What Is the Ideal Cost-Benefit Analysis?

Cost-benefit analyses are important tools in improving the quality of regulation, but can be slow and cumbersome. A new working paper criticizes how agencies apply cost-benefit analysis and proposes a simpler, faster, and more effective way of conducting cost-benefit analyses, called a “back-of-the-envelope” (BOTE) analysis.

In their paper, Christopher Carrigan and Stuart Shapiro introduce several criticisms about cost-benefit analysis’ current role in the regulatory process. They suggest that cost-benefit analysis can serve more to justify the regulatory decision than to inform it. The authors point out that federal government agencies, at times, conduct their analyses after having made their policy decisions, meaning these analyses retrospectively justify, rather than inform, these decisions.

In addition, Carrigan and Shapiro argue that the complexity of current cost-benefit analysis, with “detailed monetization and complex qualification,” may “cripple the regulatory process.” They demonstrate that regulatory analysis documents are becoming more and more complex each year with regulatory analyses from 2009 to 2012 having four times as many words on average as those in 2000. (They recognize, of course, that the length of documents can only be “a reasonable proxy” for complexity.)

Carrigan and Shapiro also claim that these analyses often fail to consider alternative policy options. According to the report, regulatory impact analyses (RIAs), in which federal agencies analyze the potential impacts of new regulations to assess whether they can achieve the desirable objectives, often include only one or two extreme alternatives, such as opting to not regulate and “imposing an unreasonably stringent level of regulation.” Carrigan and Shapiro point out that such comparisons make the agency’s preferred option look like the only viable one.

What alternative can overcome these deficiencies? Carrigan and Shapiro suggest a back-of-the-envelope – or BOTE – analysis, which has three components.

First, a BOTE analysis pursues simplicity. According to the report, the analysis’ goal should be “approximating the potential effects of a regulation rather than generating a precise estimate of the economic impact.” The authors assert that, if government agencies conduct BOTE analyses, these agencies and informed critics would be able to easily identify “what the possible best and worst case effects of the rule are.”

Second, BOTE analyses should be complete and available before government agencies select a policy option. Carrigan and Shapiro claim that a government agency should publish a BOTE analysis with enough time to receive public comments on alternative policies before it publishes a notice of proposed rulemaking (NPRM).

Third, a BOTE analysis should include “meaningful alternatives.” What are “meaningful alternatives?” Carrigan and Shapiro define them as alternatives that “would differ from each other in small ways so that tradeoffs in more stringent and more lenient policies could be seen.” The authors argue that, in a BOTE analysis, a government agency should give all alternatives “roughly equivalent consideration.”

How can agencies be encouraged to conduct BOTE analyses? Carrigan and Shapiro do not suggest mandating BOTE analyses, but prefer raising the cost of conducting opaque analyses or introducing low-cost BOTE analyses. They suggest three options to encourage government agencies to adopt BOTE analysis.

The first option would be to change the stringency of review for federal agencies’ analyses, depending on whether these agencies conduct BOTE analyses. Currently, federal government agencies must submit their cost-benefit analyses to the Office of Information and Regulatory Affairs (OIRA) for review. The report proposes that OIRA should review agencies’ analyses more stringently if these agencies do not conduct BOTE analyses and less stringently if they do. The authors claim that this will give federal agencies incentives to comply with BOTE requirements.

The second option would be to shorten subsequent OIRA review or the notice-and-comment period if government agencies conduct good BOTE analyses. The authors claim that government agencies should conduct BOTE analysis before the OIRA’s review process and the NPRM process. Currently, OIRA has ninety days to complete its review process, and government agencies must have a notice and comment period of at least sixty days. Carrigan and Shapiro argue that shortening these periods may encourage government agencies to conduct good BOTE analyses, which are simpler than traditional cost-benefit analyses, when “pressured by statutory deadlines.”

A third option, although somewhat less appealing according to the authors, would be to subject regulations without BOTE analysis to a more stringent standard of judicial review. The authors claim that judicial review will “impose costs on an agency that might otherwise ignore the requirement” and encourage agencies to adopt BOTE analysis.

BOTE analysis might be a promising solution for improving existing cost-benefit analyses. The idea has received some attention with the authors recently presenting about BOTE analyses at the annual conference of the Southern Economic Association (SEA).