Office of Management and Budget Archives - Page 2 of 3 - An Economic View of the Environment

Good News from the Regulatory Front

As each day passes, the upcoming November 2012 general elections produce new stories about potential Republican candidates for President, as well as stories about President Obama’s anticipated re-election campaign. At the same time, the 2012 elections are already affecting Congressional debates, where each side seems increasingly interested in taking symbolic actions and scoring political points that can play to its constituencies among the electorate, rather than working earnestly on the country’s business.

The new Tea Party Republicans in the House of Representatives decry the “fact” that the U.S. Environmental Protection Agency (EPA) continues to promulgate “job-killing regulations” for made-up non-problems. And Democrats in the Congress – not to mention the Administration – are eager to talk about “win-win” policies that will produce “clean energy jobs” and protect Americans from the evils of imported oil and gas.

Neither side seems willing to admit that environmental regulations bring both good news – a cleaner environment – and bad news – costs of compliance that affect not only businesses but consumers as well. Sometimes the cost-side of proposed regulations dominates. Those regulatory moves are – from an economic perspective – fundamentally unwise, since they make society worse off. In other cases, the benefits of a proposed regulation more than justify the costs that will be incurred. Such regulations are – to use a word now favored by President Obama – a wise investment. They make society better off. Failure to take action on such opportunities is imprudent, if not irresponsible. Just such an opportunity now presents itself with EPA’s Clean Air Transport Rule.

In an op-ed that appeared on April 25, 2011, in The Huffington Post (click here for link to the original op-ed), Richard Schmalensee and I assess this opportunity. Rather than summarize (or expand on) our op-ed, I simply re-produce it below as it was published by The Huffington Post, with some hyperlinks added for interested readers.

For anyone who is not familiar with my co-author, Richard Schmalensee, please note that he is the Howard W. Johnson Professor of Economics and Management at MIT, where he served as the Dean of the Sloan School of Management from 1998 to 2007. Also, he served as a Member of the President’s Council of Economic Advisers in the George H. W. Bush administration from 1989 to 1991. By the way, in previous blog posts, I’ve featured other op-eds that Dick and I have written in The Huffington Post (“Renewable Irony”) and The Boston Globe (“Beware of Scorched-Earth Strategies in Climate Debates”).

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An Opportunity for Timely Action: EPA’s Transport Rule Passes the Test

by Richard Schmalensee and Robert Stavins

The Huffington Post, April 25, 2011

At a time when EPA regulations are under harsh attack, one new environmental regulation – at least – stands out as an impressive winner for the country. Studies of the soon-to-be-finalized Clean Air Transport Rule have consistently found that the benefits created by the rule would far outweigh its costs. By reducing sulfur dioxide and nitrogen oxide emissions from power plants in 31 states in the East and Midwest, the Transport Rule will create substantial benefits through lower incidence of respiratory and heart disease, improved visibility, enhanced agricultural and forestry yields, improved ecosystem services, and other environmental amenities. According to EPA, these benefits will be 25 to 130 times greater than the associated costs. We document this in our new report, “A Guide to Economic and Policy Analysis of EPA’s Transport Rule,” which was commissioned by the Exelon Corporation.

Despite the benefits offered by the Transport Rule, some argue that it – and other EPA regulations – will stifle economic growth and threaten the reliability of our electric power system. However, a careful look at the evidence reveals that the Transport Rule is unlikely to create such risks. Analyses of the Transport Rule have found that it need not lead to significant plant retirements. Robust regulatory and market mechanisms ensure that the nation can meet emission targets while reliably meeting customer demand.

While compliance with the Transport Rule would – in some cases – require installation of new pollution control equipment, the capital expenditures required would comprise a small fraction of aggregate capital spending by the power industry. In fact, because of the Transport Rule’s unique legal circumstances, in which the Courts have mandated that EPA replace a stringent predecessor, utilities have already begun to make pollution control investments needed to comply with the Transport Rule.

The Rule’s timing can also contribute to lowering its cost and supporting other policy goals. Installation of the pollution control technologies needed to comply with the Rule could increase short-term employment. Although the longer term job impacts are less clear, these short-term employment effects would complement other policy initiatives aimed at supporting the nation’s economic recovery.

EPA analysis estimates modest impacts on regional electricity rates, but reductions in health care expenditures could partially or fully offset these effects. Expanded supplies of low-cost natural gas can also help lower the Transport Rule’s cost by providing a less costly substitute for power generated from coal.

Most importantly, actions taken to reduce emissions would create substantial health benefits. Tens of thousands of premature deaths would be eliminated annually, as would millions of non-fatal respiratory and cardiovascular illnesses. A diverse set of studies find that these health improvements will create $20 to over $300 billion in benefits annually. And, while the Transport Rule is designed to reduce the impact of upwind emissions on downwind states, upwind states would also receive substantial health benefits from the cleaner air brought about by the Rule. These upwind states have much to gain, because states with the highest emissions from coal-fired power plants are also among those with the greatest premature mortality rates from these emissions.

Along with these health benefits, the largest shares of short-term improvements in employment and regional economies are likely to accrue to the regions that are most dependent on coal-fired power, as they invest in new pollution control equipment. Thus, while designed to help regions downwind of coal-fired power plants, the Transport Rule also offers substantial benefits to upwind states.

As the U.S. economy emerges from its worst recession since the Great Depression of the 1930s and faces an increasingly competitive global marketplace, regulation such as the Transport Rule that creates positive net benefits and allows industry flexibility in creating public goods can complement strategies intended to foster economic growth. Such regulations are best identified by careful analyses to ensure that benefits truly exceed costs and avoid unfair impacts on particular groups or sectors. The Transport Rule has undergone a series of such thorough assessments, and the results consistently indicate that it would create benefits that far exceed its costs. Failure to take timely action on this opportunity would seem to be imprudent, if not irresponsible.

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*Richard Schmalensee is the Howard W. Johnson Professor of Economics and Management at the Massachusetts Institute of Technology, a research associate of the National Bureau of Economic Research, and a fellow of the Econometric Society and the American Academy of Arts and Sciences. He served as a member of the Council of Economic Advisers with primary responsibility for environmental and energy policy from 1989 through 1991. Robert N. Stavins is the Albert Pratt Professor of Business and Government at the Harvard Kennedy School, a university fellow of Resources for the Future, a research associate of the National Bureau of Economic Research, and a fellow of the Association of Environmental and Resource Economists. He served as chairman of the EPA’s Environmental Economics Advisory Committee from 1997 through 2002. Their report, “A Guide to Economic and Policy Analysis of EPA’s Transport Rule,” which was commissioned by the Exelon Corporation, can be downloaded at: http://www.analysisgroup.com/uploadedFiles/Publishing/Articles/2011_StavinsSchmalansee_TransportRuleReport.pdf

Is Benefit-Cost Analysis Helpful for Environmental Regulation?

With the locus of action on Federal climate policy moving this week from the House of Representatives to the Senate, this is a convenient moment to step back from the political fray and reflect on some fundamental questions about U.S. environmental policy.

One such question is whether economic analysis – in particular, the comparison of the benefits and costs of proposed policies – plays a truly useful role in Washington, or is it little more than a distraction of attention from more important perspectives on public policy, or – worst of all – is it counter-productive, even antithetical, to the development, assessment, and implementation of sound policy in the environmental, resource, and energy realms. With an exceptionally talented group of thinkers – including scientists, lawyers, and economists – now in key environmental and energy policy positions at the White House, the Environmental Protection Agency, the Department of Energy, and the Department of the Treasury, this question about the usefulness of benefit-cost analysis is of particular importance.

For many years, there have been calls from some quarters for greater reliance on the use of economic analysis in the development and evaluation of environmental regulations. As I have noted in previous posts on this blog, most economists would argue that economic efficiency — measured as the difference between benefits and costs — ought to be one of the key criteria for evaluating proposed regulations. (See: “The Myths of Market Prices and Efficiency,” March 3, 2009; “What Baseball Can Teach Policymakers,” April 20, 2009; “Does Economic Analysis Shortchange the Future?” April 27, 2009) Because society has limited resources to spend on regulation, such analysis can help illuminate the trade-offs involved in making different kinds of social investments. In this sense, it would seem irresponsible not to conduct such analyses, since they can inform decisions about how scarce resources can be put to the greatest social good.

In principle, benefit-cost analysis can also help answer questions of how much regulation is enough. From an efficiency standpoint, the answer to this question is simple — regulate until the incremental benefits from regulation are just offset by the incremental costs. In practice, however, the problem is much more difficult, in large part because of inherent problems in measuring marginal benefits and costs. In addition, concerns about fairness and process may be very important economic and non-economic factors. Regulatory policies inevitably involve winners and losers, even when aggregate benefits exceed aggregate costs.

Over the years, policy makers have sent mixed signals regarding the use of benefit-cost analysis in policy evaluation. Congress has passed several statutes to protect health, safety, and the environment that effectively preclude the consideration of benefits and costs in the development of certain regulations, even though other statutes actually require the use of benefit-cost analysis. At the same time, Presidents Carter, Reagan, Bush, Clinton, and Bush all put in place formal processes for reviewing economic implications of major environmental, health, and safety regulations. Apparently the Executive Branch, charged with designing and implementing regulations, has seen a greater need than the Congress to develop a yardstick against which regulatory proposals can be assessed. Benefit-cost analysis has been the yardstick of choice

It was in this context that ten years ago a group of economists from across the political spectrum jointly authored an article in Science magazine, asking whether there is role for benefit-cost analysis in environmental, health, and safety regulation. That diverse group consisted of Kenneth Arrow, Maureen Cropper, George Eads, Robert Hahn, Lester Lave, Roger Noll, Paul Portney, Milton Russell, Richard Schmalensee, Kerry Smith, and myself. That article and its findings are particularly timely, with President Obama considering putting in place a new Executive Order on Regulatory Review.

In the article, we suggested that benefit-cost analysis has a potentially important role to play in helping inform regulatory decision making, though it should not be the sole basis for such decision making. We offered eight principles.

First, benefit-cost analysis can be useful for comparing the favorable and unfavorable effects of policies, because it can help decision makers better understand the implications of decisions by identifying and, where appropriate, quantifying the favorable and unfavorable consequences of a proposed policy change. But, in some cases, there is too much uncertainty to use benefit-cost analysis to conclude that the benefits of a decision will exceed or fall short of its costs.

Second, decision makers should not be precluded from considering the economic costs and benefits of different policies in the development of regulations. Removing statutory prohibitions on the balancing of benefits and costs can help promote more efficient and effective regulation.

Third, benefit-cost analysis should be required for all major regulatory decisions. The scale of a benefit-cost analysis should depend on both the stakes involved and the likelihood that the resulting information will affect the ultimate decision.

Fourth, although agencies should be required to conduct benefit-cost analyses for major decisions, and to explain why they have selected actions for which reliable evidence indicates that expected benefits are significantly less than expected costs, those agencies should not be bound by strict benefit-cost tests. Factors other than aggregate economic benefits and costs may be important.

Fifth, benefits and costs of proposed policies should be quantified wherever possible. But not all impacts can be quantified, let alone monetized. Therefore, care should be taken to assure that quantitative factors do not dominate important qualitative factors in decision making. If an agency wishes to introduce a “margin of safety” into a decision, it should do so explicitly.

Sixth, the more external review that regulatory analyses receive, the better they are likely to be. Retrospective assessments should be carried out periodically.

Seventh, a consistent set of economic assumptions should be used in calculating benefits and costs. Key variables include the social discount rate, the value of reducing risks of premature death and accidents, and the values associated with other improvements in health.

Eighth, while benefit-cost analysis focuses primarily on the overall relationship between benefits and costs, a good analysis will also identify important distributional consequences for important subgroups of the population.

From these eight principles, we concluded that benefit-cost analysis can play an important role in legislative and regulatory policy debates on protecting and improving the natural environment, health, and safety. Although formal benefit-cost analysis should not be viewed as either necessary or sufficient for designing sensible public policy, it can provide an exceptionally useful framework for consistently organizing disparate information, and in this way, it can greatly improve the process and hence the outcome of policy analysis.

If properly done, benefit-cost analysis can be of great help to agencies participating in the development of environmental regulations, and it can likewise be useful in evaluating agency decision making and in shaping new laws (which brings us full-circle to the climate legislation that will be developed in the U.S. Senate over the weeks and months ahead, and which I hope to discuss in future posts).

National Climate Change Policy: A Quick Look Back at Waxman-Markey and the Road Ahead

Like any legislation, the Waxman‑Markey bill has its share of flaws, but its cap-and-trade system has medium and long‑term targets for reducing greenhouse gas emissions that are sensible, and the cap‑and‑trade system is — for the most part — well designed. With some exceptions, the bill’s cap‑and‑trade system will achieve meaningful reductions of carbon dioxide and other greenhouse gas emissions at minimal cost to the economy.

There has been much lamenting about the corporate give-away in the bill, but this is unfounded, as I explained in detail in my May 27^th post on The Wonderful Politics of Cap-and-Trade: A Closer Look at Waxman-Markey. Concerns have also been expressed — such as by a number of Republican members of Congress during last Friday’s floor debate in the House of Representatives — about negative impacts on the international competitiveness of U.S. firms. The only real solution to the international competitiveness issue in the long term is to bring non‑participating countries within an international climate regime in meaningful ways. (On this, please see the work of the Harvard Project on International Climate Agreements.) But that solution is fundamentally outside of the scope of the domestic policy action of any individual nation, including the United States.

In the meantime, the Waxman‑Markey approach of combining output‑based updating allocations in the short term for select sectors with the option in the long term of a Presidential determination (under stringent conditions) for import allowance requirements for specific countries and sectors was sensible and pragmatic (see my June 18^th post on Worried About International Competitiveness? Another Look at the Waxman-Markey Cap-and-Trade Proposal).

That’s the good news. But the bad news is that last-minute changes in the bill changed what was a Presidential option regarding long-term back-up border adjustments (tariffs) to a requirement that the President put such tariffs in place under specified conditions. This moved the legislation considerably closer to risky protectionism, as President Obama rightly noted in comments to the press on Sunday.

Also, the compromise amendments with the House agriculture committee that provide for generous numbers of potential offsets from the agricultural sector (regulated not by EPA, but by USDA!) are troubling — not in terms of driving up compliance costs, but in terms of reducing the real environmental performance of the system. This is because of the general problem of limited additionality of claimed reductions under offset (or emission-reduction-credit) systems, as opposed to cap-and-trade systems, plus the well-known difficulties of measuring non-point emissions, let alone emissions reductions, from agriculture.

These and other design issues will be important topics when the Senate takes up its own climate legislation, although the debate in that body on some of these issues will likely be quite different. For example, there is likely to be more interest in the Senate in the use of a “price collar,” a mechanism to constrain both the maximum and the minimum market price of allowances over time. This would be a move beyond the safety-valve mechanism that is provided in the House legislation.

When the action moves to the Senate, the greatest attention and the greatest skepticism should be directed not to the cap‑and‑trade mechanism, which is — for the most part — well designed in Waxman‑Markey, but rather to other elements of the legislation, some of which are highly problematic. While the titles of Waxman‑Markey that create the cap‑and‑trade system are ‑‑ on balance ‑‑ sensible, and will result in meaningful emissions reductions cost effectively, the other titles of the bill include a host of conventional standards and subsidies, many of which (under the cap‑and‑trade umbrella) will have minimal or no environmental benefits, but will limit flexibility and thereby have the unintended consequence of driving up compliance costs. That’s the soft under‑belly of this legislation that needs to be selectively, surgically repaired.

It is the fault of economists — myself included — that we have given so much attention to the cap-and-trade system that we have ignored these other important elements of the legislation, elements that unfortunately can degrade significantly the cost-effectiveness of the package while providing little if any incremental benefits to the environment. Even the Congressional Budget Office, in its excellent economic analysis of HR 2454, focused exclusively on the bill’s cap-and-trade program. Going forward, CBO, EPA, and independent analysts need to examine the bill’s other elements, and assess what those elements provide at what incremental cost.

A broader question — also raised by House Republicans in the floor debate — is whether the United States should be moving towards the enactment of a domestic climate policy before a sensible, post‑Kyoto international agreement has been negotiated and ratified. Such an international agreement should include not only the countries of the industrialized world, but also the key, rapidly‑growing economies of the developing world ‑‑ China, India, Brazil, Korea, Mexico, South Africa, and Indonesia ‑‑ which are and will increasingly be major contributors to emissions.

It’s natural for such a question to be raised about the very notion of the U.S. adopting a policy to help address what is fundamentally a global problem. The environmental benefits of any single nation’s reductions in greenhouse gas emissions are spread worldwide, unlike the costs. This means that for any single country, the costs of action will inevitably exceed its direct benefits, despite the fact that the global costs of action will be less than global benefits. This is the nature of a global commons problem, and this is the very reason why international cooperation is required.

The U.S. is now engaged in international negotiations, and the credibility of the U.S. as a participant, let alone as a leader, in shaping the international regime is dependent upon our demonstrated willingness to take actions at home.

Europe has put its climate policy in place, and Australia, New Zealand, and Japan are moving to have their policies in place within a year. If the United States is to play a leadership role in international negotiations for a sensible post‑Kyoto international climate regime, the country must begin to move towards an effective domestic policy ‑ with legislation that is timed and structured to coordinate with the emerging post‑Kyoto climate regime.

Without evidence of serious action by the U.S., there will be no meaningful international agreement, and certainly not one that includes the key, rapidly‑growing developing countries. U.S. policy developments can and should move in parallel with international negotiations.

So, the Waxman‑Markey bill has its share of flaws, but it represents a reasonable starting point for Senate deliberation on what can become a national climate policy that will place the United States where it ought to be -‑ in a position of international leadership to help develop a global climate agreement that is scientifically sound, economically rational, and politically acceptable to the key nations of the world.