Richard Zerbe - Research in Law and Economics -JAI Press (2007)

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LIST OF CONTRIBUTORS
USA
Yoram Bauman W
ashington State Department of Health,
Seattle, WA, USA
Carol Bray U
.S. Government Accountability Office,
Neil Bruce D
epartment of Economics, University of
Washington, Seattle, WA, USA
Jared C. Carbone D
epartment of Economics, Williams
College, Williamstown, MA, USA
Daniel H. Cole I
ndiana University School of
Law-Indianapolis, IN, USA
Scott Farrow U
MBC/Department of Economics,
Baltimore, MD, USA
Aaron Finkle D
epartment of Economics, University of
Washington, Seattle, WA, USA
Victor B. Flatt A
.L. O’ Quinn Chair in Environmental
Law, University of Houston Law Center,
Houston, TX, USA
Lawrence H. Goulder D
epartment of Economics, Stanford
University, Stanford, CA, USA
Benjamin Groom D
epartment of Economics, SOAS, London,
UK
Tim Guinane U
.S. Government Accountability Office,
USA
Robert Halvorsen D
epartment of Economics, University of
Washington, Seattle, WA, USA
ix
LIST OF CONTRIBUTORSx
Arnold C. Harberger D
epartment of Economics, University of
California, Los Angeles, CA, USA
Robert Haveman D
epartment of Economics, University of
Wisconsin-Madison, Madison, WI, USA
Richard E. Just U
niversity of Maryland, Agricultural and
Resource Economics, College Park, MD,
USA
Jack L. Knetsch P
rofessor Emeritus, Department of
Economics, Simon Fraser University,
Burnaby, British Columbia, Canada
Andreas Kontoleon D
epartment of Land Economy, University
of Cambridge, Cambridge, UK
Mark L. Plummer N
ational Marine Fisheries Service, Seattle,
WA, USA
Theodore M. Porter D
epartment of History, University of
California, Los Angeles, CA, USA
Gordon C. Rausser U
niversity of California Berkeley,
Agricultural and Resource Economics, CA,
USA
Frederick Rossi S
outhern University at Shreveport,
Shreveport, LA, USA
Andrew Schmitz F
ood and Resource Economics
Department, University of Florida,
Gainesville, FL, USA
Troy G. Schmitz M
orrison School of Agribusiness and
Resource Management, Arizona State
University, Mesa, AZ, USA
V. Kerry Smith D
epartment of Economics, Arizona State
University, Tempe, AZ, USA
List of Contributors xi
Tim Swanson D
epartment of Economics and Faculty of
Law, University College London, London,
UK
Richard O. Zerbe Jr. S
chool of Public Affairs, University of
Washington, Seattle, WA, USA
ACKNOWLEDGMENTS
These chapters were produced with support from the Daniel J. Evans School
of Public Affairs at the University of Washington, the Law School at the
University of Washington, the Philosophy Department of the University of
Washington, and The John D. and Catherine T. MacArthur Foundation.
We thank them for their support.
xiii
INTRODUCTION TO
BENEFIT–COST VOLUME
In the earlier part of the twentieth century, cost–benefit (CBA) or benefit–
cost analysis was used as a vehicle by Congress to curtail its wasteful
spending, by using the Army Corp of Engineers to examine Congressional
projects using CBA. Theodore Porter here examines the rise of the use of
CBA in historical context and finds that the Corp was highly successful in
reducing wasteful spending. Regardless of the present day effectiveness of
the Corps, CBA currently provides valuable service. To appreciate this one
need look no further than the effect Arnold Harberger’s work and students
have had in less developed countries, and at the several hundred useful
evaluations of social programs produced over the last several years. Finally,
one can look, criticisms of Ackerman and Heinzerling notwithstanding, at
many of the analyses of environmental programs.
Nevertheless, problems remain. Robert Haveman shows how the effect of
the absence of well-accepted and enforced benefit–cost standards leads to
spurious analyses that result in public waste. Haveman examines the
benefit–cost analysis performed by the City of Chicago for the FAA. The
Chicago analysis results in positive net benefits of about 2.2 billion;
Haveman’s analysis indicates a net social loss of around 4 billion. There are
as yet no uniform standards for CBA analysis even within the Federal
Government. Daniel Cole notes the limited success of OMB and EPA in
improving methodological consistency. He suggests that an independent
group of economists, policy analysts and legal scholars, under the auspices
of the National Science Foundation, take on the job of establishing revisable
‘‘best practice’’ standards. Somewhat similarly, Victor Flatt argues that the
courts can recognize the proper standard that governs what an agency can
do. The courts can then set a standard for BCA that should be used when an
agency is engaged in its application. Such an approach is consistent with the
non-delegation doctrine, which suggests agencies should not be engaging in
political manipulation in performing such analyses; political considerations
are for Congress. Taken together, then, these two articles spell out an
approach to increasing rigor and consistency. The article by Carol Bray,
xv
INTRODUCTION TO BENEFIT–COST VOLUMExvi
Scott Farrow and Tim Guinane also falls within the purview comptemplated
by these first two articles. The authors identify and review current uses of
CBA measures within the Federal Government, and then discuss the
opportunities for their expanded use and for the possibility of creating a set
of uniform standards, which they call ‘‘generally accepted analytic
principles.’’
The article in this volume by Larry Goulder considers another expansion
of CBA application, a broader domain. Goulder advances well-reasoned
arguments for a proposal by Zerbe to include the willingness to pay for
outcomes by third parties. Goulder notes that, particularly in an
international setting, third party effects might be significant enough to
justify the costs associated with estimating them. This is consistent with the
article by Richard Zerbe, Yoram Bauman and Aaron Finkle. They show
that the objections made by economists to the inclusion of moral sentiments
have little weight on either technical or utility grounds.
There is an increasing interest in considering general equilibrium (many
markets) rather than partial equilibrium (one or few markets) outcomes in
CBA use. Arnold Harberger notes that he and Glenn Jenkins find that
partial equilibrium analysis in analyzing the effects of trade are valid only
when (1) the demand and supply for the good in question are not
substantially affected by the way in which the project funds are raised, and
(2) when there are no distortions (taxes and tariffs) involved in the raising of
these funds or are taken into account elsewhere. Otherwise a general
equilibrium analysis is required.
This is not dissimilar from the results of V. Kerry Smith and Jared
Carbone who show the importance of taking into account general
equilibrium effects for the estimate of the efficiency costs of taxes in a
distorted economy. They consider environmental amenities and find it is
necessary to consider both market and non-market effects in conjunction. It
turns out that even when such amenities are less that three percent of virtual
income, the error from ignoring feedback effects between market and non-
market effects can be very large.
Stressing again the importance of general equilibrium outcomes, Richard
Just and Gordon Rausser examine the difference between partial
equilibrium and general results for vertical market structures. In particular
they examine predatory selling and bidding. Their results demonstrate that
the widely used partial equilibrium analysis is not robust for assessment of
effects of monopoly or monopsony, whether or not predation occurs. In
general monopoly and monopsony turn out to have asymmetrical effects
Introduction to Benefit–Cost Volume xvii
and the Supreme Court requirements of Brook Group for a finding of
predation do not appear to accord with the general equilibrium results.
Neil Bruce and Robert Halvorsen make another expansionary argument.
In place of the usual ‘‘value of statistical life’’ (VSL), they develop the notion
of ‘‘adding expected life years.’’ Such an approach can accommodate theeconomic result that an older person may evaluate an added year of life
more than a young person and can obviate the tortured logic to which the
VSL approach has been subject. They spell out the research that needs to be
done to establish the use of ‘‘adding expected life years.’’
Andrew Schmitz, Frederick Rossi and Troy G. Schmitz examine the
effects of trade-distorting agricultural policies. They address the question of
what difference it makes to the results when producers respond to the
government’s target price (coupling) when making production decisions or
instead make decisions based on the loan rate (decoupling). The negative
welfare effects are much less if the production decision is decoupled. More
research is needed to determine how producers form production decisions
and if there are policy changes that would support decoupling.
Timothy Swanson, Ben Groom and Andreas Kontoleon assess the effect
of information on absolute and relative ranking of the value of remote
mountain lakes. Three levels of information were provided. The first two
levels increased aggregate WTP only, but the last level also creates
differences between the ranking of four remote mountain lakes. The third
level of information, but not the first two, increased the congruence between
the respondent’s valuations and that of experts. Thus this study also
provides information about the level of information needed to get
reasonable convergence.
Information of course is the determinant to how much can be done with
CBA. Mark Plummer describes how useful results can be provided by a
hybrid of benefit–cost and cost-effectiveness analysis combined with a
hypothetical valuation experiment. Market’s example of choosing critical
habitat designation under the Endangered Species Act shows how a useful
analysis can be made under data poor circumstances. The example provided
is exemplary and valuable.
Richard O. Zerbe Jr.
Editor
‘BEST PRACTICE’ STANDARDS FOR
REGULATORY BENEFIT–COST
ANALYSIS
Daniel H. Cole
ABSTRACT
Government agencies have endeavored, with limited success, to improve the
methodological consistency of regulatory benefit–cost analysis (BCA).
This paper recommends that an independent cohort of economists, policy
analysts and legal scholars take on that task. Independently established
‘‘best practices’’ would have four positive effects: (1) they would render
BCAs more regular in form and format and, thus, more readily assessable
and replicable by social scientists; (2) improved consistency might
marginally reduce political opposition to BCA as a policy tool; (3)
politically-motivated, inter-agency methodological disputes might be
avoided; and (4) an independent set of ‘‘best practices’’ would provide a
sound, independent basis for judicial review of agency BCAs.
1. INTRODUCTION
Benefit–cost analysis (BCA)1 is an inherently controversial practice,
especially in the realm of regulatory policy. Like the Kaldor–Hicks (K-H)
efficiency criteria upon which it is based, regulatory BCA yields results that
Research in Law and Economics, Volume 23, 1–47
Copyright r 2007 by Elsevier Ltd.
All rights of reproduction in any form reserved
ISSN: 0193-5895/doi:10.1016/S0193-5895(07)23001-5
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dx.doi.org/10.1016/S0193-5895(07)23001-5.3d
DANIEL H. COLE2
are, at best, ambiguous with respect to social welfare and, at worst, subject
to manipulation for political ends. As a consequence, the results of all BCAs
are contestable.
Unfortunately, no practical alternative exists for predicting and measuring
the social-welfare outcomes of regulatory policies. In theory, the Pareto
criterion yields unambiguous results, but it is ruled out in practice by its strict
requirement of voluntary consent of all affected parties, which presumes
actual compensation of losers at their subjective valuations of their losses.
These strict conditions are met only by the negligibly small and uninteresting
set of voluntary market exchanges with no significant negative externalities.
In the realm of regulatory policy, resource allocations never are based on the
unanimous consent of all affected parties; and the losers from regulatory
policies never are compensated for losses based on their subjective
valuations. So, the strict Pareto conditions cannot be met. Consequently,
society is left with the ambiguous outcomes of imperfect and manipulable
BCAs based on the K-H criteria (or marginally improved versions of K-H
offered, for example, by Zerbe, 2001).2
The ambiguities and manipulability that render BCA generally contro-
versial are exacerbated in the realm of regulatory policy by: long time
horizons and uncertain social discount rates; the absence of primary or
secondary markets for many environmental goods, which makes any prices
assigned to them inherently contestable; and the virtual impossibility of
assigning universally acceptable values to human lives. For these reasons,
critics such as Ackerman and Heinzerling (2004) reject BCA entirely as a tool
of regulatory policy making.3
Even if regulatory BCA never can be rendered completely uncontroversial,
it can be made substantially less controversial than it is now simply by
improving its methodological consistency. Even an admittedly imperfect
methodology, applied consistently in accordance with standard criteria
widely accepted among scholars and practitioners, should be less objection-
able than various, inconsistently applied methodologies.
This paper will demonstrate that the methodological consistency of
regulatory BCA has been improving, though more in theory than in practice,
over the last decade or so, and provide a few discrete suggestions for
additional improvements. The ultimate goal – though not the goal of this
particular paper – is to standardize a set of ‘‘best practices’’ for regulatory
BCA. That goal, unfortunately, is unlikely to be achieved by the primary
users of BCAs – the regulatory agencies themselves – because those agencies
are subject to divergent political pressures that inevitably would raise
questions about the motives behind any set of standards they might establish
‘Best Practice’ Standards for Regulatory Benefit–Cost Analysis 3
and attempt to enforce. For reasons explained in Section 2, a set of ‘‘best
practices’’ established by the Environmental Protection Agency (EPA)
almost certainly would differ in important respects from a set of ‘‘best
practices’’ established by the President’s Office of Management and Budget
(OMB). The differential political biases of different agencies with different
missions would likely undermine the benefits to be gained from adopting a
set of ‘‘best practices.’’ Indeed, the EPA (2000) and OMB (2003) both have
recently published ‘‘best practice’’ guidelines, which diverge in important
respects. Multiple sets of ‘‘best practices’’ are better than none only to the
extent that multiple sets of ‘‘best practice’’ standards might provide a starting
point for conciliation and consolidation of a single set of standards.
This paper recommends that an independent and heterodox cohort of
economists, legal scholars, policy analysts, and decision theorists be
appointed under auspices of an independent organization such as the
National Academy of Sciences, American Economics Association, or a newly
minted ‘‘Society for Benefit–Cost Analysis,’’ to derive a set of ‘‘best
practices’’ for regulatory BCA. The hope is not that such a group would be
able to derive completely objective and neutral standards for BCA; that
would a pipe dream. BCA contains too many subjective elements, including
social discount rates and valuations of non-market goods and services, ever
to be completely objective and neutral. However, an independent cohort of
experts is less likely to be swayed by the immediate political concerns that
motivate the agencies that produce and utilize BCA. Independent
economists, legal scholars and policy analysts presumably would have less
of a political stake than OMB or EPA officials, for example, in the selection
of a rate (or rangeof rates) for discounting future costs and benefits or
pricing various mortality and morbidity effects.
Assuming a cohort of experts could establish a legitimate and useful set of
‘‘best practices’’ for BCA,4 their product would not constitute a legal
standard directly applicable to government agencies but a social–scientific
standard or norm that agencies might choose to adopt and reviewing courts
might choose to recognize. If some government agency based a policy
decision on a BCA that did not conform to the ‘‘best practices,’’ without a
satisfactory excuse or explanation, a reviewing court might reject the BCA
and possibly the substantive policy it supported.
In sum, the adoption of methodological ‘‘best practices’’ for regulatory
BCA could have four positive effects: (1) it would render BCAs more regular
in form and format and, thus, more readily assessable and replicable by
social scientists; (2) it presumably would reduce, at the margins, political
opposition to BCA as a policy tool; (3) it might reduce (though not
DANIEL H. COLE4
eliminate) politically-motivated, inter-agency methodological disputes; and
(4) it would provide a sound, consistent and independent basis for judicial
review of agency BCAs, which is an increasingly important consideration
given the proliferation of regulatory BCAs subject to review under state and
federal administrative procedure statutes.
This paper proceeds as follows: Section 2 offers evidence of improvements
in the consistency of BCA methodology over the last decade or so. Many
of those improvements have come from efforts to build consensus
among government agencies, including the EPA and the OMB. However,
Section 3 explains why more improvements are necessary (or, at least,
desirable), but unlikely to come from the agencies themselves because of
their divergent political and ideological commitments. Thus, this paper
recommends that the American Economic Association, the Association
of Environment and Resource Economists, the National Academy of
Sciences, or a new ‘‘Society for Benefit–Cost Analysis’’ create a task force
charged with developing a set of ‘‘best practice’’ standards for regulatory
BCA. Section 4 then offers a tentative but necessarily incomplete list of issues
such a task force might attempt to resolve in order to improve
methodological consistency. The paper concludes by reiterating the benefits
to be gained from the independent establishment of ‘‘best practice’’ standards
for regulatory BCA.
2. THE STRUGGLE FOR METHODOLOGICAL
CONSISTENCY IN BCA
Regulatory BCA is a young and still developing method for predicting ex
ante or assessing ex post the social welfare effects of public policies. Prior to
the twentieth century, when federal government regulation of economic
activity was a rare phenomenon, the lack of a regulatory BCA tool mattered
little.5 But with the rise of the welfare/administrative state during the
twentieth century – a rise enabled by theories of Pigovian welfare economics
(see Adler & Posner, 1999, p. 169) – the total of amount of regulation at all
levels of government increased dramatically. Still, before the 1970s
government agencies only rarely attempted to quantify the costs and benefits
of their burgeoning regulatory programs, let alone predict costs and benefits
prior to policy implementation. Consequently, the government and the
public had no way of knowing whether those regulatory programs were
creating more social good than harm.
‘Best Practice’ Standards for Regulatory Benefit–Cost Analysis 5
This problem called for a legislative fix that was not forthcoming. Until
the mid-1990s, Congress displayed little interest in assessing formally the
economic/welfare effects of regulatory programs.6 Consequently, nearly all
efforts to assess the costs and benefits of agency regulations came from the
Office of the President, which has the authority to regulate by Executive
Order the activities of agencies within the Executive Branch of the federal
government.7
2.1. 1970–1992: BCA under Reagan and Bush I
BCA (often referred to within the federal government as ‘‘regulatory impact
analysis’’) first emerged as a regular decision process tool at the beginning of
the 1970s,8 when Presidents Nixon, Carter, and Ford issued successive
executive orders calling for economic analyses of regulations and inter-
agency review of major rules (see Morgenstern, 1997, p. 10). During this
period, the President’s OMB emerged as ‘‘‘the lobby for economic
efficiency’’’ in government (Morgenstern, 1997, p. 10, quoting Schultze,
1977). In the 1980s, the Reagan Administration fashioned a more significant
role for BCA as a ‘‘decision rule’’ – a tool that, by itself, would determine
whether or not a regulation should be promulgated (Morrison, 1998, p. 1333,
n. 2). In 1982, President Reagan issued Executive Order (E.O.) 12,291
(46 Fed. Reg. 1193), which required that the ‘‘potential benefits’’ of all
‘‘major’’ federal regulatory actions (defined as those with economic effects
of at least $100 million, significant employment effects, or significant price
effects) had to ‘‘outweigh the potential cost to society.’’ The ostensible goal
of the E.O. was to ‘‘maximize the net benefits to society’’ from regulation.
In addition, the Order required comparative cost-effectiveness studies of
alternative means of achieving regulatory goals: ‘‘Among alternative
approaches to any given regulatory objective, the alternative involving the
least net cost to society shall be chosen.’’ Finally, the Reagan E.O. placed
the Director of the President’s OMB in charge of implementing the E.O., and
compelled executive branch agencies to submit their regulatory impact
analyses to OMB for review prior to final publication of new agency rules.
Four years later, President Reagan issued another Executive Order,
12,498, which supplemented E.O. 12,291 by requiring regulatory agencies to
submit ‘‘annual regulatory plans’’ for OMB review. According to Hahn and
Sunstein (2002, p. 1506), E.O. 12,498 ‘‘increase[d] the authority of agency
heads [political appointees] over their staffs [career bureaucrats], by exposing
proposals to top-level review at an early stage... . [I]t also increased the
DANIEL H. COLE6
authority of OMB, by allowing OMB supervision over basic plans, and by
making it hard for agencies to proceed without OMB preclearance.’’9
Despite E.Os. 12,291 and 12,498, government agencies continued to
dispute the proper role of, and approach to, BCA especially when the
Executive Orders appeared to conflict with statutory mandates calling for
regulations based not on economic costs and benefits but on the protection
of public health (see Morgenstern, 1997, pp. 10–11). The decade from 1982 to
1991 (from Reagan through Bush I) was characterized by increasing OMB
efforts (under authority granted by the two Reagan Executive Orders) to
control regulatory processes and substantial regulatory agency resistance to
OMB control. Despite E.O. 12,291’s seemingly clear mandate that agencies
base their regulatory decisions on a calculation of costs and benefits,
widespread disagreement persisted about the extent to which regulatory
decisions should depend on BCAs. Analysts also disagreed about the
appropriate methodology for conducting BCAs. Much of this disagreement,
predictably, swirled around the inherently subjective elements of BCA,
including discount rates and human-life valuations.
At the time President Reagan issued his two Executive Orders on BCA,
OMB was operating under Circular No. A-94, ‘‘Discount Rates to be Used
in Evaluating Time-Distributed Costs and Benefits’’ (March 27, 1972). That
Circular called for the use of a 10 percent real (i.e., inflation-adjusted)
discount rate for assessing federal regulations. Interestingly, OMB did not
revise that Circular in light of the Reagan Executive Orders until nearly the
end of the George H. W. Bush Administration in November 1992. For a full
decade all major federal regulations technically were required to provide net
benefits undera BCA using a 10 percent discount rate. Not surprisingly, the
regulatory agencies often ignored OMB’s Circular and utilized lower
discount rates, which justified more regulation.
Finally, on November 12, 1992 the OMB of the Bush I Administration
revised Circular A-94 (57 Fed. Reg. 53519). Among the revisions, OMB
reduced the base-case discount rate from 10 to 7 percent ostensibly because the
later rate ‘‘approximate[d] the marginal pretax rate of return on an average
investment in the private sector in recent years.’’ The guidance did not attempt
to defend or explain why historical returns on private investments constituted
an appropriate measure for regulations designed especially to deal with
pollution and other environmental externalities associated with market
failures.10 Nor did it explain why alternatives such as the ‘‘shadow price of
capital’’ or the real return on long-term government debt were inappropriate.11
Still, the move from a 10 percent discount rate to a 7 percent discount rate
‘Best Practice’ Standards for Regulatory Benefit–Cost Analysis 7
constituted a significant move toward moderation and conciliation with the
regulatory agencies.
2.2. 1993–2001: BCA under Clinton
Shortly after taking office in 1993, the Clinton Administration replaced the
two Reagan era Executive Orders with one of its own. According to Hahn
and Sunstein (2002, p. 1507), President Clinton’s E.O. 12,866 ‘‘endorsed the
essential features’’ of the Reagan orders. This is superficially true in that E.O.
12,866 continued to require agencies to perform regulatory BCAs and submit
those BCAs for OMB review. But E.O. 12,866 differed in fundamental
respects from the Reagan orders. First and foremost, it demoted BCA from a
‘‘decision rule’’ to a requisite source of information for decision making.
Unlike President Reagan’s E.O. 12,291, which expressly prohibited regulatory
measures unless the potential benefits outweighed the potential costs,
President Clinton’s E.O. 12,866 merely required agencies to prepare BCAs
to the extent consistent with their statutory mandates; it did not require the
agencies to base their regulatory decisions exclusively (or even primarily) on
the outcomes of BCAs. In addition, E.O. 12,866 mandated that agencies
consider not just economic efficiency but also ‘‘distributive impacts ... and
equity’’ when choosing among alternative regulatory approaches.
As it did during the Reagan Administration, the OMB dragged its feet in
revising its guidelines pursuant to President Clinton’s new Executive Order
on BCAs. When OMB finally did so in 1996, those revisions – referred to for
the first time as ‘‘best practices’’ for BCA – included a more elaborate,
thoughtful, and detailed explanation of BCA standards. OMB maintained its
‘‘base-case’’ 7 percent discount rate, but noted for the first time that
‘‘[m]odern research in economic theory has established a preferred model for
discounting, sometimes referred to as the shadow price approach.’’ That
approach, according to OMB, ‘‘is viewed as being approximated by the real
return to a safe asset, such as Government debt.’’ Normally, the return on
such an investment would be substantially lower than the 7 percent rate,
which the OMBmaintained as its ‘‘best practice’’ standard. Indeed, the OMB
stopped short of endorsing the shadow price method as the preferred way of
selecting a discount rate; and it required any agency preferring to use that
method to ‘‘consult with OMB prior to doing so.’’
The 1996 revisions to OMB’s guidelines for regulatory analyses also paid
more attention than had previous versions to: issues of risk and uncertainty
DANIEL H. COLE8
in BCA, including the use of sensitivity analysis; various methods for
valuing human life, among other non-market goods, through ‘‘value of
statistical life’’ and ‘‘value of statistical life-years extended’’ analyses; and
stressed the importance of making all BCA assumptions transparent. In
these and other respects, the 1996 revised OMB guidelines reflected recent
developments in the theoretical and academic literature on BCA.
A close reading of the 1996 revised guidelines suggests that OMB was
becoming more professional and ostensibly less political in its oversight of
federal regulatory processes. This evolution at OMB did not, however,
portend greater consistency in regulatory agencies’ BCAs. Agencies, including
the EPA, continued to use widely varying discount rates with little or no
explanation or justification. Between 1992 and 1998, federal agencies utilized
discount rates ranging between 3 and 10 percent for assessing regulations with
time horizons of 20 years or less, and rates between 3 and 7 percent for
longer-term regulations (with time horizons in excess of 30 years) (Morrison,
1998, Tables 1 and 2).12 The EPA itself relied on various discount rates, with
little explanation of its choice in any particular case. For example, the agency
employed a 3-percent discount rate when it sought to regulate lead-based
paint, but 7- and 10-percent rates, respectively, for assessing proposed
regulations of drinking water and locomotive emissions (Morrison, 1998,
p. 1337). A 1997 report by the General Accounting Office (GAO, 1997)
criticized the EPA’s economic analyses for their lack of transparency about
assumptions. Despite these and other evident problems of implementation,13
OMB concluded in its 1998 report to Congress that ‘‘the overall picture
remains one of slow but steady progress towards the Best Practices
standards’’ established in its 1996 revised guidance (OMB, 1998, p. 83).
It is not at all clear, however, that the OMB’s 1996 revised standards
actually constituted ‘‘best practices’’ in the first place. In October 1999,
Professor (now Dean) Richard Revesz of the New York University School of
Law testified before the Senate on the use of BCA under the Clean Air Act.14
He cited several respects in which the OMB guidelines remained deficient. In
particular, he criticized the OMB’s preferred 7 percent discount rate for being
‘‘a great deal higher than rates supported by economic theory,’’ resulting in
the undervaluation of the benefits of environmental regulations. He argued
that a 2–3 percent discount rate would be more appropriate, and noted that
the General Accounting Office and Congressional Budget Office already used
2–3 percent rates in their own economic assessments. In addition, Revesz
argued that OMB’s approach to valuing risk and human lives solely on the
basis of wage premia in labor markets was faulty because it did not take into
account the involuntary nature of many environmental risks (in contrast to
‘Best Practice’ Standards for Regulatory Benefit–Cost Analysis 9
voluntary risk acceptance by workers in exchange for additional income). In
addition, Revesz complained that workers who accept risky jobs are not
representative of the population as a whole; and he noted the particularly
painful nature of carcinogenic deaths. More generally, Revesz criticized
OMB procedures for turning BCA ‘‘into an anti-regulatory tool, rather than
into a tool to make regulation more rational.’’ He noted, for example, that
the OMB only required BCA for regulatory impositions; it did not require
BCA when regulations were relaxed or repealed, even if deregulation might
lead to net social welfare losses. He also criticized OMB for its own lack of
transparency, including its occasional failure to disclose its contacts with
groups that might be interested in the outcome of regulatory proceedings.15
Professor Revesz’s criticisms of OMB are supported by examples of direct
OMB interference in regulatory decision-making processes. The most famous
example might be the mid-1980s fight between OMB and EPA over the
latter’s BCA for proposed bans on certain uses of asbestos in the workplace
(on which see, for example, Menell & Stewart, 1994, pp. 103–116). In that
conflict, the OMB sought to impose its own estimation of benefits – $1
million per cancer case avoided – and, whereas EPA sought to discount costsand benefits from the time of workplace exposure to asbestos, the OMB
argued that the agency should discount only from the time of disease
manifestation (potentially decades after exposure). Moreover, there was
evidence that OMB pressured EPA ‘‘behind closed doors’’ to accept OMB’s
approach to discounting. Whether one sides with EPA or OMB on these
issues – the House Subcommittee on Energy and Commerce sided squarely
with the EPA (see Menell & Stewart, 1994, pp. 106–113) – the conflict itself
exemplified the absence of clear and agreed-upon ‘‘best practices’’ and the
lack of transparency in regulatory BCA.16
At the end of the 1990s, neither the OMB nor the regulatory agencies
appeared truly committed to a methodologically consistent BCA tool. This
observation should not surprise anyone familiar with the literature on
positive political-economy. Applying that literature to the case of regulatory
BCA, Eric Posner (2001, p. 1141) argues that the very purpose of requiring
regulatory agencies to perform economic analyses is not to increase the
efficiency of regulation but to ‘‘ensure that elected officials maintain power
over agency regulation.’’ On his view, the question is not whether regulatory
BCA is methodologically consistent or biased one way or another; rather the
question is whether it is effective at maintaining political control over
regulatory agencies.17
Toward the end of the Clinton Administration, in September 2000, the
EPA published a long (179 pages) and highly detailed set of Guidelines for
DANIEL H. COLE10
Preparing Economic Analyses. These Guidelines, which were based in part on
an earlier EPA publication on BCA dating from the early 1980s (EPA, 1983)
as well as OMB’s 1996 ‘‘Best Practice’’ guidelines, were peer reviewed by the
Environmental Economics Advisory Committee (EEAC) of EPA’s Science
Advisory Board.18
The EPA’s 2000 Guidelines addressed all aspects of economic analysis of
environmental policy from the setting of goals to the determination of the best
mechanisms for achieving those goals (i.e., environmental instrument choice) to
ex post assessments of implemented policies. The EPA developed a tripartite
framework under E.O. 12,866 for economic analysis of environmental
regulations, including (1) net social welfare assessments utilizing BCA, (2)
assessments of policy winners and losers using economic impact analysis (EIA),
and (3) analysis of policy consequences for disadvantaged sub-populations
using ‘‘equity assessments.’’ Each of these functions depends critically on a
clear and consistent specification of the regulatory ‘‘baseline,’’ which is the
situation at the time a new policy is promulgated and implemented. The 2000
EPA Guidelines called for the agency to make predictions on the expected
effects of a new policy from baseline. Such predications are, of course, highly
dependent on assumptions, the information available to the agency at the time
a new policy is promulgated, and issues of risk and uncertainty. In accordance
with the OMB’s 1996 ‘‘Best Practice’’ standards, EPA’s 2000 Guidelines
emphasized the importance of dealing forthrightly with uncertainty by focusing
on expected values of costs and benefits, clearly disclosing assumptions, and
subjecting those assumptions to sensitivity analyses. Also, following Arrow and
Fischer (1974), the EPA Guidelines noted the significance of ‘‘quasi-option’’
values for potentially ‘‘irreversible decisions.’’
From the perspective of those interested in the evolution of regulatory
BCA, the most interesting chapters of EPA’s 2000 Guidelines are those that
deal with social discounting and the evaluation of environmental (including
public health) benefits. In its 2000 Guidelines, EPA explicitly noted that
‘‘choosing the discount rate has been one of the most contentious and
controversial aspects of EPA’s economic analyses of environmental policies’’
(EPA, 2000, p. 33). At the same time, however, the agency was aware that
‘‘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’’ (EPA, 2000, p. 33).
EPA’s 2000 Guidelines reviewed the ever-growing literature on social
discounting, and like OMB’s 1996 revised guidelines, the agency noted
‘‘widespread support’’ for the consumption rate of interest/shadow price of
capital (CRI/SPC) method of discounting in intergenerational contexts
‘Best Practice’ Standards for Regulatory Benefit–Cost Analysis 11
(EPA, 2000, pp. 40, 43). But unlike the OMB’s 1996 revised guidelines, in
which the OMB maintained its preferred 7 percent discount rate based on
historical returns on private investments, EPA’s 2000 Guidelines actually
sought to establish BCA procedures on CRI/SPC. While noting that this
method can be very expensive to employ (EPA, 2000, p. 48, n. 20),19 EPA
concluded that relatively useful, practical measures exist: ‘‘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’’ (EPA, 2000, p. 47). Thus, EPA concluded
that its economic analyses should use a discount rate of 2–3 percent (EPA,
2000, p. 48). However, because the OMB continued to mandate a 7 percent
discount rate in its 1996 revised guidance, the EPA felt compelled to present
cost and benefit estimates using alternative 2–3 percent and 7 percent
discount rates (EPA, 2000, p. 48). Implicit throughout EPA’s discussion of
the literature on social discounting is a sense that OMB’s preferred 7 percent
discount is inappropriately high. Finally, it is worth noting that although
EPA’s 2000 Guidelines explicitly rejected use of a zero discount rate, the
agency considers it appropriate for BCAs to present streams (but not
summations) of non-discounted costs and benefits over time.
Chapter 7 of EPA’s 2000 Guidelines addressed the equally important and
contentious issue of evaluating non-market effects of environmental policies,
including the value of human lives saved. The Guidelines discussed the wide
array of market and non-market costs and benefits, and various approaches –
all of them more of less defective – to valuing non-market benefits, such as
contingent valuation and hedonic pricing. The EPA reviewed 26 articles,
including both labor market (wage-risk) and contingent valuation studies,
estimating the value of a statistical life. Those articles established a range of
values (in 1997 dollars) from $0.7 million (Kneisner & Leeth, 1991) to $16.3
million (Garen, 1988; EPA, 2000, p. 89, Exhibit 7-3). EPA selected the mean
of the range for its assumed value of a statistical human life: $4.8 million in
1990 dollars. Adjusting for inflation, the value would increase to $6.1 million
in 1999 dollars (EPA, 2000, p. 90). In addition to valuing lives saved, the EPA
also had to estimate other values not entirely encompassed in market prices,
including the morbidity benefits of regulations, i.e., the avoided costs of
non-fatal illnesses, and ecological benefits. The agency did not, however,
adopt any specific values with respect to such effects, as it did in the case of
human-life valuations.
DANIEL H. COLE12
After addressing issues of social welfare calculation and distributional
effects (i.e., equity issues), the EPA concluded its 2000 Guidelines with some
generally applicable rules governing agency BCAs. It stressed that: all aspects
of economic assessments should be presented clearly and transparently;
important data sources and references should be cited, along with their
assumptions and justifications; uncertainties should be highlighted by use of
upper- and lower-bounded ranges of expected values; policy outcomes
should be monetizedto the fullest extent feasible; unquantifiable effects
should be highlighted so that they are not ignored in policy decisions based
(in part) on BCAs; results of all distinct parts of the economic assessment –
BCA, EIA, cost-effectiveness analysis, equity effects, should be clearly
presented (EPA, 2000, pp. 175–178). Finally, the EPA stressed the limits of
economic analyses for regulatory decision-making: ‘‘The primary purpose of
conducting economic analysis is to provide policy makers and others with
detailed information on [a] wide variety of consequences of environmental
policies ... . 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 only
be qualitatively assessed. Thus, even if the criterion of economic efficiency
were the sole guide to policy decisions, social benefits and cost estimates
alone would not be sufficient to define the best policies’’ (EPA, 2000, p. 178).
In concluding that BCA should not be the sole basis for environmental
policy making, the EPA’s 2000 Guidelines were fully consistent with E.O.
12,866 (but not with its predecessor E.O. 12,291).
EPA’s 2000 Guidelines ostensibly constituted a major step in the evolution
and maturation of economic analyses at that agency. No longer, presumably,
would various EPA assessments rely, without explanation, on various
discount rates and human life valuations seemingly chosen at random. The
agency had committed itself, on paper at least, to follow certain standards
consistently, even if those standards were contestable and not fully consistent
with OMB guidelines.
2.3. 2001 to the Present: Competing ‘‘Best Practice’’ Standards and
the Political Manipulation of BCA under Bush II
Since 2000, the evolution of regulatory BCA within the federal government
has been a mixed bag of further methodological refinements and continued,
even increased, politicization. The further refinements are mostly evident in
the OMB’s Circular A-4 (in OMB, 2003). The increased politicization is
‘Best Practice’ Standards for Regulatory Benefit–Cost Analysis 13
apparent in recent cases where BCAs have been blatantly manipulated to
achieve or avoid certain outcomes.
According to OMB, the purpose of its 2003 revised Circular A-4 on
‘‘Regulatory Analysis’’ was to ‘‘refine’’ OMB’s ‘‘best practices’’ guidelines of
1996. Like EPA’s 2000 Guidelines, the OMB’s 2003 Circular A-4 was peer
reviewed by a distinguished group of social scientists.20 Interestingly, the
OMB’s newest guidelines are less than one-third the length of EPA’s
Guidelines, and whereas the EPA’s Guidelines discussed and cited literally
dozens of works in the academic literature on BCA, the OMB’s 2003 Circular
A-4 cites only a handful of articles. In many respects, however, the OMB’s
2003 document and EPA’s 2000 document express similar sentiments about
the importance of consistency, clarity, and transparency in BCA processes.
Somewhat surprisingly, OMB’s 2003 version of Circular A-4 expresses less
faith in BCA as a decision tool than did the EPA’s 2000 Guidelines. For
example, OMB notes that ‘‘you cannot conduct a good regulatory analysis
according to a formula’’ because different regulatory circumstances require
‘‘different emphasis in the analysis’’ and all BCAs require ‘‘competent
professional judgment’’ (OMB, 2003, p. 3). The 2003 OMB Circular A-4 also
states that ‘‘[w]hen important benefits and costs cannot expressed in monetary
units, BCA is less useful, and it can even be misleading, because the
calculation of net benefits in such cases does not provide a full evaluation of
all relevant benefits and costs’’ (OMB, 2003, p. 10). With respect to cost-
effectiveness studies, the OMB denies any effort to impose on regulatory
agencies a certain approach; instead it suggests that agencies – experiment
with ‘‘multiple measures of effectiveness that offer different insights and
perspectives’’ (although those measures should all be clearly articulated and
explained) (OMB, 2003, p. 13). And in accordance with E.O. 12,866, OMB’s
2003 Circular A-4 stresses the importance of distributional effects.
Much of the OMB’s discussion of BCA in 2003 Circular A-4 is
uncontroversial and thoroughly consistent with EPA’s 2000 Guidelines. Few
of the standards OMB articulates actually relate to the more controversial
aspects of BCA, e.g., the selection of a discount rate and the valuation of
non-market goods, including human life. In its revised Circular A-4, OMB
acknowledges that some costs and benefits, including ecological benefits, can
be difficult to quantify. In dealing with such difficult-to-quantify costs, it
calls on agencies to discuss the ‘‘strengths and limitations of the qualitative
information’’ (OMB, 2003, p. 27). It even allows that ‘‘unquantified benefits’’
might, from time to time, ‘‘affect a policy choice.’’ When that happens,
agency BCAs should ‘‘provide a clear explanation for the rationale behind
the choice’’ (OMB, 2003, p. 27).
DANIEL H. COLE14
In a section of the 2003 revised Circular A-4 on the assessment of fatality
risks, the OMB addresses the contentious issue of choosing a method for
assessing the value of statistical human lives. First, the agency discusses the
‘‘value of statistical life’’ (VSL) method, which has been the predominant
approach since the 1980s. Whereas EPA (2000, pp. 89–90) discerned a range
of VSL estimates in the literature from about $1 million to over $16 million,
OMB’s 2003 Circular A-4 indicates a range of $1 million to $10 million
(OMB, 2003, p. 30). Assuming that the mean of the range is generally
acceptable, OMB’s preferred VSL would be very close to the EPA’s selected
mean of $4.8 million (EPA, 2000, pp. 89–90).21 Importantly, the OMB rejects,
at least for the time being, the notion that VSL might be adjusted based on the
age of members of the affected population (OMB, 2003, p. 30). This decision
to reject age-adjusted VSL estimates reflects a concession to public opinion.
OMB previously had been widely criticized for attaching lower values to the
lives of elderly Americans (see, e.g., Los Angeles Times, April 30, 2003, p. 1).
On the other hand, OMB’s 2003 Circular A-4 embraces a second
approach to valuing fatality risks: ‘‘value of statistical life-years extended’’
(VSLY). This approach, in contrast to VSL, does account for discrepancies
in age among the members of affected populations. However, OMB
recommends that agencies adopt larger VSLY estimates for older citizens
because they face larger overall health risks from all causes and they may
have greater accumulated savings to spend on health care (OMB, 2003,
p. 30). Still, by its very nature the VSLY method discriminates against older
citizens because they have fewer life years remaining. Recognizing this
problem, OMB cautions agencies that ‘‘regulations with greater numbers of
life-years extended are not necessarily better than regulations with fewer
numbers of life-years extended’’ (OMB, 2003, p. 30). Ultimately, OMB
recommends that agencies provide estimates of both VSL and VSLY in their
BCAs (OMB, 2003, p. 30).
Between 1996 and 2003 the OMB marginally refined its position on the
social rate of discount. It maintained the same 7 percent discount rate as the
‘‘base-case for regulatory analysis’’ (OMB, 2003, p. 33), but added that
regulatory agencies ‘‘should provide estimates using both 3 percent and 7
percent’’ discount rates (OMB, 2003, p. 24). The 3 percent rate is OMB’s
estimate of the ‘‘social rate of time preference.’’ In its 1996 Circular A-94,
OMB discussed this method of discounting, but did not make any
recommendations based upon it. Apparently, by 2003 OMB had become
convinced that such a recommendation was appropriate. Finally, Circular A-4
recommends using other discount rates ‘‘to show sensitivity to the estimates
of the discount rate assumption’’ (OMB, 2003, p. 24). Thus, OMB’s 2003
‘Best Practice’ Standards for Regulatory Benefit–CostAnalysis 15
Circular A-4 is in complete agreement with EPA’s 2000 Guidelines about the
use of discount rates in regulatory economic analyses, with the caveat that
the EPA’s standards include a 7 percent discount rate only because OMB
requires it. When OMB opened its 2003 Circular A-94 for public comment,
one commentator argued that OMB should simply abandon the 7 percent
discount rate, but the OMB rejected this recommendation on the grounds
that a lower discount rate (such as 3 percent) would ‘‘not be appropriate for
regulations that had a strong displacing effect on capital investment’’ (OMB,
2003, p. 176). Once again, the OMB did not consider the propriety of basing
discount rates for environmental BCA on private investment markets that
themselves do not account for the environmental risks they generate.
OMB’s 2003 revised Circular A-4 also addresses the problem of
‘‘intergenerational discounting,’’ that is, discounting over long time periods.
While recognizing that some scholars oppose discounting the utility of
future generations, the revised Circular offers two positive reasons for
intergenerational discounting: (1) the expectation that future generations
‘‘will be wealthier and thus will value a marginal dollar of benefits and costs
by less than those alive today’’; and (2) the longer the time horizon of the
policy being analyzed, the greater the uncertainty concerning the correct
discount rate (OMB, 2003, p. 36). Based on its reading in the literature on
intergenerational discounting, the OMB recommends that agencies adopt a
third discount rate, below 3 percent but still positive, for assessing
intergenerational costs and benefits (OMB, 2003, p. 36).
Finally, OMB’s Circular A-4 addresses ‘‘other key considerations’’ in
BCA, including the treatment of technological change over time, and the
treatment of uncertainty. First, in recognition that technologies change in
response to market forces as well as regulatory requirements, OMB
recommends that agencies ‘‘should assess the likely technology changes that
would have occurred in the absence of regulatory action (technology
baseline)’’ (OMB, 2003, p. 37). Otherwise, agencies are likely to overstate the
benefits of regulatory requirements.22 With respect to uncertainty, OMB
suggests that agencies respond by conducting additional research prior to
rulemaking, especially in cases of irreversible or large up-front investments,
unless they can show that the cost of delay is likely to exceed the value of any
additional information (OMB, 2003, p. 39). OMB also recognizes the
growing literature on ‘‘real options’’ methods of incorporating uncertainty
into BCA (OMB, 2003, p. 39).23
Between EPA’s 2000 Guidelines and OMB’s 2003 Circular A-4, it appears
that the two agencies are growing closer to agreement on a set of standards
for regulatory BCA.24 Significant differences remain, and the next section of
DANIEL H. COLE16
this paper explains why it remains unlikely that EPA and OMB ever will
reach complete consensus on a set of ‘‘best practices’’ for BCA. In any event,
the improvements to BCA policies since 2000 have not been matched by
improvements in the consistency and adequacy of individual BCAs, which
in some cases at least continue to be highly influenced by partisan politics.
Political manipulation is plainly evident, for example, in the case of EPA’s
2005 BCA for the Bush Administration’s ‘‘Clear Skies’’ initiative, which was
extensively criticized in a recent Congressional Research Service (CRS)
Report to Congress (McCarthy & Parker, 2005).25 The ostensible goal of
Clear Skies was to deal comprehensively with air pollution problems from
the electric utility industry. In 2003, that industry was responsible for 72
percent of all sulfur dioxide emissions, 24 percent of nitrogen oxide
emissions, and 41 percent of carbon dioxide emissions, and more than 40
percent of all mercury emissions in the United States. Power plant emissions
of sulfur dioxide and nitrogen oxides have been trending downwards in
recent years thanks mainly to the acid rain program of the 1990 Clean Air
Act Amendments. However, utilities have long complained about the
‘‘complexity’’ of the ‘‘multilayered and interlocking pathwork of controls’’
applied to them (McCarthy & Parker, 2005, p. 2). As noted in the CRS
Report (McCarthy & Parker, 2005, pp. 2–3), a more simplified and uniform
approach has been evolving for several years within the EPA under existing
statutory mandates. However, the Bush Administration and Congress are
both advocating new legislation that would regulate utility emissions of
major air pollutants in a more comprehensive and integrated way.
The Bush Administration supports a group of bills known collectively as
‘‘Clear Skies,’’ which would require a 70 percent reduction in SO2 and NOX
emissions by 2018, although actual attainment would likely be delayed until
2026 or later because of the legislation’s generous ‘‘banking’’ provisions. Two
alternative legislative proposals, one sponsored by Senator James M. Jeffords
(I-Vt.) and the other by Senator Thomas R. Carper (D-Del.), would also
permit banking and trading of allowances, but would require greater overall
emissions reductions on shorter deadlines. In addition, and unlike Clear
Skies, the Jeffords and Carper bills, would impose regulatory controls to
reduce utility emissions of carbon dioxide in order to mitigate climate change.
On October 27, 2005, EPA published a BCA (comprised of 45 separate
documents26) which purported to compare the various legislative proposals
to control air pollution emissions from power plants. As a baseline for its
BCA, EPA assumed unrealistically that in the absence of new legislation
neither EPA nor the states would impose additional regulatory controls on
power plant emissions. This assumption was flat out contradicted by three
‘Best Practice’ Standards for Regulatory Benefit–Cost Analysis 17
newly minted EPA rules regulating power plant emissions of sulfur dioxide,
nitrogen oxides, and mercury. EPA’s final BCA for Clear Skies did not even
mention those new rules. As the CRS noted in criticizing EPA’s regulatory
baseline assumptions, ‘‘[c]ontrolling air pollution is a moving target and ... it
is important that any analysis work from updated baseline projections and
assumptions when possible’’ (McCarthy & Parker, 2005, p. 5).
One conclusion reached by EPA’s BCA on Clear Skies, and confirmed by
the CRS Report, was that Clear Skies would cost less than the alternative
legislative proposals. According to the CRS, this conclusion was unsurpris-
ing because Clear Skies ‘‘has less stringent requirements and later deadlines’’
(McCarthy & Parker, 2005, p. 5). On the other hand, Clear Skies would yield
fewer overall benefits than the other legislative proposals. According to the
EPA’s own estimates, the Clear Skies bill would provide $6 billion in annual
benefits in 2010, compared to $51 billion in annual benefits for Senator
Carper’s bill and $83 billion in annual benefits under Senator Jefford’s bill.
‘‘The higher benefits for the Carper and Jeffords bills reflect the fact that
Clear Skies’ required pollution caps are less stringent, and the implementa-
tion schedule is more relaxed’’ (McCarthy & Parker, 2005, p. 9).
The incremental benefits of Clear Skies would be even lower, if EPA’s
baseline assumptions were changed to incorporate EPA’s recently promul-
gated rules on sulfur dioxide, nitrogen oxide, and mercury emissions.
According to the CRS Report to Congress (McCarthy & Parker, 2005, p. 9),
incorporating those regulations into baseline would reduce Clear Skies’
incremental benefits (above baseline) to 10 percent in 2010 and only 2
percent in 2020. In sum, the net benefits of Senator Jefford’s bill ‘‘far exceed
those of Clear Skies’’ and Senator Carper’s bill (McCarthy & Parker, 2005,
p. 11). However, the social welfare advantages of Senator Jefford’s proposal
were minimized in EPA’s BCA by the unrealistic assumption of a baseline
that (a) excluded recently promulgatedrules and (b) presumed that, in the
absence of new legislation, no new regulations would be promulgated.
In addition to its unrealistic baseline assumptions, EPA’s BCA for Clear
Skies made no attempt to monetize environmental benefits, which
disadvantaged the Jeffords and Carper proposals significantly because their
more stringent emissions requirements were predicted to lead to greater
environmental benefits than the Bush Administration’s Clear Skies initia-
tive.27 Worse still, the BCA did not model the health effects of regulating
mercury emissions. According to another CRS Report to Congress
(McCarthy, 2005), health benefits from EPA’s mercury regulations could
range from ‘‘a few million dollars per year to several billion dollars per year’’
(McCarthy & Parker, 2005, p. 15). Omitting these benefits from the Clear
DANIEL H. COLE18
Skies BCA favored the Bush Administration’s proposal over alternative
proposals that would impose more stringent caps on mercury emissions.
Similarly, the EPA’s BCA for Clear Skies did not attempt to monetize the
benefits of reductions in carbon dioxide emissions.
Finally, the EPA’s Clear Skies BCA unreasonably assumed that the price
elasticity for electricity and natural gas would be zero and that power plants
were subject to short-term construction constraints. Both of those dubious
assumptions served to make the Bush Administration’s Clear Skies initiative
more attractive and Senator Jefford’s bill in particular less attractive. The
CRS concluded that ‘‘EPA’s benefit analysis is limited and incomplete, which
works to the disadvantage of alternatives to Clear Skies that include more
stringent standards’’ (McCarthy & Parker, 2005, p. 16). A Washington Post
reporter was somewhat more pointed in her conclusion: ‘‘The Bush
Administration skewed its analysis of pending legislation on air pollution
to favor its bill over two competing proposals.’’ The EPA argued in response
that the CRS ‘‘ignores and misinterprets our analysis’’ (Washington Post,
May 11, 2006). Interestingly, OMB has been silent about EPA’s BCA for
Clear Skies,28 which again raises the question of whether OMB review is
designed to maximize regulatory efficiency or simply to minimize regulation.
In other cases, the OMB has reviewed agency BCAs in ways that appear
(at least) to be politicized. Despite regular OMB denials that it is an anti-
regulatory agency, the empirical evidence suggests otherwise. According to a
recent review by the legal scholar David Driesen (2006, pp. 364–380) of 25
environmental, health and safety regulations ‘‘significantly affected’’ by
OMB review between June of 2001 and July of 2002, 24 were significantly
weakened and none was strengthened.29 Now this may just be evidence that
environmental, health and safety agencies always over-regulate and never
under-regulate, but that hardly seems likely.30 More likely, as Driesen (2006)
concludes, OMB review is not nearly as neutral as OMB officials and
supporters claim.31
Another recent study by Laura J. Lowenstein and Richard L. Revesz (Nov.
2004) found that OMB, in reviewing EPA BCAs, regularly substituted its
own cost and benefit valuations based on ‘‘questionable techniques that
inappropriately lower[ed] the value assigned to human lives.’’ The Bush EPA
has embraced the Value of Statistical Life-Years Saved (VSLY) approach,
instead of the traditional Value of Statistical Life Saved (VSL) approach to
valuing human lives. The VSLY approach (as already noted) reduces the
expected benefits of regulation by assigning lower values to the lives of older,
unhealthy, and disabled Americans. Pursuant to its newly adopted VSLY
approach, the EPA derived an age-based adjustment factor that reduced VSL
‘Best Practice’ Standards for Regulatory Benefit–Cost Analysis 19
estimates by 37 percent for individuals aged 70 and over. That age adjustment
factor was based on a single study conducted in the United Kingdom in 1989,
even though more recent and comprehensive American studies were available.
In addition, EPA ‘‘encouraged the use of a substantially-reduced initial VLS
estimate from which life-year values were derived.’’ Obviously, the lower the
initial VSL, discounted according to estimated life-years remaining, the lower
the VSLY-based benefits of regulation will be. Finally, EPA assumed that the
reduction in life expectancy associated with exposure to particulate matter
(dust and soot) is only five years, regardless of the individual’s age at time of
death. Significantly, EPA did not explain any of these ‘‘radical’’ departures
from prior practice. Lowestein and Revesz (Nov. 2004) conclude that ‘‘the
current administration’s approaches to valuing environmental benefits are
theoretically unjustified and have a profound anti-regulatory impact.’’32
Even though EPA and OMB have come closer to agreement about basic
principles for BCA over the past several years, the practice of BCA at both
the EPA and the OMB remains substantially politicized and methodologi-
cally inconsistent. In 2003, law professor William Funk noted that OMB
estimates of the costs and benefits of major rules still sometimes differ from
regulatory agency estimates ‘‘by more than an order of magnitude.’’33 For
example, Funk noted that the U.S. Department of Agriculture’s estimate
of the costs and benefits of a new labeling rule for meat and poultry were
$218–272 million and $1.75 billion. OMB’s estimates of the costs and
benefits of that same rule were $25–32 million and $205 million. Both
agencies amortized costs and benefits over a 20-year period using a constant
7 percent discount rate. What, then, explains the discrepancies? As Professor
Funk notes, if a ‘‘principle function of quantitative cost-benefit analysis is to
improve the transparency of analysis while improving public understanding
of the costs and benefits of regulation,’’ that function is ‘‘thwarted ... when
radically divergent numbers are offered without explanation of the reasons
for the difference.’’ Whatever progress may have made toward achieving
consensus in principles and practices of BCA over the past two decades, it is
clear that a great deal more remains to be done.
The fact that EPA and OMB have continued to manipulate and politicize
BCAs should not make us too pessimistic, however, about the utility of
BCAs for decision making. Even though EPA’s BCA for the Clear Skies
initiative was politically skewed and methodologically flawed, at least it
improved the transparency of EPA’s decision-making process. The value of
this increased transparency should not be underestimated. The BCA for
‘‘Clear Skies’’ provided the ammunition for the Congressional Research
Service’s powerful critique (see McCarthy & Parker, 2005), which helped
DANIEL H. COLE20
doom the initiative in Congress.34 Likewise, the transparency of OMB’s
regulatory review process gave Professors Lowenstein, Revesz, and Funk
the grounds to criticize that agency’s review procedures.
3. WHERE DOES BCA GO FROM HERE? A NEW
EXECUTIVE ORDER OR AN INDEPENDENT,
NON-GOVERNMENTAL TASK FORCE?
In order to correct the continuing problems of regulatory BCA, Robert
Hahn and Cass Sunstein (2002) recommend that President Bush issue a new
executive order to add ‘‘greater depth and width’’ to BCA by instituting
eight specific recommendations: First, the new executive order should
‘‘explicitly requir[e] agency compliance with OMB guidelines for regulatory
analysis.’’ According to Hahn and Sunstein (2002, p. 1494), ‘‘regulatory
compliance with [OMB] guidelines would significantly increase the
rationality and coherence of the regulatory process.’’35
Second, to reduce the actual or perceived anti-regulatory bias of OMB’s
BCA process, Hahn and Sunstein (2002, pp. 1494–1495) would create a
mechanism whereby OMB might issue ‘‘prompt letters’’ to ‘‘spur regulation
in those cases where it will do more good than harm.’’36 Third, agency BCAs
should, to the extent consistent with enabling statutes, consider substitute
risks that might be created by regulations. Atthe same time, agencies should
avoid regulating de minimis risks. Fourth, when an agency promulgates a
regulation that fails a strict BCA (of quantified costs and benefits), it should
provide its rationale for acting. For example, a statute might require the
agency to act regardless of the outcome of a BCA, or the agency may base its
decision on important and thoroughly explained qualitative data that are not
quantifiable. According to Hahn and Sunstein (2002, p. 1496), such
explanations would contribute to improved accountability and transparency.
So too would their fifth recommendation that agencies should make the
underlying assumptions of their BCAs explicit, so that ‘‘interested parties
inside and outside of the government can understand how the results were
obtained, and perform their own analysis of the issue if they so choose’’
(Hahn & Sunstein, 2002, p. 1496). Sixth, each year agencies should generate
backward-looking ‘‘regulatory retrospectives’’ as well as forward-looking
‘‘regulatory plans.’’ The purpose of the annual retrospectives would be to
facilitate OMB’s task of preparing its annual reports to Congress on
executive branch regulations. The purpose of the annual plan would be to
‘Best Practice’ Standards for Regulatory Benefit–Cost Analysis 21
facilitate OMB’s early participation in the BCA. Seventh, Hahn and Sunstein
(2002, p. 1496) recommend that the new executive order extend BCA
requirements to ‘‘independent’’ regulatory agencies. While recognizing that
such agencies never have been subject to executive orders in the past, Hahn
and Sunstein (2002, pp. 1531–1537) argue that such orders might lawfully be
extended to them.37 Eighth and finally, Hahn and Sunstein (2002, p. 1497)
recommend that the new executive order authorize limited judicial review of
agency BCAs. In effect, BCAs would come within the ambit of the
Administrative Procedures Act (APA) (5 U.S.C. y 553), so that a reviewing
court could invalidate a regulation based on a defective BCA as ‘‘arbitrary
and capricious.’’38
Several of Hahn and Sunstein’s (2002) recommendations are appealing
(and are discussed infra). However, their recommendations are unresponsive
to several of the methodological problems identified in the Section 2 of this
paper. One reason for this is that Hahn and Sunstein’s recommendations were
not motivated primarily by the authors’ perception of methodological
problems in BCA. Rather, Hahn and Sunstein (2002) were concerned first and
foremost about a perceived lack of compliance with presumably well-
established BCA principles, resulting in regulations that ‘‘seem to do more
harm than good’’ (Hahn & Sunstein, 2002, p. 1490). The empirical basis
for this finding was an earlier book of Hahn’s et al. (2000, pp. 15–19),
which examined 24 regulations and found that only 9 would pass a BCA (see
Hahn & Sunstein, 2002, pp. 1490–1491). Thus, despite their recommendation
concerning regulatory ‘‘prompt letters,’’ Hahn and Sunstein’s immediate
concern was inefficient over-regulation. In addition, Hahn and Sunstein’s
recommendations (particularly the first and sixth recommendations) suggest
that the problems with BCA in the federal government lie primarily with the
regulatory agencies and less (if at all) with OMB. Importantly, their
recommendations (except that relating to OMB ‘‘prompt letters’’) would not
significantly alter current OMB principles or practices relating to BCA.
Perhaps Hahn and Sunstein believe that OMB already has succeeded in
deriving a set of ‘‘best practices’’ for BCA with which regulatory agencies
simply should be required to comply. If so, I would suggest they are mistaken
for reasons outlined in Section 2.339 To the extent that OMB’s own BCA
principles and practice require revision, Hahn and Sunstein’s (2002)
recommendations are mostly immaterial, and the first recommendation,
which would require regulatory agencies to comply with OMB standards no
matter how unreasonable those standards might be, could well prove harmful.
The history of regulatory BCA in the federal government, recounted in
Section 2, suggests that the situation is rather more complicated than Hahn
DANIEL H. COLE22
and Sunstein’s (2002) simple story of agency under-compliance with
presumably well-founded OMB procedures. In reality, that history has
been a mixed bag of progress and politics on the part of all institutional
players, including the OMB. Were we to predict the future based on the
past, we might expect some additional tinkering with BCA policies at both
OMB and EPA. The two agencies might come somewhat closer to consensus
on methodological principles. But because of their divergent institutional
missions and political predilections it seems highly unlikely that they will
ever agree in principle, let alone in practice, to a single, useful set of ‘‘best
practices’’ for CBA. In some cases – particularly those in which the political
stakes are high – economic analyses likely would be politicized and
manipulated by one institution or another to achieve politically preferred
outcomes.
For that reason, this paper recommends that the task of establishing ‘‘best
practices’’ for environmental BCA should be taken out of the hands of the
government agencies that prepare and review them. Instead, those standards
should be set by a cohort of independent economists, legal scholars, and
policy analysts convened under the auspices of a quasi-governmental
organization, such as the National Academy of Sciences, or a non-
governmental organization, such as the American Economics Association or
a new Society for Benefit–Cost Analysis.40 The goal would not be to
establish a single, ‘‘pure’’ set of ‘‘neutral and objective’’ ‘‘best practices;’’
BCA simply contains too many subjective elements to ever claim the mantle
of objectivity. Nor should we suppose that individual members of any group
assigned to draft a set of ‘‘best practices’’ would come to the task without
their own predispositions and biases. However, if the group is sufficiently
large and representative of differing viewpoints, many of those predisposi-
tions and biases could well wash out. Meanwhile, the group’s independence
from the immediate political concerns of government agencies would allow
it to take the time to more carefully review and discuss the existing literature
on BCA. There is reason to believe that any set of revisable ‘‘best practices’’
established by such a non-governmental group is likely to less politicized
and more legitimate than any set of ‘‘best practices’’ the OMB might seek to
impose on the EPA and other regulatory agencies.
Moreover, it makes sense that the social–scientific community should play
a central role in defining what counts as ‘‘best practices’’ in regulatory BCA,
given that BCA is supposed to be a social–scientific process. Society does
not rely on government agencies to determine ‘‘best practices’’ for medical
or dental procedures, constructing and conducting experimental economic
studies, or performing empirical legal studies. Instead, society relies on more
‘Best Practice’ Standards for Regulatory Benefit–Cost Analysis 23
or less formal cohorts of medical, natural, and social scientists to develop
‘‘best practices.’’ In law, permanent non-governmental organizations such
as the American Law Institute and the National Conference of Commis-
sioners on Uniform State Laws meet annually to review and revise,
respectively, the Restatements of Law and the Uniform Commercial Code.
It hardly seems radical to suggest that independent social scientists
(including many from outside the Washington beltway) should play a lead
role in developing, reviewing, and revising ‘‘best practices’’ for the social–
scientific tool known as BCA.
Fortunately, an independent BCA task force would have a head start on
the process of setting ‘‘best practices’’ thanks to the efforts of economists
and legal scholars who already have identified – independently of pressing
regulatory and political concerns – the proper role of, approaches to, and
limitationsof BCA. The next section discusses some of the existing literature
on which the BCA ‘‘best practices’’ task force might rely; and it rehearses
some recent contributions to that literature relating to the more contentious
(because subjective) elements of BCA, including human life valuations and
social discount rates.
4. HOW AN INDEPENDENT TASK FORCE MIGHT
APPROACH THE PROBLEM OF DERIVING ‘‘BEST
PRACTICES’’ FOR REGULATORY BCA
4.1. First Determine What is Not Controversial in BCA
The logical starting point for any task force seeking to derive a set of ‘‘best
practice’’ standards for regulatory BCA is to separate out those aspects of
BCA on which consensus already exists from the more controversial aspects
that require greater research and discussion. Several basic and generally
agreed-upon principles of BCA were set out in a short article by Arrow et al.
(1996) in the journal Science: First, BCA is a more or less useful tool of
policy analysis, although in cases of great uncertainty a BCA may not be able
to draw firm conclusions about social welfare effects. Second, policy-makers
should be allowed and encouraged to use BCA.41 Third, BCAs should be
required for all major regulatory decisions. Fourth, agency actions should
not be bound by BCAs, even where BCAs indicate substantial net social
costs, because ‘‘factors other than aggregate economic benefits and costs,
such as equity within and across generations, may be important in some
DANIEL H. COLE24
decisions.’’ Fifth, benefits and costs should be quantified to the extent
feasible, and best estimates should be presented along with a description of
uncertainties. Importantly, Arrow et al. (1996, p. 222) note that quantitative
factors should not be allowed to dominate important qualitative factors in
policy-making. Indeed, they support the notion that agencies might build
‘‘margin[s] of safety’’ into their regulations. However, all qualitative
judgments in BCAs should be explicit. Sixth, Arrow et al. (1996) note that
the more external review a BCA receives, the better it is likely to be. Thus,
they support both peer review and OMB review of regulatory BCAs. They
also support retrospective analyses to determine post hoc the quality of BCA
predictions of future costs and benefits. Seventh, regulatory BCAs should be
based on a ‘‘core set of economic assumptions,’’ including about discount
rates, human life valuations, and health improvements, for the sake of
consistency and comparability. To this end, ‘‘[a] single agency should
establish a set of default values for typical benefits and costs and should
develop a standard format for presenting results’’ (Arrow et al., 1996,
p. 222). In other words, a set of ‘‘best’’ or ‘‘standard’’ practices should be
adopted. As part of this recommendation, Arrow et al. (1996, p. 222) note
the importance of discounting future benefits. But, they suggest, the discount
rate should be ‘‘based on how individuals trade off current for future
consumption.’’ This approach would almost certainly favor a lower rate than
the OMB’s current base-case rate of 7 percent. Given the difficulty (even
impossibility) of identifying a single, correct discount rate, Arrow et al.
(1996, p. 222) recommend using a range of discount rates, noting that the
same range should be used consistently in all regulatory BCAs. Eighth and
finally, the authors note that even though overall efficiency is an important
goal, agency economic analyses should pay close attention to the
distributional consequences of their policies. They caution, however, that
environmental (among other public health and safety) regulations ‘‘are
neither effective nor efficient tools for achieving redistributional goals’’
(Arrow et al., 1996, p. 222). Arrow and his colleagues conclude by reiterating
that BCA is not a panacea for policy-making: ‘‘formal benefit-cost analysis
should not be viewed as either necessary or sufficient for designing sensible
public policy.’’ It can, however, ‘‘provide an exceptionally useful framework
for consistently organizing disparate information, and in this way, it can
greatly improve the process and, hence, the outcome of policy analysis’’
(Arrow et al., 1996, p. 222).
Few readers (other than those who deny any useful role for BCA42) would
find any of Arrow et al.’s assertions to be controversial. OMB might disagree
with the recommendation that discount rates should be based solely on
‘Best Practice’ Standards for Regulatory Benefit–Cost Analysis 25
individual’s decisions about trading off between present and future
consumption, without any consideration for the displacement effects on
private investment. Otherwise, there seems very little about which either the
OMB, the EPA, or any other producer or consumer of BCAs would
complain.43 Arrow et al. (1996) articulated generally acceptable principles or
standards for producing quality economic analyses. They are not, however,
sufficient. The chief problem is that the standards enunciated by Arrow et al.
(1996) are very general while, as always, the devil is in the details. We might
all agree that regulatory BCAs should always employ a range of discount
rates for converting future costs and benefits into present prices, but just
what should those rates be? We would probably all agree that agencies
should establish a ‘‘core set of assumptions’’ for valuing for non-market
goods, such as human lives and ecological goods, and apply them
consistently from one BCA to the next, but just what should those core
assumptions be? Arrow et al. (1996) provide a useful starting point for
independent efforts to derive ‘‘best practices’’ for regulatory BCA, but most
of the heavy lifting remains to be done.
4.2. The Hard Part: Achieving Consensus on the Devilish Details
In a way, Arrow et al. (1996) created a misleading impression that BCA is
less complicated and controversial than it really is. Even the aspects of
economic analysis that appear to be purely mechanical, such as identifying
the policy alternatives and listing their impacts, are not as straightforward as
they might appear.44 Sometimes, there seem to be an almost unlimited
number of policy options for dealing with a particular social or
environmental problem. Consequently, policy analysts are forced to draw
more or less arbitrary lines between those alternatives that are addressed in a
regulatory BCA and those that are not. Likewise, analysts must draw lines
in deciding which effects of different regulatory alternatives (including the
‘‘do nothing’’ alternative) are considered (or not considered) in a BCA. For
example, a decision to locate a new road entails various direct and indirect,
primary, secondary, and even tertiary effects. Among the primary effects are
the direct costs for labor and machinery, and lost opportunities for using the
land to be covered by the road for alternative purposes. Once built, the road
will have various secondary impacts, as its very existence spurs development
of adjacent lands, particularly at major intersections. Presumably, those
indirect and secondary impacts should be considered as part of the BCA for
the road project. But what about tertiary effects, for example, if the
DANIEL H. COLE26
increased development resulting from road construction displaces economic
development from some other region of the state? It probably would not
be good enough simply to specify, for example, that policy-makers
should consider all ‘‘foreseeable and significant’’ impacts, because what is
‘‘foreseeable and significant’’ often is in the eye of the beholder. Meanwhile,
decisions about which alternative policies, and which impacts of those
policies, to consider in a BCA are always likely to be a mere subset of
all the conceivable alternatives and impacts. More or less arbitrary lines
must be drawn, and just where those lines are drawn can affect the outcome
of a BCA.
Such problems pale in comparison, however, with the inherently more
controversial aspects of economic analyses: valuing human lives (and other
non-market goods)