November 19, 1999
EPA-SAB-COUNCIL-ADV-00-003
Honorable Carol M. Browner
Administrator
U.S. Environmental Protection Agency
401 M Street, SW
Washington, DC 20460
RE: Final Advisory by the Advisory Council on Clean Air Compliance Analysis on the
1999 Prospective Study of Costs and Benefits (1999) of Implementation of the
Clean Air Act Amendments (CAAA)
Dear Ms. Browner:
On October 1, 1999, the Advisory Council on Clean Air Compliance Analysis (Council)
held a public teleconference to review a draft Agency document, The Benefits and Costs of the
Clean Air Act, 1990 to 2010; EPA Report to Congress (U.S. EPA, Office of Air and Radiation
and Office of Policy, September 1999) and held a follow-up teleconference on October 15, 1999
to review an October draft of that same document. These two closure meetings represented the
culmination of a multi-year series of review meetings during which the Council provided advice to
the Agency on the study design, methodologies, and intermediate results. The Council submits
this Advisory to complete its review responsibilities as defined in Section 812 of the CAAA. l
The Council believes that The Benefits and Costs of the Clean Air Act, 1990 to 2010 is a
serious, careful study that, in general, employs sound methods and data. While we do not endorse
all details of the study, we believe that the study's conclusions are generally consistent with the
weight of available evidence. The Council also appreciates the Agency's responsiveness over the
many years of this study's development to advice conveyed by the Council and its technical
subcommittees. While the Project Team has not followed our advice in every instance, we believe
that they have done a remarkable job on an extremely difficult project.
1 Specifically, subsection (g) of CAA §312 (as amended by §812 of the amendments) states:
"(g) The Council shall — (1) review the data to be used for any analysis required under this section and
make recommendations to the Administrator on the use of such data, (2) review the methodology used
to analyze such data and make recommendations to the Administrator on the use of such methodology;
and (3) prior to issuance of a report required under subsection (d) or (e), review the findings of such
report, and make recommendations to the Administrator concerning the validity and utility of such
findings."
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We would, however, like to bring to your attention two major issues that arose in our
review of the study. These pertain to the study's measurement of costs and representation of
uncertainty regarding costs. Following our discussion of these points, we present suggestions to
improve future Prospective Studies. Because of their importance, we would like to highlight
these suggestions here:
a) We believe that benefits and costs must be disaggregated by individual provision of
the Clean Air Act if benefit-cost analysis is to be useful in informing regulation.
b) Future studies must attempt to quantify uncertainties about regulatory costs, as
well as uncertainties about the benefits of regulations. Failure to quantify cost
uncertainties may give the impression that costs cannot exceed point estimates.
c) Cost estimates should include tax-interaction effects; i.e., they should reflect the
fact that environmental regulations may exacerbate the disincentive effects of the
personal and corporate income taxes. This may raise cost estimates considerably.
d) The Agency should revise its estimates of the Value of a Statistical Life.
e) The impact of air quality regulations should be stated in terms of a Net Cost per
Life Saved and a Net Cost per Life-year Saved to facilitate comparisons with other
health and safety regulations.
f) Attempts should be made to increase the set of ecosystem benefits valued and to
improve estimates of the exposure and effects of air toxics.
1. Comments on the Drafts Provided for Council Review
a) The Relationship between Direct and Social Costs of Compliance. Social cost is
the type of cost that is most relevant to the evaluation of the 1990 Clean Air Act.
However, the draft Prospective Study relies primarily on estimates of the "direct"
compliance costs for affected industries or pollution sources. The reliance on
direct costs is understandable, since it is more difficult to assess the social costs.
At the same time, it is important to articulate clearly and without bias the
relationship between direct and social costs.
The Council believes that the study's discussion of this issue lacks balance and is
prone to misinterpretation. The study describes in detail two factors that might
cause direct costs to overstate true social costs (absence of attention to producer
and consumer responses, and the assumption of a static technology). The October
review draft contained a discussion of the tax-interaction effect, which can cause
direct costs to understate social costs, possibly by a very large amount. In the
Council's view, this effect merited discussion in the text and should not be
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relegated to a footnote. There is now a substantial body of published theoretical
and empirical research that indicates that, under typical conditions, tax-interactions
can cause social costs to exceed direct costs by at least 25 percent, and in some
cases by 100 percent or more. Table 3-3 further contributes to potential
misinterpretation. It explicitly mentions a factor that would cause direct cost to
overstate social cost (lack of attention to producer and consumer responses) but
fails to mention explicitly the factor (tax interactions) that works in the opposite
direction. By minimizing attention to the tax-interaction effect, the study gives
readers the erroneous impression that the EPA's use of direct costs is likely to
overstate social costs.
Tax interactions occur when environmental regulations exacerbate the distortions
in labor and capital markets caused by prior income, profit, or sales taxes. These
interactions may result from any regulations that raise production costs and
thereby lower the real purchasing power stemming from given real wages. Even
"small" regulations can produce significant tax-interaction effects. The
Prospective Study fails to indicate the general relevance of these effects. The
study states that general equilibrium effects are important where the regulatory
action is known to have an impact on many sectors of the US economy. Although
this statement is technically correct, it allows for the impression that such general
equilibrium effects are unusual. It fails to point out the key finding from the
tax-interaction literature: namely, that all regulatory actions have impacts on other
sectors (particularly labor and capital markets) and that these general equilibrium
impacts, under typical conditions, raise social costs substantially relative to direct
costs.
In sum, the Council would urge the EPA to give more attention to the tax-
interaction effect in order to achieve a more balanced and straightforward
presentation of the relationship between direct costs and overall social cost. This
is necessary to avoid giving the false impression that direct costs are likely to
overstate social cost.
b) Characterization of Uncertainty with Respect to Cost Estimates. The main results
of the first Prospective Study are summarized in a table of costs and benefits that
appears both in the Executive Summary and in Chapter 8. Uncertainties about the
benefits of the CAAA are nicely illustrated by a lower bound and an upper bound
(90% confidence interval). In contrast, the cost of this environmental protection is
represented only by a central estimate. (Cost uncertainties are discussed via
sensitivity analyses in other tables, but these uncertainties are not combined into an
overall set of bounds on the central cost estimate.)
Thus the benefit-cost ratios in that main summary table vary only with
uncertainties about benefits. These ratios would vary even more if they
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incorporated some uncertainty about costs. Since costs are indeed uncertain, the
table implicitly understates the true degree of uncertainty about the net benefits of
the CAAA.
Even rough representations of uncertainty about these costs would be better than
the current implication that costs are certain. One possibility would be to assume a
uniform distribution about each element of cost, ranging from 50% to 150% of the
central estimate. A second possibility is to show an additional row of benefit-cost
ratios where the costs have been multiplied by 1.3 to account for the
tax-interaction effect. A third possibility is suggested by reference to the fact that
the Retrospective Study produced a central estimate of direct cost equal to $523
billion, while the modeling approach provided welfare effects between $493 billion
and $621 billion. Since these bounds are 6% below and 19% above the central
estimate, the same percentage bounds could be applied to the central estimate of
costs in the Prospective Study. True bounds on costs in the Prospective Study
would be preferred, but one of these rough estimates of bounds is better than using
no bounds at all.
2. Suggestions to Improve Future Prospective Studies
a) Disaggregate Benefits and Costs by Title or Provision. The Council reiterates its
strong recommendation for presenting the benefits as well as the costs of the
CAAA by title and, preferably, by provision, in future studies. Without this level
of disaggregation, the study cannot be used directly to identify how the CAAA
might be improved in the future. The Council recognizes that a thorough
disaggregation analysis was not feasible for the current study since resources were
not available for exercising several air quality models to create the needed data
base for the analysis. Future studies should not be limited in this regard since more
universal and versatile platforms for air quality modeling, such as Models-3, are
expected to be available. With careful design, using such a system, a small number
of additional comprehensive modeling simulations can provide the information
needed for a thorough bottom-up assessment of the CAAA benefits by individual
title and even by some provisions. If, in the design phase of the next prospective
study, it becomes apparent that resources cannot be allocated for these analyses,
then an alternative design strategy combining use of top-down or screening model
approaches combined with carefully selected essential comprehensive model
simulations should be pursued.
b) Characterize Uncertainty about Costs. The costs imposed by air pollution
regulations are highly uncertain. For example, the costs of sulfur dioxide
abatement under the 1990 Clean Air Act have turned out to be a fraction of what
was estimated in 1990. Unfortunately, uncertainty can lead to higher as well as
lower costs.
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EPA has relied on engineering estimates of abatement costs. Even if these
estimates were accurate estimates of the cost of equipment and operating costs,
they would understate social costs because of tax-interaction and other effects.
EPA needs to discuss and to quantify the following sources of uncertainty:
(1) Uncertainty in the engineering cost estimates.
(2) Costs in addition to the engineering estimates, such as tax-interactions.
(3) Technical change due to the technology forcing that lowers costs.
(4) Changes in the wage rate or prices of materials due to the changes in
demand.
c) Include Tax-Interaction Effects in Future Cost Estimates. One of the most
important insights to emerge in Environmental Economics in the past 25 years is
that regulations, by exacerbating existing distortions in the economy, can have
social costs considerably in excess of direct compliance costs. An environmental
regulation that raises the price of purchased goods and lowers the real wage will
tend to, other things equal, cause a substitution of leisure for labor. This
compounds the deadweight loss of the tax system, which, by driving a wedge
between the gross and net of tax wages, causes individuals to substitute leisure for
labor. This tax-interaction effect can, in some cases, double the costs of a
regulation (Goulder et al. 1999, Parry et al. 1999).2
It is important for tax-interaction effects to be included in future Prospective
Studies for two reasons. First, these costs are real. They represent real losses in
output, and they occur even for small regulations. Second, the tax-interaction
effect can at least to some degree be offset if the environmental program raises
revenues, which are used to reduce the rates of other, distorting taxes. This
implies that the costs of a program will depend on how a standard is achieved,
which has implications for the choice of regulatory approach. For example, a
permit market will have lower social costs if permits are auctioned and revenues
recycled than if permits are given away (Goulder et al. 1997; Parry 1997).3
2 Goulder, Lawrence H., Ian W. H. Parry, Roberton C. Williams III, and Dallas Burtraw, 1999. "The Cost-
Effectiveness of Alternative Instruments for Environmental Protection in a Second-Best Setting," Journal of Public
Economics 72(3):329-360; and Pany, Ian, W. H., R. C. Williams III, and L. H. Goulder, 1999. "When Can Caibon
Abatement Policies Increase Welfare? The Fundamental Role of Distorted Factor Markets," Journal of
Environmental Economics and Management 37:52-84.
3 Goulder, Lawrence H., Parry, Ian W. H., and Dallas Burtraw, "Revenue-Raising vs. Other Approaches to
Environmental Protection: The Critical Significance of Pre-Existing Tax Distortions," RAND Journal of
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d) Revise Mortality Risk Estimates. The Council is uncomfortable with the Agency's
use of $4.8 million (1990 U.S. dollars) for the Value of a Statistical Life (VSL)
and $293,000 for the Value of a Statistical Life-year (VSLY) to value mortality
risk reductions from reduced air pollution. We question the appropriateness of the
$4.8 million VSL even as a measure of prime-aged individuals' willingness to pay
(WTP) for risk reductions, and we question the application of a WTP estimate for
prime-aged individuals to a population of older individuals and people who are in
poor health. Time limitations did not permit a thorough treatment of this issue
prior to completing the first Prospective Study; hence we recommended that the
Project Team use the $4.8 million figure. For future studies, however, we
recommend that the Agency revisit the literature on the value of mortality risk
reductions. The following points should be kept in mind when examining this
literature:
(1) It is WTP for risk reductions that is the appropriate concept when valuing
the mortality benefits of environmental regulations. The costs of
environmental regulations are spread broadly over many individuals who,
indeed, are paying for the resulting risk reductions.
(2) Labor market studies measure willingness to accept (WTA) compensation
for increased risk of death. This is likely to exceed what people will pay
(WTP) for the same risk reductions.
(3) Averting behavior and consumer product safety studies, which are omitted
from the current list of 26 studies, do measure WTP. These studies should
be considered in the review.
(4) In reviewing studies the population whose preferences are measured should
be noted, as should the magnitude of the risk reduction valued. Studies
should be identified that measure WTP for risk reductions among the
populations that benefit from air quality regulation, especially older people,
and that value risk reductions of the same magnitude as those in future
Prospective Studies.
(5) There should be well-defined criteria for selecting studies, which are clearly
stated and consistently applied. For example, compensating wage studies
should adequately control for inter-industry wage differentials; contingent
valuation studies should test for sensitivity to scope.
Economics, Winter 1997; and Parry, Ian W. H., "Environmental Taxes and Quotas in the Presence of
Distorting Taxes in Factor Markets," Resource and Energy Economics, Winter 1997,19:203-20.
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e) Present Cost-Effectiveness Results. Improvements in human health remain a major
motivation behind air quality regulation and account for over 90% of the quantified
benefits from Titles I-IV of the 1990 CAAA. Reductions in premature mortality,
in turn, account for over 90% of these health benefits. Because mortality risk
reductions are such a large component of the benefits from air quality regulation,
the Council urges the Agency to express the outcomes of the CAAA in terms of:
(1) Net Cost per Life Saved, and (2) Net Cost per Life-Year Saved. These are
calculated by subtracting the value of non-mortality benefits from costs and
dividing the result by: (1) the number of statistical lives saved, and (2) the number
of statistical life-years saved.
By taking this approach the Agency would: (1) provide a measure of program
effectiveness that avoids the use of flawed measures of VSL and VSLY and, more
generally, avoids the controversies surrounding the valuation of mortality risk
change; (2) be in line with standard practice in the public health community, where
different programs are routinely compared using cost-effectiveness analysis; and
(3) facilitate comparisons of the cost effectiveness of various health and safety
programs with health-based environmental regulations. The Council feels such
comparisons are necessary for improving public decisions about the allocation of
society's scarce resources among competing ends.
f) Increase Set of Ecosystem Benefits Valued. The current Prospective Study has
made important advances in identifying ecosystem services that can be linked to air
pollution, and in trying to value these endpoints. For the purposes of valuation, it
is convenient to categorize the impact of pollution on ecosystems as follows: (1)
impacts that occur through markets (e.g., impacts of pollution on commercial
timber stands or fish populations); (2) impacts that affect recreation (e.g., damage
to National Parks from air pollution or to recreational fishing from acid rain); (3)
impacts on ecosystems for which people have well-defined non-use values (e.g.,
damage to forest canopy, the value of reduced fish populations to non-anglers);
and (4) other impacts on ecosystem functions and services, not otherwise
classified, for example water and nutrient recycling, maintenance of biodiversity,
climate stabilization. These indirect and more subtle effects may not be well
understood or even perceived by people; yet they may have important impacts on
human well being.
Techniques for valuing the first 3 categories of benefits are well-established, but
the set of applied studies is sparse. The Agency might consider funding new
studies, after determining which categories of benefits are likely to have the largest
impact on regulatory decisions. When commissioning studies to measure non-use
values, care should be taken in defining: (1) the geographical scope of what is to
be valued (for example, are people asked only for non-use values in their state?);
(2) the nature of substitutes (i.e., conditions at other locations); and (3) how many
endpoints to value at the same time. For example, in regard to this last point, if a
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regulation to reduce nitrogen oxides (NOx) affects forests through ozone and fish
population through acid rain, people should be asked to value the entire package
of ecosystem benefits brought about by NOx reduction. Adding up WTP values
from individual studies might overstate the value of the NOx reduction program if
there are important substitution effects across ecosystem services.
A problem for policy analysis is that the endpoints that affect markets or for which
people have well-defined use (recreation) and non-use values (e.g., damages to
forests, fish and wildlife populations) do not capture the totality of ecosystem
damages associated with pollution control decisions. In particular, they do not
capture ecosystem functions and services such as nutrient recycling and habitat
provision. Nor do they capture the more subtle changes in ecosystem functioning
that may to lead to non-marginal changes in ecosystem performance. Before these
changes can be valued, however, it is essential that ecologists characterize the
ecosystem outcomes (or indicators) that are important to ecosystem functioning
and then relate these outcomes (or indicators) to particular activities or pollutants.
This information is an essential foundation for economic valuation.
g) Estimate Exposure and Effects of Air Toxics. The Retrospective Study and the
first Prospective Study do not contain any quantitative benefit-cost analyses of
Toxic Air Pollutants (TAP). As the Council's Health and Ecological Effects
Subcommittee (HEES) has stated,4 the Agency does not currently have analytical
methodologies available to establish population exposure estimates, or to define
realistic risk estimates for the general population. The HEES, with approval by the
full Council, suggested an approach to identifying the research and methodological
developments needed to overcome these deficiencies. The effort requires
coordination with the SAB Executive Committee, various SAB Committees, the
Office of Research and Development and Office of Air Quality Planning and
Standards. Implementation of the plan of action outlined for the Agency will begin
a process that can lead to quantitative estimates of health, and possibly ecological
benefits for the next Prospective Study.
3. Conclusion
The purpose of conducting benefit-cost analyses is to improve the efficiency of regulation.
The suggestions we have made in this Advisory are designed to help achieve this goal. Increasing
the accuracy of benefit-cost analyses will entail measuring certain categories of benefits (e.g.,
certain ecological benefits, benefits of reduced exposure to hazardous air pollutants) and costs
(tax-interaction effects) not included in the current Prospective Study. It will also entail refining
estimates of the value of mortality benefits, which continue to dominate the monetized benefits of
4 See HEES Letter Advisories, "The Clean Air Act Amendments (CAAA) Section 812 Prospective Study of Costs and Benefits (1999):
Advisory by the Health and Ecological Effects Subcommittee on Initial Assessments of Health and Ecological Effects, Part 1", EPA-SAB-COUNCIL-
ADV-99-012 and "Part 2", EPA-SAB-COUNCIL-ADV-00-001.
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improved air quality. Of all the suggestions made above, however, we believe that disaggregating
the benefits and costs of individual provisions of the CAA is, perhaps, the most important. If our
recommendation to provide more disaggregated benefit-cost estimates can be implemented, the
specific programs which have the highest potential payoff to society can be more readily
identified. We strongly encourage the Agency to make the research investment and analytical
commitments required to ensure this objective is met in the next prospective study.
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We thank the Agency for the opportunity to review the first Prospective Study and to
make recommendations to improve the methods and data to be used in future prospective studies.
We look forward to your response to this Advisory.
Sincerely,
/signed/
Dr. Maureen L. Cropper, Chair
Advisory Council on Clean Air Compliance Analysis
Science Advisory Board
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NOTICE
This report has been written as part of the activities of the Science Advisory Board, a
public advisory group providing extramural scientific information and advice to the Administrator
and other officials of the Environmental Protection Agency. The Board is structured to provide
balanced, expert assessment of scientific matters related to problems facing the Agency. This
report has not been reviewed for approval by the Agency and, hence, the contents of this report
do not necessarily represent the views and policies of the Environmental Protection Agency, nor
of other agencies in the Executive Branch of the Federal government, nor does mention of trade
names or commercial products constitute a recommendation for use.
Distribution and Availability: This Science Advisory Board report is provided to the EPA
Administrator, senior Agency management, appropriate program staff, interested members of the
public, and is posted on the SAB website (www.epa.gov/sab). Information on its availability is
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also provided in the SAB's monthly newsletter (Happenings at the Science Advisory Board).
Additional copies and further information are available from the SAB Staff.
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U.S. ENVIRONMENTAL PROTECTION AGENCY
SCIENCE ADVISORY BOARD (SAB)
ADVISORY COUNCIL ON CLEAN AIR COMPLIANCE ANALYSIS
CHAIR
Dr. Maureen L. Cropper, The World Bank, Washington, DC
MEMBERS
Dr. Gardner M. Brown, University of Washington, Seattle, WA
Dr. Trudy Ann Cameron, University of California, Los Angeles, CA.
Dr. Don Fullerton, University of Texas, Austin, TX
Dr. Lawrence H. Goulder, Stanford University, Stanford, CA
Dr. Jane V. Hall, California State University, Fullerton, CA
Dr. Charles Kolstad, University of California, Santa Barbara, CA
Dr. Paul Lioy, Robert Wood Johnson School of Medicine, Piscataway, NJ
Dr. Paulette Middleton, RAND Center for Science & Policy, Boulder, CO
CONSULTANTS
Dr. A. Myrick Freeman, Bowdoin College, ME
Dr. Alan J. Krupnick, Resources for the Future, Washington, DC
SCIENCE ADVISORY BOARD STAFF
Dr. Angela Nugent, Designated Federal Officer, Science Advisory Board, U.S. Environmental
Protection Agency, Washington, DC
Mrs. Diana L. Pozun, Management Assistant, Science Advisory Board, U.S. Environmental
Protection Agency, Washington, DC
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