Using Benefit-Cost Studies to Set Regulatory Policy

Proponents of tougher environmental regulation focus almost exclusively on the benefits they hope to achieve, while critics seem concerned only with the high costs they anticipate. The current debate on the Clean Air Act demonstrates the shortcomings--and also the validity--of both approaches.

Surely, the air will be cleaner if the Clean Air Act is extended, and the American people will pay a high price in the process. But given the importance of a healthy environment, this is not an either/or question. When we strip away the heated rhetoric that almost invariably accompanies discussions of environmental issues, we find that the serious questions are in terms of “how much” and “how.” That is, what are the most effective ways of achieving cleaner air, safer drinking water and other environmental goals?

Here, the economic approach to public-policy decision making has something to offer. The basic economic questions facing government decision makers are twofold: Are the benefits of a specific action worth the costs? Is there a better way of achieving those benefits? Society’s bottom line is not the impact of regulatory actions on government or on business, but the effect on the consumer, on the citizen.

Benefit-cost analysis has been used for decades in examining government programs. It is neither a revolutionary new idea nor an invention of the far right. It has been attacked by both ends of the political spectrum: by the far left, because not every proposal for government intervention passes a benefit-cost test, and by the far right, because benefit-cost analysis can be used to justify government intervention.

The motive for incorporating such analysis into public-sector decision making is to lead to more efficient use of government resources by subjecting the public sector to the same type of quantitative constraints as those used in the private sector. In making an investment decision, business executives compare costs to expected revenue. If the costs exceed revenue, the investment is not considered worthwhile.

The governmental decision maker does not face the same constraints. If the costs to society of an agency action exceed the benefits, the situation does not usually have an adverse impact on the agency. In fact, the administrators may not even know about it. Requiring agencies to perform benefit-cost analyses helps to counterbalance the strong attraction toward regulatory activity by government agencies and their supporters. Otherwise, they can crow about the benefits and ignore the costs that are passed through to the consumer by the firms they regulate.

A basic relationship of costs and benefits holds for many regulatory programs. Typically, the initial regulatory effort--such as cleaning up the worst effects of pollution in a river--generates benefits significantly greater than costs. But the resources required to achieve additional cleanup become disproportionately high. At some point the added benefits are substantially less than the added costs.

The pulp-and-paper industry spent $3 billion complying with a set of federal clean-water standards and achieved a 95% reduction in pollution. But reaching a 98% reduction level cost the industry an additional $4.8 billion.

Benefit-cost analysis is a tool for identifying the optimum amount of regulation. To an economist, “over-regulation” is not an emotional term; it is shorthand for regulation for which the costs to the public are greater than the benefits.

The indirect costs, often overlooked, can be great. One researcher estimates that 30% of the decline in productivity growth in manufacturing in the 1970s can be attributed to the regulations promulgated by the Environmental Protection Agency and the Occupational Safety and Health Administration. Analysts at Consad Research Corp. estimate that the enactment of the version of the Clean Air Act now going through Congress will eliminate more than 200,000 jobs a year.

Regulation has adversely affected the pace of innovation in the pharmaceutical industry, where “regulatory lag” has become well known. The cost of developing new and more effective drugs, as a result, has increased substantially. The most dramatic example of indirect costs of regulation occurs in the automobile industry. Economists estimate that 2,000 to 4,000 lives are lost each year because complying with fuel economy standards requires companies to build cars that are lighter, and thus less safe.

When it is not feasible to put a dollar sign on the benefits, analysts can rank the cost-effectiveness of alternatives. These studies help policy-makers identify least-cost solutions to accomplish the same objective. This approach is useful in programs to reduce personal hazards. Instead of dealing with such an imponderable question as the value of a human life, the emphasis shifts to identifying the regulatory approach that maximizes the number of lives saved.

The progress of the Clean Air Act reauthorization furnishes a good (or bad) example of the need for cost-effectiveness analysis. Oil and auto interests have been battling to see who will be required to control refueling emissions that contribute to smog. Whether controls are required at service station gas pumps, or canisters are required on new cars (on-board controls), the same reductions in smog-related emissions are possible.

There are pros and cons accompanying each approach. The big advantage of controls at the pump is that they produce immediate results, whereas placing devices on new cars requires a complete turnover in the existing fleet of autos to produce the same outcome.

On the other hand, it is much easier for government to regulate a relatively few car manufacturers than thousands of gasoline retailers.

In any event, tighter controls on gas pumps, it is estimated, will reduce hydrocarbon emissions in dirty air areas at a cost of $1,000 a ton or less, whereas removing a ton of hydrocarbon using the on-board solution may cost twice as much.

But Congress seems likely to avoid making a difficult choice by requiring both sets of controls. That is the worst alternative. The combined strategy significantly increases costs while producing no added benefits.

That would be comparable to the individual who simultaneously wears a belt and suspenders to hold up his pants--incurring two sets of costs to achieve one set of benefits.

Critics offended by the notion of subjecting regulation to benefit-cost or cost-effectiveness tests unwittingly expose the weakness of their position. They must fear that their pet rules would flunk the test. After all, showing that a regulatory activity generates an excess of benefits is a strong justification for continuing it.

Benefit-cost analysis is neutral, giving equal weight to a dollar of benefits and a dollar of costs.

Because resources available to safeguard human lives are limited, economists become concerned when they see wasteful use of those resources through unwise regulation.