
examines
the
distribution
of
these
costs,
benefits,
and
impacts
among
sub­
population
s).
This
examination
includes
the
possibility
of
analyzing
a
regulation's
impact
on
the
distribution
of
national
income
or
wealth.

Generally,
cost
bearers
and
beneficiaries
belong
to
one
of
four
populations:
individuals,
businesses,
not­
for­
profit
organizations,
or
governments.
Within
each
of
these
populations
are
sub­
populations
whose
particular
circumstances
EPA
wishes
to
better
understand,
either
because
the
sub­
population
is
more
physically
susceptible
to
environmental
contamination,
is
less
than
fully
capable
of
representing
its
own
interests,
or
is
economically
disadvantaged
or
vulnerable.
For
many
of
these
sub­
populations,
the
EPA
has
been
directed
by
statute,
executive
order,
or
agency
policy
to
examine
the
effects
of
its
rules
when
they
are
expected
to
have
a
"
disproportionate,"
"
significant
and
substantial,"
or
other
such
impact
on
a
particular
subpopulation
An
equity
assessment
gives
rule
makers
a
better
understanding
of
the
economic
effects
of
the
EPA's
rules
on
these
sub­
populations
and,
for
comparison
or
other
purposes,
on
other
specific
sub­
populations
as
well.
An
equity
assessment
examines
the
magnitude
as
well
as
the
distribution
of
effects
on
sub­
populations.

There
are
several
considerations
to
keep
in
mind
when
performing
an
equity
assessment.
Each
of
these
points
will
be
detailed
in
this
chapter.

There
are
specific
equity
dimensions
that
must
always
be
considered,
but
there
are
none
that
must
always
be
analyzed
when
assessing
the
impact
of
environmental
regulations.
Generally
speaking,
the
regulation
under
review,
and
the
specific
issues
associated
with
it,
will
determine
which
equity
dimensions
are
relevant
and
in
need
of
an
equity
assessment.

The
methods
used
by
a
regulation's
BCA
and
EIA
should
guide
the
methodology
used
by
an
equity
assessment.
Neither
this
chapter
nor
OMB's
Best
Practices
and
OMB
Guidelines
outline
a
specific
methodology
for
conducting
an
equity
assessment.
However,
the
models
and
assumptions
developed
for
these
other
two
analyses
should
not
conflict
with
those
used
by
an
equity
assessment.

An
equity
assessment
may
draw
on
the
information
compiled
for
its
corresponding
BCA
as
well
as
include
measures
of
impact
similar
to
those
in
its
corresponding
EIA.
An
early
step
in
an
equity
assessment
is
to
identify
sub­
populations
likely
to
be
affected
by
a
regulation
Once
identified,
if
data
permits,
the
social
costs
and
benefits
estimated
for
the
BCA
can
be
disaggregated
and
net
benefits
examined
for
the
sub­
population
s).
An
equity
assessment
also
examines
other
economic
impacts,
such
as
increases
in
rates
of
unemployment
or
other
traditional
impact
measures,
for
the
identified
sub­
populations(
s).

160
Chapter
9:
Distributional
Analyses
An
equity
assessment
is
not
an
independent
form
of
economic
analysis,
but
is
a
reflection
of
decisions
made
on
many
of
the
other
analytic
issues
arising
in
the
benefit,
cost,
and
economic
impact
sections
of
this
guidance.
For
example,
the
analysis
of
distributions
over
long
time
horizons
can
be
greatly
affected
by
the
analyst's
treatment
of
uncertainty
or
choice
of
a
discount
rate.
Baseline
issues
are
important
in
the
determination
of
net
benefits
expected
to
accrue
to
specific
sub­
populations.
When
making
decisions
on
these
and
other
relevant
issues,
the
analyst
should
keep
in
mind
the
ramifications
borne
by
the
equity
assessment.

Many
of
the
instructions
offered
in
the
preceding
sections
on
estimating
economic
impacts
will
be
directly
applicable
to
an
equity
assessment.
The
difference
will
be
extending
the
analysis
or
presentation
of
results
to
describe
sub­
population
s)
for
which
impacts
are
estimated.
Whereas
an
EIA
focuses
on
traditional
classifications
of
affected
populations
(
like
industrial
classifications),
an
equity
assessment
often
focuses
on
"
disadvantaged
or
vulnerable"
subpopulations
(
like
low
income
households)
but,
for
comparison
or
other
purposes,
can
also
focus
on
other
relevant
sub­
populations
(
like
upper
income
households).
In
this
section,
we
outline
a
general
framework
for
conducting
an
equity
assessment
but
refer
the
reader
to
Sections
5,
6,
and
9.2
for
approaches
used
to
estimate
specific
impacts.
As
is
true
for
an
EIA,
generally
speaking,
an
equity
assessment
is
more
concerned
with
sub­
populations
experiencing
net
costs
or
other
negative
impacts
than
those
experiencing
net
benefits
or
positive
impacts.

The
following
parts
of
this
section
accomplish
three
objectives
First,
the
existing
environmental
and
administrative
statutes,
executive
orders,
and
agency
policies
which
direct
analysts
to
consider
specific
sub­
populations
when
assessing
the
economic
effects
of
EPA's
regulations
are
reviewed.
The
statutes
and
policies
are
enumerated,
the
relevant
sub­
populations
are
identified,
and
definitions
are
established
for
these
sub­
populations.
Second,
a
broad
framework
for
conducting
an
equity
assessment
is
outlined.
This
section
concludes
with
a
review
of
general
sources
of
data
for
assessing
equity
impacts.

9.3.2
Statutes
and
Policies
Requiring
Equity
Assessment
and
Definitions
of
Sub­
Populations
Equity
issues
are
at
the
heart
of
two
existing
statutes
 
The
Regulatory
Flexibility
Act
of
1980
(
RFA),
as
amended
by
the
Small
Business
Regulatory
Enforcement
Fairness
Act
of
1996
(
SBREFA),
and
The
Unfunded
Mandates
Reform
Act
of
1995
(
UMRA)
51
 
and
two
executive
orders
 
EO
12898,
"
Federal
Actions
to
Address
Environmental
Justice
in
Minority
Populations
and
Low­
Income
Populations"
and
EO
13045,
"
Protection
of
Children
From
Environmental
Health
Risks
and
Safety
Risks,"
 
all
of
which
require
agencies
to
consider
a
regulation's
distributional
impact
on
various
entities
or
sub­
populations.
52
These
administrative
laws
or
orders
suggest
several
equity
dimensions;
in
particular
entity
size,
minority
status,
income
level,
and
childhood
status.
Exhibit
9­
5
lists
these
equity
dimensions
and
links
each
to
the
relevant
statute
or
order,
to
a
population,
and
to
at
least
one
established
definition
of
sub­
populations.

A
second
executive
order
 
EO
12866,
"
Regulatory
Planning
and
Review"
has
multiple
objectives
regarding
regulatory
planning
and
review,
many
that
have
nothing
to
do
with
improvements
in
equity.
It
does,
however,
include
a
specific
directive
for
agencies
to
consider
distributive
impacts
and
equity
when
designing
regulations.
Thus,
Exhibit
9­
5
lists
the
equity
dimensions
suggested
by
the
OMB's
Best
Practices
for
EO
12866
and
noted
in
its
OMB
Guidelines
for
economic
analyses.
The
equity
dimensions
are
discussed
in
more
detail
below.

9.3.3
Entity
Size
The
RFA
as
amended
by
SBREFA
and
UMRA
require
agencies
to
consider
economic
effects
on
small
entities
 
specifically,
small
businesses,
small
governmental
161
Chapter
9:
Distributional
Analyses
51
EO
13132,
Federalism
and
EO
13084,
Consultation
and
Coordination
With
Indian
Tribal
Governments,
both
support
some
objectives
in
UMRA.

52
The
Office
of
Regulatory
Management
and
Information's
Rule
and
Policy
Information
Development
System
(
RAPIDS)
http://
intranet.
epa.
gov/
rapids
(
accessed
4/
05/
2000,
internal
EPA
document)
is
a
resource
for
those
who
wish
to
read
relevant
statutes,
executive
orders
or
Agency
policy
documents
in
their
entirety
or
to
acquire
copies.
Chapter
9:
Distributional
Analyses
162
Equity
Dimension
Administrative
Law
Population
Definitions
of
Sub­
Populations
or
Order
Entity
Size
RFA;
UMRA;
OMB
Guidance
Businesses,
to
EO
12866
Governmental
Jurisdictions,
Not­
for­
Profit
Organizations
Minority
Status
E.
O.
12898;
OMB
Individuals
or
Guidance
to
EO
Households
12866;
EO
13084
for
Indian
tribal
communities
only
Income
Level
EO
12898;
OMB
Individuals
or
Guidance
to
EO
12866
Households
The
RFA
references
the
Small
Business
Act
definition
of
small
business
which
defines
small
business
using
SIC
codes.
Definitions
sometimes
depend
on
number
of
employees
and
other
times
depend
on
annual
receipts.
The
RFA
defines
small
governmental
jurisdiction
as
the
government
of
a
city,
county,
town,
school
district,
or
special
district
with
a
population
of
less
than
50,000.
The
RFA
defines
a
small
not­
for­
profit
organization
as
an
enterprise
which
is
independently
owned
and
operated
and
is
not
dominant
in
its
field.
54
UMRA
defines
small
government
jurisdiction,
similar
to
the
RFA,
as
the
government
of
a
city,
county,
town,
school
district,
or
special
district
with
a
population
of
less
than
50,000,
and
any
tribal
government.

Minority
population
of
the
affected
area
exceeds
50
percent
or
minority
population
percentage
of
the
affected
area
is
meaningfully
greater
than
the
minority
population
percentage
in
the
general
population
or
other
appropriate
unit
of
geographic
analysis.

(
Minorities
are
those
individuals
classified
by
OMB
Directive
No.
15
as
Black/
African
American,
Hispanic,
Asian
and
Pacific
Islander,
American
Indian,
Eskimo,
Aleut,
and
other
non­
white
persons.)

"
Indian
tribe"
means
an
Indian
or
Alaska
Native
tribe,
band,
nation,
pueblo,
village,
or
community
that
the
Secretary
of
the
Interior
acknowledges
to
exist
as
an
Indian
tribe
pursuant
to
the
Federally
Recognized
Indian
Tribe
List
Act
of
1994,
25
U.
S.
C.
479a.
(
See
EO
13084.)

53
Some
environmental
statutes
may
also
identify
sub­
populations
that
merit
additional
consideration,
but
this
document
is
limited
to
those
with
broad
coverage.

54
The
RFA
also
allows
agencies
to
establish
an
alternative
definition
of
small
entity
after
notice­
and­
comment,
and
for
small
businesses
only,
after
consultation
with
the
Small
Business
Administration
(
SBA).
Annual
statistical
poverty
thresholds
from
the
U.
S.
Bureau
of
the
Census'
Current
Population
Reports,
Series
P­
60
on
Income
and
Poverty.
Consumers
grouped
according
to
consumption
expenditures
(
e.
g.,
into
deciles).
Exhibit
9­
5
Equity
Dimensions
Potentially
Relevant
to
Environmental
Policy
Analyses53
jurisdictions,
and/
or
small
not­
for­
profit
organizations.
Definitions
of
"
small"
for
each
of
these
entities
are
considered
below.
For
guidance
as
to
when
it
will
be
necessary
to
examine
the
economic
effects
of
a
regulation
under
the
RFA,
analysts
should
consult
EPA
guidelines
on
these
administrative
laws.
55
These
guidelines
include
the
types
of
economic
effects
that
must
be
considered
and
establishment
of
the
baseline
for
purposes
of
determining
if
a
rule
may
have
a
significant
economic
impact
on
a
substantial
number
of
small
entities.
Further,
these
guidelines
explain
the
requirements
in
the
event
the
rule
is
found
to
have
a
significant
economic
impact
on
a
substantial
number
of
small
entities.
Note
that
the
RFA
only
applies
to
rules
for
which
notice­
and­
comment
rulemaking
is
required.
9.3.3.1
Small
Business
The
RFA
requires
agencies
to
begin
with
the
definition
of
small
business
that
is
contained
in
the
SBA's
small
business
size
standard
regulations.
56
The
SBA
defines
small
business
by
category
of
business
using
SIC
codes,
and
in
the
case
of
manufacturing,
generally
defines
small
business
as
a
business
having
500
or
fewer
employees.
For
some
types
of
manufacturing,
however,
the
SBA's
size
standards
define
small
business
as
a
business
having
up
to
750,
1000,
or
1500
employees,
depending
on
the
particular
type
of
business.
In
the
case
of
agriculture,
mining,
and
electric,
gas,
and
sanitary
services,
the
SBA
size
standards
generally
define
small
business
with
respect
to
annual
receipts
(
from
$
0.5
million
for
crops
to
$
25
million
for
certain
types
of
pipelines).

163
Chapter
9:
Distributional
Analyses
Equity
Dimension
Administrative
Law
Population
Definitions
of
Sub­
Populations
or
Order
Childhood
Status,
EO
13045,
OMB
Individuals
or
Age
Guidance
to
EO
12866
Households
Gender
OMB
Guidance
to
Individuals
Male/
Female
EO
12866
Time
OMB
Guidance
to
Individuals
or
Current/
Future
Generations
EO
12866
Households
Physical
Sensitivity
OMB
Guidance
to
Individuals
or
EO
12866
Households
EPA's
Office
of
Children's
Health
Protection
does
not
adhere
to
a
single
definition
of
"
child."
It
suggests
that
the
definition
will
vary
depending
upon
the
issue(
s)
of
concern.

U.
S.
Bureau
of
the
Census
reports
statistics
by
age
in
five­
year
age
groups
and
for
the
following
special
age
categories:
16
years
and
over;
18
years
and
over;
15
to
44
years;
65
years
and
over;
85
years
and
over.

Varies
according
to
the
rule
under
review.
For
example,
a
rule
that
controls
an
air
pollutant
might
define
a
physically
sensitive
sub­
population
as
individuals
with
asthma.

55
U.
S.
Environmental
Protection
Agency,
Revised
Interim
Guidance
for
EPA
Rulewriters:
Regulatory
Flexibility
Act
as
Amended
by
the
Small
Business
Regulatory
Enforcement
Fairness
Act,
dated
March
29,
1999.

56
5
U.
S.
C.
§
601;
see
also
the
SBA's
"
Small
Business
Size
Regulations"
are
contained
in
the
Code
of
Federal
Regulations
at
13
CFR
121
and
in
the
Federal
Acquisition
Regulation
46
CFR
19.
The
SBA
reviews
and
reissues
the
size
standards
every
year.
The
current
version
can
be
viewed
at:
http://
www.
sbaonline.
sba.
gov/
gopher/
Financial­
Assistance/
Size­
Standards/
(
accessed
on
8/
28/
2000).
Exhibit
9­
5
Equity
Dimensions
Potentially
Relevant
to
Environmental
Policy
Analyses
(
Continued)
The
RFA
also
authorizes
any
agency
to
adopt
and
apply
an
alternative
definition
of
small
business
"
where
appropriate
to
the
activities
of
the
agency"
after
consulting
with
the
Chief
Counsel
for
Advocacy
of
the
SBA
and
after
opportunity
for
public
comment.
The
agency
must
publish
any
alternative
definition
in
the
Federal
Register.
57
9.3.3.2
Small
Governmental
Jurisdiction
The
RFA
defines
a
small
governmental
jurisdiction
as
the
government
of
a
city,
county,
town,
school
district,
or
special
district
with
a
population
of
less
than
50,000.
Similar
to
the
definition
of
small
business,
the
RFA
authorizes
agencies
to
establish
alternative
definitions
of
small
government
after
opportunity
for
public
comment
(
consultation
with
the
SBA
is
not
required).
Any
alternative
definition
must
be
"
appropriate
to
the
activity
of
the
agency"
and
"
based
on
such
factors
as
location
in
rural
or
sparsely
populated
areas
or
limited
revenues
due
to
the
population
of
such
jurisdiction."
Any
alternative
definition
must
be
published
in
the
Federal
Register.
58
Section
202
of
UMRA
directs
agencies
to
obtain
meaningful
input
from
state,
local,
and
tribal
governments
for
each
proposed
and
final
rule
"
containing
significant
federal
intergovernmental
mandates."
More
specifically,
this
requirement
is
for
rules
that
include
federal
mandates
"
which
may
result
in
the
expenditure
by
state,
local,
and
tribal
governments,
in
the
aggregate,
or
by
the
private
sector
of
$
100
million
or
more
in
any
one
year."
59
Section
203
of
UMRA
requires
that
agencies
assess
whether
its
rules
"
might
significantly
or
uniquely
affect
small
governments
so
as
to
consider
the
need
for
a
compliance
plan.
Small
governments
are
defined
in
the
paragraph
immediately
above.
The
phrase
"
small
towns"
refers
to
very
small
governments
with
populations
of
under
2,500
citizens.
As
part
of
the
"
Small
Government
Agency
Plan"
required
under
UMRA,
EPA
evaluates
such
factors
as
whether
small
governments
will
experience
higher
per­
capita
costs
due
to
economies
of
scale,
whether
they
would
need
to
hire
professional
staff
or
consultants
for
implementation,
or
if
they
would
be
required
to
purchase
and
operate
expensive
or
sophisticated
equipment.
60
9.3.3.3
Small
Not­
for­
Profit
Organization
The
RFA
defines
a
small
not­
for­
profit
organization
as
an
"
enterprise
which
is
independently
owned
and
operated
and
is
not
dominant
in
its
field."
Examples
might
include
private
hospitals
or
educational
institutions.
Here
again,
agencies
are
authorized
to
establish
alternative
definitions
"
appropriate
to
the
activities
of
the
agency"
after
providing
an
opportunity
for
public
comment
(
consultation
with
the
SBA
is
not
required).
Any
alternative
definition
must
be
published
in
the
Federal
Register.
61
9.3.4
Minority
Status
and
Income
Level
Executive
Order
12898,
"
Federal
Actions
to
Address
Environmental
Justice
in
Minority
Populations
and
Low­
Income
Populations"
and
its
accompanying
memorandum
have
the
primary
purpose
of
ensuring
that
"
each
federal
agency
shall
make
achieving
environmental
justice
part
of
its
mission
by
identifying
and
addressing,
as
appropriate,
disproportionately
high
and
adverse
human
health
or
environmental
effects
of
its
programs,
policies,
and
activities
on
minority
populations
and
low
income
populations...
."

164
Chapter
9:
Distributional
Analyses
57
U.
S.
Environmental
Protection
Agency,
Revised
Interim
Guidance
for
EPA
Rulewriters:
Regulatory
Flexibility
Act
as
Amended
by
the
Small
Business
Regulatory
Enforcement
Fairness
Act,
dated
March
29,
1999.

58
Ibid.

59
U.
S.
Environmental
Protection
Agency,
Interim
Guidance
an
the
Unfunded
Mandates
Reform
Act
of
1995,
memorandum
from
Office
of
General
Counsel,
March
23,
1995b.

60
Ibid.
p.
4.

61
U.
S.
Environmental
Protection
Agency,
Revised
Interim
Guidance
for
EPA
Rulewriters:
Regulatory
Flexibility
Act
as
Amended
by
the
Small
Business
Regulatory
Enforcement
Fairness
Act,
dated
March
29,
1999.
The
Executive
Order
also
explicitly
calls
for
the
application
of
equal
consideration
for
Native
American
programs.
62
EPA's
Interim
Final
Guidance
for
Incorporating
Environmental
Justice
Concerns
in
EPA's
NEPA
Compliance
Analyses
(
EPA,
1998),
discusses
the
meaning
of
key
terms
and
phrases
contained
in
EO
12898.
Their
conclusions
regarding
four
key
phrases:
"
minority
population
"
low­
income
population,"
"
disproportionately
high
and
adverse
human
health
effects,"
and
"
disproportionately
high
and
adverse
environmental
effects"
are
summarized
below.

9.3.4.1
Minority
Population
Minority
individuals
are
those
classified
by
Office
of
Management
and
Budget
Directive
No.
15
as
Black/
African
American,
Hispanic,
Asian
and
Pacific
Islander,
American
Indian,
Eskimo,
Aleut,
and
other
non­
white
persons.
A
minority
population
should
be
identified
where
either
(
1)
the
minority
population
of
the
affected
area
exceeds
50
percent
or
(
2)
the
minority
population
percentage
of
the
affected
area
is
meaningfully
greater
than
its
corresponding
percentage
in
the
general
population
(
or
other
appropriate
unit
of
geographic
analysis).
A
minority
population
also
exists
if
there
is
more
than
one
minority
group
present
and
the
percentage
calculated
by
aggregating
all
minority
persons
meets
one
of
these
thresholds.
In
identifying
minority
communities,
the
Agency
may
consider
as
a
community
either:
(
1)
a
group
of
individuals
living
in
geographic
proximity
to
one
another
or
(
2)
a
geographically
dispersed/
transient
set
of
individuals
(
such
as
migrant
workers
or
American
Indians),
where
either
type
of
group
experiences
common
conditions
of
environmental
exposure
or
effect.
The
selection
of
the
appropriate
unit
of
geographic
analysis
may
be
a
governing
body's
jurisdiction,
a
neighborhood,
census
tract,
or
other
similar
unit
that
is
to
be
chosen
so
as
to
not
artificially
dilute
or
inflate
the
affected
minority
population.
The
selection
of
the
appropriate
unit
of
geographic
analysis
may
also
be
influenced
by
the
accuracy
and
precision
of
environmental
quality
models.

9.3.4.2
Low­
Income
Population
Low
income
populations
in
an
affected
area
can
be
identified
with
the
annual
statistical
poverty
thresholds
from
the
U.
S.
Bureau
of
the
Census'
Current
Population
Reports,
Series
P­
60
on
Income
and
Poverty.
In
conjunction
with
census
data,
the
analysis
should
also
consider
state
and
regional
low­
income
and
poverty
definitions
as
appropriate
In
identifying
low­
income
populations,
the
Agency
may
consider
as
a
community
either
a
group
of
individuals
living
in
geographic
proximity
to
one
another
or
a
geographically
dispersed/
transient
set
of
individuals
(
such
as
migrant
workers
or
American
Indians),
where
either
type
of
group
experiences
common
conditions
of
environmental
exposure
or
effects.
63
One
alternative
to
measuring
annual
incomes
is
to
examine
expected
lifetime
incomes.
Generally,
consumption
is
better
than
annual
income
at
tracking
households'
expected
lifetime
incomes.
For
example,
an
analyst
might
divide
the
population
by
consumption
deciles
and
see
how
the
lowest
deciles
fare.
These
data
will
be
harder
to
access
as
the
Census
does
not
contain
consumption
data.

9.3.4.3
Disproportionately
High
and
Adverse
Human
Health
Effects
When
determining
whether
human
health
effects
are
disproportionately
high
and
adverse,
the
Agency
is
to
consider
the
following
three
factors
to
the
extent
practicable:

Whether
the
health
effects,
which
may
be
measured
in
risks
and
rates,
are
significant,
unacceptable,
or
above
generally
accepted
norms.
Adverse
health
165
Chapter
9:
Distributional
Analyses
62
In
addition,
EO
13084,
Consultation
and
Coordination
with
Indian
Tribal
Governments,
requires
regulations
that
"
significantly
or
uniquely"
affect
the
communities
of
Indian
tribal
governments
and
that
impose
substantial
direct
compliance
costs
on
such
communities
to
either
refund
the
direct
costs
incurred
or
to
consult
with
elected
officials
and
other
representatives
of
the
Indian
tribal
governments
and
to
provide
a
description
of
the
consultation
and/
or
communication
to
the
Office
of
Management
and
Budget.

63
Two
additional
tests
available
for
identifying
low­
income
populations
in
an
affected
area
are:
(
1)
the
U.
S.
Department
of
Health
and
Human
Services
poverty
guidelines
or
(
2)
the
U.
S.
Department
of
Housing
and
Urban
Development
statutory
definition
for
very
low­
income
for
the
purposes
of
housing
benefits
programs.
Information
on
these
and
other
tests
can
be
found
in
the
CEQ
report
Environmental
Justice:
Guidelines
for
National
Environmental
Policy
Act
(
CEQ,
1997)
and
the
Interim
Final
Guidance
for
Incorporating
Environmental
Justice
Concerns
in
EPA's
NEPA
Compliance
(
EPA,
1998).
effects
may
include
bodily
impairment,
infirmity,
illness
or
death;
64
and
Whether
the
risk
or
rate
of
hazard
exposure
by
a
minority
population
or
low­
income
population
to
an
environmental
hazard
is
significant
and
appreciably
exceeds
or
is
likely
to
appreciably
exceed
the
risk
or
rate
to
the
general
population
or
other
appropriate
comparison
group;
65
and
Whether
health
effects
occur
in
a
minority
or
lowincome
population
affected
by
cumulative
or
multiple
adverse
exposures
from
environmental
hazards.

9.3.4.4
Disproportionately
High
and
Adverse
Environmental
Effects
When
determining
whether
environmental
effects
are
adverse
and
disproportionately
high,
the
Agency
is
to
consider
the
following
three
factors
to
the
extent
practicable:

Whether
there
is
or
will
be
an
impact
on
the
natural
or
physical
environment
that
significantly
and
adversely
affects
a
minority
or
low­
income
population.
Such
effects
may
include
ecological,
cultural,
human
health,
economic,
or
social
impacts
on
minority
communities
or
low­
income
communities,
when
those
impacts
are
interrelated
with
impacts
on
the
natural
or
physical
environment;
and
Whether
environmental
effects
are
significant
and
are
or
may
be
having
an
adverse
impact
on
minority
populations
or
low­
income
populations
that
appreciably
exceeds,
or
is
likely
to
appreciably
exceed,
those
on
the
general
population
or
other
appropriate
comparison
group;
and
Whether
the
environmental
effects
occur
or
would
occur
in
a
minority
population
or
low­
income
population
affected
by
cumulative
or
multiple
adverse
exposures
from
environmental
hazards.

9.3.5
Childhood
Status
EO
13045,
Protection
of
Children
From
Environmental
Health
Risks
and
Safety
Risks
states
that:

"
A
growing
body
of
scientific
knowledge
demonstrates
that
children
may
suffer
disproportionately
from
environmental
health
risks
and
safety
risks.
.
.
.
Therefore,
to
the
extent
permitted
by
law
and
appropriate,
and
consistent
with
the
agency's
mission,
each
Federal
agency:
(
a)
shall
make
it
a
high
priority
to
identify
and
assess
environmental
health
risks
and
safety
risks
that
may
disproportionately
affect
children;
and
(
b)
shall
ensure
that
its
policies,
programs,
activities,
and
standards
address
disproportionate
risks
to
children
that
result
from
environmental
health
risks
or
safety
risks."
66
The
order
also
states
that
each
"
covered
regulatory
action"
67
submitted
to
OMB,
unless
prohibited
by
law,
should
be
accompanied
by
"...
an
evaluation
of
the
environmental
health
or
safety
effects
of
the
planned
regulation
on
children."
68
The
term
"
children"
is
not
defined.
EPA's
Office
of
Children's
Health
Protection,
established
in
response
to
this
order,
does
not
use
a
single
definition
of
"
child."
They
suggest
that
the
definition
will
vary
depending
upon
the
issue(
s)
of
concern.
See
Exhibit
9­
5
for
age
classifications
reported
by
the
U.
S.
Bureau
of
the
Census.
EPA
is
currently
developing
a
practical
guide
for
valuing
children's
health
effects.

166
Chapter
9:
Distributional
Analyses
64
The
definition
of
adverse
health
effects
contained
in
specific
environmental
statues,
under
whose
authority
a
regulation
is
being
developed
may
also
guide
the
consideration
of
adverse
health
effects
in
conducting
equity
assessments.

65
The
definition
of
risk
or
rate
of
hazard
exposure
contained
in
specific
environmental
statues
under
whose
authority
a
regulation
is
being
developed
may
also
guide
the
consideration
of
risk
or
rate
of
hazard
exposure
in
conducting
equity
assessments.

66
EO
13045,
Protection
of
Children
From
Environmental
Health
Risks
and
Safety
Risks
effective
April
21,
1997.

67
A
"
covered
regulatory
action"
is
any
substantive
action
in
a
rule
making
that
is
likely
to
result
in
a
rule
that
may
(
a)
be
economically
significant
(
have
an
annual
effect
on
the
economy
of
$
100
million
or
more
or
would
adversely
affect
in
a
material
way
the
economy,
a
sector
of
the
economy
the
environment,
and
so
on)
and
(
b)
concern
an
environmental
health
risk
that
an
agency
has
reason
to
believe
may
disproportionately
affect
children.

68
EO
13045.
9.3.6
Case
Specific
Equity
Dimensions
EO
12866,
Regulatory
Planning
and
Review
has
several
requirements
that
contribute
to
the
preparation
of
economic
information,
including
a
specific
directive
for
agencies
to
consider
distributive
impacts
and
equity
when
designing
regulations.
The
OMB
Guidelines
(
OMB,
2000)
also
makes
note
of
several
specific
equity
dimensions.
But,
unlike
the
laws
and
orders
mentioned
above,
it
does
not
suggest
that
analysts
must
always
consider
these
dimensions.
Rather,
the
suggestion
is
that
the
regulation
under
review
should
determine
which
equity
dimensions
are
relevant.

"
Those
who
bear
the
costs
of
a
regulation
and
those
who
enjoy
its
benefits
often
are
not
the
same
people.
Regulations
have
'
distributional
effects'
that
affect
different
segments
of
the
population
and
economy
in
various
ways:
by
income
groups,
race,
sex,
industrial
sector,
and
others.
Regulations
often
distribute
benefits
and
costs
unevenly
over
time,
perhaps
spanning
several
generations...
.
If
these
distributive
effects
are
important,
you
should
describe
the
effects
of
various
regulatory
alternatives
quantitatively
to
the
extent
possible,
including
their
magnitude,
likelihood
and
incidence
of
effects
on
particular
groups.
You
should
carefully
analyze
regulations
that
significantly
affect
outcomes
for
different
groups."
69
OMB
seems
to
be
offering
a
general
directive
to
study
distributive
effects
on
any
grouping
of
sub­
populations
when
those
effects
are
expected
to
be
significant,
without
requiring
agencies
to
always
consider
a
predetermined
set
of
equity
dimensions.

9.3.6.1
Additional
Equity
Dimensions
In
its
general
directive,
OMB
specifically
mentions
gender
as
a
way
to
divide
effects.
Certain
regulations
may
be
found
to
have
differential
impacts
on
males
and
females.
Thus,
we
add
gender
to
the
equity
dimensions
in
Exhibit
9­
5.
Later
in
the
OMB
Guidelines
it
states,
"
The
economic
analysis
should
also
present
information
on
the
streams
of
benefits
and
costs
over
time
in
order
to
provide
a
basis
for
judging
intertemporal
distributional
consequences,
particularly
where
intergenerational
effects
are
concerned."
70
This
leans
more
towards
being
a
directive
and
suggests
that
time
is
an
important
equity
dimension.
The
OMB
Guidelines
give
some
suggestions
for
conducting
an
intergenerational
analysis
including:

"
Special
approaches
may
also
be
appropriate
when
comparing
benefits
and
costs
across
generations
One
approach
is
to
follow
the
discounting
method
discussed
above,
and
address
the
intergenerational
equity
and
fairness
issues
explicitly,
instead
of
modifying
the
discount
rate."

"
One
alternative
approach
is
based
on
the
perspective
that
this
generation
is
concerned
about
the
welfare
of
future
generations
and,
in
fact,
is
willing
to
defer
consumption
and
invest
or
preserve
resources
for
future
use
at
a
discount
rate
that
is
less
than
the
discount
rate
used
in
making
decisions
within
a
generation.
For
this
purpose,
you
could
use
as
a
discount
rate
a
special
rate
of
time
preference
based
on
the
growth
of
per
capita
consumption.
Again,
check
with
us
if
you
plan
to
use
such
an
approach."
71
Both
OMB
and
EPA
recognize
that
inter­
generational
equity
issues
are
potentially
addressed
by
applying
a
discounting
procedure.
In
the
quotation
above,
OMB
offers
some
analytical
approaches
to
inter­
generational
discounting.
Chapter
6
of
this
document
provides
information
on
alternative
methods
of
discounting
in
this
context
and
discusses
when
such
discounting
is,
and
is
not,
appropriate.

When
discussing
risk
assessment,
the
Best
Practices
mentions
that,

"
Exposures
and
sensitivities
to
risks
may
vary
considerably
across
the
affected
population.
These
difficulties
can
lead;
for
example,
to
a
range
of
quantitative
estimates
of
risk
in
health
and
ecological
risk
assessments
that
can
span
167
Chapter
9:
Distributional
Analyses
69
OMB
Guidelines,
p.
16.

70
Ibid.,
p.
8.

71
Ibid.,
p.
8.
several
orders
of
magnitude...
.
All
of
these
concerns
should
be
reflected
in
the
uncertainties
about
outcomes
that
should
be
incorporated
in
the
analysis."
72
Hence,
we
include
physical
sensitivity
as
an
important
equity
dimension.
The
definition
of
who
precisely
is
physically
sensitive
will
vary
according
to
the
rule
being
developed
For
example,
a
rule
that
controls
an
air
pollutant
might
have
a
large
impact
on
individuals
with
asthma.
Or,
a
rule
that
diminishes
the
quantity
of
a
hazardous
substance
that
winds
up
in
soils
near
residential
areas,
might
have
a
large
impact
on
children
with
pica
(
a
disorder
that
results
in
an
urge
to
eat
non­
food
substances
such
as
dirt).

The
Best
Practices
is
not
the
only
source
directing
attention
to
physical
sensitivity.
There
are
sections
of
environmental
statutes
which
require
EPA
to
address
sensitive
populations,
analyze
effects,
and
take
actions
to
avert
or
mitigate
adverse
impacts.
For
example,
the
Clean
Air
Act
section
108(
f)(
1)(
C)
requires
the
Administrator
to
publish
and
make
available
"
information
on
other
measures
which
may
be
employed
to
reduce
the
impact
on
public
health
or
protect
the
health
of
sensitive
or
susceptible
individuals
or
groups...
."

Finally,
the
Best
Practices
mentions
that
economic
analyses
might
need
to
consider
different
age
categories.

"
The
literature
identifies
certain
attributes
of
risk
that
affect
value.
These
attributes
include
the
baseline
risk,
the
extent
to
which
the
risk
is
voluntarily
or
involuntarily
assumed,
and
features
(
such
as
age)
of
the
population
exposed
to
risk.
For
regulations
affecting
some
segments
of
the
population
(
e.
g.,
infants)
more
than
those
groups
which
have
served
as
the
basis
for
most
of
the
information
used
to
estimates
(
sic.)
values
of
a
statistical
life
(
e.
g.,
working­
age
adults),
the
use
of
values
of
a
statistical
life
from
the
literature
may
not
be
appropriate."
73
Age
is
clearly
the
issue
in
EO
13045,
though
its
specific
focus
is
on
childhood
status.
Thus,
Exhibit
9­
5
lists
childhood
status
and
age
as
two
aspects
of
a
single
equity
dimension
and
cites
the
Best
Practices
and
OMB
Guidelines,
as
well
as
EO
13045.
The
next
three
entries
of
Exhibit
9­
5
list
the
other
equity
dimensions
suggested
by
the
Best
Practices
and
OMB
Guidelines
and
links
each
to
a
population
and
at
least
one
established
definition
of
subpopulations

While
directing
agencies
to
consider
the
differential
impact
of
a
regulation
on
relevant
sub­
populations,
the
OMB
Guidelines
state
that
an
economic
analysis
should
focus
on
the
distribution
of
the
costs
and
benefits
of
complying
with
a
regulation
rather
than
on
the
financial
well­
being
of
regulated
entities.

"
Since
generally
accepted
principles
do
not
exist
for
determining
when
one
distribution
of
net
benefits
is
more
equitable
than
another,
you
should
describe
distributional
effects
without
judging
their
fairness.
You
should
describe
these
effects
broadly,
focusing
on
large
groups
with
small
effects
per
capita,
as
well
as
on
small
groups
experiencing
large
effects
per
capita.
You
should
also
note
any
equity
issues
not
related
to
the
distribution
of
policy
effects
if
they
are
important
and
describe
them
quantitatively
to
the
extent
you
can."
74
OMB
cautions
analysts
conducting
distributional
analyses
to
recognize
that
transfer
payments
will
become
relevant;
to
avoid
double­
counting
even
when
mixing
monetized
and
physical
effects
and
to
describe
distributional
effects
without
judging
their
fairness.

9.3.7
A
Framework
for
Equity
Assessment
What
follows
is
a
very
general
three­
step
framework
to
guide
analysts
conducting
equity
assessments.
Instructions
for
estimating
particular
impacts
on
sub­
populations
are
given
above
in
the
section
on
EIA.
Whether
disaggregating
benefits
and
costs
or
estimating
economic
impacts,
the
primary
purpose
of
an
equity
assessment
is
168
Chapter
9:
Distributional
Analyses
72
Best
Practices,
p.
15.

73
Ibid.,
p.
29.

74
OMB
Guidelines,
p.
16.
to
examine
regulatory
consequences
for
specific
sub­
populations
of
concern.
Thus,
the
framework
developed
here
offers
an
approach
on
how
to
identify
a
sub­
population
to
be
analyzed.

For
each
step,
choosing
to
measure
the
equity­
related
consequences
of
a
regulation
involves
balancing
costs
of
data
acquisition
and
analysis
against
the
value
of
improved
accuracy.
The
framework
attempts
to
conserve
resources
by
screening
out
situations
for
which
any
of
the
variety
of
equity
impacts
probably
will
not
occur.
This
permits
more
extensive
analytical
and
empirical
efforts
to
focus
on
circumstances
with
a
higher
probability
of
creating
significant
equity­
related
effects.
The
three
steps
should
not
be
viewed
as
necessarily
sequential.
Instead,
at
the
outset
of
a
particular
regulatory
analysis,
all
aspects
of
the
suggested
approach
should
be
considered.
This
will
help
to
ensure
that
the
data
gathered
and
the
analyses
performed
will
be
well
suited
to
measuring
the
equity
impacts
of
concern.

9.3.7.1
Step
1:
Equity
Scoping
Analysis
This
first
step
consists
of
several
tasks
described
here
in
sequential
order.

Determine
which
populations
listed
in
Exhibit
9­
5
are
within
the
scope
of
the
analysis
or
exist
relevant
markets.
In
certain
cases,
some
of
the
populations
might
not
be
connected
closely
enough
to
the
regulation
to
be
meaningfully
affected.
For
example
governmental
entities
might
not
be
involved
in
the
activities
that
would
be
affected
by
a
regulation.
If
so,
then
no
further
analysis
is
necessary
for
these
populations.
It
will
be
useful
to
make
this
determination
early
so
that
resources
may
be
used
in
the
most
effective
manner
possible.

Determine
whether
the
rule
or
regulatory
alternative
imposes
costs,
offers
benefits,
or
results
in
other
economic
effects
too
small
to
warrant
further
analysis.
When
considering
the
cost
side
of
the
analysis,
it
might
be
possible
to
argue
that
incremental
unemployment
and
plant
or
firm
closures
resulting
from
even
small
regulatory
costs
cannot
be
distinguished
from
changes
that
would
probably
be
triggered
by
the
underlying
economic
viability
of
these
activities.
This
step
also
applies
when
a
regulation
imposes
one
burden
on
an
entity,
but
reduces
another
on
the
same
entity,
so
that
the
net
effect
is
small.
Although
some
equity
impacts
might
be
dismissed
on
this
basis,
others
will
probably
require
further
analysis
beyond
this
initial
de
minimis
screen.

Identify
which
equity
dimensions
from
Exhibit
9­
5
are
relevant
if
further
analysis
is
required.
Negative
impacts
on
small
entities,
low
income
populations
minority
populations,
and
children
are
important
to
consider
in
all
cases
because
of
statutory
and
other
mandates
(
see
Section
9.3.2).
For
example
rules
requiring
additional
safeguards
against
contamination
of
groundwater
by
landfills
clearly
benefit
communities
where
landfills
are
sited.
There
is
a
long­
standing
concern
among
the
environmental
justice
movement
that
locally
unwanted
facilities,
including
landfills,
are
sited
disproportionately
in
poor
and/
or
minority
neighborhoods.
Thus,
for
regulations
affecting
siting
and
management
of
landfills,
wealth
and
race
are
equity
dimensions
of
concern.
Rules
requiring
additional
safeguards
are
likely
to
have
a
positive
impact
on
neighborhoods
hosting
landfills.
This
positive
impact
should
be
noted
and
possibly
estimated.
For
other
rules,
it
is
likely
that
concern
for
other
equity
dimensions
will
naturally
arise.

In
addition
to
those
equity
dimensions
that
must
always
be
considered
for
distributional
analysis,
the
other
dimensions
listed
by
Exhibit
9­
5
should
be
considered
as
part
of
the
effort
to
identify
which
are
relevant
In
attempting
to
decide
for
a
particular
case
whether
some
of
the
less
obvious
dimensions
matter,
analysts
should
collect
readily
accessible
information
on
the
characteristics
of
affected
entities
and
populations
Attention
should
be
paid
to
who
is
expected
to
receive
the
benefits
of
the
regulation
as
well
as
who
will
pay
the
costs.
Negative
net
benefits
or
net
costs
are
ultimately
what
should
trigger
concern.
Financial,
health,
and
other
non­
monetary
benefits
and
costs
should
be
included.

Prioritize
relevant
equity
dimensions.
Assuming
there
is
more
than
one
relevant
equity
dimension,
they
should
be
prioritized
according
to
which
dimension
seems
to
warrant
greatest
concern.
The
level
of
concern
should
be
determined
by
how
strongly
analysts
expect
a
regulation
to
affect
a
particular
sub­
population.

169
Chapter
9:
Distributional
Analyses
9.3.7.2
Step
2:
Define
Distributional
Variables
for
the
Equity
Dimensions
of
Concern
The
next
step
is
to
define
distributional
variables
associated
with
the
equity
dimensions
from
Step
1.
For
example,
if
one
were
concerned
about
a
regulation's
potential
impact
on
poor
neighborhoods,
then
a
classification
system
for
"
poor"
versus
"
not­
poor"
neighborhoods
should
be
developed.
The
established
definitions
reviewed
in
Section
9.3.2
above
could
be
used
or
alternatives
developed.
Referring
again
to
the
landfill
example
where
one
of
the
relevant
equity
dimensions
is
race,
analysts
would
need
to
establish
a
rule
for
defining
what
qualifies
as
an
African­
American
neighborhood
or
a
minority
neighborhood.
In
this
case,
one
could
rely
on
the
established
definitions
presented
in
Section
9.3.2.

9.3.7.3
Step
3:
Measure
Equity
Consequences
The
next
step
is
to
begin
to
measure
specific
economic
effects
across
the
distributional
variables.
In
some
cases,
estimating
the
equity­
related
effects
of
a
regulation
will
involve
disaggregating
existing
costs
and
benefits
and
tabulating
or
otherwise
accounting
for
their
distribution
across
the
distributional
variables
defined
in
Step
2.
This
process
would
subject
the
equity
assessment
to
the
same
set
of
assumptions
applied
to
the
benefit­
cost
analysis.

In
other
cases,
an
equity
assessment
will
examine
other
impacts,
such
as
increases
in
unemployment,
for
identified
sub­
populations.
The
section
above
on
EIA
reviews
these
other
impacts
and
outlines
how
to
estimate
them.
Any
assumptions,
for
example
those
concerning
elasticities
of
demand,
used
in
the
EIA,
should
also
be
applied
to
the
Equity
Assessment
unless
there
are
specific
reasons
for
why
the
assumptions
are
inappropriate
for
the
identified
sub­
population(
s).

A
thorough
equity
assessment,
when
resources
permit,
might
include
a
disaggregation
of
benefits
and
costs
from
the
BCA
as
well
as
an
examination
of
economic
impacts
for
the
identified
sub­
population(
s).
9.3.8
Data
for
Conducting
Equity
Assessments
The
discussion
in
the
preceding
sections
suggests
several
types
of
data
that
would
be
useful
for
estimating
the
distribution
of
impacts
of
environmental
policy
options.
This
section
presents
some
of
the
data
sources
for
each
category
of
data
needed.
This
is
not
an
exhaustive
list
of
data
sources,
but
is
presented
to
provide
initial
guidance
for
this
information.

9.3.8.1
Data
on
Businesses,
Governments,
and
Not­
For­
Profit
Organizations
Two
specific
Internet
sites
provide
access
to
some
of
the
most
commonly
needed
data.
The
first
is
the
SBA's
Office
of
Advocacy
website.
75
Data
provided
on
this
website
include
the
number
of
firms,
number
of
establishments,
employment,
annual
payroll,
and
estimated
receipts.
The
data
are
available
by
employment
size
categories.
Data
may
be
viewed
and
downloaded
for
the
U.
S.,
by
state
or
by
metropolitan
statistical
area.
A
second
website
that
analysts
may
find
useful
is
the
home
page
of
the
U.
S.
Bureau
of
the
Census,
Office
of
Statistics.
76
Here
a
variety
of
relevant
data
may
be
accessed
including
information
published
in
the
County
Business
Patterns
and
other
published
data
series
on
population
characteristics,
including
income
and
age
distributions.

9.3.8.2
Demographic
Data
The
U.
S.
Bureau
of
the
Census
collects
household
data
and
aggregates
them
in
forms
that
may
be
useful
for
environmental
justice
matters.
Data
are
available
on
population
distributions
by
race
and
household
income
at
the
state,
county,
metropolitan
statistical
area,
or
census
tract
level.
An
additional,
Census
website
allows
one
to
view
a
map
of
any
part
of
the
U.
S.,
at
the
desired
scale,
that
shows
data
on
population
distributions
by
family
income
or
a
specified
race
(
e.
g.,
percent
white
or
percent
black).
77
In
addition,
income
data
collected
by
the
Internal
Revenue
Service
and
170
Chapter
9:
Distributional
Analyses
75
The
address
for
this
site
is
http://
www.
sba.
gov/
ADVO/
stats/
(
accessed
8/
28/
2000,
internal
EPA
document).

76
The
address
for
this
site
is
http://
www.
census.
gov
(
accessed
8/
28/
2000).

77
The
address
for
this
site
is
http://
www.
census.
gov/
geo/
www/
tiger/
index.
html
(
accessed
8/
28/
2000).
made
available
in
aggregated
form
on
the
Internet
may
be
useful
for
some
analyses.
78
9.3.8.3
Other
Potentially
Useful
Data
Sources
There
is
a
range
of
other
sources
that
may
provide
useful
data
on
other
factors
potentially
relevant
to
equity
analyses
For
example,
import
and
export
data
are
available
from
the
Bureau
of
the
Census
publication,
The
U.
S.
Merchandise
Trade:
Exports,
General
Imports,
and
Imports
for
Consumption.
The
U.
S.
Department
of
Commerce
may
also
have
data
that
would
be
useful
for
estimating
changes
in
demand
as
a
result
of
regulatory
costs,
or
the
turnover
rate
for
capital
equipment
in
various
industrial
sectors.

171
Chapter
9:
Distributional
Analyses
78
The
address
of
the
website
providing
these
data
is
http://
trac.
syr.
edu/
tracirs/.
Note
that
a
user
ID
and
password
are
necessary
to
access
the
data.
Registration
is
available
at
http://
trac.
syr.
edu/
register/
registration.
html
(
accessed
8/
28/
2000).
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Heads
of
Executive
Departments
and
Agencies,
March
31.

U.
S.
Office
of
Management
and
Budget.
1996.
Economic
Analysis
of
Federal
Regulations
Under
Executive
Order
No.
12866.
(
or
Best
Practices
document),
January
11.

U.
S.
Office
of
Management
and
Budget.
1998.
North
American
Industry
Classification
System
(
NAICS)
Manual.
1998.
Washington,
D.
C.:
U.
S.
Government
Printing
Office.

U.
S.
Office
of
Management
and
Budget.
2000.
Guidelines
to
Standardize
Measures
of
Costs
and
Benefits
and
the
Format
of
Accounting
Statements.
Report
#
M­
00­
08,
(
or
OMB
Guidelines
document),
March
22.

Value
Line.
Investment
Survey,
(
loose­
leaf
in
several
volumes,
with
weekly
updates).
New
York,
NY.

174
Chapter
9:
Distributional
Analyses
10.1
Introduction
This
chapter
provides
some
general
rules
for
presenting
analytical
results
to
policy
makers
and
others
interested
in
environmental
policy
development.
As
emphasized
several
times
in
these
EA
Guidelines,
especially
by
the
flowchart
and
discussion
of
equity
assessments
in
Chapter
9,
economic
analyses
play
an
important
role
throughout
the
policy
development
process.
From
the
initial,
preliminary
evaluation
of
potential
options
and
their
consequences
through
the
preparation
of
the
final
economic
analysis
document,
economic
analysts
participate
in
an
interactive
process
with
policy
makers.
The
fundamental
goal
of
this
process
is
to
refine
the
information
available
for
making
policy
choices.

Hence,
this
guidance
for
presenting
inputs,
analyses,
and
results
applies
at
all
stages
of
this
process,
not
only
for
the
final
document
embodying
the
completed
economic
analysis.
In
particular,
reporting
ranges
of
uncertainty,
critical
assumptions,
and
key
unquantified
effects
to
decision
makers
as
they
weigh
various
options
and
alternatives
is
as
critical
as
including
these
in
a
final
economic
analysis
document
at
the
conclusion
of
the
policy
development
process.

This
chapter
first
reviews
some
important
features
of
economic
analyses
of
environmental
policies
to
include
or
describe
in
all
presentations
of
analyses
and
results.
Following
this
is
some
general
guidance
on
what
types
of
results
are
most
useful
to
report
and
useful
formats
for
presenting
them.
Some
brief
comments
on
the
relationship
between
economic
analyses
and
environmental
policy
making
conclude
the
chapter.
All
of
the
recommendations
in
this
chapter
are,
of
course,
subject
to
resource
availability
and
statutory
prohibitions.
10.2
Communicating
Assumptions
and
Methods
All
economic
analyses
of
environmental
policies
must
balance
the
goals
of
accuracy
and
completeness
against
the
costs
of
data
acquisition,
detailed
modeling,
and
valuation
of
consequences.
Hence,
the
results
of
applied
economic
analyses
inevitably
contain
uncertainties
in
particular
areas,
assumptions
in
the
place
of
data
that
are
not
available,
and
effects
that
cannot
be
quantified
or
monetized.
Analysts
should
highlight
these
limitations
when
presenting
the
inputs,
modeling,
and
results
of
economic
analyses.

Some
general
guidelines
for
communicating
these
considerations
include
the
following:

Clarity
and
transparency:
Presentations
of
economic
analyses
should
strive
for
maximum
clarity
and
transparency
of
all
aspects
of
the
assessments.
An
analysis
whose
conclusions
can
withstand
close
scrutiny
of
all
of
its
facets
is
more
likely
to
provide
policy
makers
with
the
information
they
need
to
develop
the
best
environmental
policies.
In
addition,
if
a
rule
is
later
challenged,
the
more
clear,
transparent
and
thorough
analysis
is,
the
easier
it
is
to
defend
the
agency's
regulatory
approach.

Delineation
of
data
and
assumptions:
Economic
analyses
should
clearly
describe
all
important
data
sources
and
references
used,
as
well
as
key
assumptions
and
their
justifications.
All
of
these
inputs
should
be
available
to
policy
makers,
and
other
researchers
and
policy
analysts
to
the
extent
that
these
data
are
not
175
Chapter
10
Chapter
10:
Using
Economic
Analyses
in
Decision
Making
confidential
business
information
or
some
other
form
of
private
data.

Exposition
of
modeling
techniques:
Although
modeling
frameworks
for
many
economic
analyses
can
be
complex,
it
is
important
to
convey
at
least
the
basic
framework
used
for
modeling
a
policy's
consequences
The
presentation
should
highlight
the
key
elements
or
drivers
that
dominate
the
framework
and
its
results.

Ranges
for
inputs
and
results:
At
a
minimum,
uncertainties
should
be
explored
through
the
use
of
expected
values
supplemented
by
upper
and
lower
bounds
for
important
inputs,
assumptions,
and
results.
Sensitivity
analyses
using
these
ranges
generally
enhance
the
credibility
of
environmental
policy
assessments.
If
key
elements
for
an
economic
analysis
are
extremely
uncertain,
these
should
be
clearly
indicated.
Analysts
should
explore
how
resolving
these
uncertainties
affects
the
conclusions
of
the
analysis.

Monetizing
a
policy's
effects:
To
the
extent
feasible
and
warranted
by
their
contribution
to
the
results,
as
many
of
the
effects
of
a
policy
as
possible
should
be
monetized.
This
enhances
the
value
of
the
conclusions
to
policy
makers
weighing
the
many,
often
disparate
consequences
of
different
policy
options
and
alternatives.

Highlighting
non­
monetized
and
unquantified
effects:
Economic
analyses
should
present
and
highlight
non?
monetized
effects
when
these
are
important
for
policy
decisions.
Reasons
why
these
consequences
cannot
be
valued
in
monetary
terms
are
important
to
communicate
as
well.
Unquantified,
but
potentially
significant,
consequences
of
a
policy
also
should
be
highlighted,
especially
when
these
could
be
important
enough
in
magnitude
to
affect
the
broad
conclusions
of
an
economic
analysis
of
different
policy
options
and
alternatives.

Presenting
aggregate
and
disaggregated
results:
Finally,
the
analytic
framework
should
be
organized
to
provide
information
on
the
separate
economic
consequences
of
important
individual
programs
or
component
parts
identified
with
the
regulation.
This
can
be
particularly
challenging
when
the
underlying
physical
science
and
engineering
information
needed
by
the
economist
to
prepare
the
economic
analysis
may
not
be
amenable
to
a
simple
separation
of
the
individual
contributions
of
pollution
control
choices
(
e.
g.,
installed
emission
control
devices)
to
changes
in
risks
from
pollutants.
Further,
some
economic
values
used
in
analyses
represent
a
quantified
aggregate
value
for
a
set
of
environmental
goods
(
e.
g.,
a
consumer
benefit
measure
for
total
improvements
to
surface
water),
and
it
is
unknown
how
to
divide
the
value
among
the
individual
attributes
that
comprise
this
reported
value.
Nevertheless,
it
is
valuable
to
describe
disaggregate
information
on
the
costs
and
benefits
attributable
to
individual
policies
whenever
possible,
given
the
frequent
necessity
to
package
or
link
regulatory
actions
or
evaluations
together
into
a
single
analysis.

10.3
Presenting
the
Results
The
results
of
economic
analyses
of
environmental
policies
should
generally
be
presented
in
three
clusters:

Results
from
benefit­
cost
analysis:
Estimates
of
the
net
social
benefits
should
be
presented
based
on
the
benefits
and
costs
for
which
dollar
values
can
be
assigned,
and
a
discussion
of
non­
monetizable
or
unquantifiable
benefits
and
costs
should
be
provided;

Results
from
economic
impact
analysis
and
equity
assessment:
Results
of
the
economic
impacts
analysis
and
equity
assessments
should
be
reported,
including
predicted
effects
on
prices,
profits,
plant
closures,
employment,
and
other
effects,
and
findings
concerning
the
distribution
of
effects
for
particular
groups
of
concern,
such
as
small
entities,
governments,
and
disadvantaged
and
vulnerable
populations.

Results
from
cost­
effectiveness
analysis:
This
policy
evaluation
technique
is
used
when
many
benefits
are
not
easily
monetized
and
when
the
statutes
or
other
authorities
dictate
specific
regulatory
objectives.
Results
of
these
analyses
should
also
be
presented
when
these
analyses
are
conducted.

176
Chapter
10:
Decision
Making
The
relative
importance
of
these
three
clusters
will
depend
upon
the
policy
and
statutory
context
of
the
decision.
Generally,
analyses
leading
to
these
findings
normally
should
be
conducted
simultaneously
and
the
results
should
be
presented
together
as
different
ways
to
examine
a
policy's
social
consequences.
1
10.3.1
Results
from
Benefit­
Cost
Analysis
The
net
social
benefits
of
each
major
alternative
is
estimated
by
subtracting
the
present
value
of
monetary
social
costs
from
the
present
value
of
monetary
social
benefits
(
as
defined
in
Chapter
6).
For
this
calculation
the
same
baseline
must
be
used
in
both
the
benefit
and
cost
analyses
Plausible
upper­
and
lower­
bound
estimates
of
net
benefits
should
be
provided,
the
"
best"
or
most­
likely
estimate
should
be
identified
and
the
sensitivity
of
the
net
benefits
estimate
to
variations
in
uncertain
parameters
should
be
examined.

Other
considerations
for
presenting
and
summarizing
the
results
from
benefit­
cost
analyses
include
the
following:

Discounting
benefits
and
costs
is
the
preferred
method
for
summarizing
benefits
and
costs
that
accrue
over
several
years.
The
conditions
for
discounting
in
benefit­
cost
analysis
are
outlined
in
Chapter
6.
Alternatives
to
discounting
include
annualizing
costs
and
benefits,
comparing
those
figures,
and
accumulating
costs
and
benefits
through
time
to
a
future
year.
When
both
traditional
discounting
and
these
alternatives
are
not
feasible
or
advisable,
it
is
appropriate
to
display
the
streams
of
costs
and
benefits
over
time
for
policy
makers
to
consider.

Present
and
evaluate
non­
monetized
and
nonquantified
effects.
The
net
social
benefit
estimate
should
be
carefully
evaluated
in
light
of
all
the
effects
that
have
been
excluded
because
they
cannot
be
valued
in
monetary
terms.
Thus,
immediately
following
a
net
benefit
calculation,
there
should
be
a
presentation
and
evaluation
of
all
benefits
and
costs
that
can
only
be
quantified
but
not
valued,
as
well
as
all
benefits
and
costs
that
can
be
only
qualitatively
described.

Present
the
incremental
benefits,
costs,
and
net
benefits
of
moving
from
one
regulatory
alternative
to
more
stringent
ones.
This
presentation
should
be
done
both
globally
and
by
sub­
population.
This
should
include
a
discussion
of
incremental
changes
in
quantified
and
qualitatively
described
benefits
and
costs.
It
is
sometimes
necessary
to
evaluate
all
combinations
of
options
and
alternatives
when
key
sources
of
benefits
and
costs
of
a
policy
are
affected
by
more
than
one
option.
In
these
cases,
identifying
the
combination
of
alternatives
with
the
highest
net
social
benefits
cannot
rely
only
on
the
incremental
benefits
and
costs
of
each
individual
option
when
added
to
other
pre?
existing
options.

Discuss
other
potential
costs
and
benefits
that
may
be
by­
products
of
the
proposed
action.
These
include
transfers
of
the
pollutant
problem
from
one
exposure
medium
or
program
office
jurisdiction
to
another
or
possible
exacerbation
of
exposures
for
specific
groups
(
e.
g.,
sensitive
sub­
populations,
maximum
exposure
groups,
or
specific
types
of
workers)
not
captured
already
in
the
economic
impacts
analysis
and
equity
assessment.

10.3.2
Results
from
Economic
Impacts
Analysis
and
Equity
Assessment
Economic
impact
analyses
and
equity
assessments
focus
on
distributional
outcomes.
Therefore,
the
presentation
of
these
results
should
focus
on
disaggregating
effects
to
show
impacts
separately
for
the
groups
and
sectors
of
interest.
If
costs
and/
or
benefits
vary
significantly
among
the
sectors
affected
by
the
policy,
then
both
costs
and
benefits
should
be
shown
separately
for
the
different
sectors.
Presenting
results
in
disaggregated
form
will
provide
important
information
to
policy
makers
that
may
help
them
tailor
the
rule
to
improve
its
efficiency
and
equity
outcomes.

177
Chapter
10:
Decision
Making
1
There
are
other,
more
limited
types
of
economic
analysis
that
can
inform
policy
decisions.
One
example
is
health­
health
analysis
(
sometimes
known
as
risk­
risk
analysis)
that
assesses
the
health
risks
introduced
by
diverting
to
regulation
resources
otherwise
available
for
individual
health
care.
Although
limited,
health­
health
analysis
may
be
useful
in
contexts
where
benefit­
cost
analysis
is
infeasible.
The
method
has
been
employed
by
several
researchers
(
Viscusi,
1994;
Keeney,
1997),
but
is
not
without
criticism
(
Portney
and
Stavins,
1994).
Chapter
10:
Decision
Making
178
The
results
of
the
economic
impact
analyses
should
also
be
reported
for
important
sectors
within
the
affected
community
 
identifying
specific
segments
of
industries,
regions
of
the
country,
or
types
of
firms
that
may
experience
significant
impacts
or
plant
closures
and
losses
in
employment.

Reporting
the
results
of
equity
assessments
may
include
the
distribution
of
benefits,
costs,
or
both
for
specific
subpopulations
including
those
highlighted
in
the
various
mandates.
These
include
minorities,
low­
income
populations
small
businesses,
governments,
and
non­
profits,
and
sensitive
and
vulnerable
populations
(
including
children).
Where
these
mandates
specify
requirements
that
depend
on
the
outcomes
of
the
distributional
analyses
(
such
as
the
Regulatory
Flexibility
Act),
the
presentation
of
the
results
should
conform
to
the
criteria
specified
by
the
mandate.

10.3.3
Results
from
Cost­
Effectiveness
Analysis
When
many
benefits
cannot
easily
be
monetized,
or
when
statutes
or
other
authorities
set
forth
a
specific
policy
objective,
economic
analyses
should
present
the
results
of
a
cost­
effectiveness
analysis.
This
will
provide
useful
information
to
policy
makers
and
it
conforms
to
the
general
principle
of
minimizing
the
cost
of
achieving
particular
policy
goals.

The
cost­
effectiveness
of
a
policy
option
is
calculated
by
dividing
the
annualized
cost
of
the
option
by
non­
monetary
benefit
measures.
Such
natural
units
measures
range
from
the
amount
of
the
reduction
in
pollution
measured
in
physical
terms,
to
the
ultimate
improvements
in
human
health
or
the
environment
measured
in
terms
of
specific
effects
and
damages
avoided.

Cost­
effectiveness
analysis
does
not
necessarily
reveal
what
level
of
control
is
reasonable,
nor
can
it
be
used
to
directly
compare
situations
with
different
benefit
streams.
Moreover,
other
criteria,
such
as
statutory
requirements,
enforcement
problems,
technological
feasibility,
or
quantity
and
location
of
total
emissions
abated,
may
preclude
selecting
the
least­
cost
solution
in
a
regulatory
decision.
However,
where
not
prohibited
by
statute,
cost­
effectiveness
analysis
can
indicate
which
control
measures
or
policies
are
inferior
options.
10.4
Use
of
Economic
Analyses
in
Policy
Choices
The
primary
purpose
of
conducting
economic
analysis
is
to
provide
policy
makers
and
others
with
detailed
information
on
wide
variety
of
consequences
of
environmental
policies.
One
important
element
these
analyses
have
traditionally
provided
to
the
policy­
making
process
is
estimates
of
social
benefits
and
costs
 
the
economic
efficiency
of
a
policy.
Hence,
the
EA
Guidelines
reflect
updated
information
regarding
procedures
for
calculating
benefits
and
costs,
monetizing
benefits
estimates,
and
selecting
particular
inputs
and
assumptions.

Determining
which
regulatory
options
are
best
even
on
the
restrictive
terms
of
economic
efficiency,
however,
often
is
made
difficult
by
uncertainties
in
data
and
by
the
presence
of
benefits
and
costs
that
can
be
quantified
but
not
monetized
or
that
can
only
be
qualitatively
assessed.
Thus,
even
if
the
criterion
of
economic
efficiency
were
the
sole
guide
to
policy
decisions,
social
benefit
and
cost
estimates
alone
would
not
be
sufficient
to
define
the
best
policies.

A
large
number
of
social
goals
and
statutory
and
judicial
mandates
motivate
and
shape
environmental
policy.
For
this
and
other
reasons,
the
EA
Guidelines
contain
information
concerning
procedures
for
conducting
analyses
of
other
consequences
of
environmental
policies,
such
as
economic
impacts
and
equity
effects.
This
is
consistent
with
the
fact
that
economic
efficiency
is
not
the
sole
criterion
for
developing
good
public
policies.

Even
the
most
comprehensive
economic
analyses
are
but
part
of
a
larger
policy
development
process,
one
in
which
no
individual
analytical
feature
or
empirical
finding
dominates
The
role
of
economic
analysis
is
to
organize
information
and
comprehensively
assess
the
economic
consequences
of
alternative
actions
 
benefits,
costs,
economic
impacts,
and
equity
effects
 
and
the
tradeoffs
among
them.
These
results
serve
as
important
inputs
for
this
broader
policy­
making
process
along
with
other
analyses
and
considerations.
10.5
References
Jorgenson,
D.
W.
1997.
Welfare,
Volume
2:
Measuring
Social
Welfare.
Cambridge,
MA:
MIT
Press.

Keeney,
R.
L.
1997.
Estimating
Fatalities
Induced
by
the
Economic
Costs
of
Regulations.
Journal
of
Risk
and
Uncertainty,
14(
1):
5­
23.

Portney,
P.
R.
and
R.
N.
Stavins.
1994.
Regulatory
Review
of
Environmental
Policy:
The
Potential
Role
of
Health­
Health
Analysis.
Journal
of
Risk
and
Uncertainty,
8(
1):
11­
122.

Viscusi,
W.
K.
1994.
Risk­
Risk
Analysis.
Journal
of
Risk
and
Uncertainty,
8(
1):
5­
17.

179
Chapter
10:
Decision
Making
180
Chapter
10:
Decision
Making
Appendix
A
181
Appendix
A:
An
SAB
Report
on
the
EPA
Guidelines
for
Preparing
Economic
Analysis
182
Appendix
A
United
States
Science
Advisory
EPA­
SAB­
EEAC­
99­
020
Environmental
Board
(
1400)
September
1999
Protection
Agency
Washington
DC
www.
epa.
gov/
sab
AN
SAB
REPORT
ON
THE
EPA
GUIDELINES
FOR
PREPARING
ECONOMIC
ANALYSES
A
Review
by
the
Environmental
Economics
Advisory
Committee
UNITED
STATES
ENVIRONMENTAL
PROTECTION
AGENCY
WASHINGTON,
D.
C.
20460
September
30,
1999
OFFICE
OF
THE
ADMINISTRATOR
SCIENCE
ADVISORY
BOARD
EPA­
SAB­
EEAC­
99­
020
The
Honorable
Carol
Browner
Administrator
United
States
Environmental
Protection
Agency
401
M
Street,
SW
Washington,
DC
20460
Subject:
An
SAB
Report
on
the
EPA
Guidelines
for
Preparing
Economic
Analyses
Dear
Ms.
Browner:

This
Report
on
the
Environmental
Protection
Agency's
(
EPA's)
revised
Guidelines
for
Preparing
Economic
Analyses
was
developed
by
the
Environmental
Economics
Advisory
Committee
(
EEAC)
of
the
Science
Advisory
Board
(
SAB)
in
response
to
a
charge
received
from
the
Deputy
Administrator
on
August
4,
1998
(
attached).
The
review
was
carried
out
in
a
series
of
meetings
with
the
Agency's
Office
of
Policy,
beginning
in
August
1998,
and
ending
with
a
telephone
conference
on
July
27,
1999.

As
is
described
in
detail
in
the
full
report,
the
Committee's
general
conclusion
is
that
the
Guidelines
succeed
in
reflecting
methods
and
practices
that
enjoy
widespread
acceptance
in
the
environmental
economics
profession.
Although
some
concerns
remain
about
particular
parts
of
the
Guidelines,
our
overall
assessment
is
that
the
Guidelines
are
excellent.
It
is
our
hope
that
the
Guidelines
demonstrate
EPA's
commitment
to
credible
and
consistent
economic
analyses
in
support
of
the
policy
process.

The
best
analytical
tools
of
environmental
economics
are
constantly
changing,
as
experience
with
applications
of
existing
tools
and
as
new
theoretical
and
empirical
techniques
appear
in
the
scholarly
literature.
As
a
result,
it
is
important
that
EPA
carry
out
new
reviews
of
the
Guidelines
every
two
to
three
years
to
reflect
these
developments
in
environmental
economics.
The
Committee
looks
forward
to
working
with
EPA
to
strengthen
this
document
in
the
years
ahead.
2
The
iterative
process
that
the
EEAC
employed
with
EPA
for
this
review
represents
a
departure
from
the
end­
of­
pipe
assessments
that
are
more
typical
of
SAB
practice.
It
was
consistent,
however,
with
the
Mission
Statement
of
the
EEAC
prepared
by
the
Deputy
Administrator,
and
was
consistent
with
the
SAB
Executive
Committee's
previously
expressed
aims.
Although
this
approach
will
not
necessarily
be
appropriate
for
all
SAB
reviews,
it
may
be
a
useful
model
in
selected
cases.
Therefore,
we
briefly
describe
the
procedure
in
the
full
report.

Finally,
Dr.
Albert
McGartland
and
his
staff
in
the
Office
of
Economy
and
Environment
should
be
commended
for
the
professionalism
they
brought
to
this
process.
The
excellence
of
the
revised
Guidelines
is
testimony
to
the
dedication
of
the
talented
team
of
Agency
economists
and
analysts
who
worked
on
this
project.
It
was,
as
always,
a
pleasure
for
the
EEAC
to
interact
with
Dr.
McGartland
and
his
staff.
We
anticipate
that
you
and
everyone
involved
will
be
proud
of
the
quality
of
the
new
Guidelines
for
Preparing
Economic
Analyses,
and
we
look
forward
to
your
questions
and
your
response
to
our
Report.

Sincerely,

/
s/
/
s/
Dr.
Joan
M.
Daisey,
Chair
Dr.
Robert
N.
Stavins
Science
Advisory
Board
Environmental
Economics
Advisory
Committee
Science
Advisory
Board
i
NOTICE
This
report
has
been
written
as
part
of
the
activities
of
the
Science
Advisory
Board,
a
public
advisory
group
providing
extramural
scientific
information
and
advice
to
the
Administrator
and
other
officials
of
the
Environmental
Protection
Agency.
The
Board
is
structured
to
provide
balanced,
expert
assessment
of
scientific
matters
related
to
problems
facing
the
Agency.
This
report
has
not
been
reviewed
for
approval
by
the
Agency
and,
hence,
the
contents
of
this
report
do
not
necessarily
represent
the
views
and
policies
of
the
Environmental
Protection
Agency,
nor
of
other
agencies
in
the
Executive
Branch
of
the
Federal
government,
nor
does
mention
of
trade
names
or
commercial
products
constitute
a
recommendation
for
use.

Distribution
and
Availability:
This
Science
Advisory
Board
report
is
provided
to
the
EPA
Administrator,
senior
Agency
management,
appropriate
program
staff,
interested
members
of
the
public,
and
is
posted
on
the
SAB
website
(
www.
epa.
gov/
sab).
Information
on
its
availability
is
also
provided
in
the
SAB's
monthly
newsletter
(
Happenings
at
the
Science
Advisory
Board).
Additional
copies
and
further
information
are
available
from
the
SAB
staff.
ii
U.
S.
Environmental
Protection
Agency
Science
Advisory
Board
Environmental
Economics
Advisory
Committee
Panel
for
Review
of
the
Economic
Analysis
Guidelines
CHAIRMAN
Dr.
Robert
N.
Stavins,
Albert
Pratt
Professor
of
Business
and
Government,
John
F.
Kennedy
School
of
Government,
Harvard
University,
Cambridge,
MA
MEMBERS
Dr.
Nancy
E.
Bockstael,
Professor,
Department
of
Agricultural
&
Resource
Economics,
University
of
Maryland,
College
Park,
MD
Dr.
Dallas
Burtraw,
Fellow,
Resources
for
the
Future,
Washington,
DC
Dr.
Trudy
Ann
Cameron,
Professor,
Department
of
Economics,
University
of
California,
Los
Angeles,
CA
Dr.
Maureen
L.
Cropper,
Senior
Economist,
The
World
Bank,
Washington,
DC
Dr.
Herman
E.
Daly,
Senior
Research
Scholar,
School
of
Public
Affairs,
University
of
Maryland,
College
Park,
MD
Dr.
A.
Myrick
Freeman,
Professor,
Department
of
Economics,
Bowdoin
College,
Brunswick,
ME
Dr.
Dale
W.
Jorgenson,
Frederic
Eaton
Abbe
Professor
of
Economics,
Department
of
Economics,
and
JFK
School
of
Government,
Harvard
University,
Cambridge,
MA
Dr.
Paul
L.
Joskow,
Elizabeth
and
James
Killian
Professor
of
Economics,
Massachusetts
Institute
of
Technology,
Cambridge,
MA
Dr.
Catherine
Kling,
Professor,
Department
of
Economics,
Iowa
State
University,
Ames,
IA
Dr.
Richard
L.
Revesz,
Professor
of
Law,
New
York
University
School
of
Law,
New
York,
NY
Dr.
Jason
F.
Shogren,
Stroock
Distinguished
Professor
of
Law
and
Economics,
Department
of
Economics
and
Finance;
University
of
Wyoming,
Laramie,
WY.

Dr.
Hilary
A.
Sigman,
Assistant
Professor,
Department
of
Economics,
Rutgers
University,
New
Brunswick,
NJ.
iii
SCIENCE
ADVISORY
BOARD
STAFF
Mr.
Thomas
O.
Miller,
Designated
Federal
Officer,
Science
Advisory
Board
(
1400),
U.
S.
Environmental
Protection
Agency,
Washington,
DC
Mrs.
Dorothy
M.
Clark,
Management
Assistant,
Science
Advisory
Board
(
1400),
U.
S.
Environmental
Protection
Agency,
Washington,
DC
iv
TABLE
OF
CONTENTS
1.
Executive
Summary
and
Conclusions
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
1
2.
Introduction
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
2
3.
Specific
Responses
to
Charge
Questions.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
3
3.1.
Discounting
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
3
3.2.
Quantifying
and
Valuing
Human
Fatalities
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
4
3.3.
Certainty
Equivalents
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
5
3.4.
Valuation
Approaches
for
Human
Morbidity
and
Improved
Ecological
Conditions
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
5
3.5.
Economic
Impact
and
Net
Social
Benefits
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
6
3.6.
Computable
General
Equilibrium
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
6
3.7.
Economic
Impacts
to
the
Private
Sector,
Public
Sector,
and
Households
.
.
.
.
.
.
.
.
7
3.8.
Equity
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
8
3.9.
Altruism
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
8
References
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
R­
1
Appendix
A
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
A­
1
1
1.
EXECUTIVE
SUMMARY
AND
CONCLUSIONS
The
Environmental
Economics
Advisory
Committee
(
EEAC)
of
the
EPA
Science
Advisory
Board
(
SAB)
reviewed
the
Agency's
draft
Guidelines
for
Preparing
Economic
Analyses
(
EPA,
1999)
during
a
series
of
meetings
extending
from
August
1998
to
July
1999,
in
response
to
a
request
received
from
EPA
to
perform
a
full
and
complete
review.
This
is
EPA's
first
major
overhaul
of
these
guidelines
in
more
than
a
decade.
Because
the
Guidelines
are
to
be
used
by
all
parts
of
the
Agency
for
carrying
out
regulatory
analyses,
it
is
important
that
they
reflect
"
methods
and
practices
that
enjoy
widespread
acceptance
in
the
environmental
economics
profession,"
as
specified
in
the
charge
to
the
EEAC
received
from
the
EPA
Deputy
Administrator.
The
draft
Guidelines
have
been
revised
and
improved
as
a
result
of
the
interactions
between
the
Committee
and
EPA
staff
in
several
public
meetings
over
the
past
year.
The
EEAC's
general
conclusion
is
that
the
Guidelines
reflect
best
methods
and
practices
that
enjoy
widespread
acceptance
in
the
environmental
economics
profession,
notwithstanding
the
several
EEAC
concerns
that
remain
about
particular
parts
of
the
Guidelines.
The
Committee
hopes
that
the
Guidelines
demonstrate
EPA's
commitment
to
credible
and
consistent
economic
analysis
in
support
of
the
policy
process.

The
fundamental
ingredients
of
an
economic
analysis
of
a
proposed
or
existing
environmental
policy
or
program
are
well
covered
in
the
Guidelines,
and
key
conceptual,
analytic,
and
empirical
issues
are
highlighted.
The
Guidelines
acknowledge
the
practical
limitations
facing
EPA
analysts
in
terms
of
time,
resources,
and
expertise,
and
hence
provide
flexibility
to
analysts.
The
Guidelines
are
just
that
 
guidelines
for
analysis,
not
a
rigid
(
or
simplistic)
cook
book.

Economics,
like
any
scholarly
discipline,
is
constantly
changing.
Environmental
economics,
a
relatively
young
branch
of
the
discipline,
has
experienced
particularly
rapid
growth.
New
areas
of
the
literature
continue
to
emerge,
and
existing
areas
change
and
expand.
Hence,
despite
the
Committee's
generally
positive
assessment
of
the
revised
Guidelines,
we
urge
EPA
to
carry
out
new
reviews
every
two
to
three
years.
The
time
investments
that
will
be
required
for
such
periodic
reviews
 
both
on
the
part
of
EPA
staff
and
on
the
part
of
the
EEAC
 
will
be
much
less
than
was
required
for
this
first
revision
in
ten
years.

The
interactive
process
that
the
EEAC
employed
with
EPA
for
this
review
was
something
of
a
departure
from
the
end­
of­
pipe
assessments
that
are
more
typical
of
SAB
practice.
It
was
consistent,
however,
with
the
Mission
Statement
of
the
EEAC
prepared
by
the
Deputy
Administrator,
and,
moreover,
was
consistent
with
the
SAB
Executive
Committee's
previously
expressed
interest
in
early
involvement
with
the
Agency
on
important
issues.
Although
this
approach
will
not
necessarily
be
appropriate
for
all
SAB
reviews,
it
may
be
a
useful
model
in
selected
cases.
Therefore,
we
briefly
describe
the
procedure
here.

During
the
past
twelve
months,
the
EEAC
held
three
one­
day
meetings
in
Washington,
D.
C.,
devoted
primarily
to
our
review
of
EPA's
revised
Guidelines
for
Preparing
Economic
2
Analyses,
plus
a
fourth
meeting
via
teleconference.
Each
of
the
meetings
was
attended
by
Dr.
Albert
McGartland,
Director
of
the
Office
of
Economy
and
Environment,
and
many
members
of
his
staff.
Intensive
and
extensive
substantive
discussions
at
these
meetings
provided
an
effective
forum
in
which
EEAC
members
and
the
Committee
as
a
whole
could
pose
questions,
describe
concerns,
and
express
views,
and
for
Agency
representatives
to
explain
the
thinking
behind
their
drafts.
Each
of
the
first
three
meetings
led
to
a
subsequently
revised
draft,
which
in
every
case
addressed
the
general
and
specific
concerns
expressed
by
the
EEAC
at
the
previous
meeting,
and
thereby
represented
a
significantly
improved
draft
document.
Dr.
McGartland
and
his
staff
should
be
commended
for
the
openness,
professionalism,
and
lack
of
defensiveness
which
they
brought
to
this
process.

2.
INTRODUCTION
The
Environmental
Economics
Advisory
Committee
was
requested
to
perform
a
full
and
complete
review
of
the
Guidelines
for
Preparing
Economic
Analyses
(
EAGs
or
the
Guidelines).
EPA
asked
for
comments
on
all
aspects
of
the
guidance
document
and
written
documentation,
when
applicable,
on
recommendations
from
the
Committee
for
alternative
methodologies,
assumptions
and
data
sources
to
improve
the
presentation
of
issues
addressed
in
the
guidance
document.

The
stated
intent
of
the
Guidelines
is
to:

a)
Represent
EPA
policy
on
preparing
economic
analyses
under
a
variety
of
authorizing
statutes
and
administrative
requirements,
each
of
which
can
influence
the
conduct
and
use
of
analyses
by
different
EPA
offices;

b)
Demonstrate
EPA's
commitment
to
credible/
consistent
economic
analyses
in
support
of
the
policy
making
process;

c)
Emphasize
the
need
for
analytic
efforts
commensurate
with
the
value
of
that
information
in
the
EPA
policy
making
process;

d)
Reflect
mainstream
economic
science/
methods
that
are
well
demonstrated
and
relatively
straightforward
to
apply
to
particular
environmental
issues;

e)
Cover
a
number
of
principles
and
practices
that
virtually
all
economic
analyses
should
follow
and
clarify,
for
a
number
of
identified
analytic
issues,
the
process
that
analysts
are
to
follow
as
they
organize
and
conduct
the
analysis;

f)
Account
for
some
of
the
practical
limitations
on
time
and
resources
that
EPA
analysts
must
contend
with
when
preparing
economic
analyses;
and
3
g)
Provide
some
flexibility
to
analysts
to
permit
them
to
"
customize"
analyses
to
conform
to
administrative
and
legal
procedures.

The
document
embodying
the
Guidelines
is
not
intended
to
be
a
text
on
the
theory
and
methods
of
applying
economic
analysis
to
EPA
regulations
and
policies
nor
do
they
preclude
new
or
path
breaking
forms
of
analysis.
EPA
intends
to
regularly
and
frequently
review
and
revise
parts
of
the
Guidelines
to
reflect
and
report
on
significant
changes
in
the
literature
used
to
support
EPA
analyses,
as
well
as
changes
in
administrative
and
legal
requirements
that
affect
the
conduct
of
economics
at
the
EPA.

3.
SPECIFIC
RESPONSES
TO
CHARGE
QUESTIONS
The
Committee's
specific
comments
on
the
Guidelines
are
organized
into
nine
sections,
the
first
eight
of
which
address,
respectively,
questions
posed
in
EPA's
charge
to
the
Committee.
The
last
section
includes
the
Committee's
advice
on
the
topic
of
altruistic
benefits.

3.1
Discounting
Charge
Question
1.
Does
the
published
economic
theory
and
empirical
literature
support
the
statements
in
the
guidance
document
on
the
treatment
of
discounting
benefits
and
costs
in
the
following
circumstances:
a)
private
and
public
costs
for
use
in
an
economic
impact
analysis,
b)
social
benefits
and
costs
in
an
intragenerational
context;
c)
social
benefits
and
costs
in
an
intergenerational
context;
and
d)
social
benefit
and
cost
information
that
is
reported
in
nonmonetary
terms?

The
guidance
document
is
consistent
with
published
theoretical
and
empirical
analysis
on
the
use
of
discounting
for
(
a)
private
and
public
costs
in
an
economic
impact
analysis,
and
for
(
d)
social
benefit
and
cost
information
expressed
in
non­
monetary
terms.
The
current
literature
also
supports
the
discussion
of
issue
(
b),
discounting
social
benefits
and
costs
in
an
intragenerational
context.
In
this
context,
the
document
should
encourage
the
use
of
a
discount
rate
in
the
middle
of
its
recommended
range,
in
addition
to
the
values
currently
mentioned,
to
reflect
common
practice.

The
proper
application
of
discounting
in
an
intergenerational
context
(
issue
(
c))
remains
controversial
in
the
published
literature.
The
guidance
document
lays
out
the
positions
in
this
debate
clearly.
Reflecting
the
disagreement
within
the
economics
profession,
there
is
diversity
of
opinion
within
the
EEAC
on
this
issue.
Some
members
believe
that
the
guidance
document
is
more
critical
than
the
published
literature
of
the
view
that
intergenerational
discounting
should
not
differ
from
other
discounting,
while
other
members
support
the
document's
current
emphasis.
The
final
quantitative
recommendations
for
discount
rate
values
in
the
intergenerational
context
are
broad
enough
to
be
uncontroversial.
4
3.2
Quantifying
and
Valuing
Human
Fatalities
Charge
Question
2.
Does
the
published
economic
theory
and
empirical
literature
support
the
statements
in
the
guidance
document
on
quantifying
and
valuing
the
social
benefits
of
reducing
fatal
human
health
risks?

The
guidance
document
recommends
that
the
mean
value
of
a
statistical
life
(
VSL)
based
on
26
published
studies
be
used
as
the
default
value
in
Agency
analyses.
It
urges
that
a
qualitative
discussion
of
the
appropriateness
of
this
estimate
to
the
population
and
risks
analyzed
accompany
the
use
of
the
central
tendency
estimate.

The
EEAC
encourages
the
use
of
value
of
a
statistical
life
(
VSL)
estimates
in
benefit
valuation
and
in
providing
guidance
for
policy.
Moreover,
it
believes
that
the
general
magnitude
of
the
benefit
value
suggested
in
the
Guidelines
is
in
a
reasonable
range
for
broad
population
groups.
However,
these
estimates
could
be
refined,
particularly
when
certain
segments
of
the
population
are
affected,
such
as
children
or
persons
over
the
age
of
65.

One
refinement
that
EPA
could
undertake
now
is
to
narrow
the
set
of
VSL
studies
to
the
most
reliable
estimates
for
the
U.
S.
population,
rather
than
taking
the
mean
value
from
a
set
of
studies
of
varying
quality
and
with
different
statistical
controls
and
with
populations
from
various
countries.

Hedonic
studies
based
on
market
tradeoffs
give
values
reflected
in
actual
market
decisions.
Such
studies
have
focused
primarily
on
the
labor
market,
but
some
have
considered
implicit
values
of
life
reflected
in
car
safety
and
in
housing
price
responses
to
hazardous
wastes
and
pollution.
Contingent
valuation
studies
can
also
prove
useful
with
respect
to
variations
due
to
age,
health
status,
and
other
factors
not
readily
estimated
using
market
data.

Care
should
be
taken
to
avoid
conveying
the
impression
that
$
5.8
million
(
in
1997
dollars)
is
always
and
everywhere
the
correct
figure
to
use
for
the
value
of
a
statistical
life.
Footnote
29
in
Section
7.6.1.2
attaches
some
important
caveats
to
the
$
5.8
million
figure
cited
in
the
document.
These
caveats
should
be
placed
more
prominently,
so
that
casual
readers
do
not
come
away
with
the
notion
that
$
5.8
million
is
"
the"
value
of
a
statistical
life.
It
is,
of
course,
simply
the
central
tendency
of
a
number
of
estimates
of
the
VSL
for
some
rather
narrowly
defined
subpopulations.
The
individual
study
values
from
which
this
number
is
derived
range
from
$
0.7
million
to
$
16.3
million,
indicating
considerable
heterogeneity
across
different
contexts.

In
some
cases,
it
may
be
desirable
to
use
a
VSL
estimate
specific
to
particular
populations.
The
most
prominent
possible
variation
is
with
respect
to
age,
but
characteristics
such
as
gender
and
income
could
also
be
influential.
How
and
whether
these
differences
should
affect
policy
benefit
assessment
is
more
controversial.
However,
as
a
first
step,
EPA
should
show
the
age
distribution
of
the
lives
saved,
or
the
quantity
of
life
at
risk.
In
addition,
when
policies
do
not
affect
the
entire
population
equally,
a
sensitivity
analysis
can
show
both
the
cost
per
life
saved
and
5
the
cost
per
discounted
life
year.
Policymakers
can
then
be
better
able
to
assess
the
efficacy
of
the
policy.

Clearly,
any
re­
evaluation
of
the
literature
will
take
time.
In
the
interim,
if
the
mean
VSL
cited
in
the
Guidelines
is
to
be
used,
the
limitations
of
the
estimate
should
be
described.
In
cases
where
the
estimate
is
to
be
applied
to
populations
whose
age
differs
significantly
from
the
average
age
of
the
populations
in
the
26
studies,
a
quantitative
sensitivity
analysis
should
be
performed,
such
as
that
used
in
The
Benefits
and
Costs
of
the
Clean
Air
Act,
1970­
1990
(
EPA,
1997).

3.3
Certainty
Equivalents
Charge
Question
3.
Does
the
published
economic
theory
and
empirical
literature
support
the
statements
in
the
guidance
document
on
the
treatment
of
certainty
equivalents
in
the
assessment
of
social
benefits
and
costs
of
environmental
policies?

The
discussion
of
principles
for
uncertainty
analysis
in
the
Guidelines
highlights
the
important
distinction
between
the
analyst's
uncertainty
and
individuals'
uncertainty
about
future
outcomes.
The
latter
relates
to
assessing
the
effects
of
environmental
changes
on
individuals'
welfare
under
uncertainty.
In
this
regard,
the
Guidelines
are
consistent
with
mainstream
economic
theory
and
the
empirical
literature
in
that
they
recognize
the
importance
of
taking
account
of
individual
attitudes
towards
risk
and
suggest
certainty
equivalents
as
one
way
of
incorporating
risk
aversion
into
the
assessment
of
social
benefits
and
costs
of
environmental
policies.
However,
the
Guidelines
recognize
that
information
on
risk
attitudes
may
be
difficult
to
obtain.
The
Guidelines
also
recognize
that
experts'
and
lay
individuals'
risk
perceptions
may
differ.
Because
the
latter
affect
individuals'
behavior,
it
is
important
for
the
analyst
to
consider
both
types
of
risk
assessments.
The
Guidelines
are
also
consistent
with
current
literature
in
recognizing
the
important
role
information
plays
in
welfare
evaluation
in
an
uncertain
world.

3.4
Valuation
Approaches
for
Human
Morbidity
and
Improved
Ecological
Conditions
Charge
Question
4.
Does
the
published
economic
theory
and
empirical
literature
support
the
statements
in
the
guidance
document
on
the
merits
and
limitations
of
different
valuation
approaches
to
the
measurement
of
social
benefits
from
reductions
in
human
morbidity
risks
and
improvements
in
ecological
conditions
attributable
to
environmental
policies?

Overall,
Chapter
7
does
a
very
good
job
of
explaining
the
state­
of­
the­
art
in
the
measurement
of
environmental
benefits.
This
literature
continues
to
evolve,
and
so
frequent
updates
are
likely
to
be
necessary
for
this
chapter.
All
currently
relevant
methods
appear
to
be
represented
and
sufficient
caveats
have
generally
been
offered.
Four
concerns,
however,
should
be
highlighted.
6
First,
care
should
be
taken
to
avoid
creating
the
impression
that
the
benefits
or
costs
associated
with
a
proposed
regulation
are
being
misrepresented.
Socially
efficient
policy­
making
is
not
well
served
by
exaggeration
or
understatement
of
the
benefits
or
costs
of
alternative
policy
choices.
When
benefits
are
uncertain,
expected
values
should
be
emphasized.
However,
an
assessment
should
be
made
concerning
the
sensitivity
of
the
policy
conclusions
to
the
full
range
of
possible
benefits
estimates.

Second,
the
claim
that
averting
expenditures
can
reliably
be
used
as
a
lower
bound
on
environmental
benefits
is
too
strong.
The
draft
overstates
the
idea
that
averting
behavior
is
a
generic
lower
bound
on
ex
ante
economic
value
for
morbidity
and
mortality.
The
theoretical
literature
reveals
that
averting
behavior
need
not
be
a
lower
bound
on
value
when
both
private
and
collective
risk
reduction
strategies
are
considered.
Private
actions
to
reduce
risk
mixed
with
collective
actions
yield
ambiguous
results.
Further
discussion
is
available
in
Shogren
and
Crocker
(
1999).

Third,
the
treatment
of
altruistic
benefits
should
be
clearer.
Circumstances
wherein
altruistic
benefits
should,
and
should
not,
be
included
as
a
separate
component
of
total
social
benefits
should
be
highlighted.
It
is
important
to
avoid
double­
counting
of
benefits
and
costs
in
assessing
proposed
policies.
This
issue
is
taken
up,
below,
in
Section
3.9.

3.5
Economic
Impact
and
Net
Social
Benefits
Charge
Question
5.
Does
the
published
economic
theory
and
empirical
literature
support
the
statements
in
the
guidance
document
on
the
relationships
and
distinctions
between
the
measurement
of
economic
impacts
and
net
social
benefits?

The
guidance
document
makes
it
clear
that
in
order
to
make
informed
policy
judgements
it
is
important
to
study
a
variety
of
consequences
of
environmental
policies,
including
impacts
on
particular
industries,
regions,
and
demographic
groups
(
as
well
as
other
impacts
whose
analyses
are
mandated
by
statute)
to
complement
conventional
benefit­
cost
analysis.
The
relationship
between
conventional
benefit­
cost
analysis
and
the
analysis
of
the
broad
and
diverse
distributional
impacts
of
environmental
policies
are
discussed
clearly
and
the
relationships
between
these
complementary
policy
analyses
is
consistent
with
the
published
economics
literature.

3.6
Computable
General
Equilibrium
Models
Charge
Question
6.
Does
the
guidance
document
contain
an
objective
and
reasonable
presentation
on
the
published
economic
theory,
empirical
literature,
and
analytic
tools
associated
with
computable
general
equilibrium
(
CGE)
models,
and
description
of
their
relevance
for
economic
analyses
performed
by
the
EPA?

The
use
of
general
equilibrium
analysis,
both
as
a
conceptual
and
a
numerical
tool,
is
gaining
expanded
use
in
economics.
The
Guidelines
provide
a
useful
discussion
of
the
current
7
uses
and
limitations
of
computable
general
equilibrium
(
CGE)
models
in
Chapter
8.
This
is
a
rapidly
developing
area
in
economics,
and
so
for
the
Guidelines
to
remain
relevant,
the
Agency
will
need
to
commit
to
ongoing
review
of
new
tools
and
applications
that
broaden
the
applicability
of
CGE
models,
and
that
provide
new
intellectual
insights
that
can
guide
benefit­
cost
analysis.

One
area
where
new
insights
are
proliferating
is
the
interaction
of
environmental
regulations
with
pre­
existing
economic
distortions
(
that
is,
the
deadweight
loss
due
to
existing
taxes).
Of
particular
relevance
in
this
regard
is
the
role
of
pre­
existing
taxes.
Recent
literature
in
economics
indicates
that
the
costs
and
benefits
of
regulations
can
be
substantially
different
than
indicated
by
partial
equilibrium
analysis.
In
addition,
the
relative
cost­
effectiveness
of
different
policy
instruments
(
technology
standards,
tradable
permits,
etc.)
can
be
affected
by
these
interactions.

The
Guidelines
address
the
issue
of
interactions
of
regulations
with
pre­
existing
economic
distortions
in
a
paragraph
near
the
end
of
Chapter
5,
under
the
label
"
Emerging
Cross­
Cutting
Issues."
This
is
appropriate
because
the
issue
is
both
rapidly
emerging
and
broadly
cross­
cutting.
But
the
issue
is
not
mentioned
in
Chapter
8
("
Analyzing
Social
Costs"),
where
general
equilibrium
analysis
is
discussed
in
detail.
The
exclusion
of
the
issue
from
Chapter
8
is
unfortunate:
(
a)
because
of
the
potential
magnitude
associated
with
"
interactions"
and
(
b)
because
general
equilibrium
tools
provide
the
method
for
considering
these
"
interactions."
Hence,
one
of
the
most
compelling
reasons
to
use
CGE
models
is
to
develop
an
understanding
of,
and
to
estimate
the
magnitude
of,
this
potential
influence.
While
in
most
regards,
the
discussion
of
CGE
models
is
objective
and
reasonable,
the
failure
to
integrate
a
discussion
of
tax
interactions
undermines
the
presentation.

3.7
Economic
Impacts
to
the
Private
Sector,
Public
Sector,
and
Households
Charge
Question
7.
Does
the
guidance
document
contain
an
objective
and
reasonable
presentation
on
the
measurement
of
economic
impacts,
including
approaches
suitable
to
estimate
impacts
of
environmental
regulations
on
the
private
sector,
public
sector
and
households?
This
includes,
for
example,
the
measurement
of
changes
in
market
prices,
profits,
facility
closure
and
bankruptcy
rates,
employment,
market
structure,
innovation
and
economic
growth,
regional
economies,
and
foreign
trade.

The
guidance
document
provides
an
objective
and
reasonable
presentation
of
these
topics.
3.8
Equity
Charge
Question
8.
Does
the
guidance
document
contain
a
reasonable
presentation
and
set
of
recommendations
on
the
selection
of
economic
variables
and
data
sources
used
to
measure
the
equity
dimensions
identified
as
potentially
relevant
to
environmental
policy
analysis?
8
Conventional,
primary
dictionary
definitions
of
equity
refer
to
concepts
such
as
fairness,
impartiality,
and
justice.
Thus,
equity
is
typically
treated
as
a
normative
concept
in
everyday
parlance.
The
Guidelines,
in
keeping
with
mainstream
practice
in
economics,
however,
seek
merely
to
supply
statistical
measures
of
the
distribution
of
costs
and
benefits,
leaving
it
to
citizens
to
judge
whether
the
described
distributions
are
fair
or
equitable.
In
this
way,
the
document
provides
positive
information
that
is
relevant
to
making
normative
judgments,
but
offers
no
explicit
discussion
of
norms.
At
the
same
time,
however,
since
market
prices
and
willingness­
topay
criteria
are
employed
in
the
Guidelines,
and
because
they
are
based
on
the
existing
distributions
of
income
and
wealth,
those
existing
distributions
are
implicitly
accorded
normative
status.
Some
may
object
to
taking
the
existing
distribution
as
the
norm
for
equity
assessments,
especially
as
that
distribution
has
become
more
concentrated
in
recent
decades.
This
issue
is
noted,
but
in
accord
with
mainstream
practice,
is
not
considered
further
in
the
document.

The
Guidelines
contain
a
reasonable
presentation
and
set
of
recommendations
on
the
selection
of
economic
variables
and
data
sources
that
can
be
used
to
measure
the
distributional
consequences
of
environmental
policies,
both
on
the
benefit
side
and
the
cost
side.

3.9
Altruism
The
Guidelines
would
benefit
from
a
discussion
of
when
it
is
appropriate
to
include
altruistic
benefits
in
a
benefit­
cost
analysis.
Economic
theory
is
quite
clear
on
this
point
(
Jones­
Lee,
1991).
If
I
care
about
my
neighbor
and
respect
his
preferences,
and
if
my
neighbor
would
have
to
pay
for
the
program
or
project
being
analyzed,
then
altruistic
benefits
should
not
be
counted
in
a
benefit­
cost
analysis.
The
intuition
behind
this
result
is
that,
if
I
respect
my
neighbor's
preferences,
although
I
value
the
benefits
he
will
receive
from
the
project,
I
also
care
about
the
costs
it
will
impose
on
him.
It
is,
therefore,
inappropriate
to
add
the
value
I
attach
to
his
benefits
without
considering
the
cost
implications
of
doing
this.
Comparing
individual
benefits
and
costs
in
this
case
is
the
appropriate
decision
rule.

Altruistic
benefits
may
be
counted
either
when
my
altruism
toward
my
neighbor
is
paternalistic,
or
when
I
will
in
fact
bear
the
costs
of
the
project
but
he
will
not.
In
the
first
case
(
paternalistic
altruism),
I
care
about
the
benefits
my
neighbor
will
enjoy,
e.
g.,
from
a
health
or
safety
project,
but
not
about
the
costs
the
project
will
impose
on
him.
An
example
of
the
second
case
would
be
a
project
whose
costs
are
borne
entirely
by
the
current
generation;
i.
e.,
the
project
imposes
no
costs
on
future
generations.
In
this
case,
altruism
toward
future
generations
by
the
current
generation
could
legitimately
be
counted
as
a
benefit.
R­
1
REFERENCES
Jones­
Lee,
M.
W.
(
1991).
"
Altruism
and
the
Value
of
Other
People's
Safety."
Journal
of
Risk
and
Uncertainty,
4,
pp.
213­
219.

Shogren,
Jason
F.,
and
Thomas
D.
Crocker
(
1999).
"
Risk
and
Its
Consequences,"
Journal
of
Environmental
Economics
and
Management,
37,
44­
51.

U.
S.
Environmental
Protection
Agency
(
1997).
The
Benefits
and
Costs
of
the
Clean
Air
Act,
1970
to
1990.
Submitted
to
Congress
pursuant
to
Section
812,
Clean
Air
Act
Amendments
of
1990.
Washington:
U.
S.
EPA
Office
of
Administration
and
Resources
Management/
Office
of
Policy,
Planning,
and
Evaluation.
October,
1997.

U.
S.
Environmental
Protection
Agency
(
1999).
Guidelines
for
Preparing
Economic
Analyses.
US
EPA/
OP,
Office
of
Economy
and
Environment.
June
11,
1999.
Draft.
A­
1
APPENDIX
A
CHARGE
TO
THE
COMMITTEE
August
4,
1998
Dr.
Robert
Stavins
Professor
of
Public
Policy
and
Faculty
Chair
John
F.
Kennedy
School
of
Government
Harvard
University
79
John
F.
Kennedy
Street,
Room
L­
313
Cambridge,
Massachusetts
02138
Dear
Dr.
Stavins:

The
Science
Advisory
Board,
Environmental
Economics
Advisory
Committee
(
EEAC
or
the
Committee)
is
requested
to
perform
an
advisory
review
of
a
revised
guidance
document
prepared
for
the
Environmental
Protection
Agency
(
EPA)
on
the
conduct
of
economic
analysis.
The
document,
titled
"
Guidelines
for
Preparing
Economic
Analyses,"
is
the
product
of
a
deliberative
Agency­
wide
process
initiated
at
my
direction
and
managed
by
the
EPA's
Regulatory
Policy
Council.
The
document
is
designed
to
represent
Agency
policy
on
the
preparation
of
economic
analysis
called
for
under
applicable
legislative
and
administrative
requirements,
including,
but
not
limited
to
Executive
Order
12866
on
regulatory
planning
and
review.
The
revisions
to
the
guidance
document
should
embody
sound
economic
thinking
so
that
its
application
will
continue
to
demonstrate
the
EPA's
commitment
to
make
credible
and
consistent
economic
analytic
decisions
in
support
of
the
regulatory
and
policy
making
process.
The
Agency
is
seeking
external
peer
review
of
the
guidance
documents
because
of
the
pervasive
influence
of
the
documents
on
the
conduct
of
agency­
wide
economic
analysis.

Background
The
decision
to
prepare
a
revised
document
is
based
on
a
number
of
events
and
factors.
The
current
EPA
operating
guidance
on
performing
economic
analysis
was
written
over
the
period
1983­
1986.
Since
that
time,
there
have
been
numerous
advances
in
the
economic
literature.
Because
the
guidance
document
is
primarily
intended
to
serve
as
a
source
for
technical
information
on
the
conduct
of
economic
analysis,
it
is
important
that
the
document
reflect
the
most
recent
economics
literature.

The
original
EPA
guidance
document
was
also
written
to
support
the
administrative
process
for
using
economic
information
when
developing
regulations
set
forth
in
Executive
Order
(
E.
O.)
12291
on
Regulatory
Planning
and
Review
(
released
in
1981).
The
Office
of
Management
A­
2
and
Budget
(
OMB)
issued
its
own
federal
guidelines
for
performing
economic
analysis
following
the
release
of
E.
O.
12291.
The
EPA
elected
to
issue
its
own
guidance
document
in
an
effort
to
elaborate
on
the
materials
described
in
the
OMB
guidance,
and
provide
additional
source
material
to
assist
in
the
application
of
the
OMB
analytic
principles
to
analyses
prepared
by
the
EPA.
The
issuance
of
an
updated
Order
on
the
federal
regulatory
development
process
(
E.
O.
12866
released
in
1993)
led
OMB
to
revise
its
federal
guidelines
for
performing
economic
analysis
in
early
1996.
The
new
OMB
guidance
drew
heavily
on
the
previous
document,
but
developed
additional
details
on
several
aspects
of
conducting
economic
analysis
that
reflected
advances
in
the
economic
literature,
and
added
information
on
several
administrative
measures
and
policy
objectives
receiving
additional
emphasis
included
in
E.
O.
12866.
The
new
EPA
economic
guidance
document
seeks
to
accomplish
the
same
objective,
but
in
a
manner
that
meets
the
distinctive
needs
of
EPA
staff
working
on
economic
analyses.

Other
administrative
and
legislative
requirements
were
issued
since
the
mid­
1980s
that
now
affect
the
development
and
conduct
of
economic
analysis
at
the
EPA.
Most
are
not
directed
exclusively
at
EPA
regulatory
activities,
but
their
addition
has
led
to
some
modifications
to
the
preparation
of
economic
analyses
by
the
EPA.
Some
examples
include
legislation
to
consider
unfunded
mandates
on
non­
federal
governments,
and
the
assessment
of
economic
impacts
on
small
entities.
The
revised
EPA
economic
guidance
document
seeks
to
update
and
make
reference
to
existing
and
anticipated
guidance
on
these
Congressional
mandates
and
executive
orders.

One
major
goal
of
the
new
guidance
document
is
to
provide
more
assistance
to
EPA
analysts
in
the
adoption
of
a
consistent
set
of
procedures
used
to
formulate
its
economic
analyses.
The
responsibility
for
preparing
economic
analyses
at
the
EPA
rests
in
many
different
offices
in
the
Agency.
As
a
consequence
of
differences
in
the
authorizing
statutes
they
operate
under,
the
conduct
and
use
of
economic
analysis
can
vary
across
documents
prepared
by
these
offices.
Despite
these
differences,
there
are
a
number
of
guiding
principles
and
practices
that
the
EPA
proposes
to
follow
to
aid
in
the
consistent
development
of
economic
information.
The
new
economic
guidance
document
has
been
written
to
make
clear,
for
a
number
of
identified
analytic
issues,
the
process
that
EPA
analysts
are
to
follow
as
they
organize
and
perform
their
economic
analyses.
One
of
the
objectives
in
revising
the
guidance
document
was
to
adopt
a
process
whereby
the
Agency's
economic
analytic
staff
participated
as
a
group
in
the
review
and
revision
of
the
document.
Because
these
offices
have
greater
authority
and
responsibility
for
the
content
and
quality
of
their
economic
analysis,
the
process
provided
a
productive
forum
for
raising
common
and
critical
issues
that
arise
in
the
conduct
of
economic
analysis.

The
current
guidance
document's
publication
date
of
1983
belies
the
fact
that
work
has
been
undertaken
by
EPA
since
that
time
to
support
advances
in
the
development
and
use
of
economic
tools
and
information
in
its
economic
analyses.
The
Agency
draws
upon
the
results
of
new
research
and
participates
in
professional
workshops
(
e.
g.,
events
supported
by
the
Association
of
Environmental
and
Resource
Economists)
to
be
current
with
the
state
of
economic
knowledge.
EPA
also
uses
materials
produced
by
other
government
agencies
(
e.
g.,
General
A­
3
Accounting
Office
reviews,
reports
by
the
Presidential/
Congressional
Commission
on
Risk
Assessment/
Risk
Management),
incorporating
new
information
and
thinking
into
its
economic
analyses.
Recognizing
that
the
previous
process
resulted
in
development
of
a
"
static"
EPA
economic
guidance
document,
this
effort
is
viewed
as
the
first
of
a
series
of
more
regular
and
frequent
actions
to
continually
review
and
revise
component
parts
of
the
documents.
The
development
and
release
of
materials
will
follow
a
schedule
that
reflects
and
reports
on
significant
changes
in
the
literature
used
to
support
EPA
analyses,
as
well
as
changes
in
administrative
and
legal
requirements
that
affect
the
conduct
of
economics
at
the
EPA.

The
materials
to
be
submitted
to
the
SAB­
EEAC
for
an
advisory
review
at
this
time
include
a
complete
draft
of
the
revised
guidance
document.
The
document
consists
of
a
main
document
and
five
separate
appendices.
Each
appendix
provides
greater
detail
on
subjects
treated
in
the
main
document.
The
appendices
are
organized
into
major
component
parts
of
economic
analyses
produced
by
the
EPA,
or
treat
an
analytic
topic
that
merits
significant
attention.
As
of
this
revision,
the
guidance
document
contains
appendices
on
the
analysis
of
economic
benefits,
social
costs,
economic
impacts,
equity
effects,
and
discounting
future
benefits
and
costs.

Charge
to
the
Committee:

The
charge
to
the
Committee
is
to
undertake
an
advisory
review
of
the
draft
materials
and
provide
advice
to
the
Agency
pursuant
to
a
series
of
questions
concerning
the
preparation
of
economic
analyses
by
the
EPA.
The
EPA
guidance
directly
refers
to
methods
and
practices
that
enjoy
widespread
acceptance
in
the
environmental
economics
profession.
The
guidance
document
does
not
intend
to
preclude
new
or
path
breaking
forms
of
analysis,
but
to
provide
EPA
analysts
with
a
reasonably
concise
and
thorough
treatment
of
mainstream
thinking
on
important
technical
issues
that
arise
in
the
conduct
of
economic
analysis.
The
guidance
accounts
for
some
of
the
practical
limitations
on
time
and
resources
that
EPA
analysts
must
contend
with
when
preparing
economic
analyses.
It
also
is
shaped
by
administrative
and
statutory
requirements
that
contain
direct
references
to
the
development
of
economic
information
in
the
formulation
of
regulations
(
e.
g.,
evaluations
of
economic
achievability).
As
a
result,
the
guidance
is
not
written
to
resemble
a
text
on
the
theory
and
methods
of
applying
economic
analysis
to
EPA
regulations
and
policies.
Some
of
the
language
in
the
guidance
was
chosen
for
the
express
purpose
of
providing
some
flexibility
to
analysts
that
should
enable
them
to
"
customize"
the
analysis
to
be
as
complex
and
complete
as
is
necessary
to
conform
to
administrative
and
legal
procedures.
The
document
also
emphasizes
the
need
for
the
EPA
analyst
to
ensure
that
their
analytic
efforts
are
commensurate
with
the
value
the
information
will
provide
to
the
regulatory
and
policy
making
process
at
the
EPA.
The
document
covers
a
number
of
principles
and
practices
that
virtually
all
economic
analyses
should
follow,
and
it
is
these
items
to
which
the
Committee
is
asked
to
devote
the
greatest
attention
in
its
review.

In
general,
we
believe
the
Guidance
should
reflect
mainstream
economic
science
and
methods
that
are
well
demonstrated
and
relatively
straightforward
to
apply
to
particular
environmental
issues.
Ideally,
these
methods
should
be
general
enough
that
EPA
program
A­
4
analysts
can
use
them
consistently
across
all
of
EPA's
programs.
Thus,
while
EPA
recognizes
that
this
document
needs
to
provide
pragmatic
guidance,
we
have
also
attempted
to
reflect
the
state
of
the
economic
science.
In
some
cases,
our
goal
of
making
this
useable
has
meant
that
we
had
to
shorten
or
simplify
the
document.
Your
views
about
whether
there
are
any
important
omissions
or
oversimplifications
are
critical.

The
review
questions
to
the
Committee
are
as
follows:

1.
Do
the
published
economic
theory
and
empirical
literature
support
the
statements
in
the
guidance
document
on
the
treatment
of
discounting
benefits
and
costs
in
the
following
circumstances:

1a.
Discounting
private
and
public
costs
for
use
in
an
economic
impact
analysis?

1b.
Discounting
social
benefits
and
costs
in
an
intragenerational
context?

1c.
Discounting
social
benefits
and
costs
in
an
intergenerational
context?

1d.
Discounting
social
benefit
and
cost
information
that
is
reported
in
nonmonetary
terms?

2.
Do
the
published
economic
theory
and
empirical
literature
support
the
statements
in
the
guidance
document
on
quantifying
and
valuing
the
social
benefits
of
reducing
fatal
human
health
risks?

3.
Do
the
published
economic
theory
and
empirical
literature
support
the
statements
in
the
guidance
document
on
the
treatment
of
certainty
equivalents
in
the
assessment
of
social
benefits
and
costs
of
environmental
policies?

4.
Do
the
published
economic
theory
and
empirical
literature
support
the
statements
in
the
guidance
document
on
the
merits
and
limitations
of
different
valuation
approaches
to
the
measurement
of
social
benefits
from
reductions
in
human
morbidity
risks
and
improvements
in
ecological
conditions
attributable
to
environmental
policies?

5.
Do
the
published
economic
theory
and
empirical
literature
support
the
statements
in
the
guidance
document
on
the
relationships
and
distinctions
between
the
measurement
of
economic
impacts
and
net
social
benefits?

6.
Does
the
guidance
document
contain
an
objective
and
reasonable
presentation
on
the
published
economic
theory,
empirical
literature,
and
analytic
tools
associated
with
computable
general
equilibrium
(
CGE)
models,
and
description
of
their
relevance
for
economic
analyses
performed
by
the
EPA?
A­
5
7.
Does
the
guidance
document
contain
an
objective
and
reasonable
presentation
on
the
measurement
of
economic
impacts,
including
approaches
suitable
to
estimate
impacts
of
environmental
regulations
on
the
private
sector,
public
sector
and
households?
This
includes,
for
example,
the
measurement
of
changes
in
market
prices,
profits,
facility
closure
and
bankruptcy
rates,
employment,
market
structure,
innovation
and
economic
growth,
regional
economies,
and
foreign
trade.

8.
Does
the
guidance
document
contain
a
reasonable
presentation
and
set
of
recommendations
on
the
selection
of
economic
variables
and
data
sources
used
to
measure
the
equity
dimensions
identified
as
potentially
relevant
to
environmental
policy
analysis?

The
EPA
requests
that
the
Committee
provide
written
review
and
documentation,
when
applicable,
to
support
recommended
changes
to
the
guidance
document.
Our
intention
is
that
the
Committee
conduct
a
full
and
complete
review.
Although
the
specific
questions
identified
above
are
those
EPA
believes
are
the
most
appropriate
for
the
Committee
to
consider,
EPA
seeks
comments
on
all
aspects
of
the
guidance
document.
The
EPA
also
seeks
recommendations
from
the
Committee
on
alternative
methodologies,
assumptions
and
data
sources
that
will
improve
the
presentation
of
economic
issues
addressed
in
the
guidance
document.
We
would
like
the
Committee
to
conclude
its
review
by
the
end
of
October.

Review
materials
The
first
attachment
to
this
memorandum
is
to
both
the
Designated
Federal
Official
and
Chairman
to
the
Environmental
Economics
Advisory
Committee.
The
memorandum
lists
the
publicly
available
documents
supporting
the
"
Guidelines
for
Preparing
Economic
Analyses."
This
memorandum
contains
a
list
of
the
documents
which
are
to
be
submitted
to
the
Committee
to
assist
in
their
review
of
the
guidance
document.
The
other
attachments
are
the
documents.

Please
direct
any
inquiries
regarding
the
review
materials
to
me
at
202­
260­
3354,
or
by
email
at
mcgartland.
al@
epa.
gov.
Thank
you
for
your
assistance.

Sincerely,
/
S
/
Fred
Hansen,
Deputy
Administrator
ABSTRACT
The
Environmental
Economics
Advisory
Committee
(
EEAC)
of
the
EPA
Science
Advisory
Board
(
SAB)
reviewed
the
Agency's
draft
Guidelines
for
Preparing
Economic
Analyses
during
a
series
of
meetings
extending
from
August
1998
to
July
1999,
in
response
to
a
request
received
from
EPA
to
perform
a
full
and
complete
review.
The
draft
Guidelines
have
been
revised
and
greatly
improved
as
a
result
of
the
interactions
between
the
EEAC
and
EPA
staff
during
the
public
meetings
over
the
past
year.
The
EEAC's
general
conclusion
is
that
the
Guidelines
now
succeed
in
reflecting
methods
and
practices
that
enjoy
widespread
acceptance
in
the
environmental
economics
profession,
notwithstanding
the
concerns
that
remain
with
several
particular
parts
of
the
Guidelines.

Keywords:
benefit­
cost
analysis;
economic
efficiency;
cost
effectiveness;
regulatory
impact
analysis
Appendix
B
205
Appendix
B:
EPA's
Response
to
SAB
Review
206
Appendix
B
December
21,
2000
Dr.
Robert
N.
Stavins
Chairman,
Environmental
Economics
Advisory
Committee
Science
Advisory
Board
(
A­
101)
Environmental
Protection
Agency
Ariel
Rios
Building
1200
Pennsylvania
Avenue,
N.
W.
Washington,
D.
C.
20460
Dear
Dr.
Stavins:

Thank
you
for
your
letter
to
Administrator
Browner
and
the
report
An
SAB
Report
on
the
EPA
Guidelines
for
Preparing
Economic
Analyses:
A
Review
by
the
Environmental
Economics
Advisory
Committee
(
EPA­
SAB­
EEAC­
99­
20,
September
30,
1999).
Before
I
respond
to
the
specifics
of
your
review,
allow
me
to
thank
the
Board
for
the
sustained
and
intensive
level
of
effort
devoted
by
the
SAB s
Environmental
Economic
Advisory
Committee
(
EEAC)
to
the
development
and
review
of
the
Agency s
economic
analysis
guidelines.
By
incorporating
the
 
best
mainstream 
economics
into
our
guidelines
and
analyses,
the
overall
credibility
of
our
work
will
be
sustained,
the
Agency s
decisions
will
be
better
informed,
and
public
discourse
on
environmental
policy
will
be
enhanced.
The
SAB
report
contains
a
thorough
review
of
our
Guidelines
for
Preparing
Economic
Analyses
(
or
EA
Guidelines),
and
provides
many
useful
recommendations
that
the
Agency
has
taken
under
consideration
in
revising
the
document.
Other
suggestions
in
the
review
help
illuminate
larger
issues
that
the
Agency
continues
to
explore
and
consider.

Given
the
importance
of
economic
assessments
to
the
Agency,
it
is
imperative
that
they
are
conducted
as
consistently
and
accurately
as
possible.
The
best
way
to
ensure
that
analyses
meet
these
goals
is
to
provide
Agency
analysts
with
a
clear
set
of
guidelines
and
recommendations
that
have
a
solid
foundation
in
the
current
state
of
economic
science.
As
your
letter
notes,
evolution
of
analytical
tools
and
practices
requires
that
such
guidelines
be
reviewed
every
few
years.
The
Agency
is
committed
to
undertaking
regular
reviews
of
the
materials
contained
in
the
EA
Guidelines,
and
looks
forward
to
receiving
further
recommendations
from
the
Science
Advisory
Board s
Environmental
Economics
Advisory
Committee
(
EEAC)
that
will
strengthen
and
improve
the
EA
Guidelines
in
the
years
ahead.
As
you
also
note
in
your
letter
and
report,
the
process
employed
by
the
EEAC
and
the
Agency
in
the
review
of
the
EA
Guidelines
is
unique.
The
Agency
agrees
that
this
departure
from
the
standard
practice
was
of
great
benefit
in
preparing
the
document.
Not
only
did
early
involvement
by
the
EEAC
ultimately
result
in
a
much
stronger
document,
but
the
open
exchange
between
EEAC
members,
the
Committee
as
a
whole,
and
Agency
personnel
served
to
clarify
a
number
of
issues
that
may
have
been
difficult
to
address
otherwise.
The
Agency
is
hopeful
that
a
similar
process
may
prove
useful
in
other
contexts.

The
EA
Guidelines
serve
as
a
set
of
principles,
consistent
with
current
economic
thinking,
for
analysts
to
draw
upon
in
performing
economic
analyses.
Section
Three
of
the
SAB
report
provides
specific
recommendations
for
the
application
of
these
principles.
The
Agency s
responses
to
the
main
recommendations
included
in
the
SAB
report,
including
references
to
sections
in
the
EA
Guidelines
where
resulting
changes
or
additions
to
the
document
can
be
found,
are
enclosed.

Finally,
I
would
like
to
again
thank
the
Board
for
its
thoughtful
comments
provided
in
the
report,
and
the
extensive
feedback
offered
by
the
membership
of
the
committee
during
the
public
meetings
on
the
EA
Guidelines.
The
Agency
sincerely
appreciates
the
time
and
effort
of
the
SAB
as
a
whole
and
of
the
individual
members
of
the
EEAC.

Sincerely,

/
s/
W.
Michael
McCabe
Deputy
Administrator
Enclosure
cc:
Assistant
Administrators
Associate
Administrators
Regional
Administrators
Regulatory
Policy
Council
Science
Advisory
Board
bcc:
Economic
Consistency
Workgroup
members
December
21,
2000
Dr.
Morton
Lippmann
Interim
Chairman,
Executive
Committee
Science
Advisory
Board
(
A­
101)
Environmental
Protection
Agency
Ariel
Rios
Building
1200
Pennsylvania
Avenue,
N.
W.
Washington,
D.
C.
20460
Dear
Dr.
Lippmann:

Thank
you
for
your
letter
to
Administrator
Browner
and
the
report
An
SAB
Report
on
the
EPA
Guidelines
for
Preparing
Economic
Analyses:
A
Review
by
the
Environmental
Economics
Advisory
Committee
(
EPA­
SAB­
EEAC­
99­
20,
September
30,
1999).
Before
I
respond
to
the
specifics
of
your
review,
allow
me
to
thank
the
Board
for
the
sustained
and
intensive
level
of
effort
devoted
by
the
SAB s
Environmental
Economic
Advisory
Committee
(
EEAC)
to
the
development
and
review
of
the
Agency s
economic
analysis
guidelines.
By
incorporating
the
 
best
mainstream 
economics
into
our
guidelines
and
analyses,
the
overall
credibility
of
our
work
will
be
sustained,
the
Agency s
decisions
will
be
better
informed,
and
public
discourse
on
environmental
policy
will
be
enhanced.
The
SAB
report
contains
a
thorough
review
of
our
Guidelines
for
Preparing
Economic
Analyses
(
or
EA
Guidelines),
and
provides
many
useful
recommendations
that
the
Agency
has
taken
under
consideration
in
revising
the
document.
Other
suggestions
in
the
review
help
illuminate
larger
issues
that
the
Agency
continues
to
explore
and
consider.

Given
the
importance
of
economic
assessments
to
the
Agency,
it
is
imperative
that
they
are
conducted
as
consistently
and
accurately
as
possible.
The
best
way
to
ensure
that
analyses
meet
these
goals
is
to
provide
Agency
analysts
with
a
clear
set
of
guidelines
and
recommendations
that
have
a
solid
foundation
in
the
current
state
of
economic
science.
As
your
letter
notes,
evolution
of
analytical
tools
and
practices
requires
that
such
guidelines
be
reviewed
every
few
years.
The
Agency
is
committed
to
undertaking
regular
reviews
of
the
materials
contained
in
the
EA
Guidelines,
and
looks
forward
to
receiving
further
recommendations
from
the
Science
Advisory
Board s
Environmental
Economics
Advisory
Committee
(
EEAC)
that
will
strengthen
and
improve
the
EA
Guidelines
in
the
years
ahead.
As
you
also
note
in
your
letter
and
report,
the
process
employed
by
the
EEAC
and
the
Agency
in
the
review
of
the
EA
Guidelines
is
unique.
The
Agency
agrees
that
this
departure
from
the
standard
practice
was
of
great
benefit
in
preparing
the
document.
Not
only
did
early
involvement
by
the
EEAC
ultimately
result
in
a
much
stronger
document,
but
the
open
exchange
between
EEAC
members,
the
Committee
as
a
whole,
and
Agency
personnel
served
to
clarify
a
number
of
issues
that
may
have
been
difficult
to
address
otherwise.
The
Agency
is
hopeful
that
a
similar
process
may
prove
useful
in
other
contexts.

The
EA
Guidelines
serve
as
a
set
of
principles,
consistent
with
current
economic
thinking,
for
analysts
to
draw
upon
in
performing
economic
analyses.
Section
Three
of
the
SAB
report
provides
specific
recommendations
for
the
application
of
these
principles.
The
Agency s
responses
to
the
main
recommendations
included
in
the
SAB
report,
including
references
to
sections
in
the
EA
Guidelines
where
resulting
changes
or
additions
to
the
document
can
be
found,
is
enclosed.

Finally,
I
would
like
to
again
thank
the
Board
for
its
thoughtful
comments
provided
in
the
report,
and
the
extensive
feedback
offered
by
the
membership
of
the
committee
during
the
public
meetings
on
the
EA
Guidelines.
The
Agency
sincerely
appreciates
the
time
and
effort
of
the
SAB
as
a
whole
and
of
the
individual
members
of
the
EEAC.

Sincerely,

/
s/
W.
Michael
McCabe
Deputy
Administrator
Enclosure
cc:
Assistant
Administrators
Associate
Administrators
Regional
Administrators
Regulatory
Policy
Council
Science
Advisory
Board
bcc:
Economic
Consistency
Workgroup
members
Enclosure
to
the
Deputy
Administrator s
Response
to
SAB
Report
on
the
EPA
Guidelines
for
Preparing
Economic
Analyses:
A
Review
by
the
Environmental
Economics
Committee
On
the
subject
of
discounting,
the
Agency
appreciates
the
recommendation
that,
to
reflect
common
practice,
the
EA
Guidelines
should
encourage
the
use
of
a
discount
rate
between
the
range
specified
in
the
review
draft
of
the
document.
Chapter
Six,
Section
6.3.1
in
the
final
EA
Guidelines
includes
a
recommendation
for
analysts
to
employ
such
a
rate
in
addition
to
the
other
rates
specified,
if
it
is
believed
the
additional
information
would
be
useful
to
decision
makers.
One
reason
analysts
may
include
such
a
rate
is
because
its
use
is
routinely
practiced
for
the
specific
type
of
analysis
being
performed.
An
example
would
be
the
recent
analyses
prepared
by
the
Agency
on
the
benefits
and
costs
of
the
Clean
Air
Act
and
its
1990
Amendments.
Other
economic
analyses
have
found
it
sufficient
for
decision
making
purposes
to
rely
on
presentations
of
economic
information
using
the
range
alone.
The
Agency
views
both
presentations
to
be
supported
by
the
EA
Guidelines
and
in
accord
with
the
position
taken
on
discounting
by
the
SAB
in
the
report.

Estimating
the
value
of
reductions
in
fatality
risks
remains
one
of
the
more
difficult
aspects
of
benefit­
cost
analysis,
and
the
Agency
appreciates
the
attention
given
this
issue
in
the
SAB
report.
Since
receiving
the
SAB
report
on
the
draft
EA
Guidelines,
the
Agency
has
received
additional
SAB
recommendations
on
the
subject
of
valuing
reductions
in
fatal
cancer
risks
(
SAB
report
EPA­
SAB­
EEAC­
00­
013,
dated
July
27,
2000).
As
noted
in
Chapter
Seven,
Section
7.6.1
of
the
final
document,
the
Agency
will
release
a
supplement
to
the
EA
Guidelines
on
this
topic
once
it
has
more
thoroughly
considered
the
July
27
SAB
report
on
valuing
fatal
cancer
risks.

The
Agency
agrees
with
the
SAB
that
the
limitations
associated
with
the
concepts
and
empirical
studies
available
to
use
in
quantifying
a
value
of
a
statistical
life
(
VSL)
should
be
described
in
detail
whenever
VSL
estimates
are
introduced
in
a
benefit­
cost
analysis.
The
final
EA
Guidelines
specifically
require
analysts
to
carefully
present
these
limitations
in
their
analyses.
The
document
also
advises
analysts
to
fully
characterize
the
nature
of
the
risk
and
the
populations
affected
as
they
relate
to
the
choice
of
available
literature
used
in
a
benefits
analysis,
as
well
as
the
presentation
of
uncertainties
associated
with
such
estimates.
Some
important
considerations
noted
by
the
SAB
report
have
resulted
in
an
expanded
discussion
in
the
document,
including
recognition
of
how
demographic
characteristics
(
e.
g.,
age)
of
the
population
at
risk
compare
with
those
same
characteristics
of
the
population
studied
in
the
underlying
economic
literature
used
to
derive
benefit
values.
The
final
EA
Guidelines
continues
to
make
reference
to
the
numeric
VSL
range
found
to
be
reasonable
by
the
SAB,
and
the
Agency
agrees
with
the
SAB
on
the
merits
of
improving
and
refining
measures
of
this
benefit
category
through
reasoned
use
of
the
existing
relevant
literature.
Analysts
are
further
encouraged
to
consider
quantitative
sensitivity
analyses
as
data
allow,
recognizing
that
the
need
for
such
analyses
and
the
ability
to
perform
them
may
vary
with
each
benefit
transfer
exercise.
The
SAB
report
also
notes
that
measures
of
cost­
effectiveness
may
be
employed
as
a
sensitivity
analysis,
which
is
now
included
in
the
final
document.

The
SAB
report
raises
several
issues
related
to
valuation
for
morbidity
and
ecological
effects.
The
Agency
agrees
with
the
SAB
that
the
benefits
of
a
policy
should
be
neither
understated
nor
exaggerated,
and
has
revised
the
EA
Guidelines
to
inform
analysts
of
these
hazards
and
to
encourage
explicit
consideration
of
uncertainty.
Benefits
will
always
be
uncertain
to
some
extent
and
the
Agency
agrees
that
expected
values
should
be
emphasized,
as
noted
in
Chapter
Five,
Section
5.5
in
the
expanded
discussion
of
uncertainty.

The
final
EA
Guidelines
also
contains
a
revised
discussion
of
averting
expenditures
as
a
measure
of
benefits.
This
discussion
recognizes
that
averting
behavior
is
not
always
a
lower
bound
on
an
ex
ante
economic
value
for
health
improvements
because
of
the
presence
of
private
and
collective
risk
reduction
strategies.
The
reference
on
this
subject
suggested
by
the
Committee
is
now
included
in
Chapter
Seven,
Section
7.5.1
in
the
final
EA
Guidelines.

The
Agency
agrees
with
the
SAB
that
computable
general
equilibrium
(
CGE)
analysis
is
growing
in
use
as
an
analytical
tool.
The
Agency
is
committed
to
an
ongoing
review
of
tools
that
broaden
the
applicability
of
CGE
models
and
is
enthusiastic
about
their
implications
for
benefit­
cost
analysis.
The
discussion
of
CGE
models
in
the
Chapter
Eight,
Section
8.4.5
of
the
final
EA
Guidelines
has
been
expanded
to
include
 
tax
interaction 
effects
as
recommended
in
the
SAB
report.

The
SAB
notes
that
the
document
would
benefit
from
a
more
detailed
discussion
of
the
role
of
altruism
in
benefit­
cost
analysis.
The
Agency
agrees
with
the
SAB
and
has
expanded
the
discussion
of
altruism
in
Chapter
Seven
in
order
to
clarify
when
altruistic
benefits
may
and
may
not
be
included
in
a
benefit­
cost
analysis.
The
expanded
discussion
is
found
in
Chapter
Seven,
Section
7.2.1
of
the
final
EA
Guidelines
and
draws,
in
part,
from
the
language
in
the
SAB
report.
United
States
Environmental
Protection
Agency
(
1809)
Washington,
DC
20460
Recycled/
Recyclable
Printed
with
soy­
based
inks
Guidelines
for
Preparing
Economic
Analyses
September
2000