EVALUATING REGULATORY PERFORMANCE: LEARNING FROM AND INSTITUTIONALIZING RETROSPECTIVE ANALYSIS OF EPA REGULATIONS.

AuthorAldy, Joseph E.
PositionThe EPA at Fifty Symposium

CONTENTS INTRODUCTION I. PERFORMANCE OF CLEAN AIR ACT POLLUTION MARKETS A. Types of Pollution Markets B. Why Focus on the Clean Air Act's Pollution Markets? C. Lead Credit Trading Program D. Sulfur Dioxide Cap-and-Trade Program E. NOX Budget Trading Program F. RECLAIM Cap-and-Trade Program G. Renewable Fuel Standard II. Learning from Pollution Markets' Experiences A. Do pollution markets minimize compliance costs? B. How Much Have Pollution Markets Reduced Pollution? C. Do Cost-Effective Emission Reductions Potentially Increase Damages? D. How do Imperfectly Competitive Markets Influence Pollution-Market Performance? E. What Happens to Pollution Markets Subject to Shocks? F. What Are the Labor Market Impacts of Pollution Markets? G. How Have Pollution Markets Adapted to New Information? III. Institutionalizing Retrospective Analysis A. The Need for Retrospective Analysis B. Planning for Ex Post Analysis of Regulations C. Targeting Rules for Retrospective Analysis CONCLUSION INTRODUCTION

A well-functioning environmental regulatory program makes the American people better off by protecting the air we breathe, water we drink, and food we eat. If markets work well in allocating resources, then government regulation is unnecessary. Indeed, government intervention in well-functioning markets will likely make society worse off by imposing costs that exceed their benefits. If markets do not work well, as evidenced by negative externalities such as pollution, then government regulation has the potential to remedy the market failure and make people better off. But such regulatory success is not guaranteed. A poorly designed regulation, even if motivated by a market failure, could result in costs that exceed its benefits and may exacerbate the welfare losses. A well-designed regulation, however, can improve the welfare of affected people and attempt to deliver what the market would if it were not suffering from negative externalities.

Identifying the need for environmental regulation and crafting effective interventions has relied on assessments of regulatory impacts dating back to the Carter Administration. (1) Since 1981, the Environmental Protection Agency (EPA) has assessed the benefits and costs of its major regulatory actions. (2) These assessments typically include monetized, quantified but not monetized, and qualitative characteristics of the expected benefits and costs, which can address the fundamental economic question of regulatory policy: does the regulation increase social welfare? Of course, the EPA promulgates rules under a variety of statutory authorities, (3) and a regulatory impact analysis can illustrate how a given regulatory action delivers on a statutory objective. In conducting analysis at the regulatory development stage, the EPA and stakeholders--through public comment on proposed rules--can identify less costly ways of achieving a societal goal. The evaluation of regulatory impacts, as well as prompt guidance from the external Science Advisory Board, can also inform the EPA's research agenda so that the EPA, and, in turn, the public, can better understand the environmental and public-health benefits and costs to firms subject to agency regulations.

EPA regulations may fall short of maximizing net social benefits, even if the Agency's major rules typically produce monetized benefits greater than their monetized costs. (4) The EPA promulgates regulations subject to its statutory authority, which in many cases places constraints on how it can design its regulation. A statute may prohibit an explicit consideration of benefits and costs in the design of regulations. (5) Alternatively, a statute may prescribe the regulatory intervention and provide little discretion to the EPA. (6) As a result, some regulations may fail to deliver a socially efficient level of environmental protection but nonetheless result in net social benefits.

There may also be cases in which the social costs exceed the social benefits. In that case, regulatory impact analysis can highlight opportunities for legislative reform. The EPA's regulatory impact analyses of proposed rules typically provide rigorous evidence addressing key policy questions: Do regulations deliver on the nation's environmental goals established in statute? Do they maximize net social benefits? Do they achieve their goals at the lowest possible cost? While the EPA has an impressive track record in undertaking prospective analyses of proposed regulations, the Agency, like many federal regulators, has a significantly weaker record in evaluating the performance of existing rules. (7) Every administration dating back to President Carter's in 1978 has implemented some form of retrospective review of regulations; yet there is little doubt that the EPA dedicates less attention to retrospective review than it does to prospective review. (8)

This is a critical issue in the context of environmental regulations. The EPA--or, in the case of carbon-dioxide-tailpipe and fuel-economy standards, the EPA and the Department of Transportation--has issued nearly one-third of all major federal regulations between 2007 and 2016. (9) These rules represent an even larger fraction of the monetized benefits and costs of federal regulatory actions. At least 80% of the prospective benefits and at least 66% of the prospective costs of federal regulations result from the EPA's regulatory actions to improve the environment. (10)

In addition, some environmental statutes authorize periodic review and updating, which could benefit from rigorous examination of the performance of the regulation in practice. For example, the Clean Air Act authorizes the EPA to review and revise, when necessary, the national ambient-air-quality standards for criteria pollutants, such as fine particulate matter and ozone, every five years. (11)

To illustrates ways of rigorously evaluating the performance of environmental regulations, in this Article I focus on the lessons from the policy innovation of pollution markets under the Clean Air Act. While the EPA began experimenting with some more flexible approaches to air-quality-regulation compliance in the 1970s--such as the "netting" of emissions across new and existing sources within a facility and the opportunity for new emissions sources in non-attainment areas to "offset" their emissions by reducing emissions at existing sources (12)--they were only mildly successful. (13) The EPA expanded the role of market-based instruments in the 1980s, and cap-and-trade and tradable performance standards have played important roles in implementing ambitious reductions of lead in gasoline and sulfur dioxide and nitrogen oxides at power plants. (14)

The ex post evaluations of the EPA's air-pollution markets in the academic literature provide rigorous evidence about the environmental, public-health, and economic impacts of these rules. These studies inform regulators, legislators, stakeholders, and the public on the performance of one of the most significant policy innovations of the EPA's first fifty years. Moreover, this research highlights credible approaches for estimating the causal impacts of environmental regulations that can inform how the EPA can plan for and design retrospective evaluations in future regulatory actions.

The next Part synthesizes the academic literature on the performance of Clean Air Act pollution markets. Part II draws lessons for the design of pollution markets and Part III draws lessons for institutionalizing retrospective analysis in future regulatory developments.

  1. PERFORMANCE OF CLEAN AIR ACT POLLUTION MARKETS

    1. Types of Pollution Markets

      The two most common approaches to creating pollution markets under the Clean Air Act have been tradable performance standards and cap-and-trade programs. (15) Tradable performance standards establish a rate-based standard--such as grams of a pollutant per gallon of gasoline or pounds of a pollutant per megawatt-hour of electricity--that serves as the benchmark for trading. (16) If a firm produces pollution at a rate below this standard, then it can generate credits that can be sold to other firms who may produce pollution at a rate above this standard. For compliance purposes, firms must demonstrate that a combination of their own performance and purchased credits satisfy the standard. (17) A secondary market for credits can arise in which the credit prices signal to firms opportunities for reducing pollution at lower cost. The quantity of credits generated and sold thus depends on the technological capacity of and economic incentive for firms to reduce their pollution and sell credits to other firms.

      A cap-and-trade program limits the aggregate emissions of regulated firms by establishing a fixed number of tradable emission allowances--equal to the program's overall cap--which are typically allocated to firms either as a function of their historic emissions or via an auction. (18) Firms may buy and sell allowances, but they must surrender allowances to the government to cover their emissions in order to comply with the program. The cap creates scarcity in the right to pollute, which drives the allowances' prices on the secondary market where firms buy and sell the allowances.

      These pollution-market approaches may appeal to policymakers and regulators for a variety of reasons. First, pollution markets circumvent a fundamental information problem confronting the regulator. The firms responsible for air pollution typically have much better private information about their opportunities for abating pollution than the EPA does. They also lack an incentive to share this private, firm-specific information with the regulatory agency. As a result, the EPA cannot effectively target and tailor pollution abatement obligations on a firm-by-firm basis. Instead, the Agency typically imposes a one-size-fits-all technology or performance standard, which risks a high cost per unit of pollution abated. (19)...

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