Cost-benefit analysis is the time-tested standard for developing government regulations. It provides for the writing of rules that protect public health, safety, and the environment with reasonable affordability. The Wall Street Journal recently ran an editorial on cost-benefit reform at the US Environmental Protection Agency (EPA). We wish to take exception to the editorial’s characterization which, in our view, lands on the wrong side of economic theory and practice regarding the analysis of regulations.
Modern economics is largely based on maximizing the net benefits of activities and regulations on society at large. This includes accounting for the costs to industry and others being regulated, but also accounting for the impacts of the regulation on humans and their environment—what economists term externalities. Thus, in the regulatory context, the costs and benefits being estimated are always the social costs and benefits, with the goal to maximize the net social benefits of regulations. Considering social costs (the term for private costs plus external costs and benefits) is required by the process for analysis of regulatory cost and impact.
So the idea that an agency considering social costs and benefits is something sneaky, manipulative, or wrong, as the editorial imparts, is greatly at odds with standard, widely accepted economics as well as standard government practice that has been in place since at least the Reagan administration.
Specifically, the editorial takes particular aim at the Obama EPA’s use of the social cost of carbon (SCC) and the social cost of methane (SCM), both measures of the damage from climate change to which those gases contribute. The WSJ makes four charges: (1) the agency “threw in” its “speculation” on damages from sea level rise, and more generally, the global damages from climate change; (2) the agency manipulated the numbers prior to releasing significant environmental regulations to make the damages from carbon and methane emissions bigger; (3) the agency ignored best practices from the Office of Management and Budget (OMB); and (4) the agency used a global SCC rather than a domestic SCC in its cost-benefit analyses.
Taking these in order, first up is the charge that the agency was speculative on damage assessment. In truth, the estimates of the SCC produced under the Obama administration were the result of a long, careful, and thorough process carried out by the Interagency Working Group on the Social Cost of Carbon (IWG). The IWG, formed in 2009, comprised top economists and scientists from six federal agencies, including the Departments of Agriculture, Commerce, Energy, and Transportation, as well as the Environmental Protection Agency and the Treasury, in addition to the National Economic Council, Council of Economic Advisers, Council on Environmental Quality, and the Office of Science and Technology Policy.
The IWG process was far from speculative or arbitrary; it derived its estimates using the three leading integrated assessment models for estimating the SCC from academic literature, collectively reflecting the results from hundreds of academic studies. After receiving outside peer review, the IWG issued a report containing a range of estimates for the SCC, which became the basis for federal agencies to value the benefits of reducing a ton of CO2 emissions. The IWG estimates were the subject of a full and open public comment process, and each instance in which the estimates were employed as a part of a rulemaking also provided the opportunity for further public comment. The previous approach taken by the federal government, namely to ignore damages from climate change in its analyses (effectively valuing them at exactly zero dollars), was both scientifically invalid and rejected by the courts. The scientific approach taken by the IWG in deriving its results was clearly a much better course of action, unless one doesn’t believe in using the scientific method to inform policy choices. As for valuing the social costs of reducing a ton of methane, this is a straightforward modification of the SCC estimation methodology, primarily requiring adjustments for the combined effects of the greater potency of methane as a greenhouse gas and its shorter lifetime in the atmosphere than carbon dioxide.
The second charge—that the agency manipulated the numbers on damages from carbon and methane emissions to make them bigger than they should have been—is again unfair. Indeed, the IWG report is replete with acknowledgments of uncertainty and it can easily be seen that the Working Group members did their best to do a fair and unbiased assessment. The upward revision of the numbers was in accordance with results from updated versions of the models that the IWG was using at the time. In other words, the numbers got bigger because the IWG was keeping pace with scientific progress.
The third charge claims that the Obama EPA ignored best practices while conducting their analysis. However, the OMB best practices actually support the use of a social cost of carbon in rulemaking, because this is consistent with standard economics.
If there is any genuine substance in the WSJ editorial’s charges, it is its criticism of the choice to use a domestic versus global estimate of the SCC. The argument is that the costs of a US regulation should be—and generally are—compared with the benefits to the United States of that regulation. So, for ozone regulations, for example, we don’t count the benefits to Canadians of reducing ozone in the United States that also improves air quality in Canada. Thus, symmetry and practice could argue for the domestic SCC.
However, the undeniable facts are that climate change is a global problem, that a ton of CO2 has the same effect no matter where it is emitted, and that, if every country evaluated their rules this way, the vast majority of damages from greenhouse gas emissions would go completely unaccounted for in analyses. This would lead to a wholly incomplete accounting of the problem posed by climate change, a collective underestimation of the expected damages, and a failure to address the issue. Arguing for a global SCC does not have to be seen as purely altruistic, either. As the climate gets worse, even the United States will not escape effects of greater global unrest, migration, and reduced demand for our exports, in addition to the domestic impacts. Bottom line, both the domestic and the global SCC (and the social cost of methane) should be provided as a part of agency cost-benefit analyses so decisionmakers and the public can see the consequences of the choice.
The remaining specific charge is that EPA “erroneously” counted ancillary damages from reducing fine particulates in its estimates of the benefits of reducing mercury emissions, and termed this a “statistical sleight of hand.” We have already distributed a blog on this issue, since it previously appeared in a recent Trump EPA regulatory impact analysis. In brief, there is nothing erroneous or sleight of hand about counting all the effects of a rule. In fact, it is best practice to be as comprehensive as possible. As such, the fact that the benefits from reducing particulate matter outweigh the direct benefits from reducing mercury emissions should not have bearing on the choice of whether or not to include such benefits, and further, the choice to include them has nothing to do with statistical analysis.
By our professional, if casual, tracking of WSJ stories and editorials on regulations, we have found the WSJ to be generally reasonable and professional. But this editorial lacks a basis in science and, in itself, rests on wishful thinking—the very charges it levels against the Obama EPA.