Report
to Congress on the Costs and Benefits
of Federal Regulations
Chapter
II. Estimates of the Total Annual Costs and Benefits
of Federal Regulatory Programs
- Overview
- The
Baseline Problem
- The
Apples and Oranges Problem
- Our
Estimates of the Costs and Benefits of Existing Regulations
- Total
Costs
- Table
1: Estimates of the Annual Cost of Social Regulation for 1997
- Table
2: Estimate of the Annual Total Cost of Regulation for 1997
- Total
Benefits
- Table
3: Hahn and Hird's 1988 Benefit Estimates
- Table
4: Estimates of the Total Annual Benefits and Costs of Regulation
for 1997
- Other
Estimates of the Total Costs of Regulation
- Table
5: Hopkins' Estimate of the Annual Costs of Regulation
- Assessment
of the Direct and Indirect Impact of Federal Rules
1.
Overview
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:
- High
costs and high benefits.
- High
costs and low benefits.
- Low
costs and high benefits.
- Low
costs and low benefits.
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.
Total Cost
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.
Table 1: Estimates of the Annual Cost of
Social Regulation for 1997
(Billions of 1996 dollars)
|
Environmental |
Other
Social |
Total
Social |
1988
Baseline
(EPA, Hahn and Hird) |
101 |
35 |
136 |
Cost
of rules 1987-96
( OMB) |
43 |
19 |
62 |
|
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.
Table 2: Estimate of the Annual Total Cost of Regulation For
1997
(Billions of 1996 dollars)
|
Environmental |
144 |
|
Other
Social |
54 |
|
Economic |
71 |
|
Paperwork/disclosure* |
10 |
|
|
Total |
279 |
*
Not elsewhere included.
|
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.
Total Benefits
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.
Table
3: Hahn and Hird's 1988 Benefit Estimates
(Billions of 1996 dollars)
|
|
Low |
High |
|
Environment |
21.8 |
179.3 |
|
Other
Social |
33.5 |
60.3 |
|
Economic |
0.0 |
0.0 |
|
|
Total |
55.3 |
239.6 |
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:
Table 4: Estimates of the Total Annual
Benefits and Costs of Regulation for 1997
(Billions of 1996 dollars)
|
Benefits |
Costs |
Environmental |
162 |
144 |
Other
Social |
136 |
54 |
Economic |
* |
71 |
Paperwork/disclosure |
* |
10 |
|
Total |
>298 |
279 |
*
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.
Table 5: Hopkins' Estimate of the Annual
Costs of Regulation
(Billions of 1996 dollars)
|
Environment |
185 |
|
Other
Social |
62 |
|
Economic:
Efficiency Costs |
81 |
|
Economic:
Transfer Costs |
148 |
|
Process |
232 |
|
|
Total |
708 |
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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