To presume much: federal agencies have a poor track, record when estimating proposed regulations costs and benefits.

Batkins, Sam

Countless rhetorical and political battles have been fought over the merit or fault of particular federal regulations. Typically, industry will muster ex ante estimates of a rule's costs during the rulemaking process, and the agencies and their public interest allies will respond with ex ante estimates of the public health and safety benefits of the action.

This historical regulatory yin-and-yang often takes place without ex post analysis of previous regulation, along with an assessment of whether those regulations had the effects that advocates or critics claimed at the time they were adopted. Did the rule save the predicted number of lives? Was pollution abated and can we attribute that reduction to the regulation? Unfortunately, the number of truly retrospective regulatory reviews is utterly dwarfed by the number of ex ante regulatory fights. This needs to change, and thankfully policymakers and analysts are beginning to concede this.

In recent years there has been a steady stream of retrospective reviews from various sources offering new data on regulatory performance. Generally, agency ex ante estimates on benefits have proven to have been inflated, sometimes wildly so. This shouldn't come as a surprise, as agencies have heavy incentives to "sell" their rules to the administration and the public. The research that currently exists isn't enough to completely undermine the "omniscient agency" narrative that regulatory proponents (and sometimes the courts) profess, but sound retrospective review is steadily building the case that agencies routinely rely on flawed assumptions and make unreliable projections.

COST-BENEFIT ANALYSIS IN THE REGULATORY PROCESS

The genesis of cost-benefit analysis within the executive branch dates to Presidents Lyndon Johnson and Richard Nixon. Allan Schmid, who oversaw the Army Corps of Engineers at the time, argued that such analysis should apply not only to public works projects, but also to regulations. Nevertheless, neither president established a formal cost-benefit analysis regime.

That changed under President Jimmy Carter's Executive Order 12044. The order established, among other aspects: a semiannual agenda of regulations (known today as the Unified Agenda), a requirement that significant regulations address new reporting and recordkeeping requirements, an evaluation of the direct and indirect effects of a rule, and the need to ensure that paperwork costs for the rule are minimized.

Often unnoticed about EO 12044 is its retrospective review component. The order called for a review of existing regulations to analyze the continued need for certain rules and the burdens imposed.

As part of this new process to improve federal regulation, Carter created the Office of Information and Regulatory Affairs (OIRA) in 1980 to conduct cost-benefit analysis. But it was President Ronald Reagan who assigned cost-benefit analysis a central place in regulatory policy, vowing that new regulations would not go forward unless "the potential benefits to society for the regulation outweigh the potential costs to society." This was one of the few times in history when regulation actually declined.

Every succeeding president has upheld the importance of cost-benefit analysis in regulation. Most recently, President Obama reaffirmed a commitment to cost-benefit analysis when he issued Executive Orders 13563, 13579, and 13610. In addition to common themes from the past, Obama emphasized that some important values--equity, fairness, and distributive effects--may be difficult to grasp quantitatively. He also required executive agencies (and asked independent agencies) to "engage in a periodic review of existing significant regulations." Although the Carter administration also promoted retrospective review, the Obama administration appeared to actually commit to it, identifying more than 500 rules for review. However, research suggests that some of those reviews merely provided cover for new regulations, rather than the appraisal and reform of existing rules.

Today, every cabinet agency engages in some form of cost-benefit analysis for "economically significant" rules--measures with an economic impact of $100 million or more. In addition, cabinet agencies generally follow the Office of Management and Budget's Circular A-4, which establishes guidelines for measuring benefits and costs. For example, the U.S. Department of Energy (DOE) routinely devotes countless pages of analysis to the net present value benefits and costs of a rule, the annualized costs and benefits, and how the regulation will affect consumer prices. For some large regulations, the cost-benefit analysis in the preamble is accompanied by a separate "Regulatory Impact Analysis" and several "Technical Support Documents." Yet, these documents are almost always non-existent for independent agencies, and agencies rarely carry out their own retrospective studies. To date, third parties have been tasked with producing just a handful of regulatory lookbacks.

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STUDIES IN ERROR

Although there have been several notable studies appraising individual regulations, there have been few organized attempts to tackle broad retrospective review. Thankfully, the public policy research group Resources for the Future (RFF) launched a "Regulatory Performance Initiative" aimed at documenting whether past regulation succeeded and at what cost. In nine case studies, this undertaking has performed 34 retrospective reviews on costs and benefits from environmental rulemaking.

The findings? Regulators generally bungle their estimates. For benefits, RFF found 10 of the 22 regulations or regulatory requirements overestimated benefits by 25 percent or more; six others were "relatively accurate," and six were underestimated. The research found that the U.S. Environmental Protection Agency 1 s air toxics rules tended to exaggerate benefits more often than any other policy area.

Despite this herculean research task, RFF's Richard Morgenstern stressed that good public policy needs comprehensive retrospective review. He wrote, "The lack of funding for retrospective assessments, both inside and outside of government, is clearly a barrier to further progress." Despite that barrier, there is now--thanks in part to RFF's work--a critical mass of retrospective studies that paint an unflattering picture of agency error on many levels.

Energy efficiency in Michigan / The analyses noted by RFF are not the only federal cost-benefit studies to reach questionable results. Consider the Obama administration's "Clean Power Plan," which proposes to reduce power plant emissions by 32 percent by 2030. Buried in the "building blocks" of the rule is an ambitious plan to increase energy efficiency. The more efficient homes and buildings are at using energy, the less demand for energy output, resulting in fewer greenhouse gas emissions.

But will the plan yield the desired fruit? In all its politicking for the rule, the U.S. Environmental Protection Agency failed to cite a recent National Bureau of Economic Research working paper on the utter failure of a recent DOE energy efficiency program for consumers in Michigan. According to the paper, the costs of the agency's Weatherization Assistance Program outweighed its benefits by a -9.5 percent annual rate of return. Although the program did reduce monthly energy consumption by 10 to 20 percent, the costs still trumped the benefits by 2.5-to-1.

This disparity might be explained by the "rebound effect" of efficiency. That is, as efficiency improves and the cost of consumption falls, consumers will be more inclined to increase their energy consumption; e.g., setting their thermostats higher and heating more rooms than they normally do. As the authors conclude,

   The results are striking because Michigan's cold winters and
   the likelihood that the weatherized homes were not in perfect
   condition suggest that it may have been reasonable to expect
   high returns in this setting. Regardless of one's priors, this
   paper underscores that it is critical to develop a body of credible
   evidence on the true, rather than projected, returns to energy
   efficiency investments in the residential and other sectors.

Sadly, the EPA and other regulators tend to view efficiency rules as free money. Don't expect this latest research to change that view.

OSHA's missing fatalities / The EPA is hardly the only federal agency to overestimate the benefits of its proposed regulations. An assessment of six major Occupational Safety and Health Administration (OSHA) regulations promulgated in the 1980s and 1990s found that each rule overestimated the number of fatalities prevented. Using data from the "Census on Fatal Occupational Injuries" and "National Traumatic Occupational Fatality" figures, the analysts compared the number of projected fatalities prevented from OSHA rules with actual ex post fatalities. Their conclusions were stark: "In general, we found little persuasive evidence provided to justify OSHA's calculations."

In the first rule studied, "Electrical Work Practices for General Industry," OSHA predicted a 41 percent reduction in fatalities, or 97 lives annually. Part of the problem with retrospective review is finding two numbers to compare. The authors of the study spent considerable effort attempting to recreate and justify OSHA's baseline. For the electrical work practices rule, they arrived at a baseline annual fatality figure of 135, compared to 235 for OSHA. Frequently, the authors found that OSHA would "correct" the public figures on workplace fatalities by literally doubling the number to account for underreporting. Despite the dispute over the baseline, the authors note that a significant drop in deaths didn't occur until seven years after the rule became effective. And even if they attributed all of the decline to the rule, the mortality decline "was also considerably lower than the 97 deaths projected by OSHA."

For the remaining rules, the authors found that OSHA's projections were "highly implausible," "unlikely," and "overoptimistic." In one rulemaking, "Electrical Power Generation," the authors combed through three datasets on occupational mortality and injuries and found that deaths slightly declined the year that the standards went into effect, but then increased during the next three years. No data source suggested an overall decline because of the rule.

In the final rule examined, for workplace scaffolding protection, OSHA projected roughly 42 fewer deaths because of the regulation. However, even though the standards went into effect in 1997, the authors found the number of fatalities declined by just four from 1996 and 2002. After consulting with an industry expert, they discovered no mitigating technological breakthrough that would have increased or decreased scaffolding safety.

Fewer microwaves and air conditioners / The DOE is one of the most prolific regulators in the federal government. That few people are aware of this is perhaps just as shocking as the agency's regulatory tab: more than $150 billion in net present value costs since 2007. Even according to OIRA, the DOE is the third most burdensome regulator in the federal government, behind the EPA and the Department of Transportation.

The DOE is active because policymakers believe that new energy efficiency standards essentially act as "free money" for consumers. A higher upfront purchase price for an efficient new product supposedly will pay for itself over the coming years of reduced energy use. (See "The Disappearing Benefits of Energy Efficiency," p. 4.) As discussed in the Michigan example above, these claims warrant increased scrutiny.

A recent American Action Forum (AAF) paper I authored examines two past DOE rules for microwaves and air conditioners, and the subsequent new-unit shipment rates for those two goods. If the shipment rate drops significantly below the agency's projections, then it's unlikely the actual benefits would match the agency 1 s estimates because consumers end up using fewer of the more efficient products.

For both rules, the DOE's projected shipment rates ended up being much higher than in reality. For air conditioners, the higher purchase price likely led to a rush in orders the year before the standards took effect. Then after the effective date, shipments fell 26.1 percent, compared to an agency estimate of 2.1 percent. For perspective, this drop in orders occurred before the Great Recession, in a time when unemployment hovered between 4.4 and 4.8 percent. Shipments are now still below DOE projections; thus, Americans continue to operate less efficient units, lowering potential benefits of the rule. I conclude that the benefits of the rule, initially projected at $1.2 billion compared to $1.1 billion in costs, are now likely lower than the annual burdens.

For microwaves, the DOE's erroneous projections are even more pronounced. Beginning in years before the new standard was implemented, annual microwave shipments fell as a result of the 2007 financial crisis and ensuing recession. Those lower shipment rates continued through the end of the recession and the subsequent implementation of the rule, at which time the actual shipment rate of 9.6 million was 33 percent lower than the projected rate of 14.4 million. The lower shipment rate persisted through 2014, the last year data are available.

Though it's difficult to argue that the new rule directly contributed to the decline in air conditioner sales, the large overestimate of shipment rates underscores the unreliability of agency projections about the benefits of various regulations.

EPA and coal / In one of the most expensive regulations in recent history, in 2012 the EPA finalized its Mercury Air Toxics Rule (MATS), ostensibly designed to regulate toxic gases and heavy metals from coal-fired power plants. Although the cost-benefit balance was tipped in favor of the latter based on the cuts to particulate matter emissions, the rulemaking naturally contained hundreds of assumptions: higher IQs in children, reduced mortality and morbidity, and the future of the coal industry.

If the past few years are any guide, the EPA has already missed the mark on projecting the future of coal-fired generation capacity. By 2013, the agency estimated coal would generate 341,407 megawatts (MW) of electricity. Instead, coal generation fell to 329,815 MW. Of course, environmentalists would consider that decline a bonus benefit, but it again underscores the unreliability of agency projections. And given the Clean Power Plan, the gap between EPA predictions and reality will likely continue to widen.

IMPROVING COST-BENEFIT ANALYSIS

The preceding case studies illustrate that even though there are plenty of expert analysts at these agencies, they are not soothsayers. They cannot see the future and it is to be expected that their cost-benefit analyses will not always prove accurate.

Does this mean the federal government should abandon cost-benefit analysis? No; carefully weighing expected costs and benefits is a fundamental part of policymaking, and if anything, cost-benefit analysis should be expanded to the independent agencies, which are not bound by executive order. But how can agencies improve their analysis?

Broadly speaking, even cabinet agencies that are required to conduct cost-benefit analysis underperform on this task. The Mercatus Center at George Mason University routinely tracks agency analyses and finds them lacking in several respects. Its "Regulatory Report Card," which attempts to measure the quality of agency analyses, found that since 2012 the average cabinet regulation has scored just 13.3 out of a possible score of 30, easily an "F." Revising executive orders to strengthen cost-benefit standards, providing the public with advanced notices of proposed rulemaking for billion-dollar regulations, as well as improving OMB Circular A-4, could aid in prospective analysis, but that's only half of the equation.

Engaging in a comprehensive system of retrospective analysis will aid policymakers and regulators alike, allowing them to learn from each new regulatory review. Here, the details matter. Under President Obama's EO 13563 and 13610, agencies are already supposed to conduct retrospective reviews. However, agencies often recycle old regulations and tighten regulatory requirements, rarely learning from past attempts to regulate. An AAF study I conducted found that the latest round of retrospective reports actually increased regulatory costs by $14.7 billion and added 13.4 million paperwork burden hours. In addition, for new rules, agencies should be establishing metrics to measure whether a regulation will be successful in the future. Research conducted by the George Washington University Regulatory Studies Center indicates that cabinet agencies rarely do this.

What is likely required, although this would be unpopular in conservative circles, is the creation of a new agency to conduct either prospective analysis, retrospective review, or both. In a previous Regulation article, Ike Brannon and I suggested that OIRA carry out this work using economists reassigned from the regulatory agencies. ("Toward a New and Improved Regulatory Apparatus," Fall 2013.) Other commentators favor the creation of a new independent agency to manage the regulatory state. Another option is to place regulatory economists and lawyers at a new branch of the Congressional Budget Office, capitalizing on its strong reputation for forecasting budget and tax data. Regardless of where this new analysis is conducted, it's more than clear that the status quo should not continue.

Perhaps a final way to revamp cost-benefit analysis is to amend how courts view agencies' current efforts. The Regulatory Accountability Act would change the standard of judicial review of agency cost-benefit analysis from the more deferential "arbitrary and capricious" to "substantial evidence." The higher standard would enable courts to find against agencies when their figures lack sound evidence.

But the most important step in improving cost-benefit analysis is conducting and learning from retrospective review. Whether such review is conducted after five years or 10, any effort to discern the actual effects of a rule would improve future rulemaking. If performed correctly, it would inform regulators, the courts, Congress, and the executive. As the Mercatus Center's Patrick McLaughlin has argued, it would create a sort of positive feedback loop for better policy.

Given the agency missteps noted in this article (and many more that could have been included), it's clear that regulatory decisionmaking suffers from a lack of sound evidence. Any steps taken to uncover more evidence about the effects of regulation would be most welcome.

CONCLUSION

How correct are lofty agency presumptions about regulations having large benefits and small costs? Generally, given the scant information that exists now, the agencies tend to inflate the former while low-balling the latter, though more evidence is needed before it can be stated definitively that this failure is pervasive across the regulatory state.

The federal government issues around 80 major rules each year, and maybe two or three will draw the attention of scholars interested in the actual effects of the rule. More research is needed to determine whether regulators provide dependable analysis or just engage in bureaucratic propaganda.

READINGS

* "Administration's July 2015 'Regulatory Review' Add $14.7 Billion in Costs," by Sam Batkins. American Action Forum, August 25,2015.

* "Assessing the Accuracy of OSHA's Projections of the Benefits of New Safety Standards," by Si Kyunh Seong and John MendelofF. Journal of Industrial Medicine, Vol. 45, No. 4 (April 2004).

* "Do Energy Efficiency Investments Deliver? Evidence from the Weatherization Assistance Program," by Meredith Fowlie, Michael Greenstone, and Catherine Wolfram. National Bureau of Economic Research Working Paper No. 21331, July 2015.

* "The Department of Energy: Under the Radar, Overly Burdensome," by Sam Batkins. American Action Forum, Oct. 9,2015.

SAM BATKINS is director of regulatory policy at the American Action Forum.