An appendix to More Benefits Fewer Burdens contained information on the costs ofregulations issued between 1987 and 1996, which we use below to estimate the aggregate costsof regulation. Another appendix included a discussion of regulatory reform legislation thatPresident Clinton had supported and was passed by Congress during the three-year period,including three statutes that require agencies to follow certain procedures and/or consider variouseconomic impacts before taking regulatory action: the Unfunded Mandates Reform Act of 1995,the Paperwork Reduction Act of 1995, and the Small Business Regulatory Enforcement FairnessAct of 1996.
In order to help agencies prepare the economic analyses required by Executive Order12866 or the various statutes enacted by the Congress in the last few years, OMB developed,through an interagency process, a "Best Practices" document that was issued on January 11,1996. Best Practices sets the standard for high quality economic analysis (EA) of regulation --whether in the form of a prospective regulatory impact analysis of a proposed regulation, or inthe form of a retrospective evaluation of a regulatory program. The principles that are describedin detail in Best Practices are summarized here because they can serve as an introduction to howwe have evaluated the studies on the costs and benefits of regulation discussed in the followingchapters. We discuss those principles in Best Practices that are general in nature, then those thatpertain to benefits, and then those that pertain to costs.
General Principles
Costs and benefits must be measured relative to a baseline. Best Practices states that "thebaseline should be the best assessment of the way the world would look absent the proposedregulation." Typically, the baseline should start with the world before the action taken, beconsistent with other pending government actions, and applied equally to benefits and costs. Insome instances where the likelihood of government actions are uncertain, analysis with multiplebaselines is appropriate.
Costs and benefits should be presented in a way to maximize their consistency orcomparability. Costs and benefits can be monetized, quantified but not monetized, or presentedin qualitative terms. A monetized estimate is one that either occurs naturally in dollars (e.g.,increased costs by a business to purchase equipment needed to comply with a regulation) or hasbeen converted into dollars using some specified methodology (e.g., the number of avoidedhealth effects multiplied by individuals' estimated willingness-to-pay to avoid them). Aquantitative estimate is one which is expressed in metric units other than dollars (e.g., tons ofpollution controlled, number of endangered species protected from extinction). Finally, aqualitative estimate is one which is expressed in ordinal or nominal units or is purely descriptive.Presentation of monetized benefits and costs is preferred where acceptable estimates are possible.However, monetization of some of the effects of regulations is often difficult, if not impossible,and even the quantification of some effects may not be easy. As discussed below, aggregatingcosts and benefits is particularly difficult, if not impossible, where they are not presented inconsistent or comparable units.
An economic analysis cannot reach a conclusion about whether net benefits aremaximized -- the key economic goal for good regulation -- without consideration of a broadrange of alternative regulatory options. To help decision-makers understand the full effects ofalternative actions, the analysis should present available physical or other quantitative measuresof the effects of the alternative actions where it is not possible to present monetized benefits andcosts, and also present qualitative information to characterize effects that cannot be quantified.Information should include the magnitude, timing, and likelihood of impacts, plus other relevantdimensions (e.g., irreversibility and uniqueness). Where benefit or cost estimates are heavilydependent on certain assumptions, it is essential to make those assumptions explicit, and wherealternative assumptions are plausible, to carry out sensitivity analyses based on the alternativeassumptions.
The large uncertainties implicit in many estimates of risks to public health, safety or theenvironment make treatment of risk and uncertainty especially important. In general, theanalysis should fully describe the range of risk reductions, including an identification of thecentral tendency in the distribution; risk estimates should not present either the upper-bound orthe lower-bound estimate alone.
Those who bear the costs of a regulation and those who enjoy its benefits often are notthe same people. The term "distributional effects" refers to the distribution of the net effects of aregulatory alternative across the population and economy, divided in various ways (e.g., incomegroups, race, sex, industrial sector). Where distributive effects are thought to be important, theeffects of various regulatory alternatives should be described quantitatively to the extentpossible, including their magnitude, likelihood, and incidence of effects on particular groups.There are no generally accepted principles for determining when one distribution of net benefitsis more equitable than another. Thus, the analysis should be careful to describe distributionaleffects without judging their fairness.
Benefits
The analysis should state the beneficial effects of the proposed regulatory change and itsprincipal alternatives. In each case, there should be an explanation of the mechanism by whichthe proposed action is expected to yield the anticipated benefits. As noted above, an attemptshould be made to quantify all potential real benefits to society in monetary terms to themaximum extent possible, by type and time period. Any benefits that cannot be monetized, suchas an increase in the rate of introducing more productive new technology or a decrease in the riskof extinction of endangered species, should also be presented and explained.
The concept of "opportunity cost" is the appropriate construct for valuing both benefitsand costs. The principle of "willingness-to-pay" captures the notion of opportunity cost byproviding an aggregate measure of what individuals are willing to forgo to enjoy a particularbenefit. Market transactions provide the richest data base for estimating benefits based onwillingness-to-pay, as long as the goods and services affected by a potential regulation are tradedin markets.
Where market transactions are difficult to monitor or markets do not exist, analystsshould use appropriate proxies that simulate willingness-to-pay based on market exchange. Avariety of methods have been developed for estimating indirectly traded benefits. Generally,these methods apply statistical techniques to distill from observable market transactions theportion of willingness-to-pay that can be attributed to the benefit in question.Contingent-valuation methods have become increasingly common for estimating indirectlytraded benefits, but the reliance of these methods on hypothetical scenarios and the complexitiesof the goods being valued by this technique raise issues about its validity and reliability inestimating willingness-to-pay compared to methods based on (indirect) revealed preferences.
Health and safety benefits are a major category of benefits that are indirectly traded in themarket. The willingness-to-pay approach is conceptually superior, but measurement difficultiesmay cause agencies to prefer valuations of reductions in risks of nonfatal illness or injury basedon the expected direct costs avoided by such risk reductions. The primary components of thedirect-cost approach are medical and other costs of offsetting illness or injury; costs for avertingillness or injury (e.g., expenses for goods such as bottled water or job safety equipment thatwould not be incurred in the absence of the health or safety risk); and the value of lostproduction.
Values of fatality risk reduction often figure prominently in assessments ofgovernment action. Reductions in fatality risks as a result of government action are bestmonetized according to the willingness-to-pay approach for small reductions in mortality risk,usually presented in terms of the value of a "statistical life" or of "statistical life-years" extended.
Another type of benefit can be characterized as "losses avoided." When our bankingsystem and capital markets systems work well, providing capital and credit to the economy, it iseasy to forget that effective supervision and regulation is needed to prevent disasters like thethrift crisis of the 1980s.
It is important to keep in mind the larger objective of consistency -- subject to statutorylimitations -- in the estimates of benefits applied across regulations and agencies for comparablerisks. Failure to maintain such consistency prevents achievement of the most risk reduction froma given level of resources spent on risk reduction.
Costs
The preferred measure of cost is the "opportunity cost" of the resources used or thebenefits forgone as a result of the regulatory action. Opportunity costs include, but are notlimited to, private-sector compliance costs and government administrative costs. Opportunitycosts also include losses in consumers' or producers' surpluses, discomfort or inconvenience, andloss of time. The opportunity cost of an alternative also incorporates the value of the benefitsforgone as a consequence of that alternative. For example, the opportunity cost of banning aproduct (e.g., a drug, food additive, or hazardous chemical) is the forgone net benefit of thatproduct, taking into account the mitigating effects of potential substitutes. Note that since "costs"may be viewed as benefits foregone, the difficulties in estimating benefits described above inprinciple also apply to the estimation of costs.
All costs calculated should be incremental -- that is, they should represent changes incosts that would occur if the regulatory option is chosen compared to costs in the base case(ordinarily no regulation or the existing regulation) or under a less stringent alternative. As withbenefit estimates, the calculation of costs should reflect the full probability distribution ofpotential consequences.
An important, but sometimes difficult, problem in cost estimation is to distinguishbetween real costs and transfer payments. As discussed below, transfer payments are not socialcosts but rather are payments that reflect a redistribution of wealth. As Best Practices states"While transfers should not be included in the EA's estimates of the benefits and costs of aregulation, they may be important for describing the distributional effects of a regulation."
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