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Canadian Cost-Benefit Analysis Guide: Regulatory Proposals (view source)

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'''<big>We have archived this page and will not be updating it.</big>'''

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You can use it for research or reference. Consult our Cabinet Directive on Regulations: Policies, guidance and tools web page for the policy instruments and guidance in effect.</blockquote>

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==Introduction==

The ''Canadian Cost-Benefit Analysis Guide'' is provided for the use of federal departments and agencies as they perform cost-benefit analysis to support regulatory decisions. The guide incorporates the evolution of regulatory policy and developments in the analysis of the impacts of regulations in Canada and elsewhere over the past decade. In November 1999, the Government of Canada instituted the policy that a cost-benefit analysis must be carried out for all significant regulatory proposals to assess their potential impacts on the environment, workers, businesses, consumers, and other sectors of society.<ref>Government of Canada, Privy Council Office, ''Government of Canada Regulatory Policy'', November 1999.</ref> Regulatory authorities must make a convincing case that the regulatory approach recommended is superior to non-regulatory alternatives. They must demonstrate not only that the benefits to Canadians outweigh the costs, but also that they have structured the regulatory program so that the excess of benefits over costs is maximized.

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In Canada, a guide was first published in 1995.<ref>Government of Canada, Treasury Board of Canada Secretariat, ''Benefit-Cost Analysis Guide for Regulatory Programs'', August 1995.</ref> The 1995 guide required updating to reflect the changes in the economy, new regulatory policies, and advances in analytical methods. This guide is designed to outline in brief the analytical methodologies, empirical techniques, and practical approaches to performing analyses of regulatory policies. Efficiency is not the sole criterion for decision making of a regulatory policy. The stakeholder analysis of who gains or loses as a result of a regulation can be critical to decision making; it is therefore included as part of the overall impact analysis in this guide. This guide will assist regulatory officials in employing techniques developed elsewhere to produce consistent high-quality cost-benefit analyses of proposed and existing regulations.

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==The Need for Government Intervention==

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==The Need for Government Intervention ==

The ''Cabinet Directive on Streamlining Regulation'' notes that, "Regulation is an important tool for protecting the health and safety of Canadians, preserving the environment, and securing the conditions for an innovative and prosperous economy." In a perfectly competitive market, the outputs of the goods and services of the economy and the set of prices for these outputs are determined in the marketplace in accordance with consumers' preferences and incomes, as well as producers' minimization of cost for a given output. In this market, the outcome is efficient and social welfare is maximized. However, in some situations, markets fail to achieve such efficient outcomes. ''Market'' ''failure'' refers to situations in which the conditions required to achieve the market-efficient outcome are not present. Market failure is an important reason for the need for government intervention. Common examples of market failure are the existence of significant externalities, the exercise of market power by a small number of producers or buyers, natural monopolies, and informational asymmetry between producers and their customers.<ref>See e.g. the Office of Management and Budget, Circular A-4, September 2003; OECD, ''Cost-Benefit Analysis and Environment: Recent Developments'', 2005.</ref>

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'''Issues and Objectives'''

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* A regulation was proposed by Environment Canada on the use of 2-BE beginning in 2007 that would limit the concentration of 2-BE used in a wide range of consumer products for household cleaners, automobile cleaners, and paints. It is considered toxic based on its health hazard potential and it may endanger human life and health.

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*A regulation was proposed by Environment Canada on the use of 2-BE beginning in 2007 that would limit the concentration of 2-BE used in a wide range of consumer products for household cleaners, automobile cleaners, and paints. It is considered toxic based on its health hazard potential and it may endanger human life and health.

'''Baseline Scenario'''

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* In conducting the cost-benefit analysis for the proposed regulation over a period of 20 years, the first step is to establish a baseline scenario of what the outcomes would be over time with no regulation in place.

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*In conducting the cost-benefit analysis for the proposed regulation over a period of 20 years, the first step is to establish a baseline scenario of what the outcomes would be over time with no regulation in place.

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* By observing the historical data, it was discovered that the quantity of 2-BE used in Canada was growing in the 1990s and peaked in the year 2000 at approximately 8 kilotonnes (kt). Since 2001, the quantities of 2-BE used have been declining, reaching about 4.6 kt in 2004. This represents an average annual decline rate of 12.6 per cent because of the replacement of 2-BE with alternative formulations. Moreover, several product types, especially paints and coatings products, show a trend towards lower volatile organic compounds (VOCc) that are based on 2-BE alternatives. However, 2-BE use would not be expected to decline much beyond 2010, due to its intermediate demand in a variety of industrial processes.

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*By observing the historical data, it was discovered that the quantity of 2-BE used in Canada was growing in the 1990s and peaked in the year 2000 at approximately 8 kilotonnes (kt). Since 2001, the quantities of 2-BE used have been declining, reaching about 4.6 kt in 2004. This represents an average annual decline rate of 12.6 per cent because of the replacement of 2-BE with alternative formulations. Moreover, several product types, especially paints and coatings products, show a trend towards lower volatile organic compounds (VOCc) that are based on 2-BE alternatives. However, 2-BE use would not be expected to decline much beyond 2010, due to its intermediate demand in a variety of industrial processes.

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* The total use of 2-BE is therefore projected to fall to about 2.6 kt by 2010, composed of about 0.5 kt of 2-BE used in consumer products and 2.1 kt used in industrial applications. With this trend, one would expect the quantities of 2-BE used in the baseline scenario to decline over the study period.

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*The total use of 2-BE is therefore projected to fall to about 2.6 kt by 2010, composed of about 0.5 kt of 2-BE used in consumer products and 2.1 kt used in industrial applications. With this trend, one would expect the quantities of 2-BE used in the baseline scenario to decline over the study period.

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* The baseline scenario assumes that the current compliance levels would prevail. As all the manufacturers of products will be regulated and internal reviews will ensure their compliance, it is reasonable to assume a full compliance of the industry with the regulation.

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*The baseline scenario assumes that the current compliance levels would prevail. As all the manufacturers of products will be regulated and internal reviews will ensure their compliance, it is reasonable to assume a full compliance of the industry with the regulation.

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* The regulations specify limits on the concentration of 2-BE in specific products. If the limits are at risk of being exceeded, the manufacturing process must switch to a less toxic alternative. The difference between the amount of 2-BE used in the baseline and with the regulation represents the incremental effect of the regulation.

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*The regulations specify limits on the concentration of 2-BE in specific products. If the limits are at risk of being exceeded, the manufacturing process must switch to a less toxic alternative. The difference between the amount of 2-BE used in the baseline and with the regulation represents the incremental effect of the regulation.

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* In order to assess the net benefits of the regulation, one ought to further calculate the number of people exposed to 2-BE contained in the affected products consumed in both the baseline scenario and the regulation scenario.</blockquote>One can expect that the specification of baseline conditions can have profound influence on the measurement of benefits and costs. Therefore, the following aspects need to be properly addressed while establishing the baseline:

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*In order to assess the net benefits of the regulation, one ought to further calculate the number of people exposed to 2-BE contained in the affected products consumed in both the baseline scenario and the regulation scenario.</blockquote>One can expect that the specification of baseline conditions can have profound influence on the measurement of benefits and costs. Therefore, the following aspects need to be properly addressed while establishing the baseline:

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* identify the nature and size of the issues that the policy will address;

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*identify the nature and size of the issues that the policy will address;

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* assess the characteristics and magnitude of risk associated with the issues;

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*assess the characteristics and magnitude of risk associated with the issues;

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* specify the nature of uncertainty and risk involved in the baseline situation, including innovation and scientific risks;

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*specify the nature of uncertainty and risk involved in the baseline situation, including innovation and scientific risks;

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* describe the assumptions made about the projection of benefits and costs in the future; and

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*describe the assumptions made about the projection of benefits and costs in the future; and

* take into account the regulations imposed by other regulatory agencies, such as provincial governments.

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== Step 2: Setting Objectives<ref>See Canada, ''Cabinet Directive on Streamlining Regulation'', April 2007; and Canada, Privy Council Office, ''Assessing, Selecting and Implementing Instruments for Government Action'', 2005.</ref> ==

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== Step 2: Setting Objectives<ref>See Canada, ''Cabinet Directive on Streamlining Regulation'', April 2007; and Canada, Privy Council Office, ''Assessing, Selecting and Implementing Instruments for Government Action'', 2005.</ref>==

After policy issues are properly assessed, the regulatory authority will be required to determine whether government interventions are needed and, if so, to what extent the government will intervene. The objectives can be economic, environmental, or social. In the case of health, the environment, and safety, presumably setting the objectives would involve the degree of public tolerance of risk, the costs of government action, and private compliance. Consultations with Canadians and stakeholders in particular are warranted at this time.

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The potential benefits of a policy can be represented by the gap between the baseline situation and the "with policy" scenario, as shown in Figure 1. It may be determined by the degree of government intervention or stringency of policy. The process of assessment and consultation will provide valuable information and help the regulatory authority set out alternative objectives for actions.

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== Step 3: Developing Alternative Regulatory and Non-Regulatory Options<ref>For a more extensive treatment of the alternatives to regulation, see Canada, Privy Council Office, ''Assessing, Selecting and Implementing Instruments for Government Action'', 2005.</ref> ==

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== Step 3: Developing Alternative Regulatory and Non-Regulatory Options<ref>For a more extensive treatment of the alternatives to regulation, see Canada, Privy Council Office, ''Assessing, Selecting and Implementing Instruments for Government Action'', 2005.</ref>==

A spectrum of tools is available to risk managers. They range from regulatory to voluntary tools. As a best practice, all promising tools should be objectively considered when managing risk. One should consider the tools that have the potential to be more efficient or cost-effective. The initial selection of alternatives is likely to be based on a preliminary analysis of their characteristics or on the prior experience of other jurisdictions that have employed such options.<ref>The Qualitative Screening of Management Tools (QSMT) of Environment Canada is a screening method that narrows the number of tools under consideration and helps identify the most promising tools for achieving the identified objective.</ref>

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It is important that departments and agencies also consider the mix of regulatory and non-regulatory options. ''Temporal'' and ''spatial dimensions'' are also important in designing regulatory programs. For example, a program may initially begin with a voluntary approach and then over time move to a mandatory approach that meets international standards with short-term financial support for small and medium-sized firms during the adjustment period. The regulatory program may also vary from one region of Canada to another.

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=== Regulatory approaches ===

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===Regulatory approaches===

Even when regulating, departments and agencies will have at their disposal a variety of regulatory options. Each of the options will have different implications for the amount of cost and benefits, and their distribution. Some of the main regulatory approaches include the following:

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''Enforcement methods:'' Enforcement methods are used to ensure compliance with the regulations. These can vary from stringent on-site inspections to complaints made by stakeholders. The types of penalties for non-compliance will also affect the costs and benefits of the regulation. For example, a minor financial penalty for non-compliance may be much less intrusive than an automatic loss of a licence but still achieve the intended compliance level.

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=== Non-regulatory approaches ===

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===Non-regulatory approaches===

Alternative approaches to command and control regulations are non-regulatory measures. These approaches may include tradable permits, taxes, charges, or subsidies. Such instruments can affect consumer and producer behaviour in order to achieve the same regulatory objectives. These approaches may require different information and tools than those used to analyze the impact of command and control regulatory measures.

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In addition, there are other instruments such as information and education, standards, and other forms of voluntary action that can also be considered part of non-regulatory instruments.

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== Step 4: Assessing Benefits and Costs ==

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==Step 4: Assessing Benefits and Costs==

=== Identification of significant impacts ===

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Some impacts may be difficult to quantify because of their nature or the lack of data or scientific knowledge. These impacts should be described and documented.

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=== Measurement of benefits ===

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===Measurement of benefits===

A fundamental tool of applied welfare economics is the willingness to pay (WTP) principle.<ref>More explanation can be found in Harberger, Arnold C., "Three Basic Postulates for Applied Welfare Economics." In: ''Journal of Economic Literature'', Vol. IX, No. 3, September, 1971 ; and Townley, Peter G. C., ''Principles of Cost-Benefit Analysis in a Canadian Context'', Scarborough: Prentice Hall Canada Inc., 1998.</ref> The amount (demand price) that an individual is willing to pay for an incremental unit of a good or service measures its economic value to the demander and hence its economic benefit to the economy. For example, this is the maximum amount of money an individual would be willing to pay to improve human health, to avoid getting hurt, to obtain an environmental improvement or to preserve natural resources, etc. Conversely, willingness to accept (WTA) compensation is the minimum amount of money an individual is willing to accept for not receiving the improvement.

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Quantification and valuation of these impacts is quite different from simply looking at conventional market prices. Nevertheless, monetary values of a policy's impact are very important because they allow decision makers to compare costs and benefits. The challenge facing analysts is how to value these effects in monetary terms. If an original estimation of the benefits for the specific situation is too difficult or will take too much time, then one must try to draw upon existing valuation estimates made by others in similar circumstances.

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==== Methods for measuring benefits ====

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====Methods for measuring benefits====

A number of methods have been developed to measure the benefits of various programs or policies. WTP is still the guiding principle for the measurement. The most straightforward situation occurs when market prices are distorted in ways that are clearly defined. For example, there may be taxes, subsidies, or quantitative controls in these markets.

The evaluation of benefits is more challenging for most environmental, health, safety, and security initiatives because of the absence of markets. Examples include control of air and water pollutants; drug monitoring for health; privacy; and gun control for safety and security. Nevertheless, a variety of techniques have been developed to value these goods or services in a manner consistent with the valuation of marketed goods. The revealed preference and stated preference methods used to quantify the benefits of non-market goods and services are also discussed briefly below.

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===== A. Correcting market prices for distortions =====

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=====A. Correcting market prices for distortions =====

If markets for the goods and services affected by the policy are competitive and not distorted by taxes or subsidies, their market prices will provide the best estimates of benefits. This is based on the principle of WTP for measuring benefits or the opportunity cost of the resources used to measure costs. However, if the markets are not competitive or distorted, then economic prices of the goods or services need to be estimated in order to correctly value the costs and benefits. In Canada, two major areas need special attention.<ref>The market exchange rate in Canada may also not reflect the true value of foreign currency because of distortions associated with the traded goods sector. In 1995, Industry Canada estimated that the shadow price of foreign exchange was greater than its market price by 3.5 per cent to 4.5 per cent. Thus, a premium of approximately 4 per cent should be added when valuing the tradable goods or services generated from the regulatory actions. Similarly, the 4 per cent premium should be counted as an additional cost to the spending on tradable goods or services. See Industry Canada and the Centre for the Study of International Economic Relations, University of Western Ontario, ''The Shadow Price of Foreign Exchange in the'' ''Canadian Economy'', 1995.</ref>

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====== ''Taxes, subsidies, and imperfect competition'' ======

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======''Taxes, subsidies, and imperfect competition''======

In Canada, the goods and services tax and provincial sales taxes are generally imposed on goods or services, hence consumers pay more than the market prices by the amount of taxes. In situations when consumers forgo their consumption of certain goods and services, they will be forgoing the value of the goods and services inclusive of taxes. It is the gross-of-tax values that should be measured as the benefits associated with changes in the level of consumption of the goods or services affected by the policy, as they reflect consumers' willingness to pay for these items.

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In some markets, Canada has introduced supply management policies such as the marketing boards for milk, chickens, and eggs. For example, the Canadian Dairy Commission, a Crown corporation, has the mandate of coordinating federal and provincial dairy policies, and creating a mechanism for milk production that will help control supply and stabilize sales revenues. The Commission sets up a benchmark price of milk for the provinces and monitors the national demand and supply of milk. In the cost-benefit analysis, adjustments for the market changes should be made to account for the costs created by regulations that bring about such supply restrictions.

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====== ''Labour markets'' ======

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======''Labour markets''======

When the level of employment has been affected by regulatory actions, then labour market externalities may be created. This is because the opportunity costs of the workers who either fill new jobs or are displaced from previous employment are not necessarily the same as the market wages the workers receive. The main distortions in the Canadian labour markets are personal income taxes and unemployment insurance benefits. The differences between the opportunity costs of the labour being employed in jobs and the market wage paid will vary with the type of skills required, labour market unemployment rates, and the duration of the jobs. This is particularly important if regulations affect the levels of employment in temporary jobs that are complementary to the income support provided by the Canadian unemployment insurance system. The opportunity cost per month of labour employed in temporary jobs tends to be significantly higher than for permanent jobs. This is because in permanent jobs little or no unemployment insurance will be claimed because the employers retain the same workers on a year-round basis.<ref>Harberger, Arnold C., ''The Social Opportunity Cost of Labor: Problems of Concept and Measurement as Seen from a Canadian Perspective''. Report for the Canadian Immigration and Employment Commission Task Force on Labour Market Development, Ottawa, 1980.</ref>

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===== B. Revealed preference methods =====

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=====B. Revealed preference methods =====

These methods estimate the values placed on health, the environment, and other goods using data obtained by observing the actual choices made by individuals in related markets. From this information, the analyst can infer the value of the policy impact being evaluated. The following are general applications of some of these methods. Care should be taken when they are applied because certain conditions must hold.

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====== ''The hedonic price method'' ======

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======''The hedonic price method''======

The hedonic price method estimates the value of a non-market good, such as noise, by observing behaviour in the market for a related good. It relates the price of a marketed good with a bundle of characteristics or attributes associated with the good. For example, the price of a car is a function of size, fuel efficiency, safety, comfort, noise, and reliability. Such a relationship expressed as a hedonic price function can be estimated using statistical techniques such as ordinary least squares (OLS). Once the functional relationship is established and coefficients are estimated, the implicit or shadow price of a characteristic can be obtained by partial differentiation. This allows the estimation of a demand curve for a characteristic of interest.

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This method has been used to estimate the value of non-market goods such as air pollution, water quality, and road traffic. Nevertheless, care must be taken where a good can have several intangible attributes. If the attributes included as explanatory variables are closely correlated with each other, coefficient estimates can be biased. Multi-collinearity can also bring instability to the parameter estimates and, if serious, can reduce the confidence attached to model predictions. Other problems with the hedonic price method include omitted variable bias and wrong choice of functional form. Analysts must decide which characteristics to include as explanatory variables; omitting a characteristic that has a significant impact on the market good can lead to biased coefficient estimates. Additionally, analysts must decide on the functional form for the hedonic price function.

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====== ''The travel cost method'' ======

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======''The travel cost method''======

The travel cost method seeks to place a value on non-market environmental goods by using consumption behaviour in a related market. Specifically, the costs of consuming the services of the environmental asset are used as a proxy for price. This method has been used for valuing recreational premises. The recreational activity is a non-market good. However, the value of a recreational activity can be measured through the market for the costs of travelling to the area by individuals or households because there is a trade-off between the benefit gained from visiting the recreational area and the value of money and time spent to travel there. These costs can be estimated by the number of trips made by individuals or households and the amount of money they spend on the trips. The latter usually includes (a) the transportation costs in air fares, taxis, fuel, wear of tires, depreciation of vehicles, etc. and (b) the costs of time spent on travelling. In the cost-benefit analysis, time spent on travelling should be measured by the opportunity cost of time for the driver and passengers.

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An approach to deal with these biases could be to use a survey involving a hypothetical product. For instance, a survey could be produced that asks respondents to value a sunscreen that might reduce the risk of developing skin cancer. By measuring the willingness to pay for such a risk reduction, the other benefits of the product would be controlled for. <blockquote>

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====== ''Cost-of-illness method'' ======

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======''Cost-of-illness method''======

</blockquote>The cost-of-illness method estimates the explicit market costs resulting from a change in the incidence of a given illness. It generally relies on direct costs such as medical treatment, rehabilitation, and accommodation. It does not account for indirect costs such as the loss of income or the loss of leisure time, let alone the cost of pain and suffering. Therefore, the reduction in medical costs incurred because of a health intervention should be considered a lower bound estimate of the WTP.

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===== C. Stated preference methods =====

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=====C. Stated preference methods=====

Stated preference methods refer to a direct survey approach to estimating the value placed on non-market goods or services. They rely on information obtained through surveys rather than on the indirect valuation through revealed preference methods. This approach attempts to measure the WTP directly through surveys that ask respondents about their evaluation of changes in the level of environmental quality, health, and safety.

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* the survey should be conducted within an acceptable length for a typical interview in order to collect adequate information and reduce refusal rates from respondents;

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* a pilot survey is important to finalize the construction and design of the questionnaire;

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*a pilot survey is important to finalize the construction and design of the questionnaire;

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* the good or service being evaluated should be clearly explained to the respondent, as well as the objectives of the study;

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*the good or service being evaluated should be clearly explained to the respondent, as well as the objectives of the study;

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* the socio-economic and demographic characteristics should be part of the questionnaires in order to cross-check the respondent's WTP;

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*the socio-economic and demographic characteristics should be part of the questionnaires in order to cross-check the respondent's WTP;

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* WTP questions should be designed within the budget limits of the respondent;

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*WTP questions should be designed within the budget limits of the respondent;

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* the selection and size of the sample should be stratified or clustered according to proper sampling techniques;

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*the selection and size of the sample should be stratified or clustered according to proper sampling techniques;

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* statistical adjustments to the results should be made to account for non-response bias, if any; and

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*statistical adjustments to the results should be made to account for non-response bias, if any; and

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* statistical analysis should be transparent and properly documented.

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*statistical analysis should be transparent and properly documented.

Surveys can be conducted either by mail, by telephone, or in person. In-person interviews are most reliable but also expensive and time-consuming. In some cases, direct interviews are essential due to the complexity of the questions. Mail and telephone surveys are much cheaper to carry out, but the quality of both the responses and the analysis that can be performed using these results is lower.

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In addition to contingent valuation, there has been a growing interest in conjoint analysis or choice modelling approaches. This technique is considered a family of survey-based methodologies for modelling preferences for goods where goods are expressed in terms of their attributes and the categories of these attributes. Respondents are asked to make a choice of a good based on the preferences for the types and levels of the attributes associated with the good. The amount of WTP can be estimated indirectly from the prices of the relevant attributes of the good being valued.<ref>Organisation for Economic Co-operation and Development, ''Cost-Benefit Analysis and the Environment: Recent Developments'', 2005, Chapter 9.</ref>

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===== D. Benefit transfer methods =====

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=====D. Benefit transfer methods=====

The benefit transfer approach relies on information from existing studies that have applied these non-market methods of valuation. This is in fact using the value of a good or service in an existing study as a proxy for the value of the same good or service in another study.

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The following basic steps should be undertaken in selecting benefit transfer studies for use:

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* the selected case studies should be of the same nature as the policy case in terms of the good or service in question and socio-economic conditions, including the size of population, demographic characteristics, economic conditions, value judgment, etc.;

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*the selected case studies should be of the same nature as the policy case in terms of the good or service in question and socio-economic conditions, including the size of population, demographic characteristics, economic conditions, value judgment, etc.;

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* the selected studies should be based on their comprehensiveness and quality of data, sound theoretical concepts, and careful analysis of empirical results; and

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*the selected studies should be based on their comprehensiveness and quality of data, sound theoretical concepts, and careful analysis of empirical results; and

* the welfare measures (WTP versus WTA) should be comparable to the policy case.

As a general rule, transferring unadjusted values of benefits from the selected studies to the policy option is rare because the underlying conditions may not hold. The commonly used adjustments for transferred benefits in determining WTP include changes in income per capita, changes in age structure, changes in population density, and levels of education. Adjustments can be made in either the point transfer or a function transfer expressed as a function of various relevant characteristics.

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==== Valuation of some major benefit items ====

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====Valuation of some major benefit items====

Programs or policies can generate many kinds of benefits. This section describes some of these benefits, including improvement of human health, ecological benefits, and reduction of physical damages to materials.

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===== ''Human health'' =====

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=====''Human health''=====

Health and environmental policies may affect human health in a number of ways. They may save lives by reducing the risk of mortality. They may also improve the health of those living with diseases, i.e. there may be a morbidity benefit. Other benefits may include some reduction in tension or stress, or an improvement in mental health. Presumably, individuals are willing to pay if some improvements are made in each of these areas. The question is how one can place a value on them, and how much.

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A morbidity benefit is the reduction in the risk of non-fatal health effects that can be characterized by duration and severity. The preferred measure for morbidity benefit is WTP to reduce the risk of getting ill. This measure includes the direct costs of medical treatment and the indirect costs of time lost for work and other leisure activities imposed by an illness. A number of studies on morbidity values are available in the literature using contingent valuation or averting behaviour methods. However, there are methodological issues associated with the benefit transfer of morbidity valuations in assessing the impacts of regulatory actions. When considering a benefit transfer, analysts must assess the correspondence between the health effect valued in the existing studies and the health effect influenced by the policy option in question. The issue of the valuation of morbidity is a critical issue in estimation of the quality adjusted life years (QALYs) for different treatments of diseases. Estimates of QALYs for a wide range of diseases and treatments have been made by the World Health Organization and Health Canada. Much of this well-developed methodology is relevant to the valuation of the impact of regulations on morbidity.<ref>Phillips, Ceri and Guy Thompson, "What is a QALY?" In: ''Hayward Medical Communications'', Vol.1, no.6, 2003.</ref>

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===== ''Ecological benefit'' =====

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=====''Ecological benefit''=====

Ecosystems basically provide services that benefit humans. The benefits may be thought of as flows of services from a natural asset such as a scenic vista, wildlife viewing, hiking, and boating. The benefits of improved ecological conditions can be evaluated using averting behaviour, hedonic, or stated preference methods. Such evaluations move into some of the most controversial and fluid areas of the analysis of benefits and costs. As an active area of research, however, progress is being made and examples of high-quality published analysis are now available for most of these impacts.

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===== ''Reduced material damages'' =====

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=====''Reduced material damages''=====

These are welfare impacts that arise from changes in the provision of service flows from the material environment. Material damages include the changes in the provision of services flows from materials that are due to the impact that environmental changes have on the quality and quantity of materials. To measure the benefits, one must determine the extent to which the environmental quality and materials are linked, as well as evaluate the responses of consumers and producers to the service flows of the materials. These valuations are relatively straightforward, as technical data on the normal service lives and on the replacement costs of a wide range of material and equipment are usually available. The changes in the service lives and the benefit or costs that are created usually can be measured with a considerable degree of accuracy.

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While quantifying the benefits assists the decision makers in understanding the magnitude of the effects of alternative regulatory policies, some benefits may be too difficult to quantify in monetary terms. However, they also can be too important to ignore. In this situation, one should:

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* list all quantitative information that cannot be monetized;

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*list all quantitative information that cannot be monetized;

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* explain why these physical quantitative items cannot be monetized;

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*explain why these physical quantitative items cannot be monetized;

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* describe the timing and likelihood of such effects;

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*describe the timing and likelihood of such effects;

* describe unquantifiable effects such as ecological gains, improvement in quality of life, aesthetic considerations, etc.; and

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* discuss the strengths and limitations of the qualitative information.

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*discuss the strengths and limitations of the qualitative information.

==== Treatment of uncertainty and risk ====

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Monte Carlo simulations may be performed using a computer software program. The steps required in undertaking the analysis of a policy or regulatory option are described as follows:

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* identify risk variables that not only constitute a large share of benefits or costs of the policy or regulation but that are also uncertain in nature;

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*identify risk variables that not only constitute a large share of benefits or costs of the policy or regulation but that are also uncertain in nature;

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* assess how likely the risk is to occur;

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*assess how likely the risk is to occur;

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* select the probability distribution (e.g. uniform, triangular, normal, step, discrete) and the range of values for each risk variable;

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*select the probability distribution (e.g. uniform, triangular, normal, step, discrete) and the range of values for each risk variable;

* select the appropriate probability distribution based on a historical series of values or the opinions of experts in the field;

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* identify the relationships between two variables to avoid inconsistent simulation results;

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*identify the relationships between two variables to avoid inconsistent simulation results;

* specify the desired number of simulation runs; and

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* present a series of statistical measures such as the expected present value of net benefits and the variability of the outcomes.

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*present a series of statistical measures such as the expected present value of net benefits and the variability of the outcomes.

The identified scientific limitations and uncertainties that have a high likelihood of significant impact on the results of the analysis need to be disclosed and reported in a transparent manner. The analysts should include a discussion of the difficulties in trying to resolve the scientific limitations and uncertainties involved, e.g. feasibility, and financial and time constraints on research, etc.

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Another source of uncertainty is the presence of different models capable of explaining the same phenomenon. Each alternative model may yield different results, therefore the model uncertainty also needs to be well documented and disclosed. Whenever possible, the results should be evaluated for each alternative model separately and then compared with those obtained from the other alternative models. A central measure of the estimate in this case will be a weighted average of the results obtained from the alternative models. Expert judgment might be needed in estimating the probability weights to be used in the calculation of the central value.

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=== Measurement of costs ===

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===Measurement of costs===

The objective of a cost-benefit analysis is to estimate the net impact of a policy. The previous section dealt with the incremental benefits of the "with policy" scenario as compared to the baseline scenario. This section considers the other side of the equation, i.e. the incremental costs of each of the "with regulation" options as compared to the baseline scenario.

The costs are simply the costs of the resources used as a consequence of the implementation of the policy. There are generally two types of direct costs: one is the compliance costs incurred by the private sector and the other is the administrative costs incurred by government. There also may be other indirect costs associated with the particular cases.

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==== Compliance costs incurred by the private sector ====

+

==== Compliance costs incurred by the private sector====

The compliance costs are the costs incurred by businesses or their private entities in order to operate within the rules set down by the policy. They include capital costs, as well as operating, maintenance, and administrative costs. In the case of pollution control, businesses may choose or be required to purchase and install new machinery and equipment in order to eliminate or reduce emissions of pollutants. In this case, a significant part of the compliance costs may be in the form of investment expenditures incurred. There may be changes in costs of the production process that require the installation of new capital equipment. These are also part of the expenditures that should be attributed to the policy.

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The labour costs required to install new equipment or operate the facilities should also be measured at their opportunity costs. This is because the wage bill does not necessarily represent the opportunity cost of labour involved. Adjustments will usually need to be made for the changes in income tax receipts and the unemployment insurance benefit payments brought about by the additional employment of labour.

−

==== Administrative costs to governments ====

+

====Administrative costs to governments====

In order to enforce a regulatory policy, governments will incur additional costs of administration, monitoring, and enforcement. As was discussed in the previous section, these costs can be either capital or operating costs. For example, in the case of setting up a system of tradable permits for pollution control, the government will first need to develop an operating system and will then need to spend resources to enforce the system. All capital and operating costs associated with the design and operation of the system of tradable permits should be accounted for.

Monitoring and enforcement costs are normally based on the budgetary cost of the necessary administrative activities. These costs should include both the direct costs and the overhead costs of the public administration that is given to this task. In addition to the compliance costs incurred by the private sector and the administrative costs incurred by governments, there may be transitional costs as a result of the implementation of the regulation. For further details, see the ''Guide to the Costing of Outputs in the Government of Canada''.<ref>Canada, Treasury Board of Canada Secretariat, ''Guide to the Costing of Outputs in the Government of Canada'', 1994.</ref>

−

==== Transitional costs ====

+

====Transitional costs====

Transitional costs refer to the costs incurred by producers, and consumers, during the transitional phase that may not be captured by the estimates of the private resource costs mentioned above. For example, when new equipment is installed, a production line may need to be stopped or slowed down. Presumably, some losses are incurred because of the lower level of production. The size of these costs depends upon the duration of the disruption and other factors. For example, if plants or factories are shut down in order to meet environmental regulations, workers will likely be laid off and will need to search for new jobs. To the extent that the incomes of the workers fall for a period of time until they find other employment, there is a cost imposed on labour by the transition that should be included. In most cases, the transitional costs tend to be small and can be ignored for all intents and purposes. If they are significant, these costs should be estimated and included.

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In general, the costs of a policy are measured by changes in business and government activities that are affected directly by the policy. As for the cost of the indirect impacts, it will depend upon the specific policy and the significance of the indirect impacts. If the effects on some markets are significant, the changes in the activity times the unit value of the distortion is the appropriate adjustment to be included in the appraisal. If output is expanded in any of these other markets and is taxed, there is a net benefit because what demanders are willing to pay is larger than the resource cost of production. If in any of the other markets there is a production subsidy, there will be an additional cost as a result of the intervention because the resource cost of additional production will be greater than the price people are willing to pay for the item. If the policy causes the output of another market to decline, then the signs of the adjustment for taxes and subsidies are simply reversed

−

=== Criteria ===

+

=== Criteria===

Once the incremental benefits and costs have been quantified in monetary terms for both the "with policy" scenario and the baseline scenario, we can calculate the net present value of the incremental benefits using the discount rate. The preferred option from an efficiency perspective would be the one with the largest net present value.

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'''Alternative Options'''

−

* The baseline option: In recommending an appropriate policy or regulation to deal with the above problems, one needs to establish the baseline scenario over the policy period, say 20 years from 2001 to 2020, including the likely regulations of the sulphur content in gasoline in Europe and the United States, since those areas supplied some of the gasoline consumed in eastern and central Canada.

+

*The baseline option: In recommending an appropriate policy or regulation to deal with the above problems, one needs to establish the baseline scenario over the policy period, say 20 years from 2001 to 2020, including the likely regulations of the sulphur content in gasoline in Europe and the United States, since those areas supplied some of the gasoline consumed in eastern and central Canada.

−

* Alternative options included a complete ban of sulphur in gasoline, harmonization of the sulphur content of gasoline with that of the United States, economic instruments, or other options requiring varying levels of low sulphur in gasoline to be implemented in phases. For example, one option considered was the maximum annual average level of sulphur for each refinery to be 30 ppm, with the level of sulphur never exceeding 80 ppm at any time during the year.

+

*Alternative options included a complete ban of sulphur in gasoline, harmonization of the sulphur content of gasoline with that of the United States, economic instruments, or other options requiring varying levels of low sulphur in gasoline to be implemented in phases. For example, one option considered was the maximum annual average level of sulphur for each refinery to be 30 ppm, with the level of sulphur never exceeding 80 ppm at any time during the year.

'''Cost-Benefit Analysis'''

−

* The analysis should be carried out in an incremental manner. That is, the incremental benefits and costs of each of the alternative options are estimated and compared to the baseline option. For the purpose of illustration, we use the above example as one of the alternative options.

+

*The analysis should be carried out in an incremental manner. That is, the incremental benefits and costs of each of the alternative options are estimated and compared to the baseline option. For the purpose of illustration, we use the above example as one of the alternative options.

−

* Benefits: These refer to health and environmental benefits that result from the reductions of the adverse environmental and health effects as compared to the base scenarios. These include the following:

+

*Benefits: These refer to health and environmental benefits that result from the reductions of the adverse environmental and health effects as compared to the base scenarios. These include the following:

−

** Reducing sulphur in gasoline over time would lower emissions of SO2 proportionally to the reductions in the fuel sulphur content, as well as reducing emissions of CO, NOx and VOCs. The Health and Environment Impact Assessment Panel estimated that over the 20-year period, there would be a reduction of approximately 2,100 premature deaths, 90,000 respiratory cases in children, 3,200,000 acute asthma symptom days, and other respiratory problems.

+

**Reducing sulphur in gasoline over time would lower emissions of SO2 proportionally to the reductions in the fuel sulphur content, as well as reducing emissions of CO, NOx and VOCs. The Health and Environment Impact Assessment Panel estimated that over the 20-year period, there would be a reduction of approximately 2,100 premature deaths, 90,000 respiratory cases in children, 3,200,000 acute asthma symptom days, and other respiratory problems.

−

** These impacts can be quantified in monetary values associated with premature mortality and illness costs over the 20-year period, using the benefit transfer methods.

+

**These impacts can be quantified in monetary values associated with premature mortality and illness costs over the 20-year period, using the benefit transfer methods.

−

* Costs: These costs include compliance costs to refineries and independent suppliers, costs borne by consumers, and enforcement costs to governments:

+

*Costs: These costs include compliance costs to refineries and independent suppliers, costs borne by consumers, and enforcement costs to governments:

** Canadian refineries were expected to incur $1.8 billion in capital expenditures and $119 million per annum in operating costs to produce low sulphur gasoline. Part of the costs was expected to be recovered by the refineries from their customers through an increase in the price of gasoline. The Panel estimated that about three to four refineries were expected to be shut down rather than making the necessary investment to produce 30 ppm gasoline. A typical refinery directly employed about 350 people (ranging from 100 to 800).

−

** Importers and blenders of gasoline would be affected by the regulation. As Europe was the main source of imported gasoline, the types of gasoline produced by European countries would have a direct impact on the cost to importers.

+

**Importers and blenders of gasoline would be affected by the regulation. As Europe was the main source of imported gasoline, the types of gasoline produced by European countries would have a direct impact on the cost to importers.

−

** There were compliance costs incurred by primary suppliers using a pool average, since they had to demonstrate that they must comply with the average, independent auditing records and reports. In addition, compliance must be met by all gasoline domestically produced or imported under a pool average that is subject to a never-to-be-exceeded cap of sulphur content.

+

**There were compliance costs incurred by primary suppliers using a pool average, since they had to demonstrate that they must comply with the average, independent auditing records and reports. In addition, compliance must be met by all gasoline domestically produced or imported under a pool average that is subject to a never-to-be-exceeded cap of sulphur content.

−

** The cost passed on by refineries was assumed to be borne by consumers. There should be no double counting with the costs borne by the refinery industry.

+

**The cost passed on by refineries was assumed to be borne by consumers. There should be no double counting with the costs borne by the refinery industry.

−

** Administration and enforcement of the regulations by the government required a wide range of planned and ad hoc inspections, audits, samplings, analyses, investigations, and legal actions by Environment Canada.

+

**Administration and enforcement of the regulations by the government required a wide range of planned and ad hoc inspections, audits, samplings, analyses, investigations, and legal actions by Environment Canada.

−

** All costs should be quantified annually and measured in the resource costs rather than the financial costs.

+

**All costs should be quantified annually and measured in the resource costs rather than the financial costs.

−

** Net benefits: The annual net benefits were estimated over the 20-year period and discounted by the discount rate in order to derive the present value of the option under consideration.

+

**Net benefits: The annual net benefits were estimated over the 20-year period and discounted by the discount rate in order to derive the present value of the option under consideration.

</blockquote>

−

=== Cost-effectiveness analysis ===

+

===Cost-effectiveness analysis===

When benefits cannot be expressed in monetary values in a meaningful way, a cost-effectiveness analysis (CEA) should be carried out to assist in making effective decisions. A CEA calculates cost-effectiveness ratios of different alternative policy options and then compares the resulting ratios so that the most efficient option is chosen. In a sense, a CEA ensures technical efficiency in the process of achieving a desired outcome.

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Some caveats are noted below for the measurement of the associated costs.

−

* The marginal cost-effectiveness should be calculated. It is the marginal or incremental cost-effectiveness of the policy that should be compared with the baseline cost-effectiveness scenario. The policy that has the lowest marginal cost per unit of effectiveness will be the most efficient way to use resources.

+

*The marginal cost-effectiveness should be calculated. It is the marginal or incremental cost-effectiveness of the policy that should be compared with the baseline cost-effectiveness scenario. The policy that has the lowest marginal cost per unit of effectiveness will be the most efficient way to use resources.

* The costs include all compliance costs incurred by the private sector and the administrative costs to governments. They should be based on the resource or opportunity costs, not just the financial costs of goods and services.

* The costs should be properly defined and measured in the calculation of cost-effectiveness.

−

* The costs incurred may be capital or operating expenditures that are spread over many years. Both the costs and benefits should be discounted to a common time period in order to make a comparison of alternative options. It should be noted that the benefits are measured in physical units instead of monetary values. The quantities over time of the measure of effectiveness should be discounted to the same date in time as the costs.

+

*The costs incurred may be capital or operating expenditures that are spread over many years. Both the costs and benefits should be discounted to a common time period in order to make a comparison of alternative options. It should be noted that the benefits are measured in physical units instead of monetary values. The quantities over time of the measure of effectiveness should be discounted to the same date in time as the costs.

One should be aware of some of the shortcomings inherent in the cost-effectiveness approach. It is a poor measure of the consumers' willingness to pay principle because there is no monetary value placed on the benefits. Furthermore, in the calculation of cost-effectiveness, the numerator does not take into account the scale of alternative options. Nevertheless, the cost-effectiveness ratio is still a very useful criterion for selection of alternative regulatory options when the benefits cannot be monetized.

−

=== Impacts on stakeholders ===

+

===Impacts on stakeholders===

There are various entities or stakeholders that can be affected by a specific policy. The assumptions used for the stakeholder analysis must be consistent with those of the cost-benefit analysis. The cost-benefit analysis begins with the identification of the direct effects and then adjusts various goods and services affected for a variety of distortions in the markets. Central to the stakeholder analysis is the need to identify the affected subpopulations, whether they are winners or losers, and how much they would gain or lose as a result of the implementation of the policy. Most stakeholders are concerned about their private costs and benefits. In order to monitor and enforce the policy, governments are expected to incur certain administrative costs that should be included as part of the economic cost for implementation of the regulatory policy.

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The stakeholder analysis may begin with the estimation of the change in compliance costs for the affected sector that can be attributed to a policy and then assess their impacts on the production costs of the sector. The analysis must also estimate the change in the prices consumers will pay for the goods and services affected and the effect of this on other related sectors. The following are kinds of impacts that are likely to occur and need to be assessed.

−

==== Impacts on industry ====

+

====Impacts on industry====

Many policies are intended to change the way something is produced, input used in the production, or the quantity of a product being produced. The focus of the analysis will initially be on the change in compliance costs for the affected sector or how compliance with the policy affects the production costs of the sector or the item, the nature of the firm's supply response to this change in cost, and its competitive position in comparison with its rivals. At the same time, it is important to estimate how the demand and supply of substitute or complementary goods and services respond to changes in the prices of the affected item. The ultimate impact is the measurement of the implementation of the policy on the financial profitability of the regulated firms and industry.

Policies can unintentionally create barriers to entry for other firms and may result in market concentration. They might also restrict the level of international competition. The economic consequences are lack of competition and less incentive for innovation, eventually leading to lower productivity and slower economic growth.

−

==== Impacts on employment ====

+

====Impacts on employment====

Regulations may impair the competitiveness of certain firms. Some firms may close as a result of extremely high compliance costs and low financial profitability. Such closures might have serious political ramifications for the region where the firm is located. This can vary from case to case. The analysis should examine the viability of the firms affected in terms of their profitability, liquidity, and cash flow It should assess the number of firms being affected in the industry and by region. Since jobs are one of the most important concerns for workers and politicians, the number of workers affected by the plant closures should be estimated.

That being said, it should be noted that the social loss or loss of private incomes as a result of plant closures should be carefully assessed and included as part of the stakeholder analysis. It should be measured by the earnings prior to the closure in excess of the economic opportunity cost of the laid-off workers. The opportunity cost of workers will vary by occupation, skill level, working environment, market condition, region, and unemployment insurance scheme.<ref>See e.g. Harberger, Arnold C., ''The Social Opportunity Cost of Labor: Problems of Concept and Measurement as Seen from a Canadian Perspective''. Report for the Canadian Immigration and Employment Commission Task Force on Labour Market Development, Ottawa 1980.</ref>

−

==== Impacts on consumers and individuals ====

+

====Impacts on consumers and individuals====

An increase in compliance costs will likely affect the prices of goods or services in the regulated industry. The question is whether the increase in compliance costs will have direct impacts on the affected firms and, if positive, how and what portion of the compliance costs can be passed on to customers. It is a complicated question because one has to examine the demand and supply conditions in the affected markets. In these cases, the basic question is the nature of the competitive conditions within the country. The elasticities of supply and demand, as well as cross-price elasticities of demand for the goods and services affected, need to be used to measure the impacts on these markets.

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The more the price of goods or services in the regulated sector is shifted forward, the greater the likelihood that the regulated firms will recover their initial compliance costs from their customers. The net impacts on the respective stakeholders should be properly assessed and double counting in terms of effects must be avoided.

−

==== Impacts on governments ====

+

====Impacts on governments====

A regulation may increase costs incurred by the government due to additional administration, monitoring, and enforcement. If the regulation has a significant impact on domestic demand or supply, it may also affect the tax revenues of governments. These impacts will usually affect the different levels of government differently and should be properly recorded as part of the stakeholder analysis.

−

==== Impacts on other stakeholders ====

+

==== Impacts on other stakeholders====

Depending upon the types of policy, there can be different economic and social impacts on a variety of stakeholders. A stakeholder analysis first identifies the direct impact of a regulation and then analyzes the interactions between a regulated market and other related markets. For example, the production and prices of regulated industries can be affected by an environmental policy that requires additional investment in equipment to control emissions of pollutants. In the case of health and safety, a ban on a certain drug will create a change in prices that will set in motion a change in consumers' demand for substitute medications and the production of these substitutes. In the end, it seeks to allocate among stakeholders the net benefits or losses generated by a regulatory intervention.

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'''Issues'''

−

* Over the period from 1995 to 1999, more than 14,000 fires started from smokers' materials, including cigarettes, cigars, and pipes. These fires killed 356 people, injured 1,615 others, and caused more than $200 million in property damage. Most of the victims were children, the elderly, and low-income families.

+

*Over the period from 1995 to 1999, more than 14,000 fires started from smokers' materials, including cigarettes, cigars, and pipes. These fires killed 356 people, injured 1,615 others, and caused more than $200 million in property damage. Most of the victims were children, the elderly, and low-income families.

'''Proposed Regulations'''

−

* To address the problem resulting from fires started by cigarettes, a regulation was proposed to reduce the ignition propensity of cigarette paper. Beginning October 1, 2005 , all manufacturers and importers of cigarettes are required to ensure the cigarettes they supply will burn the full length no more than 25 per cent of the time when tested on 10 layers of filter paper using the ASTM E2187‑04 Standard Test Method for Measuring the Ignition Strength of Cigarettes.

+

*To address the problem resulting from fires started by cigarettes, a regulation was proposed to reduce the ignition propensity of cigarette paper. Beginning October 1, 2005 , all manufacturers and importers of cigarettes are required to ensure the cigarettes they supply will burn the full length no more than 25 per cent of the time when tested on 10 layers of filter paper using the ASTM E2187‑04 Standard Test Method for Measuring the Ignition Strength of Cigarettes.

−

* It is a performance standard that prescribes an objective established by the regulatory authority.

+

*It is a performance standard that prescribes an objective established by the regulatory authority.

'''Cost-Benefit Analysis'''

−

* Two alternative approaches were undertaken by the research team to estimate the amount of compliance costs to the private sector and their impacts on the economy: a modelled estimate based on a representative cigarette manufacturer and an estimate based on an industry outreach survey.

+

*Two alternative approaches were undertaken by the research team to estimate the amount of compliance costs to the private sector and their impacts on the economy: a modelled estimate based on a representative cigarette manufacturer and an estimate based on an industry outreach survey.

−

* The costs include capital and operating costs. They are expenses of purchasing and operating new equipment, changing production processes or inputs, undertaking additional quality assurance checks, and conducting toxicity tests to ensure compliance with the standard. On average, the cost of compliance was estimated at $0.126 per carton using the modelled estimate and at $0.257 per carton using the survey method. Using the annual production of 206.5 million cartons in 2002, this translates into annual costs of $26 million and $53 million, respectively.

+

*The costs include capital and operating costs. They are expenses of purchasing and operating new equipment, changing production processes or inputs, undertaking additional quality assurance checks, and conducting toxicity tests to ensure compliance with the standard. On average, the cost of compliance was estimated at $0.126 per carton using the modelled estimate and at $0.257 per carton using the survey method. Using the annual production of 206.5 million cartons in 2002, this translates into annual costs of $26 million and $53 million, respectively.

−

* The benefits include three major categories, i.e. the reduction of deaths, injuries, and property damages. It is, however, important to estimate the annual incremental benefits of the proposed regulation against the baseline situation. The empirical estimates were mainly based on annual reports of the Canadian Council of Fire Marshals and Fire Commissioners, and data from Alberta and Ontario. The benefits are briefly described below:

+

*The benefits include three major categories, i.e. the reduction of deaths, injuries, and property damages. It is, however, important to estimate the annual incremental benefits of the proposed regulation against the baseline situation. The empirical estimates were mainly based on annual reports of the Canadian Council of Fire Marshals and Fire Commissioners, and data from Alberta and Ontario. The benefits are briefly described below:

−

** reduction in property damages: the estimates are based on the estimated loss expressed in monetary values at markets;

+

**reduction in property damages: the estimates are based on the estimated loss expressed in monetary values at markets;

−

** reduction in fatalities: the analysis uses the VSL approach and adopted a benefit of $5.8 million in 2002 dollars; and

+

**reduction in fatalities: the analysis uses the VSL approach and adopted a benefit of $5.8 million in 2002 dollars; and

−

** reduction in injuries: the analysis relies on benefit transfer techniques. The benefits include reduction costs such as emergency transportation and care, hospital stays, medication, and doctors' visits. However, it does not include WTP to avoid pain and suffering, the loss of work time, and the value of leisure time. It is a lower bound estimate.

+

**reduction in injuries: the analysis relies on benefit transfer techniques. The benefits include reduction costs such as emergency transportation and care, hospital stays, medication, and doctors' visits. However, it does not include WTP to avoid pain and suffering, the loss of work time, and the value of leisure time. It is a lower bound estimate.

−

** The annual net benefits are obtained from the estimated amounts of the benefits in excess of the costs. The stream of net annual benefits is then discounted by the discount rate to obtain the net present value to see if the proposed regulation would generate a positive benefit to Canadians as a whole.

+

**The annual net benefits are obtained from the estimated amounts of the benefits in excess of the costs. The stream of net annual benefits is then discounted by the discount rate to obtain the net present value to see if the proposed regulation would generate a positive benefit to Canadians as a whole.

'''Stakeholder Analysis'''

−

* The impact of the regulation on stakeholders depends on who bears the costs of complying with it, which, in turn, depends on the extent to which the cost can be shifted forward by manufacturers or importers of cigarettes to consumers.

+

*The impact of the regulation on stakeholders depends on who bears the costs of complying with it, which, in turn, depends on the extent to which the cost can be shifted forward by manufacturers or importers of cigarettes to consumers.

* The stakeholders in this case include cigarette manufacturers, consumers, tobacco growers, paper suppliers, distributors, retailers and importers, and governments.

−

* The impact on each stakeholder should be examined independently with respect to the supply and demand of their individual market and their financial capability. For example, whether the compliance cost can be shifted to consumers will depend largely upon the demand elasticities for cigarettes and the available substitutes for cigarettes.

+

*The impact on each stakeholder should be examined independently with respect to the supply and demand of their individual market and their financial capability. For example, whether the compliance cost can be shifted to consumers will depend largely upon the demand elasticities for cigarettes and the available substitutes for cigarettes.

−

* The assumptions made in the stakeholder analysis should be properly assessed and clearly documented.</blockquote>

+

*The assumptions made in the stakeholder analysis should be properly assessed and clearly documented.</blockquote>

−

=== Discount rates ===

+

===Discount rates===

For each option under consideration, the stream of costs and benefits will usually not occur in the same year but is spread over several years. Discounting allows for the systematic comparison of costs and benefits that occur in different time periods by allowing one to calculate the net present value of the intervention. If the costs and benefits are expressed in current prices or nominal dollars, they should be deflated to become real prices or prices expressed in terms of the price level of a specific year. In this way, the changes in the reported values of benefits and costs over time that are due purely to inflation are removed.

The discounted present value of net benefits is the algebraic sum of the present values of the expected incremental net benefits of the policy option over and above the baseline scenario during the policy's anticipated impact time period. If the net present value (NPV) is greater than or equal to zero, then the policy is expected to generate more benefits than costs and should be recommended for implementation. However, if the NPV is less than zero, the policy should not be recommended for implementation on efficiency grounds.

−

==== Rational approaches to discount rates ====

+

====Rational approaches to discount rates====

Choosing a discount rate has been one of the most contentious and controversial aspects of the cost-benefit analysis of regulatory policies. The term ''discount rate'' refers to the time value of the costs and benefits from the viewpoint of society. It is similar to the concept of the private opportunity cost of capital used to discount a stream of net cash flows of an investment project, but the implications can be more complex.

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Moreover, a risk-adjusted discount rate has also been suggested elsewhere to account for the systematic risk of future uncertainty. Since the streams of uncertain future costs and benefits are mainly related to the input variables themselves, they are best dealt with in the Monte Carlo risk analysis rather than the adjusted discount rates.

−

==== Discount rates ====

+

====Discount rates====

When a program requires funds that are extracted from the capital markets, the funds are drawn from three sources. First, funds that would have been invested in other investment activities have now been displaced by expenditures required by the policy action. The cost of these funds is the return that would have been earned on the alternative investments. Second, funds come from different categories of savers in the country who postpone their consumption in the expectation of getting a return on their savings. The cost of this part of the funds is reflected in the interest rate that the savers earn net of personal income tax. Third, some funds may come from abroad, that is from foreign savers. The cost of these funds would be the marginal cost of foreign borrowing. At the margin, the cost associated with incremental foreign borrowing is measured by the interest expense on the incremental borrowings plus the marginal change in the cost of foreign borrowing times the quantity of the stock of foreign debt negotiated at variable interest rates.

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The government has established the Centre of Regulatory Expertise that for a period of five years will help departments and agencies adjust to the new approach to regulating, including cost-benefit analysis, instrument choice, and performance measurement. This assistance will include the provision of specialist analytical services. Departments and agencies are expected to discuss their approach to cost-benefit analysis with their Treasury Board of Canada Secretariat analyst, including the need for and approach to discounting any longer-term costs and benefits associated with proposals involving, for example, health and environmental regulation.

−

==== Annualized costs and benefits ====

+

====Annualized costs and benefits====

Cost-benefit analysis results should also be presented in terms of annualized values. This is especially the case when alternative policies have different time horizons. Comparing the net present value between two policies will not be valid unless further adjustments are made.<ref>One can adjust the costs and benefits of alternative options to the same length of periods. See e.g. Harberger, Arnold C. and Jenkins, Glenn P., ''Manual on Cost-Benefit Analysis for Investment Decisions,'' Queen's University, Kingston, Canada, 2002.</ref> However, once net benefits are annualized to become constant annual values, comparing annualized net benefits is equivalent to comparing the net present values of net benefits with further adjustments.

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Suppose there are two mutually exclusive projects. Project A generates a present value of net benefits of $1,500 million over a five-year period. Project B generates a present value of net benefits of $1,700 million over a seven-year period. With the simple net present value criteria, Project B would be recommended. However, we have problems with a longer time horizon than that of Project A.

−

* We can calculate the annualized value of the net benefits as follows:

+

*We can calculate the annualized value of the net benefits as follows:

For Project A, the annualized value of the benefits is:

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* Conclusion: The higher present value of the net benefits for Project B than for Project A is due to a longer time horizon. When the value of net benefits is normalized with respect to time period, it is shown that Project A is in fact preferred.</blockquote>

−

== STEP 5: Preparing an Accounting Statement ==

+

==STEP 5: Preparing an Accounting Statement==

After completing the analysis, it is expected that the results will be summarized in an accounting statement. Analysts are advised to adopt the format that is best suited for a specific policy, while remaining faithful to the intent of the accounting statement, as illustrated below. The purpose is to highlight key components of the benefits and costs associated with the policy and the total net outcome of the analysis.

−

=== Cost-benefit analysis for each option (accounting statement section A) ===

+

===Cost-benefit analysis for each option (accounting statement section A)===

Table 1 provides the incremental benefits and costs of the policy as compared to the baseline scenario. For each option, two sets of analytical results can be shown. Part I presents the results of benefits and costs based on single (deterministic) values for all of the variables affecting the policy outcome, where no risk or uncertainty is assumed for the values. Part II presents Monte Carlo simulation results by dealing with uncertainty and risk surrounding the future value each of the key input variables contributes to the policy outcome.

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Projections of the future benefits and costs so far have been discussed in terms of deterministic values. In practice, it is highly unlikely that the values of all key benefit and cost items will be known with certainty in the future. The reasons for risk and uncertainty can be a lack of information, competitive forces, advances in scientific knowledge, or technological progress. One should build a set of data around the identified input risk variables (e.g. variables 1, 2, 3, as shown in Part II of Table 1) based on the historical data or judgment of experts in the fields to generate a range of possible values and different probability distributions. Using Monte Carlo simulations, one should present the expected net benefits with probabilities given for higher and lower ranges of the values for the outcome. The presentation of the results of the analysis in this way will be more meaningful for decision makers.

−

=== 5.2 Stakeholder analysis for each option (accounting statement section B) ===

+

===5.2 Stakeholder analysis for each option (accounting statement section B)===

In addition to the cost-benefit analysis, one should also present the distribution of the impacts of the policy on various stakeholders and the environment. However, the impacts depend upon the types of regulation that may have impacts on different kinds of stakeholders. If the impacts are on different types of business, it may be presented in terms of net financial profits by specific sector. Sectors can be grouped according to the North American Industrial Classification System. If policies have significant impacts on consumers, the effects should be shown as an incremental burden on individuals and households that may be presented in terms of income groups. In the case of governments, the effects on the budgets of the federal, provincial, and other governments should be shown separately. The effects should also be shown by region or by gender, if there are significant differences in impacts. In the end, the net impact on each of the stakeholders for the nation as a whole should be presented and double counting must be avoided.

The stakeholder impacts by category shown in Table 2 are presented for illustrative purposes. Details of the template could depend upon the specific issues and respective areas of departmental responsibilities.

−

==== Table 1 ====

+

====Table 1====

Accounting Statement Section A: Cost-Benefit Analysis for Each Option

−

===== Part I: Deterministic Case =====

+

=====Part I: Deterministic Case=====

{| class="wikitable"

|+

!Category

!Year 1

−

!Year 2

+

! Year 2

!Year 3

!…

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|

−

|n/a

+

| n/a

|n/a

|-

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|

−

|n/a

+

| n/a

|n/a

|-

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|}

−

===== PART II: Dealing With Risk/Uncertainty =====

+

=====PART II: Dealing With Risk/Uncertainty=====

{| class="wikitable"

|+

Line 699: Line 704:

|-

|

−

| colspan="2" |Expected Value:

+

| colspan="2" | Expected Value:

|-

|

Line 708: Line 713:

|}

−

==== Table 2 ====

+

====Table 2====

Accounting Statement Section B: Stakeholder Analysis for Each Option

{| class="wikitable"

Line 714: Line 719:

!Category

!Year 1

−

!Year 2

+

! Year 2

!Year 3

!…

Line 784: Line 789:

|

|-

−

!Impacts on the Environment

+

! Impacts on the Environment

|

Line 800: Line 805:

|

|-

−

!Atlantic

+

! Atlantic

|

Line 824: Line 829:

|

|-

−

!Prairies

+

! Prairies

|

Line 841: Line 846:

|}

−

== References ==

+

==References==

−

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+

*Agnar, Sandmo and Jacques Dreze, "Discount Rates for Public Investment in Closed and Open Economics." In: ''Economica'', November 1971.

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*Arrow, Kenneth, Robert Solow, Paul R. Portney, Edward E. Leamer, Roy Radner, and Howard Schuman, "Report of the Natural Oceanic and Atmospheric Administration: A Panel on Contingent Valuation." In: ''Federal Register'', 58, No. 10, January 15, 1993.

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+

*Australia, Office of Regulation Review, ''A Guide to Regulation'', second edition, December 1998.

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*Brean, Donald; David Burgess, Ronald Hirshhorn, and Joseph Schulman, ''Treatment of'' ''Private and Public Charges for Capital in a "Full-Cost Accounting" of Transportation: Final Report'', March 2005.

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*Burgess, David F., "The Social Discount Rate for Canada: Theory and Evidence." In: ''Canadian Public Policy'', Summer 1981.

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* Burgess, David F., "Removing Some Dissonance from the Social Discount Rate Debate," unpublished paper, Department of Economics, University of Western Ontario, London, Canada, June 2006.

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*Burgess, David F., "Removing Some Dissonance from the Social Discount Rate Debate," unpublished paper, Department of Economics, University of Western Ontario, London, Canada, June 2006.

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*Canada, Privy Council Office, ''Government Directive on Regulating'', document created for discussion and Consultation purposes only, February 2006.

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* Canada, Privy Council Office, ''Government of Canada Regulatory Policy'', November 1999.

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*Canada, Privy Council Office, ''Government of Canada Regulatory Policy'', November 1999.

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+

*Chestnut, L. G., D. Mills, and R. D. Rowe, ''Air Quality Valuation Model Version 3.0 (AQVM 3.0), Report 2: Methodology'', Colorado: Stratus Consulting, 1999.

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*Duhamel, M., "On the Social Welfare Objectives of Canada's Antitrust Statute." In: ''[http://ideas.repec.org/s/cpp/issued.html Canadian Public Policy]'', [https://www.utpjournals.press/loi/cpp/ University of Toronto Press], 29(3), pp. 301-317, September 2003.

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*Duhamel, M., "The Optimality of Arbitrary Partial Equilibrium Welfare Analysis." In: ''Journal of Public Economic Theory'', 2005 (forthcoming).

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*Environment Canada, ''Benefit-Cost Analysis of a Proposed Regulatory Instrument for 2-Butoxyethanol''. Report prepared by HLB Decision Economics Inc., in association with Douglas Environmental Solutions and Michael Holiday & Associates, April 2005.

−

* European Commission, ''Impact Assessment Guidelines'', June 15, 2005.

+

*European Commission, ''Impact Assessment Guidelines'', June 15, 2005.

−

* Garber, Alan M. and Charles Phelps, "Economic Foundations of Cost-effectiveness Analysis", ''Journal of Health Economics'', 16, 1997.

+

*Garber, Alan M. and Charles Phelps, "Economic Foundations of Cost-effectiveness Analysis", ''Journal of Health Economics'', 16, 1997.

−

* Goulder, L. H. and R. C. Williams III, "The Substantial Bias from Ignoring General Equilibrium Effects in Estimating Excess Burden, and a Practical Solution," ''Journal of Political Economy'', 2003.

+

*Goulder, L. H. and R. C. Williams III, "The Substantial Bias from Ignoring General Equilibrium Effects in Estimating Excess Burden, and a Practical Solution," ''Journal of Political Economy'', 2003.

−

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+

*Canada, Treasury Board of Canada Secretariat'', Cost-Benefit Analysis Guide for Regulatory Programs'', August 1995.

−

* Canada, Treasury Board of Canada Secretariat'', Benefit-Cost Analysis Guide,'' Ministry of Supply and Services, 1998.

+

*Canada, Treasury Board of Canada Secretariat'', Benefit-Cost Analysis Guide,'' Ministry of Supply and Services, 1998.

−

* Harberger, Arnold C. and Glenn P. Jenkins, ''Manual on Cost Benefit Analysis for Investment Decisions'', Queen's University, Kingston, Canada, 2002.

+

*Harberger, Arnold C. and Glenn P. Jenkins, ''Manual on Cost Benefit Analysis for Investment Decisions'', Queen's University, Kingston, Canada, 2002.

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*Harberger, Arnold C., "On Measuring the Social Opportunity Cost of Public Funds." In: Arnold C. Harberger, ed., ''Project Evaluation-Collected Papers'', Chicago: University of Chicago Press, 1972.

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* Harberger, Arnold C., "The Social Opportunity Cost of Labor: Problems of Concept and Measurement as Seen from a Canadian Perspective", Report for the ''Canadian Immigration and Employment Commission, Task Force on Labor Market Development'', Ottawa, 1980.

+

*Harberger, Arnold C., "The Social Opportunity Cost of Labor: Problems of Concept and Measurement as Seen from a Canadian Perspective", Report for the ''Canadian Immigration and Employment Commission, Task Force on Labor Market Development'', Ottawa, 1980.

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* Harberger, Arnold C., "Three Basic Postulates for Applied Welfare Economics." In: ''Journal of Economic Literature'', Vol. IX, No. 3, September 1971.

+

*Harberger, Arnold C., "Three Basic Postulates for Applied Welfare Economics." In: ''Journal of Economic Literature'', Vol. IX, No. 3, September 1971.

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*United Kingdom, HM Treasury, ''Managing Risks to the Public: Appraisal Guidance'', June 2005.

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* Industry Canada and the Centre for the Study of International Economic Relations, University of Western Ontario, ''The Shadow Price of Foreign Exchange in the'' ''Canadian Economy'', 1995.

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*Industry Canada and the Centre for the Study of International Economic Relations, University of Western Ontario, ''The Shadow Price of Foreign Exchange in the'' ''Canadian Economy'', 1995.

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* Jenkins, Glenn P., "Measurement of Rates of Return and Taxation from Private Capital in Canada." In: ''Benefit-Costs Analysis'', W.A. Niskanen et al., editors, Aldine, 1972.

+

*Jenkins, Glenn P., "Measurement of Rates of Return and Taxation from Private Capital in Canada." In: ''Benefit-Costs Analysis'', W.A. Niskanen et al., editors, Aldine, 1972.

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* Jenkins, Glenn P., "The Public-Sector Discount Rate for Canada: Some Further Observations." In: ''Canadian Public Policy'', Summer 1981.

+

*Jenkins, Glenn P., "The Public-Sector Discount Rate for Canada: Some Further Observations." In: ''Canadian Public Policy'', Summer 1981.

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* Jenkins, Glenn and Chun-Yan Kuo, "The Economic Opportunity Cost of Capital for Canada-An Empirical Update, "QED Working Paper Number 1133, Department of Economics, Queen's University, Kingston, Canada, 2007. Available at http://www.queensjdiexec.org/publications/qed_dp_201.pdf. (PDF Version 115 kb)

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*Jenkins, Glenn and Chun-Yan Kuo, "The Economic Opportunity Cost of Capital for Canada-An Empirical Update, "QED Working Paper Number 1133, Department of Economics, Queen's University, Kingston, Canada, 2007. Available at http://www.queensjdiexec.org/publications/qed_dp_201.pdf. (PDF Version 115 kb)

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*Health and Environment Impact Assessment Panel, Joint Industry and Government Study: Sulphur in Gasoline and Diesel Fuels, ''Health and Environment Impact Assessment Panel Report'', June 25, 1997.

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* Mishan, E. J., ''Cost-benefit Analysis'', London: George Allen & Unwin Ltd., 1971.

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*Mishan, E. J., ''Cost-benefit Analysis'', London: George Allen & Unwin Ltd., 1971.

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*Organisation for Economic Co-operation and Development, ''Cost-Benefit Analysis and the Environment: Recent Developments'', 2005.

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* Organisation for Economic Co-operation and Development, ''Regulatory Impact Analysis (RIA) Inventory'', April 2004.

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*Ross, T. and R. Winter, "The Efficiency Defense in Merger Law: Economic Foundations and Recent Canadian Developments." In: ''Antitrust Law Journal'', December 2004.

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*Sjaastad, Larry A. and Daniel L. Wisecarver, "The Social Cost of Public Finance."In: ''The Journal of Political Economy'', Vol. 85, No. 3, June 1977.

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Nancy.luo

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