Midnight Changes to Cost-Benefit Analysis?

Much is being made of the outgoing Bush Administration’s “midnight regulations,”  and with good reason, too.  Many of them roll back crucial protections for public health, safety, and the environment.  So far, they include relaxed requirements for building filthy coal plants near national parks and the elimination of a requirement mandating that federal agencies consult with independent scientists prior to taking actions that might impact endangered species.

The fact is, however, that the Bush Administration has been surreptitiously weakening regulations for the last eight years through the backdoor process of regulatory review.   And, thanks to a proposed guidance recently released by the White House Office of Management and Budget (OMB), the process of regulatory review may be tilted even further in favor of weakening regulations.

The proposed guidance involves a new requirement for how the Office of Information and Regulatory Affairs (OIRA) conducts cost-benefit analysis during its review of agency regulations.  OIRA is a small and somewhat obscure bureau within OMB, but it has a broad portfolio.  A series of Executive Orders dating back to the early days of the Reagan Administration has directed OIRA to review all major federal agency rules (those that have some specified large impact on the economy or the federal budget), by applying cost-benefit analysis.  In theory, the review is intended to ensure that these agency rules are economically efficient.  But in practice—and OIRA has gotten plenty of practice—that is, its analyses are slanted against protective regulations.

CPR’s Member Scholars have marshaled a large body of work detailing just exactly how and why OIRA’s approach to cost-benefit analysis is biased towards weaker regulations.  Generally speaking, OIRA’s methods systematically overestimate costs and underestimate benefits, thus presenting a distorted view of the true value of a proposed regulation.  If enacted, the Bush Administration’s new proposed guidance would serve to distort this view even further.

The proposed change would require agencies to incorporate international trade effects into their cost-benefit analyses of proposed rules.  In particular, it would require agencies to determine the degree to which a regulation interferes with international trade, to attempt to put a monetary value on the disrupted trade, and then to include this monetary value as a “cost” of the proposed regulation.

The problem with this proposed change to cost-benefit analysis is that it rests on two problematic assumptions:  (1) that regulation always reduces international trade and (2) that international trade necessarily leads to net benefits for the United States.

First, domestic regulation can just as easily have the effect of fostering international trade and resultant economic growth.  Consider, for example, regulation in the United States imposing limits on carbon dioxide emissions.  Such a regulation is likely to stimulate technological innovations in renewable energy technologies and in energy efficiency advancements for which there is already high demand abroad, thus stimulating domestic economic growth.

Second, international trade can just as easily result in net costs for participating countries.  This is because international trade invariably yields new costs for the participating countries, and, in some instances, these new costs may offset most or all of the benefits from trade.  To take a simple example, international trade produces greater transportation-related costs in the form of depleted natural resources (e.g., oil) and negative externalities (e.g., air pollution and greenhouse gas emissions), since goods must travel greater distances in order to reach the end user.  If these costs more than offset the benefits of the international trade, a regulation that interferes with or disrupts it may actually produce net benefits.

In short, the trade-related impacts of domestic regulation are exceedingly complex, and probably impossible to calculate with any accuracy.  If anything is certain, it is that those impacts are likely to include both costs and benefits, and the attempt to reduce these complex issues into a simplistic, one-size-fits-all, costs-only formula will only serve to add further distortion and bias to cost-benefit analysis.

This proposed change was announced in OMB’s recent Draft 2008 Report to Congress on the Benefits and Costs of Federal Regulations.  OMB has published these reports on annual basis since 1997.  The reports were initially intended to present an honest assessment of how cost-benefit analysis has affected regulatory efficiency.  In recent years, however, the Bush Administration has used them to promote its anti-regulatory agenda, by using them as a platform to denigrate regulations as an enemy of economic growth and to trumpet the Administration’s success in reducing levels of environmental, health, and safety regulation.

As part of its ongoing efforts to serve as a watchdog for OMB’s anti-regulatory activities, CPR Member Scholars have diligently commented on these reports every year since 2002.  These comments highlight the scholars’ criticisms of cost-benefit analysis in general and of its application to specific rules in particular.  CPR Member Scholars will continue to issue such comments on these and other OMB reports regarding cost-benefit analysis in the future.

The full set of comments on this year’s OMB report, by CPR Member Scholar Amy Sinden and myself, is available on the CPR website.  (And under the heading of "credit where it's due," many of Professor Sinden's insights on the subject are also reflected in this blog posting.)