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: 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  Both options required 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  Assuming that: 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 1. Regulatory politics 2. Agenda control 3. Hard numbers problem 4. 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.