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January 11, 1996
Economic Analysis of Federal Regulations
Under Executive Order 12866
After President Clinton signed Executive Order 12866, "Regulatory
Planning and Review," the Administrator of the Office of Information and
Regulatory Affairs of the Office of Management and Budget convened an
interagency group to review the state of the art for economic analyses
of regulatory actions required by the Executive Order. The group was
co-chaired by a Member of the Council of Economic Advisers and included
representatives of all the major regulatory agencies. This document
represents the results of an exhaustive two-year effort by the group to
describe "best practices" for preparing the economic analysis of a
significant regulatory action called for by the Executive Order.
1. More Performance-Oriented Standards for Health, Safety, and
2. Different Requirements for Different Segments of the
3. Alternative Levels of Stringency
4. Alternative Effective Dates of Compliance
5. Alternative Methods of Ensuring Compliance
6. Informational Measures
7. More Market-Oriented Approaches
8. Considering Specific Statutory Requirements
2. Evaluation of Alternatives
(a) Basic guidance
(b) Additional considerations
(c) Intergenerational analysis
4. Treatment of Risk and Uncertainty
(a) Risk assessment
(b) Valuing risk levels and changes
6. International Trade Effects
7. Nonmonetized Benefits and Costs
8. Distributional Effects and Equity
B. Benefit Estimates
1. General Considerations
2. Principles for Valuing Benefits Directly Traded in Markets
3. Principles for Valuing Benefits Indirectly Traded in Markets
4. Principles for Valuing Benefits That Are Not Traded Directly or
Indirectly in Markets
5. Methods for Valuing Health and Safety Effects
(a) Nonfatal illness and injury
(b) Fatality risks
(c) Alternative methodological frameworks for estimating benefits from
reduced fatality risks
C. Cost Estimates
1. General Considerations
2. Real Costs Versus Transfer Payments
(a) Scarcity rents and monopoly profits
(b) Insurance payments
(c) Indirect taxes and subsidies
(d) Distribution expenses
In accordance with the regulatory philosophy and principles provided in Sections 1(a) and
(b) and Section 6(a)(3)(C) of Executive Order 12866, an Economic Analysis (EA) of
proposed or existing regulations should inform decisionmakers of the consequences of
alternative actions. In particular, the EA should provide information allowing
decisionmakers to determine that:
There is adequate information indicating the need for and consequences of the
The potential benefits to society justify the potential costs, recognizing that not all
benefits and costs can be described in monetary or even in quantitative
terms, unless a statute requires another regulatory approach;
The proposed action will maximize net benefits to society (including potential
economic, environmental, public health and safety, and other advantages;
distributional impacts; and equity), unless a statute requires another
Where a statute requires a specific regulatory approach, the proposed action will
be the most cost-effective, including reliance on performance objectives to
the extent feasible;
Agency decisions are based on the best reasonably obtainable scientific, technical,
economic, and other information.
While most EAs should include these elements, variations consistent with the spirit and
intent of the Executive Order may be warranted for some regulatory actions. In particular,
regulations establishing terms or conditions of Federal grants, contracts, or financial
assistance may call for a different form of regulatory analysis, although a full-blown
benefit-cost analysis of the entire program may be appropriate to inform Congress and the
President more fully about its desirability.
The EA that the agency prepares should also satisfy the requirements of the "Unfunded
Mandates Reform Act of 1995" (P.L. 104-4). Title II of this statute (Section 201) directs
agencies "unless otherwise prohibited by law [to] assess the effects of Federal regulatory
actions on State, local, and tribal governments, and the private sector..." Section 202(a)
directs agencies to provide a qualitative and quantitative assessment of the anticipated
costs and benefits of a Federal mandate resulting in annual expenditures of $100 million or
more, including the costs and benefits to State, local, and tribal governments or the private
sector. Section 205(a) requires that for those regulations for which an agency prepares a
statement under Section 202, "the agency shall  identify and consider a reasonable
number of regulatory alternatives and  from those alternatives select the least costly,
most cost-effective or least burdensome alternative that achieves the objectives of the
proposed rule." If the agency does not select "the least costly, most cost-effective, or
least burdensome option, and if the requirements of Section 205(a) are not "inconsistent
with law," Section 205(b) requires that the agency head publish "with the final rule an
explanation of why the least costly, most cost-effective, or least burdensome method was
The "Regulatory Flexibility Act" (P.L. 96-354) requires Federal agencies to give special
consideration to the impact of regulation on small businesses. The Act specifies that a
regulatory flexibility analysis must be prepared if a screening analysis indicates that a
regulation will have a significant impact on a substantial number of small entities. The EA
that the agency prepares should incorporate the regulatory flexibility analysis, as
This document is not in the form of a mechanistic blueprint, for a good EA cannot be
written according to a formula. Competent professional judgment is indispensable for the
preparation of a high-quality analysis. Different regulations may call for very different
emphases in analysis. For one proposed regulation, the crucial issue may be the question
of whether a market failure exists, and much of the analysis may need to be devoted to
that key question. In another case, the existence of a market failure may be obvious from
the outset, but extensive analysis might be necessary to estimate the magnitude of benefits
to be expected from proposed regulatory alternatives.
Analysis of the risks, benefits, and costs associated with regulation must be guided by the
principles of full disclosure and transparency. Data, models, inferences, and assumptions
should be identified and evaluated explicitly, together with adequate justifications of
choices made, and assessments of the effects of these choices on the analysis. The
existence of plausible alternative models or assumptions, and their implications, should be
identified. In the absence of adequate valid data, properly identified assumptions are
necessary for conducting an assessment.
Analysis of the risks, benefits, and costs associated with regulation inevitably also involves
uncertainties and requires informed professional judgments. There should be balance
between thoroughness of analysis and practical limits to the agency's capacity to carry out
analysis. The amount of analysis (whether scientific, statistical, or economic) that a
particular issue requires depends on the need for more thorough analysis because of the
importance and complexity of the issue, the need for expedition, the nature of the
statutory language and the extent of statutory discretion, and the sensitivity of net benefits
to the choice of regulatory alternatives. In particular, a less detailed or intensive analysis
of the entire range of regulatory options is needed when regulatory options are limited by
statute. Even in these cases, however, agencies should provide some analysis of other
regulatory options that satisfy the philosophy and principles of the Executive Order, in
order to provide decisionmakers with information for judging the consequences of the
statutory constraints. Whenever an agency has questions about such issues as the
appropriate analytical techniques to use or the alternatives that should be considered in
developing an EA under the Executive Order, it should consult with the Office of
Management and Budget as early in the analysis stage as possible.
Preliminary and final Economic Analyses of economically "significant " rules ( as defined
in Section 3(f)(1) of the Executive Order) should contain three elements: (1) a statement
of the need for the proposed action, (2) an examination of alternative approaches, and (3)
an analysis of benefits and costs. These elements are described in Sections I-III below.
The same basic analytical principles apply to the review of existing regulations, as called
for under Section 5 of the Executive Order. In this case, the regulation under review
should be compared to a baseline case of not taking the regulatory action and to
In order to establish the need for the proposed action, the analysis should discuss whether
the problem constitutes a significant market failure. If the problem does not constitute a
market failure, the analysis should provide an alternative demonstration of compelling
public need, such as improving governmental processes or addressing distributional
concerns. If the proposed action is a result of a statutory or judicial directive, that should
be so stated.
A. Market Failure
The analysis should determine whether there exists a market failure that is likely to be
significant. In particular, the analysis should distinguish actual market failures from
potential market failures that can be resolved at relatively low cost by market participants.
Examples of the latter include spillover effects that affected parties can effectively
internalize by negotiation, and problems resulting from information asymmetries that can
be effectively resolved by the affected parties through vertical integration. Once a
significant market failure has been identified, the analysis should show how adequately the
regulatory alternatives to be considered address the specified market failure.
The major types of market failure include: externality, natural monopoly, market power,
and inadequate or asymmetric information.
1. Externality. An externality occurs when one party's actions impose uncompensated
benefits or costs on another. Environmental problems are a classic case of externality.
Another example is the case of common property resources that may become congested or
overused, such as fisheries or the broadcast spectrum. A third example is a "public good,"
such as defense or basic scientific research, which is distinguished by the fact that it is
inefficient, or impossible, to exclude individuals from its benefits.
2. Natural Monopoly. A natural monopoly exists where a market can be served at lowest
cost only if production is limited to a single producer. Local gas and electricity
distribution services are examples.
3. Market Power. Firms exercise market power when they reduce output below what a
competitive industry would sell. They may exercise market power collectively or
unilaterally. Government action can be a source of market power, for example if
regulatory actions exclude low-cost imports, allowing domestic producers to raise price by
4. Inadequate or Asymmetric Information. Market failures may also result from
inadequate or asymmetric information. The appropriate level of information is not
necessarily perfect or full information because information, like other goods, is costly.
The market may supply less than the appropriate level of information because it is often
infeasible to exclude nonpayers from reaping benefits from the provision of information by
others. In markets for goods and services, inadequate information can generate a variety
of social costs, including inefficiently low innovation, market power, or inefficient
resource allocation resulting from deception of consumers. Markets may also fail to
allocate resources efficiently when some economic actors have more information than
On the other hand, the market may supply a reasonably adequate level of information.
Sellers have an incentive to provide informative advertising to increase sales by
highlighting distinctive characteristics of their products. There are also a variety of ways
in which "reputation effects" may serve to provide adequate information. Buyers may
obtain reasonably adequate information about product characteristics even when the seller
does not provide that information, for example, if buyer search costs are low (as when the
quality of a good can be determined by inspection at point of sale), if buyers have
previously used the product, if sellers offer warranties, or if adequate information is
provided by third parties. In addition, insurance markets are important sources of
information about risks.
Government action may have unintentional harmful effects on the efficiency of market
outcomes. For this reason there should be a presumption against the need for regulatory
actions that, on conceptual grounds, are not expected to generate net benefits, except in
special circumstances. In light of actual experience, a particularly demanding burden of
proof is required to demonstrate the need for any of the following types of regulations:
price controls in competitive markets;
production or sales quotas in competitive markets;
mandatory uniform quality standards for goods or services, unless they have hidden
safety hazards or other defects or involve externalities and the problem cannot be
adequately dealt with by voluntary standards or information disclosing the hazard to
potential buyers or users; or
controls on entry into employment or production, except (a) where indispensable to
protect health and safety (e.g., FAA tests for commercial pilots) or (b) to manage the
use of common property resources (e.g., fisheries, airwaves, Federal lands, and
B. Appropriateness of Alternatives to Federal Regulation
Even where a market failure exists, there may be no need for Federal regulatory
intervention if other means of dealing with the market failure would resolve the problem
adequately or better than the proposed Federal regulation would. These alternatives may
include the judicial system, antitrust enforcement, and workers' compensation systems.
Other nonregulatory alternatives could include, for example, subsidizing actions to achieve
a desired outcome; such subsidies may be more efficient than rigid mandates. Similarly, a
fee or charge, such as an effluent discharge fee, may be a preferable alternative to banning
or restricting a product or action. Legislative measures that make use of economic
incentives, such as changes in insurance provisions, should be considered where feasible.
Modifications to existing regulations should be considered if those regulations have
created or contributed to a problem that the new regulation is intended to correct, and if
such changes can achieve the goal more efficiently or effectively.
Another important factor to consider in assessing the appropriateness of a Federal
regulation is regulation at the State or local level, if such an option is available. In some
cases, the nature of the market failure may itself suggest the most appropriate
governmental level of regulation. For example, problems that spill across State lines (such
as acid rain whose precursors are transported widely in the atmosphere) are probably best
controlled by Federal regulation, while more localized problems may be more efficiently
addressed locally. Where regulation at the Federal level appears appropriate, for example
to address interstate commerce issues, the analysis should attempt to determine whether
the burdens on interstate commerce arising from different State and local regulations,
including the compliance costs imposed on national firms, are greater than the potential
advantages of diversity, such as improved performance from competition among
governmental units in serving taxpayers and citizens and local political choice.
The EA should show that the agency has considered the most important alternative
approaches to the problem and provide the agency's reasoning for selecting the proposed
regulatory action over such alternatives. Ordinarily, it will be possible to eliminate some
alternatives by a preliminary analysis, leaving a manageable number of alternatives to be
evaluated according to the principles of the Executive Order. The number and choice of
alternatives to be selected for detailed benefit-cost analysis is a matter of judgment. There
must be some balance between thoroughness of analysis and practical limits to the
agency's capacity to carry out analysis. With this qualifier in mind, the agency should
nevertheless explore modifications of some or all of a regulation's attributes or provisions
to identify appropriate alternatives.
Alternative regulatory actions that should be explored include the following:
1. More Performance-Oriented Standards for Health, Safety, and Environmental
Regulations. Performance standards are generally to be preferred to engineering or design
standards because performance standards provide the regulated parties the flexibility to
achieve the regulatory objective in a more cost-effective way. It is therefore misleading
and inappropriate to characterize a standard as a performance standard if it is set so that
there is only one feasible way to meet it; as a practical matter, such a standard is a design
standard. In general, a performance standard should be preferred wherever that
performance can be measured or reasonably imputed. Performance standards should be
applied with a scope appropriate to the problem the regulation seeks to address. For
example, to create the greatest opportunities for the regulated parties to achieve cost
savings while meeting the regulatory objective, compliance with air emission standards can
be allowed on a plant-wide, firm-wide, or region-wide basis rather than vent by vent,
provided this does not produce unacceptable air quality outcomes (such as "hot spots"
from local pollution concentration).
2. Different Requirements for Different Segments of the Regulated Population. There
might be different requirements established for large and small firms, for example. If such
a differentiation is made, it should be based on perceptible differences in the costs of
compliance or in the benefits to be expected from compliance. It is not efficient to place a
heavier burden on one segment of the regulated population solely on the grounds that it is
better able to afford the higher cost; this has the potential to load on the most productive
sectors of the economy costs that are disproportionate to the damages they create.
3. Alternative Levels of Stringency. In general, both the benefits and costs associated with
a regulation will increase with the level of stringency (although marginal costs generally
increase with stringency, whereas marginal benefits decrease). It is important to consider
alternative levels of stringency to better understand the relationship between stringency
and the size and distribution of benefits and costs among different groups.
4. Alternative Effective Dates of Compliance. The timing of a regulation may also have an
important effect on its net benefits. For example, costs of a regulation may vary
substantially with different compliance dates for an industry that requires a year or more to
plan its production runs efficiently. In this instance, a regulation that provides sufficient
lead time is likely to achieve its goals at a much lower overall cost than a regulation that is
effective immediately, although the benefits also could be lower.
5. Alternative Methods of Ensuring Compliance. Compliance alternatives for Federal,
state, or local enforcement include on-site inspection, periodic reporting, and compliance
penalties structured to provide the most appropriate incentives. When alternative
monitoring and reporting methods vary in their costs and benefits, promising alternatives
should be considered in identifying the regulatory alternative that maximizes net benefits.
For example, in some circumstances random monitoring will be less expensive and nearly
as effective as continuous monitoring in achieving compliance.
6. Informational Measures. Measures to improve the availability of information include
government establishment of a standardized testing and rating system (the use of which
could be made mandatory or left voluntary), mandatory disclosure requirements (e.g., by
advertising, labeling, or enclosures), and government provision of information (e.g., by
government publications, telephone hotlines, or public interest broadcast announcements).
If intervention is necessary to address a market failure arising from inadequate or
asymmetric information, informational remedies will often be the preferred approaches.
As an alternative to a mandatory product standard or ban, a regulatory measure to
improve the availability of information (particularly about the concealed characteristics of
products) gives consumers a greater choice. Incentives for information dissemination also
are provided by features of product liability law that reduce liability or damages for firms
that have provided consumers with notice.
Except for prohibiting indisputably false statements (whose banning can be presumed
beneficial), specific informational measures should be evaluated in terms of their benefits
and costs. The key to analyzing informational measures is a comparison of the actions of
the affected parties with the information provided in the baseline (including any
information displaced by mandated disclosures) and the actions of affected parties with the
information requirements being imposed. Some effects of informational measures can
easily be overlooked. For example, the costs of a mandatory disclosure requirement for a
consumer product include not only the cost of gathering and communicating the required
information, but also the loss of net benefits of any information displaced by the mandated
information, the effect of providing too much information that is ignored or information
that is misinterpreted, and inefficiencies arising from the incentive that mandatory
disclosure may give to overinvest in a particular characteristic of a product or service.
Where information on the benefits and costs of alternative informational measures is
insufficient to provide a clear choice between them, as will often be the case, the least
intrusive informational alternative, sufficient to accomplish the regulatory objective,
should be considered. For example, to correct an informational market failure it may be
sufficient for government to establish a standardized testing and rating system without
mandating its use, because competing firms that score well according to the system will
have ample incentive to publicize the fact.
7. More Market-Oriented Approaches. In general, alternatives that provide for more
market-oriented approaches, with the use of economic incentives replacing command-and-control requirements, are more cost-effective and should be explored. Market-oriented
alternatives that may be considered include fees, subsidies, penalties, marketable permits
or offsets, changes in liabilities or property rights (including policies that alter the incentive
of insurers and insured parties), and required bonds, insurance or warranties. (In many
instances, implementing these alternatives will require legislation.)
8. Considering Specific Statutory Requirements. When a statute establishes a specific
regulatory requirement and the agency has discretion to adopt a more stringent standard,
the agency should examine the benefits and costs of the specific statutory requirement as
well as the more stringent alternative and present information that justifies the more
stringent alternative if that is what the agency proposes.
The preliminary analysis described in Sections I and II will lead to the identification of a
workable number of alternatives for consideration.
1. Baseline. The benefits and costs of each alternative must be measured against a
baseline. The baseline should be the best assessment of the way the world would look
absent the proposed regulation. That assessment may consider a wide range of factors,
including the likely evolution of the market, likely changes in exogenous factors affecting
benefits and costs, likely changes in regulations promulgated by the agency or other
government entities, and the likely degree of compliance by regulated entities with other
regulations. Often it may be reasonable for the agency to forecast that the world absent
the regulation will resemble the present. For the review of an existing regulation, the
baseline should be no change in existing regulation; this baseline can then be compared
against reasonable alternatives.
When more than one baseline appears reasonable or the baseline is very uncertain, and
when the estimated benefits and costs of proposed rules are likely to vary significantly
with the baseline selected, the agency may choose to measure benefits and costs against
multiple alternative baselines as a form of sensitivity analysis. For example, the agency
may choose to conduct a sensitivity analysis involving the consequences for benefits and
costs of different assumptions about likely regulation by other governmental entities, or
the degree of compliance with the agency's own existing rules. In every case, an agency
must measure both benefits and costs against the identical baseline. The agency should
also provide an explanation of the plausibility of the alternative baselines used in the
2. Evaluation of Alternatives. Agencies should identify (with an appropriate level of
analysis) alternatives that meet the criteria of the Executive Order as summarized at the
beginning of this document, as well as identifying statutory requirements that affect the
selection of a regulatory approach. If legal constraints prevent the selection of a
regulatory action that best satisfies the philosophy and principles of the Order, these
constraints should be identified and explained, and their opportunity cost should be
estimated. To the fullest extent possible, benefits and costs should be expressed in
discounted constant dollars. Appropriate discounting procedures are discussed in the
Information on distributional impacts related to the alternatives should accompany the
analysis of aggregate benefits and costs. Where relevant and feasible, agencies can also
indicate how aggregate benefits and costs depend on the incidence of benefits and costs.
Agencies should present a reasoned explanation or analysis to justify their choice among
The distinction between benefits and costs in benefit-cost analysis is somewhat arbitrary,
since a positive benefit may be considered a negative cost, and vice versa, without
affecting net benefits. This implies that the considerations applicable to benefit estimates
also apply to cost estimates and vice versa.
In choosing among mutually exclusive alternatives, benefit-cost ratios should be used with
care. Selecting the alternative with the highest benefit-cost ratio may not identify the best
alternative, since an alternative with a lower benefit-cost ratio than another may have
higher net benefits. In addition, the internal rate of return should not be used as a criterion
for choosing among mutually exclusive alternatives. It is often difficult to compute and is
problematical when multiple rates exist.
Where monetization is not possible for certain elements of the benefits or costs that are
essential to consider, other quantitative and qualitative characterizations of these elements
should be provided (see sections 7 and 8 below). Cost-effectiveness analysis also should
be used where possible to evaluate alternatives. Costs should be calculated net of
monetized benefits. Where some benefits are monetizable and others are not, a cost-effectiveness analysis will generally not yield an unambiguous choice; nevertheless, such
an analysis is helpful for calculating a "breakeven" value for the unmonetized benefits (i.e.,
a value that would result in the action having positive net benefits). Such a value can be
evaluated for its reasonableness in the discussion of the justification of the proposed
action. Cost-effectiveness analysis should also be used to compare regulatory alternatives
in cases where the level of benefits is specified by statute.
If the proposed regulation is composed of a number of distinct provisions, it is important
to evaluate the benefits and costs of the different provisions separately. The interaction
effects between separate provisions (such that the existence of one provision affects the
benefits or costs arising from another provision) may complicate the analysis but does not
eliminate the need to examine provisions separately. In such a case, the desirability of a
specific provision may be appraised by determining the net benefits of the proposed
regulation with and without the provision in question. Where the number of provisions is
large and interaction effects are pervasive, it is obviously impractical to analyze all possible
combinations of provisions in this way. Some judgment must be used to select the most
significant or suspect provisions for such analysis.
3. Discounting. One of the problems that arises in developing a benefit-cost analysis is
that the benefits and costs often occur in different time periods. When this occurs, it is not
appropriate, when comparing benefits and costs, to simply add up the benefits and costs
accruing over time. Discounting takes account of the fact that resources (goods or
services) that are available in a given year are worth more than the identical resources
available in a later year. One reason for this is that resources can be invested so as to
return more resources later. In addition, people tend to be impatient and to prefer earlier
consumption over later consumption.
(a) Basic considerations. Constant-dollar benefits and costs must be discounted to present
values before benefits and costs in different years can be added together to determine
overall net benefits. To obtain constant dollar estimates, benefit and cost streams in
nominal dollars should be adjusted to correct for inflation. The basic guidance on discount
rates for regulatory and other analyses is provided in OMB Circular A-94. The discount
rate specified in that guidance is intended to be an approximation of the opportunity cost
of capital, which is the before-tax rate of return to incremental private investment. The
Circular A-94 rate, which was revised in 1992 based on an extensive review and public
comment, reflects the rates of return on low yielding forms of capital, such as housing, as
well as the higher rates of returns yielded by corporate capital. This average rate currently
is estimated to be 7 percent in real terms (i.e., after adjusting for inflation). As noted in
the A-94 guidance, agencies may also present sensitivity analyses using other discount
rates, along with a justification for the consideration of these alternative rates. The
economic analysis also should contain a schedule indicating when all benefits and costs are
expected to occur.
In general, the discount rate should not be adjusted to account for the uncertainty of
future benefits and costs. Risk and uncertainty should be dealt with according to the
principles presented in Section 4 below and not by changing the discount rate.
Even those benefits and costs that are hard to quantify in monetary terms should be
discounted. The schedule of benefits and costs over time therefore should include benefits
that are hard to monetize. In many instances where it is difficult to monetize benefits,
agencies conduct regulatory "cost-effectiveness" analyses instead of "net benefits"
analyses. When the effects of alternative options are measured in units that accrue at the
same time that the costs are incurred, annualizing costs is sufficient and further
discounting of non-monetized benefits is unnecessary; for instance, the annualized cost per
ton of reducing certain polluting emissions can be an appropriate measure of cost-effectiveness. However, when effects are measured in units that accrue later than when
the costs are incurred, such as the reduction of adverse health effects that occur only after
a long period of exposure, the annualized cost per unit should be calculated after
discounting for the delay between accrual of the costs and the effects.
In assessing the present value of benefits and costs from a regulation, it may be necessary
to consider implications of changing relative prices over time. For example, increasing
scarcity of certain environmental resources could increase their value over time relative to
conventional consumer goods. In such a situation, it is inappropriate to use current
relative values for assessing regulatory impacts. However, while taking into account changes over time in relative values may have an effect similar to discounting
environmental impacts at a lower rate, it is important to separate the effects of discounting
from the effects of relative price changes in the economic analysis. In particular, the
discount rate should not be adjusted for expected changes in the relative prices of goods
over time. Instead, any changes in relative prices that are anticipated should be
incorporated directly in the calculations of benefit and cost streams.
(b) Additional considerations. Modern research in economic theory has established a
preferred model for discounting, sometimes referred to as the shadow price approach.
The basic concept is that economic welfare is ultimately determined by consumption;
investment affects welfare only to the extent that it affects current and future
consumption. Thus, any effect that a government program has on public or private
investment must be converted to an associated stream of effects on consumption before
Converting investment-related benefits and costs to their consumption-equivalents as
required by this approach involves calculating the "shadow price of capital." This shadow
price reflects the present value of the future changes in consumption arising from a
marginal change in investment, using the consumption rate of interest (also termed the rate
of time preference) as the discount rate. The calculation of the shadow price of capital
requires assumptions about the extent to which government actions -- including
regulations -- crowd out private investment, the social (i.e., before-tax) returns to this
investment, and the rate of reinvestment of future yields from current investment.
Estimates of the shadow price are quite sensitive to these assumptions. For example, in
some applications it may be appropriate to assume that access to global capital markets
implies no crowding out of private investment by government actions or that monetary
and fiscal authorities determine aggregate levels of investment so that the impact of the
contemplated regulation on total private investment can be ignored. Alternatively, there is
evidence that domestic saving affects domestic investment and that regulatory costs may
also reduce investment. In these cases, more substantial crowding out would be an
The rate of time preference is also a complex issue. Generally, it is viewed as being
approximated by the real return to a safe asset, such as Government debt. However, a
substantial fraction of the population does little or no saving and may borrow at relatively
high interest rates.
While the shadow price approach is theoretically preferred, there are several practical
challenges to its use. Agencies wishing to use this methodology should consult with OMB
prior to doing so, and should clearly explain their solutions to the methodological and
empirical challenges noted above.
(c) Intergenerational analysis. Comparisons of benefits and costs across generations raise
special questions about equity, in addition to conventional concerns about efficiency. One
approach to these questions is to follow the discounting procedures described above and
to address equity issues explicitly rather than through modification of the discount rate.
An alternative approach is to use a special social rate of time preference when conducting
intergenerational analyses in order to properly value changes in consumption in different
generations. For example, one philosophical perspective is that the social marginal rate of
substitution between the well-being of members of successive generations may be less than
the individual rate of time preference, and that future generations should not have their
expected welfare discounted just because they come later in time. Instead, this view
suggests that discounting should reflect only the growth of per capita consumption and the
corresponding decrease in marginal utility over time. As this approach uses a
consumption-based rate of interest, costs and benefits must also be adjusted to reflect the
shadow price of capital. As in other cases when agencies seek to use the shadow price of
capital approach, they should consult with OMB prior to conducting special analyses of
regulations having substantial intergenerational effects.
4. Treatment of Risk and Uncertainty. The effects of regulatory actions frequently are not
known with certainty but can be predicted in terms of their probability of occurrence. The
term "risk" in this document refers generally to a probability distribution over a set of
outcomes. When the outcomes in question are hazards or injuries, risk can be understood
to refer to the probabilities of different potential severities of hazard or injury. For
example, the risk of cancer from exposure to a chemical means a change in the probability
of contracting cancer caused by that exposure. There also are risks associated with
economic benefits and costs, e.g., the risk of a financial loss of $X means the probability
of losing $X.
Often risks, benefits, and costs are measured imperfectly because key parameters are not
known precisely; instead, the economic analysis must rely upon statistical probability
distributions for the values of parameters. Both the inherent lack of certainty about the
consequences of a potential hazard (for example, the odds of contracting cancer) and the
lack of complete knowledge about parameter values that define risk relationships (for
example, the relationship between presence of a carcinogen in the food supply and the rate
of absorption of the carcinogen) should be considered.
The term "uncertainty" often is used in economic assessments as a synonym for risk.
However, in this document uncertainty refers more specifically to the fact that knowledge
of the probabilities and sets of possible outcomes that characterize a probability
distribution of risks, based on experimentation, statistical sampling, and other scientific
tools, is itself incomplete. Thus, for example, a cancer risk might be described as a one-in-one-thousand chance of contracting cancer after 70 years of exposure. However, this
estimate may be uncertain because individuals vary in their levels of exposure and their
sensitivity to such exposures; the science underlying the quantification of the hazard is
uncertain; or there are plausible competitors to the model for converting scientific
knowledge and empirical measures of exposures into risk units. Estimates of regulatory
benefits entail additional uncertainties, such as the appropriate measures for converting
from units of risk to units of value. Cost estimates also will be uncertain when there are
uncertainties in opportunity costs or the compliance strategies of regulated entities.
Estimating the benefits and costs of risk-reducing regulations includes two components: a
risk assessment that, in part, characterizes the probabilities of occurrence of outcomes of
interest; and a valuation of the levels and changes in risk experienced by affected
populations as a result of the regulation. It is essential that both parts of such evaluations
be conceptually consistent. In particular, risk assessments should be conducted in a way
that permits their use in a more general benefit-cost framework, just as the benefit-cost
analysis should attempt to capture the results of the risk assessment and not oversimplify
the results (e.g., the analysis should address the benefit and cost implications of probability
Risk management is an activity conceptually distinct from risk assessment or valuation,
involving a policy of whether and how to respond to risks to health, safety, and the
environment. The appropriate level of protection is a policy choice rather than a scientific
one. The risk assessment should generate a credible, objective, realistic, and scientifically
balanced analysis; present information on hazard, dose-response, and exposure (or
analogous material for non-health assessments); and explain the confidence in each
assessment by clearly delineating strengths, uncertainties, and assumptions, along with the
impacts of these factors on the overall assessment. The data, assumptions, models, and
inferences used in the risk assessment to construct quantitative characterizations of the
probabilities of occurrence of health, safety, or ecological effects should not reflect
unstated or unsupported preferences for protecting public health and the environment, or
unstated safety factors to account for uncertainty and unmeasured variability. Such
procedures may introduce levels of conservatism that cumulate across assumptions and
make it difficult for decisionmakers to evaluate the magnitude of the risks involved.
(a) Risk assessment. The assessment of outcomes associated with regulatory action to
address risks to health, safety, and the environment raises a number of scientific
difficulties. Key issues involve the quality and reliability of the data, models, assumptions,
scientific inferences, and other information used in risk analyses. Analysts rarely, if ever,
have complete information. It may be difficult to identify the full range of impacts. Little
definitive may be known about the structure of key relationships and therefore about
appropriate model specification. Data relating to effects that can be identified may be
sketchy, incomplete, or subject to measurement error or statistical bias. Exposures and
sensitivities to risks may vary considerably across the affected population. These
difficulties can lead, for example, to a range of quantitative estimates of risk in health and
ecological risk assessments that can span several orders of magnitude. Uncertainties in
cost estimates also can be significant, in particular because of lack of experience with the
adjustments that markets can make to reduce regulatory burdens, the difficulty of
identifying and quantifying opportunity cost, and the potential for enhanced or retarded
technical innovation. All of these concerns should be reflected in the uncertainties about
outcomes that should be incorporated in the analysis.
The treatment of uncertainty in developing risk, benefit, and cost information also must be
guided by the principles of full disclosure and transparency, as with other elements of an
EA. Data, models, and their implications for risk assessment should be identified in the
risk characterization. Inferences and assumptions should be identified and evaluated
explicitly, together with adequate justifications of choices made, and assessments of the
effects of these choices on the analysis.
Informed judgment is necessary to evaluate conflicting scientific theories. In some cases it
may be possible to weigh conflicting evidence in developing the overall risk assessment.
In other cases, the level of scientific uncertainty may be so large that a risk assessment can
only present discrete alternative scenarios without a quantitative assessment of their
relative likelihood. For example, in assessing the potential outcomes of an environmental
effect, there may be a limited number of scientific studies with strongly divergent results.
In such cases, the assessment should present results representing a range of plausible
scenarios, together with any information that can help in providing a qualitative judgment
of which scenarios are more scientifically plausible.
In the absence of adequate valid data, properly identified assumptions are necessary for
conducting an assessment. The existence of plausible alternative models and their
implications should be carried through as part of each risk characterization product.
Alternative models and assumptions should be used in the risk assessment as needed to
provide decisionmakers with information on the robustness of risk estimates and estimates
of regulatory impacts. As with other elements of an EA, there should be balance between
thoroughness of analysis in the treatment of risk and uncertainty and practical limits on the
capacity to carry out analysis. The range of models, assumptions, or scenarios presented
in the risk assessment need not be exhaustive, nor is it necessary that each alternative be
evaluated at every step of the assessment. The assessment should provide sufficient
information for decisionmakers to understand the degree of scientific uncertainty and the
robustness of estimated risks, benefits, and costs. The choice of models or scenarios used
in the risk assessment should be explained.
Where feasible, data and assumptions should be presented in a manner that permits
quantitative evaluation of their incremental effects. The cumulative effects of assumptions
and inferences should also be evaluated. A full characterization of risks should include
findings for the entire affected population and relevant subpopulations. Assumptions
should be consistent with reasonably obtainable scientific information. Thus, for example,
low-dose toxicity extrapolations should be consistent with physiological knowledge;
assumptions about environmental fate and transport of contaminants should be consistent
with principles of environmental chemistry.
The material provided should permit the reader to replicate the analysis and quantify the
effects of key assumptions. Such analyses are becoming increasingly easy to perform
because of advances in computing power and new methodological developments. Thus,
the level and scope of disclosure and transparency should increase over time.
In order for the EA to evaluate outcomes involving risks, risk assessments must provide
some estimates of the probability distribution of risks with and without the regulation.
Whenever it is possible to quantitatively characterize the probability distributions, some
estimates of central tendency (e.g., mean and median) must be provided in addition to
ranges, variances, specified low-end and high-end percentile estimates, and other
characteristics of the distribution.
Overall risk estimates cannot be more precise than their most uncertain component. Thus,
risk estimates should be reported in a way that reflects the degree of uncertainty present in
order to prevent creating a false sense of precision. The accuracy with which quantitative
estimates are reported must be supported by the quality of the data and models used. In
all cases, the level of precision should be stated explicitly.
Overall uncertainty is typically a consequence of uncertainties about many different
factors. Appropriate statistical techniques should be used to combine uncertainties about
separate factors into an overall probability distribution for a risk. When such techniques
cannot be used, other methods may be useful for providing more complete information:
Monte Carlo analysis and other simulation methods can be used to estimate
probability distributions of the net benefits of alternative policy choices. It requires
explicit quantitative characterization of variability to derive an overall probability
distribution of net benefits. Parameter or model probability distributions may be
derived empirically (for example, directly from population data or indirectly from
regression or other statistical models) or by assumption. This approach has the
advantage of weighing explicitly the likelihood of alternative outcomes, permitting
evaluation of their relative importance. However, care must be taken to consider the
entire output of the analysis rather than placing undue reliance on any one statistic.
Because of the sensitivity of such simulations to assumptions about correlations
between parameters, the likelihood that a particular specification is correct, omitted
factors, and assumptions about the distribution of parameters, etc., special care should
be taken to address these potential pitfalls. The quality of the overall analysis is only
as good as the quality of its components; faulty assumptions or model specifications
will yield faulty results.
Sensitivity analysis is carried out by conducting analyses over the full range of
plausible values of key parameters and plausible model specifications. Sensitivity
analysis is particularly attractive when there are several easily identifiable critical
assumptions in the analysis, when information is inadequate to carry out a more
formal probabilistic simulation, or when the nature and scope of the regulation do not
warrant more extensive analysis. One important form of sensitivity analysis involves
estimating "switch points," that is, critical parameter values at which estimated net
benefits change sign. Sensitivity analysis is useful for evaluating the robustness of
conclusions about net benefits with respect to changes in model parameters.
Sensitivity analysis should convey as much information as possible about the likely
plausibility or frequency of occurrence of different scenarios (sets of parameter
Delphi methods involve derivation of estimates by groups of experts and can be used
to identify attributes of subjective probability distributions. This method can be
especially useful when there is diffuse or divergent prior knowledge. Care must be
taken, however, to preserve any scientific controversy arising in a delphi analysis.
Meta-analysis involves combining data or results from a number of different studies.
For example, one could re-estimate key model parameters using combined data from
a number of different sources, thereby improving confidence in the parameter
estimates. Alternatively, one could use parameter estimates (elasticities of supply and
demand, implicit values of mortality risk reduction) from a number of different studies
as data points, and analyze variations in those results as functions of potential causal
factors. Care must be taken to ensure that the data used are comparable, that
appropriate statistical methods are used, and that spurious correlation problems are
considered. One significant pitfall in the use of meta-analysis arises from combining
results from several studies that do not measure comparable independent or
New methods may become available in the future as well. This document is not intended
to discourage or inhibit their use, but rather to encourage and stimulate their development.
Uncertainty may arise from a variety of fundamentally different sources, including lack of
data, variability in populations or natural conditions, limitations in fundamental scientific
knowledge (both social and natural) resulting in lack of knowledge about key
relationships, or fundamental unpredictability of various phenomena. The nature of these
different sources may suggest different approaches. For example, when uncertainty is due
to lack of information, one policy alternative may be to defer action pending further study.
One factor that may help determine whether further study is justifiable as a policy
alternative is an evaluation of the potential benefits of the information relative to the
resources needed to acquire it and the potential costs of delaying action. When
uncertainty is due largely to observable variability in populations or natural conditions, one
policy alternative may be to refine targeting, that is, to differentiate policies across key
subgroups. Analysis of such policies should consider the incremental benefits of improved
efficiency from targeting, any incremental costs of monitoring and enforcement, and
changes in the distribution of benefits and costs.
(b) Valuing risk levels and changes. To value changes in risk arising from variability in
expected outcomes as a consequence of regulation, agencies should consider the expected
net benefits of the risk change, taking into account the probability distribution of potential
outcomes with and without the regulation. The more familiar examples deal with valuing
risks associated with incurring possible future costs. When costs are subject to risk, they
are generally appraised by risk-averse individuals at more than the expected value. For
example, riskier financial instruments must generally earn a higher average rate of return in
order to attract investors. Similarly, the owner of a facility may be willing to pay more to
reduce the probability of fire than the reduction in expected loss, because of aversion to
the risk of the loss. This also explains why property owners are willing to buy fire
insurance at a price that exceeds expected losses. To accurately value the net benefits of a
regulation, regulation-induced changes in expenditures on self-protection, mitigation, or
other risk-reduction measures should be included.
Under the standard assumption in economic theory that individuals make choices among
outcomes subject to risks to maximize expected utility, risk aversion is incorporated into
net benefits estimates by expressing benefits and costs in terms of their certainty
equivalents. Certainty equivalents are defined as net benefits occurring with certainty that
would have the same value to individuals as the expected value of an alternative whose net
benefits are subject to risk. For risk-averse individuals, the certainty equivalent of such a
net benefit stream would be smaller than the expected value of those net benefits, because
risk intrinsically has a negative value. The difference between the expected value of net
benefits subject to risk and the certainty equivalent is called the risk premium. Similarly,
regulations that reduce the overall variability of net benefits will have a certainty
equivalent value that is larger than the expected value of the net benefits by an amount that
reflects the value of the variability of outcomes.
Typically total expected net benefits and risk premia are calculated on the basis of a
representative set of individual preferences. Agencies should also present available
information on the incidence of benefits, costs, and risks where necessary for judging
distributional consequences. Where information is available on differences in valuation
across income levels or other identifiable criteria, agencies can use this information and
information on the incidence of regulatory effects in calculating total net benefits
The importance of including estimates of individuals' willingness to pay for risk reduction
varies. Willingness to pay for reduced risks is likely to be more significant if risks are
difficult to diversify because of incomplete risk and insurance markets, or if the net
benefits of the regulation are correlated with overall market returns to investment. When
the effects of regulation fall primarily on private parties, it is sufficient to incorporate
measures of individual risk aversion. For regulatory benefits or costs that accrue to the
Federal government (for example, income from oil production), the Federal government
should be treated as risk neutral because of its high degree of diversification.
As noted in the previous section, the discount rate generally should not be adjusted as a
device to account for the uncertainty of future benefits or costs. Any allowance for
uncertainty should be made by adjusting the monetary values of changes in benefits or
costs (for the year in which they occur) so that they are expressed in terms of their
certainty equivalents. The adjustment for uncertainty may well vary over time because the
degree of uncertainty may change. For example, price forecasts are typically characterized
by increasing uncertainty (forecast error) over time, because of an increasing likelihood of
unforeseen (and unforeseeable) changes in market conditions as time passes. In such
cases, the certainty equivalents of net benefits will tend to change systematically over time;
these changes should be taken into account in analyzing regulations that have substantial
effects over a long time period. Uncertainty that increases systematically over time will
result in certainty equivalents that fall systematically over time; however, these decreases
in certainty equivalents will mimic the effects of an increase in the discount rate only under
5. Assumptions. Where benefit or cost estimates are heavily dependent on certain
assumptions, it is essential to make those assumptions explicit and, where alternative
assumptions are plausible, to carry out sensitivity analyses based on the alternative
assumptions. If the value of net benefits changes sign with alternative plausible
assumptions, further analysis may be necessary to develop more evidence on which of the
alternative assumptions is more appropriate. Because the adoption of a particular
estimation methodology sometimes implies major hidden assumptions, it is important to
analyze estimation methodologies carefully to make hidden assumptions explicit.
Special challenges arise in evaluating the results of an EA that relies strongly upon
proprietary data or analyses whose disclosure is limited by confidentiality agreements. In
some cases, such data and analysis may be the best, or even the only, means to address an
important aspect of a proposed regulation. Nevertheless, given the difficulties that this
confidentiality presents to OMB review and meaningful public participation in the
rulemaking, agencies should exercise great care in relying strongly upon proprietary
material in developing an EA. When such material is used, it is essential that agencies
provide as much information as possible concerning the underlying scientific,
technological, behavioral, and valuation assumptions and conclusions. This can be
accomplished, for example, by providing information about the values of key input
parameters used in a modeling analysis or the implied behavioral response rates derived
from sensitivity analysis.
The effectiveness of proposed rules may depend in part upon agency enforcement
strategies, which may vary over time as agency priorities and budgetary constraints
change. Because an agency usually cannot commit to an enforcement strategy at the time
the rule is promulgated, the analysis of a rule's benefits and costs should generally assume
that compliance with the rule is complete, although there may be circumstances when
other assumptions should be considered as well. The analysis of a new or revised rule
should differentiate between its benefits and costs, given an assumed level of compliance,
and the implications of changes in compliance with an existing rule.
6. International Trade Effects. In calculating the benefits and costs of a proposed
regulatory action, generally no explicit distinction needs to be made between domestic and
foreign resources. If, for example, compliance with a proposed regulation requires the
purchase of specific equipment, the opportunity cost of that equipment is ordinarily best
represented by its domestic cost in dollars, regardless of whether the equipment is
produced domestically or imported. The relative value of domestic and foreign resources
is correctly represented by their respective dollar values, as long as the foreign exchange
value of the dollar is determined by the exchange market. Nonetheless, an awareness of
the role of international trade may be quite useful for assessing the benefits and costs of a
proposed regulatory action. For example, the existence of foreign competition may make
the demand curve facing a domestic industry more elastic than it would be otherwise.
Elasticities of demand and supply frequently can significantly affect the magnitude of the
benefits or costs of a regulation.
Regulations limiting imports -- whether through direct prohibitions or fees, or indirectly
through an adverse differential effect on foreign producers or consumers relative to
domestic producers and consumers -- raise special analytic issues. The economic loss to
the United States from limiting imports should be reflected in the net benefit estimate.
However, a benefit-cost analysis will generally not be able to measure the potential U.S.
loss from the threat of future retaliation by foreign governments. This threat should then
be treated as a qualitative cost (see section 7).
7. Nonmonetized Benefits and Costs. 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. Effects that cannot be fully monetized or otherwise
quantified should be described. Those effects that can be quantified should be presented
along with qualitative information to characterize effects that are not quantified.
Irrespective of the presentation of monetized benefits and costs, the EA should present
available physical or other quantitative measures of the effects of the alternative actions to
help decisionmakers understand the full effects of alternative actions. These include the
magnitude, timing, and likelihood of impacts, plus other relevant dimensions (e.g.,
irreversibility and uniqueness). For instance, assume the effects of a water quality
regulation include increases in fish populations and habitat over the affected stream
segments and that it is not possible to monetize such effects. It would then be appropriate
to describe the benefits in terms of stream miles of habitat improvement and increases in
fish population by species (as well as to describe the timing and likelihood of such effects,
etc.). Care should be taken, however, when estimates of monetized and physical effects
are mixed in the same analysis so as to avoid double-counting of benefits. Finally, the EA
should distinguish between effects unquantified because they were judged to be relatively
unimportant, and effects that could not be quantified for other reasons.
8. Distributional Effects and Equity. Those who bear the costs of a regulation and those
who enjoy its benefits often are not the same people. The term "distributional effects"
refers to the description of the net effects of a regulatory alternative across the population
and economy, divided up in various ways (e.g., income groups, race, sex, industrial
sector). Benefits and costs of a regulation may be distributed unevenly over time, perhaps
spanning several generations. Distributional effects may also arise through "transfer
payments" arising from a regulatory action. For example, the revenue collected through a
fee, surcharge, or tax (in excess of the cost of any service provided) is a transfer payments.
Where distributive effects are thought to be important, the effects of various regulatory
alternatives should be described quantitatively to the extent possible, including their
magnitude, likelihood, and incidence of effects on particular groups. Agencies should be
alert for situations in which regulatory alternatives result in significant changes in
treatment or outcomes for different groups. Effects on the distribution of income that are
transmitted through changes in market prices can be important, albeit sometimes difficult
to assess. The EA should also present information on the streams of benefits and costs
over time in order to provide a basis for judging intertemporal distributional
consequences, particularly where intergenerational effects are concerned.
There are no generally accepted principles for determining when one distribution of net
benefits is more equitable than another. Thus, the EA should be careful to describe
distributional effects without judging their fairness. These descriptions should be broad,
focusing on large groups with small effects per capita as well as on small groups
experiencing large effects per capita. Equity issues not related to the distribution of policy
effects should be noted when important and described quantitatively to the extent feasible.
B. Benefit Estimates
The EA should state the beneficial effects of the proposed regulatory change and its
principal alternatives. In each case, there should be an explanation of the mechanism by
which the proposed action is expected to yield the anticipated benefits. An attempt should
be made to quantify all potential real incremental benefits to society in monetary terms to
the maximum extent possible. A schedule of monetized benefits should be included that
would show the type of benefit and when it would accrue; the numbers in this table should
be expressed in constant, undiscounted dollars. Any benefits that cannot be monetized,
such as an increase in the rate of introducing more productive new technology or a
decrease in the risk of extinction of endangered species, should also be presented and
The EA should identify and explain the data or studies on which benefit estimates are
based with enough detail to permit independent assessment and verification of the results.
Where benefit estimates are derived from a statistical study, the EA should provide
sufficient information so that an independent observer can determine the
representativeness of the sample, the reliability of extrapolations used to develop
aggregate estimates, and the statistical significance of the results.
The calculation of benefits (including benefits of risk reductions) should reflect the full
probability distribution of potential consequences. For example, extreme safety or health
results should be weighted, along with other possible outcomes, by estimates of their
probability of occurrence based on the available evidence to estimate the expected result
of a proposed regulation. To the extent possible, the probability distributions of benefits
should be presented. Extreme estimates should be presented as complements to central
tendency and other estimates. If fundamental scientific disagreement or lack of knowledge
precludes construction of a scientifically defensible probability distribution, benefits should
be described under plausible alternative assumptions, along with a characterization of the
evidence underlying each alternative view. This will allow for a reasoned determination by
decisionmakers of the appropriate level of regulatory action.
It is important to guard against double-counting of benefits. For example, if a regulation
improves the quality of the environment in a community, the value of real estate in the
community might rise, reflecting the greater attractiveness of living in the improved
environment Inferring benefits from changes in property values is complex. On the one
hand, the rise in property values may reflect the capitalized value of these improvements.
On the other hand, benefit estimates that do not incorporate the consequences of land use
changes will not capture the full effects of regulation. For regulations with significant
effects on land uses, these effects must be separated from the capitalization of direct
regulatory impacts into property values.
1. General Considerations. The concept of "opportunity cost" is the appropriate construct
for valuing both benefits and costs. The principle of "willingness-to-pay" captures the
notion of opportunity cost by providing an aggregate measure of what individuals are
willing to forgo to enjoy a particular benefit. Market transactions provide the richest data
base for estimating benefits based on willingness-to-pay, as long as the goods and services
affected by a potential regulation are traded in markets. It is more difficult to estimate
benefits where market transactions are difficult to monitor or markets do not exist.
Regulatory analysts in these cases need to develop appropriate proxies that simulate
market exchange. Indeed, the analytical process of deriving benefit estimates by
simulating markets may suggest alternative regulatory strategies that create such markets.
Either willingness-to-pay (WTP) or willingness-to-accept (WTA) can provide an
appropriate measure of benefits, depending on the allocation of property rights. The
common preference for WTP over WTA measures is based on the empirical difficulties in
estimating the latter.
Estimates of willingness-to-pay based on observable and replicable behavior deserve the
greatest level of confidence. Greater uncertainty attends benefit estimates that are neither
derived from market transactions nor based on behavior that is observable or replicable.
While innovative benefit estimation methodologies will be necessary or desirable in some
cases, use of such methods intensifies the need for quality control to ensure that estimates
are reliable and conform as closely as possible to what would be observed if markets
2. Principles for Valuing Benefits Directly Traded in Markets. Ordinarily, goods and
services are to be valued at their market prices. However, in some instances, the market
value of a good or service may not reflect its true value to society.
If a regulatory alternative involves changes in such a good or service, its monetary value
for purposes of benefit-cost analysis should be derived using an estimate of its true value
to society (often called its "shadow price"). For example, suppose a particular air
pollutant damages crops. One of the benefits of controlling that pollutant will be the value
of the crop saved as a result of the controls. That value would typically be determined by
reference to the price of the crop. If, however, the price of that crop is held above the
unregulated market equilibrium price by a government price-support program, an estimate
based on the support price would overstate the value of the benefit of controlling the
pollutant. Therefore, the social value of the benefit should be calculated using a shadow
price for crops subject to price supports. The estimated shadow price is intended to
reflect the value to society of marginal uses of the crop (e.g., the world price if the
marginal use is for exports). If the marginal use is to add to very large surplus stockpiles,
the shadow price would be the value of the last units released from storage minus storage
cost. Therefore, where stockpiles are large and growing, the shadow price is likely to be
low and could well be negative.
In other cases, market prices could understate social values, for example where production
of a particular good also provides opportunities for improving basic knowledge.
3. Principles for Valuing Benefits That Are Indirectly Traded in Markets. In some
important instances, a benefit corresponds to a good or service that is indirectly traded in
the marketplace. Examples include reductions in health-and-safety risks, the use-values of
environmental amenities and scenic vistas. To estimate the monetary value of such an
indirectly traded good, the willingness-to-pay valuation methodology is considered the
conceptually superior approach. As noted in Sections 4 and 5 immediately following,
alternative methods may be used where there are practical obstacles to the accurate
application of direct willingness-to-pay methodologies.
A variety of methods have been developed for estimating indirectly traded benefits.
Generally, these methods apply statistical techniques to distill from observable market
transactions the portion of willingness-to-pay that can be attributed to the benefit in
question. Examples include estimates of the value of environmental amenities derived
from travel-cost studies, hedonic price models that measure differences or changes in the
value of land, and statistical studies of occupational-risk premiums in wage rates. For all
these methods, care is needed in designing protocols for reliably estimating benefits or in
adapting the results of previous studies to new applications. The use of occupational-risk
premiums can be a source of bias because the risks, when recognized, may be voluntarily
rather than involuntarily assumed, and the sample of individuals upon which premium
estimates are based may be skewed toward more risk-tolerant people.
Contingent-valuation methods have become increasingly common for estimating indirectly
traded benefits, but the reliance of these methods on hypothetical scenarios and the
complexities of the goods being valued by this technique raise issues about its accuracy in
estimating willingness to pay compared to methods based on (indirect) revealed
preferences. Accordingly, value estimates derived from contingent-valuation studies
require greater analytical care than studies based on observable behavior. For example,
the contingent valuation instrument must portray a realistic choice situation for
respondents -- where the hypothetical choice situation corresponds closely with the policy
context to which the estimates will be applied. The practice of contingent valuation is
rapidly evolving, and agencies relying upon this tool for valuation should judge the
reliability of their benefit estimates using this technique in light of advances in the state of
4. Principles and Methods for Valuing Goods That Are Not Traded Directly or Indirectly
in Markets. Some types of goods, such as preserving environmental or cultural amenities
apart from their use and direct enjoyment by people, are not traded directly or indirectly in
markets. The practical obstacles to accurate measurement are similar to (but generally
more severe than) those arising with respect to indirect benefits, principally because there
are few or no related market transactions to provide data for willingness-to-pay estimates.
For many of these goods, particularly goods providing "nonuse" values, contingent-valuation methods may provide the only analytical approaches currently available for
estimating values. The absence of observable and replicable behavior with respect to the
good in question, combined with the complex and often unfamiliar nature of the goods
being valued, argues for great care in the design and execution of surveys, rigorous
analysis of the results, and a full characterization of the uncertainties in the estimates to
meet best practices in the use of this method.
5. Methods for Valuing Health and Safety Benefits. Regulations that address health and
safety concerns often yield a variety of benefits traded directly in markets, benefits
indirectly traded in markets, and benefits not traded in markets. A major component of
many such regulations is a reduction is the risk of illness, injury or premature death. There
are differences of opinion about the various approaches for monetizing such risk
reductions. In assessing health and safety benefits, the analysis should present estimates of
both the risks of nonfatal illness or injury and fatality risks, and may include any particular
strengths or weakness of such analyses the agencies think appropriate, in order to
accurately assess the benefits of government action.
(a) Nonfatal illness and injury. Although the willingness-to-pay approach is conceptually
superior, measurement difficulties may cause the agency to prefer valuations of reductions
in risks of nonfatal illness or injury based on the expected direct costs avoided by such risk
reductions. For example, an injury-value estimate from a willingness-to-pay study may be
an average over a specific combination of injuries of varying severity. If the average injury
severity in such a study differs greatly from the injury severity addressed by the regulatory
action, then the study's estimated injury value may not be appropriate for evaluating that
action. More generally, willingness-to-pay estimates may be unavailable or too tentative
to provide a solid base for the evaluation. The agency should use whatever approach it
can justify as most appropriate for the decision at hand, keeping in mind that direct cost
measures can be expected to understate the true cost. As discussed above (Section
III.A.3), costs and benefits should be appropriately discounted to reflect the latency period
between exposure and illness.
The primary components of the direct-cost approach are medical and other costs of
offsetting illness or injury; costs for averting illness or injury (e.g., expenses for goods
such as bottled water or job safety equipment that would not be incurred in the absence of
the health or safety risk); and the value of lost production. Possibly important costs that
might be omitted by the use of the direct-cost approach are the costs of pain, suffering and
time lost (due to illness, injury, or averting behavior) from leisure and other activities that
are not directly valued in the market. The present value of the expected stream of costs
should be included. For long-term chronic illness or incapacitation the direct-cost
approach may be particularly problematic compared to a willingness-to-pay estimate
analogous to the valuation of mortality risks (discussed below).
Valuing lost production and other time-related costs gives rise to a number of
methodological concerns. For occupational illness or injury, lost production can be
measured by losses in workers' value of marginal product. In valuing the effects of
broader environmental hazards, however, attention must be given to the composition of
the exposed population. For example, some portion of the working-age population may
be unemployed, while others will be retired. Still others may have chosen to be
homemakers or home caregivers. Valuation of nonfatal illness or injury to these parts of
the population presents a greater challenge than valuing the loss of employee services
using wage rates. Finally, the valuation of health impacts on children or retirees through
the direct-cost approach is especially problematic since their zero opportunity cost in the
labor market is not a good proxy for the social cost of illness. The agency should use
whatever approach it can justify but should provide a clear explanation of the assumptions
and reasoning used in the valuation.
(b) Fatality risks. Values of fatality risk reduction often figure prominently in assessments
of government action. Estimates of these values that are as accurate as possible, given the
circumstances being assessed and the state of knowledge, will reduce the prospects for
inadequate or excessive action.
Reductions in fatality risks as a result of government action are best monetized according
to the willingness-to-pay approach. The value of changes in fatality risk is sometimes
expressed in terms of the "value of statistical life" (VSL) or the "value of a life". These
terms are confusing at best and should be carefully described when used. It should be
made clear that these terms refer to the willingness to pay for reductions in risks of
premature death (scaled by the reduction in risk being valued). That is, such estimates
refer only to the value of relatively small changes in the risk of death. They have no
application to an identifiable individual.
There is also confusion about the term "statistical life." This terms refers to the sum of
risk reductions expected in a population. For example, if the annual risk of death is
reduced by one in a million for each of two million people, that represents two "statistical
lives" saved per year (two million x one millionth = two). If the annual risk of death is
reduced by one in 10 million for each of 20 million people, that also represents two
statistical lives saved.
Another way of expressing reductions in fatality risks is in terms of the "value of statistical
life-years extended" (VSLY). For example, if a regulation protected individuals whose
average remaining life expectancy was 40 years, then a risk reduction of one fatality would
be expressed as 40 life-years extended. This approach allows distinctions in risk-reduction
measures based on their effects on longevity. However, this does not automatically mean
that regulations with greater numbers of life-years extended will be favored over
regulations with fewer numbers of life-years extended. VSL and VSLY ultimately depend
on the willingness to pay for various forms of mortality risk reduction, not just longevity
As described below, there are several ways that the benefits of mortality risk reduction can
be estimated. In considering these alternatives, however, it is important to keep in mind
the larger objective of consistency -- subject to statutory limitations -- in the estimates of
benefits applied across regulations and agencies for comparable risks. Failure to maintain
such consistency prevents achievement of the most risk reduction from a given level of
resources spent on risk reduction. The valuation of mortality risk reduction is an evolving
area in terms of results and methodology. Agencies generally should utilize valuation
estimates, either explicitly or implicitly calculated, that are consistent with the current state
of knowledge at the time that the analysis is being performed, and should show that their
approach to valuation reflects the current state of knowledge. Significant deviations from
the prevailing state of knowledge should be explained.
(c) Alternative methodological frameworks for estimating benefits from reduced fatality
risks. Several alternative ways of incorporating the value of reducing fatality risks into the
framework of benefit-cost analysis may be appropriate. These may involve either explicit
or implicit valuation of fatality risks, and generally involve the use of estimates of the VSL
from studies on wage compensation for occupational hazards (which generally are in the
range of 10-4 annually), on consumer product purchase and use decisions, or from a
limited literature using contingent-valuation approaches. Because these estimates may not
be entirely appropriate for the risk being evaluated in some cases (e.g., the use of
occupational risk premia for environmental hazards), agencies should provide an
explanation for their selection of estimates and for any adjustments of the estimates to
reflect the nature of the risk being evaluated.
One acceptable explicit valuation approach would be for the agency to select a single
estimate of the value of reductions in fatality risk at ordinarily encountered risk levels, or a
distribution of such values, and use these values consistently for evaluating all its programs
that affect ordinary fatality risks. Where the analysis uses a range of alternative values for
reductions in fatality risk, it may be useful to calculate break-even values, as in other
sensitivity analyses. This requires calculating the borderline value of reductions in fatality
risk at which the net benefit decision criterion would switch over from favoring one
alternative to favoring another (i.e., the value of fatality risk at which the net benefits of
the two alternatives are equal). This method will frequently be infeasible because of its
computational demands but, where feasible, it may be a useful addition to the sensitivity
An implicit valuation approach that could be used entails calculations of the net
incremental cost per unit of reduction in fatality risk (cost per "statistical life saved") of
alternative measures, with net incremental costs defined as costs minus monetized benefits.
Alternatives can be arrayed in order of increasing reductions in expected fatalities.
Generally this will also correspond to increasing incremental cost. (It is possible that there
will be some initial economies of scale, with declining incremental costs. If incremental
costs are declining over a broad range of alternative measures, it is likely that there are
flaws in the definition of the measures or the estimation of their effects.) The incremental
cost per life saved then can be calculated for each adjacent pair of alternatives. With this
construction, the choice to undertake a certain set of measures while eschewing others
implies a lower and upper bound for the value per life saved; it would be at least as large
as the incremental cost of the most expensive measure undertaken, but not as large as the
cheapest measure not undertaken. In contrast to explicit valuation approaches, this avoids
the necessity of specifying in advance a value for reductions in fatality risks. However, the
range of values should be consistent with estimated values of reductions in fatality risks
calculated according to the willingness-to-pay methodology, and the method should be
consistently applied across regulatory decisions (within statutory limitations), in order to
assure that regulation achieves the greatest risk reduction possible from the level of
resources committed to risk reduction.
While there are theoretical advantages to using a value of statistical life-year-extended
approach, current research does not provide a definitive way of developing estimates of
VSLY that are sensitive to such factors as current age, latency of effect, life years
remaining, and social valuation of different risk reductions. In lieu of such information,
there are several options for deriving the value of a life-year saved from an estimate of the
value of life, but each of these methods has drawbacks. One approach is to use results
from the wage compensation literature (which focus on the effect of age on WTP to avoid
risk of occupational fatality). However, these results may not be appropriate for other
types of risks. Another approach is to annualize the VSL using an appropriate rate of
discount and the average life years remaining. This approach does not provide an
independent estimate of VSLY; it simply rescales the VSL estimate. Agencies should
consider providing estimates of both VSL and VSLY, while recognizing the developing
state of knowledge in this area.
Whether the VSLs (or VSLYs) are chosen explicitly or are an implicit outcome of a cost-effectiveness approach, the choice of estimates ideally should be based on a comparison of
the context of the regulation affecting risks and the context of the study or studies being
relied on for value estimates. The literature identifies certain attributes of risk that affect
value. These attributes include the baseline risk, the extent to which the risk is voluntarily
or involuntarily assumed, and features (such as age) of the population exposed to risk.
For regulations affecting some segments of the population (e.g., infants) more than those
groups which have served as the basis for most of the information used to estimates VSLs
(e.g., working-age adults), the use of VSLs from the literature may not be appropriate. At
a minimum, differences in regulatory and study contexts should be acknowledged and a
rationale for the choice of the value estimate should be provided.
Based on the literature, both the scale of baseline risks and their degree of voluntariness
appear to affect VSLs. However, the risk from an involuntary hazard typically is too small
to represent a significant portion of baseline risk. (For example, average annual mortality
risks for men aged 55-64 are about two per hundred, while occupational fatality risk
reductions typically achieved by regulations are between two per ten thousand and two
per million annually.) In such cases, it may be legitimate to assume that the valuation of
risks can be treated as independent of baseline risk.
To value reductions in more voluntarily incurred risks (e.g., those related to motorcycling
without a helmet) that are "high," agencies should consider using lower values than those
applied to reductions in involuntary risk. When a higher-risk option is chosen voluntarily,
those who assume the risk may be more risk-tolerant, i.e., they may place a relatively
lower value on avoiding risks. Empirical studies of risk premiums in higher-risk
occupations suggest that reductions in risks for voluntarily assumed high risk jobs (e.g.,
above 10-4 annually) are valued less than equal risk reductions for lower-risk jobs.
However, when occupational choices are limited, the occupational risks incurred may be
more involuntary in nature.
C. Cost Estimates
1. General Considerations. The preferred measure of cost is the "opportunity cost" of the
resources used or the benefits forgone as a result of the regulatory action. Opportunity
costs include, but are not limited to, private-sector compliance costs and government
administrative costs. Opportunity costs also include losses in consumers' or producers'
surpluses, discomfort or inconvenience, and loss of time. These effects should be
incorporated in the analysis and given a monetary value wherever possible. (Producers'
surplus is the difference between the amount a producer is paid for a unit of a good and
the minimum amount the producer would accept to supply that unit. It is measured by the
area between the price and the supply curve for that unit. Consumers' surplus is the
difference between what a consumer pays for a unit of a good and the maximum amount
the consumer would be willing to pay for that unit. It is measured by the distance between
the price and the demand curve for that unit.)
The opportunity cost of an alternative also incorporates the value of the benefits forgone
as a consequence of that alternative. For example, the opportunity cost of banning a
product (e.g., a drug, food additive, or hazardous chemical) is the forgone net benefit of
that product, taking into account the mitigating effects of potential substitutes. As another
example, even if a resource required by regulation does not have to be paid for because it
is already owned by the regulated firm, the use of that resource to meet the regulatory
requirement has an opportunity cost equal to the net benefit it would have provided in the
absence of the requirement. Any such forgone benefits should be monetized wherever
possible and either added to the costs or subtracted from the benefits of that alternative.
Any costs that are averted as a result of an alternative should be monetized wherever
possible and either added to the benefits or subtracted from the costs of that alternative.
All costs calculated should be incremental, that is, they should represent changes in costs
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.
Future costs that would be incurred even if the regulation is not promulgated, as well as
costs that have already been incurred (sunk costs), are not part of incremental costs. If
marginal cost is not constant for any component of costs, incremental costs should be
calculated as the area under the marginal cost curve over the relevant range. A schedule
of monetized costs should be included that would show the type of cost and when it
would occur; the numbers in this table should be expressed in constant, undiscounted
The EA should identify and explain the data or studies on which cost estimates are based
with enough detail to permit independent assessment and verification of the results.
Where cost estimates are derived from a statistical study, the EA should provide sufficient
information so that an independent observer can determine the representativeness of the
sample, the reliability of extrapolations used to develop aggregate estimates, and the
statistical significance of the results.
As with benefit estimates, the calculation of costs should reflect the full probability
distribution of potential consequences. Extreme values should be weighted, along with
other possible outcomes, by estimates of their probability of occurrence based on the
available evidence to estimate the expected result of a proposed regulation. If
fundamental scientific disagreement or lack of knowledge precludes construction of a
scientifically defensible probability distribution, costs should be described under plausible
alternative assumptions, along with a characterization of the evidence underlying each
alternative view. This will allow for a reasoned determination by decisionmakers of the
appropriate level of regulatory action. That level of action should derive from the
decisionmaking process, not from adjusting cost estimates upward or downward at the
information-gathering or analytical stages of the process.
Estimates of costs should be based on credible changes in technology over time. For
example, a slowing in the rate of innovation or of adoption of new technology because of
delays in the regulatory approval process or the setting of more stringent standards for
new facilities than existing ones may entail significant costs. On the other hand, a shift to
regulatory performance standards and incentive-based policies may lead to cost-saving
innovations that should be taken into account. In some cases agencies are limited under
statute to considering only technologies that have been demonstrated to be feasible. In
these situations, it may also be useful to estimate costs and cost savings assuming a wider
range of technical possibilities.
As in the calculation of benefits, costs should not be double counted. Two accounting
cost concepts that should not be counted as costs in benefit-cost analysis are interest and
depreciation. The time value of money is already accounted for by the discounting of
benefits and costs. Generally, depreciation is already taken into account by the time
distribution of benefits and costs. One legitimate use for depreciation calculations in
benefit-cost analysis is to estimate the salvage value of a capital investment.
2. Real Costs Versus Transfer Payments. An important, but sometimes difficult, problem
in cost estimation is to distinguish between real costs and transfer payments. Transfer
payments are not social costs but rather are payments that reflect a redistribution of
wealth. While transfers should not be included in the EA's estimates of the benefits and
costs of a regulation, they may be important for describing the distributional effects of a
regulation. Scarcity rents and monopoly profits, insurance payments, government
subsidies and taxes, and distribution expenses are four potential problem areas that may
affect both social benefits and costs as well as involve significant transfer payments.
(a) Scarcity rents and monopoly profits. If, for example, sales of a competitively produced
product were restricted by a government regulation so as to raise prices to consumers, the
resulting profit increases for sellers are not a net social benefit of the rule, nor is their
payment by consumers generally a net social cost, though there may be important
distributional consequences. The social benefit-cost effects of the regulation would be
represented by changes in producers' and consumers' surpluses, including the net surplus
reduction from reduced availability of the product. The same conclusion applies if the
government restriction provides an opportunity for the exercise of market power by
sellers, in which case the net cost of the regulation would include the cost of reduced
product provision due both to the government mandate and the induced change in market
(b) Insurance payments. Potential pitfalls in benefit-cost analysis may also arise in the
case of insurance payments, which are transfers. Suppose, for example, a worker safety
regulation, by decreasing employee injuries, led to reductions in firms' insurance premium
payments. It would be incorrect to count the amount of the reduction in insurance
premiums as a benefit of the rule. The proper measure of benefits for the EA is the value
of the reduction in worker injuries, monetized as described previously, plus any reduction
in real costs of administering insurance (such as the time insurance company employees
needed to process claims) due to the reduction in worker insurance claims. Reductions in
insurance premiums that are matched by reductions in insurance claim payments are
changes in transfer payments, not benefits.
(c) Indirect taxes and subsidies. A third instance where special treatment may be needed
to deal with transfer payments is the case of indirect taxes (tariffs or excise taxes) or
subsidies on specific goods or services. Suppose a regulation requires firms to purchase a
$10,000 piece of imported equipment, on which there is a $1,000 customs duty. For
purposes of benefit-cost analysis, the cost of the regulation for each firm ordinarily would
be $10,000, not $11,000, since the $1,000 customs duty is a transfer payment from the
firm to the Treasury, not a real resource cost. This approach, which implicitly assumes
that the equipment is supplied at constant costs, should be used except in special
circumstances. Where the taxed equipment is not supplied at constant cost, the technically
correct treatment is to calculate how many of the units purchased as a result of the
regulation are supplied from increased production and how many from decreased
purchases by other buyers. The former units would be valued at the price without the tax
and the latter units would be valued at the price including tax. This calculation is usually
difficult and imprecise because it requires estimates of supply and demand elasticities,
which are often difficult to obtain and inexact. Therefore, this treatment should only be
used where the benefit-cost conclusions are likely to be sensitive to the treatment of the
indirect tax. While costs ordinarily should be adjusted to remove indirect taxes on specific
goods or services as described here, similar treatment is not warranted for other taxes,
such as general sales taxes applying equally to most goods and services or income taxes.
(d) Distribution expenses. The treatment of distribution expenses is also a source of
potential error. For example, suppose a particular regulation raises the cost of a product
by $100 and that wholesale and retail distribution expenses are on average 50 percent of
the factory-level cost. It would ordinarily be incorrect to add a $50 distribution markup to
the $100 cost increase to derive a $150 incremental cost per product for benefit-cost
analysis. Most real resource costs of distribution do not increase with the price of the
product being distributed. In that case, either distribution expenses would be unchanged
or, if they increased, the increase would represent distributor monopoly profits. Since the
latter are transfer payments, not real resource costs, in neither case should additional
distribution expenses be included in the benefit-cost analysis. However, increased
distribution expenses should be counted as costs to the extent that they correspond to
increased real resource costs of the distribution sector as a result of the change in the price
or characteristics of the product, or if regulation directly affects distribution costs.
Judith D. Bentkover, Vincent T. Covello, and Jeryl Mumpower, Eds., Benefits
Assessment: The State of the Art.
Jack Hirshliefer and John G. Riley, The Analytics of Uncertainty and Information. An
advanced treatment of many issues related to risk and uncertainty.
Myrick Freeman, The Measurement of Environmental and Resource Values: Theory and
Methods. A comprehensive high-level treatment of environmental valuation issues.
Robert C. Lind, Ed., Discounting for Time and Risk in Energy Policy. An advanced
treatment of issues related to public and private sector discounting.
E. J. Mishan, Economics for Social Decisions: Elements of Cost-Benefit Analysis.
Assumes some knowledge of economics. Chapters 5-8 should be helpful on the important
subjects of producers' and consumers' surpluses (not discussed extensively in this
Robert Cameron Mitchell and Richard C. Carson, Using Surveys to Value Public Goods:
The Contingent Valuation Method. Provides a valuable discussion on the potential
strengths and pitfalls associated with the use of contingent-valuation methods.
V. Kerry Smith, Ed., Advances in Applied Micro-economics: Risk, Uncertainty, and the
Valuation of Benefits and Costs.
Edith Stokey and Richard Zeckhauser, A Primer for Policy Analysis. Chapters 9 and 10
provide a good introduction to basic concepts.
George Tolley, Donald Kenkel, and Robert Fabian, Eds., Valuing Health for Policy: An
Economic Approach. An excellent summary of methods to value reduction in morbidity
and extensions to life expectancy.
W. Kip Viscusi, Risk By Choice. Chapter 6 is a good starting point for
the topic of valuing
health and safety benefits. Other more technical sources are given in