Benefit-cost analysis has a potentially important role to play in helping inform regulatory decision-making, although it should not be the sole basis for such decision-making. This paper offers eight principles on the appropriate use of benefit-cost analysis.Environment, Health and Safety, Regulatory Reform

Arrow, Kenneth J.

Cropper, Maureen L.

Eads, George C.

Hahn, Robert W.

Lave, Lester B.

Noll, Roger G.

Portney, Paul R.

Russell, Milton

Schmalensee, Richard L.

Smith, V. Kerry

Stavins, Robert N.

English

Research Papers in Economics

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
The attached material is posted on regulation2point0.org with permission. Reprint  Series
12 April  1996,  Volume  272,  pp.  221-222
Is  There  a  Role  for  Benefit-Cost
Analysis  in  Environmental,  Health,
and  Safety  Regulation?
Kenneth  J. Arrow,  Maureen  L. Cropper,  George  C. Eads,
Robert  W.  Hahn,  Lester  B. Lave,  Roger  G. No11,  Paul R. Portney,
Milton  Russell,  Richard  Schmalensee,  V. Kerry  Smith,
and  Robert  N. Stavins
Copyright  @ 1996 by  the  American  Association  for  the  Advancement  of  Science..
I'
.
In J,
1?
regulations  has the  potential  to  save signif-
icant  numbers  of  lives  while  using  fewer
resources (3).  The  estimated  cost per statis-
tical  life  s~ved has varied  across regulations
by  a factor  of  more  than  $10  million  (4),
ranging  from  an estimated  cost of $200,000
per  statistical  life  saved with  the  Environ-
mental  Protection  Agency's  (EPA's)  1979
trihalomethane  drinking  water  standard  to
more  than  $6.3  trillion  with  EP  A's  1990
hazardous waste listing  for  wood-preserving
chemicals  (3,  5).  Thus,  a  reallocation  of
priorities  among  these  same  regulations
could  save many  more  lives  at  the  given
cost, or alternatively,  save the same number
of  lives  at  a much  lower  cost  (6).
Most  economists  would  argue that  eco-
nomic  efficiency,  measured  as  the  differ-
ence  between  benefits  and  costs, ought  to
be one of the fundamental  criteria  for  eval-
uating  proposed environmental,  health,  and
safety regulations.  Because society  has lim-
ited  resources to  spend on  regulation,  ben-
efit-cost  analysis  can  help  illuminate  the
trade-offs  involved  in  making  different
kinds  of social investments.  In  this regard, it
seems almost  irresponsible  to  not  conduct
such analyses, because they  can  inform  de-
cisions  about  how  scarce resources can  be
put  to  the greatest social good. Benefit-cost
analysis  can  also help  answer  the  question
of how  much  regulation  is enough.  From an
efficiency  standpoint,  the  answer  to  this
question  is simple:  regulate  until  the  incre-
mental  benefits  from  regulation  are just off-
set  by  the  incremental  costs.  In  practice,
however,  the  problem  is much  more  diffi-  I
cult,  in  large part  because of inherent  prob-
lems  in  measuring  marginal  benefits  and
costs. In  addition,  concerns  about  fairness
and process may be important  noneconom-
ic factors  that  merit  consideration.  Regula-
tory  policies  inevitably  involve  winners  and
losers, even when  aggregate benefits  exceed
aggregate costs (7).
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
Kenneth  J.  Arrow,  Maureen  L.  Cropper,  George  C.  Eads,
Robert  W.  Hahn,  Lester  B.  Lave,  Roger  G.  No11, Paul  R.  Portney,
Milton  Russell,  Richard  Schmalensee,  V.  Kerry  Smith,
Robert  N.  Stavins
The  growing  impact  of  regulations  on  the
economy  has  led  both  Congress  and  the
Administration  to  search  for  new  ways of
reforming  the  regulatory  process. Many  of
these initiatives  call  for  greater  reliance  on
the  use of  economic  analysis  in  the  devel-
opment  and evaluation  of regulations.  One
specific  approach  being  advocated  is bene-
fit-cost  analysis, an economic  tool  for  com-
paring  the  desirable  and  undesirable  im-
pacts of proposed  policies.
For  environmental,  health,  and  safety
regulation,  benefits  are typically  defined  in
terms  of  the  value  of  having  a cleaner  en-
vironment  or  a  safer  workplace.  Ideally,
costs should be measured in the same terms:
the  losses implied  by  the  increased  prices
that  result  from  the  costs of  meeting  a reg-
ulatory  objective.  In practice,  the costs tend
to  be measured on  the  basis of direct  com-
pliance  costs, with  secondary consideration
given  to  indirect  costs, such as the  value  of
time  spent  waiting  in  a motor  vehicle  in-
spection  line.
The  direct  costs of federal  environmen-
tal,  health,  and  safety regulation  appear to
be on the order of $200 billion  annually,  or
about  the  size of  all  domestic  nondefense
discretionary  spending  ( 1  ) .The  benefits  of
the  regulations  are  less  certain,  but  evi-
dence suggests that  some but  not  all  recent
regulations  would  pass a  benefit-cost  test
(2).  Moreover,  a  reallocation  of  expendi-
tures on  environmental,  health,  and  safety
K.  J  Arrow  and  R.  G.  No11  are  in  the  Department  of
Economics,  Stanford  University,  Stanford,  CA  94305,
USA.  M. L  Cropper  is at the World  Bank,  1818  H Street,
NW,  Washington,  DC  20433,  USA.  G  C.  Eads  is  at
Charles  River  Associates,  1001  Pennsylvania  Avenue,
NW,  Washington,  DC 20004,  USA.  R. W.  Hahn  is at the
American  Enterprise  Institute,  1150  17th  Street,  NW,
Washington,  DC 20036,  USA.  L  B  Lave  is in the  Grad-
uate  School  of  Industrial  Organization,  Carnegie  Mellon
University,  Pittsburgh,  PA 15213,  USA  P  R. Portneyis  at
Resources  for  the  Future,  1616  P Street,  NW,  Washing-
ton,  DC 20036,  USA  M.  Russeil  is in the  Department  of
Economics,  University  of  Tennessee,  Knoxville,  TN
37996,  USA.  R. Schmalensee  is at the  Sloan  School  of
Management,  Massachusetts  Institute  of  Technology,
Cambridge,  MA  02139,  USA.  V.  K.  Smith  is  at  Duke
University,  Durham,  NC  27708,  USA.  R. N. Stavins  is at
the  John  F.  Kennedy  School  of  Government,  Harvard
University,  Cambridge,  MA 02138,  USA.
;CIENCE  .VOL.  272  .12  APRIL  1996 221
preclude  the  consideration  of  benefits  and
costs in  the  development  of certain  regula-
tions,  even  though  other  statutes  actually
require  the  use of  benefit-cost  analysis  (8).
Meanwhile,  former  presidents  Carter,  Rea-
gan,  and  Bush  and  President  Clinton  have
all  introduced  formal  processes for  review-
ing  economic  implications  of  major  envi-
ronmental,  health,  and  safety  regulations.
Apparently  the  Executive  Branch,  charged
with  designing  and  implementing  regula-
tions,  has seen a need to develop  a yardstick
against  which  the  efficiency  of  regulatory
proposals can be assessed.  Benefit-cost  anal-
ysis has been  the  yardstick  of  choice  (9).
We  suggest that  benefit-cost  analysis has
a potentially  important  role  to play  in help-
ing  inform  regulatory  decision-making,  al-
though  it  should  not  be  the  sole  basis for
such decision-making.  We  offer  the  follow-
ing  eight  principles  on  the  appropriate  use
of  benefit-cost  analysis  (10).
1)  Benefit-cost analysis is useful for  com-
paring the favorable and unfavorable effects of
policies. Benefit-cost  analysis can help  deci-
sion-makers  better  understand  the  implica-
tions  of decisions  by identifying  and, where
appropriate,  quantifying  the  favorable  and
unfavorable  consequences  of  a  proposed
policy  change,  even  when  information  on
benefits  and  costs,  is  highly  uncertain.  In
some  cases, however,  benefit-cost  analysis
cannot  be  used to  conclude  that  the  eco-
nomic  benefits  of  a decision  will  exceed or
fall  short  of its costs, because there  is simply
too  much  uncertainty.
2)  Decision-makers should not be precluded
from considering  the economic  costs  and benefits
of different policies in  the development of regu-
lations. Agencies should be allowed to use ecO-
nomic analysis to help set regulatory priorities.
Removing  statutory  prohibitions  on the bal-
ancing  of  benefits  and  costs can  help  pro-
mote more efficient  and effective  regulation.
Congress could  further  promote  more  effec-
tive  use  of  resources  by  explicitly  asking
agencies  to  consider  benefits  and  costs  in
formulating  their  regulatory  priorities.
3)  Benefit-cost analysis should be required
for all major regulatory decisions  .Although  the
precise definition  of  "major"  requires  judg-
ment  (11 ),  this  general  requirement  should
.be  applied  to  all  government  agencies. The
scale of a benefit-cost  analysis should depend
on  both  the  stakes involved  and  the  likeli-
hood  that  the  resulting  information  will  af-
fect the ultimate  decision.  For example, ben-
efit-cost  analyses of policies  intended  to  re-
tard  or halt  depletion  of stratospheric  ozone
were worthwhile  because of the  large stakes
involved  and  the  potential  for  influencing
public  policy.
4) Although  agencies  should be required to
conduct  benefit-cost  analyses for  major  deci-
sions and  to  explain  why  they have selected
actions  for  which  reliable  evidence indicatesBoth  economic  efficiency  ar(d  int~
generational  equity  require  that  benefits
and  costs  experienced  in  future  years  be
given  less weight  in  decisfon-making  than
those  experienced  today.  The  rate  at
which  future  benefits  and  costs should  be
discounted  to  present  values will  generally
not  equal  the  rate  of  return  on  private
investment.  The  discount  rate  should  in-
stead be based on how  individuals  trade  off
current  for  future  consumption.  Given  un-
certainties  in  identifying  the  correct  dis-
count  rate,  it  is appropriate  to  use a range
of  rates.  Ideally,  the  same  range  of  dis-
count  rates should  be used in  all  regulatory
analyses.
8) Although  benefit-cost analysis should fo-
cus primarily  on  the overall relation  between
benefits and  costs  ,  a  good analysis will  also
identify  important  distributional  consequences.
Available  data often  permit  reliable  estima-
tion  of  major  policy  impacts  on  important
subgroups  of  the  populatioR  (15).  On  the
other  hand,  environmental,  health,  and
safety  regulations  are  neither  effective  nor
efficient  tools for  achieving  redistributional
goals.
Conclusion.  Benefit-cost  analysis  can
play  an  important  role  in  legislative  and
regulatory  policy  debates  on  protecting
and  improving  health,  safety, and  the  nat-
ural  environment.  Although  formal  bene-
fit-cost  analysis  should  not  be  viewed  as
either  necessary or  sufficient  for  designing
sensible  public  policy,  it  can  provide  an
exceptionally  useful  framework  for  consis-
tently  organizing  disparate  information,
and  in  this'way,  it  can greatly  improve  the
process and,  hence,  the  outcome  of  policy
analysis.  If  propetly  done,  benefit-cost
analysis  can  be  of  great  help  to  agencies
participating  in  the  development  of  envi-
ronmental,  health,  and  safety  regulations,
and  it  can  likewise  be useful  in  evaluating
agency  decision-making  and  in  shaping
statutes.
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, such as equity  within  and across
generations,  may  be  important  in  some
decisions.
5)  Benefits and  costs of  proposed policies
should be quantified  wherever possible. Best
estimates should  be  presented along  with  a
descriPtion of  the uncertainties.  In  most  in-
stances, it should  be possible to describe the
effects of proposed policy  changes in  quan-
titative  terms; however,  not  all  impacts  can
be quantified,  let alone be given  a monetary
value.  Therefore,  care  should  be  taken  to
assure that  quantitative  factors do not  dom-
inate  important  qualitative  factors  in  deci-
sion-making.  If  an  agency  wishes  to  intro-
duce a "margin  of safety"  into  a decision,  it
should  do so explicitly  (12).
Whenever  possible, values used to quan-
tify  benefits  and  costs  in  monetary  terms
should  be based on  trade-offs  that  individ-
uals  would  make,  either  directly  or,  as is
often  the  case, indirectly  in  labor,  housing,
or other  markets  (13).  Benefit-cost  analysis
is premised on the notion  that  the values to
be assigned to program effects-favorable  or
unfavorable-should  be those of the  affect-
ed individuals,  not  the values held  by econ-
omists, moral  philosophers,  environmental-
ists, or  others.
6) The more external review that regulatory
analyses  receive, the better they are likely to be  .
Historically,  the  u.s.  Office  of  Manage-
ment  and  Budget  has played  a key  role  in
reviewing  selected  major  regulations,  par-
ticularly  those  aimed  at  protecting  the  en-
vironment,  health,  and  safety.  Peer review
of  economic  analyses  should  be  used  for
regulations  with  potentially  large economic
impacts  (14).  Retrospective  assessments of
selected  regulatory  impact  analyses should
be carried  out  periodically.
7)  A  core  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. It  is important
to  be able  to  compare  results  across analy-
ses,  and a common  set of economic  assump-
tions  increases the  feasibility  of  such com-
parisons.  In  addition,  a common  set of  ap-
propriate  economic  assumptions  can  im-
prove  the  quality  of  individual  analyses. A
single  agency  should  establish  a set of  de-
fault  values  for  typical  benefits  and  costs
and  should  develop  a  standard  format  for
presenting  results.
REFERENCES  AND  NOTES
mental  protection,  see  (16)
5.  Office  of Management  and  Budget,  Regulatory  Pro-
gram  of  the  United  States  Govemment:  April  1,
1992-March  31,  1993  (Government  Printing  Office,
Washin9ton,  DC,  1993).
6.  If the  goals  of  a program  or  the  level  of  a  particular
standard  have  been  specified,  economic  analysis
can still play an important  role in evaluating  the costs
of various  approaches  for achieving  these  goals  Too
frequently,  regulation  has  used  a one-size-fits-all  or
command-and-control  approach  to  achieve  speci-
fied  goals.  Cost-effectiveness  analysis,  which  identi-
fies  the  minimum-cost  means  to  achieve  a  given
goal,  can  aid in designing  more  flexible  approaches,
such  as  using  markets  and  performance  standards
that  reward  results
7  L. Lave,  in (2).
8.  Several  statutes  have been  interpreted  to  restrict  the
ability  of  regulators  to  consider  benefits  and  costs.
Examples  include  the  Federal  Food,  Drug,  and  Cos-
metic  Act  (Delaney  Clause);  health  standards  under
the  Occupational  Safety  and  Health  Act;  safety  reg-
ulations  from  the  National  Highway  and  Transporta-
tion  Safety  Agency;  the  Clean  Air  Act;  the  Clean
Water  Act;  the Resource  Conservation  and  Recovery
Act;  the  Safe  Drinking  Water  Act;  and  the  Compre-
hensive  Environmental  Response,  Compensation,
and  Liability  Act.  On  the  other  hand,  the  Consumer
Product  Safety  Act,  the  Toxic  Substances  Control
Act,  and  the  Federal  Insecticide,  Fungicide,  and  Ro-
denticide  Act  explicitly  allow  regulators  to  consider
benefits  and  costs.
9.  In particular  cases,  such  as the  phasing  out of lead in
gasoline  and  the  banning  of  certain  asbestos  prod-
ucts,  benefit-cost  analysis  has  played  an  important
role  in decision-making  (17).
10.  For a more  extended  discussion,  see (18).
11.  In this  context,  "major"  has  traditionally  been  de-
fined  in terms  of  annual  economic  impacts  on  the
cost  side.
12  For  example,  potentially  irreversible  consequences
are  not  outside  the  scope  of  benefit-cost  analysis.
The  combination  of  irreversibilities  and  uncertainty
can  have  significant  effects  on  valuation
13  For a conceptual  overview  of methods  of estimating
the  benefits  of  environmental  regulation  and  a brief
survey  of empirical  estimates,  see (19). Forexamina-
tions  of regulatory  costs,  see  (16)
14.  For a description  of problems  that  arise when  bene-
fit-cost  analysis  is used  in the  absence  of standard-
ized  peer  review,  see (20).
15.  G.  B.  Christiansen  and  T.  H.  Tietenberg,  in Hand-
book  of  Natural  Resource  and  Energy  Economics  ,
A.  V  Kneese  and  J.  L. Sweeney,  Eds.  (North-Hoi-
land,  Amsterdam,  1985),  vol.  1, pp.  345-393.
16  R  Schmalensee,  in  Balancing  Economic  Growth
and  Environmental  Goals,  M.  B.  Kotowski,  Ed.
(American  Council  for  Capital  Formation,  Center  for
Policy  Research,  Washington,  DC,  1994),  pp.  55-
75;  A.  B. Jaffe,  S.  R. Peterson,  P. R. Portney,  R. N.
Stavins,  J. Econ.  Lit.  33,  132  (1995).
17.  A.  Fraas,  Law  Contemp.  Probl.  54,  113  (1991).  c
18.  K  J  Arrow  et al.,  Benefit-Cost  Analysis  in Environ-
mental,  Health,  and  Safety  Regulation  (AEI  Press,
Washington,  DC,  1996).
19.  M. L. Cropper  and  W. E. Oates,  J. Econ.  Lit. 30, 675
(1992);  A  M.  Freeman,  The Measurement  of  Envi-
ronmental  and  Resource  Values  (Resources  for  the
Future,  Washington,  DC,  1993).
20.  W.  N. Grubb,  D. Whittington,  M  Humphries,  in En-
vironmental  Policy  Under  Reagan's  Executive  Order:
The Role  of  Benefit-Cost  Analysis,  V.  K. Smith,  Ed.
(Univ  of North  Carolina  Press,  Chapel  Hill, 1984),  pp.
121-164
21.  This  work  was  sponsored  by  the  American  Enter-
prise  Institute,  the Annapolis  Center,  and  Resources
for the  Future,  with  funding  provided  by the  Annap-
olis  Center.  The  manuscript  benefited  from  com-
ments  from  an editor  and  a referee,  but  the  authors
alone  are responsible  for the  final  product.
1.  T.  D  Hopkins,  "Cost  of  Regulation.  Filling  in  the
Gaps"  (report  prepared  for  the  Regulatory  Informa-
tion  Service  Center,  Rochester,  NY,  1992);  Office  of
Management  and  Budget,  Budget  of  the  United
States  Government,  Fiscal  Year  1996  (Government  f
Printing  Office,  Washington,  DC,  1995).
2.  R. W.  Hahn,  in Risks,  Costs,  and  Lives  Saved'  Get-
ting Better  Results  from  Regulation,  R. W.  Hahn,  Ed.
(Oxford  Univ.  Press,  Oxford,  and  AEI  Press,  Wash-
ington,  DC,  in press).
3.  J.  F. Morrall,  Regulation  10,  25  (November-Decem-
ber  1986)
4.  These  figures  represent  the  incremental  direct  cost
of  part  or  all  of  proposed  regulations  relative  to
specified  baselines.  For examinations  of issues  as-
sociated  with  estimating  the  full  costs  of  environ-
SCIENCE.  VOl.  272  . 2  APRIL  1996 222

Benefit-Cost Analysis in Environmental, Health, and Safety Regulation

Cost of Regulation. Filling in the Gaps&quot; (report prepared for the Regulatory Information Service

Costs, and Lives Saved' Getting Better Results from Regulation,

For a description of problems that arise when benefit-cost analysis is used in the absence of standardized peer review, see (20).

For a more extended discussion,

Humphries, in Environmental Policy Under Reagan's Executive Order: The Role of Benefit-Cost Analysis,

In particular cases, such as the phasing out of lead in gasoline and the banning of certain asbestos products, benefit-cost analysis has played an important role in decision-making (17).

Law Contemp.

Office of Management and Budget, Regulatory Program of the United States Govemment: April 1, 1992-March 31,

The Measurement of Environmental and Resource Values (Resources for the Future,

These figures represent the incremental direct cost of part or all of proposed regulations relative to specified baselines. For examinations of issues associated with estimating the full costs of environSCIENCE.

Is There a Role for Benefit-Cost Analysis in Environmental, Health, and Safety Regulation?

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Is There a Role for Benefit-Cost Analysis in Environmental, Health, and Safety Regulation?

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