Economic Failure at U.S. EPA: NAM Study Raises the Hard Questions

By Travis Fisher -- January 9, 2013

A recent study commissioned by the National Association of Manufacturers critically assessed the U.S. Environmental Protection Agency’s cost- benefit analysis with respect to six key regulations: Utility MACT, Boiler MACT, Coal Combustion Residuals, the Cross-State Air Pollution Rule, Cooling Water Intake Structures, and Ground-Level Ozone. The NAM study details the significant differences between EPA’s cost estimates and those of industry sources, while highlighting problems and inconsistencies with EPA’s methodology. Most importantly for manufacturers, the study estimates the impact of EPA rules on the manufacturing industry, directly and through indirect macroeconomic effects.

A key finding of the report is that “the annual compliance costs for all six regulations range from $36 billion to $111.2 billion (by EPA estimates) and from $63.2 billion to $138.2 billion (by industry estimates).” Notably, the study was picked up in the trade press and recognized by the House Energy and Commerce Committee, which reiterated the study’s finding that “major new EPA rules could cost manufacturers hundreds of billions of dollars and eliminate millions of American jobs.”

Textbook Regulation: Forgetting Government Failure

The NAM study acknowledges significant gains in air and water quality in the United States since the creation of the EPA but contends that federal regulators are up against steeply diminishing returns.

After more than 40 years of improvement in air and water quality, further progress is still possible. But how much more? What would be the benefits? And at what cost? Economics is about making the best use of scarce resources, and public policy formulation must heed its implications: policy decisions may produce economic benefits, but they also impose costs. Economics also teaches the theory of diminishing marginal returns, which holds that even though an additional unit of input may generate more output, there is a point beyond which the addition to total output from each new increment of input begins to decline. These economic concepts are relevant to the public’s understanding of the implications of these emerging EPA regulations.

Or, as Julian Simon put it when he discussed the trade-offs of dealing with pollution:

Economists conceptualize the reduction of pollution as a social good that can be achieved technologically but costs resources.  The question before us is: What is the optimal level of pollution, in light of our tastes for a cleaner environment relative to our desire for other goods?

Given the likely reality of diminishing returns to more regulation, and the increasing costs of tighter controls, EPA may not be acting in the public interest in chasing lower emissions standards or mandating new control technology. The low-hanging fruit has been picked. In textbook econ terms, regulating beyond the point where MB = MC leads to a reduction in net benefits, i.e., a situation where society is worse off.

The authors argue that the EPA consistently goes beyond the goal of maximizing net benefits into the uneconomic territory of maximizing total benefits (focusing on slowly increasing benefits, while ignoring quickly increasing costs). “Rather than aim for the optimal regulation level,” NAM states, EPA “seeks to maximize the total benefit of regulation without giving much consideration to the net benefit to society, which declines with too much regulation.”

This is certainly troublesome. But it shouldn’t be surprising to anyone familiar with Public Choice economics, an intellectual tradition (and school of thought led by Nobel Laureate James Buchanan) that takes the romance out of politics. In this case the romantic idea is that the EPA acts purely in the public interest (and maximizes net benefits to society, for example).

The unromantic reality is that the EPA is a bundle of individuals whose incentives and intentions may have very little to do with the public interest. For instance, many have cited the EPA’s (political) “War on Coal” despite coal’s overwhelmingly positive impact on society.

Seen through the public choice lens, real-world regulation suffers from government failure in its quest to address market failure. The cure might be worse than the disease, particularly in the context of diminishing returns as outlined by NAM.

Executive Order Rhetoric vs. EPA Action

The NAM study also highlights the inconsistencies between the EPA’s actions and the Administration’s rhetoric in Executive Order 13563, which calls for regulators to:

1)      Ensure the benefits of a regulation are worth the costs (positive net benefits);

2)      Tailor regulations to make them less burdensome;

3)      Choose approaches that maximize net benefits;

4)      Base regulations on outcomes rather than behavior (in the clean air context, think emissions levels rather than technology standards); and

5)      Identify alternatives to direct regulation (the ol’ Cass Sunstein “nudge”).

As the study recalls:

In January 2011, President Obama issued Executive Order 13563, entitled “Improving Regulation and Regulatory Review.” Among the Executive Order’s “General Principles of Regulation” is the requirement that regulators “must identify and use the best, most innovative and least burdensome tools for achieving regulatory ends.”

Contrasting the above quote with statements from the EPA, the study notes:

In describing its Utility MACT rule in the Federal Register in 2011, the EPA wrote: “We may determine it is necessary to regulate under section 112 even if we are uncertain whether [the rule] will address the identified hazards. We believe it is reasonable to err on the side of regulation of such highly toxic pollutants in the face of uncertainty.”

Section 112 of the Clean Air Act requires the use of a technology standard for controlling hazardous air pollutants (which includes mercury after the “appropriate and necessary” finding in 2000). But the technology standard is in direct opposition to Executive Order 13563, which is not completely meaningless – it was invoked to put the EPA in its place when it false-started on ground-level ozone regulation in 2011.

As the EPA summarizes: “The 1990 Clean Air Act Amendments revised Section 112 to first require issuance of technology-based standards for major sources and certain area sources.” (emphasis added) So the EPA continues, “in the face of uncertainty,” its very expensive command-and-control approach to regulation despite President Obama’s direction to reconsider technology standards.

In contrast to a different publicly stated goal of the President – transparency – recently resigned EPA Administrator Lisa Jackson apparently used an alias email account under the name “Richard Windsor.” Does this bizarre story square with the President’s goal to “usher in a new era of open government”?

Underestimated Costs, Uncertain Benefits

For each of the six targeted regulations, the NAM Study compares the EPA’s cost estimate with the estimate from industry. The results are:

• Utility MACT ($9.6 billion vs. $11.9 billion)
• Boiler MACT ($1.9 billion vs. $2.7 billion)
• Coal Combustion Residuals ($1.5 billion vs. $7.6 billion)
• Cross-State Air Pollution Rule ($3.6 billion vs. $14-18 billion)
• Cooling Water Intake Structures ($0.3-4.6 billion vs. $8 billion)
• Ground-Level Ozone ($19 billion vs. $1 trillion).

The study provides a list of reasons why industry and the EPA differ in their expectations of the cost of EPA regulations:

[C]ompared to industry estimates, the EPA (1) includes more aggressive assumptions about the capacity of the industry to comply; (2) underestimates the true likely impact of the financial burden on the industry by assuming long-term amortization of capital requirements; (3) excludes real compliance costs attributed to compliance with other rules when those rules remain in doubt or under legal risk; and (4) fails to account for the costs of its regulations on the broader economy.

To the first point, one of the more egregious assumptions the EPA makes is that technology will be able to detect the level of emissions that it is mandating. The study references comments in the EPA docket and a report by the Competitive Enterprise Institute:

According to recent testimony from one such company requesting that the EPA reconsider its Utility MACT mandates, “The current state-of-the-art CEMS [continuous emissions monitoring systems] technologies available and referenced in the [EPA’s Utility MACT] rule are not capable of measuring emissions levels needed to comply with the new limits.” According to industry experts, Utility MACT’s mercury limit is at a level one-third of the detection level of current monitoring technology. For acid gases, the emissions limit is almost 20 times below the detection limit.

The Competitive Enterprise Institute report explains what that means:

[P]ollution control vendors cannot issue guarantees that their equipment will achieve compliance with the regulation. Without such guarantees, investors cannot be sure that new generating units will be in compliance with EPA regulations.

The benefits side of the EPA’s calculation is no better. First, it relies heavily on “co-benefits” from reducing fine particulate matter, or “PM2.5,” which is regulated under an entirely separate rule. Second (looking past the co-benefits issue for a moment), it assigns huge benefits to reductions in PM2.5. However, the causal link between public health and PM2.5 is uncertain, and not all fine particles are created equal. As the NAM study points out:

The EPA’s estimated benefits are not statistically significant. The ranges of the estimated benefits are widely distributed, and therefore, the midpoints used by the EPA are meaningless.

I should note that after the NAM Study was published, the EPA proposed new, even tighter regulations on PM2.5. Here is a link to the NAM press release.

(Un)Economic Impact of EPA Regulation

The study, performed on behalf of NAM, naturally focuses on the economic impact of the EPA’s major rules on U.S. manufacturing. And the effects are large – as the study notes:

We estimate that the manufacturing sector accounts for $8.8 billion and nearly 40 percent of total annualized compliance costs per year for Utility MACT, Boiler MACT and CCR. We also estimate that the manufacturing sector will account for $54 billion of the $141.8 billion upfront capital expenditures to comply with the three rules. This is a significant burden for the manufacturing sector, particularly given the fragile state of the U.S.economy.

Agreed, but unless we want to take a trip on the negative railroad, the right economic impact to focus on when analyzing policy is the impact on the consumer. Sometimes producers complain and consumers come out unscathed or even better off. But in this case a NERA study estimates double-digit percentage increases in both electricity and natural gas prices.

And since electricity and natural gas are ubiquitous production inputs, an increase in their prices means (all else equal) an increase in the price of just about everything, not just higher utility bills.

Conclusion

The EPA increasingly appears to be working against the public interest and ignoring the directives of its own Administration. On a crusade, it charges forward with expensive rules amid a sour economy and despite scientific uncertainty.

With a second term for President Obama and a new Administrator of his choosing, it’s anyone’s guess what the EPA will look like in the coming years. We can hope it will listen to its Administration, to the critics of its cost-benefit analysis methods, or at least to common sense.