In April, President Biden issued an Executive Order on Modernizing Regulatory Review with some critical steps to help update and improve guidance for agency rulemaking processes. As part of this action, the Office of Management and Budget (OMB) has proposed updates to Circular A-4, a bedrock guidance document, which will greatly improve how federal agencies account for the benefits and costs of their actions and therefore better serve the public interest.
What is Circular A-4?
Dating back to the 1980s, cost-benefit analysis has been an integral part of how federal agencies evaluate the impacts of different regulatory options and inform decisions on which ones to move forward based on maximizing net benefits (unless there is a statutory requirement to use a different approach). OMB’s Circular A-4 is a critical guidance document for these regulatory cost-benefit analyses, and it has not been updated in twenty years. This document, which remains obscure to most of the public, is nevertheless crucial to how agencies evaluate the costs and benefits of decisions that affect all our lives. The Office of Information and Regulatory Affairs (OIRA) is the specific arm of OMB that is tasked with providing guidance and reviewing all agency regulations, including the cost-benefit analyses, to make sure they meet statutory and legal requirements.
Undoubtedly, cost-benefit analyses have shortcomings, including their inability to fully account for benefits and costs that are hard to monetize but nevertheless significant. Decisions about which benefits and costs get counted and the underlying assumptions used to estimate those costs and benefits can significantly affect the outcome of these analyses–and have important equity and justice implications. And, of course, on issues where public health is the overriding concern (e.g. for regulating toxic chemicals), health-based standards are the legal requirement and economic considerations must be secondary. Nevertheless, there are many applications of cost-benefit analyses where sound principles and guidance can help inform better decision-making to protect people and the environment.
OIRA’s proposal to update Circular A-4 makes significant strides in improving the methodology and data used to guide the evaluation of costs and benefits and ultimately the choices made by agencies. The proposed updates are especially critical to help ensure that environmental and public health priorities are better and more equitably accounted for in our policymaking processes, in line with the latest science and economics. There are also some areas for improvement that could make this guidance better when it is finalized.
OIRA has also proposed accompanying updates to circular A-94, which provides general guidance on the use of cost-benefit analysis for certain categories of federal actions, which are not regulatory in nature, including guidance on discount rates, treatment of uncertainty, treatment of inflation and measuring the economic incidence on households and businesses. This, too, has not been updated in twenty years.
Four significant improvements proposed
The new Circular A-4 guidance is a significant revamp and expansion of the previous guidance and includes several important improvements. In a preamble to the guidance, OMB lays out its rationale for these changes. Below are four major areas of improvement in the proposal:
- Changes to the discount rate which will help ensure that agencies are using a more appropriate discount rate and taking better account of intergenerational equity. As the guidance notes, when benefits or costs occur in different time periods, they cannot simply be added together, and an appropriate discount rate must be applied to translate future dollar values to their value today. Generally, impacts that occur closer in time to today are understood to have a higher value for people. However, the choice of discount rate matters and the higher the discount rate applied, the lesser is the value of costs and benefits that occur far in the future relative to those that occur today. This can materially affect choices we make today that could have impacts far into the future. OMB’s current guidance for discount rates applied to costs and benefits occurring at different times is to apply a 3%-7% discount rate, depending on whether society’s perspective or private entities’ perspectives are being considered in a particular circumstance. The updated proposed guidance lowers the discount rate to reflect current economic realities, the latest economic thinking, and the need to address intergenerational equity for impacts that cut across longer time periods. As it notes, the ‘real (inflation-adjusted) rate of return on long-term U.S. government debt provides a fair approximation of the social rate of time preference.’ Based on treasury returns over the most recent 10-year period, which are much lower than for previous periods used in the old guidance, this results in a proposal for the social rate of time preference to be pegged at 1.7%. The update also proposes to eliminate the use of the capital discount rate (currently estimated at 7%) and replace it with the shadow price of capital, reflecting the latest economics. And finally the proposal recognizes that there are special ethical considerations involved when costs and benefits occur across generations. To address intergenerational equity, the proposal aims to reflect the latest economic thinking and is taking comment on some options including whether to use a declining discount rate.
- Methodologies for conducting distributional analyses that will help ensure a more equitable assessment of costs and benefits to different populations. The old circular A-4 guidance gives very short shrift to distributional analyses even though it recognizes that the costs and benefits of regulatory actions often are not borne equally by different segments of the population. The reality is that, to date, most agency rulemakings have not included such distributional analyses. The proposed guidance recognizes the importance of undertaking analyses that break down impacts by group based on income, which is often the most tractable pathway. But it also notes that other approaches might be more appropriate in certain circumstances. “Other economic and demographic categories such as those based on race and ethnicity, sex, gender, geography, wealth, disability, sexual orientation, religion, national origin, age or birth cohort, family composition, or veteran status—among others—may be relevant to a particular regulation.” Where possible and appropriate, an analysis of incidence could usefully be extended to include some of these categories. In addition, there is guidance on how to set baselines for doing distributional analysis and how to conduct a weighted cost-benefit analysis reflective of the marginal utility of income for populations with different income levels (recognizing than an extra dollar is more valuable for a person with lower income than a richer person). This more substantive guidance provides a much more solid basis for agencies to undertake these kinds of distributional analyses and integrate them into regulatory cost-benefit analyses, although it stops short of requiring it.
- Much more thorough consideration of transboundary effects of regulations which is a huge improvement and is especially critical in the context of global challenges like climate change. The updated proposal goes a long way toward providing greater context and justification for regulatory cost-benefit analyses to consider the full geographic scope of the impact of regulations beyond the boundaries of the U.S. It recognizes that U.S. citizens and residents can be affected by regulatory impacts beyond U.S. geographic borders; and that the U.S. might have strategic interests in recognizing transboundary effects especially when seeking reciprocal action from other nations and in the context of regulations to address global commons issues.
- Better treatment of uncertainty in evaluating the benefits, costs and incidence of regulatory actions. The guidance recognizes the importance of including uncertain effects to ensure robust analysis, rather than just eliminating or minimizing impacts that have uncertainty attached to them. It calls for ‘credible, objective, realistic, and scientifically balanced’ analysis of uncertainty. This includes presentation of a range of scenarios if appropriate and clearly noting when irreversibility is material to the material to the analysis, such as when ‘regulating an exhaustible resource or an endangered species.’
The OMB is also undertaking a careful process of external peer review and public comment on this proposal, which will help ensure that the final guidance is technically robust, serves the public interest, and is durable across future administrations. In a forthcoming action, OMB will also be issuing Guidance for Assessing Changes in Environmental and Ecosystem Services in Benefit-Cost Analysis and is now accepting nominations for independent experts to participate in scientific peer review of this guidance.
The President’s Executive Order also directs OIRA, working together with relevant agencies, to take steps to help ensure more inclusive public participation in regulatory processes, including for underserved communities.
Room for further improvement
While the proposal to update Circular A-4 makes important strides forward, there are some areas where further improvements are needed. Four specific aspects that OMB should address in the final proposal are:
- Regular updates to the risk-free consumption discount rate as the 30-year average Treasury rate changes over time.
- Adoption of a declining discount rate schedule for longer time horizons, in keeping with the latest economic literature on this topic
- Clearer guidance on conducting distributional analysis of the impacts of regulations, including specifying when to require it instead of just leaving it optional, and providing more direction on how to incorporate distributional impacts for historically marginalized and disadvantaged communities. Distributional analyses should be a requirement for health and safety related regulations. Given the clear evidence of racial disparities in exposure to pollution and consequent negative health outcomes in our nation, especially for Black, Latino and Indigenous populations, it is critical that distributional analyses are not simply done on the basis of income.
- Specifically calling for a regular cycle of updates based on the best available science and economics
Why these changes matter
Our nation’s ability to move forward policies that safeguard the broad interests of the public and improve the well-being of all people depends on the tools and frameworks we use to inform regulatory decisions.
Examples abound for how the current outdated Circular A-4 guidance has fallen short, leading to less protective regulations and even regulations that exacerbate long-standing inequities and injustices. The cost-benefit analyses used by the US Army Corps of Engineers, using the monetized value of property and infrastructure to calculate the costs and benefits of its investments, have left lower income communities less well defended from flooding than richer communities. EPA regulations have not adequately protected the health of EJ communities marked by a legacy of structural racism. Investments in climate action that will be critical for the well-being of our children and grandchildren are heavily discounted and made to seem less beneficial by applying inappropriately high discount rates.
OMB has a unique opportunity now to finalize robust, science-based, and equitable guidance through critical updates to Circular A-4. We look forward to these much-needed and long-overdue changes and improvements being finalized expeditiously so agencies can implement them, and we can all reap the benefits of better policies and regulations.