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Benefit-Cost in Practice: Implementing the Efficiency Standard Chapter 10
Introduction • From the efficiency perspective, pollution should be reduced until the additional costs of control just outweigh the additional benefits • Calculate all the costs • Calculate all the benefits • This allows us to pinpoint the efficient level of pollution through benefit-cost analysis
Regulatory Impact Analyses • The EPA conducts formal benefit-cost analyses (known as regulatory impact analyses or RIAs) of any new regulation expected to cost more than $100 million • For safety-based laws, EPA is supposed to examine several different options that achieve a safety goal and choose the most efficient
A “Good” Benefit-Cost Study • A good benefit-cost study will • Follow accepted procedures • Provide a clear statement of all assumptions • Point out uncertainties where they exist • Suggest realistic margins of error
Doing Benefit-Cost 1:Lead Standards • Under the Safe Drinking Water Act, the EPA was required to establish “action standards” for lead in drinking water • Lead leaches from solder in older water systems
Estimating Costs • Determine which of the 63,000 plus systems nationwide would require remedial action, and at what level, to achieve the three different targets • Establish engineering cost estimates for the different steps • Study gives a plus or minus 50% range for uncertainty in its cost estimates
EPA’s Summary What’s Missing?!
The Most Efficient Option • The net monetary benefits to society of the three options are: • Option A: $62,685 million • Option B: $59,601 million • Option C: $20,670 million • The most efficient option then is option A because it maximizes the net monetary benefits to society
Benefit-Cost Ratio • The benefit-cost ratio is the value of the benefits of an option divided by its costs • B/C ratio greater than one means total benefits exceed total costs • Options A, B, and C all have B/C ratios greater than 1 • Greatest B/C ratio is not the same as the most efficient option…
The EPA’s Choice • Interestingly, the EPA did not choose Option A despite it being most efficient • In fact, the report never acknowledged that option A was the most efficient!! • Instead, the agency relied on the uncertainty in the benefit estimates and opted for the less expensive option B
Lessons • Due to substantial uncertainty, benefit-cost analysis cannot discriminate between “relatively close” options • Note: the B/C ratio has nothing to do with efficiency • The B/C ratio for A was lower (11) than option B (15.3)
Doing Benefit-Cost2 :Landfill Regulation • The EPA, under the Resource Conservation and Recovery Act (RCRA), was directed to draft regulations for the siting, construction and maintenance of municipal solid waste landfills • Two approaches • Pollute and cleanup • Prevention
Cost Estimates • EPA cost estimates, based on the engineering approach, included expenses associated with: • Land clearing, Excavation, Equipment, Labor, Liner materials • Both options required groundwater monitoring wells • Most added costs for the “pollute and cleanup” option were for corrective action, while 50% of the added costs for the “prevent” option were for liners
Benefit Estimates • Two quantitative estimates • Reduction in cancer risk • Estimated risk of cancer is 5.7 over the next 300 years • Both plans reduce this risk by 2.4 over the 300 year period: why? • Avoided cost of replacing damaged groundwater • Cost of replacing with an alternative supply; this probably overstates the benefits
No • Assuming that: • All benefits are captured by mitigating the effects on groundwater, and • The study’s complex modeling process generates “precise” benefit and cost predictions • Both plans are losers by an efficiency standard • Complying with existing water laws costs $2.5 billion more than supplying groundwater users with a new supply • Moving to a pollution prevention strategy makes matters even worse
Are there missing benefits from the prevention option? • Stricter standards may encourage more recycling and waste reduction. Are these benefits likely to be large? • Bottom-line: very few people depend on water that might be contaminated by municipal landfills. Benefits of regulation likely to be small.
Benefit-Cost Problems • These two examples illustrate “good” benefit-cost studies • There are lots of “bad” studies manufactured by “economists-for- hire” • But even honest analysts face pressures:
Political Influence In Benefit-Cost 1. Regulatory politics 2. Agenda control 3. Hard numbers problem 4. Paralysis by analysis
Regulatory Politics • EPA benefit-cost analysts may face pressure from their superiors at the Office of Management and Budget (OMB) to generate numbers in support of their preferred rule • Study may be put off until decisions have already been made
The Scientific Agenda • Big business has influenced the scientific agenda by funding conferences and targeting research in certain areas • Even academic scientists must often obtain research funding from industry
Hard Numbers Problem Benefit-cost studies can provide a false sense of precision to decision makers • “Hard” numbers are really “soft” when uncertainty and incomplete benefit coverage are factored in • Decision makers don’t want uncertainty; they want an answer
Paralysis by Analysis • Paralysis by analysis: • Opponents of government action can resort to the legal system and exploit the uncertainty in the process to delay or block the implementation of regulations
Summary: Is Benefit-Cost Analysis Useful? • Two questions? • Is it capable of identifying the efficient pollution level? (this chapter) • Is efficiency in pollution control the right standard? (previous chapters)
Up to the Job? Yes • While benefit-cost analysis cannot pinpoint the efficient pollution level with the accuracy suggested by diagrams, it is helpful when uncertainty about benefits is low (landfill case?) • More generally, BCA: • Provides a framework for a general “balancing” of benefits against costs • Can rank dissimilar proposals in terms of efficiency
Up to the Job? No. • Benefit-cost’s fatal flaw is its inability to price the values of life, health, nature and the future. • Especially over the long run, choice of a discount rate can dramatically alter the conclusions of benefit-cost studies.
Up to the Job? We report. You decide.