Cost-benefit analysis (CBA) is a tool used by regulatory decision makers to identify the costs and benefits, in financial terms, of a regulation to society as a whole. Persons preparing a CBA attempt to assign a monetary value (also know as monetizing) to all the predicted costs and benefits of a regulation. These include not only the direct costs and benefits, but any tangential effects a regulation may impose on society. In evaluating the effects on society, CBA includes costs and benefits to industry, government, individual citizens, communities, the environment, and the economy at large.
CBA is most useful when compared to another CBA. Federal agencies will often prepare multiple CBAs each for a different regulatory alternative.
CBA is required under the current set of guidelines governing the federal regulatory process. Executive Order 12866, Regulatory Planning and Review, calls for a CBA to be prepared for any "significant" proposed regulation. (For more, click here.) The E.O. also requires CBAs for regulatory alternatives.
CBA is one tool regulatory decision makers use in determining how to move forward on a proposed regulation or whether to move forward at all. Decision makers use CBA as an important consideration in pursuing regulations. CBA, as it is used in regulatory decision making, primarily produces two measurable conclusions: cost effectiveness and net benefits.
Cost effectiveness is a conclusion decision makers can draw only when considering multiple regulatory approaches. Cost effectiveness is measured as a ratio of benefits to monetized costs. In the cost effectiveness measure, benefits are not monetized. The cost effectiveness ratio only needs to compare a monetary cost to a quantifiable benefit (such as reduction in cases of cancer, or lives saved).
When decision makers compare the cost effectiveness of multiple regulatory alternatives, they can determine one to be the most cost-effective. This will be the one for which the benefit to cost ratio is the highest. In plain terms, the most cost-effective alternative is the one for which society gets the biggest bang for its buck.
Cost effectiveness should not be confused with overall effectiveness. The most cost-effective alternative may have minor benefits so long as the costs are low in proportion to those benefits. The most overall effective alternative is the one for which the benefits are the greatest.
The net benefits measure derives one figure for each regulatory alternative. The net benefits measure is the difference between the monetized costs and monetized benefits of a regulatory alternative. The net benefits measure is expressed in dollars.
The idea of CBA is entrenched in the federal regulatory process. CBA in rulemaking began to take hold during the presidency of Ronald Reagan. Executive Order 12866, signed by President Bill Clinton in 1993, created the current precedent for CBA in rulemaking.
The George W. Bush administration has produced more formal guidelines for agencies producing CBA and has focused the analysis on the net benefit calculation. In 2003, the White House Office of Management and Budget (OMB) issued Circular A-4 which details methods for identifying costs and benefits as well as exactly what should be included in an agency's CBA. In the guidance, OMB refers to the combination of CBA and other information as "regulatory analysis."
A regulatory analysis is to include a statement of need for a rulemaking, an identification of regulatory alternatives, and an identification of costs and benefits. Circular A-4 goes into great detail concerning each of these aspects of the analysis. Regulatory analysis also requires the development of a baseline for comparison purposes and an identification of "distributional effects." According to Circular A-4, "The term 'distributional effect' refers to the impact of a regulatory action across the population and economy, divided up in various ways (e.g., income groups, race, sex, industrial sector, geography). Benefits and costs of a regulation may also be distributed unevenly over time, perhaps spanning several generations."
Under Executive Order 12866, agencies are to produce and provide to OMB's Office of Information and Regulatory Affairs (OIRA) a regulatory analysis for any significant regulatory action. For more on that process, click here.