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For the purpose of environmental rulemaking, cost–benefit analysis is meant to ensure that environmental regulations are only enacted when the benefits to society of improved environmental quality and health exceed any costs to affected industries. In this commentary, Ted Gayer identifies reasons why cost–benefit analysis has sometimes fallen short of these objectives and proposes three specific reforms to improve the value Americans receive from environmental regulations.
Three Steps to Improving Cost–Benefit Analysis of Environmental Regulatory Rulemaking
July 5, 2011
Environmental regulations are meant to correct harmful market failures, but they also come with real costs—shown through increased prices of some goods and removal of others from the marketplace. The challenge, therefore, is to determine how best to protect human health, safety, and the environment without unnecessarily stifling economic growth. Cost–benefit analysis is the essential tool for meeting this challenge: for the past 30 years, it has been a cornerstone of the regulatory approval process. In practice, however, the use of cost–benefit analysis has sometimes fallen short, resulting in regulations that impose higher costs than necessary. In a new paper for The Hamilton Project, I propose three reforms to help improve regulatory review processes to get the most “bang for the buck” from U.S. environmental regulations. At the heart of these suggestions is an improved, more rigorous approach to using cost–benefit analysis as a central tool in regulatory rulemaking.
1. Require a Checklist of Empirical Practices
Any cost–benefit analysis of an environmental regulation relies on underlying empirical studies of the impacts different pollutants or activities have on health and the environment. However, not all studies are created equal. Some are rigorous and of high quality, whereas others rely on less credible research designs. Currently, most agencies do not formally evaluate the quality of the empirical studies they base their conclusions on, nor are they required to report the necessary information for others to make such an assessment. I propose establishing a checklist of good empirical practices that all agencies would be required to use and make public when evaluating environmental regulations.
Additionally, the public and outside researchers must be able to scrutinize and evaluate the studies used in cost–benefit analyses. Today, such scrutiny is impossible in many cases because not enough information about the underlying studies or assumptions is released to the public. Agencies should require all studies used for cost–benefit analyses to be released, including all data sets and methodological details so that independent researchers can replicate the results. These decentralized evaluations would improve the empirical inputs to cost–benefit analyses, as well as provide the public with more information about the expected impacts of proposed regulations.
2. Exclude Private Net Benefits from Cost–Benefit Analyses for Energy-Efficiency Standards
Energy-efficiency regulations, such as gas mileage requirements for cars or energy use standards for appliances, remove less efficient products from the marketplace. Although such regulations yield some environmental benefits, traditionally, cost–benefit methodology has assumed that these regulations also impose costs on consumers by forcing them to either pay higher prices or by eliminating products from the marketplace that they would otherwise purchase.
An individual planning to buy a car, for example, would understand that a large sedan has worse gas mileage than a compact car and would incorporate into her purchase decision the higher expense of gas over the period she expects to own the car. These expected fuel costs would be considered along with the car’s other characteristics, including trunk size, comfort, and so on, to make a decision. Assuming no market barriers that interfere with consumer behavior, under the traditional approach to cost–benefit analysis, regulations that alter consumer’s choices are typically assumed to not have any private net benefits. Rather, whereas a regulation that requires consumers to buy a more expensive, more energy-efficient product may produce social benefits from reduced pollution, it cannot be assumed to make the consumer herself better off; if the product were indeed better, the consumer would have bought it in the first place.
Increasingly, regulators are relying on an alternative approach to cost–benefit analysis, based on the claim that consumers benefit from such energy-efficiency regulations. This method incorporates the idea that consumers undervalue the savings in fuel costs of energy efficient products when making purchasing decisions and asserts that regulators can therefore help consumers by mandating the use of more energy efficiency products.
I do not believe there is strong enough evidence to support this view, that regulators are able to improve on the personal energy decisions that consumers make for themselves. The recent shift from the long-standing economic principle—under which consumers are presumed best able to make market decisions in their own self-interest—risks moving regulatory policy from an emphasis on mitigating harm people impose on others toward a paternalistic emphasis on mitigating harm people impose on themselves. This will result in less effective environmental regulations. Consequently, cost–benefit analyses of energy efficiency regulations should stick with the traditional approach of assuming that removing products from the marketplace harms consumers.
3. Improve Regulatory Oversight through an Early Review Process for Major Regulations
These proposals will only be effective if the regulatory oversight process is improved. Currently, cost–benefit analysis is often incorporated far too late in the decisionmaking process. The Office of Information and Regulatory Affairs (OIRA), which is charged with leading the executive branch’s review of significant regulations, is often given only a few weeks to review agencies’ analyses of environmental regulations. I propose that a new executive order require an early review process for major environmental regulations. Any regulation with expected economic impacts of more than $1 billion, as well as other regulations chosen at the discretion of the director of OIRA, would undergo an in-depth, six-month early review process. This would allow more time for rigorous cost–benefit analysis, and would provide a greater opportunity for that work to substantively influence proposed regulations.
Americans rely on environmental regulations to protect the air we breathe and the water we drink. These rules, however, have significant costs to American workers and businesses. Cost–benefit analysis does and should play a central role in designing and choosing among regulatory options. However, the ability of cost–benefit analysis to ensure that Americans get the largest bang for their buck from environmental regulations is hampered by reliance on less-credible empirical research, improper assumptions, and insufficient incorporation of cost–benefit analysis into the decisionmaking process. Combined, my three proposals address each of these issues, and would improve the value Americans receive from environmental regulations.
Ted Gayer is a senior fellow and co-director of the Economic Studies Program at the Brookings Institution. His new paper, “A Better Approach to Environmental Regulation: Getting the Costs and Benefits Right,” is available from The Hamilton Project website at www.hamiltonproject.org.
Gillingham, Kenneth, Richard G. Newell, and Karen Palmer. 2009. Energy Efficiency Economics and Policy. Discussion paper 09-13. Washington, DC: Resources for the Future.
Glaeser, Edward L. 2006. Paternalism and Psychology. Regulation 29: 32–38.
Greenstone, Michael, and Ted Gayer. 2009. Quasi-Experimental and Experimental Approaches to Environmental Economics. Journal of Environmental Economics and Management 57: 21–44.
Office of Management and Budget (OMB). 2003. Circular A-4.