1 “Benefit-cost analysis” used to be known (and is still known by some) as “cost-benefitanalysis.” Perhaps in response to advice from savvy marketing experts, the words “cost” and“benefit” have been interchanged. The intent (if there was one) presumably was to make thetechnique more palatable to consumers. Though it seems a concession to political correctness,this paper will adhere to the new standard usage.

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Draft May 16, 2006Please do not cite or quote.

TOWARDS ‘BEST PRACTICE’ STANDARDS IN ENVIRONMENTAL BENEFIT-COST ANALYSIS

Daniel H. ColeR. Bruce Townsend Professor of Law

Indiana University School of Law at Indianapolis

Prepared for Conference on “What We Can Do to Improve the Use of Benefit-Cost Analysis,”University of Washington School of Law and Department of Economics,

Seattle, Washington, May 18-19, 2006.

INTRODUCTION

Benefit-cost analysis (BCA1) is an inherently controversial practice, especially in the

realm of environmental policy. Like the Kaldor-Hicks (K-H) efficiency criteria upon which it is

based, BCA yields results that are, at best, ambiguous with respect to social welfare and, at

worst, subject to manipulation for political ends. As a consequence, the results of all BCAs are

contestable.

Unfortunately, no practical alternative exists for predicting and measuring the social-

welfare outcomes of regulatory policies. In theory, the Pareto criterion yields unambiguous

results, but it is ruled out in practice by its strict requirement of voluntary consent of all affected

parties, which presumes actual compensation of losers at their subjective valuations of their

2 Because of these strict conditions, the Pareto criterion is applicable only to voluntarymarket exchanges with no negative externalities.

3 On the relative merits and demerits of the Pareto efficiency criterion and the Kaldor-Hicks efficiency criteria, see, e.g., Cole and Grossman (2004, 10-12) and Mercuro and Medema(1997, 43-50). It is worth noting that several of the improvements Zerbe offers to K-H analysis –the incorporation of transaction cost analysis and fairness/equity considerations, as well as theobjection to using BCA as a decision rule – have been widely adopted as standards for BCAs,and are likely to be considered “best practices” for BCA. See Zerbe (2004, 17-18) and infra Sec.I.

4 At least, Ackerman and Heinzerling (2004) claim to reject BCA. In my view, it simplyis not possible for humans to make judgments without estimating, however informally (and insome cases mistakenly) the costs and benefits (broadly conceived). To assert that public policydecisions should involve no form of BCA, one would have to be prepared to either (a) expend nosocial resources on resolving the largest perceived social problem, or (b) expend all social

2

losses.2 These strict conditions are met only by the negligibly small and uninteresting set of

voluntary market exchanges with no significant negative externalities. In the realm of

environmental policy, resource allocations never are based on the unanimous consent of all

affected parties. Moreover, the losers from regulatory policies never are compensated at their

own subjective valuations of losses. So, the strict Pareto conditions cannot be met.

Consequently, society is left with the ambiguous outcomes of imperfect and manipulable BCAs

based on the K-H criteria (or marginally improved versions of K-H offered, for example, by

Zerbe 2001).3

The ambiguities and manipulability that render BCA generally controversial are

exacerbated in the realm of environmental policy by: long time horizons and uncertain social

discount rates; the absence of primary or secondary markets for many environmental goods,

which makes any prices assigned to them inherently contestable; and the sheer impossibility of

assigning universally acceptable values to human lives. For these reasons, some critics (such as

Ackerman and Heinzerling 20044) reject BCA entirely as a tool of regulatory policy making.

resources on eliminating the first unit of even a small social problem. Since no one makes suchassertions a commitment to some form of BCA seems unavoidable. Once someone asks, “Howmuch should we spend to avoid or achieve X?”, we are in the realm of BCA. Ackerman andHeinzerling (2004, 9) concede as much in noting that society should not be willing to spend aninfinite amount of money to protect life, health, and nature. Thus, they do not object to socialwelfare judgments per se. Rather, they object to formalized BCAs based what they perceive tobe crude assignments and calculations of dollars and cents. Instead, they offer “an attitude . . .that trusts collective, commonsense judgments, and is humble in the face of uncertainty,steadfast in confronting urgent problems, and committed to fairness within and beyond thisgeneration.” Presumably, these “collective, commonsense judgments” involve some kind ofinformal balancing of costs and benefits (broadly conceived).This paper does not consider therelative merits of such informal and holistic BCAs, but focuses entirely on the morecontroversial formal BCAs.

3

Even if environmental BCA never can be rendered completely uncontroversial, it can be

made substantially less controversial than it is now simply by improving its methodological

consistency. Even an admittedly imperfect methodology, applied consistently in accordance with

standard criteria widely accepted among scholars and practitioners, should be less objectionable

than various, inconsistently applied methodologies.

This paper will demonstrate that the methodological consistency of environmental BCA

has been improving, at least in theory, over the last decade or so, and provide a few discrete

suggestions as to additional improvements. The ultimate goal – though not the goal of this

particular paper – is to standardize a set of “best practices” for environmental BCA. That goal,

unfortunately, is unlikely to be achieved by the primary users of BCAs – the regulatory agencies

themselves – because they are subject to divergent political pressures that inevitably would raise

questions about the motives behind any set of standards they might establish and attempt to

enforce. For reasons explained in Section I, a set of “best practices” established by the

Environmental Protection Agency (EPA) almost certainly would differ in important respects

from a set of “best practices” established by the President’s Office of Management and Budget

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(OMB). The perceived differential political biases of different agencies with different missions

would undermine the benefits to be gained from adopting a set of “best practices.” Indeed, the

EPA (2000) and OMB (2003) both have recently published (what amount to) “best practice”

guidelines, which diverge in important respects. In my view, multiple sets of “best practices” are

better than none only to the extent that multiple sets of “best practice” standards might provide a

starting point for conciliation and consolidation of a single set of standards.

This paper recommends that a cohort of environmental economists, legal scholars, and

policy analysts be appointed under auspices of an independent organization such as the National

Academy of Sciences, American Economics Association, or the Association of Environmental

and Resource Economist to derive a set of “best practices” for environmental BCA. The hope is

not that such a group would be able to derive completely objective and neutral standards for

BCA – that would a pipedream. BCA contains too many subjective elements, including social

discount rates and valuations of non-market goods and services, ever to be completely objective

and neutral. However, an independent cohort of experts is less likely to be swayed by the

immediate political concerns that motivate the agencies that utilize BCA. Independent

economists, legal scholars and policy analysts presumably would have less of a political stake

than OMB or EPA officials, for example, in the selection of a rate (or range of rates) for

discounting future costs and benefits or pricing various mortality and morbidity effects.

Assuming a cohort of experts could establish a legitimate and useful set of “best

practices” for BCA, their product would not constitute a legal standard directly applicable to

government agencies but a social-scientific standard or norm that reviewing courts might choose

to recognize. So, if some government agency based a policy decision on a BCA that did not

5 The focus is on environmental BCA rather than BCA more generally in recognition ofthe distinct possibility that fundamentally different areas of policy analysis might requiresubstantially different methodological choices. The recommendations in this paper are to beunderstood as applying only to environmental BCA.

5

conform to the “best practices,” without a satisfactory excuse or explanation, a reviewing court

might reject the BCA and possibly the substantive policy it supported.

In sum, the adoption of methodological “best practices” for BCA could have four

positive effects: (1) it presumably would reduce, at the margins, political opposition to BCA as a

policy tool; (2) it would render BCAs more regular in form and format and, thus, more readily

assessable and replicable by social scientists; (3) it might reduce (though probably not eliminate)

politically-motivated, inter-agency methodological disputes; and (4) it would provide a sound

and consistent basis for judicial review of agency BCAs, which is an increasingly important

consideration given the proliferation of regulatory BCAs subject to review under state and

federal administrative procedure statutes.

This paper proceeds as follows: Section I offers evidence of improvements in the

consistency of environmental BCA methodology over the last decade or so. Many of those

improvements have come from efforts to build consensus among government agencies, including

the EPA and the OMB. However, Section II explains why more improvements are necessary (or,

at least, desirable), but unlikely to come from the agencies themselves because of their divergent

political and ideological commitments. Thus, the paper recommends that the American

Economic Association, the Association of Environment and Resource Economists, or the

National Academy of Sciences create a task force charged with developing a set of “best

practice” standards for environmental BCA.5 Section III then offers a tentative (but necessarily

6 State and local regulation of economic activity was prevalent during the nineteenthcentury, however (see, e.g., Novak 1993). BCA certainly might have been a useful tool forassessing efficiency (or inefficiency) of, for example, canal and railroad subsidies, usury laws,grants of local or state monopoly entitlements, manufacturing and packaging requirements, etc.

6

incomplete) list of issues such a task force might attempt to resolve in order to improve

methodological consistency. The paper concludes by reiterating the benefits to be gained from

the independent establishment of “best practice” standards for environmental BCA.

I. THE STRUGGLE FOR METHODOLOGICAL CONSISTENCY IN BCA

Regulatory BCA is a young and still developing method for predicting ex ante or

assessing ex post the social welfare effects of public policies. Prior to the twentieth century,

when federal government regulation of economic activity was a rare phenomenon, the lack of a

regulatory BCA tool mattered little.6 But with the rise of the welfare/administrative state during

the twentieth century – a rise enabled by the growth of (Pigovian) welfare economics theory (see

Adler and Posner 1999, 169) – the total of amount of regulation, at all levels of government,

increased dramatically. Nevertheless, before the 1970s government agencies only rarely

attempted to quantify the costs and benefits of their burgeoning regulatory programs, let alone

predict costs and benefits prior to policy implementation. Consequently, the government – and

the public – had no way of knowing whether those regulatory programs were creating more

social good than harm.

7 In the mid-1990s, Congress imposed substantial BCA-related requirements on federalagencies in the Unfunded Mandates Reform Act of 1995 (2 U.S.C. §§ 1501 et seq.) and theSmall Business Regulatory Enforcement Fairness Act of 1996 (5 U.S.C. §§ 601 and 801-808). Inneither of these (or any other) statutes, however, did Congress specify BCA procedures orassumptions such as discount rates or the value of human lives and other non-market goods. Inother words, Congress has not participated at all in the ongoing evolution of “best practice”standards for BCA.

8 The courts have also played a limited role in limiting regulatory agency authority,including with respect to BCA. That role will be discussed later in this paper.

9 Adler and Posner (1999, 169) note that the Administration of Franklin D. Rooseveltwas actually the first to use BCA for assessing flood control projects during the New Deal era,and enjoyed a “brief period of popularity in the 1960s.” It was in the 1970s, however, thatPresidents began requiring “regulatory impact analyses” as a regular procedure in regulatorydecision making.

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This problem called for a legislative fix that was not forthcoming. Until the mid-1990s,

Congress displayed little interest in assessing the economic effects of regulatory programs.7

Consequently, nearly all efforts to assess the costs and benefits of agency regulations came from

the Office of the President, which has the authority to regulate by Executive Order the activities

of agencies within the Executive Branch of the federal government.8

A. 1970-1992: BCA under Reagan and Bush I

BCA (sometimes referred to as “regulatory impact analysis”) first emerged as a regular

decision process tool at the beginning of the 1970s,9 when Presidents Nixon, Carter, and Ford

issued successive executive orders calling for economic analyses of regulations and inter-agency

review of major rules (see Morgenstern 1997, 10). During this period, the President’s Office of

Management and Budget (OMB) emerged as “‘the lobby for economic efficiency’” in

government (Morgenstern 1997, 10, quoting Shultze 1977). In the 1980s, the Reagan

10 Like all other Executive Orders, E.O. 12,498 and E.O. 12,291 applied only toExecutive Branch agencies; they did not, and probably could not, apply to “independent”regulatory agencies, such as the Federal Energy Regulatory Commission. Robert W. Hahn and

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Administration fashioned a more significant role for BCA as a “decision rule” – a tool that, by

itself, would determine whether or not a regulation should be promulgated (Morrison 1998, 1333

n. 2). In 1982, President Reagan issued Executive Order (EO) 12,291 (46 Fed. Reg. 1193), which

required that the “potential benefits” of all “major” federal regulatory actions (defined as those

with economic effects of at least $100 million, significant employment effects, or significant

price effects) had to “outweigh the potential cost to society.” The ostensible goal of the EO was

to “maximize the net benefits to society” from regulation. In addition, the Order required

comparative cost-effectiveness studies of alternative means of achieving regulatory goals:

“Among alternative approaches to any given regulatory objective, the alternative involving the

least net cost to society shall be chosen.” Finally, the Reagan EO placed the Director of the

President’s Office of Management and Budget (OMB) in charge of implementing the EO, and

compelled executive branch agencies to submit their regulatory impact analyses to OMB for

review prior to final publication of new agency rules.

Four years later, President Reagan issued another Executive Order, 12,498, which

supplemented EO 12,291 by requiring regulatory agencies to submit for OMB review “annual

regulatory plans.” According to Hahn and Sunstein (2002, 1506), EO 12,498 “increase[d] the

authority of agency heads [political appointees] over their staffs [career bureaucrats], by

exposing proposals to top-level review at an early stage.... [I]t also increased the authority of

OMB, by allowing OMB supervision over basic plans, and by making it hard for agencies to

proceed without OMB preclearance.”10

Cass R. Sunstein (2002, 1496, 1531-37) have argued that Executive Orders requiring BCAsmight lawfully be applied to independent regulatory agencies. Their arguments are novel andplausible but, as the authors themselves note, “not obviously correct.” In any event, no presidenthas yet asserted such authority over independent regulatory agencies.

9

Despite (or perhaps because of) E.O. 12,291 and E.O. 12,498, government agencies

continued to dispute the proper role of, and approach to, BCA, especially when Executive Orders

appeared to conflict with statutory mandates calling for regulations based not on economic costs

and benefits but on the protection of public health (see Morgenstern 1997, 10-11). The decade

from 1982 to 1991 (from Reagan through Bush I) was characterized by increasing OMB efforts

(under authority granted by the two Reagan Executive Orders) to control regulatory processes

and substantial regulatory agency resistance to OMB control. Despite E.O. 12,291's seemingly

clear mandate that agencies base their regulatory decisions on a calculation of costs and benefits,

widespread disagreement persisted about the extent to which regulatory decisions should depend

on BCAs. Disagreement also persisted about the appropriate methodology for conducting BCAs.

Much of this disagreement, predictably, swirled around the subjective elements of BCA,

including discount rates and human-life valuations.

At the time President Reagan issued his two Executive Orders on BCA, OMB was

operating under Circular No. A-94, “Discount Rates to be Used in Evaluating Time-Distributed

Costs and Benefits” (March 27, 1972). That Circular called for the use of a 10 percent discount

rate for assessing federal regulations. Interestingly, OMB did not revise that Circular in light of

the Reagan Executive Orders nearly until the end of the George H.W. Bush Administration in

November 1992. For a full decade all major federal regulations technically were required to

provide net benefits under a BCA using a 10 percent discount rate. Not surprisingly, the

11 Interestingly, before 1992, OMB employed an even higher discount rate of 10 percent(see Revesz 1999, 978, discussing OMB Circular No. A-94, Discount Rate to be Used inEvaluating Time-Distributed Costs and Benefits (Mar. 27, 1972)).

12 To the extent that pollution and other environmental problems are the result of privateinvestment decisions with short time horizons and high discount rates, it seems perverse torequire regulations designed to correct those problems to rely on similarly high discount rates.

13 The OMB guidance did, however, allow agencies to seek OMB permission to use alower discount rate, based on the “shadow price of capital,” for assessing longer-term regulatoryprograms.

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regulatory agencies often (but not always) ignored OMB’s Circular and utilized lower discount

rates, which justified more regulation.

Finally, on November 12, 1992 the OMB of the Bush I Administration revised Circular

A-94 (57 Fed. Reg. 53519). Among the revisions, OMB reduced the base-case discount rate

from 10 percent to 7 percent because that rate “approximate[d] the marginal pretax rate of return

on an average investment in the private sector in recent years.”11 The guidance did not attempt to

defend or explain why historical returns on private investments constitute an appropriate

measure for regulations designed especially to deal with pollution and other externalities

associated with market failures.12 Nor did it explain why alternatives such as the “shadow price

of capital” or the real return on long-term government debt were inappropriate.13 Still, the move

from a 10 percent discount rate to a 7 percent discount rate constituted a significant move

towards moderation and conciliation with the regulatory agencies.

B. 1993-2001: BCA Under Clinton

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Shortly after taking office in 1993, the Clinton Administration replaced the two Reagan

era Executive Orders with one of its own. According to Hahn and Sunstein (2002., 1507),

President Clinton’s E.O. 12,866 “endorsed the essential features” of the Reagan orders. This is

superficially true in that E.O. 12,866 continued to require agencies to perform regulatory BCAs

and submit those BCAs for OMB review. But E.O. 12,866 differed in fundamental respects from

the Reagan orders. First and foremost, it demoted BCA from a “decision rule” to a requisite

source of information for decision making. Unlike President Reagan’s E.O. 12,291, which

expressly prohibited regulatory measures unless the potential benefits outweighed the potential

costs, President Clinton’s E.O. 12,866 merely required agencies to prepare BCAs (to the extent

consistent with their statutory mandates); it did not require the agencies to base all (or really any)

of their regulatory decisions exclusively (or even primarily) on the outcomes of BCAs. In

addition, E.O. 12,866 mandated that agencies consider “distributive impacts... and equity”, in

addition to economic costs, when choosing among alternative regulatory approaches.

As it did during the Reagan Administration, the OMB dragged its feet in revising its

guidelines pursuant to President Clinton’s new Executive Order on BCAs. When OMB finally

did revise its guidelines in 1996, those revisions – referred to for the first time as “best practices”

for BCA – included a more elaborate, thoughtful, and detailed explanation of BCA standards.

OMB maintained its “base-case” 7 percent discount rate, but noted for the first time that

“[m]odern research in economic theory has established a preferred model for discounting,

sometimes referred to as the shadow price approach.” That approach, according to OMB, “is

viewed as being approximated by the real return to a safe asset, such as Government debt.”

Normally, the return on such an investment would be substantially lower than the 7 percent rate

14 Hahn (2000) claims that the absence of information about net costs and benefits in amajority of regulatory impact analyses prepared during the 1990s indicates that agencies werenot even attempting to engage in BCA.

12

the OMB maintained as its “best practice” standard. Perhaps for this reason, the OMB stopped

short of endorsing the shadow price method as the preferred way of selecting a discount rate; and

it required any agency preferring to use that method to “consult with OMB prior to doing so.”

The 1996 revisions to OMB’s economic analysis guidelines also paid more attention than

previous versions to: issues of risk and uncertainty in BCA, including the use of sensitivity

analysis; various methods for valuing human life, among other non-market goods, through

“value of statistical life” and “value of statistical life-years extended” analyses; and stressed the

importance of making all BCA assumptions transparent. In these and other respects, the 1996

revised OMB guidelines reflected recent developments in the theoretical and academic literature

on BCA.

A close reading of the 1996 revised guidelines suggest that OMB was becoming more

professional and ostensibly (if not really) less political in its oversight of federal regulatory

processes. This evolution at OMB did not, however, lead to greater consistency in regulatory

agencies’ BCAs. Agencies, including the EPA, continued to use widely varying discount rates

with little or no explanation or justification. Between 1992 and 1998, federal agencies utilized

discount rates ranging between 3 and 10 percent for assessing regulations with time horizons of

20 years or less, and rates between 3 and 7 percent for longer-term regulations (with time

horizons in excess of 30 years) (Morrisson 1998, Tables 1 and 2).14 The EPA relied on various

discount rates, with little explanation of its choice in any particular case. For example, the

agency employed a 3-percent discount rate when it sought to regulate lead-based paint, but 7-

15 In a review of 12 EPA regulations from the late 1980s and 1990s, Hahn and Sunstein(2002, 1512 Table 3) note extreme variations – from $9 billion to $40 billion – in EPA’sassessed cost for statistical life saved. However, these figures need to be taken with severalgrains of salt. Also see generally Heinzerling (1998) and Parker (2003).

16 Dean Revesz’s testimony is available on the World Wide Web athttp:/epw.senate.gov/107th/rev_1014.htm.

13

and 10-percent rates, respectively, for assessing proposed regulations of drinking water and

locomotive emissions (Morrisson 1998, 1337). A 1997 report by the General Accounting Office

(GAO 1997) criticized the EPA’s economic analyses for their lack of transparency about

assumptions. Despite these and other evident problems of implementation,15 OMB concluded in

its 1998 Report to Congress that “the overall picture remains one of slow but steady progress

towards the Best Practices standards” established in its 1996 revised guidance (OMB 1998, 83).

It is not at all clear, however, that the 1996 OMB revised standards actually constituted

“best practices” in the first place. In October 1999, Professor (now Dean) Richard Revesz of the

New York University School of Law testified before the Senate on the use of BCA under the

Clean Air Act.16 He cited several respects in which the OMB guidelines remained deficient. In

particular, he criticized the OMB’s preferred 7 percent discount rate for being “a great deal

higher than rates supported by economic theory,” resulting in the undervaluation of the benefits

of environmental regulations. He argued that a 2 to 3 percent discount rate would be more

appropriate as well as consistent, and noted that the General Accounting Office and

Congressional Budget Office already used 2 to 3 percent rates in their own economic

assessments. In addition, Professor Revesz argued that OMB’s approach to valuing risk and

human lives on the basis of wage premia in labor markets was faulty because it did not take into

account the involuntary nature of many environmental risks, the fact that workers who accept

17 Dean Revesz was hardly the only critic of OMB’s approach to BCA in the 1990s. Foranothre example, see Heinzerling (1998).

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risky jobs are not representative of the population as a whole, and the painful nature of

carcinogenic deaths, among other factors. More generally, Professor Revesz criticized OMB

procedures for turning BCA “into an anti-regulatory tool, rather than into a tool to make

regulation more rational.” He noted, for example, that the OMB only required BCA for

regulatory impositions; it did not require BCA when regulations were repealed, even if

deregulation might lead to net social welfare losses. He also criticized OMB for its own lack of

transparency, including its occasional failure to disclose its contacts with groups that might be

interested in the outcome of regulatory proceedings.17

Professor Revesz’s criticisms of OMB are illustrated by tales of direct OMB interference

in regulatory decision making processes. The most famous example might be the mid-1980s

fight between OMB and EPA over the latter’s BCA for proposed bans on certain uses of asbestos

in the workplace (on which see, for example, Menell and Stewart 1994, 103-116). In that

conflict, the OMB sought to impose its own estimation of benefits – $1 million per cancer case

avoided – and, whereas EPA sought to discount costs and benefits from the time of workplace

exposure to asbestos, the OMB argued that the agency should discount only from the time of

disease manifestation (potentially decades after exposure). Moreover, there was evidence that

OMB exerted pressure on EPA “behind closed doors” to accept OMB’s approach to discounting.

Whether one sides with EPA or OMB on these issues (the House Subcommittee on Energy and

Commerce sided squarely with the EPA (see Menell and Stewart 1994, 106-113)) the conflict

itself exemplified the absence of clear and agreed-upon “best practices” and the lack of

18 In the case of EPA’s huge ex post BCA for the Clean Air Act, 1970-1990 (EPA 1998),OMB criticized the scientific basis for some of EPA’s conclusions. For example, with respect toEPA’s conclusions about the net benefits from reduced exposure to particulate matter, OMB“contend[ed] that the state of the science is such that there is considerable uncertainty associatedwith the magnitude and causation of particulate matter benefits categories” (Croote 1999). TheEPA’s science-based conclusions in that BCA were all vetted by the agency’s Science AdvisoryBoard. Yet, the OMB – an agency with relatively little independent scientific expertise – soughtto override that Board’s recommendations. In particular, where EPA’s Science Advisory Boardrecommended that EPA assume a 5 year distributed lag structure in its analyses, OMB claimedthat period was too short and recommended a 15 year lag structure instead (Croote 1999). Thiswas hardly the only time the OMB inappropriately interfered with scientists’ expert opinions.According to Chris Mooney (2005, 61), the OMB edited, without permission, the congressionaltestimony of a government climatologist to emphasize, contrary to the climatologist’s opinion,scientific uncertainties about global climate change.

19 This should not be taken as an endorsement of Posner’s perspective. For one thing, it isunclear whether “elected officials” understand BCA procedures well enough to manipulate themto “control” regulatory staffers. In addition, the history of BCA in the federal governmentsuggests that its main effect has been to create contests between competing bureaucraciesrepresenting different interests, neither of which actually may be controlled by “electedofficials.” Finally, although the present author agrees that politics will always play a role inBCA, just as it will always play a role in all regulatory proceedings, this paper is animated by theauthor’s belief that BCA can be a truly useful tool of policy analysis.

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transparency in regulatory BCA.18

At the end of the 1990s, it appears that neither the OMB nor the regulatory agencies were

truly committed to an unbiased and methodologically consistent BCA tool. This observation

should not surprise anyone familiar with the literature on positive political-economy. Applying

that literature to the case of regulatory BCA, Eric Posner (2001, 1141) goes so far as to argue

that the very purpose of requiring regulatory agencies to perform economic analyses is not to

increase efficiency but to “ensure that elected officials maintain power over agency regulation.”

On his view, the question is not whether regulatory BCA is methodologically consistent or

biased one way or another; rather the question is whether it is effective at maintaining political

control over regulatory agencies.19

20 Members of the EEAC included many of the country’s leading environmentaleconomists, including Nancy Bockstael, Trudy Cameron, Herman Daly, Dale Jorgenson, A.Myrick Freeman, Lawrence Goulder, Catherine Kling, Jason Shogren, Hilary Sigman, RichardSchmalensee, Robert Stavins, Richard Revesz, Dallas Burtraw, Maureen Cropper, Paul Joskow,Kip Viscusi and Charles Kolstad

16

Towards the end of the Clinton Administration, in September 2000, the EPA published a

long (179 pages) and highly detailed set of Guidelines for Preparing Economic Analyses. The

Guidelines, which were based in part on an earlier EPA publication on BCA dating from the

early 1980s (EPA 1983) as well OMB’s 1996 “Best Practices” guidelines, were peer reviewed

by the Environmental Economics Advisory Committee (EEAC) of EPA’s Science Advisory

Board.20

The EPA’s 2000 Guidelines address all aspects of economic analysis of environmental

policy from the setting of goals to the determination of the best mechanisms for achieving those

goals (i.e., environmental instrument choice) to ex post assessments of implemented policies.

The EPA developed a tripartite framework under E.O. 12,866 for economic analysis of

environmental regulations, including (1) net social welfare assessments utilizing BCA, (2)

assessments of policy winners and losers using economic impact analysis (EIA), and (3) analysis

of policy consequences for disadvantaged sub-populations using “equity assessments.” Each of

these functions depends critically on a clear and consistent specification of the regulatory

“baseline,” which is the situation at the time a new policy is promulgated and implemented.

Once the baseline is established, the 2000 EPA Guidelines call for the agency to make

predictions on the expected effects resulting from a new policy. Of course, such predictions are

highly dependent on assumptions, the information available to the agency at the time a new

policy is promulgated, and issues of risk and uncertainty. In accordance with the OMB’s 1996

17

“Best Practice” standards, EPA’s 2000 Guidelines emphasize the importance of dealing

forthrightly with uncertainty by focusing on expected values of costs and benefits, clearly

disclosing assumptions, and subjecting those assumptions to sensitivity analyses. Also, following

Arrow and Fisher (1974), the EPA Guidelines note the significance of “quasi-option” values for

potentially “irreversible decisions.”

From the perspective of those interested in the evolution of regulatory BCA, the most

interesting chapters of EPA’s 2000 Guidelines are those dealing with social discounting and the

evaluation of environmental (including public health) benefits. These, of course, are two of the

most important, most subjective and, therefore, most contentious parts of any regulatory BCA. In

its 2000 Guidelines EPA explicitly notes that “choosing the discount rate has been one of the

most contentious and controversial aspects of EPA’s economic analyses of environmental

policies” (EPA 2000, 33). At the same time, however, EPA is aware that “the effects on net

benefits of alternative assumptions made for measuring and valuing uncertain effects of

environmental policies can overwhelm the effects of changes in the discount rate” (EPA 2000,

33).

EPA’s 2000 Guidelines reviewed the ever-growing literature on social discounting, and

like OMB’s 1996 revised guidelines, the agency noted “widespread support” for the

consumption rate of interest/shadow price of capital (CRI/SPC) method of discounting in inter-

generational contexts (EPA 2000, 40, 43). But unlike the OMB’s 1996 revised guidelines, in

which the OMB stuck to its preferred 7 percent discount rate based on historical returns on

private investments, EPA’s 2000 Guidelines actually sought to establish BCA procedures on

CRI/SPC. Even while noting that this method can be very expensive to employ (EPA 2000, 48

21 To minimize costs, including the costs of uncertainty, EPA recommends that analystsuse a “value-of-information approach to determine whether it is worthwhile to pursue aquantitative assessment of the effects of private capital displacement” (EPA 2000, 48 n. 20).

18

n.20),21 EPA concluded that relatively useful, practical measures exist: “What is offered in the

empirical literature for choosing a social discount rate focuses on estimating the consumption

rate of interest at which individuals translate consumption through time with reasonable

certainty. . . . For this, historical rates of return, post-tax and after inflation, on ‘safe’ assets, such

as U.S. Treasury securities, are normally used, typically resulting in rates in the range of one to

three percent” (EPA 2000, 47). Thus, EPA concluded that its economic analyses should use a

discount rate of two to three percent (EPA 2000, 48). However, because the OMB has mandated

a 7 percent discount rate in its 1996 revised guidance, the EPA felt compelled to present cost and

benefit estimates using alternative 2-3 percent and 7 percent discount rates (EPA 2000, 48).

Implicit throughout EPA’s discussion of the literature on social discounting is a sense that

OMB’s preferred 7 percent discount is inappropriate. Finally, it is worth noting that although

EPA’s 2000 Guidelines explicitly reject use of a zero discount rate, the agency does conclude

that it is appropriate that its BCAs present streams (but not summations) of non-discounted costs

and benefits over time.

Chapter 7 of EPA’s 2000 Guidelines addresses the equally important and contentious

issue of evaluating non-market effects of environmental policies, including the value of human

lives saved. The Guidelines discuss the wide array of market and non-market costs and benefits,

and various approaches – all of them more of less defective – to valuing non-market benefits,

such as contingent valuation and hedonic pricing. The EPA reviewed 26 articles, including both

labor market (wage-risk) and contingent valuation studies, estimating the value of a statistical

19

life. Those articles established a range of values (in 1997 dollars) from $0.7 million (Kneisner

and Leeth 1991) to $16.3 million (Garen 1988) (EPA 2000, 89, Exhibit 7-3). EPA chose the

mean of the range for its assumed value of a statistical human life: $4.8 million in 1990 dollars.

Adjusting for inflation, the value would increase to $6.1 million in 1999 dollars (EPA 2000, 90).

In addition to valuing lives saved, the EPA also had to estimate other values not entirely

encompassed in market prices, including the morbidity benefits of regulations, i.e., the avoided

costs of non-fatal illnesses, and ecological benefits. However, the agency did not adopt any

specific values with respect to such effects, as it did in the case of human-life valuations.

After addressing issues of social welfare calculation and distributional effects (i.e., equity

issues), the EPA concluded its 2000 Guidelines with some generally applicable rules governing

agency BCAs. It stressed that: all aspects of economic assessments should be presented clearly

and transparently; important data sources and references should be cited, along with their

assumptions and justifications; uncertainties should be highlighted by use of upper- and lower-

bounded ranges of expected values; policy outcomes should be monetized to the fullest extent

feasible; unquantifiable effects should be highlighted so that they are not ignored in policy

decisions based (in part) on BCAs; results of all distinct parts of the economic assessment –

BCA, economic impact analysis, cost-effectiveness analysis, equity effects, should be clearly

presented (EPA 2000, 175-178). Finally, the EPA stressed the limits of economic analyses for

regulatory decision-making: “The primary purpose of conducting economic analysis is to

provide policy makers and others with detailed information on [a] wide variety of consequences

of environmental policies.... Determining which regulatory options are best even on the

restrictive terms of economic efficiency, however, often is made difficult by uncertainties in data

20

and by the presence of benefits and costs that can only be qualitatively assessed. Thus, even if

the criterion of economic efficiency were the sole guide to policy decisions, social benefits and

cost estimates alone would not be sufficient to define the best policies” (EPA 2000, 178). In

concluding that BCA should not be the sole basis for environmental policy making, the EPA was

fully consistent with E.O. 12,866 (but not with its predecessor E.O. 12,291).

EPA’s 2000 Guidelines ostensibly constituted a major step in the evolution and

maturation of economic analyses at that agency. No longer, presumably, would various EPA

assessments rely, without explanation, on various discount rates and human life valuations

seemingly chosen at random. The agency finally had committed itself, on paper at least, to

follow certain standards consistently, even if those standards were contestable and not fully

consistent with OMB guidelines.

C. 2001 to the Present: Competing “Best Practice” Standards and the Political

Manipulation of BCA Under Bush II

Since 2000, the evolution of regulatory BCA within the federal government has been a

mixed bag of further methodological refinements and increased politicization. The further

refinements are mostly evident in the OMB’s latest revisions to Circular A-94 (OMB 2003). The

increased politicization is apparent in recent cases where BCAs have been blatantly manipulated

to achieve (or avoid) certain outcomes.

According to OMB, the purpose of its 2003 revised Circular A-94 on “Regulatory

Analysis” was to “refine” OMB’s “best practices” guidelines of 1996. Like EPA’s 2000

22 Members of the OMB peer review panel included Lester Lave, Milton C. Weinstein,James K. Hammitt, Kerry Smith, Douglas K. Owens, Cass Sunstein, Jonathan Weiner, and W.Kip Viscusi.

21

Guidelines, OMB’s the revised Circular A-94 was peer reviewed by a distinguished group of

social scientists.22 Interestingly, the OMB’s newest guidelines are less than one-third the length

of EPA’s Guidelines, and whereas the EPA’s Guidelines discussed and cited literally dozens of

works in the academic literature on BCA, the OMB’s 2003 Circular A-94 cited only a handful of

articles. In many respects, however, the OMB’s 2003 document and EPA’s 2000 document

express similar sentiments about the importance of consistency, clarity, and transparency in BCA

processes. Indeed, in some respects, OMB’s 2003 version of Circular A-94 expresses less faith

in BCA as a decision tool than did the EPA’s 2000 Guidelines. For example, OMB notes that

“you cannot conduct a good regulatory analysis according to a formula” because different

regulatory circumstances require “different emphasis in the analysis” and all BCAs require

“competent professional judgment” (OMB 2003, 3). The 2003 OMB Circular A-94 also states

that “[w]hen important benefits and costs cannot expressed in monetary units, BCA is less

useful, and it can even be misleading, because the calculation of net benefits in such cases does

not provide a full evaluation of all relevant benefits and costs” (OMB 2003, 10). With respect to

cost-effectiveness studies, the OMB denies any effort to impose on regulatory agencies a certain

approach; instead it suggests that agencies to experiment with “multiple measures of

effectiveness that offer different insights and perspectives” (although those measures should all

be clearly articulated and explained) (OMB 2003, 13). And in accordance with E.O. 12,866,

OMB’s 2003 Circular A-94 stresses the importance of distributional effects.

Much of the OMB’s discussion of BCA in 2003 Circular A-94 is uncontroversial and

23 However, OMB did not actually specify that it was advocating the use of the mean ofthe range. Nor did it specify whether its estimates were in current (2003) dollars.

22

thoroughly consistent with EPA’s 2000 Guidelines. Few of the standards OMB articulates

actually relate to the more controversial aspects of BCA, e.g., the selection of a discount rate and

the valuation of non-market goods, including human life. In its revised Circular A-94 OMB

acknowledges that some costs and benefits, including ecological benefits, can be difficult to

quantify. In dealing with such difficult-to-quantify costs, it calls on agencies to discuss the

“strengths and limitations of the qualitative information” (OMB 2003, 27). It even allows that

“unquantified benefits” might, from time to time, “affect a policy choice.” When that happens,

agency BCAs should “provide a clear explanation for the rationale behind the choice” (OMB

2003, 27).

In a section of the 2003 revised Circular A-94 devoted to assessing fatality risks, the

OMB addresses the contentious issue of choosing a method for assessing the value of statistical

human lives. First, the agency discusses the “value of statistical life” (VSL) method, which has

been the predominant approach since the 1980s. Where EPA (2000, 89-90) discerned a range of

VSL estimates in the literature from about $1 million to over $16 million, OMB’s 2003 Circular

A-94 indicates a range of $1 million to $10 million (OMB 2003, 30). Assuming that the mean of

the range is generally acceptable, OMB’s preferred VSL would be $5 million – very close to the

EPA’s selected mean of $4.8 million (EPA, 2000, 89-90).23 Importantly, the OMB rejected, at

least for the time being, the notion that VSL might be adjusted based on the age of members of

the affected population (OMB 2003, 30). This rejection was important because OMB previously

had been widely criticized for attaching lower values to the lives of elderly Americans.

23

On the other hand, OMB’s 2003 Circular A-94 addressed a second approach to valuing

fatality risks: “value of statistical life-years extended” (VSLY). This approach, in contrast to

VSL, does account for discrepancies in age among the members of affected populations. OMB

recommends that agencies adopt larger VSLY estimates for older citizens because they face

larger overall health risks from all causes and they may have greater accumulated savings to

spend on health care (OMB 2003, 30). Still, by its very nature the VSLY method discriminates

against older citizens because they have fewer life years remaining. Recognizing this problem,

OMB cautions agencies that “regulations with greater numbers of life-years extended are not

necessarily better than regulations with fewer numbers of life-years extended” (OMB 2003, 30).

Ultimately, OMB recommends that agencies provide estimates of both VSL and VSLY in their

BCAs (OMB 2003, 30).

Between 1996 and 2003, OMB marginally refined its position on the social rate of

discount. It maintains the same 7 percent discount rate as the “base-case for regulatory analysis”

(OMB 2003, 33), but adds that regulatory agencies “should provide estimates using both 3

percent and 7 percent” discount rates (OMB 2003, 24). The 3 percent rate is OMB’s estimate of

the “social rate of time preference.” In its 1996 version of Circular A-94, OMB discussed this

method of discounting, but did not make any recommendations based upon it. Apparently, by

2003 OMB had become convinced that such a recommendation was appropriate. Finally,

Circular A-94 recommends using other discount rates “to show sensitivity to the estimates of the

discount rate assumption” (OMB 2003, 24). Thus, OMB’s 2003 Circular A-94 is in complete

agreement with EPA’s 2000 Guidelines about the use of discount rates in regulatory economic

analyses, with the caveat that the EPA’s standards include a 7 percent discount rate only because

24

OMB requires it. A commentator on OMB’s revised Circular A-94 argued that OMB should

abandon the 7 percent discount rate, but the OMB rejected this recommendation on the grounds

that a lower discount rate (such as 3 percent) would “not be appropriate for regulations that had a

strong displacing effect on capital investment” (OMB 2003, 176). Once again, the OMB did not

consider the propriety of basing discount rates for environmental BCA on private investment

markets that themselves do not account for the environmental risks they generate.

OMB also discussed the problem of “intergenerational discounting,” that is, discounting

over long time periods. While recognizing that some scholars oppose discounting the utility of

future generations, OMB 2003 revised Circular A-94 offers two positive reasons for

intergenerational discounting: (1) the expectation that future generations “will be wealthier and

thus will value a marginal dollar of benefits and costs by less than those alive today”; and (2) the

longer the time horizon of the policy being analyzed, the greater the uncertainty concerning the

correct discount rate (OMB 2003, 36). Based on its reading in the literature on intergenerational

discounting, OMB recommends that agencies adopt a third discount rate, below 3 percent but

still positive, for assessing intergenerational costs and benefits (OMB 2003, 36).

Finally, OMB’s revised Circular A-94 addresses “other key considerations” in BCA,

including the treatment of technological change over time, and the treatment of uncertainty.

First, in recognition that technologies change in response to market forces as well as regulatory

requirements, OMB recommends that agencies “should assess the likely technology changes that

would have occurred in the absence of regulatory action (technology baseline)” (OMB 2003,

24 OMB ignored the opposite but equally important problem that industry cost estimatesoften overstate the costs of complying with regulations in part because industry assessments failto consider technological developments (see ).

25 This discussion of Clear Skies relies heavily on that CRS Report to Congress(McCarthy and Parker 2005).

25

37). Otherwise, agencies are likely to overstate the benefits of regulatory requirements.24 With

respect to uncertainty, OMB suggests that agencies respond by conducting additional research

prior to rulemaking, especially in cases of irreversible or large up-front investments, unless they

can show that the cost of delay is likely to exceed the value of any additional information (OMB

2003, 39). OMB also recognizes the growing literature on “real options” methods of

incorporating uncertainty into BCA (OMB 2003, 39).

Between EPA’s 2000 Guidelines and OMB’s 2003 revised Circular A-94, it appears that

the two agencies have been growing closer to an agreed set of standards for regulatory BCA.

Obviously, significant differences remain, and in the next section of this paper I will explain why

I think it unlikely that EPA and OMB ever will reach complete consensus on a set of “best

practices” for BCA. In any event, the improvements to BCA policies since 2000 have not been

matched by improvements in the consistency and adequacy of individual BCAs, which in some

cases at least continue to be highly influenced by partisan politics.

Political manipulation is plainly evident, for example, in the case of EPA’s 2005 BCA for

the Bush Administration’s “Clear Skies” initiative, which was extensively criticized in a recent

Congressional Research Service (CRS) Report to Congress (McCarthy and Parker 2005).25 The

ostensible goal of Clear Skies was to deal comprehensively with air pollution problems from the

electric utility industry. In 2003, that industry was responsible for 72 percent of all sulfur dioxide

26

emissions, 24 percent of nitrogen oxide emissions, and 41 percent of carbon dioxide emissions,

and more than 40 percent of all mercury emissions in the United States. Power plant emissions of

sulfur dioxide and nitrogen oxides has been trending downwards in recent years thanks mainly to

the acid rain program of the 1990 Clean Air Act Amendments. However, utilities have long

complained about the “complexity” of the “multilayered and interlocking pathwork of controls”

applied to them (McCarthy and Parker 2005, 2). As noted in the CRS Report (McCarthy and

Parker 2005, 2-3), a more simplified and uniform approach has been evolving for several years

within the EPA under existing statutory mandates. However, the Bush Administration and

Congress are both advocating new legislation that would, in a more comprehensive and

integrated way, regulate utility emissions of major air pollutants.

The Bush Administration supports a group of bills known collectively as “Clear Skies,”

which would require a 70 percent reduction in SO2 and NOX emissions by 2018, although actual

attainment would likely be delayed until 2026 or later because of the legislation’s generous

“banking” provisions. Two alternative legislative proposals, one sponsored by Senator James M.

Jeffords (I-Vt.) and the other by Senator Thomas R. Carper (D-Del.), would also permit banking

and trading of allowances, but would require greater overall emissions reductions on shorter

deadlines. In addition, and unlike Clear Skies, the Jeffords and Carper bills, would impose

regulatory controls to reduce utility emissions of carbon dioxide in order to mitigate climate

change.

26 This fact is itself problematic from the point of view of those concerned with thetransparency, clarity, and utility of BCAs.

27

On October 27, 2005, EPA published a BCA (comprised of 45 separate documents26)

which purported to compare the various legislative proposals to control air pollution emissions

from power plants. As a baseline for its BCA, EPA assumed unrealistically that in the absence of

new legislation neither EPA nor the states would impose additional regulatory controls on power

plant emissions. This assumption was flat out contradicted by three newly minted EPA rules

regulating power plant emissions of sulfur dioxide, nitrogen oxides, and mercury. EPA’s final

BCA for Clear Skies did not even mention those new rules. As the CRS noted in criticizing

EPA’s regulatory baseline assumptions, “[c]ontrolling air pollution is a moving target and ... it is

important that any analysis work from updated baseline projections and assumptions when

possible” (McCarthy and Parker 2005, 5).

One conclusion reached by EPA’s BCA on Clear Skies, and confirmed by the CRS

Report, was that Clear Skies would cost less than the alternative legislative proposals. According

to the CRS, this conclusion was unsurprising because Clear Skies “has less stringent

requirements and later deadlines” (McCarthy and Parker 2005, 5). On the other hand, Clear

Skies would yield fewer overall benefits than the other legislative proposals. According to the

EPA’s own estimates, the Clear Skies bill would provide $6 billion in annual benefits in 2010,

compared to $51 billion in annual benefits for Senator Carper’s bill and $83 billion in annual

benefits under Senator Jefford’s bill. “The higher benefits for the Carper and Jeffords bills reflect

the fact that Clear Skies’ required pollution caps are less stringent, and the implementation

schedule is more relaxed” (McCarthy and Parker 2005, 9).

27 This is an object lesson in how the failure to monetize (to the extent feasible)environmental benefits can lead to under-regulation. As has often happened in the past, whenEPA failed to express environmental benefits in economic terms, those benefits were assigned ade facto value of zero.

28

The incremental benefits of Clear Skies would be much lower, if EPA’s baseline

assumptions were changed to incorporate EPA’s recently promulgated rules on sulfur dioxide,

nitrogen oxide, and mercury emissions. According to the CRS Report to Congress (McCarthy

and Parker 2005, 9), incorporating those regulations into baseline would reduce Clear Skies’

incremental benefits (above baseline) to 10 percent in 2010 and only 2 percent in 2020. In sum,

the net benefits of Senator Jefford’s bill “far exceed those of Clear Skies” and Senator Carper’s

bill (McCarthy and Parker 2005, 11). However, the social welfare advantages of Senator

Jefford’s proposal were minimized in EPA’s BCA by the unrealistic assumption of a baseline

that (a) excluded recently promulgated rules and (b) presumed that, in the absence of new

legislation, no new regulations would be promulgated.

In addition to its unrealistic baseline assumptions, EPA’s “Clear Skies” BCA made no

attempt to monetize environmental benefits, which disadvantaged the Jeffords and Carper

proposals significantly because their more stringent emissions requirements were predicted to

lead to greater environmental benefits than the Bush Administration’s Clear Skies initiative.27

Worse still, the BCA did not model the health effects of regulating mercury emissions.

According to another CRS Report to Congress (McCarthy 2005), health benefits from EPA’s

mercury regulations could range from “a few million dollars per year to several billion dollars

per year” (McCarthy and Parker 2005, 15). Omitting these benefits from the Clear Skies BCA

favored the Bush Administration’s proposal over alternative proposals that would impose more

28 In another recent case, a U.S. Fish and Wildlife Service BCA for protecting endangeredbull trout in Montana was altered to eliminate 55 pages that detailed the expected benefits.According to the Fish and Wildlife Service, the pages were cut because the methodology usedwas deemed to be unreliable (Wash. Post, April 17, 2004). According to the Washington Post,the Bush Administration relied on similar methodology in deriving the benefits for its ClearSkies intiative, which it widely publicized.

29

stringent caps on mercury emissions. Similarly, the EPA’s BCA on Clear Skies did not attempt

to monetize the benefits of reductions in carbon dioxide emissions.

Finally, the EPA’s Clear Skies BCA unreasonably assumed that the price elasticity for

electricity and natural gas would be zero and that power plants were subject to short-term

construction constraints. Both of those dubious assumptions served to make the Bush

Administration’s Clear Skies initiative more attractive and Senator Jefford’s bill in particular

less attractive. The CRS concluded that “EPA’s benefit analysis is limited and incomplete, which

works to the disadvantage of alternatives to Clear Skies that include more stringent standards”

(McCarthy and Parker 2005, 16). A Washington Post reporter was somewhat more pointed in her

conclusion: “The Bush Administration skewed its analysis of pending legislation on air pollution

to favor its bill over two competing proposals.” The EPA, in response, argued that the CRS

“ignores and misinterprets our analysis” (Wash. Post, May 11 2006). Interestingly, OMB has

been silent about EPA’s BCA for Clear Skies,28 which again raises the question of whether OMB

review is designed to maximize regulatory efficiency or minimize regulatory impositions.

In other cases, the OMB has reviewed agency BCAs in ways that appear (at least) to be

politicized. Despite regular OMB denials that it is an anti-regulatory agency, the empirical

evidence suggests otherwise. According to a recent review by the legal scholar David Driesen

(2006, 364-380), of 25 environmental, health and safety regulations “significantly affected” by

29 For a discussion of under-regulation by EPA, see, e.g., Heinzerling (1998, 2014-17).

30 In fact, Driesen’s conclusion goes farther in alleging that BCA itself has an inevitableanti-regulatory bias. While I agree with him that there is no such thing as an “objective” BCA, Ido believe that BCA can be performed in a reasonably unbiased manner. That OMB may, in fact,have an ant-regulatory bias is not proof that BCAs inevitably are biased.

30

OMB review between June of 2001 and July of 2002, 24 were significantly weakened and none

was strengthened. Now this may just be evidence that environmental, health and safety agencies

always over-regulate and never under-regulate, but that hardly seems likely.29 More likely, as

Driesen (2006) concludes, OMB review is not nearly as neutral as OMB officials and supporters

would have us believe.30

Another recent study by Larua J. Lowenstein and Richard L. Revesz (Nov. 2004) found

that OMB, in reviewing EPA BCAs, regularly substituted its own cost and benefit valuations

based on “questionable techniques that inappropriately lower[ed] the value assigned to human

lives:” The Bush EPA has embraced the Value of Statistical Life-Years Saved (VSLY) approach,

instead of the traditional Value of Life Saved (VSL) approach to valuing human lives. The

VSLY approach (as already noted) reduces the expected benefits of regulation by assigning

lower values to the lives of older, unhealthy, and disabled Americans. Pursuant to its newly

adopted VSLY approach, the EPA derived an age-based adjustment factor that reduced VSL

estimates by 37 percent for individuals aged 70 and over. That age adjustment factor was based

on a single study conducted in the United Kingdom in 1989, even though more recent and

comprehensive American studies were available. In addition, EPA “encouraged the use of a

substantially-reduced initial VLS estimate from which life-year values were derived.”

Obviously, the lower the initial VSL, which is subsequently discounted according to estimated

31 They also led to a backlash against EPA and OMB, which ultimately led to theabandonment of the “senior death discount,” as it came to be known (Lowestein and ReveszNov. 2004).

32 Letter from William Funk to Lorraine Hunt, Office of Information and RegulatoryAffairs, OMB, dated April 24, 2003 (copy of letter on file with the author).

31

life-years remaining, the lower the VSLY-based benefits of regulation. Finally, EPA assumed

that the reduction in life expectancy associated with exposure to particulate matter (dust and

soot) is only five years, regardless of the individual’s age at time of death. Significantly, EPA

did not explain any of these “radical” departures from prior practice. Lowestein and Revesz

(Nov. 2004) conclude that “the current administration’s approaches to valuing environmental

benefits are theoretically unjustified and have a profound anti-regulatory impact.”31

Even though EPA and OMB have come closer to agreement about basic principles for

BCA over the past several years, the practice of BCA at both the EPA and the OMB remains

substantially politicized and methodologically inconsistent. In 2003, law professor William Funk

noted that OMB estimates of the costs and benefits of major rules still sometimes differ from

regulatory agency estimates “by more than an order of magnitude.”32 For example, Funk noted

that the U.S. Department of Agriculture’s estimate of the costs and benefits of a new labeling

rule for meat and poultry were $218-272 million and $1.75 billion, respectively. OMB’s

estimates of the costs and benefits of that same rule were $25-32 million and $205 million,

respectively. Both agencies amortized costs and benefits over a 20-year period using a constant 7

percent discount rate. What, then, explains the discrepancies? As Professor Funk notes, if a

“principle function of quantitative cost-benefit analysis is to improve the transparency of

analysis while improving public understanding of the costs and benefits of regulation,” that

33 So, too, I might point out, would regulatory compliance with EPA’s more detailed2000 Guidelines.

34 There is no reason, of course, why the OMB cannot issue such “prompt letters,” as itsdiscretion, under current circumstances. And it is unclear that an express authorization, as to amandate, to do so would alter current OMB practice.

32

function is “thwarted ... when radically divergent numbers are offered without explanation of the

reasons for the difference.” Whatever progress may have made toward achieving consensus in

principles and practices of BCA over the past two decades, it is clear that a great deal more

remains to be done.

II. WHERE DOES BCA GO FROM HERE?

A NEW EXECUTIVE ORDER OR AN INDEPENDENT TASK FORCE?

In order to correct continuing problems with the use of regulatory BCA, Robert Hahn and

Cass Sunstein (2002) recommend that President Bush issue a new executive order to add

“greater depth and width” to BCA by incorporating eight specific recommendations: First, it

should “explicitly requir[e] agency compliance with OMB guidelines for regulatory analysis.

According to Hahn and Sunstein (2002, 1494), “regulatory compliance with [OMB] guidelines

would significantly increase the rationality and coherence of the regulatory process.33 Second, to

reduce the actual or perceived anti-regulatory bias of OMB’s BCA process, Hahn and Sunstein

(2002, 1494-95) would create a mechanism whereby OMB might issue “prompt letters” to “spur

regulation in those cases where it will do more good than harm.”34 Third, agency BCAs should,

to the extent consistent with enabling statutes, consider substitute risks that might be created by

35 See supra note 10

33

regulations; at the same time, agencies should avoid regulating de minimis risks. Fourth, when an

agency promulgates a regulation that fails a strict BCA (of quantified costs and benefits), it

should its rationale for acting. For example, a statute might require the agency act regardless of

the outcome of a BCA, or the agency may base its decision on important and thoroughly

explained qualitative data that are not quantifiable. According to Hahn and Sunstein (2002,

1496), such explanations would contribute to accountability and transparency. Fifth, Hahn and

Sunstein (2002, 1496) suggest that agencies should make the underlying assumptions of their

BCAs explicit, so that “interested parties inside and outside of the government can understand

how the results were obtained, and perform their own analysis of the issue if they so choose.”

Sixth, each year agencies should generate backward-looking “regulatory retrospectives” as well

as forward-looking “regulatory plans.” The purpose of the annual retrospectives would be to

facilitate OMB’s task of preparing its annual reports to Congress on executive branch

regulations. The purpose of the annual plan would be to facilitate OMB’s early participation in

the BCA. Seventh, Hahn and Sunstein (2002, 1496) recommend that the new executive order

extend BCA requirements to “independent” regulatory agencies. While recognizing that such

agencies never have been subject to executive orders in the past, Hahn and Sunstein (2002,

1531-37) argue that such orders might lawfully be extended to them.35 Eighth and finally, Hahn

and Sunstein (2002, 1497) recommend that the new executive order authorize limited judicial

review of agency BCAs. In effect, BCAs would come within the ambit of the Administrative

Procedures Act (APA) (5 U.S.C. § 553), so that a reviewing court could invalidate a regulation

36 It it not clear that such an express authorization is necessary. Courts have, if onlyrarely, overruled agency regulations based on defective BCAs. See, e.g., Corrosion ProofFittings v. U.S. Environmental Protection Agency, 947 F.2d 1201 (5th Cir. 1991) (overturningEPA regulations banning certain uses of asbestos in the workplace in large part because of theagency’s failure to provide substantial evidence that its proposed bans constituted the “leastburdensome regulation,” as required under the Toxic Substances Control Act (TSCA), 15 U.S.C.§ 2650). Of course, in that case the court could rely on express statutory language that seemed torequire a BCA. However, there is no reason why courts, on their own initiative, could notconstrue the Administrative Procedures Act (5 U.S.C. § 553) to require BCAs to support allmajor rules under that statutes prohibition on “arbitrary and capricious” regulations.

34

based on a defective BCA as “arbitrary and capricious.36

Several of Hahn and Sunstein’s (2002) recommendations are appealing (I will discuss

some of them inter alia). However, their recommendations are unresponsive to several of the

methodological problems identified in the previous section of this paper. One reason for this is

that Hahn and Sunstein’s recommendations were not motivated primarily by the authors’

perception of methodological problems in BCA. Rather, Hahn and Sunstein (2002) were

concerned primarily about a perceived lack of compliance with (presumably well-established)

BCA principles, resulting in regulations that “seem to do more harm than good.” (Hahn and

Sunstein 2002, 1490). The empirical basis for this finding was a book by Hahn (2000, 15-19),

which examined 24 regulations and found that only 9 would pass a BCA (see Hahn and Sunstein

2002, 1490-91). Thus, despite their recommendation concerning regulatory “prompt letters,”

Hahn and Sunstein’s immediate concern was inefficient over-regulation. In addition, Hahn and

Sunstein’s recommendations (particularly the first and sixth recommendations) suggest that the

problems with BCA in the federal government lie primarily with the regulatory agencies and

hardly at all with OMB. Importantly, their recommendations (except the one relating to OMB

“prompt letters”) would not significantly alter current OMB principles or practices relating to

37 See especially supra notes 16-17 and accompanying text (describing Dean RichardRevesz’s 1998 congressional testimony criticizing OMB’s BCA principles and practices).

35

BCA. Perhaps Hahn and Sunstein believe that OMB already has succeeded in deriving a set of

“best practices” for BCA with which regulatory agencies simply should be required to comply. If

so, I would suggest they are mistaken for reasons outlined in the previous section.37 To the extent

that OMB’s own BCA principles and practice require revision, Hahn and Sunstein’s (2002)

recommendations are at best immaterial and potentially harmful (especially the first which

would require regulatory agencies to comply with OMB standards no matter how unreasonable

those standards might be).

The history of regulatory BCA in the federal government, recounted in the preceding

section, suggests that the situation is rather more complicated than Hahn and Sunstein’s (2002)

simple story of agency under-compliance with presumably well-founded OMB procedures. In

reality, that history has been a mixed bag of progress and politics on the part of all institutional

players, including the OMB. Were we to predict the future based on the past, we might expect

some additional tinkering with BCA policies at both OMB and EPA. The two agencies might

come somewhat closer to consensus on methodological principles. But because of their divergent

institutional missions and political predilections it seems highly unlikely that they will ever agree

in principle, let alone in practice, to a single, useful set of “best practices” for CBA. In some

cases – particularly those in which the political stakes are high – economic analyses likely would

be politicized and manipulated by one institution or another to achieve preferred policy

outcomes.

36

For that reason, this paper recommends that the task of establishing “best practice”

standards be taken out of the hands of the government agencies that prepare and review them.

Instead, those standards should be set by a specially appointed group of independent economists,

legal scholars, and policy analysts convened under the auspices of a quasi-governmental

organization, such as the National Academy of Sciences, or a non-governmental organization,

such as the American Economics Association or the Association of Environmental and Resource

Economists. The goal would not be to establish a “pure” set of “neutral and objective” “best

practices;” BCA simply contains too many subjective elements to ever claim the mantle of

objectivity. Nor should we suppose that individual members of any group assigned to draft a set

of “best practices” would come to the task without their own predispositions and biases.

However, if the group is sufficiently large and representative of differing viewpoints, many of

those predispositions and biases are likely to wash out. Meanwhile, the group’s independence

from the immediate political concerns of government agencies would allow it to take the time to

more carefully review and discuss the existing literature on BCA. There is reason to believe that

any set of (revisable) “best practices” established by such a non-governmental group is likely to

less politicized and more legitimate than any set of “best practices” the OMB might seek to

impose on the EPA and other regulatory agencies.

Moreover, it makes sense that the social-scientific community would play a central role

in defining what counts as “best practices” in BCA, given that BCA is supposed to be (more or

less) scientific process. Society does not rely on government agencies to determine “best

practices” for medical or dental procedures, constructing and conducting experimental economic

studies, or performing empirical legal studies. Instead, society relies on more or less formal

37

cohorts of medical, natural, and social scientists to develop “best practice” models. It hardly

seems radical to suggest that independent social scientists play the lead role in developing “best

practices” for the social-scientific tool known as BCA.

Fortunately, an independent BCA task force will already have a head start on the process

of setting “best practices” thanks to the efforts of economists and legal scholars who already

have identified – independently of government political concerns – the proper role of,

approaches to, and limitations of BCA. The next section discusses some of the existing literature

on which the BCA “best practices” task force might rely; and it rehearses some recent

contributions to that literature relating to the more contentious (because subjective) elements of

BCA, including human life valuations and social discount rates.

III. HOW AN INDEPENDENT TASK FORCE MIGHT APPROACH THE PROBLEM OF DERIVING

“BEST PRACTICES” FOR REGULATORY BCA

A. Begin By Determining What is Not Controversial in BCA

The logical starting point for any task force seeking to derive a set of “best practice”

standards for regulatory BCA is to separate out those aspects of BCA that are generally

uncontroversial, and on which consensus already exists, from the more controversial aspects that

require greater research and discussion. Several basic and generally agreed-upon principles of

BCA were set out in a short article by Arrow et al. (1996) in the journal Science: First, BCA is a

more or less useful tool of policy analysis, although in cases of great uncertainty a BCA may not

38 The ostensible purpose of this normative suggestion was to encourage Congress toamend statutes that seem to prevent the use of BCA. For example, the U.S. Clean Air Act (42U.S.C. §§ 7401 et seq.) requires that national ambient air quality standards (NAAQS) for criteriapollutants be set only with regard to public health (42 U.S.C. § 7409). The EPA consistently hasinterpreted this provision to not allow considerations of cost in setting NAAQS. The SupremeCourt upheld this interpretation of the Act in American Trucking Association v. Whitman, 531U.S. 457 (2001), despite an amicus brief from the authors of the Science article arguing that EPAshould be allowed to consider costs in setting NAAQS. It is worth noting, however, that it hasbecome standard practice at EPA to prepare BCAs for proposed changes in NAAQS (as theagency did in promulgating new NAAQS for particular matter and ozone, which were the objectsof litigation in the American Trucking case). Those BCAs cannot be used for setting policy, butEPA recognizes that favorable BCAs (those that show substantial net benefits) can serve toneutralize political opposition.

38

be able to draw firm conclusions about social welfare effects. Second, policy-makers should be

allowed and encouraged to use BCA.38 Third, BCAs should be required for all major regulatory

decisions. Fourth, agency actions should not be bound by BCAs, even where BCAs indicate

substantial net social costs, because “factors other than aggregate economic benefits and costs,

such as equity within and across generations, may be important in some decisions.” Fifth,

benefits and costs should be quantified to the extent feasible, and best estimates should be

presented along with a description of uncertainties. Importantly, Arrow et al. (1996, 222) note

that quantitative factors should not be allowed to dominate important qualitative factors in

policy-making. Indeed, they support the notion that agencies might build “margin[s] of safety”

into their regulations. However, all qualitative judgments in BCAs should be explicit. Sixth,

Arrow et al. (1996) note that the more external review a BCA receives, the better it is likely to

be. Thus, they support both peer review and OMB review of regulatory BCAs. They also support

retrospective analyses to determine post hoc the quality of BCA predictions of future costs and

benefits. Seventh, regulatory BCAs should be based on a “core set of economic assumptions,”

including about discount rates, human life valuations, and health improvements, for the sake of

39 See supra note 4 and accompanying text.

39

consistency and comparability. To this end, “[a] single agency should establish a set of default

values for typical benefits and costs and should develop a standard format for presenting results”

(Arrow et al. 1996, 222). In other words, a set of “best” or “standard” practices should be

adopted. As part of this recommendation, Arrow et al. (1996, 222) note the importance of

discounting future benefits. But, they suggest, the discount rate should be “based on how

individuals trade off current for future consumption.” This approach would almost certainly

favor a lower rate than the OMB’s current base-case rate of 7 percent. Given the difficulty (even

impossibility) of identifying a single, correct discount rate, Arrow et al. (1996, 222) recommend

using a range of discount rates, noting that the same range should be used consistently in all

regulatory BCAs. Eighth and finally, the authors note that even though overall efficiency is an

important goal, agency economic analyses should pay close attention to the distributional

consequences of their policies. They caution, however, that environmental (among other public

health and safety) regulations “are neither effective nor efficient tools for achieving

redistributional goals” (Arrow et al. 1996, 222). Arrow and his colleagues conclude by

reiterating that BCA is not a panacea for policy-making: “formal benefit-cost analysis should not

be viewed as either necessary or sufficient for designing sensible public policy.” It can, however,

“provide an exceptionally useful framework for consistently organizing disparate information,

and in this way, it can greatly improve the process and, hence, the outcome of policy analysis”

(Arrow et al. 1996, 222).

Few readers would find any of Arrow et al.’s assertions to be controversial (except,

perhaps, among those who deny any useful role for BCA in public policy-making39). OMB might

40 See supra note ___ and accompanying text.

41 One exception may be the commitment of Arrow et al. (1996) to discounting allfuture benefits and costs in every case. In the next section of this paper, I will present reasonswhy a task force appointed to establish “best practices” for BCA should at least take seriouslyarguments that intergenerational discounting (that is, discounting at a non-zero rate) is notalways appropriate.

40

disagree with the recommendation that discount rates be based solely on individual decisions

about trading off between present and future consumption, without any consideration for the

displacement effects on private investment.40 Otherwise, there seems very little about which

either the OMB, the EPA, or any other producer or consumer of BCAs would complain.41 Arrow

et al. (1996) articulated generally acceptable principles or standards for producing quality

economic analyses. They are not, however, sufficient. The chief problem is that the standards

enunciated by Arrow et al. (1996) are very general. As always, the devil is in the details. We

might all agree that regulatory BCAs should always use a range of discount rates for converting

future costs and benefits into present prices. But just what should those rates be? We probably all

would agree that agencies should establish a “core set of assumptions” for valuing for non-

market goods, such as human lives and ecological goods, and apply them consistently from one

BCA to the next. But just what should those core assumptions be? Arrow et al. (1996) provide a

useful starting point for independent efforts to derive “best practices” for regulatory BCA, but

most of the heavy lifting remains to be done.

42 This paragraph is based in large part on a chapter by the same author in Laitos et al.(2006, 50-51).

41

B. The Hard Part: Achieving Consensus on the Devilish Details

In a way, Arrow et al. (1996) create a misleading impression that BCA is less

complicated and controversial than it really is. Even the aspects of economic analysis that appear

to be purely mechanical, such as identifying the policy alternatives and listing their impacts, are

not as straightforward as they might appear.42 Sometimes, there seem to be an almost unlimited

number of policy options for dealing with a particular environmental problem. Consequently,

policy analysts are forced to draw more or less arbitrary lines between those alternatives that are

addressed in a regulatory BCA and those that are not. Likewise, analysts must draw lines in

deciding which effects of different regulatory alternatives (including the “do nothing”

alternative) are considered (or not considered) in a BCA. For example, a decision to locate a new

road entails various direct and indirect, primary, secondary and even tertiary effects. Among the

primary effects are the direct costs for labor and machinery, and lost opportunities for using the

land to be covered by the road for alternative purposes. Once built, the road will have various

secondary impacts, as its very existence spurs development of adjacent lands, particularly at

major intersections. Presumably those indirect and secondary impacts should be considered as

part of the BCA for the road project. But what about tertiary effects, for example if the increased

development resulting from road construction displaces economic development from some other

area of the state? It probably would not be good enough simply to specify, for example, that

policy-makers should consider all “foreseeable and significant” impacts, because what is

43 For an assessment of the current state of the art, see Kopp, Krupnick and Toman (Jan.1997) and Ashenfelter (Jan. 2006).

44 Lowenstein and Revesz (Nov. 2004) argue that the value of contingent valuationstudies remain quite limited, and that it is inappropriate for agencies to put great stock incontingent valuation studies especially when wage-studies and other more accurate measures ofhuman-life valuations based on willingness-to-pay and willingness-to-accept are available.

42

“foreseeable and significant” often is in the eye of the beholder. Meanwhile, decisions about

which alternative policies, and which impacts of those policies, to consider in a BCA are always

likely to be a mere subset of all the conceivable alternatives and impacts. More or less arbitrary

lines must be drawn, and just where those lines are drawn will affect the outcome of a BCA.

Such problems pale in comparison, however, with the inherently more controversial

aspects of economic analyses: valuing human lives (and other non-market goods) and selecting

discount rates. These are the issues on which an independent BCA task force would clearly

spend the bulk of its time and effort.

1. A Few Thoughts on Valuing Human Lives and Health (Among Other Non-market

Goods)

The theoretical, experimental, and empirical literatures on valuing non-market goods,

including human lives, has expanded tremendously over the past 20 years.43 Some real progress

has been made – for instance, contingent valuation techniques have been improved significantly

(see, e.g. Arrow et al. 1993; Carson et al. 1996) – but obviously a great deal of room remains for

further improvements.44 This is not the place for a thorough literature review, or even a review of

all the issues relating to valuation of non-market goods. I would, however, like to stress just a

45 See the discussion in the last section of EPA’s unjustified substitution of VSLY forVSL.

46 Also see the discussion in the previous section of EPA’s abuse of the VSLY method.

47 See supra note 16.

43

couple of points that have been under-emphasized in the literature.

One major current debate in this area of CBA concerns the choice between the value-of-

statistical-lives (VSL) and the value-of-statistical-life-years (VSLY) technique.45 The former has

been the traditional approach to valuing human lives, but in recent years the later technique has

gained adherents (see, e.g., Moore and Viscusi 1988; Aldy and Viscusi Apr. 2006).46 The appeal

of VSLY is that it differentiates in an intuitive way between saving young lives and saving the

lives of older people. The presumption is that society benefits more from saving younger lives

because of their greater productive potential. In addition, it seems more fair to value younger

lives more highly because older people have already benefitted from more life opportunities and

experiences. Differentiating between older and younger lives seems intuitively sensible because

of the way individuals tend to regret more the loss of young life. Consider the typical responses

to the respective deaths of a 15-year-old and a 74-year-old, even if their deaths result from

identical causes (say, cancer). Normally, individuals would consider the death of the 15-year-old

the greater loss the 74-year-old already had “lived a full life.” However, as Richard Revesz

pointed out in testimony before Congress in 1997,47 the VSLY approach generally ignores the

fundamental economic principle of scarcity: “Just as individuals value diamonds more than

water (because diamonds are scarcer), so too they are likely to value life years more highly when

they have fewer life years left.” In addition, VSLY bears no connection to individuals’

48 Lowenstein and Revesz (Nov. 2004, ___) cite recent empirical studies indicate thatolder Americans and unhealthy Americans do not have lower willingness-to-pay forenvironmental regulations; indeed some studies suggest that older Americans are willing to paymore than younger Americans (see, e.g., Alberini et al. 2002; Smith 2002).

49 See id.

44

willingness-to-pay.48 Consequently, there is no principled economic basis for discriminating

against the elderly in regulatory BCA on account of the life years they have already spent. Dean

Revesz also offers a scathing critique of the alternative approach known as Quality-Adjusted

Life Years (QALY), according to which the lives of people who already have diseases, such as

asthma, should receive a lower value in BCA than the lives of healthy individuals. This

approach, Dean Revesz concludes, is simply “incompatible with cost-benefit analysis,” because

it irrebuttably presumes that individuals in poor health possess a lower willingness-to-pay for

environmental, health and safety regulations.49 Dean Revesz may (or may not) be right that

QALY and VSLY approaches are never preferable to the traditional VSL approach. One of the

more important jobs for an independent task force assigned to derive a set of “best practices” for

environmental BCA is to work through the literature on VSL, VSLY, and QALY more carefully

and thoughtfully than the OMB, the EPA or any other agency has done so far in order to better

explain the various strengths and weaknesses of each approach and recommend which approach

is most appropriate in various circumstances.

“Best practice” standards for valuing human lives, environmental amenities and other

non-market goods are never going to be completely uncontroversial, and they certainly should

not be immutable. But they might be made marginally less controversial than they are today, if

an independent task force can provide clear and coherent reasons why certain valuations are

50 This example is taken from Cole and Grossman (2005, 326).

45

better than others for various certain kinds of regulatory BCAs.

2. Some Thoughts on Discounting

Economists and other scholars have made progress in narrowing the range of discount

rates that are appropriate for environmental BCA. There now seems to be consensus on at least

two points: (1) OMB’s old 10 percent discount rate was too high; and (2) BCAs generally should

provide calculations based on a range of alternative discount rates, in recognition that any single

chosen discount rate may well be mistaken. I do not know of any professional economist, legal

scholar, or policy analyst (outside of the private industries that are subject to environmental

regulation) who does not concur in these two points. Yet, nothing in BCA remains as contentious

as the issue of discounting. The reason for this is obvious enough: even a small change in the

discount rate can have a profound impact on the outcome of a BCA, even without changing any

of the underlying cost and benefit figures. A public policy/investment that would produce $10

million in net benefits 100 years from now has a present value of just under $30,000 using a

discount rate of 6 percent. If we changed the discount rate from 6 percent to 4 percent, the

present value of the policy/investment would rise almost $200,000. And if we lowered the

discount rate to 3 percent, the present value of the policy/investment would be more than

$500,000.50 Importantly, neither the 6 percent, 4 percent or 3 percent rate is objectively correct.

There is no such thing as an objectively correct social discount rate. As Paul Portney and John

Weyant (1999, 4) have observed, “[t]hose looking for guidance on the choice of a discount rate

51 For a particularly clear explanation of the arguments in favor of discounting, see Farberand Hemmersbaugh (1993).

46

could find justification [in the literature] for a rate at or near zero, as high as 20 percent, and any

and all values in between.”

Since Portney and Weyant (1999), a consensus seems to have emerged, at least with

respect to environmental BCAs, that discount rates in excess of 7 percent are unjustifiable.

Indeed, many scholars and policy analysts today believe that OMB’s preferred base-case rate of

7 percent is twice as high as it should be. That is to say, the literature on social discounting of

future environmental costs and benefits is evolving toward a lower range of acceptable discount

rates.

But should regulatory BCAs discount future costs and benefits in the first place? This

question has not been seriously contemplated for a long time. Most of us (the present author

included) take the answer for granted because it seems so obvious. On closer examination,

however, it is not so clear that the practice of discounting is always well justified.

There are three main arguments in favor of discounting future costs and benefits in

environmental BCAs: (1) the time value of money/opportunity cost of capital; (2) the observed

fact that all individuals always discount future costs and benefits at some positive rate; and (3)

not discounting leads to perverse results.51 Each of these arguments is correct, but I will argue

that only the first and second provide substantial justification for discounting.

The first reason to discount is because of the time-value of money/opportunity cost of

capital. Since a dollar today can be invested at a positive rate of interest to yield more than one

dollar at some future date (after adjusting for inflation), a future dollar simply must be worth less

52 For empirical confirmation of this, see, e.g., Moore and Vicusi (1990a, 1990b);Johannesson and Johanson (1996) and Poulos and Whittington (2000).

47

than one dollar today. The second reason to discount is that we all do it, formally or informally,

virtually all of the time.52 Approach a stranger and ask her whether she would rather you gave

her a dollar today or a dollar two days from now, and the response will always be the same. For

each of us, a dollar today simply is more valuable than a dollar tomorrow, or the next day, or the

day after that. Thus, as David Pearce et al. (2003, 122) conclude, it is a “brute fact ... that we do

discount for time and for space.” Finally, economists note that not discounting leads to perverse

results. This is their trump card – the argument they always pull out whenever anyone suggests

that future environmental costs and benefits should not be discounted. They usually make the

point by telling a simple story. Here is the EPA’s version of that story:

Suppose ... there is a policy that is estimated to save five lives in the year it is

implemented. This policy can either be implemented today (Option A) or 20 years

from now (Option B), and the undiscounted costs in current dollars are the same

for both options. If the discounted costs are compared with undiscounted benefits,

a cost-effectiveness evaluation will clearly favor Option B. Thus, failing to

discount benefits can produce a situation in which society has little motive to

pursue current environmental benefits because by investing instead, larger net

environmental benefits can be gained in the more distant future (EPA 2000, 53).

48

OMB tells variations on the same story to make the same point about the perverse outcomes of

BCAs that do not discount future costs and benefits:

First, consider the simple case in which the agency faces two regulatory

alternatives: Option A will save 10,000 lives within 15 years and Option B will

save 10,000 lives in 50 years. If a zero discount rate is applied to these health

gains, the two options will be viewed as equivalent, which is counter to the

common sense and technical view that it is preferable to save the 10,000 lives

sooner rather than later....

Second, consider a slightly more complex case where Option A, which saves

10,000 lives at a low cost (e.g., $10 million or $1,000 per life saved) is being

analyzed as to the proper effective date. If a lower discount rate is applied to

future health gains than future costs, then it can be shown that Option A will look

even better analytically if the effective date is delayed a year (because the future

costs will be discounted more than the future lifesaving). This reflects the Keller-

Cretin paradox, named for analysts at the Rand Corporation, which states that any

attempt to assign a lower rate of discount to future health gains than costs will

produce the perverse result that an attractive lifesaving investment will always be

made more attractive with delay of its effective date. In order to avoid this

perversity, there is professional consensus that the same discount rate should be

applied to future health gains and costs (OMB 2003, 177).

53 Citations omitted.

54 Quoted in Devine (2004, 211). See also Cowen and Parfit (1992).

55 Although, it may be subject to John Maynard Keynes’s (2000 [1923], __) hard and fasttime horizon: “Long run is a misleading guide to current affairs. in the long run, we are alldead.”

49

Pearce et al. (2003, 125) explain the “Keller-Cretin paradox” this way: “The logical implication

of zero discounting is the impoverishment of the current generation. This finding would of

course relate to every generation, so that, in effect, each successive generation would find itself

being impoverished in order to further the well-being of the next,” ad infinitum.53

The stories told by the EPA and the OMB plainly illustrate how not discounting can lead

to perverse outcomes, i.e., outcomes that cut against strong moral intuitions we all hold. The

argument seems compelling, but there is one problem: in some cases discounting itself leads to

perverse results. The philosopher Derek Parfit (1984, 357) has observed that “[a]t a discount rate

of five percent, one death next year counts for more than a billion deaths in 500 years. On this

view, catastrophes in the further future can now be regarded as morally trivial.”54 The 5 percent

discount rate would justify deliberate decisions today that we know, with certainty, would be

immensely harmful in the distant future. The economist Robert C. Lind (1990, S-20) similarly

notes that the practice of discounting “implies that, regardless of how small the cost today of

preventing an environmental catastrophe that will eventually wipe out the entire economy, it

would not be worth this cost to the present generation if the benefits in the future are sufficiently

distant.” This outcome from discounting is not obviously less perverse than those cited by OMB

and EPA from not discounting.55 The same moral intuition that urges us to save 10 lives sooner

rather than later finds repugnant the notion that millions or billions of future lives might be

50

deliberately forfeit to save a single life today. Likewise, our moral intuition suggests that it is

worth bearing a small cost today to avoid a certain future environmental catastrophe. If both

discounting and not discounting lead to perverse outcomes in some (perhaps extreme) cases,

then, as a general rule, those outcomes cannot constitute good reasons for either discounting or

not discounting.

The practice of discounting remains strongly supported, however, by the time value of

money/opportunity cost of capital and the fact that individuals do seem to discount future costs

and benefits at some positive rate virtually all of the time. Nevertheless, an independent task

force charged with establishing a set of best practices for BCA should at least take seriously

arguments against discounting (at least in some cases). We have already seen that Parfit (1984)

thinks discounting is morally dubious. He is not alone. Many bright thinkers, including several

eminent economists, have argued, and continue to argue, against discounting in at least some

cases. Their arguments deserve careful and respectful attention.

Stanley Jevons (1941 [1871], 72-3) accepted that individuals do discount future costs and

benefits, but he thought it an immoral practice: “To secure a maximum benefit in life, all future

pleasures or pains, should act upon us with the same force as if they were present, allowance

being made for their uncertainty .... But no human mind is constituted in this perfect way: a

future feeling is always less influential than a present one.” In 1928, Frank Ramsey (1928, 261)

wrote that discounting is “ethically indefensible and arises merely from the weakness of the

imagination.” Forty years later, William Baumol (1968, 801), suggested that a zero discount rate

might be sensible in some narrow circumstances to avoid irreversible and potentially

catastrophic environmental harms. More recently, Partha Dasgupta (2001, 105-06) recommended

56 Farber (2003) is another supporter of hyperbolic discounting.

57 Schelling (1999), by contrast, believes that discounting is not even an appropriate toolfor assessing climate change policies because those policies are not like normal investments,where X invests or saves now for X’s own future benefit. Rather, in Schelling’s view climatechange policies are more like foreign aid programs because the investments will be made by X –current generations in developed countries – for the benefit of Y – present or future generationsin developing countries, which in the absence of policies to mitigate the effects of climatechange are likely to bear most of the costs.

51

hyperbolic discounting “at a rate that declines with time and tends to zero.”56 Elsewhere,

Dasgupta and co-authors Karl-Göran Mäler and Scott Barrett (1999) have suggested the

appropriate discount rate for future costs and benefits relating to global climate change, which

they recognize as a special case, might be zero or even negative.57

How certain should we be that all of these eminent economists are wrong, and that we are

correct in our belief that a zero discount rate is never appropriate? This is a question I would

pose to the independent task force charged with establishing a set of “best practices” for

environmental BCA.

Even if we are right that future costs and benefits always should be discounted at some

positive rate, does current BCA practice, which relies for the most part on bifurcated analyses

using 7 percent and 3 percent discount rates, reflect the “best” practice? It is increasingly

difficult to find an economist or policy analyst outside of the OMB or private industry who

believes that a 7 percent discount rate should be the “base-case” rate for environmental BCAs.

To the contrary, economists seem increasingly to agree with Partha Dasgupta (2001) about both

the propriety of “hyperbolic discounting,” i.e., using discount rates that decline over time, and

using lower rates tending toward zero. In a recent survey, Martin Weitzman (2000) asked 2000

of his fellow economists to give him their “professionally considered gut feeling” about the

58 The discussion of Weitzman’s survey and the UK Treasury’s scheduling of declininglong-term discount rates is adapted from Cole and Grossman (2005, 326-27).

52

appropriate discount rates for assessing policies designed to mitigate global climate change (an

environmental problem requiring policies with pretty long time horizons). Weitzman aggregated

their responses in the table appearing below:

Table 1: Aggregation of Economists’ Recommended Discount Rates for Climate Change Policy

Time from Present Discount Rate (%)

1-5 years 4

6-25 years 3

26-75 years 2

76-300 years 1

More than 300 years 0

Source: Weitzman (2000, 261)

Weitzman’s findings suggest that OMB’s current 7 percent “base-case” discount rate is way out

of line with current economic theory and practice even with respect to environmental policies

with short time horizons. Interestingly, the results of Weitzman’s survey are similar to the U.K.

Treasury’s recommended schedule of declining long-term discount rates, presented below:58

53

Table 2: UK Treasury’s Schedule of Declining Long-Term Discount Rates

Period of Years Discount Rate (%)

0-30 3.5

31-75 3

76-125 2.5

126-200 2

201-300 1.5

301+ 1

Source: Her Majesty’s Treasury (2003, Annex 6, Table 6.1)

A consensus seems to be emerging in favor of hyperbolic discounting with rates that, from top to

bottom, are lower than those currently required by OMB and EPA guidelines. I would anticipate

that a set of “best practices” standards created by task force of independent experts would reflect

this emerging consensus. Perhaps instead of 7 and 3 percent discount rates, the “best practice”

standards for discounting would range from 1 to 5 percent, depending on the time horizon and

other characteristics of the regulatory policy under review.

3. Other Considerations

A panel tasked with developing “best practice” standards for environmental BCA should

pay close attention to arguments made by critics of current BCA policies; and it should carefully

consider recommendations that might turn such critics into supporters. For example, in a truly

impressive critique of governmental BCAs as well as those of “regulatory score-keepers” such as

John Morrall, John Graham and Robert Hahn, Richard W. Parker (2003, 1415-18) offers several

59 As Parker (2003, 1416 n.257) notes, OMB already has endorsed this recommendation.

54

concrete suggestions for how the method of BCA might be improved: (1) In light of empirical

evidence that refutes the idea that agencies routinely overstate the benefits of regulations,

regulatory agencies “need to do a much better job explaining the significance of costs and

benefits (particularly unquantified costs and benefits), and the reasons underlying the agency’s

determination that the benefits justify the costs.” (2) Valuations of human lives should “reflect

the involuntariness of certain risks, the effect on risk preferences on income distribution and

growth, and heterogeneity of risk preferences.” (3) Agencies should at least consider

“abandoning the pretense that monetary values assigned to non-monetary impacts are

numerically rigorous and scientifically based. They are not, nor need they be.” (4) Agencies

should avoid the “semantically misleading practice of discounting the number of lives saved.”59

(5) All analyses based on monetizing and/or discounting non-monetary values should be

presented in a clear enough way that reviewers can “reach their own conclusions” about whether

the monetary values attached are appropriate and whether the benefits justify the costs. (6)

Agency BCAs should highlight all relevant uncertainties so as to avoid the fallacy of misplaced

concreteness. (7) Retrospective studies should be encouraged to assess post hoc the quality of

past BCAs and improve future BCAs. (8) BCAs ought to be used not only to assess existing

regulations and regulatory proposals but also to identify risks that should be, but are not

currently, regulated. And (9) to the extent that good BCAs are costly, it is important that

Congress provide sufficient funding to agencies to perform proper and complete economic

analyses.

55

Parker’s (2003) recommendations are not obviously radical or unreasonable. In some

respects, they are similar to recommendations made by Hahn and Sunstein (2002) and Revesz

(1999). If a task force charged with elaborating “best practice” standards for regulatory BCA

takes them seriously, along with the concerns of other BCA “critics,” methodological

improvements may result and, just as importantly, political opposition to the practice of BCA

would be reduced.

IV. HOW AN INDEPENDENTLY ADOPTED SET OF “BEST PRACTICE” STANDARDS

MIGHT AFFECT GOVERNMENT POLICY

It would be one thing for a group of economists, legal scholars, and policy analysts,

gathered under the auspices of the National Academy of Sciences or some other

nongovernmental organization, to derive a set of “best practices” for environmental BCA. It

would be another for those “best practice” standards to actually influence policy-making in the

federal government. What would induce the EPA or the OMB to subscribe to independently

promulgated “best practice” standards? After all, each of those agencies has invested a good

deal of time and effort already in preparing their own BCA guidelines, and yet they do not

follow their own rules consistently.

An independently established set of “best practices” for BCA would have no independent

legal status. Neither the OMB, the EPA, nor any other government agency would be legally

obligated to follow them. However, in my view, an independently derived set of “best practices”

could be useful, even if they had no legal status, because they might serve as a political

56

benchmark against which agency BCAs, and OMB reviews of those BCAs, might be judged in

Congress and the White House. A legitimate and well-received set of “best practice” standards,

derived by independent “experts,” presumably would put some pressure on those who prepare

and review BCAs to conform to the “best practices.”

It would be better still if the courts gave legal status to “best practice” standards for

environmental BCAs by adopting them informally (i.e., by decision) as a benchmark either under

the APA’s “arbitrary and capricious” standard of judicial review or as a matter of federal

common law. Some legal scholars are more optimistic than others about the likelihood that the

federal courts might adopt and enforce such “best practice” standards against federal regulatory

agencies. Among the pessimists is Edward R. Morrison (1998, 1350-51), who has observed that

“[n]o court has developed a meaningful standard of review for agency choice of discount rates.

This is troubling because legislation increasingly requires cost-benefit analysis. As such

legislation is enacted, courts will encounter challenges to the methods – including discount rates

– agencies use to conduct the analysis.” As Morrison notes, courts have only rarely invalidated

agency regulations because of inadequate BCAs. In Corrosion Proof Fittings v. EPA, 947 F.2d

1201 (5th Cir. 1991), the U.S. Court of Appeals for the Fifth Circuit invalidated EPA bans on

certain workplace uses of asbestos because EPA acted unreasonably in not discounting future

benefits (along with future costs) stemming from those bans. In Ohio v. Department of Interior,

880 F.2d 432 (D.C. Cir. 1989), the D.C. Circuit (the most influential court in the country on

administrative law matters) ruled that Interior Department did not act unreasonably when it

complied with OMB rules by discounting future benefits. In both of those cases, Morrison (1998,

1355) notes, the courts reached the right results: “discounting is reasonable; not discounting is

60 Anthony Bertelli (1999, 743) is similarly pessimistic that courts might build upondecisions like Corrosion Proof Fittings and Ohio v. Department of Interior to develop a“common law of cost-benefit analysis.”

57

arbitrary.” However, neither court enunciated a generally applicable standard of review for

regulatory BCAs. Meanwhile, most other courts “treat the choice of discount rate as a matter of

agency discretion” (Morrison 1998 1356). In those courts, an agency might depart from “best

practice” standards for BCA as it sees fit. In conclusion, Morrison would like to see courts adopt

firm standards of review for regulatory BCAs, but he is not optimistic that they will.60

Cass Sunstein (2001) takes a more optimistic view in suggesting that we are on the verge

of moving from the era of the welfare/administrative state to a new era he refers to as the “cost-

benefit state.” The courts have an important role to play – indeed, they are already playing it – in

the transition. While there appears to be no explicit judicial initiative to create a new body of

administrative common law to govern BCA and other methodologies of the new “cost-benefit

state,” Sunstein (2001, 1654) discerns some generally applicable principles emerging from

discrete judicial decisions (mostly arising in the D.C. Circuit), including the following: (1) de

minimis exceptions to regulatory requirements should be allowed; (2) even if a statute specifies a

requirement of “absolute” safety, administrative agencies should be allowed to permit

“acceptable” risks; (3) agencies should generally be allowed to consider both costs and

feasibility in promulgating regulations pursuant to statutory mandates; and (4) agencies should

generally be allowed to balance costs against benefits in designing regulations. Sunstein

concedes that these principles raise as many questions as they answer. For instance, should

agencies be required to compare costs and benefits? What constitutes a “de minimus risk”? What

risks are, or are not, “acceptable”? Nevertheless, Sunstein (2001, 1655) is convinced that at least

61 Zaring (2006, 297) notes that the phrase “best practices” appeared only three times inthe 1980 Federal Register (of agency regulations), but appeared 300 times in the 2004 FederalRegister.

62 Citing Int’l Union v. Chao, 361 F.3d 249, 252 (3d Cir. 2004).

58

some “cost-benefit default principles have emerged as a central part of what amounts to the

federal common law or regulatory policy.”

All of the cases Sunstein (2001) reviewed concerned regulations duly promulgated by

administrative agencies pursuant to statutory mandates. It is one thing for courts to interpret and

enforce statutory mandates against administrative agencies based on well-established rules of

statutory construction. It would be another thing entirely for courts to assess regulations on the

basis of “best practice” standards promulgated not by Congress or any government agency but

by an independent group of social scientists. In an article forthcoming in the New York

University Law Review, David Zaring (2006) reviews the recent ten-fold increase in “best

practice rulemaking” by federal agencies,61 and finds that “there is nothing particular “best”

about “best practices” (not surprising given this paper’s review of OMB’s “best practice”

standards for regulatory BCA). More importantly for present purposes, Zaring (2006, 299) finds

that “best practice” standards are designed and implemented (or not implemented) “without

judicial supervision and ... outside the familiar framework of the Administrative Procedure Act.”

“Best practices” fall outside the normal scope of judicial review of administrative agency action

because the APA “exempts ‘interpretative rules’ and ‘general statements of policy’ from its

notice and comment requirements” (Zaring 2006, 309-310). Consequently, “[f]ederal courts have

found that best practices are ‘non-binding and unenforceable’” (Zaring 2006, 31062). If “best

practice” standards promulgated by administrative agencies are judicially unenforceable, then

59

what hope is there that a set of “best practices” for environmental BCA promulgated by an

independent, nongovernmental body might be judicially enforced? Zaring (2006) recommends

that Congress enact an “Informal Administrative Procedure Act” to provide at least some judicial

supervision. However, even if Congress enacted such a law, it would not apply to “best practice”

standards promulgated by a non-federal agency.

There remain two ways an independently generated set of “best practices” for regulatory

BCA could be made judicially enforceable: (1) once promulgated, Congress could enact a statute

based on the “best practices,” which would then apply to all federal agencies and be enforceable

in court; or (2) litigants could cite the “best practices” in arguing that agency rules are or are not

“arbitrary and capricious” under the APA. This would, of course, require the court to decide that

failure to conform to the “best practices” is unreasonable. At the same time, compliance with

“best practices” could become something like a “state-of-the art” defense to claims that BCAs

are deficient (i.e., arbitrary and capricious).

CONCLUSION

This paper has considered the evolution of BCA as a decision tool within the federal

government over the past 30 years. There has been some real progress in the methodology and

application of BCA. But that progress has been hampered by political disputes within and

between the agencies charged with preparing and reviewing BCAs. Today, the EPA and OMB

are largely (though not completely) in agreement about how BCAs should be done. But actual

BCAs remain methodologically inconsistent; and they are subject to substantial political

60

manipulation. Unfortunately, there is little reason to expect that the governmental agencies

charged with designing, applying and reviewing BCAs would be able to resolve these problems.

The political stakes are too high and the agencies too mission-driven to permit them to reach

consensus on a consistently applicable set of “best practice” standards for regulatory BCA.

For that reason, this paper recommends that a group of independent economists, legal

scholars, and policy analysts be convened under auspices of the National Academy of Sciences

or some other nongovernmental organization to develop a set of “best practices.” The product of

their efforts would not be panacea. In particular, it would not necessarily solve problems of

implementation. But it would, at least, establish a social-scientific norm against which agency

BCAs, and OMB reviews of BCAs, could be independently judged. Such a social-scientific

norm might even give the courts a confident basis for performing procedural reviews of agency

BCAs under the Administrative Procedure Act. In addition, an independently derived set of “best

practices” for environmental BCA might breed greater consistency in BCA method and practice,

which would presumably reduce political opposition to BCA as a policy tool.

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