On Balance: Looking Below the Surface at Regulatory Compliance Costs

 June 26, 2019

By: Ann Wolverton

Academic researchers and government institutions have both encouraged retrospective analysis of the costs and benefits of regulation to facilitate evidence-based review and possibly revision of the design and stringency of existing regulations (White House 2012; Morgenstern 2015). However, rigorous examples of these types of ex post analyses are relatively rare. This post describes a study comparing the retrospective costs (evaluated ex post) of a U.S. Environmental Protection Agency (EPA) regulation to the cost estimates reported during the regulatory process (calculated ex ante). These findings are reported in more detail in a recent article, “Retrospective Evaluation of the Costs of Complying with Light-Duty Vehicle Surface Coating Requirements,” published in the Spring Issue of the Journal of Benefit Cost Analysis, with co-authors Nathalie Simon and Ann E. Ferris.

In recent years, the EPA has attempted to conduct retrospective cost analysis systematically by developing a framework that identifies the main cost components and key questions analysts should ask when evaluating them ex post.  (The framework is described in detail in an article from a 2014 Special Issue of the Journal of Benefit Cost Analysis, Retrospective Cost Analyses of EPA Regulations: A Case Study Approach.)

The current study compares the EPA’s ex ante estimates of the direct costs of compliance with the 2004 National Emission Standard for Hazardous Air Pollutants (NESHAP) for automobile and light-duty truck surface coating to ex post estimates. Our ex post estimates are based on compliance data for nine assembly plants. Data were collected via a pilot survey and follow-up interviews. Unlike many prior retrospective studies on the cost of regulatory compliance, we used this information to identify key reasons for differences between the ex ante and ex post estimates.

We find that the EPA substantially overestimated the cost of complying with the 2004 NESHAP for the plants we surveyed. The difference in costs is largely attributable to the fact that plants chose to pursue a compliance strategy that differed from the one EPA predicted would dominate ex ante. Specifically, plants chose to reformulate their coatings to emit fewer hazardous air pollutants (HAPs) rather than install end-of-pipe abatement control technology in their paint shops. The ex ante analysis does not offer a clear explanation for why EPA thought firms would install the more expensive end-of-pipe option except to note the possibility that reformulation would have hard-to-quantify indirect costs such as loss of market share over time due to lower quality coatings. We found no evidence of coating quality issues ex post.

While the plant managers surveyed found it relatively easy to identify the method used to comply with the standard, they struggled to estimate the cost of compliance (i.e., the cost of reformulation for the plants we surveyed). One reason for this response was that adoption of a lower-HAP formulation required no additional actions on the part of plant engineers. However, given that paint suppliers conducted research and development (R&D) over several years to design and refine lower HAP formulations, manufacturers likely paid more for these coatings. To delve more deeply into this issue, we interviewed two paint suppliers that reformulated coatings for several leading manufacturers. Suppliers confirmed that R&D costs were passed on to manufacturers in the form of higher paint prices. We found that the EPA’s ex ante estimates of the cost of reformulation tended to be at the lower end but within the range of the ex post cost estimates provided by the paint suppliers.

Because we surveyed only 9 of the 37 plants subject to the 2004 NESHAP at the time of our study, it was not possible to produce an aggregate ex post compliance cost estimate. However, we identified several reasons why it is likely that ex ante compliance costs were similarly overestimated for the industry as a whole. First, while the EPA analyzed compliance on a plant-by-plant basis, many firms pursued a corporate-wide strategy of reformulating coatings, which implies that the EPA’s assumption that plants would use an end-of-pipe technology to meet the standard is also likely incorrect for the plants we did not survey.

Second, the standards were “performance-based” rather than prescribing a specific technology; individual plants could choose how to comply with emission limits. Since ex post reformulation was less expensive than the end-of-pipe technology, it is likely that many plants pursued the lower cost abatement option. It is also worth noting that exogenous factors such as high workforce costs, increasing pressure from foreign competition, and a mismatch between the vehicles consumers wanted and what firms produced caused many plants to close, shrinking the regulated universe from the 60 plants that were originally subject to the rule.

The study provides ex post evidence on compliance costs for one environmental regulation, but the findings suggest how ex ante analyses, in general, might be improved. For instance, when lower-cost technologies are in development, evaluating what would occur if they became widely available could help regulators assess whether cost estimates are robust to alternative scenarios. In addition, better understanding of how investment decisions are made within an industry could help inform the question of whether it is more appropriate to assume compliance decisions are made at the plant or corporate level.

Ann Wolverton is a senior economist at the National Center for Environmental Economics at the U.S. Environmental Protection Agency. She received her Ph.D. from the University of Texas at Austin.

Disclaimer: The views expressed in this paper are those of the author(s) and do not necessarily represent those of the U.S. Environmental Protection Agency (EPA).