The EPA’s Benefit/Cost Jihad on U.S. Electric Utilities
[Ed. Note: Also see Mr. Vaughn's previous post: The U.S. EPA’s Regulatory Clean Air Benefit-Cost Estimates (30 free lunches for the price of 1?)]
President Obama’s deferment of the EPA’s latest ozone standards puts on hold annual compliance costs that the Agency estimated at $90 billion by 2020. The Wall Street Journal termed the $90 billion figure an “undoubtedly lowball estimate.” 
Undoubtedly, to be sure (more on that in a moment). Even so, it’s news when the EPA ‘fesses up to costs as serious as $90 billion, instead of estimating chump change, such as the $0.8 billion a year estimated for the proposed “Clean Air Transport Rule” (CATR) aimed at utilities.
Getting Into the Numbers
The $0.8 billion estimate has flown under the media’s radar but—in its own way—merits more media attention than the $90 ozone number. That’s because the $0.8 billion plays the role of denominator in the EPA’s nuttiest claim of all time: a benefit-cost ratio of 350-to-1 for a proposed regulation written under the Clean Air Act (CAA). Playing the role of numerator in that ratio are $280 billion of annual (mostly human health) benefits. 
Heretofore, the EPA’s benefit-cost ratios for its CAA regulation were only about one-tenth as grandiose—in the vicinity of 35-to-1.  Even 35-to-1 is mind-boggling enough but 350-to-1? That’s the equivalent of a private-sector CEO claiming that the company’s latest “must-have” gizmo will attract 350 willingly-paid dollars out of customers’ wallets for every dollar’s worth of resources consumed in the process—or $349 of pure profit out of every $350 of revenue. Wall Street would dismiss that CEO as obviously delusional.
The EPA, however, caters not to Wall Street cynics but to audiences wanting to believe that yet another CAA regulation will crank out phenomenal benefits at almost no cost. So, in that respect, the 350-to-1 claim is just more of the same from the EPA. But, the ratio is so obviously way-over-the-top that it signals something way out of the ordinary: a jihad against the regulated power industry.
Obama vs. the Math
A 350-to-1 benefit/cost ratio thumbs its nose at the Obama Administration’s latest directive to reconsider seriously actions that might impose “unjustified costs.”  What Agency is going to reconsider a regulation after claiming that benefits outweigh costs by 350-to-1?
That ratio puts President Obama in an uncomfortable position: question the EPA’s benefit/cost methodology in front of his base of faithful enviros or be seen by the rest of the public taking seriously a claim that—if actually true—would mean:
- Annual CATR benefits would “cover” compliance costs in a few hours. Annual benefits of $280 billion work out nearly $0.77 billion a day. At that rate, benefits would cover the entire $0.8 billion increase in Americans’ electric bills (as the compliance costs get passed along) in a mere 25 hours after the New Year rings in!
- Annual CATR benefits will go from $0 to more than twice annual Iraq War expenditures in only two years. According to the Congressional Budget Office, the U.S. spent $124 billion in 2007 conducting the Iraq war—including “the surge” approved by then-President George Bush. More than twice that amount of CATR benefits ($280 billion) will be rolling in during 2014—scarcely two years from right now.
- Total annual benefits from all CAA regulations can approach the economy’s entire annual GDP. A long list of enormous estimated human health benefits for now-existing CAA regulations precede the EPA’s enormous benefits estimate for the proposed CATR. Adding all the benefit estimates together shows that the American people would be willing to spend more than four-fifths of the country’s entire gross domestic product (GDP), rather than do without the health benefits from already-existing CAA regulations. 
Taking into account the dollars Americans spend directly on doctors, hospitals, prescription drugs and so on, shows that Americans would be willing to spend approximately 100% of the GDP on health care, leaving approximately $0 to spend on such discretionary items as food, shelter, and clothing. And, that’s before the CATR would add annual benefits more than twice what Americans spend on dental care.
I could continue with my numerical scoffing but why bother? Anyone willing to spend even a moment’s reflection on the implications flowing from the EPA’s off-the-wall benefit numbers can easily deduce that those estimates are pure fantasy.
EPA’s Compliance Costs
But, what of the EPA’s estimated compliance costs—the denominator of the benefit/cost ratio? One must snap on the green eyeshades to explain why and how the EPA’s accounting procedures are designed to produce laughably-low estimates of direct compliance costs. But, snapping on the eyeshades also makes eyes glaze over. So, right about now, you may want to reach for another cup of coffee.
The Wall Street Journal’s reference to the EPA’s ozone compliance cost estimate—“$90 billion by 2020”—makes unwitting reference to the Agency’s primary abuse of regulatory cost accounting. Sure, the $90 billion figure gets attention (which is why The Journal mentioned it) but who cares about 2020?
Certainly not President Obama. He’s interested in 2012—specifically November 2012. Therefore, President Obama’s deferment of the ozone standards must mean that the compliance costs for 2012 are much higher than the $90 billion for 2020.
But, you won’t hear from the EPA just how much higher. The EPA has always couched its cost, benefit, and resulting B-C ratio estimates in terms of a single year of its own choosing—and always for a year that poses it the least political problems. For ozone, the EPA anointed 2020. For CATR, the EPA anointed 2014 —not as distant as 2020 but still several months after November 2012.
Net Present Value of Cost Streams, Not Isolated Single-Year Annual Costs
NERA Economic Consulting in a May 2011 study done for the American Coalition for Clean Coal Electricity estimates that the EPA’s related CATR and MACT (Utility Maximum Achievable Control) proposals would have a net present value of $184 billion (in $2010).  The EPA’s RIAs on CATR and MACT reference annual compliance costs of $0.8 billion in 2014 for CATR and $10.9 billion in 2016 for MACT. 
The major difference between NERA and the EPA analysis lies—not in their disparate dollar estimates—but in their units of measure: net present value of multi-year cost streams (NERA) vs. annual cost for a single year (EPA).
NERA points out—correctly—that adoption of the CATR and MACT proposals would increase compliance costs indefinitely into the future. Hence, the net present value of this prospective multi-year cost stream is the appropriate measure.
In a true benefit/cost ratio estimate, the net present value of the cost stream would occupy the denominator and in the numerator would be the net present value of the prospective multi-year benefit stream. And, this true benefit/cost ratio estimate would apply right now—in 2011—and, so, provide truly useful information to Americans on the proposed regulation’s prospects for making them better (or worse) off on net.
But, the EPA resists net present values of multi-year cost (and benefit) streams as tenaciously as a Three-Card-Monte dealer resists the loss of two of his three cards. Estimating net present values would close off the accounting trick that the EPA uses in the shadows of its opaque RIAs to lowball cost estimates: “allocate” as many costs as possible to years other than the anointed year.
EPA’s anointed year also bears the weight of the estimated benefit/cost ratio; e.g., the estimated 350-to-1 ratio for CATR compares estimated benefits for 2014 and estimated costs for 2014. What about benefit-cost ratios for years like 2013, 2015, 2016, 2017 and so on? Fuhghedaboutem. The EPA certainly has.
EPA Gimmickry: Browner to Jackson
Up-front capital expenditures are the single most important category of direct compliance costs and are the cost dollars most abused by the EPA’s “allocation” scheme. Research and development (R&D), new capital equipment, product redesign, product testing, factory retooling all must be done before arrival of the regulatory deadlines (if the companies are to meet those deadlines).
The EPA’s menu of accounting gimmicks keep from the anointed year (and, hence, also from the benefit/cost ratio) most, and sometimes all, of these up-front costs. Nothing quite pumps up a benefit/cost ratio estimate fed to unsuspecting media than $0 of included up-front capital expenditures.
EPA benefit/cost studies are notorious for ignoring second-round impacts; e.g., the impacts on industries that buy the regulated products or services as inputs. Less commonly recognized, however, is that the Agency’s benefit/cost ratios also exclude gobs of first-round cost impacts.
The EPA has been cranking out benefit/cost ratio estimates shorn of up-front capital expenditures for a very long time. For instance, in 2000 with Carol Browner as Administrator, the EPA executed this scam to perfection in estimating (a relatively paltry 16-to-1) benefit/cost ratio that included exactly $0 of up-front capital expenditures.
Browner’s regulation targeted the emissions of nitrous oxides (NOx) and particulate matter (PM) from heavy-duty diesel trucks and buses. That regulation’s RIA allocated the up-front capital expenditures over the first few years that would follow the initial appearance of compliant vehicles—taking care in that process to allocate $0 of those expenditures to 2030 (a nuance the EPA overlooked in its December 2000 press release). For obscure and economically-irrelevant reasons, the EPA anointed 2030 to bear the weight of its benefit/cost ratio estimate.
Who in 2000, besides the EPA’s accounting wizards, cared a fig about 2030—some three decades into the future? The directly-regulated companies (and their customers) cared far more about 2007—the first year that compliant vehicles had to show up in the marketplace per the EPA’s diktat.
For the proposed CATR, Lisa Jackson’s EPA allocates nearly $0 of up-front capital costs to the benefit/cost ratio, instead of the literal $0 allocated by Carol Browner’s EPA to the benefit/cost ratio for the heavy-duty diesel rule. The EPA’s estimate of $0.8 billion in annual costs for CATR covers the up-front capital costs along with “annual incremental operating expenses.” 
So, the EPA’s mysterious “capital recovery factor” allocates an unspecified amount of up-front capital costs that must be somewhere between $0 and $0.8 billion. Suppose, for the sake of argument, that capital costs account for more than half of the $0.8 billion—say, $0.5 billion. The EPA’s analogue to annual revenues—$280 billion of benefits—would “recover” capital costs in less than a day. That’s literally unbelievable.
In short, the EPA’s once again allocated the vast majority of up-front capital costs to years other than its anointed year (2014, in this particular case). That ploy ensures the end result will be “undoubtedly” a “lowball” cost estimate.
That ploy would be impossible, however, if the EPA estimated the net present value of the CATR’s compliance cost stream, as done by the NERA study. An honest net present value would provide a credible cost number, relevant for voters ahead of the November 2012 election.
Election Politics ….
For that very reason, the EPA won’t provide such a cost estimate. Doing so would explode the myth that the CAA’s historical benefits exceed costs by around 35-to-1 (let alone by 350-to-1).
An honest cost number would also hinder the EPA’s jihad against the U.S. electric power industry. Its 350-to-1 benefit/cost ratio serves as a rallying cry for the faithful, not as an honest estimate for the sober-minded to consider before the November 2012 elections.
 U.S. Environmental Protection Agency (EPA): Office of Air and Radiation, Regulatory Impact Analysis for the Federal Implementation Plans to Reduce Interstate Transport of Fine Particulate Matter and Ozone in 27 States: Correction of SIP Approvals for 22 States, EPA-HQ-OAR-2009-0491, June 2011, p. 1. Depending on the discount rate applied in the analysis, “the benefits outweigh social costs from 150 up to 350 to 1, or from 110 up to 335 to 1.”
 For instance, see Fred Krupp, President, Environmental Defense Fund, “The New Path Forward on Climate Change,” November 16, 2010: “There may be no greater governmental success story than the Clean Air Act. The benefits of that law to our economy and our health have outweighed costs by more than 30 to 1.”