Regulatory Review and Cost-Benefit Analysis

In a Memorandum issued within a few days after he assumed office, President Barack Obama called for an overhaul of the policies the White House uses to review regulations proposed by federal departments and agencies. The president acknowledged the necessity of regulatory review "to ensure consistency with Presidential priorities, to coordinate regulatory policy, and to offer a dispassionate and analytical 'second opinion' on agency actions." Critics of previous administrations had charged that they misused the process of regulatory review to thwart agency actions. "In this time of fundamental transformation," the president wrote, "that process--and the principles governing regulation in general--should be revisited." Regulatory agencies have missions--but they must also consider the economic costs and consequences of what they do. This essay considers how the White House, in reviewing regulations, can direct agencies to take these costs and consequences into account while letting them do their work. Regulatory Review From the time of the Reagan administration, federal agencies, including the Environmental Protection Agency (EPA), and departments, such as the Department of Labor and the Department of Agriculture, have had to obtain the approval of the White House before proposing any major regulation. Each year, the White House through its Office of Information and Regulatory Affairs (OIRA) in the Office of Management and Budget (OMB) reviews about 500 rulemakings. Those it approves may become law; those it rejects it "returns" to the agency. The Executive Order that currently governs regulatory review within OIRA requires every department and agency that proposes a regulation to "assess both the costs and the benefits of the intended regulation" and to "propose or adopt a regulation only upon a reasoned determination that the benefits of the intended regulation justify its costs." This requirement may seem innocuous; that agencies should balance the benefits and costs of a regulation appears to make common sense. Yet over the past 30 years, economists have developed a formal and technical method of defining and measuring "costs" and "benefits." Agencies must package regulatory proposals in a way that passes a cost-benefit test in the specific and technical sense that "costs" and "benefits" are now defined and measured within the theory of microeconomics. Within microeconomic theory, benefits are measured in terms of the amount people are willing to pay for outcomes they want. In economic parlance, "benefit" and "willingness to pay" (WTP) refer to the same thing. According to one authoritative text, "Benefits are the sums of the maximum amounts that people would be willing to pay to gain outcomes that they view as desirable." Costs are measured in terms of the minimum amounts people demand as compensation (or are willing to accept) to allow outcomes they do not like. "Willingness to accept" (WTA) is counted as a kind of negative WTP. Economists measure the "net benefits" of a policy as the sum of the WTP (including negative WTA) of all those people it affects. Economic theory dictates, "Adopt all policies that have net positive benefits" or, more generally, "Choose the combination of policies that maximizes net benefits." The directive to "assess both the costs and the benefits of the intended regulation" does not invite agencies to discuss the reasons for and against a policy. No one would object to that kind of invitation. Instead, the directive is interpreted to presuppose the reason for any rulemaking, that is, to maximize net benefits. To meet the conditions OIRA sets for regulatory approval, an agency must think in terms of net WTP from the time it begins a rulemaking. To obtain OIRA approval, the agency must also show that no alternative regulation achieves a better balance between benefits and costs, as these are defined and measured within the two corners--WTP and WTA--of microeconomic theory. …