Tag: benefit-cost analysis

We’re from the government and we’re here to help

Imagine you are in the market for a new light truck.  Let’s say it’s a new Ford Explorer.  You go to your favorite Ford dealer and the helpful salesperson tells you that she has two 2011 Explorers with identical performance and features.  One of these cars costs $2000 more and gets 49.6 mpg, the other gets 27.5 mpg.  You are the type of driver who buys a new car with cash every 10-12 years and drives it into the ground.  So you do some quick calculations using a 7% discount rate and figure that you will save nearly $5,200 in gasoline over the life of the car.  That’s a net gain of $3,200 over the life of the car.  Moreover, you will recoup your additional expenses in the first four years of ownership.  Your friend who is shopping with you, finances all of his vehicles. But you run the calculations for him and discover that even if he finances the car over 60 months, he will save $12 per month during the loan period.

If this deal sounds good to you, you are in luck.  This is exactly the deal that the National Highway Traffic Safety Administration (NHTSA) and the Environmental Protection Agency (EPA) claim to be offering in their newly proposed regulation for increased fuel efficiency standards, laboriously titled “2017 and Later Model Year Light-Duty Vehicle Greenhouse Gas Emissions and Corporate Average Fuel Economy Standards” [FactSheet, Full Notice of Proposed Rulemaking (800+ pages)].

The goal of the proposed NHTSA rule is to increase the average industry fleet-wide fuel economy for cars and light trucks to 40.1 mpg by 2021 and to 49.6 mpg by 2025.  The simultaneous rule by EPA, which is based off the fuel economy standards proposed by NHTSA, limits greenhouse gas emissions from vehicles to 163 grams per mile (g/m) by 2025.  The claim is that these standards can be met and in so doing, consumers will actually save an average of $3,200 per vehicle over the life of a new car.  We are from the government and we are here to help!

There is a lot of flexibility built into this rule.  There are options to earn credits for over-compliance, which can both be carried forward (banking) and carried back (borrowing).  There are allowances for credit transfer between cars and light trucks and even credit trading across manufacturers.  There is also plenty of flexibility built into the GHG standards allowing for credits for air-conditioning improvements, off-cycle improvements, an electric vehicle multiplier, and credits for hybridization of full size trucks.  All of these sources of regulatory flexibility should lower the costs of attaining the standard and allow each manufacturer to attain the standard in a cost-effective way given its fleet.

Still, the presentation of benefits and costs suggests a free lunch.  Actually, a lunch that you are paid $3,200 to eat.  Even with all of these cost-lowering flexibility measures, this seems hard to swallow.  And it should be, because it is wrong.

To see why the costs are much higher than the analysis suggest, image you are back at the Ford dealer.  The salesperson presents a new 2011 Explorer, which gets 27.5 mpg and tells you that this car retails for $22,000.  Then she shows you a 1997 model-year Ford Explorer that has never been driven or owned (the odometer reads 0), but this 1997 Explorer has been tweaked to get 49.6 mpg.  She’ll sell you this modified 1997 model Explorer for $24,000.  What do you choose?  Many of you will get the 2011 model with the worse gas mileage.  Some of you might buy the 1997 model car with the better gas mileage, but clearly your cost is not just $2000.  It’s the monetary costs ($2,000) plus the difference in performance/features between the 1997 and the 2011 model.

What the benefit-cost analysis conducted by NHTSA and EPA says is that by 2025 the car manufactures can produce a car that has the same performance as 2011 cars on the market today, but gets double the gas mileage.  This car will cost $2,000 more than cars sold today.  But nobody expects that absent this regulation 2025 models will perform like 2011 models.  We expect innovation in performance, features, safety, etc.  The real cost of the regulation is how much of this we will give up between now and 2025 in order to get a doubling of the fuel economy of vehicles.

I have blogged before about my frustration that the right insists that all regulation is job-killing.  But I’m equally frustrated when the left insists that regulations are costless. Maybe doubling fuel economy is a good idea.  Maybe the benefits to us of reduced carbon emissions, reduced oil consumption, increased national security, are worth trading off more horsepower, torque, or other features.  Maybe not.  But that is what a benefit-cost analysis should be helping us decide.   We want jobs, economic growth, clean air, clean water, good schools, etc.  The challenge is how to balance out those competing desires with our limited resources.  It may not be a great sound bite, but it is the truth.

1997 Ford Explorer

2011 Ford Explorer

Jobs Versus Children’s Health—A false choice

In January 2009 I was awoken by the sound of my eldest child wheezing and gasping for air.  We called 911 and emergency personnel arrived to give her some oxygen.  After a short time they determined it was a severe croup episode and not, as I feared, a first asthma attack.  But that is a night I will never forget.  The fear you feel as a parent when your child cannot breathe is intense.  Millions of parents live with that background fear on a daily basis because their children suffer from chronic asthma. The Centers for Disease Control estimate that 7.0 million children (9.4%) have asthma as do 17.5 million (7.7%) adults.[i] Asthma results in 17.0 million health visits per year, 450,000 inpatient hospital stays with an average length of 3 days, and 3,447 deaths.[ii]

What does all this have to do with Environmental Economics?

President Obama recently asked EPA Administrator Lisa Jackson to withdraw a proposed refinement of the National Ambient Air Quality Standards (NAAQS) for ground level ozone that would have lowered allowable ozone levels from 0.84 parts per billion (ppb) to a range of 0.60 to 0.70 ppb.  Ground level ozone (not to be confused with stratospheric ozone which has the big hole) is also known as smog, and is a key contributor to asthma and other illnesses and deaths.

To be fair, the ozone NAAQS will be revisited in 2013, so Obama’s decision really only put off the debate for two years.  But why delay two years when the rule was ready to go forward now?  Must be economics.  Or is it?

In announcing his decision, President Obama said “I have continued to underscore the importance of reducing regulatory burdens and regulatory uncertainty, particularly as our economy continues to recover.”[iii] The announcement was made shortly after a bad jobs report was issued which further enhances the appearance that the postponed regulation was a “job killer.”  But the jobs versus environment rhetoric is just that—rhetoric.  It has no basis in economic analysis because economic analysis is not based on counting up jobs!

A good economic analysis compares the costs of complying with the regulation to the benefits resulting from the regulation.  The benefits in this case are the health benefits associated with reduced incidence of asthma and other health impacts.  Compliance costs include costs of purchasing new pollution control equipment, changing fuel sources, changing operational practices, and so forth.  The jobs analysis is really a non-starter.  Could we lose some jobs if we require more regulatory expenditures—certainly.  Could we gain jobs in industries that are selling and developing pollution control equipment–certainly.  Are these exactly a wash—probably not.  But we will also reduce hospitalizations, school days missed, and even deaths from asthma and other illness.  The key is that economic analysis is not “jobs analysis.” We do our best to measure the benefits and the costs of compliance in dollars.  Then we can compare dollars spent to dollars gained and not compare jobs to asthma cases.

So what did the economic analysis of the proposed ozone rule say about the costs and benefits of tightening the standard?  Not a lot that is useful, unfortunately.  This is not because the economic analysis is badly done (although I might quibble a bit on a few points), but rather because there is significant uncertainty over both costs and benefits of the proposed rule.  There are at least three major sources of uncertainty in the economic analysis.

  1. Modeling uncertainty:  Ozone isn’t a pollutant that gets directly emitted from smokestacks or tailpipes.  Ozone is the result of combining two other pollutants, NOx and VOCs, with sunlight.  As a result, you have to model the ozone-generating process and estimate how many counties might not be in compliance when the rule becomes binding in 2020.
  2. Cost uncertainty:  Once you estimate which counties would exceed the standard you need to come up with estimates of compliance.  But for some counties it was estimated that compliance was not possible with known technologies.  Compliance in 2020 relies on technologies that we don’t know about in 2011 and cannot accurately price.  It also relies on estimates of how costs of current technologies may change over the next 9 years.
  3. Benefits uncertainty:  The benefits estimates rely on models of the relationship between ozone levels and deaths and illnesses.  There are several different models available in the peer-reviewed literature including three meta-analyses, yet these models still give answers that vary significantly.

These uncertainties mean that for each of the standards considered there is a large spread in estimated costs and estimated benefits such that the range of possible net benefits (benefits minus costs) always straddles zero.  The figure below captures the highest and lowest benefit and cost estimates for each standard.  You can see that the uncertainty in benefits is greater than the uncertainty in costs at all levels and that the uncertainty in both benefits and costs increases as the standard becomes more stringent.

click image to enlarge

Figure Source: United States Environmental Protection Agency.  Summary of the updated Regulatory Impact Analysis (RIA) for the Reconsideration of the 2008 Ozone National Ambient Air Quality Standard (NAAQS).  January 1, 2010. Available at:  http://www.epa.gov/ttnecas1/regdata/RIAs/s1-supplemental_analysis_full.pdf.  Last accessed, September 7, 2011.

With this much uncertainty in both costs and benefits, reasonable people could certainly disagree about the best course of action. I personally was very disappointed in President Obama’s decision.  I would strongly support an increase in stringency for the ozone standard based on the economic analysis presented in the Regulatory Impact Analysis.

How could I feel so strongly given all the uncertainties?  The reason is that historically we have systematically underestimated benefits from air pollution regulations and overestimated costs.  The retrospective benefit-cost analysis of the Clean Air Act from 1970-1990 estimated total benefits attributable to air regulations between 5.6 and 49.4 trillion dollars with a central tendency of 22.2 trillion.  The total costs were roughly 0.5 trillion.  That means that we are better off by around 21.7 trillion dollars because of these regulations.[iv]

Furthermore, most of the “unexpected” gains in benefits came from regulations of particulate matter.  The proposed ozone rule lowers emissions of NOx which also results in lower emissions of small particles (PM2.5) which are very harmful for health.  So if I had to bet on where we were likely to end up on the “distribution” of net benefits I would place my bet on higher end of the range.  And that means I’m betting that we are better off as an economy with more stringent ozone regulations.  I wish President Obama hadn’t caved to political pressures and supported his EPA Administrator in making that same bet.


[i] Centers for Disease Control and Prevention.  Fast Stats:  Asthma. Available at:  http://www.cdc.gov/nchs/fastats/asthma.htm.  Last Accessed:  September 8, 2011.

[ii] ibid

[iii] White House.  Office of the Press Secretary.  Statement by the President on the Ozone National Ambient Air Quality Standards. September 2, 2011.  Available at:  http://www.whitehouse.gov/the-press-office/2011/09/02/statement-president-ozone-national-ambient-air-quality-standards.  Last Accessed:  September 9, 2011.

[iv] United States Environmental Protection Agency. The Benefits and Costs of the Clean Air Act, 1970 to 1990.  Executive Summary. pp: ES-8.  Available at:  http://www.epa.gov/oar/sect812/1970-1990/812exec2.pdf.  Last Accessed: September 8, 2011.