This is a tool widely used by economists to provide a structured understanding of the pros and cons of regulatory alternatives. Among non-economists, however, it is widely misunderstood.
“Pros” on one side of the scale are the benefits that are expected to result from taking regulatory action. Benefits can take many forms, but they consist of the value that people place on the goods and services that a regulation is expected to produce. Economists try to convert benefits into dollars (or some other monetary unit) to facilitate comparison with cost. Monetization can be simple and uncontroversial, or difficult, highly contested and subject to serious manipulation. This is especially true when benefits or costs arise in the form of changes in risk to health, safety or the environment. Although there is no question that people value these things, estimating how much they value them can be difficult.
“Cons” on the other side of the scale are the costs that must be borne to comply with regulatory standards or requirements. Costs are almost always thought of as expenditures in dollars (or some other monetary unit), but this is always incorrect. Properly understood, cost is the value of benefits foregone by devoting resources toward this purpose instead of their highest and best use. One must estimate expenditures, determine where these expenditures otherwise would have been made, identify the benefits that would have accrued from these expenditures, and finally value the benefits that would must be foregone. This is complicated, and rarely if ever done.
Generally, cost exceeds expenditures. That means expenditure is an inaccurate measure of cost. A lot of effort often is devoted to producing very precise measures or estimates of expenditure, but the resulting values are systematically biased to understate costs. Because they are systematically biased, they are not objective within the meaning of the federal Information Quality Act.
Regulatory benefit-cost analyses frequently suffer from systematic biases that understate costs and overstate benefits. Costs are systematically understated by the use of expenditures as a proxy. Benefits are systematically overstated by the use of quantitative risk assessments as inputs. Conventional risk assessment practice embeds systematic upward bias in the estimation of health risk. For example, U.S. EPA’s Staff Paper on Risk Assessment Principles and Practices clearly states that, as a matter of policy, the Agency’s human health risk assessments are more likely to overstate than understate risk:
[S]ince EPA is a health and environmental protective agency, EPA’s policy is that risk assessments should not knowingly underestimate or grossly overestimate risks. This policy position prompts risk assessments to take a more “protective” stance given the underlying uncertainty with the risk estimates generated (p. 13).
“Knowingly underestimate” and “grossly overestimate” are not equivalent constructs. That is the very definition of bias.
The accepted way to evaluate each regulatory alternative is to subtract (unbiased) estimates of cost from (unbiased) estimates of benefit. Ideally, cost would be subtracted from benefit for each affected person and these differences would be summed across the affected population. Alternatives can then be ranked in descending order of net benefits. In practice, however, unbiased estimates of average cost and benefit have proved to be elusive, in large part for the reasons described above. Thus, rankings of regulatory alternatives can be fraught with uncertainty and must be interpreted with great care and caution.
The U.S. Office of Management and Budget has published several government-wide guidance documents on how to perform benefit-cost analysis of regulatory actions:
- 1991: “Regulatory Impact Analysis Guidance (Appendix V in the 1990-91 edition of the then-annual Regulatory Program of the United States, not on line)
- 1996: “Economic Analysis of Federal Regulations”
- 2000: “Guidelines to Standardize Measures of Costs and Benefits and the Format of Accounting Statements”
- 2003: “Regulatory Analysis” (OMB Circular A-4)
These documents differ mostly on discrete technical matters of interest only to professional economists and benefit-cost practitioners.
- Cost-benefit analysis arose from project management applications, whereas benefit-cost analysis is more often used in regulatory contexts.
- Cost-benefit analysis is more commonly used by British economists, benefit-cost analysis by American economists
- Among non-economists in the U.S. examining regulatory applications:
- Cost-benefit analysis is the term more likely to be used by persons who dislike it or object to its use.
- Benefit-cost analysis is the term more likely to be used by persons who like it or approve of its use.
Because cost is properly understood as benefits foregone, Neutral Source managing editor Richard Belzer frequently refers to CBA or BCA as “benefits/benefits foregone analysis.” Although this admittedly awkward formulation is unlikely to ever catch on, it focuses attention on the prevailing myths that costs are “just money” and that that they are easier to estimate than benefits.