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The new Circular A-4 will avoid biased climate economic analysis
An update to the influential US government guidelines encourages economic analysis tailored to the unique aspects of climate change and the energy transition
On November 9 the White House released guidance for the economic analysis of federal government regulations – a document called Circular A-4 (they also released its sister document, Circular A-94, which provides guidance for the analysis of Federal spending programs). The revisions bring the guidance—last updated in 2003—in line with important advances in scholarship and changes in economic conditions.
Climate regulations require unique considerations in benefit-cost analyses due to the unprecedented challenges and opportunities raised by climate change and a rapid transition to a clean energy economy. However, the old A-4 gave little attention to climate. The climate policy literature was in its relative infancy. Applying a generic set of economic assumptions to the analysis of climate regulations has led to misleading policy analysis.
While many of the climate-related updates are controversial, an analysis that adopts the practices described in the updated guidance will avoid common unforced errors in climate economics, and thus improve analyses of the benefits, costs, and justifications of climate regulations.
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Avoiding biased estimates of the benefits of climate regulations
Avoided damages from climate change are the primary rationale for climate regulations. But putting monetary values on the myriad ways climate change will affect the world over many centuries is as difficult as it sounds, and the new A-4 does not provide a full blueprint for overcoming these challenges. But the guidance will facilitate better estimates of the benefits of climate regulations by enabling analysts to account for the following critical features of climate damages:
Global scope. The old A-4 told analysts to “focus on benefits and costs that accrue to citizens and residents of the United States.” The Trump administration used this guidance to justify a focus only on domestic climate damages. The new A-4 provides more flexibility to consider a broader geographic scope when appropriate, including when “regulating an externality on the basis of its global effects supports a cooperative international approach.”
Distributional concerns. The old A-4 said that benefit-cost analyses should be undertaken “ignoring distributional effects,” under the theory that any distributional concerns are better addressed via other policy changes (e.g. to the tax and transfer system). This rationale makes little sense in valuing climate damages, which will disproportionately affect people who cannot afford to prepare or respond and who will not be compensated by changes to the US tax and transfer system. The new A-4 enables analysts to apply “distributional weights” that account for the larger value that people place on an additional dollar (of benefits or costs) when they have fewer dollars to begin with.
Risk reductions. The old A-4 also told analysts to “assume risk neutrality in your analysis,”—which means ignoring how regulations add or reduce risks to society—under the theory that the risks associated with regulations will converge to zero when spread over a large population. Government estimates of the “social cost of carbon” have relied on this guidance to justify the omission of potentially large risk-reducing benefits of climate regulations. The new A-4 provides analysts with flexibility to account for “risk aversion” when appropriate, including when regulations address systemic and often uninsurable risks like climate change.
Non-monetized effects. Studies naturally focus on the climate damages that are easiest to identify and quantify. But climate change is a threat multiplier that will affect human societies in ways that are unprecedented, unknown, and difficult to quantify. The new A-4 adds an extensive discussion of non-monetized benefits and costs, requiring analysts to prominently feature non-monetized effects in situations, like climate damages, where most of the effects may be omitted from a quantitative analysis.
Discounting the future. The old A-4 included a discussion of the “special ethical considerations” that arise when comparing benefits and costs across generations. But these concerns were relegated to sensitivity analysis, “in addition to calculating net benefits using discount rates of 3 and 7 percent.” The 3 and 7 percent annual rates of discounting the future were derived from market rates of return during the late 20th century. Most discounting experts prefer lower rates in a climate analysis that better account for the far future damages and uncertainties. The new A-4 provides an extensive discussion about long-term discounting, recognizing “various reasonable approaches” and providing a default schedule of discount rates that begin at 2 percent and decline over longer time horizons.
The White House solicited expert peer review and public comments on the revised guidelines, which included pushback on many of these topics. For example, commenters expressed concerns about the normative judgments involved in distributional weighting, the analytical complexities involved in accounting for risk aversion, and whether market interest rates should be used to discount the far future.
These critiques raise legitimate concerns but, notably, they do not defend the status quo approaches or identify widely- accepted alternatives. Indeed, the challenges to producing policy-relevant estimates of the monetary value of climate damages may be insurmountable. The international climate community has largely moved beyond a benefit-cost approach to climate mitigation, focusing instead on science-informed temperature and emissions targets. The specific regulatory and legal history of Federal regulatory analysis in the United States makes it difficult for the US government to fully follow suit.
Avoiding biased estimates of the costs of climate regulations
Estimating the costs of climate regulations is inherently challenging as well. These estimates depend on how technological progress and behavioral changes will evolve in the face of unprecedented policies to accelerate an energy transition. Predicting the future is hard. The A-4 offers analysts no silver bullets.
But the updates include new guidelines that should encourage improved economic analysis on at least two topics of critical importance to the costs of climate regulations: (1) developing baselines with realistic policy and technology projections; and (2) general equilibrium analyses that capture effects across the economy.
As the new A-4 notes, accurately capturing the incremental effects of a regulation requires “an analytically reasonable forecast of the way the world would look absent the regulatory action being assessed,” i.e., a defensible baseline. The old A-4 said the same. However, it has been common practice to use relatively static baseline forecasts that assume little technological change and no additional policy action (such as the Energy Information Administration’s Annual Energy Outlook Reference Case). In contrast, the clean energy technology and policy landscape evolves rapidly each year, with technology costs falling and policy actions accelerating. By systematically underestimating these trends in the baseline forecasts, analysis commonly attributes effects to regulations that would have occurred even in their absence.
A notable example was the regulatory analysis of the Clean Power Plan, the Obama-era regulation of carbon dioxide emissions from power plants. These standards would have accomplished little more than cementing ongoing trends. But, by using a relatively static baseline, EPA attributed much of the costs of the ongoing buildout of clean energy and efficiency measures to the Clean Power Plan, providing the appearance of a more costly (and beneficial) regulatory action. The Supreme Court struck down the Clean Power Plan in 2022, citing EPA’s estimates of “billions of dollars in compliance costs” in concluding that a regulation with such major economic significance overstepped EPA’s statutory authority.
In contrast to past practices, the new A-4 encourages analysis to include “the likely paths of future government programs and policies” in baselines, and to pay particular attention “to ways in which conditions will change absent the regulation—e.g., technological advances, demographic changes, changes in the economy, or alterations to the climate.” While asking analysts to forecast such changes will make developing a baseline more challenging, it will also help to avoid a clear source of bias in estimates of regulatory effects.
General equilibrium analysis—which considers effects of regulations across markets and sectors—is another new area of focus in the updated A-4. Policy analyses often focus on the jobs and income that may be directly created or lost due to compliance with regulations and associated spending. But major climate regulations will have effects that reverberate throughout the economy. For example, any effects on electricity or natural gas prices can affect households across the country and consumers across sectors where these fuels are used. In addition, regulations that constrain certain economic activities or redistribute wealth may also have indirect effects on labor markets if they change the incentives for additional labor effort.
These indirect effects have the potential to dwarf the direct effects of regulations, at least on the economy as a whole, so it makes little sense to draw broad conclusions about the macroeconomic effects of regulations that focus on direct effects alone.
The A-4 update explains that general equilibrium analysis may be particularly important when “regulation causes substantial price changes in markets other than the directly affected market or noteworthy reallocation of time or services not allocated through markets.” Agencies are warned to avoid “input-output models,” which use simplistic multipliers to convert changes in spending into economic effects. Federal agencies are arguably ahead of the curve in conducting cross-sectoral analyses—for example, EPA has developed a general equilibrium model for use in regulatory analysis.
The new A-4 also notes important drawbacks of general equilibrium analysis. These models can be “black boxes” with potentially inappropriate assumptions embedded in them, such as “fiscal closure rules” that assume government spending will be combined with a particular approach to revenue generation. In addition, assumptions of an economy “in equilibrium” may be poorly suited for a rapid transition to a clean energy economy.
A more holistic vision for climate action
In addition to the wonky details noted above, the A-4 has a section called “Identifying the Potential Needs for Federal Regulatory Action,” which is also updated from the 2003 version. The old A-4 included a “presumption against economic regulation” and a “demanding burden of proof” to justify certain regulatory approaches, while the new A-4 omits this language and provides a more wide-ranging discussion of the ways in which government regulations can improve the lives of Americans by correcting market failures, overcoming behavioral biases, and promoting equity.
These changes between the 2003 and 2023 versions of Circular A-4 reflect a transformation not only among the politicians and economists within the government but also within the field of climate economics. The days of considering climate change only as an externality to be corrected with a carbon price have given way to a more holistic consideration of the many barriers to a net zero emissions economy, how public policy can help overcome those barriers, and the trade-offs and unintended consequences of such interventions.