Issues in Its Use in Regulation
John L. Moore
Environment and Natural Resources Policy Division
June 28, 1995
HOW PUBLIC ACTIONS ARE
TECHNICAL ISSUES CONFRONTING COST-BENEFIT ANALYSIS
USE OF COST-BENEFIT ANALYSIS MAY CHANGE
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
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:
Guidelines to assure greater consistency in techniques as
well as for defining the respective roles of cost-benefit and other related evaluation
Significantly increased funds to do these analyses in a
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 Lines of Argument
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)
Argument on use of cost-benefit analysis seems to fall along three
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
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).
Issues to be Addressed
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:
How public actions are evaluated;
The technical issues confronting cost-benefit analysis; and
How the use of cost-benefit analysis may change.
HOW PUBLIC ACTIONS ARE
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.
1) What is cost-benefit analysis?
2) What related analytic tools are used in evaluating public actions
What is Cost-Benefit
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
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:
As a formal economic analysis of the gains to the economy
or social well-being from a public action where the difference between monetized benefits
and costs is used as a test or screen for evaluating alternatives and for guiding the
scale of a public action.
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.
Alternatively, cost-benefit is often used:
As a framework for organizing quantitative and qualitative
information on the positive and negative effects of a public action.
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:
1) Efficient markets within the private sector which provide goods
and services at the lowest costs and which do so without adverse effects on pubic safety,
health, or the environment require little regulation or government involvement.
Cost-benefit analysis may be used in these circumstances when the government evaluates the
provision of services that are also provided by private markets.
2) Inefficient markets within the private sector often call for
varying degrees of regulation, depending upon how their activities impact upon health,
safety, or environmental needs of the nation. This situation is often referred to as the
"market failure problem." The side effects from industrial activity which cause
pollution fall in this category, and cost-benefit analysis is sometimes used as a guide to
effective policies for minimizing such problems .
3) Some societal needs can only be met effectively through
government action. National defense, building of some highways, some public health
protection, and preservation of large, unique scenic areas or ecological systems can fall
in this category. As with the second area above, cost-benefit analysis can provide
guidance for some of these government actions.
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
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:
1) Projects that will add to economic output (net domestic product);
2) Actions not directly measurable in gross domestic product terms
but which have the potential to increase national economic well-being by creating more
collective benefits than costs (usually estimated in monetary terms).
What Other Analytic Tools
are Used in Evaluating Public Actions and Regulations?
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:
In the process of evaluating policy alternatives that help
shape statutory provisions;
In shaping broad regulatory strategies in response to
legislative requirements; or
In evaluating specific regulations agencies intend to issue
in response to regulatory strategies.
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:
Health-based or environmental protection standards -- where
the primary objective is reducing risk of harm to socially acceptable levels -- whatever
the cost -- in line with the best available scientific data;
Technology based standards -- where the primary objective is
to achieve implementation and results that are predictable and certain;
Risk-benefit or cost-risk -- where the objective is balancing
health or environmental protection with the cost of achieving that protection;
Cost-effectiveness -- where the goal is implementing a
specified environmental, health, or safety objective at the least or most effective cost;
Cost-benefit -- where the objective is to determine an action
and the level of that action that achieves the greatest net economic benefit or is the
most economically efficient.
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
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
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.
TECHNICAL ISSUES CONFRONTING COST-BENEFIT ANALYSIS
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:
1) What are the issues in estimating costs?
2) What are the issues in estimating benefits?
3) What are the limits in using formal cost-benefit analysis in
What are the
Issues in Estimating Costs?
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:
Difficulty in predicting technical innovations that may
reduce long term compliance costs, which can lead to an overstatement of costs relative to
Indirect or hidden costs caused by the regulatory process
such-as uncertainty, delay, or rigidity in implementation that are difficult to quantify
and include in the scope of a cost-benefit analysis; and
Physical effects or "costs" such as second order or
consequential effects like other forms of pollution which are difficult or impossible to
value in dollar terms.
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.
the Issues in Estimating Benefits?
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:
monetization of positive effects;
scope of benefits; and
comparing benefits and costs that occur at different points
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)
Comparisons Over Time
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
Mortality Due to Chronic Exposure
Mortality Due to Acute Exposure
Morbidity Due to Chronic Exposure
Morbidity Due to Acute Exposure
|Soiling and Materials Damage
Commercial and Industrial facilities
Government and Institutional Facilities
|Climate and Visibility Effects
Visibility at Parks
|Non-Human Biological Effects
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
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
USE OF COST-BENEFIT ANALYSIS MAY CHANGE
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:
1) How would proposed regulatory reforms change how agencies
currently deal with costs and benefits of regulations?
2) What implementation issues do reform proposals imply?
How Would Regulatory Reform
Change How Agencies Currently Deal with Costs and Benefits of Regulation?
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
The threshold triggering requirements for more rigorous
examination of regulations including cost-benefit analyses; and
The required use of net benefit comparisons in setting
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
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:
How many rules would fall under requirements for formal
cost-benefit analysis and how much additional data collection and analysis would be needed
to do cost-benefit analysis;
Whether other agencies' cost experiences would be similar to
that of EPA's under Executive Order 12291;
Whether regulatory reform requirements significantly reduced
the number of major rules analyzed by agencies;
How much of what agencies already spend in evaluating
regulations would go towards the expanded requirements; and
Judicial challenges requiring court expenses and additional
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.
What Implementation Issues Do
Reform Proposals Imply?
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)
Regulatory Impact Analyses (RIAs), such as those discussed in the
following chapters in terms of their handling of human health effects, can provide policy
makers a valuable one-stop source of information on a wide range of information involving
a pollution control regulatory action. RIAs go beyond the seeming absolutism of a single
numerical standard, with all its presumed certainty and efficiency and seeming precision:
The numerical standard speaks with the authority of precision, the
supporting documentation, in many cases, with the real-world ambiguity of an
imprecise science and imperfect world.
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.
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.
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. Environmental
Policy and the Economy: Conflicts and Concordances. CRS Report 95-147 ENR by John E.
Blodgett. January 10, 1995.
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
Analysis and Cost-Benefit Analysis of Environmental Regulations. CRS Report 94-961 ENR
by Linda-Jo Schierow. December 2, 1994.
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,
2. U.S. Library of Congress. Congressional Research Service. Environmental Policy and the Economy: Conflicts and Concordances. CRS
Report 95-147 ENR by John E. Blodgett. January 10, 1995.
3. U.S. Library of Congress. Congressional Research Service. Federal
Regulatory Reform: An Overview. CRS Issue Brief 95035 by Rogelio Garcia. Updated
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.
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.
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
15. U.S. Library of Congress. Congressional Research Service. Risk Analysis and Cost-Benefit Analysis of Environmental Regulations.
CRS Report; 94-961 ENR by Linda-Jo Schierow. December 2, 1994. p. 31.
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).
21. Ibid. and Office of Management and Budget
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.