Regulatory budgeting

SAMUEL HUGHES4300 Republic Plaza, 370 17th St., Denver, CO 80202, U.S.A., E-mail: samuel.hughes@ey.com

Introduction

Recent e¡orts to eliminate the federal budget de¢cit and reduce overall govern-ment debt have placed increasing pressure on lawmakers to focus on the cost-e¡ectiveness of government policy. It is apparent that if Congress is going tomaintain budget surpluses over the longrun without increasing the tax burden,then fundamental changes in the role of government are necessary. However,the budget debate has historically focused on taxing and spending, overlookinganother fundamental way in which government exerts in its in£uence overprivate businesses and consumers: economic and social regulation.

Regulation of economic activity is one of the most politically expedientalternatives to carry out public policy, because it does not require the govern-ment to tax or spend money directly, at least not to any substantial extent.Nevertheless, this approach is hardly costless to society. As a number of studieshave shown, regulatory programs typically impose heavy economic burdens onthe private sector (and, indirectly, on the government itself). Despite this,government decisionmakers often focus only on the regulatory spending thatsurfaces in the ¢scal budget; that is, the relatively modest sum that is spent tosta¡ and operate regulatory agencies.

Such `on-budget' spending for the federal government's regulatory agencieshas increased steadily over the last 25 years (except for a slight dip duringPresident Reagan's ¢rst term). In 1997, federal regulatory agencies employednearly 124,000 people, a 26% increase from 1985. Much of this growth isattributable to the rapid expansion of social regulation (dealing with areassuch as safety, health, and the environment). Traditional economic regulationof industry and ¢nance also expanded rapidly over the past decades butcurrently makes up less than 25 percent of total regulatory sta¤ng.

Although these spending trends are of concern, many would correctly pointout that the budgets of regulatory agencies are a small fraction of the federalgovernment's budget. Indeed, even if all of these regulatory agencies were elim-inated outright, an action that even the most strident budget hawk would notsupport, the savings would not substantially contribute to long-run ¢scal stability.

However, the actual economic impact of regulation goes far beyond the¢scal budgets of regulatory agencies. Indeed, the costs of regulation are largelyhidden. Consumers and businesses must pay ^ directly or indirectly ^ tocomply with the rules enacted by regulatory agencies. For example, when the

Policy Sciences 31: 247^278, 1998.ß 1998Kluwer Academic Publishers. Printed in the Netherlands.

EPA decrees that coal-¢red power plants must reduce their emissions in a givenyear, ¢rms must pay for installing new pollution-control equipment. Thisincrease in business costs has two distinct e¡ects. First, consumers must pay ahigher price for electricity and will thus tend to demand less of it. Second, thisdrop in demand will cause electricity providers to reduce production.

This simple analysis is not intended to imply that pollution control is not aworthy objective. Rather, it highlights the obvious fact that regulation imposes`o¡-budget' costs that are not re£ected in the administrative budgets of runningthe regulatory agency yet remain a very real burden to consumers and busi-nesses. Recent proposals to reform the regulatory process highlight the incen-tive problems these hidden costs create; because regulatory agencies do nothave to account for the costs their actions impose on the rest of society, theyhave little incentive to minimize those costs or even to weigh the costs of theiractions versus the bene¢ts.

Indeed, in the name of the public good, regulators frequently impose ine¤-cient rules that cost more than the value of any bene¢ts. For example, in themid-1980s, the Occupational Safety and Health Administration (OSHA) andthe Environmental Protection Agency (EPA) began requiring the removal ofasbestos from schools and other public places. Compliance costs were enor-mous (roughly $8 billion in 1984 dollars), but achieved only a minuscule level ofrisk reduction. Ironically, asbestos removal e¡orts may have actually increasedhealth risks by raising the ambient levels of asbestos ¢bers in the air. Manyscientists believe that sealing the asbestos in place would have been a muchsafer and less expensive alternative to removal. Unfortunately, regulators oftenhave little incentive to consider such common sense approaches when carryingout their duties.

Accountability through regulatory budgeting

To make regulators more accountable for the costs they impose on society andto give Congress and the executive branch a mechanism for controlling thesecosts, analysts have proposed the adoption of a regulatory budget. Analogousto a conventional ¢scal budget, a regulatory budget would establish a limit onthe total costs that can be generated by the entire regulatory system. Each year,the federal government would then allocate this sum among the various regu-latory agencies. Each of these agencies would then be required by law tooperate within its individual regulatory budget and its ¢scal budget.

The administrative procedure for implementing a regulatory budget wouldmirror that of a ¢scal budget. In addition to the traditional budget submissions,the president would send to the Congress a budget limiting the regulatory coststhat could be imposed on the nation. After hearings by the relevant commit-tees, each house would vote on the speci¢cs and a conference committee wouldproduce a compromise bill. After enactment by both houses, the regulatorybudget would be forwarded to the president to sign into law. Like the ¢scal

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budget, the regulatory budget would be open to vigorous debate. If an individualagency were to consider new regulations that imposed aggregate costs in excessof its budget allowance, it would be faced with two basic choices: revise theproposed regulations to reduce the costs of compliance, or revise an existinglower-priority regulation.

A striking feature of regulatory budgeting is that it focuses solely on thecosts rather than the bene¢ts of regulation. Like an individual household, eachregulatory agency would face a budget constraint that limits its total spending.This constraint would provide an incentive for agencies to allocate their resour-ces in the most e¤cient manner to achieve their policy objectives (i.e. workersafety, environmental protection, etc.). If forced to choose between programs,agencies would be encouraged to choose those that provide the greatest bene¢tper dollar of cost. By formalizing this portion of the budget allocation process,Congress and the president will also have an added interest in ensuring thatregulatory funds are allocated to the agencies which produce the most substan-tial bene¢ts for society.

Estimating regulatory costs

The primary di¤culty in implementing a regulatory budget is cost estimation.Without reliable, consistent estimates of costs (broken down by agency and byregulation), it is impossible for a budgeting authority to make sensible alloca-tions of resources across di¡erent regulatory programs. Unfortunately, there nouni¢ed data source of regulatory costs nor even a standard de¢nition of thesecosts.

Broadly speaking, regulatory costs fall into three distinct categories:

1. Operation of the regulatory agency. These costs represent the workersalaries, administrative costs, and capital expenditures needed to operatea federal agency.

2. Compliance by businesses, consumers, and government agencies. This cat-egory includes the direct expenditures that are needed to comply with agiven regulation. So-called process costs ^ the costs of ¢lling out paper-work and dealing with administrative requirements ^ also fall into thiscategory of direct costs.

3. Indirect economic costs in the form of reduced output and e¤ciency loss.For example, if a regulatory agency mandates a new safety device onladders, then the price of ladders will almost certainly rise as manufac-turers face higher costs. Because of this, some consumers who wouldhave bought ladders at the old price will now ¢nd themselves priced outof the market. Additionally, ladder manufacturers will earn fewer pro¢ts;indeed, some of the marginal ¢rms may go out of business. These com-bined e¡ects are often termed `deadweight loss' by economists, to re£ectthe unrecoverable costs to society of reduced ladder production.

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Ideally, a regulatory budget would cover all of these costs. In practice, however,reliable measurements of these costs are frequently unavailable. Operatingcosts are relatively easy to quantify, as they are already reported as part of the¢scal budget; they are by far the smallest part of the cost of regulation. Com-pliance costs, when they are available, are generally obtained through surveysor audits of a¡ected ¢rms or are calculated using market data. For example, inthe example of a ladder safety device, the direct compliance expenditures arethe cost of the safety device (which is either observed ex post by auditors, or isestimated a priori by an engineering study) multiplied by the number of laddersproduced during the year. Alternatively, if the government requires a ¢rm tolower its pollution emissions, the direct costs would equal the expenditures the¢rm makes to install and operate the pollution control equipment that isnecessary to achieve the regulatory standard.

Measuring indirect costs

These direct costs are often very substantial. Nevertheless, economists are alsoconcerned with e¤ciency losses, a much broader measure that accounts for thenumerous indirect impacts of federal intervention into private markets. Onewidely accepted standard to evaluate e¤ciency losses is the `compensationprinciple,' which states that the true cost of a regulation is measured by theamount of money that would be needed to compensate all a¡ected individualsto make them indi¡erent to the regulated and nonregulated worlds. The costs andbene¢ts of regulation do not typically fall uniformly across society; any regula-tory change creates classes of winners and losers. Clearly, if the winners can fullycompensate the losers while still remaining better o¡ themselves, the regulationcan be viewed as bene¢cial in the sense that its total bene¢ts exceed its total costs.

General equilibrium analysis provides the most complete measure of e¤-ciency costs by simultaneously examining the interaction of all consumers, all¢rms, and all markets. However, such analysis is extremely complex and isoften intractable without severe restrictions and assumptions about the struc-ture and operation of the economy. As such, its usefulness in a policy structuresuch as the regulatory budget is probably limited. Nevertheless, general equili-brium models present the most theoretically appealing way to measure the totalimpact of regulation. Hazilla and Kopp, for example, use general equilibriumanalysis to estimate the true social cost of the Clean Air and CleanWater Actsin 1990 at more than $200 billion compared to the EPA's engineering compliancecost estimates of $76.6 billion (both ¢gures in 1990 dollars).1

In contrast to general equilibrium models, partial equilibrium models con-¢ne themselves to the e¡ects of regulatory change in one particular marketwhile ignoring the spillover e¡ects to other markets. Under many conditions,partial equilibrium analysis provides a ¢rst-order approximation of the generalequilibrium e¡ects while still remaining computationally tractable. Essentially,partial equilibrium analysis examines the changes in market supply and de-

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mand following regulatory change and measures the losses to producers (de-creased pro¢ts) and consumers (increased prices) of the a¡ected product.

As an example of this, consider the diagrams in Figure 1 which represent thesupply and demand curves for local- and long-distance telephone service. Understandard economic assumptions, the demand curve represents consumers'willingness to pay, while the supply curve represents the marginal cost of serviceprovision. At the equilibrium price, the di¡erence between total willingness topay and total marginal costs is referred to as the market's economic surplus. Ifthe equilibrium price is altered through regulation, economic surplus is generallyreduced. This reduction can be illustrated graphically by the regulation-inducedchange in the area between the market supply and demand curves.

Under telecommunications regulation, the price of long-distance service isset arti¢cially high in order to subsidize money-losing local telephone service inlow-tra¤c areas. This cross-subsidization creates deadweight losses in bothmarkets, as a wedge is driven between the marginal cost of telephone serviceand the pricing of that service. In the long-distance market, the price of serviceis set in excess of marginal cost. At the same time, in the local market, pricesare set below marginal cost, implying that the consumer's willingness to pay isless than the incremental cost of service.

After regulation, consumers pay a higher price for long-distance service.The rectangle ABCD represents a transfer of income from consumers to pro-ducers. However, the price increase also reduced the quantity demanded oflong-distance service, creating a deadweight loss equal to CDE. In the totalservice market, arti¢cially low prices create additional surplus for consumers(ABCE), but at the expense of producers who must make local service availableat below cost. The losses to producers in the local market are represented byABFE. The di¡erence between the losses to producers and gains to consumers,CEF, is the deadweight loss.

Quantifying the area of these deadweight losses requires information on theslope, or elasticity, of the market supply and demand curves, as well as thechanges in equilibrium price and/or quantity following regulation. Using such

Fig. 1. Supply and demand curves for local- and long-distance telephone service.Source: Author's calculations

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data, Crandall estimates deregulating residential service in 1988 would haveyielded large e¤ciency gains: roughly $11 billion annually.2

Empirical estimates

Many economic studies have attempted to quantify the costs ^ direct or indirect^ imposed by various regulations. This section highlights several major e¡ortsto aggregate the estimates of industry- or regulation-speci¢c studies to arrive ata comprehensive regulatory cost ¢gure.

Aggregate study 1: Weidenbaum and DeFina

If there is a consensus within the regulatory literature, it is that the total costsof regulation are very large ^ even by governmental standards ^ and aregrowing.Weidenbaum and DeFina were among the ¢rst researchers to attempta detailed estimate of the aggregate costs imposed by regulation.3 Their 1978study calculates the budgets as well as the compliance costs imposed by 26regulatory agencies. Operating costs of the federal agencies were obtained fromthe federal budget, while compliance costs were estimated from other studieswhen available.

It should be emphasized that these 26 agencies do not represent the entirefederal regulatory apparatus. No compliance costs were available for majorregulatory agencies such as the Department of Energy, the National HighwayTra¤c Safety Administration (NHTSA), the Consumer Product Safety Com-mission, and many others. Furthermore, many estimates of compliance costsused by Weidenbaum and DeFina examine only one regulation or group ofregulations and do not focus on the entire regulatory charter of a speci¢cagency. Thus, the cost estimates presented in Table 1 generally underestimatethe actual economic impact of the listed regulatory agencies.

Social regulation

Environmental Protection AgencyDuring the late 1970s and early 1980s, the Council on Environmental Qualitypublished estimates of public and private incremental compliance costs ofpollution abatement. These estimates cover the outlays for federally requiredplant and equipment. In 1976, these costs are estimated at $7.8 billion.4

Department of TransportationAutomobile manufacturers are required to install safety and emissions controlequipment that signi¢cantly increase the price of new automobiles. From timeto time, the Bureau of Labor Statistics issues the details on the price increases

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associated with speci¢c regulatory changes. Table 2 is based on BLS reports for1968^1975.

Applying this $556.87 ¢gure to the 6,731,000 automobiles sold in 1975 pro-duces the $3.748 million compliance cost estimate.5

Table 1. Regulatory costs in 1976 (millions of dollars).

Operating Compliance Total Compliance cost source

Social regulation

EPA 416 7,760 8,176 Council on environmental qualityDOT 183 3,748 3,931 BLSLabor dept. 253 3,670 3,923 McGraw Hill; ThieblotDOA 408 986 1,394 PosnerDept. of health 229 360 589 Pelzman; Grabowski & VernonEEOC 64 345 409 EEOC; Van Alstyne and ColdrenTreasury Dept. 458 n/a 458 n/aFEA 186 n/a 186 n/aJustice Dept. 184 n/a 184 n/aDept. of interior 92 n/a 92 n/aNLRB 74 n/a 74 n/aCPSC 43 n/a 42 n/aNTSB 12 n/a 12 n/a

Subtotal 2,601 16,869 19,470

Economic regulation

ICC and CAB 146 13,701 13,847 Peck, Jordan, KeelerITC 11 4,700 4,711 MintzFCC 54 1,000 1,054 Comanor, MitchellFTC 49 1,000 1,049 Wharton Econ. ForecastingAssociatesFederal Reserve n/a 118 118 SmithFPC 39 58 97 MacAvoyNRC 208 n/a 208 n/aSEC 54 n/a 54 n/aCFTC 12 n/a 12 n/aFMC 8 n/a 8 n/aRB 6 n/a 6 n/aCASB 1 n/a 1 n/a

Subtotal 588 20,577 21,165

Paperwork burden ^ 25,000 25,000

Totals (1976 dollars) 3,189 62,446 65,635

Totals (1988 dollars) 6,133 120,094 126,227

Source: Robert W. Crandall, After the Breakup, (Washington, D.C.: Brookings Institution, 1991),pp. 132^144.

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Table 2. Incremental compliance costs of automobile regulation, 1968^1975.

Year Action Cost(1976 dollars)

1968 Seat- and shoulder-belt installations 18.79HEW standards for exhaust emissions systems 26.13

1968^1969 Windshield defrosting and defogging systems 1.09Windshield wiping and washing systems 1.94Door latches and hinge systems 0.85Lamps re£ective devices, and associated equipment 9.77

1969 Head restraints 25.80

1970 Lamps re£ective devices, and associated equipment 5.84Standards for exhaust emissions systems 5.03

1968^1970 Theft protection (steering, transmission, ignition locking andbuzzing system 11.46

Occupant protection in interior (glove box door remains closed onimpact) 0.51

1971 Fuel evaporative systems 26.60

1972 Improved exhaust emissions standards required by Clean Air Act 8.16Warranty changes resulting from federal requirement that allexhaust emissions systems bye warranted for ¢ve years or50,000 miles 1.36

Voluntarily added safety features in anticipation of future safetyrequirements 2.72

Seat-belt warning system and locking device on retractors 27.54

1972^1973 Exterior protection (standard No. 215) 89.47

1973 Improvements in location, identi¢cation, and illumination ofcontrols 0.77

Reduced £ammability of interior materials 7.42

1969^1973 Improved side-door strength 19.58

1974 Interlock system, other changes to meet federal safety requirements 123.74Improved exhaust emissions systems to comply with the FederalClean Air Act 1.61

1975 Additional safety feature associated with federal motor vehiclesafety standards Nos. 105, 208, 216 11.34

Installation of catalytic converter 126.35

1968^1975 Total 556.87

Source: MurrayWeidenbaum, Business Government, and the Public (Englewood Cli¡s, N.J.: Prentice-Hall, 1977), p. 48; U.S. Department of Labor Statistics.

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Department of LaborThe Fourth Annual McGraw-Hill Survey estimates the compliance costs ofOSHA regulation to private industry at $3.2 billion in 1976. Universities spentan additional $33 million in OSHA compliance costs. The Davis-Bacon Act,which requires payment of `prevailing wages' and fringe bene¢ts to workersemployed on federal projects, also creates signi¢cant compliance costs bypreventing acceptance of low-cost bids. Thiebolt estimated this cost di¡erentialin 1971 by examining changes in bids during a one-month suspension of the actwhen all pending construction projects were opened for rebids. Thiebolt ¢ndsthat the low rebids were 0.63 percent lower than the low initial bids. Applied tothe $38 billion of government spending on construction in 1976, this di¡erentialyields $240 million in savings.6

Department of AgricultureAlthough the U.S. Department of Agriculture (USDA) regulates many markets,the reported compliance cost applies only to one product ^ milk. Regulatorsclassify milk into two grades: grade A for human consumption in £uid form,and grade B for manufacturing purposes. Federal milk orders, administered bythe USDA, pool milk sales within a particular region and set the minimumprices that ¢rms must pay for both grades of milk. Typically, the price for gradeA milk is set above the market equilibrium price, encouraging farmers to over-produce. Excess grade A milk is either redistributed (often to low-incomeconsumers through federal programs) or is destroyed.

Kessel regresses milk prices on distances from milk production centers forboth regulated and unregulated urban markets and ¢nds that the net e¡ect ofmilk price regulation is to create an overall 11 percent price increase for dairyproducts. Posner utilizes this ¢gure and data on milk price elasticity to calcu-late total social costs equal to 10 percent of total industry sales.7 As these salestotaled $9.9 billion in 1976,Weidenbaum and DeFina's estimated compliancecost is $986 million.

Department of Health, Education, and WelfareThe Federal Drug Administration imposes strict regulatory controls over thedrug industry that slow the development and marketing of new pharmaceut-icals. Grabowski and Vernon compare industry dynamics in the United Statesbefore and after the introduction of the 1962 Kefauver-Harris amendments.Research opportunities are assumed to be the same across all countries, withany di¡erences attributed to regulatory structures. Using the United Kingdomas a base for comparison, the authors ¢nd that `increased regulation, by itself,roughly doubled the cost of producing and introducing a new chemical entity inthe post-amendment period.'8

However, Peltzman argues that the 1962 amendments also produced limitede¤ciency gains by decreasing the sales of ine¡ective or ine¤cient drugs thatwere identi¢ed during the approval process. Combining the estimates of thesetwo e¡ects for a base year of 1970, and then extrapolating to 1976, produces acost estimate of $360 million.

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Equal Employment Opportunity CommissionMost of the compliance costs dealing with EEOC regulation are hidden. How-ever, one quanti¢able portion of these costs is the amount prohibits discrimina-tion in employment conditions. The EEOC reports that these awards totaled$262 million in 1976.

Additionally, a study by the American Council on Education surveyedseveral major universities to determine the incremental costs of various regu8-lations.Weidenbaum and DeFina extrapolate these ¢ndings to all U.S. academicinstitutions and conclude that required EEOC programs cost universities $83million in 1976.9

Economic regulation

Interstate Commerce Commission and Civil Aeronautics BoardGovernment regulation of ground transportation often involves cross-subsidi-zation, where some customers pay charges in excess of costs to subsidize otherconsumers who pay charges that are less than the cost of service. As illustratedearlier, this pricing scheme creates e¤ciency losses by encouraging an un-economic use of resources; namely, high-cost transportation is overutilizedwhile low-cost transportation is underutilized. Harbeson uses partial equili-brium analysis to estimate the total cost of such ine¤cient pricing at $4.0billion, a ¢gure that Weidenbaum and DeFina adjust downward to $3.8 bil-lion to account for alternative methodologies presented in the economic liter-ature.10

Throughout the 1970s, the Civil Aeronautics Board (CAB) controlled faresin the interstate air transportation industry. Fares were generally set above thecompetitive equilibrium price, which required the CAB to restrict entry into themarket. Using partial equilibrium analysis, Posner examines a range of plausibledemand elasticities to calculate the net social loss due to these regulations in1968. Weidenbaum and DeFina take the lower end of this range, combine itwith the ground transportation cost estimates, and adjust for in£ation andchanges in business volumes to arrive at a net cost of transportation regulation:$13.7 billion in 1976.11

International Trade CommissionImport quotas in£ate prices of domestically produced goods to the detrimentof consumers. Additionally, import quotas create e¤ciency losses by reducingconsumption of a¡ected products and distorting the allocation of domesticresources towards production of goods protected by quotas. Using partialequilibrium analysis, Mintz ¢nds the annual costs associated with importquotas of sugar, textiles, and meat to be $3.7 billion in 1973. Adjusted forin£ation, this ¢gure rises to $4.7 billion in 1976 dollars.12 Of course, these threeclasses of products represent only a small portion of the goods protected bytari¡s and quotas.

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Federal Communications CommissionAlthough the FCC historically held wide-ranging regulatory powers that coverthe telephone and telegraph industries, the cost estimate reported in Table 1stems from only one facet of FCC regulatory activity: cable television. Toprotect UHF stations from competition, the FCC severely restricted entry intothe cable TV market. Comanor and Mitchell estimate the e¤ciency loss to thisregulation at $1 billion to $2 billion, depending on the elasticity of demand forcable services.Weidenbaum and DeFina use the lower range of this estimate fortheir compliance costs estimate.13

Federal Trade CommissionOne credit ruling issued by the FTC makes third-party ¢nancing agenciessubject to all claims asserted by the purchaser against the seller (the Holder-in-Due-Course Doctrine). Wharton Econometric Forecasting Associates estimatesthat this ruling lowered consumption expenditures by $1 billion to $2 billion.To maintain a conservative estimate, Weidenbaum and DeFina use the lowerend of this range in their cost estimate.14

Federal Reserve SystemThe Equal Credit Opportunity Act of 1974 was enacted to prevent creditdiscrimination on the basis of sex or marital status. Smith identi¢es sevendistinct nonrecurring costs associated with this regulation: legal fees, training,destruction of obsolete forms, reprogramming of computer systems, additionalstorage space, printing and mailing of new credit history notices, and conver-sion of old credit systems. Smith also identi¢es three recurring costs: reportpreparation, purchases of multiple credit reports, and increased data process-ing and customer service requirements. The nonrecurring costs are estimatedat $175 million, while the recurring costs (which are used in Weidenbaum/De Fina's cost estimate) are $118 million.15

Federal Power CommissionThe FPC (now the Federal Energy Regulatory Commission) regulates theelectrical generation industry to guarantee electricity supply throughout theUnited States, using cross-subsidization to lower prices in rural, low-densityareas. Power companies must routinely participate in `cost-of-service' reviewsto justify their pricing. These reviews require the services of industry experts,lawyers, and executives. MacAvoy surveys the costs of rate case defendants and¢nds the compliance costs of FPC regulation to be $36 million in 1970. Ad-justed for in£ation, this ¢gure rises to $58 million in 1976.16

Paperwork BurdenIn 1977, the Commission on Federal Paperwork released a study detailing thehours required to comply with the thousands of forms issued by the federalgovernment. The commission concluded that $25 billion to $32 billion wasspent in 1976 on paperwork.Weidenbaum and DeFina use the low end of thisrange in their cost estimate.17

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Aggregate study 2: Hahn and Hird

In a 1991 paper, Robert Hahn and John Hird build upon the work of earlieraggregate studies by examining regulatory costs and bene¢ts following themany institutional changes in the late 1970s/early 1980s.18 Speci¢cally, theCarter and Reagan administrations were responsible for the deregulation oftrucking, railroads, natural gas, oil, and airlines. At the same time, the regula-tion of workplace safety and environmental protection increased dramatically.

In addition to compliance and e¤ciency costs, Hahn and Hird also reportthe transfer payments that are associated with most forms of economic regu-lation.Whereas e¤ciency costs represent unrecoverable losses to society, trans-fers simply redistribute income from one group to another. For example, asnoted earlier, telecommunications regulation involved a transfer of wealth fromlong-distance consumers to local-service consumers.

Nevertheless, the distinction between transfer payments and e¤ciency costsis blurred when one considers that most transfers do not occur e¡ortlessly. AsRichard Posner points out, theft produces a transfer of wealth from the robbedto the robber. But this transfer also imposes many e¤ciency costs to society. Thepro¢ts to be made in crime attract others into the criminal profession. Likewise,citizens invest productive economic resources into crime prevention.19

Even when transfers are legal, transfer recipients frequently compete (eitherthrough litigation or political lobbying) to maintain their redistributions or toobtain more of them. As an example of this phenomenon, which economiststerm rent-seeking, witness AT&T's extensive political and judicial e¡orts to keepout competition in the long-distance market prior to the 1984 telephone dereg-ulation. Because of rent-seeking, transfer payments may not be as costless assimply giving money from one group to another. The friction produced by com-peting political interests tends to transform redistributions into e¤ciency losses.

When subtracting such transfer payments, Hahn and Hird ¢nd the e¤ciencycosts of economic regulation in 1988 to be approximately $46 billion, whilesocial regulatory costs were $93 billion, for a total regulatory cost of $139billion.When transfers are included, this ¢gure increases to $330 billion.

Environment

Hahn and Hird use the EPA's own estimate of 1981 compliance costs (adjustedto 1988 dollars) for the Clean Air and CleanWater Acts as a low-end estimate($55.4 billion). This ¢gure is taken from a 1984 survey of private compliancecosts conducted by the Commerce Department. By using this 1981 ¢gure,Hahn and Hird do not take into account the rapid rise in compliance costsduring the early- and mid-1980s. As such, they have severely understated actual1988 pollution compliance costs. Indeed, more recent Commerce Departmentdata put total 1988 spending for pollution abatement and controls at $84.1billion. This estimate is over 50 percent more than Hahn and Hird's low-end

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¢gure. It is also nearly 10 percent more than Hahn and Hird's high-end estimateof $77.6 billion (taken from a general equilibrium study conducted by Hazillaand Kopp).20

Other social regulation

Highway safetyCrandall et al. tabulate data obtained from the General Accounting O¤ce andBureau of Labor Statistics regarding the estimated compliance costs to federalautomobile safety standards from 1966^1984.21 These cost estimates are largelybased on engineering studies but do not take into account the `learning curve'of automobile parts manufacturers. That is, as ¢rms become more experiencedat producing safety equipment, their average costs generally decline. Because ofthis, Crandall et al. adjust the GAO and BLS data to account for a 5 percentannual learning curve. In 1981, the cost of safety equipment per vehicle was$822. Adjusted for the learning curve, this ¢gure declines to $512. Given salesof 10.5 million new cars in 1981, the total cost ¢gure is $7 billion to $10.3billion.

Hahn and Hird choose to subtract the compliance cost with federal bumperstandards from Crandall's aggregate cost ¢gure, lowering the cost estimate to$4.9 billion to $6.9 billion. Adjusted to 1988 dollars, this range rises to $6.4billion to $9 billion, the average of which is reported in Table 3.

OSHACrandall reports data on real capital expenditures for OSHA programs.22 In1985, this ¢gure was $6.9 billion (in 1982 dollars). Adjusted for in£ation, thisestimate rises to $8.5 billion in 1988 dollars. A similar cost estimate is reportedby Denison, who utilizes BLS survey data to measure the total incrementalcosts of employee safety and health regulation.23 In 1975, this ¢gure totaled $6.3billion ($9 billion in 1988 dollars). The average of Crandall's and Denison's¢gures is reported in Table 3.

NuclearThis cost estimate is taken from a DOE policy study which assumes thatincreases in the real costs of nuclear plant construction during 1979^1981 weredue entirely to regulatory e¡ects.24 In 1979, the cost of a new reactor averaged$560 million; by 1981, this ¢gure rose to $1.185 billion (both ¢gures are in 1977dollars). Assuming that all new and existing reactors would comply with theadditional regulations that prompted this price increase, and adjusting forin£ation, provides the aggregate cost estimate reported in Table 3.

DrugsA 1973 Peltzman study observes that the development of `new chemical entities'dropped markedly following the passage of the 1962 Kefauver-Harris amend-

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ments to the Food, Drug, and Cosmetics Act.25 Although intended to improvethe e¤cacy of new drugs, these amendments imposed large costs on pharma-ceutical manufacturers which retarded innovation within the industry. Peltz-man concludes that the net e¡ect of the 1962 amendments is equivalent to a5 percent to 10 percent tax on consumers. Given the $30 billion spent on legaldrugs in 1988, this translates to roughly $1.5 billion to $3 billion.

Equal Employment Opportunity CommissionHahn and Hird use the Weidenbaum/DeFina ¢gure discussed earlier, adjustedto 1988 dollars.

Economic regulation

International tradeA 1986 report published by the Institute for International Economics examines31 case studies of trade protection. The authors use partial equilibrium analysisto estimate the welfare costs and transfer payments associated with variousinternational trade restraints. Trade barriers create domestic price increasesthat impose direct costs on consumers. Partially o¡setting these costs are trans-fers to producers of protected goods (who receive higher prices for their mer-chandise), and to government (which collects tax and tari¡ revenue). Theauthors estimate these transfers total $98.1 billion. E¤ciency costs to tradeprotection are also large, estimated at $17.3 billion.26

TelecommunicationsAs noted previously, long-distance markets have historically supported low-tra¤c local markets through a system of cross-subsidization. These subsidies ^largely in the form of access fees paid by long-distance customers ^ drive awedge between cost and price in both markets.Wenders estimates the e¤ciencycosts of such regulation at nearly $14.1 billion.27

Lacking any direct estimates of transfer costs in these markets, Hahn andHird state that a 3 : 1 ratio of transfers to e¤ciency costs is a good rule of thumbthat seems consistent with a broad range of economic studies that have esti-mated both types of costs. Using this 3 : 1 ratio, Hahn and Hird calculate thetransfer costs to telecommunications regulation as $42.3 billion.

Agricultural price supportsGardner utilizes partial equilibrium analysis to compute welfare costs andtransfer payments in a number of agricultural markets. Taxpayers lose $18.5billion, consumers lose $5.1 billion due to higher prices, but producers gain$17.2 billion. Thus, the net economic cost to these price supports is $6.3 billion.Gardner adds to this ¢gure the roughly $400 million budget of the AgriculturalStabilization and Conservation Service to arrive at a total cost of $6.7 billion.Transfers are considerably higher, estimated at $18.4 billion.28

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AirlineDespite the widespread air deregulation in the late 1970s, signi¢cant pricingine¤ciencies persist in commercial air markets. Speci¢cally, aircraft landingfees continue to be based on aircraft weight, rather than on a plane's contributionto airport congestion. Essentially, this regulated pricing structure serves to sub-sidize small private and commuter planes at the expense of large cargo aircraft.

To calculate optimal fees based on marginal-cost, Morrison and Winstonconstruct an airport cost function which includes capital and operating costs,as well as a delay function that illustrates the tradeo¡ between runway use andcongestion.29 Using Airline Service Quality Performance data provided by theDOT, they estimate that ine¤cient pricing creates $3.8 billion in e¤ciencycosts, and $7.7 billion in transfers from commercial carriers to general aviation.

RailRail regulation gives rise to two distinct economic e¡ects. First, regulatorstypically set prices well in excess of costs, which creates transfers to rail suppliers

Table 3. Hahn and hird estimates of 1988 regulatory costs (billions of dollars).

Costa Transfersa Source

Environment 67 n/a EPA; Hazilla/Kopp

Other social regulation

Highway safety 7.7 n/a CrandallOSHA 8.8 n/a Crandall, Denison; ViscusiNuclear power 6.5 n/a Litan/NordhausDrugs 2.2 n/a PeltzmanEEOC 0.9 n/a Weidenbaum/DeFina

Subtotal (rounded) 26 n/a

Economic regulation

International trade 17.3 98.1 Institute for international economicsTelecommunications 14.1 42.3 WendersAgricultural price supports 6.7 18.4 GardnerAirline 3.8 7.7 Morrison and WinstonRail 2.3 6.8 WinstonPostal n/a 8.0 President's commission on privatizationMilk 0.7 2.2 MacAvoyNatural gas 0.3 5.0 LouryOther 0.9 2.4 Litan/Nordhaus; Thiebolt; Jantscher

Subtotal (rounded) 46 191

Total (1988 dollars) 139 191

a Average of high and low estimates.Source: Robert W. Hahn and John A. Hird, `The costs and Bene¢ts of regulation: Review andSynthesis,'Yale Journal on Regulation,Winter 1991, pp. 233^278.

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as well as e¤ciency losses from oversupply of rail service. Second, regulatorsrestrict the abandonment of service on low-tra¤c, unpro¢table routes.Winstonsurveys several studies of rail regulation and reports a consensus annual costestimate of $2 billion from rate regulation and $4.9 billion from excess capacityfor a total of $6.9 billion.30 However, between 1980 and 1988, roughly two-thirds of the rail market was deregulated. Applying this ¢gure to the above costestimate yields $2.3 billion in e¤ciency costs for 1988. The 3 : 1 rule is used tocalculate transfer payments.

PostalThe law prohibiting private carriers from delivering ¢rst-class mail imposessigni¢cant costs on society. The President's Commission on Privatization Re-port states that elimination of the federal mail monopoly would provide costsavings of $4 billion to $12 billion annually.31 These costs are exclusively trans-fers to postal employees, who receive a wage premium relative to their privatesector counterparts.

MilkMacAvoy surveys the economic e¡ects of the Agricultural Act of 1937, whichauthorizes the federal regulation of £uid milk marketing (the details of milkregulation are discussed earlier in the Weidenbaum/DeFina survey.32 Partialequilibrium analysis yields e¤ciency losses of $400 million to $900 million andnet transfers to dairy farmers of $9 million to $3.5 billion. Interestingly, thesetransfers are largely to producers of grade A milk. Grade B producers, whichtend to be smaller farms, are actually hurt by price regulation.

Natural gasLoury uses partial equilibrium analysis to estimate the e¤ciency cost of naturalgas price controls in 1978 to be $3.7 billion per year. Hahn and Hird useLoury's data to estimate annual transfer payments of $83.8 billion. In 1988,however, only 40 percent of the natural gas market remained subject to priceregulation and only 6 percent of the market faced binding regulations. Apply-ing this 6 percent ¢gure to the above cost estimates yields $300 million ine¤ciency costs and $5 billion in transfers. However, the deregulation of naturalgas at the federal level is now complete.

OtherOther regulations included by Hahn and Hird are credit regulation, ocean ship-ping regulation, and barge regulation (cited in an aggregate study conducted byLitan and Nordhaus). Additionally, the Thiebolt study of the Davis-Bacon Act(cited by Weidenbaum and DeFina) is included under this heading. Hahn andHird apply the 3 : 1 rule to estimate transfers for these regulations.

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Aggregate study 3: Hopkins

In a comprehensive 1991 study of regulatory costs, Thomas Hopkins extendsthe Weidenbaum/DeFina and Hahn/Hird results. For his estimate of 1988regulatory costs, Hopkins relies heavily on Hahn/Hird's ¢gures for social andeconomic regulation. However, Hopkins uses more current EPA survey data toestimate the compliance costs to environmental regulation, arriving at a ¢gurenearly 30 percent greater than Hahn and Hird's.

Hopkins also considers the costs of `process regulation:' the paperworkinvolved in taxation and other activities that are not directly linked to a regu-latory objective.33 The OMB reports that roughly 5.2 billion hours were spentcomplying with federal paperwork requirements in 1988. Hopkins subtractsprocurement paperwork from the OMB ¢gure, as these costs are re£ected inthe federal budget along with other purchasing costs. If the time spent ¢llingout paperwork is valued at $20 per hour, the resultant cost estimate is $97billion.

In addition to these paperwork costs, Hopkins considers the excessive ad-ministrative costs arising from federal regulation of health care. Using Canadaas a benchmark,Woolhandler and Himmelstein estimate that 60 percent to 70percent of U.S. administrative costs could be saved under a more streamlinedhealth-care system.34 Hopkins opts to attribute half of this wasteful adminis-trative cost to regulation, and concludes that health-care regulatory coststotaled $41 billion in 1988.When added to the paperwork-burden cost estimatediscussed earlier, this ¢gure rises to the $138 billion reported in Table 4.

It is not clear how much of Hopkins' process regulation costs should beincluded in a regulatory budget. For example, more than 80 percent of theOMB's paperwork compliance measure represents tax accounting and ¢ling.While tax compliance laws may be burdensome, they are not strictly regula-tions of economic activity. As such, Hopkins' $138 billion estimate likely over-states dramatically the true process costs of regulation in a regulatory budget.

Review of aggregate studiesDespite the lack of a uni¢ed methodology in these studies, none of the costestimates appears to be widely inconsistent with the others. (See Table 5 for acomparison of cost estimates in constant dollars.) Taken together, these studiesprovide useful approximations of regulation's total cost, which appears to belarge and rising in recent decades.

Nevertheless, these studies represent only a starting point in terms of imple-menting a regulatory budget. Although the driving force behind such a budgetis concern over the aggregate costs of regulation, actual implementation ofsuch a budget requires estimates of the costs imposed by speci¢c regulatoryagencies. Furthermore, to be credible in a policy environment, the methodologyused to produce cost estimates must be clearly de¢ned and consistently applied.The next sections examine several widely-used sources of cost data to examinewhich would be useful in a regulatory budget.

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Sources of cost data

Regulatory impact analyses

There are several governmental sources of regulatory cost estimates. ExecutiveOrder 12291, signed by President Reagan in 1981, requires regulatory agenciesto conduct regulatory impact analyses (RIA) when issuing major rules (i.e.those that have an economic impact of $100 million or more). To satisfy therequirements of Executive Order 12291, an RIA must show that:

1. There is adequate information concerning the need for and the conse-quences of a regulatory action.

2. The bene¢ts to society exceed the costs.3. The proposed action is the best alternative to meet the regulatory objective.

Beginning in 1992, the O¤ce of Information and Regulatory A¡airs (OIRA)has requested that agencies provide their RIA cost-bene¢t information forpublication in the Regulatory Program.

Although useful starting points for analysis, these government estimatessu¡er from a number of problems that limit their usefulness in a regulatory

Table 4. Hopkin's estimate of 1988 regulatory costs (billions of dollars).

Cost Source

Environment 86 EPAOther social regulation 26 Hahn/HirdEconomic regulationE¤ciency costs 46 Hahn/HirdTransfer costs 191 Hahn/Hird

Process regulation 138 OMB; CBO;Woolhandler/Himmelstein

Total 487

Source: Richard Posner, `The Social Costs of Monopoly and Regulation,' Journal of PoliticalEconomy , 83: 4 (1975), p. 807.

Table 5. Summary of aggregate studies.

Authors Year Cost of regulation(billions of 1988 dollars)

Weidenbaum/DeFina 1976 125Hahn/Hird 1988 139a

Hopkins 1988 158b

a Excluding transfers.b Excluding transfers and process regulation.Source: Author's calculations.

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budget. First, regulatory authorities may have strong incentives to understatethe true costs of their regulations. Second, RIAs are required only for majorrules, which comprise only a small percentage of the regulations issued in eachyear. Third, most RIAs focus exclusively on direct compliance costs and do notattempt to measure the indirect social costs of regulation. Fourth, and mostimportantly, despite the guidelines set out by Executive Order 12291 and otherlegislation, cost estimates are simply not produced for many regulatory pro-grams. Often, statutory or judicial deadlines do not allow time for thoroughanalysis of costs and bene¢ts before implementation. Even when detailed RIAsare produced, they are generally not subject to a systematic review process.

Census data

The Bureau of the Census has constructed comprehensive estimates of com-pliance costs for the most costly form of regulation: environmental protection.Since 1973, the Census Bureau has conducted an annual Survey of PollutionAbatement Costs and Expenditures. The survey covers 17,000 ¢rms from nearlyall manufacturing industries, and requires detailed disclosure of annual operat-ing expenses and capital expenditures for pollution abatement. The publishedsurvey results break down the data by:

1. state:2. industry (i.e. paper, petroleum, transportation),3. media;

a. air;b. water;c. solid/contained waste;

4. abatement technique;a. end of line;b. production process enhancements;

5. type of expenditure;a. capital;

i. underground storage tanks;ii. site cleanup;iii. noise;iv. radiation;v. multimedia;

b. operating;i. depreciation;ii. salaries and wages;iii. fuel and electricity;iv. contract work/services;v. materials;vi. payments to government

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There are several obvious bene¢ts to using Census data in cost estimates. First,as a relatively disinterested party, the Census has less incentive to skew thenumbers than federal regulatory agencies. Second, the detail obtained by Cen-sus surveys allows for cost estimates of speci¢c regulatory programs. It wouldbe relatively easy to expand the Census environmental surveys to include costsfor other major areas of regulation, such as OSHA and the FDA.

Department of Commerce

The Department of Commerce utilizes the Census data, as well as Censussurveys of public utilities, to construct its Pollution Abatement and ControlExpenditures (PACE) report, published annually in the Survey of Current Busi-ness.35 This report estimates the economy's total spending for pollution abate-ment and control, broken down by sector (i.e. personal consumption, business,government) and type (i.e. air, water, solid waste). In addition to the Censusdata, the PACE report uses the Commerce Department's estimates of non-manufacturing and residential spending for solid-waste disposal, motor-vehicleemission abatement costs, regulatory monitoring and enforcement costs, andseveral other smaller sources.

Table 6 illustrates the growth in Commerce Department estimates of pollu-tion control expenditures since 1972.

Environmental Protection Agency

In 1991, the EPA published a detailed report that expanded the CommerceDepartment estimates to include regulatory impact analyses for new and pro-posed regulations. Additionally, the EPA forecasted the growth in environmentalexpenditures through the year 2000.36 As Tables 7 and 8 illustrate, spending onpollution control has increased dramatically since 1980, in both an absoluteand relative sense. These numbers are even more dramatic when one considersthat they do not include the costs of many federal environmental programs thatare not pollution control measures, such as wildlife conservation and landmanagement. (The economic in£uence of these latter programs has also beenrising over the past decade.)

Breaking down spending for pollution control by source reveals that over 80percent of environmental compliance costs are borne directly by consumers,business, and local governments.

Strengths and weaknesses of government data

As the Census Bureau, Commerce Department, and EPA studies illustrate, thefederal government already collects detailed information on direct expenditures

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Table 6. Spending for pollution abatement and controls, 1972^1992 (billions of 1988 dollars).

Total Air Water Solidwaste

Regulation &monitoring

Research &development

1972 47.5 16.9 19.3 8.9 1.0 2.31973 51.3 18.9 20.4 9.3 1.2 2.41974 53.8 19.6 21.7 9.7 1.4 2.41975 59.1 22.0 24.7 9.8 1.4 2.41976 62.1 22.6 26.7 10.1 1.4 2.61977 63.7 23.6 26.3 10.8 1.6 2.81978 66.8 24.5 27.6 11.7 1.7 2.91979 68.0 25.2 28.1 11.7 1.8 2.81980 67.7 25.3 27.5 12.2 1.9 2.51981 65.7 26.5 24.7 12.1 1.9 2.21982 63.7 25.8 24.0 11.5 1.8 2.01983 65.9 26.7 24.1 12.8 1.7 1.81984 71.1 29.1 25.7 14.4 1.6 1.61985 75.2 30.0 26.9 16.2 1.4 1.71986 80.0 31.4 28.6 17.6 1.6 1.81987 80.1 28.3 30.4 19,3 1.6 1.81988 84.1 29.9 30.2 21.9 1.7 1.81989 84.3 26.8 31.1 24.0 1.7 1.91990 86.6 25.5 33.6 25.7 1.7 1.61991 86.0 23.6 33.1 27.0 1.7 1.71992 90.4 24.7 34.1 29.6 1.7 1.7

Source: Environmental Investments: The Cost of a Clean Environment (Washington, D.C.: IslandPress, 1991).

Table 7. EPA estimates of environmental expenditures (billions of 1988 dollars).

Spending % of GDP

1980 62 1.61990 107 2.12000 (est.) 171 2.8

Source: Environmental Investments: The Cost of a Clean Environment (Washington, D.C.: IslandPress, 1991.

Table 8. Who pays for environmental compliance costs?

Federal State Local Private

1980 11% 4% 22% 63%1990 12% 3% 22% 63%2000 (est.) 15% 3% 22% 60%

Source: Environmental Investments: The Costs of a Clean Environment (Washington, D.C.: IslandPress, 1991).

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for pollution abatement and control. The primary strength of these data sourcesis their ability to track how much is being spent on particular types of pollutioncontrol equipment. For example, the EPA data break down spending for spe-ci¢c types of pollutants, such as acid rain, radon, sewage sludge, dioxin, andasbestos. This level of detail is critical for making meaningful comparisons ofcosts across di¡erent regulatory objectives.

Nevertheless, these data sources su¡er from a number of weaknesses. First,information on pollution abatement and control costs are relevant in estimat-ing only the direct costs of environmental regulation, such as the purchase andoperation of pollution control equipment; they exclude the indirect, deadweightlosses of regulation. Weitzman concludes that the total economic costs ofenvironmental regulation are two to three times the direct cost estimates.37

Of equal concern is that, although useful as an initial benchmark, theresults of the PACE and EPA surveys can not be interpreted as the true directcosts of environmental regulation. After all, even in the absence of environ-mental regulation, ¢rms and consumers would continue to devote largeamounts of resources to pollution control. By simply adding up all pollutioncontrol expenditures, these surveys may overstate the direct costs of environ-mental regulation. What is truly of interest to regulatory budgeters is theincremental cost of regulation. That is, beyond voluntary expenditures onpollution control, how much more do ¢rms and consumers spend to complywith regulation?

Estimation of what would have happened in the absence of regulation isa decidedly inexact science. Nevertheless, during the early 1980s, the Councilon Environmental Quality (CEQ) constructed incremental costs of federalenvironmental regulation by extrapolating trends from the late 1960s, prior tothe establishment of a large federal regulatory presence.38 In 1979, these incre-mental costs were estimated at $56.9 billion (in 1988 dollars), or approximately85 percent of the comparable Commerce Department estimates of total PACspending for the same year.

The EPA has also attempted to estimate the incremental cost of speci¢cregulations. Speci¢cally, the Clean Air and CleanWater acts required the EPAto provide detailed compliance cost estimates to Congress. The annual cost ofthese two Acts alone was estimated at $55 billion in 1981.39

Although these studies indicate that the incremental costs of environmentalregulation are very large, the cost estimates of the CEQ and EPA are stillincomplete. In particular, they cover only the expenditures to install andoperate pollution control equipment, while ignoring the potentially large costsof lawyers and administrative sta¡ that ¢rms must employ in order to ensurecompliance with regulations.

These problems indicate that, although the environmental cost data collectedby the federal government are a rich source of detailed information, they still donot provide precise estimates of incremental regulatory costs.

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Private sources

The Business Roundtable Study

Perhaps the most direct method of calculating incremental regulatory costs isto perform a ¢nancial audit of a¡ected ¢rms. One of the most ambitiousprivate-sector studies to utilize this approach is the Cost of Government Regu-lation Study, conducted in 1979 by the Business Roundtable (BR). In this study,the BR retained the accounting ¢rm of Arthur Andersen to examine the¢nancial records of selected ¢rms to accurately measure the incremental costof certain regulations in 1977. The procedure used to calculate these incrementalcosts was as follows:

1. Identify actions taken by a ¢rm to comply with a speci¢c regulation.2. Calculate the cost of the actions through reference to accounting or other

¢nancial records (when necessary, these records are supplemented bydata drawn from production and engineering records).

3. Determine a clear counterfactual; that is, how would the company havetaken action in the absence of regulation?

4. Calculate the cost of the actions that would have been taken in theabsence of regulation.

5. Calculate the incremental cost by subtracting the cost of the actions thatwould have been taken in the absence of regulation from the cost of theactions it did take.

Obviously, the determination of a counterfactual in step 3 is problematic. Atbest, the counterfactual is a subjective belief regarding what would have hap-pened. Many ¢rms do not simply react to new regulations; they attempt toforecast changes in the regulatory climate and act preemptively. Such actionmay actually help to hold o¡ new regulations by showing a voluntary intereston the part of business in meeting safety, environmental, or other regulatorygoals. Because of these dynamics, any counterfactual will be no more than abest guess as to how ¢rms would truly react in the absence of regulation.

However, this problem is not unique to the BR study. Indeed, all e¡orts toestimate regulatory costs must grapple with this issue. Other than ignoring theissue ^ and thus implicitly assuming that regulation is responsible for allexpenditures to reduce pollution, improve worker safety, etc. ^ there is littlealternative but to apply some subjective analysis to arrive at a counterfactual.The BR study may actually provide one of the more sensible, balanced ap-proaches to this problem.

The BR study covered only a small sample of companies (48) in a limitedsubset of industries (20). Furthermore, the study examined only selected regu-lations issued by six regulatory agencies: EPA, EEOC, OSHA, DOE, FTC, andthe Employee Retirement Income Security Act (ERISA). Nevertheless, theincremental costs of these regulations were found to be quite high: more than

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$4.7 billion (in 1988 dollars) for the sample of companies studied. This ¢gure isparticularly striking when one considers that:

1. The six agencies included in the study account for only a fraction of totalregulatory impact. Indeed, all industry-speci¢c regulatory agencies (suchas the FDA and FCC) were excluded from the study.

2. Although the ¢rms included in the study were generally large, they com-prise only a small portion of total national output. Many industries ^including agriculture, construction, government, retailing, and mostservice industries ^ were excluded from the study. The ¢rms that didparticipate in the study employed only 5 percent of U.S. civilian employees(excluding agriculture and government).

3. By focusing solely on incremental costs associated with speci¢c compliancerequirements, the study ignores all secondary costs to regulation (such asdeadweight loss, productivity loss, international competitiveness, etc.).

The BR study con¢rms a number of ¢ndings from other economic research.First, manufacturing ¢rms are hit particularly hard by many regulations. In thesample of ¢rms studied by Arthur Andersen, almost 90 percent of the costswere borne by manufacturing companies. Indeed, for the manufacturing ¢rmsincluded in the study, the incremental costs of regulation were equal to 17percent of total capital expenditures, 23 percent of net income after taxes, and43 percent of research and development expenditures. The e¡ects of regulationalso vary widely across di¡erent industries. In the banking industry, the incre-mental cost of OSHA regulations was only $11 per worker in 1977; in thechemical industry, the cost was nearly 40 times greater: $396 per year (using1988 dollars in both instances).

Second, environmental and other social regulation make up the largestshare of regulatory costs. Of the regulations studied, those issued by OSHA,EEOC, and EPA accounted for 92 percent of measured costs. In contrast, theeconomic regulations of the FTC made up only 1 percent of measured costs.

Third, although it is di¤cult to extrapolate the BR ¢ndings to formulate anaggregate ¢gure of regulatory costs, back-of-envelope computations indicatethat the BR ¢gures appear to be consistent with those obtained in other studies.The Weidenbaum/DeFina study found total 1976 regulatory costs to be morethan $125 billion (when measured in 1988 dollars).

The main contribution of the BR study is to illustrate the feasibility ofconstructing accurate incremental cost estimates from ¢rm-level ¢nancial data.With this micro-approach, it is possible to construct detailed cost estimatespertaining to a speci¢c regulation. As such, it becomes possible to understandbetter the precise impacts of regulation within and across di¡erent industries.

However, the cost of conducting large-scale audits of ¢rms a¡ected byregulation (essentially all ¢rms) would be extremely high and time-consuming.Perhaps selected audits of a few representative ¢rms could provide baseline costestimates that could then be extrapolated to produce aggregate ¢gures. A more

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serious problem with this approach is that ¢nancial audits provide little predic-tive power as to what future regulations will cost.

Engineering studies

Engineering studies provide a cheaper, more £exible alternative to ¢nancialaudits. Under this approach, engineers and other technical experts calculatethe incremental costs of a particular regulation for a typical ¢rm. This result isthen extrapolated across all ¢rms within an industry to arrive at a regulatorycost estimate.

One problem with this approach is that it assumes that all ¢rms will utilizethe same technology to achieve a regulatory goal. In reality, ¢rms may employradically di¡erent production techniques. This is especially true in industrieswhere capital depreciates relatively slowly. For example, within the steel indus-try there is a wide range of production technologies that are utilized in di¡erentplants.

Another problem is, once again, the formulation of a counterfactual; that is,it is di¤cult for engineers to make long-run predictions of what a productwould cost in the absence of regulation. For example, the federal governmentis currently phasing in regulations that mandate the installation of air bags inall automobiles (the Surface Transportation E¤ciency Act requires that driver-and passenger-side air bags be installed in all new cars by the 1998 model year,and in all light trucks by 1999). Although it may be relatively easy to measurethe cost of air bag installation, extrapolating this ¢gure across all cars soldwould overstate the cost of air bag regulation. This is because vehicle manufac-turers are already providing air bags in many automobiles not because ofregulation, but because of consumer demand.

Engineering estimates of regulatory costs have been used extensively in theautomobile industry. Crandall et al. review the evidence from both governmen-tal and industry sources when formulating their cost estimates of federal emis-sions standards. One component of these estimates is the cost of equipmentneeded to comply with emissions regulation. Other costs are more di¤cult toestimate, such as reductions in fuel economy, reliability, and product qualitythat result from pollution control equipment. Crandall et al. estimate the equip-ment costs of emissions regulation to be more than $650 per vehicle in 1984(measured in 1988 dollars). Accounting for other consumer costs created byemissions regulation ^ such as decreased fuel economy, increased maintenance,and higher fuel prices ^ raises this ¢gure to more than $1,800.40

Safety regulation also imposes a large cost burden on auto manufacturersand consumers. Crandall et al. estimate the equipment costs of safety regula-tion to be over $550 per vehicle in 1984, with an additional $130 in consumercosts due to increased maintenance and fuel costs. Thus, the cost of safety andemission regulations totaled nearly $2,500 in 1984.

Although measuring the ex post equipment cost of automobile regulation is

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relatively straightforward, it is considerably more di¤cult to estimate the costsof future regulations that require the implementation of new production tech-nologies. As an example of this phenomenon, consider the wide range ofestimates surrounding the debate over exhaust emissions from passenger carsand trucks. Over the past thirty years, polluting emissions from these vehicleshave been reduced by more than 90 percent, at an estimated equipment cost ofroughly $1,150 per vehicle in 1994 (measured in 1994 dollars and excluding theother consumers costs discussed above).41 Standards set forth in the Clean AirAct will reduce these emissions further in future years but at an unknown cost.

The California Air Resources Board (CARB) estimated that the requiredhardware modi¢cations to meet the more stringent emissions standards wouldaverage less than $500 per vehicle. Automobile manufacturers reported that,under the new standards, nearly all vehicles would require expensive electri-cally-heated catalysts or hydrocarbon traps that would raise the cost per vehicleby $6,500, or 13 times the CARB estimate. A third-party study took the middleground, declaring that CARB drastically underestimated the cost of new cata-lyst equipment, while automobile manufacturers drastically overestimated thelong-run e¤ciency gains of learning-by-doing. The third-party estimate con-cluded that the incremental cost of new regulatory standards would be slightlymore than $2,000 cost per vehicle, or roughly twice the cost of existing pollu-tion control equipment. Even CARB's $500 estimate illustrates the substantialdiminishing marginal returns to pollution control.42

Econometric studies

The fundamental problem with econometric studies is that e¤ciency losses maynot be the most appropriate cost measure to incorporate in a regulatory budget.The federal ¢scal budget makes no e¡ort to estimate e¤ciency costs, despite thefact that Congress and the president routinely enact ¢scal legislation that haslarge indirect e¡ects. For example, nearly every tax (and tax exemption) createseconomic distortions that give rise to e¤ciency losses. These indirect costs arenot re£ected in the ¢scal budget, which is simply an accounting statement thatdetails the direct expenditures and receipts of the federal government. Although¢scal budgets constrain the government's ability to tax and spend, they do notensure that these activities are done in ways that minimize indirect economicloss. Nevertheless, the ¢scal budget remains a critical component in determin-ing how expenditures will be allocated across government agencies. Further-more, few would contend that the ¢scal budgeting process does not impose auseful restraint on government spending.

Nevertheless, econometric studies provide the best indicator of the overallimpact of regulation. In addition to compliance costs, transfers, and deadweightlosses, some researchers have identi¢ed strong dynamic e¡ects of regulation.Speci¢cally, there appears to be a strong negative relationship between regula-tion and long-run economic factors, such as innovation and productivity

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growth. In one macroeconomic study, Gray ¢nds a signi¢cant negative rela-tionship between the rise of OSHA and EPA regulations and the decline inproductivity growth during 1958^78.43 He estimates that these regulations re-duced productivity growth in manufacturing by 0.44 percentage points per yearduring this period.

Although they do not help to explain the costs of individual regulations froma budgeting standpoint, macroeconomic studies such as Gray's provide someindication of the powerful, long-run e¡ects of regulation that are not capturedin more traditional cost measures. Improved data sources and computationalpower have increased the reliability of general and partial equilibrium models.Nevertheless, academic cost estimates for particular programs often varywidely; as such, their inclusion in a regulatory budget would likely introduceuncertainty and subjectivity into the budgeting process. Furthermore, therather esoteric assumptions required to estimate these models may give theimpression of statistical impropriety, limiting their usefulness in a budgetingprocess where transparency is highly valued.

A balanced approach

Ideally, a regulatory budget should rely on a variety of methods to estimateregulatory costs. Industry surveys and engineering studies can be used toevaluate the compliance costs of current regulations. RIAs conducted by theregulatory agencies can be used to approximate the costs of new regulations,with ¢nancial audits used ex post to verify the accuracy of the initial estimates.Over time, a systematic review process and regulatory cost databank will helpto develop a standard methodology of collecting and comparing cost informa-tion.

To facilitate this process, a government agency could serve as an `honestbroker,' a regulatory counterpart to the Congressional Budget O¤ce that gathersdata from federal agencies, industry, and academia to produce coherent esti-mates of regulatory costs. The O¤ce of Information and Regulatory A¡airs ^ adivision of the OMB set up to carry out the Paperwork Reduction Act ^ couldserve in this capacity. Estimates of indirect costs could also be gathered which,although not formally incorporated into the regulatory budget, could providemore information to the public and political decisionmakers about the ultimateimpacts of regulation.

Even without precise, complete cost estimates for all agencies, the bene¢t ofa uni¢ed database of regulatory cost information would be enormous. It wouldbe helpful if, in addition to the annual ¢scal budget, the federal governmentpublished a book of tables detailing regulatory costs across di¡erent agencies.This approach would cut through the fog surrounding many debates overregulatory cost, allowing easy comparison and evaluation of policy alternatives.

Although the bene¢ts of such information are obvious, the implementationof most regulatory decisions today occurs in a knowledge vacuum. Citizens,

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politicians, and regulators are often oblivious to the costs that new and existingregulations impose on society. A regulatory budget would help society appraisethe merits of various federal policies, while introducing badly-needed economicincentives into the regulatory process.

Objections to regulatory budgeting

As the adoption of a regulatory budget would represent a dramatic departurefrom `business as usual,' it faces considerable opposition from special-interestgroups. The following question-and-answer series examines some of the majorconcerns about this proposal.

Q: A regulatory budget is inherently `antiregulation.' It will be used to `roll back'the positive gains in areas such as worker safety, the environment, and consumerprotection.

A: The underlying tenets of economics are that society's wants are limitless,while the resources used to achieve these wants are limited. Sound, e¡ectivepolicy requires that our limited resources be allocated in the most e¤cientmanner to achieve our limitless wants. Because of this, it is not enough that aparticular regulation achieves some good; it must achieve more good than anyalternative use of society's resources.

Unfortunately, the current regulatory system provides little incentive forregulators to achieve such e¤ciency. Some regulations impose massive costson society with few resultant bene¢ts. As such, these costs could be better spenton more e¡ective programs. For example, OSHA regulation of formaldehydeas a hazardous substance is estimated to cost $72 billion (in 1984 dollars) perlife saved. Although each life is precious, this sum could have had a far greaterbene¢t to society if it were spent on more e¤cient regulatory programs, such asNHTSA regulations that govern passive seat-belt restraints (which cost only$300,000 per life saved). Alternatively, imagine the bene¢ts that $72 billioncould generate if allocated to programs such as infant immunization or tighterenforcement of drunken-driving laws. Without a budget constraint, regulatorsare not forced to examine these tradeo¡s across policies in any meaningful way.

Q: Regulators would be unable to respond to unanticipated (and therefore un-budgeted) health and safety risks until the next ¢scal year.

A: Although regulatory budgeting is intended to constrain the actions ofregulators, it is not intended to prevent agencies such as the EPA or FDA fromtaking actions to correct urgent health risks. Just as the ¢scal budget is supple-mented during times of natural disaster, so, too, can the regulatory budget bealtered to provide funds for unanticipated risks.

Q: By excluding indirect costs from the budget, it is possible that federal agencieswould increasingly enact programs that impose large indirect costs on society but

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small direct costs. An example: instead of requiring expensive emission controlson a hazardous-waste facility, a regulator might ban the facility outright. In thissense, regulatory budgeting could actually worsen the present situation.

A: Although this is clearly a concern, it is possible to check these distor-tionary e¡ects. For a regulator to shift its costs in this fashion, it must alreadypossess the discretion to do so. If regulatory budgeting was part of a largerreform package that restricted the ability of agencies to impose arbitrary indirectcosts, most of these theoretical problems could be averted.

The parallel between regulatory and ¢scal budgets is an important one.Regulatory budgets would acknowledge the direct costs of regulation in thesame sense that ¢scal budgets acknowledge the direct costs of taxation andde¢cit spending. Thus, the same political process that serves to constrain ¢scalactivity would also constrain regulatory activity. By doing so, the growingtendency of government to impose regulations that are costly to businessesand consumers (but do not contribute to budget de¢cits) would be reduced.

Q: There is no precise way to determine what the optimum level of regulatoryexpenditures should be. Therefore, the size of the regulatory budget could easilybe set too high or too low.

A: Although true, there is also no precise way to determine what the opti-mum level of ¢scal expenditures should be either. The fact remains, however,that budgeting decisions must be made. The ¢scal budget process has provideda mechanism through which the president and Congress can debate the meritsof various programs and, through a coalition process, arrive at a compromise.The same procedure could be used in allocating regulatory resources.

Q: Although regulatory budgeting acknowledges the costs of regulation, it stilldoes not require the government to pay for these costs through increased taxes orde¢cit spending. Because of this, government could arbitrarily increase the size ofthe regulatory budget without facing the traditional constraints of ¢scal budgeting.

A: Although this is a legitimate concern, several barriers prevent govern-ment from constantly expanding the size of the regulatory budget. First, thesize of the budget would be jointly determined by Congress and the President,not the regulators themselves. Increasing the budget would thus require acoalition of lawmakers, rather than the discretionary authority of a singleagency head.

Second, by making it subject to debate in the same manner as the ¢scalbudget, the regulatory budget will help bring the issue of regulatory costs tothe voting public. If better informed about the costs of regulation, voters couldmake better decisions about what policies (and thus what leaders) they support.An example of this phenomenon is o¡ered by the polling process. If asked,`Should the government require that ladders be made as safe as possible?' mostpeople would respond in the a¤rmative. But if asked, `Would you personally bewilling to pay additional taxes for a ladder with an added safety device?' thepoll results would likely change substantially.

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Another e¡ective constraint on the regulatory budget would be to tie it to the¢scal budget. For example, the rate of growth in the regulatory budget could beset equal to the rate of growth in federal spending. In any event, by bringing thedirect costs of regulation to the surface, there will be increased incentive forlawmakers and voters alike to check the presently unconstrained growth inregulatory costs.

Q: Regulatory budgeting blurs the line between private and public funds. Byformalizing the regulatory budget process, the power of regulators to tax ¢rmsand individuals is legitimized and institutionalized.

A: This concern is largely philosophical, and may never be e¡ectivelyanswered. Although such taxation already takes place, the acknowledgment ofsuch activity as appropriate and normal could potentially encourage furtherencroachment of government into traditionally private-sector activities. How-ever, if one believes that informed voters make more intelligent decisions, it ishard to justify that the best costs are hidden costs. Instead of legitimizing thespending of private money by the federal government, regulatory budgetingwould likely serve as a wake-up call to those who have unconditionally sup-ported the actions of regulatory agencies, while remaining unaware of thesubstantial ine¤ciencies of certain regulatory actions.

Conclusion

As the answers to the preceding questions illustrate, the regulatory budget isbest viewed as an extension of the ¢scal budget. The ¢scal budget is an im-perfect process, but nevertheless provides an essential constraint to the actionsof the executive and legislative branches. Imagine if each senator could spendas much money as he or she desired, and that these expenditures were subject toonly cursory review. Sadly, this ine¤cient state of a¡airs provides a gooddescription of how the current regulatory process functions.

A regulatory budget, as part of a larger regulatory reform package, wouldserve to check the excesses of government regulation. More importantly, itwould ensure that the public receives more bene¢t per dollar spent on health,safety, the environment, and other critical areas.

Notes

1. Hazilla, Michael and Raymond J. Kopp (1990). `Social cost of environmental quality regula-tions: a general equilibrium analysis,'Journal of Political Economy 98: 4, pp. 853^873.

2. Crandall, Robert W. (1991). After the Breakup. Washington D.C.: Brookings Institution, pp.132^144.

3. Weidenbaum, Murray L. and Robert DeFina (1978). `The cost of federal regulation of eco-nomic activity.'American Enterprise Institute, May.

276

4. The Seventh Annual Report of the Council on Environmental Quality, p. 166; The Fifth AnnualReport of the Council on Environmental Quality, p. 175.

5. Weidenbaum, Murray (1977). Business, Government, and the Public. Englewood Cli¡s, N.J.:Prentice-Hall, p. 48; U.S. Department of Labor, Bureau of Labor Statistics.

6. Fourth Annual McGraw-Hill Survey ^ Investment in Employee Safety and Health, cited in TimeEngel,OSHA: An Overview, American Conservative Union Issues Analysis Series (June 1977),p. 7; A. J. Thieblot (1971). The Davis-Bacon Act: The Economics of Prevailing Wage Laws.Washington, D.C.: American Enterprise Institute, p. 3, 6.

7. Kessel, Reuben (1975). `Economic e¡ects of federal regulation of milk markets,'Journal of Lawand Economics, October, p. 56; Posner, Richard (1975). `The social costs of monopoly andregulation,'Journal of Political Economy 83: 4, p. 807.

8. Grabowski, H. and J. Vernon (1976). `Consumer protection regulation in ethical drugs,' (un-published paper), pp. 3^4; Peltzman, Sam (1973). An evaluation of consumer protectionlegislation: the 1962 drug amendments,'Journal of Political Economy, October, p. 1090.

9. Fair Employment Compliance (1976), December 25, p. 2; Alstyne, Carol Van and SharonColdren (1976). The Costs of Implementing Federally Mandated Social Programs at Collegesand Universities.Washington D.C.: American Enterprise Institute.

10. Harbeson, Robert W. (1969). `Toward better resource allocation in transport,' Journal of Lawand Economics, October, pp. 322^334.

11. Posner, Richard (1975). `The social costs of monopoly and regulation,' Journal of PoliticalEconomy 83: 4, pp. 807^827.

12. Mintz, Ilse (1973). U.S. Import Quotas: Costs and Consequences.Washington D.C.: AmericanEnterprise Institute, p. 20.

13. Comanor, W. and B. Mitchell (1972). `The costs of planning: the FCC and cable television,'Journal of Law and Economics, April, p. 177.

14. Wharton Econometric Forecasting Associates, Inc.,Wharton Short-Term Econometric ModelPost-Meeting Forecast Review, June 1, 1977).

15. Smith, Robert S. (1976).The Occupational Safety and Health Act.Washington, D.C.: AmericanEnterprise Institute.

16. MacAvoy, Paul W. (1970). `The e¡ectiveness of the federal power commission,'Bell Journal ofEconomics, Autumn, p. 274.

17. Commission on Federal Paperwork (1977). Final Summary Report.Washington, D.C.: Govern-ment Printing O¤ce, p. 5.

18. Hahn, Robert W. and John A. Hird (1991). `The costs and bene¢ts of regulation: review andsynthesis,'Yale Journal on Regulation,Winter, pp. 233^278.

19. Posner. `The social costs of monopoly and regulation,' p. 807.20. Hazilla and Kopp. `Social cost of environmental quality regulations,' pp. 853^873.21. Crandall, Robert W., Howard K. Gruenspecht, Theodore E. Keeler and Lester B. Lave (1986).

Regulating the Automobile.Washington, D.C.: Brookings Institute, pp. 27^43.22. Crandall, Robert W. (1988). `What ever happened to deregulation,' in David Boaz, ed. Assess-

ing the ReaganYears.Washington D.C.: CATO Institute, pp. 271^290.23. Denison, Edward F. (1979). Accounting for Slower Economic Growth: The United States in the

1970s.Washington D.C.: Brookings Institution, pp. 72^73.24. Cited in Robert E. Litan and William D. Nordhaus (1983).Reforming Federal Regulation. New

Haven: Yale University Press, pp. 183^189.25. Peltzman. An evaluation of consumer protection legislation,' p. 1090.26. Hufbauer, Gary Clyde, Diane T. Berliner and Kimberly Ann Elliott (1986).Trade Protection in

the United States: 31 Case Studies. Washington, D.C.: Institute for International Economics,pp. 14^15.

27. Wenders, John T. (1987).The Economics of Telecommunications:Theory and Policy. Cambridge:Ballinger, pp. 63^92.

28. Gardner, B. (1987). Protection of regulatory Agriculture:Why, How, and Who Loses?. Univer-sity of Maryland Department of Agricultural and Resource Economics Working Paper No.87^15.

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29. Morrison, Steven A. and Cli¡ord Winston (1989). `Enhancing the performance of the deregu-lated air transportation system,' Brookings Papers on Economic Activity: Microeconomics 1,pp. 61^123.

30. Winston, Cli¡ord (1985). `Conceptual developments in the economics of transportation: aninterpretive survey,'Journal of Economic Literature 23, March, p. 57^94.

31. President's Commission on Privatization: Toward More E¡ective Government, 113 (1988).32. MacAvoy, Paul W. (1977). Federal Milk Marketing Orders and Price Supports. Washington

D.C.: American Enterprise Institute, p. 97^112.33. Hopkins, Thomas D. (1991). `Cost of regulation.' Rochester Institute of Technology Working

Paper, December.34. Woolhandler, Ste¤e and David V. Himmelstein (1991). `The deteriorating administrative

e¤ciency of the U.S. health care system,'New England Journal of Medicine 324: 18, May.35. Rutledge, Gary L. and Christine R.Vogan (1994). `Pollution abatement and control expendi-

tures, 1972^92,'Survey of Current Business, May, pp. 36^49.36. Environmentals Investments: The Cost of a Clean Environment. Washington, D.C.: Island

Press, 1991.37. Weitzman, Martin L. (1994). `On the ` environmental'' discount rate,' Journal of Environmental

Economics and Management 26: 2, March, pp. 200^209.38. Environmental Quality ^ 1980. Council on Environmental Quality, December 1980, pp. 393^

400.39. 1988 dollars. U.S. Environmental Protection Agency. `Final report: the cost of clean air and

water: report to congress 1984.' Washington: U.S. Environmental Protection Agency, May1984), cited in Michael Hazilla and Raymond Kopp, `Social cost of environmental qualityregulations: a general equilibrium analysis,'Journal of Political Economy, vol. 98, no. 4, 1990.

40. Crandall et al.Regulating the Automobile, pp. 30^38.41. Fauth, Gary (1994). `Regulating the automobile: learning from cost-e¡ective analysis,' Busi-

ness Economics, October, pp. 23^28.42. Ibid.43. Gray, Wayne (1987). `The cost of regulation: OSHA, EPA and the productivity slowdown,'

American Economic Review, December, pp. 998^1006.

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