Monthly Archives: July 2009

Cost Benefit Analysis in Environmental Regulation

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In the article, we suggested that benefit-cost analysis has a potentially important role to play in helping inform regulatory decision making, though it should not be the sole basis for such decision making. We offered eight principles.

First, benefit-cost analysis can be useful for comparing the favorable and unfavorable effects of policies, because it can help decision makers better understand the implications of decisions by identifying and, where appropriate, quantifying the favorable and unfavorable consequences of a proposed policy change. But, in some cases, there is too much uncertainty to use benefit-cost analysis to conclude that the benefits of a decision will exceed or fall short of its costs.

Second, decision makers should not be precluded from considering the economic costs and benefits of different policies in the development of regulations. Removing statutory prohibitions on the balancing of benefits and costs can help promote more efficient and effective regulation.

Third, benefit-cost analysis should be required for all major regulatory decisions. The scale of a benefit-cost analysis should depend on both the stakes involved and the likelihood that the resulting information will affect the ultimate decision.

Fourth, although agencies should be required to conduct benefit-cost analyses for major decisions, and to explain why they have selected actions for which reliable evidence indicates that expected benefits are significantly less than expected costs, those agencies should not be bound by strict benefit-cost tests. Factors other than aggregate economic benefits and costs may be important.

Fifth, benefits and costs of proposed policies should be quantified wherever possible. But not all impacts can be quantified, let alone monetized. Therefore, care should be taken to assure that quantitative factors do not dominate important qualitative factors in decision making. If an agency wishes to introduce a “margin of safety” into a decision, it should do so explicitly.

Sixth, the more external review that regulatory analyses receive, the better they are likely to be. Retrospective assessments should be carried out periodically.

Seventh, a consistent set of economic assumptions should be used in calculating benefits and costs. Key variables include the social discount rate, the value of reducing risks of premature death and accidents, and the values associated with other improvements in health.

Eighth, while benefit-cost analysis focuses primarily on the overall relationship between benefits and costs, a good analysis will also identify important distributional consequences for important subgroups of the population.

via Harvard University – Belfer Center for Science and International Affairs – An Economic View of the Environment » Blog Archive » Is Benefit-Cost Analysis Helpful for Environmental Regulation?.

Rudd takes centre stage in climate talks

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The focal point of the partnership will be Australia’s Global Carbon Capture and Storage Institute.

The President announced the creation of the partnership in a joint press conference with Mr Rudd, who is attending the summit as part of his ongoing overseas trip.

“Australia, for example, is creating a new centre which Kevin will be introducing shortly which points to the ability for us to pool our resources in order to see the technological breakthroughs necessary in order for us to solve this problem,” Mr Obama said.

Mr Rudd first announced the formation of the Institute in April but used the meeting in the Italian town of ‘L’Aquila to relaunch it.

Mr Rudd says 23 governments and more than 100 companies are now backing the Australian institute.

“It’s mission is clear,” he said.

“It’s to get large-scale carbon capture and storage projects done around the world, not just discussed.

“Unless we do these projects we will not have an effect in bringing down those huge numbers of energy production I referred to before coming from coal, and their greenhouse emission impact.”

via Rudd takes centre stage in climate talks – ABC News (Australian Broadcasting Corporation).

Lessons for Australian ETS

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With the recent passing of the climate legislation in the US Congress it is important to look at two aspects of a cap and trade system. One is the effect of free permits and the second the value of carbon offsets.

Good lesson for the Australian ETS. Both links are the courtesy of Greg Mankiw.

On the free permits:

In simple economic models, a cap-and-trade system can be identical to a carbon tax. If the government sells all of the permits to firms at auction, it raises the same revenue as if it had imposed a tax on carbon. Like a carbon tax, a cap-and-trade system is a market-based regulatory mechanism to reduce carbon emissions. These mechanisms impose a cost on carbon emissions by requiring emitters to either pay a tax or obtain a permit. Ideally, this cost should be equal to the environmental damage caused by emissions. Market-based solutions tend to be the most efficient regulatory approach for correcting environmental externalities because producers and consumers are left free to choose the most cost-effective way to reduce emissions. This efficiency can be lost under regulatory systems that dictate particular ways to reduce emissions.

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Therefore, under a system of free permit allocation, the stockholders of companies that receive free permits would receive windfall gains. A cap-and-trade system with freely allocated permits is equivalent to a carbon tax in which the tax revenue is given to stockholders. This gift does not provide the economic benefits of a reduction in taxes on business investment, because the gift is not linked to firms’ current investments.

On Carbon offsets:

So what is the problem with offsets? In a nutshell, it is a problem of measurement. One of the nice features of a cap-and-trade program is that it is fairly easy to measure emissions. The existing acid rain cap-and-trade program requires power plants to install sulfur dioxide monitors in their smoke stacks, which provide precise information to the Environmental Protection Agency at low administrative cost. (The acid rain program does not allow sulfur dioxide offsets.) For a carbon cap-and-trade program, emissions would be measured based on the carbon content of different fossil fuels, which is also a relatively straightforward procedure. But offsets require the measurement of emission reductions, rather than emissions. This simple difference introduces a host of problems, because it is awfully difficult to know what would have happened to emissions absent a given offset project. For example, planting a tree will only lead to a net reduction in carbon emissions if 1) the tree would not have been planted without the offset provision, and 2) the tree will not be subsequently destroyed after the offset purchase takes place. If these two conditions, known as additionality and permanence, are not met, then offsets will not amount to real reductions, and allowing them will loosen the pre-established emissions cap.

The House learned this lesson the hard way. Shortly after purchasing carbon offsets from the Chicago Climate Exchange, the Washington Post reported that the emissions reductions were rather illusory. To take just one important example, the House spent $14,500 to pay farmers for carbon-reducing “no-till” farming, even though the practice was started prior to the purchase of the offsets. Farmers might have been motivated to practice no-till farming to reduce fuel use or to qualify for federal soil-conservation funds. By failing to meet the additionality requirement for offsets, the money spent by the House on no-till farming did not result in the intended amount of carbon reductions.