A game theoretic analysis of alternative institutions for regulatory cost-benefit analysis.

• Author: Johnston, Jason Scott
• Position: Federal government

INTRODUCTION: RE-VISIONING THE COST-BENEFIT CONTROVERSY

How and whether federal regulators consider both the costs and benefits of regulation has become a central issue in proposals to reform the federal administrative state. To the horror of many labor and environmental group leaders, the Bush administration began by rescinding or withdrawing several high profile workplace and environmental rules and announcing the practical death of the Kyoto Treaty on global warming. These actions were justified on the ground that the measures' benefits were far outweighed by their economic costs. (1) Those executive branch decisions followed quickly on the heels of the United States Supreme Court's recent decision that Congress does not impermissibly delegate its legislative authority when it bars federal agencies from considering the cost of regulations. (2)

These recent events have elevated the public prominence of the debate over regulatory cost-benefit analysis. That debate, however, has been with us since the day the first wave of late twentieth-century federal health and environmental statutes were passed. Executive orders requiring agency cost-benefit analysis have been a significant feature of the regulatory landscape since the Nixon administration. (3) Requiting regulations to undergo rigorous cost-benefit analysis was one of the foundations of the Contract with America on which House Republicans successfully campaigned during the 1994 midterm elections. The 104th Congress failed in its attempt to enact a statutory "supermandate" (4) requiring that all new federal regulations be justified by cost-benefit analysis. (5) It did succeed, however, in requiring all federal agencies to disclose rulemakings to Congress and include a cost-benefit analysis with any "major" rulemaking (one determined by the Office of Management and Budget to involve at least $100 million in economic costs). (6) Although congressional attempts to amend specific statutes to require that regulatory standards be cost-benefit justified have failed, (7) Congress has recently funded a three-year pilot project in which the General Accounting Office will conduct an independent cost-benefit analysis of all "economically significant" regulations (those with an economic impact of $100 million or more).

With policymakers focusing so much attention on regulatory cost-benefit analysis, it is not surprising that legal commentators have recently undertaken important reevaluations of whether and how cost-benefit analysis should be done. Before his appointment to the United States Supreme Court, Justice Breyer published an influential book skewering the apparent irrationality of the Environmental Protection Agency's risk regulations. (8) According to Justice Breyer's figures, (9) the Environmental Protection Agency (EPA) often promulgated regulations whose benefits were miniscule in comparison to the costs they imposed on the affected industry, and failed to regulate many risks that scientists felt were serious and should be regulated. To solve the problem, Breyer proposed a super-agency composed of experts who would evaluate the actual costs and benefits of risk regulation, and then prioritize regulations according to their net social benefits. Similarly convinced that "under any measure, there can be no doubt that resources for risk reduction are badly allocated," (10) Professor Sunstein has advocated the enactment of a federal statute requiring that all federal agencies must at least consider and balance regulatory costs against regulatory benefits. (11) More recently, Sunstein has argued that by frequently either requiring cost-benefit analysis in statutes or interpreting existing statutes to at least allow agencies to consider compliance costs in standard-setting, the federal courts and Congress may have made such a statutory supermandate unnecessary: the "cost-benefit" state may already be here. (12) Indeed, although some analysts have attempted to provide a rigorous normative justification for regulatory cost-benefit analysis, (13) much of the recent literature on federal regulation takes regulatory cost-benefit analysis as a given, and compares how agencies actually do cost-benefit analysis with various conceptions of how they should do so. (14)

Other commentators criticize the failure of particular statutes to explicitly require cost-benefit analysis. Because nationally uniform federal pollution standards fail to take account of the actual costs and benefits of pollution control in particular localities, they have long been criticized as inefficient. (15) As a number of scholars have recently pointed out, however, supposedly uniform national environmental standards are in practice subject to tremendous regional variation that reflect primarily the varying cost of compliance. (16) Some argue that since the costs of environmental regulations inevitably enter the regulatory process sub rosa--as regulatory cost-bearers and beneficiaries lobby the President, Congress and the agency, and engage in protracted litigation if a rule is actually finalized--the consideration of costs should become an explicit part of the agency's statutory mandate. (17)

Despite this general enthusiasm for regulatory cost-benefit analysis, little work has yet been done analyzing how the actual behavior of regulatory agencies is likely to be affected by alternative institutional requirements for cost-benefit analysis. Many cost-benefit advocates seem to think that it is obvious that if statutes were amended to require regulatory agencies to analyze the costs and benefits of their proposed rules, then those agencies would promulgate fewer regulations. These advocates further assume that these few regulations would be "better," because agencies would have taken a better and more detailed account of the real economic costs of regulatory compliance. (18) But there has been neither empirical nor theoretical investigation of these conjectures.

This gap in the literature is especially striking given the fact that regulatory cost-benefit analysis is in fact already required by both a series of executive orders (19) and recent federal statutes. (20) Under those orders, through its Office of Information and Regulatory Affairs (OIRA), the White House Office of Management and Budget (OMB) has come to specialize in regulatory cost-benefit analysis. But in the eyes of OMB's critics, it does not conduct an open and objective cost-benefit analysis, but rather provides a closed, nonpublic forum for regulated firms to present only their side--the cost side--of the story. (21) There have been all sorts of proposals to reform the OMB regulatory review process. (22) Yet as with proposals to make cost-benefit analysis a statutory requirement, there has been little if any empirical or theoretical analysis of how OMB review influences the behavior of regulatory agencies. (23)

In this Article, I address these gaps in the literature by using the tools of game theory to model how regulatory decision making is likely to vary both with statutory type--whether the statute explicitly requires cost-benefit analysis--and with the substantive expertise and procedural openness of OMB review. I model notice-and-comment rulemaking as a sequential game. This game begins with (1) the agency's decision whether to propose a rule, proceeds through (2) a lobbying stage in which both the agency and regulatory targets lobby the executive and legislative branches, and ends with (3) a decision by the regulatory target on whether or not to seek judicial review of the regulation. In this game, regulatory targets possess private information as to the cost of compliance and have two opportunities to block regulation. Their first chance is provided by a lobbying contest that is initiated by (and sometimes even before) a regulation is proposed. Here, they attempt to increase the political costs to the agency from going forward with the regulation as proposed. If they fail to kill the regulation, then targets have an opportunity to seek judicial review of the regulation. Although simplified, this sequential game captures many of the key strategic features of the regulation game, and generates a number of nonintuitive insights into agency rulemaking incentives under alternative institutional environments.

The model is first employed to analyze agency rulemaking incentives under a benefits statute versus a cost-benefit statute. (24) It is important to begin with a clear idea of what I mean by these terms. Under a benefits statute, the agency is commanded to focus only on gross, not net regulatory benefits. Under section 101 (a) of the Federal Water Pollution Control Act Amendments of 1972, for instance, Congress instructed the EPA to eliminate totally the discharge of pollutants into the navigable waters of the United States by 1985, and "wherever attainable" to bring all such waters up to fishable/swimmable quality by 1983. (25) Likewise, under section 109 of the Glean Air Act (as amended in 1990), the EPA is instructed to set primary national ambient air quality standards (NAAQs) at that level "which ... allowing an adequate margin of safety, are requisite to protect the public health." (26) Neither of these statutory provisions makes any mention of the cost of achieving their ambitious goals. They are, in my terminology, benefits statutes.

There are two species of cost-benefit statutes. Under what I shall call a substantive cost-benefit statute, the agency is explicitly instructed to balance the costs and benefits of alternative standards for reducing environmental or health risks, and to set the standard at a "reasonable" level. One illustration of a substantive cost-benefit statute is provided by the Flood Control Act of 1936. The Act instructs the Army Corps of Engineers to "improve or participate in the improvement of navigable waters ... for flood-control purposes if the benefits to whomsoever they may accrue...