Benefit-Cost in Practice: Implementing the Efficiency Standard Chapter 10 Benefit-Cost in Practice: Implementing the Efficiency Standard

Introduction From the efficiency perspective, pollution should be reduced until the additional costs of control just outweigh the additional benefits Calculate all the costs Calculate all the benefits This allows us to pinpoint the efficient level of pollution through benefit-cost analysis

Regulatory Impact Analyses The EPA conducts formal benefit-cost analyses (known as regulatory impact analyses or RIAs) of any new regulation expected to cost more than $100 million For safety-based laws, EPA is supposed to examine several different options that achieve a safety goal and choose the most efficient

A “Good” Benefit-Cost Study A good benefit-cost study will Follow accepted procedures Provide a clear statement of all assumptions Point out uncertainties where they exist Suggest realistic margins of error

Doing Benefit-Cost 1: Lead Standards Under the Safe Drinking Water Act, the EPA was required to establish “action standards” for lead in drinking water Lead leaches from solder in older water systems

Three Options

Estimating Costs Determine which of the 63,000 plus systems nationwide would require remedial action, and at what level, to achieve the three different targets Establish engineering cost estimates for the different steps Study gives a plus or minus 50% range for uncertainty in its cost estimates

Estimating Benefits

Estimating Benefits

Estimating Benefits: What’s Missing?

EPA’s Summary What’s Missing?!

The Most Efficient Option The net monetary benefits to society of the three options are: Option A: $62,685 million Option B: $59,601 million Option C: $20,670 million The most efficient option then is option A because it maximizes the net monetary benefits to society

Estimated Benefits and Costs of Reducing Lead

Benefit-Cost Ratio The benefit-cost ratio is the value of the benefits of an option divided by its costs B/C ratio greater than one means total benefits exceed total costs Options A, B, and C all have B/C ratios greater than 1 Greatest B/C ratio is not the same as the most efficient option…

Uncertainty of Benefit-Cost Estimates

The EPA’s Choice Interestingly, the EPA did not choose Option A despite it being most efficient In fact, the report never acknowledged that option A was the most efficient!! Instead, the agency relied on the uncertainty in the benefit estimates and opted for the less expensive option B

Lessons Due to substantial uncertainty, benefit-cost analysis cannot discriminate between “relatively close” options Note: the B/C ratio has nothing to do with efficiency The B/C ratio for A was lower (11) than option B (15.3)

Doing Benefit-Cost2 : Landfill Regulation The EPA, under the Resource Conservation and Recovery Act (RCRA), was directed to draft regulations for the siting, construction and maintenance of municipal solid waste landfills Two approaches Pollute and cleanup Prevention

Cost Estimates EPA cost estimates, based on the engineering approach, included expenses associated with: Land clearing Excavation Equipment Labor Liner materials Groundwater monitoring wells Most added costs for the “pollute and cleanup” option were for corrective action, while 50% of the added costs for the “prevent” option were for liners

Benefit Estimates Two quantitative estimates Reduction in cancer risk Estimated risk of cancer is 5.7 over the next 300 years Both plans reduce this risk by 2.4 over the 300 year period: why? Avoided cost of replacing damaged groundwater Cost of replacing with an alternative supply; this probably overstates the benefits

Is either option efficient?

No Assumpting that: Both plans are losers by an efficiency standard All benefits are captured by mitigating the effects on groundwater, and The study’s complex modeling process generates “precise” benefit and cost predictions Both plans are losers by an efficiency standard Complying with existing water laws costs $2.5 billion more than supplying groundwater users with a new supply Moving to a pollution prevention strategy makes matters even worse

Are there missing benefits from the prevention option? Stricter standards may encourage more recycling and waste reduction. Are these benefits likely to be large? Bottom-line: very few people depend on water that might be contaminated by municipal landfills. Benefits of regulation likely to be small.

Benefit-Cost Problems These two examples illustrate “good” benefit-cost studies There are lots of “bad” studies manufactured by “economists-for- hire” But even honest analysts face pressures:

Political Influence In Benefit-Cost Regulatory politics Agenda control Hard numbers problem Paralysis by analysis

Regulatory Politics EPA benefit-cost analysts may face pressure from their superiors at the Office of Management and Budget (OMB) to generate numbers in support of their preferred rule Study may be put off until decisions have already been made

The Scientific Agenda Big business has influenced the scientific agenda by funding conferences and targeting research in certain areas Even academic scientists must often obtain research funding from industry

Hard Numbers Problem Benefit-cost studies can provide a false sense of precision to decision makers “Hard” numbers are really “soft” when uncertainty and incomplete benefit coverage are factored in Decision makers don’t want uncertainty; they want an answer

Paralysis by Analysis Paralysis by analysis: Opponents of government action can resort to the legal system and exploit the uncertainty in the process to delay or block the implementation of regulations

Summary: Is Benefit-Cost Analysis Useful? Two questions? Is it capable of identifying the efficient pollution level? (this chapter) Is efficiency in pollution control the right standard? (previous chapters)

Up to the Job? Yes While benefit-cost analysis cannot pinpoint the efficient pollution level with the accuracy suggested by diagrams, it is helpful when uncertainty about benefits is low (landfill case?) More generally, BCA: Provides a framework for a general “balancing” of benefits against costs Can rank dissimilar proposals in terms of efficiency

Up to the Job? No. Benefit-cost’s fatal flaw is its inability to price the values of life, health, nature and the future. Especially over the long run choice of a discount rate can dramatically alter the conclusions of benefit-cost studies.

Up to the Job? We report. You decide.