1987-11-01

Risk Analysis Under Executive Order No. 12291 872530

Executive Order No. 12291 requires that the federal regulatory agencies undertake a cost-benefit analysis of any proposed social regulation to show that its benefits exceed its costs. This paper outlines the essential elements of a cost-benefit analysis; describes the key regulatory actors, namely Congress, the Office of Management and Budget, and the regulatory agencies; assesses the quality of the regulatory analyses performed under the Order; and concludes by offering ten recommendations to improve social regulation.On February 17, 1981, within a month of entering office, President Reagan issued Executive Order No. 12291 as part of his program for regulatory reform. The Order requires a cost-benefit analysis of any major proposed regulation in order to determine if “the potential benefits to society for the regulation outweigh the potential costs to society.”(1) Despite this presidential mandate, six years later the exercise of cost-benefit analysis by the federal regulatory agencies remains limited and haphazard. Additionally, the role of the Office of Management and Budget in administering the Order has come under fire.The topic of this paper is the process by which the federal government analyzes and promulgates social regulations--that is, regulations of hazards to health, safety, and the environment--under Executive Order No. 12291. First, I review the critical steps in the application of cost-benefit analysis under the Order. Second, I examine the interaction between the Congress, the Office of Management and Budget, and the key regulatory agencies, focusing on the response of the agencies to the Executive Order and its promotion of cost-benefit analysis. Third, I assess the quality of the regulatory analyses that the agencies have performed so far under the Order. Fourth, and last, I offer ten recommendations for the improvement of the analysis of social regulation. (The reader already familiar with the subject might choose to skip the first two sections.)I do not examine the merits of cost-benefit analysis in the abstract, but rather its use in the current regulatory environment.(2) In particular, I do not scrutinize the appropriateness of economic efficiency as the objective of social regulation, nor the basic assumptions of welfare economics.The principal motivation behind the promulgation of Executive Order No. 12291 was, in fact, the enhancement of the “efficiency” of governmental regulations.(3) The Order expressly specifies that the objective of regulation is “to maximize the net benefits to society.”(4) Given limitations on the resources that society is willing and able to direct against hazards, it makes sense to employ these resources as effectively as possible, that is, to get the “biggest bang for the buck.”(5) As the Regulatory Program of the President argues: [W]e cannot eliminate death. Because the amount of money we can spend to reduce risks will always be limited, we can extend the most lives only if we reduce risks in the most cost-effective way possible. If we spend money or impose costs that reduce risks inefficiently, we will waste opportunities to save or extend lives and we will reduce our standard of living from what it could be if we were efficient. It is not enough that a regulation simply reduces risk; a regulation must reduce risks in the most efficient way. Otherwise, society would be better off making different kinds of life-extending investments.(6) A first level of efficiency addresses the allocation of resources across different regulatory programs and agencies. Proponents of cost-benefit analysis and the Executive Order regularly point to the wide disparity between the cost per life saved of different regulations as evidence of their inefficiency. Redirection of resources, they argue, from the costlier to the cheaper, more effective programs would allow society to protect the same number of people at lower total cost, or, alternatively, to save more people at the same cost.Despite this argument from its advocates, Executive Order No. 12291 does not oversee the efficient allocation of resources between programs; it does not directly compare the effectiveness of different programs. Instead, the Order contemplates a second level of efficiency, namely the optimal level of stringency of a given regulation per se. It asks, for example, “How strict should be the limit on emissions of a particular pollutant?” and not, “Should the government devote greater resources to the control of this pollutant when it confronts more important hazards?” The requirement of the Order is simply that each individual regulation have a positive net benefit, that is, that its benefits exceed its costs.(7) There are two ways to think about the advantages of this rule.First, if the benefits of a regulation exceed its costs, then in theory the government could tax those who receive the benefits by an amount equal to the costs, and then fully compensate those who bear the costs. The latter will end up even, and the former, ahead. In effect, the program is creating wealth. (In practice, of course, compensation does not occur.)Second, the theoretically optimal level of stringency of a regulatory standard occurs where the marginal benefit of tightening or relaxing the standard equals the marginal cost of so doing. In practice, to determine this optimal point precisely is difficult. However, one can show that a shift in the level of stringency that generates positive net benefits represents an improvement over the previous level of stringency, and thus movement closer towards the optimal point.(8)

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