The ongoing efforts in the 104th Congress to legislate requirements for cost-benefit analysis (CBA) and the revised OMB Guidelines for the conduct of such assessments during a regulatory rule making process, highlights the need for a comprehensive examination of the role cost-benefit analysis can play in agency decision-making. This white paper summarizes the state of knowledge and offers suggestions for improvement in the conduct and use cost-benefit analysis, especially in the context of environmental regulations. Its scope is not confined to assessments of cancer risks or other toxic substances concerns , but rather, addresses the entire range of environmental policy issues.
CBA is a technique intended to improve the quality of public policy decisions, using as a metric a monetary measure of the aggregate change in individual well-being resulting from a policy decision. Individual welfare is assumed to depend on the satisfaction of individual preferences, and monetary measures of welfare change are derived by observing how much individuals are willing to pay, i.e., willing to give up in terms of other consumption opportunities. This approach can be applied to nonmarket "public goods" like environmental quality or environmental risk reduction as well as to market goods and services, though the measurement of nonmarket values is more challenging. Cost-effectiveness analysis (CEA) is a subset of cost-benefit analysis in which a policy outcome (e.g., a specified reduction of ambient pollution concentration) is taken as given and the analysis seeks to identify the least-cost means for achieving the goal (taking into account any ancillary benefits of alternative actions as well).
To its adherents, the advantages of CBA (and CEA) include transparency and the resulting potential for engendering accountability; the provision of a framework for consistent data collection and identification of gaps and uncertainty in knowledge; and, with the use of a money metric, the ability to aggregate dissimilar effects, such as those on health, visibility, and crops, into one measure of net benefits. Criticisms of CBA hinge on questions about a) the assumption that individual well-being can be characterized in terms of preference satisfaction; b) the assumption that aggregate social well-being can be expressed as an aggregation (usually just a simple summation) of individual social welfare; c) the empirical problems encountered in quantifying economic value and aggregating measures of individual welfare.
We take a) as axiomatic, noting also that because CEA is a subset of CBA, philosophical objections to the use of a preference-based approach to individual welfare measurement apply equally to both. For b) we agree that CBA does not incorporate all factors that can and should influence judgments on the social worth of a policy, and that individual preference satisfaction is not the only factor. Nevertheless, we assert that CBA must be included as a key factor. Other arguments under c) are measurement problems -- how choices based on preferences permit can one to infer economic values in practice.
The state of the science of measuring such economic values is exceedingly active. Estimates of the willingness to pay for reductions in mortality and morbidity risks, for avoiding environmental damages to recreation opportunities, and for avoiding visibility degradation, are the most active and successful areas of valuation. Issues of a higher order stalk the estimation of nonuse values, and a variety of mostly empirical concerns have left materials damages poorly understood. Estimation of the costs of reducing environmental effects, while generally thought to be relatively straightforward, are found to be at least as challenging as estimating the benefits, although there are easy-to-estimate, but perhaps, poor proxies for the loss in social well-being such costs represent.
The white paper offers a number of suggestions to regulatory agencies in conducting CBA, drawing upon the "best practices" identified in the new OMB Guidelines. These include the use of clear and consistent baseline assumptions; the evaluation of an appropriately broad range of policy alternatives, including alternatives to new regulation; appropriate treatment of discounting future benefits and costs, and accounting for the cost of risk-bearing; the use of probabilistic analyses and other methods to explore the robustness of conclusions; the identification of nonmonetizable or nonquantifiable aspects of a policy, and the potential incidence of all effects; and, last but not least, the use of benefit and cost measures that are grounded in economic theory (i.e., measures of willingness to pay and opportunity cost).
The paper also argues that from an economic perspective, risk assessment is a subset of benefits analysis in that quantitative relationships between pollution exposure and some human or ecological response are needed to estimate the population response and thus the marginal change in welfare resulting from a policy. The culture of risk assessment is not generally oriented towards this role, implying that risk assessments do not always provide the necessary input to an economic benefits analysis. Suggested changes in risk assessment practices include: estimating population risks, not just individual risks; providing information on the entire distribution of risks, including central tendencies, rather than just upper-end risk measures based on conservative assumptions about the potential threat; providing as much information as is practicable about how risks vary with exposure, rather than just identifying "safe" or "acceptable" threshold levels of exposure; and considering substitution risks as of equal importance to direct risk reductions. Economists and risk assessors together must also address how to give appropriate attention to both lay perceptions and expert assessments of risks.
The improvements in the methodologies for estimating the costs and benefits of regulatory activities discussed above are necessary but not sufficient for significantly improving regulatory decisions. Several more overarching issues involving the role of cost-benefit analysis in public decisionmaking must also be debated and resolved. These include: