Policy Analysis Tools:

1. Policy Analysis Tools: Cost-Benefit Analysis

2. Cost-Benefit Analysis A technique for systematically estimating the efficiency impacts of policies Valuable in identifying and categorizing costs and benefits for rational decision making in the public arena Used with variable success in a broad range of public policy areas Success of use depends on the degree to which cost and benefits can be monetized

3. It can answer logical, rational questions such as: Should government produce a good/service? e.g., public housing, parking garage Should government intervene in the market? Regulating airline safety, automobile safety How much of the good/service should be produced? Superfund cleanups, public transportation Cost-Benefit Analysis

4. Getting a handle on the costs and benefits of proposed policies

5. Cost-Benefit Analysis It is a technique that can be used to evaluate government projects and programs. It encompasses an appraisal of a policy based on the costs and benefits of the project, measured in comparable units within and across time.

6. Limitations to Cost-Benefit Analysis

7. Limitations to Cost-Benefit Analysis

8. Limitations to C-B Analysis in the Social Policy Arena Measurement of benefits Some excellent sources of data: flood control, bridges, cancer screening Some immeasurable benefits Impact of education, welfare programs Benefits of greater safety, wildlife preservation

9. Measurement of costs Direct outlays are easy to determined Private cost Burden on taxpayers, inequities Social costs Concentrated highly visible costs (housing, welfare) Widespread invisible (tax burden) Opportunity costs (rarely considered)

10. Criterion of efficiency Bottom line for decision making? Issues of equity Who pays, who gains? Externalities Unintended side effect (+ and -) Offsetting behavior Limitations to C-B Analysis in the Social Policy Arena

11. Advantages of Cost-Benefit Analysis

12. Advantages of CBA Provides a decision making tool that is based on objective standards Allows for a quantitative comparison between multiple solutions for policy problems Can be used to monitor the efficiency of existing programs

13. Some central C-B concepts before we start……

14. Central C-B Concepts  Time Value of Money Cost of life

15. Cost-Benefit Concepts Time Value of Money: inflation discount rate

16. Inflation A dollar today is always more valuable than a dollar next year Consumer Price Index An index of prices used to measure the change in the cost of basic goods and services in comparison with a fixed base period Measures inflation Considerable variation across time

18. Inflation In a cost-benefit analysis decisions must be made in “constant” dollars You can’t add “apples” and “oranges”

19. How do we deal with inflation and the value of money over time? How do we add “apples” and “oranges”

20. Discounting Discounting takes care of two factors that make it difficult to add up monies over time: The influence of inflation The earning power of money Using a discount rate you “extract” out the “inflation+interest” effect from future costs and benefits Future dollars are worth less today

21. In addition, using a discount rate you are assuming that money invested today can “grow” at a compound rate, producing more money in the future You need less money now to produce a specified amount of money in the future Discounting

22. Cost-Benefit Concepts Discount Rate Formula

23. Discount Rate Choice of a discount rate is speculative and subject to much debate What will future inflation rate be? What will investment yields be in the future? Discount rate= Estimate (inflation rate + bond yield rate) E.g., 2% + 6%=8% discount rate

24. An example

25. Assume that you will be given exactly $1,000 from Grandma on your birthday for the next 3 years. How much is this 3 year b-day present worth to you TODAY? Assume an annual interest/discount rate of 6%. Present Value

26. Assume that you will be given exactly $1,000 from Grandma on your birthday for the next 3 years. How much is this 3 year b-day present worth to you TODAY? Assume an annual interest/discount rate of 6%. Present Value

27. = (1,000)/(1.06) 1 + (1,000)/(1.06) 2 + (1,000)/(1.06) 3 Present Value (Formula) Dn = $ / (1+r)n

28. Cost-Benefit Analysis Overview

29. Step 1: Identifying Relevant Impacts

30. Identifying Relevant Impacts Identify all relevant impacts Classify them as costs or benefits for various groups Choosing geographic boundaries e.g., flood control, public libraries, etc. Choosing relevant groups with preference standing Whose costs and benefits will be measured in a decision to improve security in a local prison?

31. Step 2: Monetizing Relevant Impacts

32. Monetizing Relevant Impacts Valuing inputs: Measurable costs (objective) Opportunity costs (subjective)

33. Monetizing Relevant Impacts Valuing outcomes: Benefits of policy/program (objective) Willingness to pay (subjective)

34. Step 3: Discounting for Time and Risk

35. Discounting for Time and Risk Discounted future benefits/costs Taking account of risk Capital depreciation

36. Step 4: Choosing Among Alternative Policies

37. Choosing Among Alternative Policies Cost benefit ratio Benefits/Costs > 1 = implement policy

38. Numerical Example

39. Cost-Benefit AnalysisAn Example

40. Taxing alcohol to save lives Highway fatalities caused by alcohol impaired drivers Problem of younger drivers Innocent lives lost Injury and property damage Cost of morbidity: health care, accidents at work, loss of productivity, etc.

41. Identifying the Costs and Benefits Over a Specified Period of Time Time Period: 1 year Benefits (1) Tax revenue 30% increase in tax Consumer drink less (-16.6% in demand) ESTIMATE = Increase of $16,739 billion

42. Identifying the Costs and Benefits Over a Specified Period of Time Benefit (2) Reduction in fatalities 1,650 fewer young driver fatalities 1,270 non-driver fatalities from young drivers 861 driver and non-driver fatalities from >21 year old drivers Assume each life is worth $1million Benefit (3) Reduction in property damage $0.65 billion/year

43. Benefit (4) Health and productivity gains Absenteeism and workplace accidents $4.29billion in annual health savings $6.61billion in productivity savings Identifying the Costs and Benefits Over a Specified Period of Time

44. How to count “lives saved” Three estimates: Upper bound: consumers of alcohol are totally uninformed about increased risks of alcohol consumption = all drivers and victims fatalities regarded as benefits Lower bound: consumers of alcohol are totally informed about increased risks of alcohol consumption = only victim fatalities regarded as benefits Best guess: between the two

47. Another example

48. School Bus SafetyEnhancement Program Installation of seat belts on school busses to ensure child safety when traveling on the bus

49. Identifying the Costs and Benefits Over a Specified Period of Time

50. Time period Assume a 20 year decision period Benefits Assume the only benefits are children’s lives saved No injuries are taken into account in this example Assume each child’s life is worth $1,000,000 today Assume that 350 children’s lives are lost on school buses each year in the state directly as a result of no seat belts Identifying the Costs and Benefits Over a Specified Period of Time

51. Costs Assume it costs it cost $4,000mill to install the seatbelts on all school buses in the state Assume that it costs $10mill to maintain these seatbelts in useable order in the first year Assume that after 10 years many of the seatbelts have to be replaced at a cost of $200mill in 2017 (Capital depreciation) Identifying the Costs and Benefits Over a Specified Period of Time

52. Time Value of Money Assume that the cost of a child’s life increases at 3% per year (inflation) Assume that the cost of maintaining seatbelts on school buses increases by 3% per year (inflation) Assume that money invested today in a fund can earn 3.7% interest per year above inflation and that inflation is running at an average of 3% per year (6.7% discount rate) Identifying the Costs and Benefits Over a Specified Period of Time

54. Lets recap what we know so far…

55. Cost-benefit analysis Provides a rational framework for decision making in the public arena Allows us to compare multiple solutions to problems simultaneously Provides an objective criterion to base the decision on (efficiency, or at least benefits > cost)

56. But…..the approach has limitations Measurement of costs and benefits Efficiency criterion not always applicable Cannot take into account equity issues in cost distribution Often cannot predict externalities that can significantly impact the analysis

57. Despite limitations …still a useful tool Time value of money Concept of inflation Value of the Consumer Price Index Capital depreciation And…of course the ‘discount rate’

58. A discount rate is a single combined number that estimates two components: What the inflation rate will be in future years What percentage interest rate above inflation money will earn so that it grows in future years.

59. So…….. If inflation is running at 3.5% and you’ve managed to get a rate of return on your invested money from the bank of 6.3% you are beating inflation by 3% and your money is working for you. The concept of a ‘discount rate’ assumes that the rate of return on invested money that is greater than inflation on average. How much greater depends on the value of the discount rate you choose to use in your cost-benefit analysis.

60. Now…..onto the next question

61. Question: Can lives saved or lost be reasonably monetized?

62. Well, even if you don’t…. the Federal government values lives every day…….

63. Federal Aviation Administration(Flight TWA 800)

64. TWA Flight 800 was a TWA passenger flight that disintegrated while flying from John F. Kennedy International Airport (New York) to Charles de Gaulle International Airport (Paris) in 1996, killing all 230 aboard. The incident has been one of the most investigated crashes in aviation history.

65. The aircraft was flying more than eight miles off the coast of East Moriches, New York (on Long Island) when the plane's center wing fuel tank exploded. The aircraft developed cracks around the nose as a consequence of the explosion, and the front part of the aircraft broke off (including the cockpit and first class section). The left wing ruptured, and the leaking fuel from the left wing tank ignited in the air, triggering a second explosion.

66. A four-year investigation by the U.S. National Transportation Safety Board, the only official investigation to date, concluded that fumes inside the center wing tank ignited, causing the explosion. The NTSB concluded that the spark was created by faulty wire insulation and an electrical arc.

67. The NTSB contends that the explosion could have been prevented by use of a system to smother flammable vapors inside fuel tanks, rather than the industry standards of the time that focused on eliminating ignition sources that could enter them from the outside.

68. The Cost of Saving a Life

69. Can we reasonably value a life? And, are all lives lost of equal value?

70. An alternative method… LIFE YEARS SAVED

71. LIFE YEARS SAVED Avoiding a particular risk of death today means that you are more likely to live the statistically average life span. The difference between this average life span and a premature death is the number of “life years” saved.

72. Consider the case of mammograms……. If we gave every woman in the U.S. an annual mammogram we would detect some breast cancers in the early stages and prevent some women from dying prematurely

73. Mammogram screening But, since the number of women whose lives would be saved is small, the cost per life saved would be high since we’d be screening lots of women who never get breast cancer. Besides, in the absence of a mammogram women would most likely get an annual physical breast exam, which might detect the cancer anyway. So, we need to focus on the additional cost of the mammogram policy and compare it to the net additional benefit (additional life years saved) of adding the mammogram policy. Remembering that policy benefits will differ for women of different ages.

74. Hillary Rodham Clinton did just that in 1993/94 in an attempt to reform the U.S. health care system She devised the Clinton health care plan in which it was decided not to cover a cost for a life year saved that exceeded $100,000.

75. But, even additional years of life are not of equal value: Need a measure that captures “quality” of remaining life years

76. Let’s consider an example

77. Quality-adjusted Life Year (QALY) Patient Option 1: No Surgery 10 remaining years of life Quality = .6 QALY = 6 years

78. Quality-adjusted Life Year (QALY) Patient Option 2: Surgery 15 remaining years of life Quality = .8 QALY = 12 years

79. Quality-adjusted Life Year (QALY) Patient Option 2: Surgery 15 remaining years of life Quality = .8 QALY = 12 years longevity effect (5 X .8) = 4yrs QOL effect = (10 X (.8 - .6)) = 2 years

80. Alternatives to Cost-Benefit Analysis

81. Alternatives to Cost-Benefit Analysis Cost-effectiveness analysis Risk-Risk analysis Health-Health analysis

82. Cost-effectiveness analysis Makes programs with identical types of outcomes comparable Shows which program yields the greatest outcome per dollar spent DOES NOT indicate whether a particular policy has positive net benefits overall Example: Effectiveness of medication versus diet in preventing heart attacks compared to the costs of the two programs

83. Other examples of how cost-effectiveness analysis is used: Feb 2000 JAMA: Study concluded that annual retinal screening for individuals with Type 2 diabetes may not be warranted on cost-effectiveness grounds (QALY=$150,000). Vijan et al. 2000 JAMA: Compared with biannual screening, annual retinotherapy screening for low-risk patients with diabetes cost more than $100,000 for each QALY NEJM 2000: Extending hospital stays beyond 4 days for patients with uncomplicated myocardial infractions was economically unattractive since it cost more than $105,000 per QALY Annals of Internal Medicine 2000: Viagra is a cost effective treatment for erectile dysfunction, producing an incremental QALY for the relatively low cost of $11,000

84. Risk-Risk Analysis Policy analysts have long realized that reducing one risk may unintentionally raise another risk Risk-Risk analysis can be used to yield a count of desired/undesired outcomes in different units Does not take account of the costs and benefits of a policy Example: treating drinking water with chlorine reduces the incidence of infectious diseases, but exposure to chlorine raises the risk of cancer

85. Health-Health Analysis An analyst who knows how the costs of a program are distributed forecasts the number of adverse health outcomes induced by the program The analyst then compares a count of the fatalities averted by a program versus a count of fatalities induced by an alternative program

86. E.g., Passenger-side airbags: For every five lives saved by passenger-side airbags, a life (usually a child) is lost. That’s a 5:1 health-health ratio. Program beneficiaries (adults) are different from those who bear the cost (children), yielding DISTRIBUTIONAL differences. Disadvantage? It confines the analysis to a tally of mortality costs. Health-Health Analysis

87. In summary Comparing methods

88. Methods comparing cost and benefits Cost-benefit analysis $benefits - $costs (same units) Cost-effectiveness analysis $costs compared to desirable (adverse) outcomes

89. Risk-Risk analysis Measures only probabilities of outcomes Health-Health analysis Lives saved-lives lost Measures only mortality risks Methods comparing cost and benefits

90. Methods of Comparing Costs and Benefits