Using Net Benefit Accounts to discipline agencies: a thought experiment.

• Author: Posner, Eric A.

Executive orders extending back to 1981 direct regulatory agencies to perform cost-benefit analyses of major regulations, (1) and to comply with the analyses when not barred by statute, as is usually the case. (2) Indeed, some statutes require cost-benefit analysis, and courts increasingly have demanded it even when the statutes are vague. (3) Yet, though agencies issue cost-benefit analyses more frequently than in the past, and though their analyses tend to be more sophisticated, there is no evidence that regulatory performance has improved since 1981. (4)

One hypothesis for the lack of regulatory improvement is that the executive orders do not contain effective enforcement mechanisms. The regulatory process gives agencies the power to set the agenda, and institutional specialization gives agencies superior information about the effects of regulations. As a result, agencies can, in effect, make take-it-or-leave-it offers to the President (really, the Office of Management and Budget (OMB)). Agencies thus can formulate regulations so that they are better, from the OMB's perspective, than the status quo, while being biased in favor of the agencies' regulatory goals, rather than the requirements of cost-benefit analysis. The OMB cannot punish the agency without undermining the President's own political goals. And although legislation and judicial enforcement can improve agencies' incentives, legislators and judges are also vulnerable to the agencies' strategic and informational advantages.

If this portrait is accurate, supporters of cost-benefit analysis need to give greater attention to enforcement issues than they have in the past. (5) In this Article, I sketch out a mechanism for increasing agency incentives to comply with cost-benefit principles, so that agencies are more likely to issue cost-justified regulation, rather than reporting cost-benefit analyses while in fact ignoring the results, or complying by providing shoddy cost-benefit analyses designed to rationalize the agency's behavior. The proposed mechanism is, at this point, not fully worked out, but rather is intended as a thought experiment to provoke further discussion. (6)

Under my proposal, agencies would be given what I will call "Net Benefit Accounts" (NBAs). These are budget-like devices for accounting for the benefits and costs that regulations produce over time: the benefit of every regulation would take the form of an addition to the agency's NBA, and the cost would take the form of a subtraction. Agencies would be required to keep positive balances in their NBAs. Agencies with large surpluses in their NBAs would be permitted to draw down a portion of the surplus for the purpose of issuing cost-unjustified regulations for which the agency has a strong preference.

The NBA idea is not entirely new. It shares some of the characteristics of the "regulatory budget," an idea that has been knocked about in the literature for more than twenty years. (7) Under the regulatory budget proposal, agencies would not be able to issue regulations that in the aggregate impose costs on regulated entities greater than a ceiling enacted periodically by Congress. The regulatory budget system does not reflect the benefits generated by any particular regulation. By contrast, the NBA reflects both the benefits and the costs of each particular regulation. (8)

NBAs have, in the best case, two advantages over the status quo. First, they serve an auditing function: they aggregate information about agencies' regulatory activities in a way that facilitates monitoring by elected officials and commentators. The aggregation of information distinguishes the NBAs' auditing function from that of ordinary cost-benefit analysis as it is used in the status quo. Second, NBAs potentially improve the incentives of agencies to comply with cost-benefit analyses by rewarding them when they issue "socially valuable" regulations. (9) The current enforcement system, by contrast, depends not on systematic incentives, but rather on ad hoc intervention by the political branches when an agency's regulation fails cost-benefit analysis.

The NBA system is, however, not a panacea. It would entail significant implementation problems, similar to those that afflict the regulatory budget proposal. (10) But given the potential advantages of the NBA system, and given the fact that the system is different enough from regulatory budgets to warrant separate consideration, I believe that NBAs could contribute to both cost-benefit scholarship and practice.

1. THE PROBLEM

   I will assume that agencies conceive of themselves as having a "mission"--into protect the environment, to help farmers, to ensure that drugs are safe and effective, and so forth. (11) In formal terms, agencies have preferences for policy outcomes that are generally more interventionist than those of the median voter or elected official. By contrast, some commentators assume that the preferences of agencies are determined by industries or groups that "capture" them, or by the political ambitions of the officials appointed to head them; or, conversely, by some general conception of the public interest. (12) Although all these factors clearly play a role--and there are agencies that do seem to be controlled by political appointees, such as the early Reagan-era EPA--I will stick to my simpler assumption.

   If my assumption is correct, then it seems clear that when the EPA (for example) evaluates potential regulations, its conclusions will sometimes violate the results of a cost-benefit analysis. Put most simply, EPA officials will value some environmental amenity like clean air more than citizens do, as determined by studies of health benefits and the like. As a result, the EPA will want to regulate at a higher level than that which would be justified by a cost-benefit analysis. To rationalize the regulation, the EPA will be tempted to appeal to nonmonetizable benefits excluded from the cost-benefit analysis by standard practice, or to argue that the cost estimates used in the cost-benefit analysis are exaggerated.

   A president or Congress that has the political will could punish agencies that issue cost-unjustified regulations. (13) Agencies enjoy strategic advantages over these actors, however. Agencies have a first-mover advantage. They look for problems, and they are generally the first to propose a regulation. The President and/or Congress can reverse, or interfere with, a proposed regulation ex post, but the agency generally will craft a proposed regulation so as to make elected officials slightly more than indifferent between implementation and nonimplementation (and years more of delay). Regulations will, then, tend to fall short of optimality, though perhaps not as much as if no cost-benefit analysis were performed and the agencies were completely autonomous. (14)

2. A PROPOSED SOLUTION: NET BENEFIT ACCOUNTS

   As a partial solution to these problems, I propose that each agency be given a Net Benefit Account. An NBA is an account that holds fictive dollars to which a regulation's social benefits are added and from which its social costs are subtracted. The NBA system is designed to force agencies to internalize (in a political, rather than financial, sense) the benefits and costs imposed by their regulations on industry and other groups.

   Let me start with an example. Suppose that an agency has a certain mission to do X (protect the environment, enhance food safety, etc.). Congress gives the agency two separate budgets. (15) The first budget covers its ordinary operating expenses, such as the cost of office space and salaries for employees. This budget consists of actual dollars, to be used to pay these expenses. The second budget goes into an NBA. This budget consists of fictive dollars. For simplicity, let this amount be 100.

   Under current executive orders, an agency performs a cost-benefit analysis whenever it issues a major regulation. Under the NBA system, the agency's own cost-benefit analysis is audited, either by a separate government agency like the General Accounting Office (GAO) or Office of Information and Regulatory Affairs (OIRA), or by a private accounting firm. (16) The audit verifies that the agency has followed good practices, such as relying on peer-reviewed studies and using consistent assumptions when calculating the impact of regulations. This audit, through its reliance on crude, bright-line rules, would permit only an approximation of the true social value of the regulation, just as audits of business firms permit only an approximation of the firms' financial health. If the regulation passes the audit, the agency's figures would be used for NBA calculations. If not, the auditor would either ask the agency to revise its figures or the auditor would substitute its own figures for those of the agency in NBA calculations. (17)

   Let's suppose the first hypothetical regulation produces benefits of 40 and costs of 30 over one year (at which point it expires). This means that it produces a net benefit of 10, over...