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This chapter discusses the total annual costs and benefits of existing Federal regulatory programs called for by Section 645(a)(1). Before doing so, however, it is important to place the subject in perspective.
First, when we speak of the costs or benefits of "regulations," we are in, reality, speaking of the costs and benefits of legislation as well as regulation, for it is usually impossible, and often not productive, to try to allocate costs and benefits between the authorizing statute and its implementing or interpreting regulations.
Second, we need to keep in mind the discussion in Chapter I on best practices for estimating costs and benefits and the limitations on valid and reliable quantitative measures.
Third, it is important to ask: What public policy purposes do aggregate estimates serve if the ultimate goal is to develop the information necessary to make decisions about specific regulatory programs or program elements? And, in particular: In what ways can these estimates help support the recommendations to reform the regulatory system required of the Director by Section 645 (a)(4)? Clearly, knowing the costs and benefits of individual proposals for regulatory actions and their alternatives, including the alternative of no action, enables policy officials to make decisions that improve society's well being. But for reasons discussed below, knowing the total costs and total benefits of all of the many and diverse regulations that the Federal government has issued provides little specific guidance for decisions on reforming regulatory programs.
For example, four possible outcomes can result from totaling up the costs and benefits of all existing Federal regulations:
Given the intensity of the debate over regulatory reform, categories (3) and (4) are not likely outcomes of careful and fair accounting. A priori, it is not clear which of the remaining two categories is most likely. But does it matter? In each case, the policy guidance would be the same. Real economic improvement comes from expanding those significant regulatory programs that provide benefits that are greater than costs and contracting those programs that provide benefits that are less than costs. The substance is in the details, not in the total.
The implication of this discussion is that an excessive amount of resources should not be devoted to estimating the total costs and benefits of all Federal regulations. To the extent that the costs and benefits of specific regulatory programs can easily be combined, some indication of the importance of regulatory reform can be inferred by the magnitude of these estimates, but knowing the exact amounts of total costs and benefits, even if that were possible, adds little of value.
This proposition is important because it is extremely difficult, if not impossible, to estimate the actual total costs and benefits of all existing Federal regulations with any degree of precision. There are at least two types of intractable problems that make this so.
The Baseline Problem
In order to estimate the impact of regulations on society and the economy, one has to determine the counterfactual -- that is, how things would have been if the regulation had not been issued. In other words, what is the baseline against which costs and benefits should be measured? With respect to estimating total costs and benefits of all Federal regulations, the baseline problem has several dimensions.
First, it is impossible to determine the true counterfactual, since it never happened. What would have happened in the absence of regulation can only be an educated guess. Furthermore, the greater the hypothesized difference between reality and the counterfactual, the more problematic the exercise. For example, some estimates of the total cost of regulation include the cost of compliance with our tax system. But to twist a phrase, one can no more easily imagine a world without taxes than one can imagine a world without death. It is also difficult to imagine a world without health, safety, and environmental regulation. Could a civil society even exist without regulation? In other words, what do we use as the baseline for a world without any regulation?
Second, even disregarding the problem of modeling large changes, there are significant difficulties in determining the counterfactual for individual regulations that one could begin to aggregate. One can survey firms and other regulated entities on their expected compliance costs either ex ante, before the regulation is implemented, or ex post, after the regulation has gone into effect. For both types of studies, the problem of potential bias must be kept in mind. It is often alleged that strategic behavior may color both regulators' and the regulated's estimates of the cost of regulation (Hahn and Hird 1991, Hopkins 1991, and Hahn 1996). Agencies are generally advocates of their programs and businesses generally are not in favor of regulation. In the ordinary course, therefore, the best studies are ex post studies done by individuals who do not have vested interests, but do have reputations as objective analysts to uphold.
Often only ex ante cost estimates are available, but even if firms' or agencies' estimates are unbiased at the time, technological change or "learning-by-doing" may result in those estimates overstating compliance costs (Hahn and Hird 1991 and Hahn 1996). In fact, there is much evidence that competition among regulated firms often reduces expected compliance costs once real time and effort is directed at the problem (Office of Technology Assessment 1995).
While ex post studies are likely to be more accurate than ex ante studies because firms should by then have had experience with actual regulatory compliance costs, ex post cost estimates have their own problems. Properly done they are likely to be resource and time intensive. Firms do not usually keep their cost accounting estimates according to what regulations are driving them. Thus, when surveyed, firms have to reconstruct causality. A recent General Accounting Office (GAO) report details the difficulties the GAO had in trying to determine the total cost of Federal regulation by surveying a sample of firms. The firms reported great difficulty in estimating their own costs of compliance because they could not easily separate Federal from State and local regulation and because they did not keep records on incremental costs of regulation (See GAO 1996, pp. 49-51). Some studies have attempted to address this problem reasonably successfully by comparing the results of different degrees of regulation in different localities or time periods.
Moreover, virtually all of the studies of the costs of regulation produced to date are measuring the expenditures of firms required (ex ante or ex post) by regulation, whereas the cost to society of regulation should be measured by the change in consumer and producer surplus associated with the regulation and with any price and/or income changes that may result (Cropper and Oates 1992). At one extreme, ignoring the consumer surplus loss produced by a ban understates costs to society because although no compliance expenditures are required, consumers can no longer buy the product. At the other extreme, calculating compliance expenditures based on pre-regulation output overstates costs because if the firm raises prices to cover compliance costs, consumers will shift to other products, which reduces their welfare losses (Cropper and Oats 1992, p. 722).
A third problem relates to the economy and the appropriateness of the baseline for the purpose for which it is expected to be used. If the objective is to reduce the burden of existing regulation, even ex post evaluation surveys may be inadequate for they would reflect the cost of gearing up to comply, not the cost saving of no longer having to comply with a given regulatory program. While the former is relevant for deciding whether to regulate, the latter would be the relevant concept if one is considering reducing regulation. There is also the dynamic nature of the economy, whereby technological advances over time are likely to reduce the start-up cost of compliance the firm originally faced. In addition, sunk costs, such as specialized capital costs and the cost of changing procedures already in place, make the cost savings from eliminating regulation less than the cost of complying with those regulations. Very few studies exist, especially for health, safety and environmental regulation, that attempt to determine the cost savings that would result from reducing or eliminating existing regulation.
It is important to note that this dynamic nature of the economy may affect the estimation of benefits as well as costs. Technological improvements could reduce predicted benefits. For example, medical progress can reduce the future benefits estimated for health, safety and environmental regulations, just as productivity improvements in manufacturing reduces the costs of compliance of some regulations. New drugs or medical procedures can reduce the benefits of regulations aimed at reducing exposure to certain harmful agents such as an infectious disease or even sunlight. Regulations aimed at increasing the energy efficiency of consumer products or buildings may see their expected benefits reduced by new technology that reduces the cost of producing energy. Furthermore, productivity improvements lead directly to higher incomes, which lead people to demand better health and more safety. Business responds to these demands by providing safer products and workplaces, even in the absence of regulation. Individuals with rising incomes may also purchase or donate land to nature conservancies to provide ecological benefits. Yet as on the cost side, the baseline that is used is almost always the status quo, not what is likely to be true in the future.
Fourth, the construction of a baseline may be complicated where, as frequently occurs, there are several causes of the change in behavior attributed to a Federal regulation. State and local regulations may also require some level of compliance. The tort system, voluntary standards organizations, and public pressure also cause firms to provide a certain degree of public protection in the absence of Federal regulation. As GAO points out, determining how much of the costs and benefits of these activities to attribute solely to Federal regulation is a difficult undertaking (GAO 1996). Adding to the complexity, the degree to which these other factors cause firms and other regulated entities to provide safe and healthful products and workplaces and engage in environmentally sound practices changes over time, generally increasing with increasing per capita incomes and knowledge about cause and effect.
Thus, although the National Highway Traffic Safety Administration has significantly increased the safety of automobiles, it is not likely that if the agency's regulations were eliminated the automobile companies would discontinue the safety features that had been mandated. Consumers demand safer cars than they used to and automobile companies are concerned about product liability. This same phenomenon exists with the environment, although probably to a lesser extent. Environmentally responsible behavior has become good for the bottom line. One paper company interviewed by GAO said that it would have incurred a substantial amount of its compliance costs even if there were no regulations, simply as good business practices (GAO 1996, p. 51). Over time, this "rising baseline" phenomenon reduces the true costs and benefits of health, safety, and environmental regulations. Estimates of the aggregate costs and benefits of regulation that include unadjusted estimates from aging studies are thus likely to be over estimates of the current costs and benefits of those regulations.
The Apples and Oranges Problem
The studies that have attempted to tote up the total costs and benefits of Federal regulations have basically added together a diverse set of individual studies. Unfortunately, these individual studies vary in quality, methodology, and type of regulatory costs included. Thus we have an apples and oranges problem, or, more aptly, an apples, oranges, kiwis, grapefruit, etc., problem.
Part of the problem arises because of the nature of regulation itself. There are over 130,000 pages of regulations in the Code of Federal Regulation, with about 60 federal agencies issuing regulations at the rate of about 4,000 per year. For our purposes, a "regulation" or "rule" means an agency statement of general applicability and future effect, which the agency intends to have the force and effect of law, that is designed to implement, interpret, or prescribe law or policy or to describe the procedure or practice of an agency. Clearly, "regulation" encompasses a lot of territory. The Hopkins series of studies (1991,1992, 1995,1996), which are the latest attempts to aggregate the costs of all regulations for which estimates are available and which we discuss in detail later, include five major categories of regulation:
Environmental. As the EPA points out, the true social cost of regulations aimed at improving the quality of the environment are represented by the total value that society places on the goods and services foregone as a result of resources being diverted to environmental protection. (Cost of a Clean Environment, pp. 1-2 to 1-3.) These costs include the direct compliance costs of the capital equipment and labor needed to meet the standard, as well as the more indirect consumer and producer surplus losses that result from lost or delayed consumption and production opportunities resulting from the higher prices and reduced output needed to pay for the direct compliance costs. In the case of a product ban or prohibitive compliance costs, almost all of the costs represent consumer and producer surplus losses. Most of the cost estimates used in this report do not include consumer and producer surplus losses because it is difficult to estimate the demand and supply curves needed to do this type of analysis.
Further indirect effects on productivity and efficiency result from these price and output changes as they filter through other sectors of the economy. According to EPA in the Cost of Clean report, recent research indicates that compliance cost estimates may understate substantially the true long-term costs of pollution control (p. 1-3). The estimates used in this report do not include these indirect and general equilibrium effects.
The benefits of environmental protection are represented by the value that society places on improved health, recreational opportunities, quality of life, visibility, preservation of ecosystems, biodiversity, and other attributes of protecting or enhancing our environment. As discussed in chapter I, the value is best measured by society's willingness-to-pay for these attributes. Because most types of improvements in environmental quality are not traded in markets, benefits must be estimated by indirect means using sophisticated statistical techniques that generally make benefit estimation more problematic than cost estimation.
Although the EPA issues the great majority of environmental regulations, DOI, DOT, and the DOE, among others, also issue rules aimed at improving the environment.
Other Social. This category of regulation includes rules designed to advance the health and safety of consumers and workers, as well as regulations aimed at promoting social goals such as equal opportunity, equal access to facilities, and protection from fraud and deception. They are often lumped together with environmental regulation in the category of "Social Regulation." Social regulation is mainly concerned with controlling the harmful or unintended consequences of market transactions, such as air pollution, occupationally induced illness, or automobile accidents. These consequences are commonly called "negative externalities" and regulation designed to deal with them attempts to "internalize" the externalities. This can be done by regulating the amount of the externality, e.g., banning a pollutant or limiting it to a "safe" level, or by regulating how a product is produced or used. Social regulation may also require the disclosure of information about a product, service or manufacturing process where inadequate or asymmetric information may place consumers, citizens or workers at a disadvantage. The techniques and methodological concerns involved in the estimation of the social costs and benefits generated by these rules is similar to those involved in the estimation of costs and benefits of environmental regulation discussed above.
Economic. Economic regulation is so-called because it directly restricts firms' primary economic activities, e.g., its pricing and output decisions. It may also limit the entry or exit of firms into or out of certain specific types of businesses. The regulations are usually applied on an industry basis such as agriculture, trucking, or communications. In the United States, this type of regulation at the Federal level has often been administered by what are referred to as "independent" commissions, e.g., the FCC, ICC or FERC, whose members are appointed but not removable without good cause by the President. The economic loss caused by this type of regulation results from the higher prices and inefficient operations that often result when competition is prevented from developing.
The costs of such regulation are usually measured by modeling or comparing specific regulated sectors with less regulated sectors, estimating the consumer and producer surplus losses that result from higher prices and lack of service, and estimating the excess costs that may result from the lack of competition. In contrast to social regulatory cost estimates, these estimates are mainly indirect costs.
Economic regulation may produce social benefits when natural monopolies are regulated to simulate competition. Although Hahn and Hird (1991) argue that the dollar amount of such efficiency benefits are small in a dynamic and technologically vibrant economy, this judgement is an educated guess based on a reading of recent history, rather than the result of an empirical study. It appears to be based largely on the widely accepted view that the U.S. economy has become more competitive over time, leaving little scope for benefits from eliminating monopoly, and on the observation that much of the motivation for economic regulation is to enhance one group at the expense of another. As noted above, such transfers are not generally considered social costs or benefits. But even though monopoly power may not be long lasting in a dynamic U.S. economy, it is not nonexistent at a given point in time.
Moreover, while Hahn and Hird (1991) define economic regulation as including only regulation of entry, output, and prices, in practice they appear to lump all Federal regulation of banking and other financial institutions, as well as consumer protection regulation through mandated disclosure requirements, into the "economic regulation" category in their cost estimates. In our view, chartering , branching, interest rate, and activity regulation are the only major categories of banking regulation that conform to the definition of economic regulation used here. The other categories are "safety-and- soundness" regulation and "consumer information and protection" regulation, both of which fit more logically into the "other social regulations" category used in this study (White 1991, pp. 32-33). This definitional issue is important because the type and magnitude of benefits associated with the different categories of banking regulation differ greatly. In particular, while costs may exceed benefits for some types of economic (entry, output, and prices) regulation, safety-and-soundness regulation is essential to a well-functioning financial system and thus fully justifies the cost (White 1991), and the consumer protection regulation applicable to banking is similar to consumer protection information for other industries where there is general agreement that the benefits exceed the costs.
Transfer. As discussed in chapter I, transfers are payments from one group in society to another and therefore are not real costs to society as a whole. One person's loss is another person's gain. Examples of transfers include payments to Social Security recipients from taxpayers and the higher profits that farmers receive as a result of the higher prices consumers must pay for farm products limited by production quotas. Nevertheless, Hopkins (1991) includes transfer costs in the total cost of regulations. He does place them in a separate category and points out that they are different from the real social costs that result from economic efficiency losses. Also as discussed in Chapter I, OMB's guidance states that transfers should not be added to the cost and benefit totals included in regulatory assessments but should be discussed and noted for policy makers.
Process. Process costs, according to Hopkins, are the administrative or paperwork costs of filling out government forms such as income tax, immigration, social security, procurement etc. Although there are benefits to the services that these government programs provide and some minimum amount of process cost is necessary to deliver these services, it makes little sense to try to place a separate value on administration. Rather, process costs should be viewed as a "cost of doing business" that should be minimized for a given level or quality of service.
Adding these various categories together, as Hopkins and others have done, does two things. It produces large numbers and it creates confusion. It produces large numbers by including "costs" that are not normally considered as part of the regulatory reform debate. For example, costs such as the burden of filling out income tax forms or doing the paperwork needed to get visas, passports, small business loans, and veterans benefits are not what one usually thinks about when worrying about the cost of regulation. Nor do we usually think that the income gained by farmers from price support programs or the increased sales by domestic businesses as a result of trade protection are costs of regulation. Congress did not seek oversight of these types of costs when, in the last Congress, it debated legislative proposals for comprehensive regulatory reform, such as S. 343 and H.R. 9, or when it passed the Unfunded Mandate Reform Act of 1995 or the Small Business Regulatory Enforcement Fairness Act of 1996.
Adding these categories of regulation together with health, safety and environmental regulation also creates confusion if the ultimate goal is to make recommendations for regulatory reform because the appropriate policies to reduce any adverse effects from these programs are very different. To reduce price supports, modify international trade protectionism, and minimize non-cost-effective health, safety, and environmental regulation would take very different paths. It may make it appreciably more difficult. Lumping them together does not enlighten the search for appropriate reforms.
In sum, adding up the costs and benefits of the various regulatory programs may give us a rough estimate of the magnitude of the impact of regulatory activities on the economy and make it clear that regulation plays an important role in our economy. We do not disagree that this is important information to have. Indeed, we can use the total cost figures to begin to track the extent of this activity relative to other aggregate data. For example, our calculations indicate that regulatory costs are about 4 percent (3.7%) of GDP in 1997. We have also looked at 1988, and found that regulatory costs were then roughly the same percentage. From this comparison, we can say that there has been no material growth in the cost of regulation relative to the size of the economy in the last decade.
However, these data provide little useful information about what to do next. If what is intended is to make regulation more efficient, one needs to estimate the incremental costs and benefits of individual regulations, or specific provisions of individual regulations, on a case-by-case basis. If what is intended is to reduce the burden of existing, health, safety and environmental regulation, one needs to estimate how firms would react to the removal of requirements, not how they acted when the requirements were originally imposed. If what is intended is to improve the cost-effectiveness of new regulations, one needs to know what factors are preventing future regulations from being more cost-effective. But none of this information is found in the aggregate estimates of the costs and benefits of regulation done to date.
2. Our Estimates of the Costs and Benefits of Existing Regulations
To meet the requirements of Section 645(a)(1), we surveyed the existing literature on the total costs and benefits of regulation, supplementing it with information we have obtained from reviewing regulatory impact analyses over the last ten years under Executive Orders 12291 and 12866. Our review of the literature revealed only one comprehensive study that attempted to estimate the total costs and benefits of all Federal regulations (Hahn and Hird 1991). Hahn and Hird's estimates were peer reviewed and published in one of the top economics/ legal journals specializing in regulatory issues, the Yale Journal on Regulation. In addition, EPA issued a report to Congress at about the same time known as the Cost of Clean report (EPA 1990). The Cost of Clean report is recognized as the most thorough and careful attempt to estimate the compliance cost of environmental regulation published to date.
The Hahn and Hird study compiled cost and benefit estimates from over 25 studies published mostly by academics in peer reviewed journals, e.g.,. Hufbauer (1986) for international trade, Wenders (1987) for telecommunications, Gardner (1987) for agricultural price supports, Morrison and Winston (1986 and 1989) for airlines, Crandall (1986) for highway safety, and Crandall (1988), Denison, (1979), and Viscusi (1983) for Occupational Safety and Health. It should be noted that although all of these studies are generally recognized as the best available, they are not without shortcomings. For example, the Crandall (1988) and Denison (1979) studies relied upon for the cost of OSHA regulations used survey data that included expenditures that firms would have made on safety in the absence of OSHA regulation.
The Cost of Clean report's estimates of costs are based on annual survey data from the Department of Commerce's "Pollution Abatement and Control Expenditures" (PACE) reports, regulatory impact analyses of major EPA regulations, and special analyses by EPA program offices or contractors. The PACE report surveys, which were conducted through 1994, but discontinued thereafter, cannot be used without careful adjustments because they contain pollution control expenditures that are not Federally mandated. EPA is continuing its efforts to review the costs and benefits of certain of its regulatory programs. It has completed reports on drinking water (EPA 1993) and surface water (EPA 1995) and is presently working on a report required by the Clean Air Act Amendments of 1990 on the costs and benefits of the Clean Air Act, which it plans to submit to Congress in October of 1997. A draft of this report presents estimates that appear to be at variance with some of the numbers we report below (EPA 1997).
In addition, we used information about the costs and benefits of major regulations reviewed by OMB under Executive Orders 12291 and 12866. (We include the rules published in 1987 and 1988 to allow for a lag between publication of the rule and the expenditure of funds for compliance and realization of benefits.) The rules included are generally all final rules with annual costs of $100 million or more issued by Executive Branch agencies, which we believe capture at least 90 percent of the costs added by all rules. The cost estimates themselves are agency estimates that have gone through OMB review and the Administrative Procedure Act requirements for notice and comment by the public.
Using the estimates for Federally mandated regulatory costs from the Cost of Clean report (1990, Table 8-9D) for environmental regulation and Hahn and Hird's estimates for other social regulation for a 1988 base, we added the cost of all major regulations reviewed by OMB under Executive Orders 12291 and 12866 and issued by the agencies between 1987 and 1996. Table 1 shows our calculations for the costs of social regulations.
|Environmental||Other Social||Total Social|
(EPA, Hahn and Hird)
of rules 1987-96
|Total for 1997||144||54||198|
While our estimates do not include the costs of regulations with costs below $100 million nor regulations from independent agencies such as the CSPC or NRC, and there is a possibility that agencies understate the costs of proposed rules (Hopkins, 1992, p. 13), we believe that, if anything, the estimates overstate actual direct costs because of the rising baseline phenomenon discussed above. For example, as a sensitivity analysis, it does not seem implausible that, for environmental and other social regulations over ten years old, no more than half of compliance costs would likely be saved if these Federal regulations magically disappeared over night. The automobile companies are not likely to make their cars less safe or less fuel efficient. Similarly, the great majority of firms are not likely to stop controlling asbestos and cotton dust fibers or lead dust and benzene emissions in the workplace if these regulations were abolished. Nor would the judicial tort system likely tolerate increased levels of harmful pollution or harmful products. If this scenario is correct, then the cost of social regulation in 1997 would fall to $130 billion (136/2 + 62 = 130), or $93 billion for environmental regulations and $37 billion for other social regulation.
To the cost estimates for environmental and other social regulation, we must add the costs of the other types of regulation, i.e., economic and process regulation. We use the Hahn and Hird estimate for the efficiency cost of economic regulation for 1988. Because the great majority of these regulations are issued by independent regulatory agencies (e .g., the FCC, the ITC, and the FDIC) that were not required under Executive Orders 12291 or 12866 to submit information on benefits and costs of regulations to OMB, we did not have our own data to update the 1988 baseline. Instead, we relied on a study by Hopkins (1992) who derived an estimate of $81 billion for the efficiency costs of economic regulation for 1997.
Hopkins (1992) made several additions to Hahn and Hird to update economic regulation costs to 1997: $10 billion for surface transportation costs, $5 billion for the Jones Act, and $5 billion for banking regulations (p. 27). However, since Hopkins made his estimates in 1992, there have been several developments resulting in further deregulation, especially in banking -- with the passage of the Interstate Banking and Branching Efficiency Act of 1994 and the recent actions taken by the four Federal bank regulatory agencies to reduce regulatory burdens -- and in telecommunications -- where the FCC has also taken steps to increase competition and implement the Telecommunications Act of 1996. To take into account the recent deregulation in financial services and telecommunications, we reduced the Hopkins' estimate by $10 billion.
We do not include Hopkins' estimate of the transfer costs of economic regulation, because, as noted above, we do not believe that transfers are costs that should be included in total cost of regulation estimates. However, if one insists on adding transfer costs using the Hopkins' methodology, the total would increase by about $140 billion because he assumes transfer costs are about twice efficiency costs. However, by definition, this transfer amount must also be added to total benefits .
We also do not include most of the process or paperwork cost estimated by Hopkins and others (Hopkins 1991 and 1992 and Weidenbaum and DeFina 1978) because these costs are for the most part already included in cost estimates supplied by the agencies and reviewed by OMB or are tax paperwork costs which we point out above do not logically fit with traditional regulation. However, the cost of paperwork imposed by the independent agencies should be included because those agencies do not submit the cots of the underlying regulations to OMB and thus they would not be included in our Executive Order 12291 and 12866 estimates. According to OMB's latest estimates from its information collection budget (OMB 1997), the burden hours of paperwork imposed by the independent agencies was about 390 million hours (or about $10 billion in costs using a $26.50 per hour estimate to take into account the fact that these agencies' paperwork often require some professional expertise to fill them out (Hopkins 1991)). Most of these costs are the costs of disclosing information to consumers or investors to prevent fraud and deception (FTC, SEC and FDIC represent about 75 percent of the total). We include these costs in Table 2.
Although for the reasons stated above we do not believe it is productive to add the cost of tax paperwork to the total cost of regulation, these are real costs and should be considered in their own context. Indeed IRS paperwork is by far the largest component of OMB's information collection budget. According to our latest estimates, the total burden hours for Treasury for FY 1997 is about 5.3 billion (OMB 1997), of which 99 percent is for the IRS. Using the $26.50 estimate as the opportunity cost of an hour's time in filling out tax forms produces a total cost of about $140 billion. This estimate by itself may be informative but it should not be added to our total cost estimate. If it were added, the benefits of our tax system (revenue received was about $1.5 trillion for FY 1997) should also be added to our benefit totals. Therefore, our best estimate of the total cost of regulation for 1997 is shown in Table 2.
Aggregating benefits from individual regulations poses special problems even beyond those discussed above for aggregating costs. There are several important limits to such an exercise. First among these is uncertainty. Because so much of the uncertainty in possible benefit estimation is unknown, and so little is known about the relationships among benefit estimates of different regulations, analysts have virtually no basis for aggregating benefits in a manner that might preserve information about the likely distribution of aggregate benefits.
Second, as noted above, benefits, like costs, may be presented as monetized, quantified, or in narrative forms. For a variety of reasons, many of them understandable, if not legitimate, agencies often do not express beneficial effects in monetizable terms that can easily be aggregated. What is being described may not be readily amenable to quantification or monetization (e.g., the value of greater national security or of increased individual privacy), or the agency may have chosen not to develop monetized estimates because of resource or time constraints. Moreover, while some of the effects are present as quantified estimates, these cannot be summed if they are not expressed in common units. Of course, when effects are not expressed in quantitative terms, this aggregation problem is even more acute. We can only conclude that estimates of the total benefits of regulation will be understated by an unknown amount until all significant benefits are monetized.
Because of the difficulty of estimating benefits, there are very few studies that attempt to estimate the total benefits as well as costs of regulation. Indeed the only study that has attempted to estimate the total benefits of all regulations is the study by Hahn and Hird that we relied upon for the 1988 cost baseline. Hahn and Hird present a broad range of estimates of the annual benefits of regulation in billions as of 1988, shown in Table 3, which we have converted to 1996 dollars using the CPI.
Note that while Hahn and Hird do not include any benefits from economic regulation (on the grounds that they are negligible in most cases), they state that the regulation of natural monopolies can theoretically produce efficiency gains (p. 253). We believe that Hahn and Hird are being too pessimistic about the benefits of regulating natural monopolies; indeed, our experience with local telephone markets suggests that they have appreciably under estimated the benefits of regulating certain markets. More importantly, it appears that although consumer protection regulation through disclosure requirements more logically fits with social regulation, the Hahn and Hird study included some disclosure regulation costs in the economic regulation category, but they did not include any of its benefits. We are not able to remedy this imbalance, for while we have been able to estimate the costs of some disclosure regulation from independent agencies using our information collection burden estimates, we do not have estimates of the benefits of these regulations. We know, however, that there are significant benefits from various disclosure requirements. For example, the SEC, by promoting investors' confidence in the integrity of the capital markets and providing price and trade information, reduces the cost of raising capital, facilitates innovation, and guides resources to their most valued uses. Thus, in the table below, we use asterisks for the benefits of economic and paperwork/disclosure regulation to indicate that these benefits may be significant but that valid and reliable estimates remain to be done.
Since the Hahn and Hird study, the only systematic study of the benefits together with the costs of major social regulations, of which we are aware, is a study by Hahn, published jointly by Oxford University Press and the AEI Press in 1996. In that study, Hahn reviewed the regulatory impact statements required by Executive Orders 12291 and 12866 for major regulations produced by agencies between 1990 and mid-1995. Hahn accepted the agency estimates of benefits at face value, used consensus estimates from the academic literature to value the benefits (e.g., the Viscusi 1992, estimate for a "statistical life"), and used consistent assumptions across agencies to produce monetized benefit estimates (pp. 214-217). He found that 54 regulations had produced almost $500 billion in benefits in present value (discounting at 5 percent and using his middle value consensus estimates) (p. 218). Hahn also calculated that these regulations produced $220 billion in net costs (gross costs minus any costs savings produced by regulation).
Unfortunately, we do not have enough information to convert Hahn's present value estimates to annual estimates so that we could compare them to our annual cost estimates presented above. However, we can use Hahn's benefit/cost ratio ($500b/$220b) or 2.5, assume that it holds for the full period since 1988, and calculate an aggregate benefit estimate. It should be noted, however, that Hahn believes his aggregate net benefit estimates " . . . are likely to substantially overstate actual net benefits" (p. 224). Both our estimates and Hahn's estimates would most likely include almost the same set of regulations issued between 1990 and 1995 because we both attempted to be exhaustive in our cost collection effort. According to our sample, about 80 percent of the costs of social regulation issued between 1989 and 1996 were issued between 1990 and 1995. Assuming that in 1988, social regulation produced net benefits of $2 billion as Hahn and Hird suggest, and using Hahn's benefit-cost ratios for environmental (1.4) and other social regulation (5.3), we calculate that the benefits of regulation in 1996 were as follows, and we present our cost estimates for comparison:
|* Indicates that significant benefits remain to be quantified, including the benefits of regulating local phone monopolies and the information disclosure requirements of the banking and capital market regulatory agencies. Note that financial safety and soundness regulation is not included in the above totals.|
As explained above, these are very rough estimates and viewed alone not very informative. Moreover, there is particular uncertainty about the benefits of all categories of regulation. With that very important caveat, the total numbers on costs and benefits indicate that regulation has produced about as much, if not more, in benefits as in costs, although according to these estimates environmental and other social regulation has clearly produced benefits significantly greater than direct compliance costs. Disaggregating the totals a little reveals that "Other Social" regulation produces very large net benefits, but if one digs into both the Hahn and Hird, and Hahn studies in greater detail, it becomes clear that most of the benefits of this category are produced by highway safety regulation. Hahn and Hird state that they found very little "credible evidence" that as of 1988, OSHA regulations had produce any significant benefits (275-276), although Hahn's 1996 study found that OSHA regulations had produced over $50 billion (present value) in net benefits by 1995.
Hahn makes clear that even though his study found that the 53 regulations issued between 1990 and 1995 produce very large net benefits, only 23 would "pass" a cost-benefit test. He also points out that if the rules that had not passed the test had not been issued, net benefits would have been $115 billion, or about 40 percent greater (p. 221). He also finds that all safety regulations have benefits greater than costs, and that regulations based on the Clean Air Act and the Safe Drinking Water Act had positive net benefits (p. 221) (which is corroborated by the EPA Drinking Water study (1993). An analysis of the costs and benefits of regulations based on other regulatory programs produced mixed results. The message is clear: the policy content is in the details.
3. Other Estimates of the Total Costs of Regulation
As noted, the estimates of total costs and benefits that we have provided overstates, we believe, both the benefits and most certainly the costs of regulation. Nonetheless, our cost estimates are substantially less than other numbers that are often cited and have gained a certain credibility in the debate. We would note that, apart from the Hahn and Hird study we used, all other estimates of total costs do not present benefit estimates. We believe that presenting costs without benefits is not very informative and potentially misleading. In any event, some explanation of the difference between our numbers and other numbers that have been cited is appropriate.
According to a 1995 report to Congress by the Small Business Administration's (SBA) Office of Advocacy, there are estimates of the total cost of regulation generated by the Heritage Foundation as high as $810 billion to $1.7 trillion for 1992 with benefits reportedly netted out. We cite this study because it is the largest estimate of the costs of regulation that we are aware of. Our reference to it should not be construed as any endorsement of it; indeed, it has not been peer reviewed, it has not been published in a reputable journal, and, most importantly, the basis for the estimate has not been made publicly available. Our own view is that the numbers are either wrong or are measuring something other than what we are talking about.
On the other hand, there is a series of Hopkins studies of the total cost of regulation (1991, 1992, 1995, and 1996), which is both well known and better documented. The Hopkins estimates have also received attention from the Congress. A recent GAO study, Regulatory Reform: Information on Costs, Cost-Effectiveness, and Mandated Deadlines for Regulation (1995), was asked to focus on the Hopkins study because of its prominence and the fact that it was the only game in town.
Hopkins relied on the paper by Hahn and Hird (1991) that provided estimates of the costs and benefits of economic and social regulation for 1988, on the 1990 study by the EPA, The Cost of a Clean, and various reports from OMB: The Information Collection Budget (various years) -- that is, the same materials that we used for our 1988 cost baseline. Hopkins also reviewed two earlier attempts at adding up the total costs of regulation as of 1976-77 by Weidenbaum and DeFina (1978) and Litan and Nordhaus (1983) to make estimates of the trend in total regulatory costs over this decade. He also projected cost to the year 2000, based on estimates from the Cost of Clean, extrapolations of past trends, and some educated guess work about the future costs of compliance with regulations required by statutes such as the Clean Air Act Amendments of 1990 and the Americans with Disabilities Act of 1990. Because we focus our attention on the state of regulation as of 1997, we do not directly critique the earlier studies by Weidenbaum and DeFina or Litan and Nordhaus, nor do we discuss Hopkins' extrapolations beyond 1997.
Hopkins' cost estimate for 1997 (presented by us in 1996 dollars using the CPI), is shown in Table 5.
|Economic: Efficiency Costs||81|
|Economic: Transfer Costs||148|
One important problem with these estimates is that, with the exception of the Process estimate, they are based on individual studies that were published, for the most part, between 1975 and 1990 and then, as mentioned above, extrapolated to 1997 based on the Cost of Clean cost projections for future years for environmental regulation and his own ad hoc "guesstimates" (his words (1991, p. 11)) for other social and economic regulation. Note that although we also use data from 1988 and earlier, his approach to update the information to 1997 differs significantly from ours. Rather than extrapolate, as he did, we used timely information supplied by the agencies over the period 1987 to 1996 that was subject to notice and public comment and OMB review, as well as more recent experience. Ideally, to get a realistic picture of the total costs of regulation, one needs to do a comprehensive study of all regulatory costs facing the economy at a given point in time. But that would be prohibitively expensive and, as pointed out above, ex post surveys of the costs of existing regulations have their own problems.
A second problem relates to the appropriateness of Hopkins' adjustments. Specifically, Hopkins' adds to EPA's Cost of Clean report (the 1988 base), $10 billion for the Clean Air Act Amendments, $8 billion for Superfund/RCRA, and $1 billion for several DOT environmental regulations. It is not clear, however, how these figures are derived. Similarly, Hopkins' estimate for "other" social regulation costs starts with Hahn and Hird (as we did), but adds an additional $1 billion and an assumed rise of 5% percent per year for OSHA regulations, and adds $4 billion for the new universal accessibility standards, $500 million for food labeling regulations, $200 million for energy conservation standards, and $1.6 billion for clinical lab regulations. These amounts are taken from a combination of agency and industry sources, although again it is not clear how the specific numbers were derived.
As noted above, we used Hopkins' updates for the changes in Economic: Efficiency Costs to 1997, reduced by $10 billion to account for the deregulation that has taken place in banking and telecommunications since Hopkins derived his estimate in 1992. We did not, however, include Hopkins' estimate of Economic: Transfer Costs. Hopkins acknowledges that transfers are exchanges of funds from one group to another, but he argues that the existence of transfers creates real social costs because they give rise to "rent-seeking behavior." ("Rent seeking behavior" is behavior that attempts to capture or create excess profits usually by influencing government actions, such as regulations.) He states that the existence of transfers creates real costs that exhausts the amount of the transfer as interest groups and their lobbyists, lawyers and experts campaign for those funds (p. 29). We believe that Hopkins has the causality wrong. Rather than the existence of a transfer program causing rent-seeking behavior, rent-seeking behavior causes the transfer. It is the possibility that rent-seeking behavior may result in a gain that causes special interests to form and campaign for special treatment. The transfer program does not have to exist, just the possibility that one could be set up. Thus to the extent that rent-seeking behavior imposes real costs on society, those costs would be more appropriately attributable to our democratic political system than to a particular regulation.
We also believe that Hopkins' has overstated the costs of Process regulation, which for the most part either represents double counting or more appropriately belongs elsewhere. Most of Hopkins' estimate is based on the burden hour estimates reported in OMB's annual Information Collection Budgets (various years ) of the time it takes the public to comply with information requests made or generated by the Federal government. He multiplies burden hours by $26.50 per hour (in 1996 dollars), an estimate of the public's opportunity cost for filling out forms and gathering information. While average private nonagricultural hourly earnings was $11.82 in 1996 (less than 45 percent of the number he used), Hopkins argues that his time cost estimate is not too high because about 85 percent of the burden hour estimate is from the Treasury Department, much of which represents the time it takes high priced tax accountants to fill out income and corporate tax forms.
We believe the paperwork costs of the tax code should not be included in an estimate of the total cost of regulation that is being developed to enable proposals for regulatory reform. First, filling out tax forms is not the result of "regulations" but rather of the tax code itself, with most regulations merely providing interpretations and clarifications of tax law. Second, Hopkins assumes a zero baseline -- that is, he implicitly assumes that replacing the revenue generated by the present tax code could be done with no record keeping or reporting costs. The implicit baseline is a world without taxes. Third, reforming the tax code is an entirely different public policy area than regulation, and lumping the two together, especially when the tax numbers are so large relative to social and economic regulatory costs, just confuses the issue.
Hopkins has removed the cost of procurement paperwork, such as that imposed by DOD and GSA, based on an OMB estimate that in 1990 the procurement paperwork burden was about 30 percent of the total non-tax-related paperwork. He correctly points out that those costs are mostly paid by taxpayers through higher procurement costs, and thus it would be double counting to include them as private sector regulatory costs. However, most of the remaining paperwork costs also represent double counting, because the estimates of regulatory costs for individual social and economic regulations that he uses already include these costs as a cost of compliance. Specifically, the compliance cost estimates submitted to OMB and included in our estimate for the cost of social regulation include associated paperwork costs. Although Hopkins admits the likelihood of double counting, he dismisses it because "the dominance in this category of tax-related paperwork suggests this is not likely a serious problem" (1991, p. 14). But once tax-related paperwork is removed, it becomes a serious problem.
Hopkins also adds to his Process costs estimates $10 billion in 1997 as the amount that State and local government spent to comply with Federal mandates. However, we cannot determine a clear basis for his estimate. Because our approach of adding the costs of all social regulations issued since 1987 should capture State and local regulatory costs, there should not be a special provision for State and local mandates.
The final piece of Hopkins' Process cost estimate is an estimate of how much more overhead the U.S. multi-payer health care system generates than Canada's single-government- payer system. His argument here is that because the United States has less regulation, it has higher regulatory costs. It is certainly true that regulation can improve efficiency, but it seems disingenuous to argue that because regulations have not mandated a single payer system or restricted private payment systems, etc., regulatory costs are increased. These increased cost estimates (Woolhandler and Himmelstein, 1991), if they are true (they are controversial), are more properly treated as potential benefits from regulation (or of a government program), not as costs of not regulating. Additionally, as discussed above, including these costs confuses the regulatory reform debate.
In sum, in our view, Hopkins' total cost estimate is substantially greater than ours because he includes inappropriate transfers and process costs and less accurate estimates of the growth of social regulation since 1988.
4. Assessment of the Direct and Indirect Impact of Federal Rules
A proper assessment of the costs and benefits of regulation would have to take into account both the direct and indirect impact of regulation on the economy. As reported above, our estimate of the direct effect is that, in the aggregate, the net benefits of regulation issued to date is positive. The few studies that have attempted to determine the indirect effects of regulation on productively and welfare have found significant indirect effects, implying that the direct effects reported above are significant understatements of the full costs of regulation (Hazilla and Kopp 1990 and Jorgenson and Wilcoxen 1990). However, as Hahn and Hird (1991) point out, it is not clear how to evaluate these studies and others like them, which are based on huge, complex and often proprietary models of the U.S. economy. This makes it almost impossible to validate the models or to view the assumptions on which they are based.
These studies have another major problem because they only take into account indirect cost effects and do not include the indirect beneficial effects that may result from better health and safer lives. Yet it is generally agreed that healthier people tend to work harder and longer and save and invest more, thereby increasing the growth of the economy. Therefore, without knowing what the indirect and general equilibrium benefits of regulation are, one should not draw conclusions by only looking at the indirect costs. Models that take into account the indirect benefits and general equilibrium effects of longer life spans, higher levels of environmental quality, and more equal opportunities remain to be developed.
The best survey of what we know about the full range of indirect costs and benefits of social regulation was recently published in one of the leading economic journals: the Journal of Economic Literature (Jaffe, Peterson, Portney, and Stavins 1995). Although concentrating on environmental regulation, their discussion should apply to health and safety regulation as well because they are similar in their economic effects and the direct costs of health and safety regulation are only about one third the amount of environmental regulation. The authors conclude from a survey of the literature that environmental regulation has little impact on "competitiveness as measured by net exports, overall trade flows, and plant location decisions (p. 157), " modest adverse impacts on productivity" (p. 151) and "significant dynamic impacts . . . in the form of costs associated with reduced investment" based on computable general equilibrium models (p. 151). However, they also point out that, for the most part, these estimates do not take into account the feedback effect from improvements in the environment (p. 153).
Jaffe et al. also examine the contention that environmental and other social regulation may actually enhance economic growth and competitiveness by stimulating improvements in productivity as firms compete among themselves to comply with regulations in the least cost way. We discussed this proposition above as a reason why the actual costs of compliance ex post often turns out to be less than predicted ex ante. Several authors have extended this proposition beyond the ad hoc to include the economy as a whole (Porter 1991 and Gardiner 1994). This line of reasoning claims that the country that leads in environmental protection will gain a lasting comparative advantage in international trade in the supplier industries because of having been the "first mover" into an area that other countries must follow.
We are cautious about extending such claims to the economy as a whole. To be sure, certain sectors benefit and we may even develop a comparative advantage in them, but other sectors must invariably lose their comparative advantage because resources are drawn from them and comparative advantage is by definition a relative phenomenon. Jaffe, et al., (p. 157) conclude:
"Thus, overall, the literature on the 'Porter hypothesis' remains one with a high ratio of speculation and anecdote to systematic evidence. While economists have good reason to be skeptical of arguments based on nonoptimizing behavior where the only support is anecdotal, it is also important to recognize that if we wish to persuade others of the validity of our analysis we must go beyond tautological arguments that rest solely on the postulate of profit-maximization. Systematic empirical analysis in this area is only beginning, and it is too soon to tell if it will ultimately provide a clear answer."
We agree with this statement and hope that this report stimulates "systematic empirical analysis" in this area, as well as work on as the broader issue of how to improve the estimation of the costs and benefits of regulatory programs discussed in this report.
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