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CEI Study Challenges EPA Claim to Deliver $30 in Benefits for Every Dollar of Cost

by Marlo Lewis on March 23, 2011

in Blog, Features

Do EPA’s Clean Air Act (CAA) rules produce more than $30 in benefits for every dollar of cost? That’s what the agency claims in a report published earlier this month:

Our central benefits estimate exceeds costs by a factor of more than 30 to one, and the high benefits estimate exceeds costs by 90 times. Even the low benefits estimate exceeds costs by about three to one.

Obama administration officials and their allies tout EPA’s benefit-cost estimates as a reason why Congress should allow the agency to regulate greenhouse gases (GHGs). EPA Administrator Lisa Jackson, for example, cited the 30 to 1 ratio in her Feb. 9, 2011 testimony opposing the Energy Tax Prevention Act, a bill that would strip EPA of its non-congressionally authorized power to dictate national policy on climate change. Jackson suggested that if Congress lets EPA regulate GHGs, net annual CAA benefits will reach $2 trillion by 2020.

EPA’s GHG rules cannot possibly harm the economy, we’re told, because the CAA has a 40-year track record of delivering trillions of dollars in net benefits.

Skepticism regarding such claims is warranted. EPA’s benefit estimates assume that air pollution at today’s historically low levels kills tens of thousands of Americans annually. This is dubious. As my colleague Joel Schwartz documents:

Through exaggeration, omission of contrary evidence, and lack of context, regulators, activists, and even many health scientists mispresent the results of air pollution healh studies and the overall weight of the evidence from the research literature. They create the appearance that harm from air pollution is much greater and more certain than suggested by the underlying evidence.

Skepticism is also appropriate because EPA’s benefit-cost estimates are a form of self-evaluation in which the agency, in effect, writes its own report card. That EPA gives its regulations a triple A rating is not surprising. What is surprising is that people take such self-evaluations at face value. As economists Richard Belzer and Randall Lutter commented about EPA’s October 1997 cost-benefit report:

The same agencies that evaluate performance also design and administer the very regulatory programs they are evaluating. It is hard to understand why anyone should expect self-examinations to be objective and informative. Investors want businesses to be audited by analysts without financial conflicts of interest. Scientists reject research that cannot be replicated independently. Consumers flock to independent testing organizations rather than rely exclusively on sellers’ claims. Only in the public sector, where bureaucrats are protected from the discipline of market forces, do we rely on self-evaluations of performance.

To survive and grow, EPA must continually persuade Congress to “invest” our tax dollars in its policies and programs. EPA’s claim to deliver trillion-dollar benefits is a winning sales pitch in Washington’s budget battles. If a Wall Street broker were to promise clients a 30 to 1 rate of return on investment, however, he would likely be investigated by the SEC.

How does EPA estimate costs and benefits, and do such estimates justify public trust in the wisdom of EPA’s global warming regulations? Economist Garrett Vaughn examines these issues in Clearing the Air on EPA’s False Regulatory Cost-Benefit Estimates and Its Anti-Carbon Agenda, a study published last week by the Competitive Enterprise Institute.

Vaughn begins by noting a mismatch between the Obama administration’s words and deeds. Nobody ever claimed the Waxman-Markey cap-and-trade bill’s benefits would exceed costs by 30 to 1.  Yet  Waxkey supporters — including EPA – repeatedly asserted that cap-and-trade is superior to CAA regulation as a climate change mitigation strategy:

If the Obama administration actually believed the EPA’s enormous net benefit estimates, it would have gone immediately to direct regulation and not put the Democratic Party’s congressional majorities in the 2010 mid-term elections in jeopardy by pressing for House and Senate votes on cap-and-trade. The specter of EPA regulation served as a threat precisely because members of Congress and the administration understand well that EPA regulations actually impose costs far in excess of benefits, the EPA’s official claims to the contrary notwithstanding.

Next, Vaughn points out that EPA’s annual net benefit estimates imply wildly implausible cumulative benefits:

Assuming the same rate of growth in CAA annual net benefits from 1990 through 2010 as the EPA estimated for 1975 through 1990, would have led the agency to estimate 2010 net benefits from both the CAA and the CAAA [Clean Air Act Amendments of 1990] of more than $12 trillion (in 2010 dollars). That amount would equal more than four-fifths of the United States’ 2010 GDP—a sum far beyond any reasonable person’s willing suspension of disbelief.

Vaughn then develops his central thesis — that EPA’s high benefit-cost ratios depend on accounting tricks. One trick is to assume that regulated entities fully “recover” their compliance costs by passing those onto customers in the form of higher prices. This assumption flouts Econ 101, the ”law of demand,” which stipulates that higher prices reduce demand, thereby reducing sales, output, employment, and income.

Ignoring the law of demand leads EPA to low-ball regulatory burdens. Vaughn illustrates this point with EPA’s year 2000 heavy-duty (HD) vehicle emission standards rule:

. . . the EPA’s B-C analysis of the current HD rule assumed that each year’s vehicle sales would be exactly 12,800 units greater than the previous year’s sales—regulation or no—from 2007 through 2030 (see the MAPI report’s Table 6). The first deadline under the current HD rule was set for the 2007 model year. Did HD vehicle sales in 2007 exceed those of 2006 by approximately 12,800 units? In a word, no. Sales in 2007 plunged, in accordance with the law of demand, giving the industry an early start on the Great Recession.

A closely related trick is comparing costs and benefits in the years after full recovery is assumed. In those years compliance costs are assumed to be zero dollars. In contrast, regulatory benefits increase as newer, compliant equipment replaces older non-compliant equipment. A very high benefit-cost ratio is guaranteed when the denominator is set at $0.00. EPA’s year 2000 HD vehicle rule is again a case in point. The rule projects that costs will be fully recovered by 2014 but that benefits increase through 2030. Vaughn comments:

Once “recovered,” the EPA treats annualized up-front costs as $0.00 for each and every year starting with 2015. Finally, the EPA estimates a B-C ratio for a single 12-month period: the year 2030, for a regulation proposed exactly three decades earlier. The EPA treats the up-front capital costs—no matter how many millions or billions of dollars—as $0.00 in 2030 (having been fully “recovered” by 2014). Hence, in the EPA’s unique method of estimating B-C ratios for its regulations, up-front capital expenditures become what economists term a “free good.”

In reality, compliance costs will not fall to zero in 2014, because EPA has proposed new emission standards for diesel trucks that will impose new costs on the same regulated entities:

The EPA’s B-C analysis for the current HD rule assumed that affected manufacturers would “recover” their upfront capital expenditures by 2014 through higher consumer prices on compliant vehicles. With the proposed HD rule, compliant vehicles in the pipeline for 2014 have been effectively outlawed by the very same EPA, negating the potential of those vehicles to help fully “recover” manufacturers’ upfront capital expenditures, as portrayed by the EPA’s 2000 B-C analysis of the current HD rule.

Even if EPA’s air quality rules did deliver $30 in benefits for every dollar of cost, it is still doubtful that the benefits of EPA’s GHG regulations will exceed costs. Unlike bona fide air pollutants, GHGs pose no threat to public health or welfare via inhilation or other forms of direct exposure. Moreover, because GHGs are assumed to affect the climate via their global concentration, Americans will pay all the (very real) costs of EPA’s GHG rules while reaping only a fraction of the (hypothetical) benefits.

Ironically, EPA’s GHG rules could increase net global emissions, producing “negative” benefits:

Most U.S. CO2 emissions come from the use of fossil fuels—coal, oil, and natural gas—that meet around 85 percent of this nation’s energy needs. Therefore, EPA regulations targeting GHG emissions cannot avoid increasing energy costs for U.S. companies and thereby handing a competitive advantage to their foreign competitors. In addition, regulatory restrictions on energy use by U.S. companies would soften world energy demand and lower energy prices for foreign companies, further stimulating GHG emissions in other countries. As a consequence, the EPA’s unilateral anti-carbon agenda may have the perverse result of increasing global GHG emissions, not reducing them.

Vaughn provides a more technical analysis of EPA’s regulatory accounting methods in his 2006 study, Slight of Hand: How the EPA’s Benefit-Cost Analyses Promote More Regulation and Burden Manufacturers, published by the Manufacturers Alliance/MAPI.

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