CRS Report: 95-760 - Cost-Benefit Analysis: Issues in its Use in Regulation

Regulatory reform legislation before the 104th Congress would require Federal agencies to evaluate more rigorously the regulations that they issue. Reform measures include requirements that cost-benefit analysis be used as an aid in setting regulatory priorities and improving economic efficiency. The various reform bills set cost-impact thresholds for triggering cost-benefit studies ranging from $25 to $100 million in annual regulatory costs to the economy.

This report sketches issues underlying broader use of cost-benefit analysis. It focuses on cost-benefit as one of several related frameworks for assessing regulatory actions or policies. Cost-benefit is the broadest of these frameworks, which also include impact assessment, risk assessment, and cost-effectiveness. Which analytical framework is appropriate depends on the regulatory context. (Assuring equity, administrative practicality, ease of public understanding, or certainty in implementation may be as important as achieving economic efficiency.) Though cost-benefit analysis is not a substitute for political decision-making, it can often be an important input into that process.

Formal cost-benefit analysis compares the monetary benefits and costs of government actions aimed at improving public well-being. Such public sector actions range from infrastructure improvements and education on the one hand to protection of environmental quality, human health, and safety, on the other.

Cost-benefit analysis can be expensive and difficult to explain because indirect methods are usually employed to approximate monetary values of public actions. Indirect estimating methods are necessary because many public services and benefits have no private sector equivalents; consequently, no market prices exist for directly estimating benefits. Analysts approximate monetized benefits using various estimating and survey techniques. Human health data, statistical and engineering models, and laboratory experiments play various roles. Resulting monetary estimates vary widely and are subject to professional disagreement on methods. Measurement problems can also lead to some important cost-benefit categories being ignored, and results can be subject to wide interpretation in partisan debates. It is reasonable to expect that these factors would result in some reduction and modifications as well as administrative and judicial delay of regulatory initiatives, for good or ill.

Issues of technique and practical concern suggest some implementation needs, if this tool is to be used more systematically. These needs are driven both by the threshold level chosen for assessing regulatory impacts and by how the technique might be used in selecting regulatory strategies. Needs may include:

Cost-benefit analysis is a technique for comparatively assessing the (monetized) costs and benefits of an activity or project over a relevant time period. The technique has its origins in economic feasibility studies of public infrastructure projects such as dams and levees. Its use has grown concurrently with the increase since the 1970s in laws and regulations to protect health, safety, and environmental values.

To use cost-benefit analysis in evaluating the merits of public actions requires translation of positive and negative effects to a common measure, normally dollars. The methods and assumptions needed to measure positive and negative effects and to translate such effects to dollars can make cost-benefit analysis a complex and controversial undertaking.

Legislation under consideration in the 104th Congress would expand the use of cost-benefit analysis in the regulatory process. Various proposals would require systematic assessment and balancing of costs and benefits for major regulations affecting human health, safety, or the environment.(l) Thresholds triggering a required comparison of costs and benefits vary between bills; the lowest trigger proposed is $25 million in estimated annual regulatory cost impacts.

In part, because of a possibly lower threshold and the proposed number of factors agencies would need to consider in doing cost-benefit and risk assessment, the reform legislation has generated considerable debate and controversy. It would be expected to significantly change how government agencies develop and implement certain types of regulations. Debate over the merits of various proposals revolves around the practicality and usefulness of mandating its use. The conflicts involve more questions of "how much" and "to what end" than "whether", since these techniques are already used by Federal agencies to differing degrees in assessing many of their regulatory activities.

The debate over cost-benefit analysis is focused on its possible value in reducing the perceived economic burden and complexity of traditional regulatory approaches. For example, with improvements in some conventional air and water quality variables largely achieved, many of the remaining or growing pollution problems involve less obvious threats from diffuse and often technically complex sources. In these circumstances, traditional command and control regulatory approaches for improving environmental well-being can impose large direct and indirect costs for less easily demonstrated benefits.(2) Greater use of cost-benefit analysis thus is part of the broader regulatory reform effort calling for increased flexibility in regulatory approaches and increased accountability and scrutiny of regulatory decisions.(3)

1) Some believe that the only regulations that should be maintained or adopted are those that clearly pass the cost-benefit test -- namely, benefits must demonstrably exceed the costs.

Proponents of this position argue that promulgating only those regulations where benefits outweigh or justify costs (presumably in monetary terms) can help rationalize the regulatory process and improve priority setting. In this view, such reform would increase the likelihood that regulations will not place burdens on businesses and consumers that are out of proportion to gains in health, safety, or environmental protection. Such a change could lead to more systematic consideration of more efficient ways to achieve desirable health, safety, and environmental protection goals. Excessive regulations would be minimized, eliminating rules and enforcement where goals are ill defined and measurement of costs or benefits is uncertain.

2) Others argue that cost-benefit analysis can be an important and useful exercise in assessing the impacts of regulatory actions, but the resources demanded for full and rigorous cost-benefit analysis can be excessively costly and time consuming with the result that cost-benefit analysis can impede legitimate protection.

Proponents of this position fear that efforts to use cost-benefit comparisons for establishing regulatory priorities will end up emphasizing only those aspects of health, safety, and environmental protection which can be easily translated to dollar terms. Such an outcome would weigh heavily against intangible or nonmonetary aspects of health, safety, and environmental protection, which is often what these types of regulations are intended to protect or enhance in the first place. In this view, the effort to make such comparisons will significantly impede the legitimate government role of protecting and enhancing public well-being. As a practical matter, an expanded effort to employ cost-benefit analysis could tie up significant agency resources in efforts involving scientific uncertainty, inadequate data, and inherent value trade-offs lying outside the authority of agency decision making.

3) Finally, many argue that cost-benefit analysis is an incomplete tool for regulatory impact analysis, particularly with respect to non quantitative values, and related methods of analysis such as risk assessment and cost-effectiveness are more appropriate.

Proponents of this view argue that no one opposes the use of cost-benefit in a quantitative or qualitative sense in assessing regulatory impacts in instances where it is feasible. However, there is a wide range of opinion regarding how rigorously the method should be used, given that costs and benefits in many instances are so difficult or perhaps impossible to measure, even in an approximate way. Cost-benefit analysis, despite its widespread application, is still a primitive art. Much of the policy dispute is really about the rigorous use of cost-benefit analysis versus the use of other related methods of regulatory impact assessment; namely, 1) the less rigorous use of cost-benefit (based on a combination of qualitative and quantitative assessment); risk analysis; and cost-effectiveness (these terms are described below).

Formal cost-benefit analysis often demands costly and sometimes disputed expertise and data. Done carefully,- it provides an array of information that can inform the decision process. Done poorly or taken out of context, the results can create a false sense of clarity and precision. Methods, data, expense, and prospects for court challenges on use and abuse are the concerns that are driving debate on how greater use of this tool may figure in regulatory reform.

In providing an overview of the issues underlying an expanded role for cost-benefit analysis, this report addresses three areas:

In a complex society and economy, governments provide important public services and establish the rules needed for protecting public health, safety, fair markets, and the general welfare. Cost-benefit analysis and related regulatory assessment techniques are often part of the process by which governments judge the merits of proposed actions. The regulatory reform debate has focused attention on these techniques and initially prompts two basic questions.

Cost-benefit analysis is one way to organize, evaluate, and present information about the actions that governments take to improve public well-being. Because this analytical tool often involves placing monetary values on attributes of human well-being for which no market prices exist, its use is often complicated, expensive, and controversial.(4)

Cost-benefit analysis is a set of procedures to measure the merit of some public sector actions in dollar terms. It is used as a counterpart to private-sector profitability accounting. The difference is that most public actions to improve public well-being do not have well established private markets which generate price information on which to judge their value or benefits. To compare the public benefit of such actions to their costs, benefits (and sometimes costs) are indirectly estimated in dollar terms. The objective is to determine the alternative for public action that produces the largest net gain to the society. In this case, gain is not in terms of private sector profit, but rather as an estimated surplus of monetized benefits over estimated costs. Based on this criterion, cost-benefit analysis attempts to identify the most economically efficient way of meeting a public objective. Other goals of public management are not focused on in this process, but in some cases may be subsumed in the analysis.

Federal agencies have used cost-benefit analysis extensively since the 1930s. The government initially used the technique to evaluate the economic feasibility of water resource projects, applying it later to other public infrastructure projects and more recently to social regulation.

Cost-benefit can be applied to public actions using varying degrees of formality (how far analysts go in trying to compare monetized benefits with costs). At one level, cost-benefit analysis can be used:

The objective in this use of the tool is to provide decision guidance on which actions improve economic efficiency, i.e. which action produces the greatest net economic gain regardless of who within the economy actually gains and loses as a result.

This can include both monetary and nonmonetary costs and benefits, impacts on different economic interests, and positive and negative physical effects on the environment, human health, safety, etc. This broad impact analysis is currently done by government agencies for major regulations and some proposals would codify this process for all regulations above certain minimum thresholds.

With the increase in scope and complexity of social regulation since the early 1970s, agencies under various executive orders have extended cost-benefit analysis to health, safety, and environmental regulations.(5) Extending the technique beyond traditional infrastructure projects, however, has added to conceptual as well as practical concerns about how this tool is used, particularly when attempts are made to make strict comparisons of monetized benefits and costs.

The underlying intent of cost-benefit analysis is to indicate whether a public action to improve public well-being adds more in economic gain than it takes from private economic activity by diverting private resources or increasing the cost of doing business -- known as compliance costs. Cost-benefit analysis applies differently to three different economic circumstances:

The role of cost-benefit analysis has grown along with the nation's effort to deal with market failures affecting health, safety, and environmental conditions over the last 25 years. For most of our Nation's development, private markets did not have to be much concerned about how their production or consumption activities affected health, safety, or environmental conditions. The cost of such effects was ignored or was paid by affected individuals or society at large. Regulation that did occur was at the local or state level.

With growth in population and economic output, and increasingly complex technology, the magnitude of adverse side effects began becoming recognized as costly intrusions or objectionable to groups that could not generate remedy within the capacity of local and state governments. Increasingly since the late 1960s, the Federal government has taken the lead in dealing with those situations where production or consumption causes significant adverse effects. Through tighter regulation as well as greater concern for the public, private markets have had to include (internalize) more of the costs of protecting health, safety, and environmental values. As the regulatory process has grown and become more complex, there is evolving concern that the extent and manner of some Federal regulations places an undue cost burden on private persons and markets and other levels of government. Consequently, there is a growing interest in assessing the cost versus the benefits of such regulation.

Whether dealing with a public sector project or a proposed health or environmental policy, cost-benefit analysis is an attempt to estimate whether these activities will achieve an improvement in the allocation of resources; i.e., is the nation better off in economic terms as a result of a proposed change? This efficiency criterion can apply either to:

In concept, cost-benefit analysis can play a role at all stages of public policy decision making including regulatory impact assessment. Its role is to help focus government efforts on the most efficient options for achieving public objectives. This could occur:

The distinction between achieving economic efficiency and meeting other legitimate goals of public management illustrates why formal cost-benefit analysis (comparison of monetized benefits to costs) may not always be a complete or appropriate framework for designing and assessing regulatory strategies and specific rules.(6) Decisions about a particular public action dealing with health, safety, or the environment depend on what is known about a publicly perceived concern; the likely consequences of not acting; what can be done; and the consequences or costs of taking alternative remedial actions. Public actions to protect public well-being often are taken on the pragmatic basis of matching public needs and expectations on the one hand with technical, legal, and resource capability to implement and manage, on the other. Decision making involves balancing conflicting objectives of public management. These objectives can at various times and circumstances involve considerations of equity (fairness in how different groups are treated), practicality of administration, understandability by the public, predictability in implementation, and cost effectiveness or economic efficiency.

Often decisions involving complex health, safety, or environmental problems must be made in the context of considerable uncertainty about the consequences of either acting or not acting. Resources devoted to scientific and economic understanding can only go so far in providing insights, leaving decision makers with incomplete knowledge. Choices sometimes involve: 1) taking an action now which turns out to be too costly as more knowledge is gained or; 2) deferring action now to learn later that negative effects are greater than originally thought. In these circumstances, comparison of pros and cons (or positive and negative consequences) to arrive at policies for reducing a problem is a common sense form of cost-benefit analysis. Because of large uncertainties and value tradeoffs involved in such circumstances, however, characterizing many of the effects in monetary terms is impractical or impossible. Thus other frameworks related to cost-benefit analysis are often used in developing and evaluating regulatory strategies and actions. These other frameworks reduce the information and analysis burden when non-efficiency objectives weigh more heavily in decision making. These frameworks differ in the scope of what is included based on considerations of uncertainty of consequences, equity of protection, and practicality in implementation within our system of governmental authorities and capabilities. Emphasis on economic efficiency becomes increasingly the focus in descending order of these frameworks as follows:

To illustrate how these frameworks may apply in developing and evaluating regulatory strategies, the example of urban air quality standards provides a good case-in-point. For reasons of fairness, Congress has required that urban air quality standards be set at a level that has an adequate margin of safety (based on the best available scientific data) to protect vulnerable elements of the population, such as those with respiratory diseases. Governments implement such standards through directives to owners of pollution sources concerning types and levels of control mechanisms as well as operational changes to meet local air quality standards. Such standards reduce the potential for premature death related to air pollution episodes and may have other positive effects. This is a "health-based" approach which attempts to achieve equity (that is, to reduce harm to all individuals regardless of their sensitivity to the pollutant). All citizens are assured certain minimum health-based environmental protection as a matter of "right", but at a higher cost than if standards were set to meet the needs of the majority of the exposed population.

To extend the above example, a technology based approach could have been proposed for protecting vulnerable individuals while allowing less costly overall air quality standards. On a purely hypothetical basis, sensitive individuals could be subsidized in the purchase of respiratory aids such as masks, medications, or breathing apparatus, thus assuring equitable protection at the expense of administrative simplicity and personal convenience.

An alternative way to view the problem is to try to establish an air quality standard that strikes a balance between the costs of implementation and the health risks that are avoided, in this case numbers of premature deaths. A cost-risk approach would accept some probable number of premature deaths due to air pollution in order to set an air quality standard with lower costs of compliance.

Still another way to approach the issue could be in terms of a standard that protects vulnerable people, as in the health-based approach, but uses a cost-effectiveness regulatory strategy for implementation. Here, the issue is not the standard, but how it is achieved. Typically, those responsible for implementation would be given wide latitude for achieving specified results. Ideally, each emissions source would find the lowest cost alternative for each amount of reduced air pollution. This flexibility could be achieved through flexible regulatory policies such as pollution trading mechanisms, process and locational changes, and changing production inputs, among others. This approach could achieve equity if standards protect vulnerable populations and promote economic efficiency. However, the probability of achieving the objective may be less.

Finally, the problem could have been approached by trying to determine the air quality standard and methods of implementation which produced the largest surplus of benefits over costs. This cost-benefit approach would attempt to estimate the monetized gain for various levels of reduction of the air pollutant compared to the costs for each level- of reduction. The level where incremental economic benefits approximated the incremental costs would help set the standard to be achieved. The benefits measured by this approach to a regulatory strategy would include not only reduced risk of premature death but reduced days of illness; possibly increased visibility benefiting aesthetic and recreational values; reduced material damage from reduced corrosion; and reduced damage to aquatic and terrestrial ecosystems resulting from reduced acidic effects.

Translating estimates of these physical improvements due to improved air quality into monetary values involves various significant estimates. These may include estimates of lost wages due to illness or death, willingness to pay to reduce frequency of respiratory illness, estimates of reduced medical expenditures, estimates of reduced annual corrosion damage to structures, reduced yields or damages to plants, and other approximations of consumer willingness to pay to gain environmental improvements. Against a range of these monetized benefits, costs of reduced air pollution are compared to estimate an "optimal" level of pollution reduction or one which produces the largest net economic gain.

Because cost-benefit analysis attempts to identify the most economically efficient option, the type of information needed for comprehensive analysis tends to become more complex at the implementation end of regulatory decision making.(7) This is usually because highly specific actions or detailed regulations have numerous options and ramifications; have many other detailed alternatives; require numerous assumptions about other conditions affecting the outcome of the analysis; are typically concentrated on specific interests inviting intensive conflict over assumptions, methods, and data; and can involve important considerations beyond concerns about general economic efficiency.

As a result, the tool often is applied less formally as a guide for impact assessment. This less restrictive application of cost-benefit involves an assessment of what can be measured in monetary terms and an identification and measurement of other changes to the extent practical. The objective is to provide a comprehensive evaluation of positive and negative economic and other changes in quantitative and qualitative terms.

While the rationale for comparing costs and benefits of public actions is straightforward, valuing costs and benefits in dollar terms and translating future costs and benefits into present-year dollars is not. In particular, evaluating alternative public actions where costs and benefits affect different groups of people at differing points in time raises important ethical (and political) as well as methodological concerns. These issues are discussed below.

Combining complex methods -for assessing regulatory impacts, the techniques used in cost-benefit analysis are often the source of controversy and confusion. Credibility challenges may result because of inadequate data, the simplified assumptions necessary for analysis, and value judgments about the distribution of costs and benefits inherent in the method. These technical challenges are discussed as follows:

Costs in cost-benefit studies are typically easier to estimate than benefits. The direct effects of regulatory compliance usually involve actions that are measurable in conventional monetary terms and that are relatively easy to identify. In dealing with costs, the analyst is trying to place monetary estimates on what is foregone or the resource cost to the economy as a result of a regulatory or other public action aimed at maintaining or improving some aspect of public well being. There are a number of circumstances, where cost estimation presents problems. These can include:

Some costs of public actions may be lost opportunities for other uses of an entire resource that may largely involve intangible values. Monetary estimates may not adequately reflect how the public values such loss. For example, damming of a geologically and aesthetically unique canyon could produce benefits measurable in monetary terms including water supply, recreation, and hydroelectricity. The costs of building and operating the facility and acquiring land are also directly measured in dollars. The two magnitudes can be compared to determine if monetary benefits exceed monetary cost. However, the public value of enjoying and preserving a unique geographic feature is not so readily included in the cost estimate. Valuation of lost recreational or scientific values may be attempted, but monetization of the uniqueness is difficult. Economic analysis in this type of situation can indicate what is lost in conventional economic output if the project is foregone. Such information could be viewed as the minimum value that society puts on preserving a unique resource and would be a valuable reference point for debating the merits of preservation.

Benefits are sometimes measurable in conventional economic terms such as the net revenue of agricultural output resulting from a large scale irrigation project. Problems occur when benefits are collective or public in nature and there is no market value that can be directly used to compare with monetary costs.

Examples of benefits that are collective in nature range from the traditional, such as parks, to human health and safety. These types of values do not trade as such in any market, but society implicitly chooses a level and method for assuring such benefits and makes resource commitments to those ends.

Estimating benefits that are collective in nature requires some form of translation to monetary terms in order to attempt a formal cost-benefit analysis. The possible methods for doing such monetary approximations are the subject of years of academic and agency endeavors, with no agreed upon standards even within similar areas. Scientific uncertainties, lack of comprehensive data, and limits on resources for thorough analysis compound methodological problems.(8)

As with costs, challenges in estimating benefits tend to fall into a few important categories. These include:

In response to estimation problems, analysts attempt to simulate the hypothetical monetary value that representative recipients place on changes in the level of benefits. Sometimes analysts try to measure the value of reduced mortality or illness by estimating how much reducing a risk would avoid in lost wages or medical expenditures. Other times, analysts try to find surrogates for market-determined valuations by surveying individuals for their hypothetical willingness to pay to reduce risks, preserve habitat, avoid illness or premature death, among others.

These methods encounter various criticisms. For example, using lost wages or income to value mortality or illness reductions cannot incorporate other human values affected by health, safety, or environmental risks. Pain and suffering, loss of affection, and family stability are examples. In some circumstances, this method could show very few benefits for avoiding premature death if wages are low relative to future social security retirement and long term care costs that would be avoided by premature death . Similarly, willingness-to-pay estimates beg significant questions of validity. One concern with willingness-to-pay, particularly for complex environmental and health areas, is the capacity of individuals to evaluate small hypothetical improvements in subtle. or long term health, safety, or environmental characteristics on the one hand and to indicate hypothetical increases in personal expenditures within their personal resources to achieve such improvements, on the other.(9) Other issues include ethical considerations concerning whose willingness to pay is used in estimating benefits. For example, the willingness to pay to reduce the risk of a health hazard would likely be smaller for a low-income population than for an upper income one, even though the health impacts could be similar. The same argument could be made if lost wages and medical expenditures were used to estimate benefits of reducing the risk of a given hazard. Given these types of limitations, analysts often produce wide ranges of possible monetized benefits. This use of monetization can be helpful, at a minimum, in comparing policy or regulatory options.

The exercise of trying to monetize complex benefits may not always yield dependable quantitative or monetary estimates, but can be useful in increasing understanding of how complex regulatory actions affect different aspects of public well-being. For example, the table on the following page shows the range of possible benefit categories that the EPA identified in examining changes to an existing air quality standard for sulfur dioxide. This assessment illustrates the range of what must be considered and the limitations in developing monetary estimates. Of the 48 categories of possible benefits (16 types of impacts for 3 pollutants), EPA had data to do a partial assessment for 8 categories. An additional 36 categories were believed to have possible benefits, but no assessment was possible, and 4 were believed not to have benefits from additional control.(l0) This example underscores one of the major challenges in doing cost-benefit analyses, namely the scope of what is included. Things that are easy to monetize or are more immediate in impact are often only a portion of the full range of potential effects. For example, as part of the assessment of sulfate (S04) mortality risk reduction, EPA provided illustrative estimates of potential benefits. EPA argued that scientific uncertainty implied a potential benefit of tighter standards of zero ranging up to $385 billion.(11)

In comparing benefits and costs that occur at different points in time, it is necessary to translate future dollar values into present values so that the comparison is done from a common point of reference. This is done to account for the time value of money, since benefits received or costs incurred in the future are worth less to people than those in the present. Translation to present values is accomplished by discounting costs and benefits with an appropriate interest rate. For example, a dollar to be received a year from now discounted at a 5 percent rate has a present value of $0.95 today, since one could invest the $0.95 at 5 percent and have a dollar a year from now. Similarly, at a 10 percent discount rate, a dollar received a year from now would have a present value of $0.91.

Alternative SO2 National Ambient
Air Quality Standards Potential Benefit Categories

	Direct SO₂	SO₄	Other Particulate Matter
Health Effects • Mortality Due to Chronic Exposure • Mortality Due to Acute Exposure • Morbidity Due to Chronic Exposure • Morbidity Due to Acute Exposure	NP E NP E	NP NP NP NP	NP NP E E
Soiling and Materials Damage • Residential Facilities • Commercial and Industrial facilities • Government and Institutional Facilities	E NP NP	NP NP NP	E NP NP
Climate and Visibility Effects • Local Visibility • Non-Local Visibility • Climate • Visibility at Parks • Transportation Safety	NU NU NP NU NU	E NP NP NP NP	NP NP NP NP NP
Non-Human Biological Effects • Agriculture • Forestry • Fishing • Ecosystem	E NP NP NP	NP NP NP NP	NP NP NP NP

E - Estimated but coverage limited
NP - Not estimated; benefits possible
NU - Not estimated; benefits unlikely

Source: U.S. Environmental Protection Agency, 1987. Draft Regulatory Impact Analysis on the National Ambient Air Quality Standard for Sulfur Dioxide p VI-4

The level of interest rate chosen for discounting can have a pronounced effect on the comparison of costs and benefits that are widely dispersed in time. Using a lower interest rate might represent society's concern for the distant future (because long term benefits are reduced less with a lower discount rate compared to current costs). Using a higher rate tends to reflect society's concern for immediate productivity lost by taking resources from high return private production to pay for future benefits (the higher discount rate reduces the present value of distant benefits compared to more immediate costs).(l2)

Discounting of distant benefits may also lead to politically unacceptable conclusions when economic efficiency is proposed as the decision criterion. For example, a standard that protects adults from an increased risk of premature death might not be adequate to protect children. Monetizing future losses in wages and added medical expenditures due to premature death for both adults and children might show a larger future benefit for protecting children (due to more years of lost wages) but discounting the more distant benefit for children could show a lower present value of benefits than the present value for protecting current adults. If the additional costs of strengthening the standard to protect children exceeded the present value of their benefits, on economic grounds, the additional protection would not be recommended. This also presumes that lost wages and medical expenditures are an acceptable surrogate for benefits of reducing the risk of premature death. This is not to say that discounting future costs and benefits in order to compare them at a common point in time is not necessary for proper use of cost-benefit analysis, but it does illustrate equity concerns that decision makers must take into account.

What are the Limits in Using Formal Cost-Benefit Analysis in Regulatory Decision-Making?

The issue of developing or preserving a geologically unique canyon discussed above (p. 11) helps illustrate the limits on formal cost-benefit analysis as an input in public decision making. Cost-benefit analysis might show a net benefit because it failed to value the loss of a unique resource adequately. A decision to develop or to preserve a geographically unique area is a value trade-off. The decision processes within a legitimate political system must choose between two incompatible public uses where there is no meaningful method of monetary valuation between the alternatives.

What is at stake in the example is a redistribution of opportunity as a result of a political decision, essentially a social decision changing the underlying distribution of opportunities. Cost-benefit analysis, however, seeks to improve the allocation of resources within the existing distribution of opportunities, wealth, or income. The method does provide dollar-valued information to the decision but it does not provide a basis for analysts to judge one outcome as superior to the other. This is a political decision of representative government, which must wrestle with a broader range of criteria including equity, implementability, etc. On the other hand, an impact analysis can provide an array of information on positive and negative effects, many in monetary terms, on both sides of the development-preservation trade-off.

This distinction of choosing between competing social values in public sector decisions and making allocational changes within existing social values is important in many environmental, health, and safety questions. As noted in a recent review of issues surrounding the economic efficiency criterion and the role of cost-benefit analysis " .. new, and less permissive legislation and court decisions regarding toxic chemicals is an example of reallocating economic opportunity between those who manufacture and use chemical compounds and those who bear the real and psychic costs of their use.''(l3) Congress and the courts, however, could just as easily reverse this trend in the future.

The economic efficiency criterion underlying cost-benefit analysis does not provide complete guidance on the value choice for this type of issue because the issue really is a redistribution of "rights" which determines a new distribution of income within the political system. The redistribution then defines a new set of conditions for efficiency in the economy.

Thus, formal cost-benefit analysis cannot offer definitive judgments in setting the objectives of public action to protect health, safety, or environmental values. Such economic analysis, however, serves two other useful purposes. First, it offers a systematic way to judge the cost-effectiveness of many health and environmental policies or regulations intended to achieve publicly determined objectives. Whether the objectives are worth their costs is beyond the scope of the economic efficiency criterion, but analyzing the most efficient way to achieve a policy objective is not. Second, for some public actions involving nonmonetary or intangible values, economic analysis can indicate what must be foregone in conventional economic values in taking that action. This is not an indication of the monetary value of potential benefits but rather an indicator of the minimum value that society would have to place on protecting such intangible values.

If regulatory reform results in more extensive and intensive use of cost-benefit analysis by agencies, an adjustment period similar to early experience with environmental impact statements could be anticipated. Over a ten to fifteen year period, methods and procedures improved and the judicial system developed ways to handle challenges without excessive delays. Agency experience with cost-benefit analysis to date may indicate some of the early challenges facing greater use of this tool in regulatory decision making. Questions addressed here include:

Cost-benefit analysis has been a central feature of past efforts to reform and change the Federal regulatory process. As discussed in an earlier CRS report, cost-benefit requirements in Executive Order 12044 by the Carter Administration and more so in Executive Order 12291 (which replaced 12044) under the Reagan Administration were major initiatives to improve rule making and reduce adverse economic impacts.(l4)

Executive Order 12291 required that all Federal agencies submit to the Office of Management and Budget regulatory impact analyses for all major regulations, to the extent allowed by law. Major regulations were defined as those having an impact on the economy of over $100 million annually, or that had other major cost or price impacts. The regulatory impact analyses were to show that estimated benefits from a proposed regulation would outweigh the costs and that the surplus of benefits over costs exceeded alternative approaches to the goal.

In 1993, the Clinton Administration issued Executive Order 12866 which replaced Reagan's Executive Order 12291. While the two have many similarities including the same $100 million impact threshold, the Clinton order put a different emphasis on the use of cost-benefit analysis. As discussed in a recent CRS, report on risk analysis, the orders put different emphases on how regulatory objectives are chosen.(l5) Executive Order 12291 directed agencies to develop regulations that were economically efficient or that achieved the largest surplus of benefits over costs, subject to requirements of existing law. The Clinton directives call for agencies to set regulatory objectives based on public need. Within the objective of public well-being, however, the cost of specific regulations must be justified by the expected benefits.

The current role of cost-benefit analysis could change significantly under regulatory reform. Changes would depend on which features of various bills are ultimately adopted(16) and on how the current or a future administration implemented required changes. Two key provisions that would affect agency practices and allocation of effort are:

The interaction of a lower threshold for doing cost-benefit analyses and a more explicit use of cost-benefit analysis to set priorities could require a large commitment of agency resources. For example, under the Reagan Administration's Executive Order, EPA prepared several cost-benefit analyses for final major rules. To the extent that current regulatory reform efforts result in reimposition of this earlier cost-benefit requirement, EPA cost experience would be suggestive of future resource needs. For example, from 1981 to 1986, EPA's cost of preparing a cost-benefit analysis for a major rule averaged $675,000.(17) These costs varied from $210,000 to $2,380,000 for individual cost-benefit analyses. Of the 1,686 final rules issued by EPA between 1981 and 1992, 60 were major final rules of which 80 percent, or an average of 4 per year, received formal cost-benefit analysis.(l8)

The EPA experience could be indicative of resource needs for government wide cost-benefit studies of health, safety, and environmental regulations. Total costs would depend on the interaction of several factors:

Available information is insufficient to assess the interaction of these factors under alternate regulatory reform scenarios, but some partial estimates can be made from available data. For example, EPA's average cost per regulation of doing formal cost-benefit analysis under Executive Order 12291 in today's dollars would be roughly $1,000,000.(19) These costs were for rules having an estimated impact on the economy of $100 million or more or having a price or cost impact on a specific sector, in some instances less than $20 million. The number of future major rules that would be subject to formal cost-benefit analysis is not known, but data are available from the Office of Management and Budget (OMB) on the number of major proposed and final rules that they have reviewed annually since 1981.(20) Between 1981 and 1990, OMB reviewed annually an average of 71 major final and proposed rules. This total included an annual average of 31 major proposed rules and an average of 40 major final rules. Unless they were significantly different, separate cost-benefit studies would generally not be done for both proposed and final rules so that the number of individual cost-benefit studies required or the amount of effort would be less than the total of major rules. In contrast to the 1980s, between 1991 and 1994, an average of 125 major proposed and final rules were evaluated, with OMB providing no breakdown between proposed and final rules.(21)

If regulatory reform requires a lower threshold for applying formal cost-benefit analysis, more rules will have to be evaluated. For example, the total number of rules (major and nonmajor) reviewed by OMB between 1981 and 1993 was well over 2,000 annually. Under the changes by the Clinton Administration, only "significant actions" are reviewed by OMB dropping the total to 829 in 1994. If the impact threshold for doing risk assessment and cost-benefit is set at the $25 million level, the EPA, for example, has about 100 regulations currently that would be subject to rigorous study requirements.(22) If the $1,000,000 average cost per formal cost-benefit analysis is indicative of agency expenditures (this assumes that rules with smaller economic impacts would still require additional data collection and analysis), then the annual expenditures by EPA would be about $100 million. This is close to the estimate by CBO of additional costs to EPA of about $125 million annually for doing risk assessment and cost-benefit for any regulations having more than an annual impact of $25 million. The CBO also estimates the cost for all agencies in complying with the $25 million threshold at $250 million annually.(23) However, these costs should be less if rules are less complex and far reaching. Also, against added government costs for doing cost-benefit analyses is the likely reduction in compliance costs borne by the private sector.

Other indications of the effect of requiring more extensive and rigorous evaluation is experience from the last year of the Bush Administration. In the regulatory program published for 1991, OMB asked agencies to provide cost-benefit information not just for major rules but for all significant regulations.(24) This increased the number of rules covered by cost-benefit assessment requirements from about 80 to 500 per year. As reported in the FY1993 Budget presentation, agencies were not able to consistently provide cost and benefit estimates on all of the significant rules. For the 67 rules that were expected to be promulgated in 1992, for which summary cost and benefit estimates were available, quality of information varied significantly. Agencies were more successful in providing estimates of costs than benefits. For benefits, most estimates were in terms of physical changes (death or illness avoided, reduced quantities of pollution, etc.). Of the remainder, 6 included monetary benefits, 7 were purely descriptive (e.g.; increase energy efficiency), and 18 had unknown benefits. Although most included monetized costs, one used only physical effects (e.g.; tons of increased air pollution) and 12 had unknown costs.

Past agency difficulties in characterizing benefits and some costs and in monetizing many physical benefits would likely be an equal or greater challenge with the proposed requirements for greater quantification of regulatory effects. Methods issues are especially challenging in the areas of health, safety, and environment. In addition to the overriding challenge of putting dollar values on nonmonetary aspects of regulations, agencies would likely face the need to collect much more data on many new areas of regulation that were previously not subject to requirements. On the other hand, one likely result of regulatory reform could be fewer regulations and thus less total need for rigorous evaluation.

Given the above considerations, greater use of cost-benefit analysis in assessing new regulations implies a range of options, with significant analytical costs and formality at the far end. At one level, it offers a common sense framework for organizing monetary and nonmonetary effects, thus aiding complex public policy decisions on similar types of regulatory alternatives. At a more detailed, quantitative and comprehensive level, professionally acceptable monetary comparisons of costs and benefits may require a significant resource commitment by many Federal agencies.

Greater agency use of cost-benefit analysis will likely require increased measurement of small positive or negative changes in health, environment or safety conditions. This is particularly the case when such effects are very long term or uncertain or where suspected but subtle interactive effects are not well understood or directly measurable. Dealing with this situation implies significant resource commitments to increase scientific understanding, as well as efforts to expand data capabilities. This raises questions of adequacy of research and monitoring in areas such as ecology, epidemiology, toxicology, and economics.

Past experience with regulatory impact analyses, which include comparisons of monetized costs and benefits, indicate the potentials and limitations for more rigorous evaluation of new regulations. A previous CRS review of experience gained in assessing the impacts of air quality regulations offers a concise summary of issues in the debate on greater use of cost-benefit analysis:(25)

If Congress requires greater use of cost-benefit analysis, more extensive guidelines would appear to be needed for achieving consistency and comparability in analyses done among various regulatory areas.

Bromley, Daniel W. "The Ideology of Efficiency: Searching for a Theory of Policy Analysis." Journal of Environmental Economics and Management. Vol. 19, 1990.

Cato Institute. The Cato Handbook for Congress: 104th Congress. Washington, D.C. 1995.

Hahn, Robert W. and John A. Hird. The Costs and Benefits of Regulation: Review and Synthesis. Yale Journal of Regulation. Vol. 8: 233, 1990.

Heimann, Christopher Martin et al. "Project: The Impact of Cost-Benefit Analysis on Federal Administrative Law." Administrative Law Review. Vol. 42, No. 4. Fall 1990.

Hopkins, Thomas D. "The Costs of Federal Regulation." Journal of Regulation and Social Costs. Vol. 2. March 1993.

Lave, Lester and Howard Gruenspecht. "Increasing the Efficiency and Effectiveness of Environmental Decisions: Benefit-Cost Analysis and Effluent Fees - A Critical Review." Journal of Air and Waste Management Association. Vol. 41, No. 5. May 1991.

Luken, Ralph A. and Arthur G. Fraas. "The U.S. Regulatory Analysis Framework: A Review." Oxford Review of Economic Policy. Vol.9, No. 4. 1993.

Neely, Alfred S. "Statutory Inhibitions to the Application of Principles of Cost/Benefit Analysis in Administrative Decision Making: Duquesne Law Review. Vol. 23, No. 3. Spring 1985.

U.S. Environmental Protection Agency, Office of Policy Analysis. EPA's Use of Benefit-Cost Analysis 1981-1987. August 1987.

U.S. General Accounting Office. Regulatory Reform: Information on Costs, Cost-Effectiveness, and Mandated Deadlines for Regulations. GAO/PEMB-95-18BR. March 1996.

U.S. Library of Congress. Congressional Research Service. Cost-Benefit Analysis in Federal Regulation: A Review and Analysis of Developments, 1978-1984. Report No. 84-74 E by Julius W. Allen. Washington, D.C., 1984.

U.S. Library of Congress. Congressional Research Service. Health Benefits of Air Pollution Control: A Discussion. CRS Report 89-161 ENR by John E. Blodgett. February, 1989.

U.S. Library of Congress. Congressional Research Service. Risk and Cost-Benefit Provisions in House and Senate Bills--Update. CRS Report 95-576 ENR by Linda-Jo Schierow. May 8, 1995.

U.S. Senate. Hearing Before the Committee on Energy and Natural Resources. Use of Risk Analysis and Cost-Benefit Analysis in Setting Environmental Priorities. 1st Sess. S. Hrg. 103-336, November 9, 1993. U.S. Government Printing Office. Washington, D.C. 1994.

l. For a comparison of various bills and their provisions, see U.S. Library of Congress. Congressional Research Service. Risk and Cost-Benefit Provisions in House and Senate Bills--Update. CRS Report 95-576 ENR by Linda-Jo Schierow. May 8, 1995.

4. For a recent review of issues in the use of cost-benefit analysis see: U.S. Senate. Hearing Before the Committee on Energy and Natural Resources. Use of Risk Analysis and Cost-Benefit Analysis in Setting Environmental Priorities. 1st Sess. S. Hrg. 103-336, November 9, 1993. U.S. Government Printing Office. Washington, D.C. 1994.

5. For an overview of recent studies applying cost-benefit analysis to social regulation see: Hahn, Robert W. and John A. Hird. The Costs and Benefits of Regulation: Review and Synthesis. Yale Journal of Regulation. Vol. 8: 233, 1990. pp. 233-280

6. This characterization of evaluation frameworks is discussed in: Lave, Lester and Howard Gruenspecht. "Increasing the Efficiency and Effectiveness of Environmental Decisions: Benefit-Cost Analysis and Effluent Fees - A Critical Review. Journal of Air and Waste Management Association. Vol. 41, No. 5. May 1991.

7. e.g., the level of public health protection, environmental protection, safety, etc. at which additional benefits equal additional costs, or the level at which the surplus of benefits over costs is the largest.

8. Lave, Lester and Howard Gruenspecht. Increasing the Efficiency and Effectiveness of Environmental Decisions: Benefit-Cost Analysis and Effluent Fees, A Critical Review. Op. Cit. p. 683

9. For example, airline travelers might be asked how much they would be willing to pay to reduce the commercial fatality rate by one death per so many million passenger miles or to reduce the risk of dying in a crash from 1 in 10,000 to 1 in 10,500. To over simplify, this information is extrapolated to a larger traveling population to approximate perceived benefits which are then compared to the cost of the safety improvement or regulation. For an extensive discussion of these types of issues see: U.S. Library of Congress. Congressional Research Service. Health Benefits of Air Pollution Control: A Discussion. CRS Report 89-161 ENR by John E. Blodgett. February, 1989.

l0. U.S. Library of Congress. Congressional Research Service. The Clean Air Standards Attainment Act: An Analysis of Welfare Benefits from S. 1894. CRS Report for Congress, 88-298 ENR by Larry B. Parker. April, 1988. p. 8

ll. Loc. Cit. p. 12 and Office of Air and Radiation, Environmental Protection Agency. Regulatory Impact Analysis on the National Ambient Air Quality Standards for Sulfur Oxides (Draft). Research Triangle Park, North Carolina, 1987. Appendix B.

12. For a discussion of discounting and other technical issues in using cost-benefit analysis see: Heimann, Christopher Martin et al. "Project: The Impact of Cost-Benefit Analysis on Federal Administrative Law." Administrative Law Review. Vol. 42, No. 4. Fall 1990.

13. Bromley, Daniel W. "The Ideology of Efficiency: Searching for a Theory of Policy Analysis." Journal of Environmental Economics and Management. Vol. 19, 1990. p.101

14. U.S. Library of Congress. Congressional Research Service. Cost-Benefit Analysis in Federal Regulation: A Review and Analysis of Developments, 1978-1984. Report No. 84-74 E by Julius W. Allen. Washington, D.C., 1984

16. For comparison of the risk and cost-benefit provisions of the various reform proposals see: U.S. Library of Congress. Congressional Research Service. Risk and Cost-Benefit Provisions in House and Senate Bills--Update. CRS Report 95-576 ENR by Linda Jo Schierow. May 8, 1995.

17. U.S, Environmental Protection Agency, Office of Policy Analysis. EPA's Use of Benefit-CostAnalysis 1981-1987. August 1987.

18. Luken, Ralph A. and Arthur G. Fraas. "The U.S. Regulatory Analysis Framework: A Review." Oxford Review of Economic Policy. Vol.9, No. 4. 1993. p. 100

19. This is calculated by multiplying the average cost of EPA's cost-benefit studies done between 1981 and 1986 ($675,000) by the percent increase in the GDP implicit price deflator from 1983 to 1994, roughly a 45 percent increase. The year 1983 was used as the mid-point for price increase calculations since the EPA costs were spread over a five year period. The resulting estimate of $975,000 per cost-benefit was rounded to $1,000,000 given the rough nature of the overall calculation.

20. Executive of fine of the President of the United States. Of fine of Management and Budget. Regulatory Program of the U.S. Government, April 1, 1992 - March 31, 1993. (Exhibit 4).

22. U. S. Environmental Protection Agency. Questions and Answers on H.R. 9 Memo to the Honorable George Brown, Committee on Science, U.S. House of Representatives from the EPA Administrator. January 31,1995

23. "CBO: House Risk Bill Would Add $250 Million to Federal Regulatory Budget." Risk Policy Report. February 21, 1995. p. 6

24. Executive Office of the President of the United States. Budget of the United States Government, Fiscal Year 1993. Part One - 400.

25. Evaluating Health Benefits in Clean Air Act Regulatory Impact Analyses." in Health Benefits of Air Pollution Control: A Discussion op. Cit. p. 327

Redistributed as a Service of the National Library for the Environment*

Cost-Benefit Analysis: Issues in Its Use in Regulation

Cost-Benefit Analysis:
Issues in Its Use in Regulation