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 benefitsCalculate all the costsCalculate 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 willFollow accepted proceduresProvide a clear statement of all assumptionsPoint out uncertainties where they existSuggest 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 millionOption B: $59,601 millionOption 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 costsB/C ratio greater than one means total

benefits exceed total costsOptions A, B, and C all have B/C ratios greater

than 1Greatest 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 efficiencyThe 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 approachesPollute and cleanupPrevention

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 estimatesReduction 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, andThe 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 costsCan 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.