Cost-benefit analysis is one of the most common types of analysis that we conduct at Scioto Analysis. Put simply, cost-benefit analysis is a process where we inventory costs and benefits of a public policy and express them in monetary terms. Cost-benefit analysis is valuable because it produces a clean, top-level finding: what is the net present value of a public policy? What is the value of the benefits the policy produces? What is the value of the costs the policy incurs?
Most recently, Scioto Analysis released a cost-benefit analysis of data center policy in Ohio. Some other cost-benefit analyses we’ve conducted in the past include analyses of congestion fees in New York City, homelessness in Hawaii, and cigarette taxes in Ohio.
Cost-benefit analysis is most commonly used at the federal level. In fact, most major federal regulations are required to undergo a formal cost-benefit analysis. Cost-benefit analysis can be a valuable decision-making tool. In fact, one of the most consequential cost-benefit analyses in federal history came from an administration known for deregulation.
The hole in the ozone layer
In May 1985, a Nature report found that a massive hole had opened in the ozone shield and suggested the use of “chlorofluorocarbons” were responsible for it. Chlorofluorocarbons came into widespread use in the 1950s for industrial and consumer goods such as refrigerators, air conditioners, fire extinguishers, and spray cans. The ozone layer absorbs a great deal of ultraviolet radiation from the sun, so a compromised ozone layer posed a threat to human health, wildlife, and ecosystem strength.
Formal diplomatic negotiations surrounding chlorofluorocarbon reduction began in late 1986, and dozens of nations signed the Montreal Protocol in late 1987, an agreement to significantly reduce chlorofluorocarbons in the atmosphere by regulating their production and consumption.
The Reagan administration was divided over how aggressively to push for reductions in chlorofluorocarbons. Interior Secretary Donald Hodel led a coalition of officials from the Departments of Commerce and Agriculture, the Office of Management and Budget, and parts of the staff who questioned both the science and economic costs of chlorofluorocarbon controls.
The core disagreement was over the size of the cuts. The State Department and Environmental Protection Agency recommended a freeze and 20% reduction in chlorofluorocarbons, followed by a second-stage cut of about 30%. Hodel’s coalition, along with the European Commission, Japan, and the Soviet Union, opposed the second stage. With the administrations split, there was an important question that needed an answer: were reductions in chlorofluorocarbons worth the cost? That’s where cost-benefit analysis came in: cost-benefit analysis could help estimate the net social value of each scenario.
The cost-benefit analysis of reducing CFCs
The Council of Economic Advisers’s first estimate came in a May 1987 memo. Using the Environmental Protection Agency’s risk assessment, it estimated that a freeze and 20% reduction in chlorofluorocarbons would prevent about 992,900 skin cancer deaths among Americans alive in 1987 and those born through 2075, and that an additional 30% reduction would prevent another 78,700 deaths. The Council calculated the monetary benefits of a freeze and 20% reductions to be $1.3 trillion (in 1987 dollars) and the costs to be no more than $13 billion, a benefit-cost ratio of about 100:1. However, the memo didn’t state its key assumptions, such as the value of a statistical life or the discount rate it used, and it only counted costs through 2000.
A few weeks later, a more complete interagency cost-benefit analysis, with assumptions the Council endorsed, was presented to the Domestic Policy Council. Rather than relying on a single set of assumptions, it tested 32 combinations of the following assumptions:
a value of a statistical life of $2 million or $4 million
a value of life that either stayed constant or grew 2% per year
discount rates of 4% or 6%
four different timelines for when deaths would occur
The June analysis also extended costs indefinitely, assuming they would grow between 0.625% and 2.5% per year. Under these assumptions, moving from no action to a freeze and 20% reduction produced average benefits of $773 billion at a 4% discount rate and $137 billion at a 6% discount rate, and costs of roughly $5 billion to $10 billion. At a 4% discount rate, that’s a benefit-cost ratio of roughly 75:1 to 150:1. In this analysis benefits exceeded costs in all 32 combinations.
This range of benefit-cost ratios is very high, and it suggests that the benefits exceeded the costs by a great deal. Over the past several years, the cost-benefit analyses conducted by Scioto Analysis with the highest benefit-cost ratios were for an Ohio cigarette tax, with a benefit-cost ratio of 23:1, and for a full replacement of lead service lines in Ohio, with a benefit-cost ratio of 31:1. Upon reviewing the Washington State Institute for Public Policy’s current cost-benefit analyses, a leading organization in the cost-benefit analysis field, I found just 20 of 336 studies with a benefit-cost ratio above 100:1.
The June analysis also evaluated the additional 30% reduction. It estimated benefits of $58 billion at a 4% discount rate and $11 billion at a 6% discount, and costs of roughly $9 billion to $19 billion. Benefits exceeded costs in 56% of the combinations, were roughly equal to costs in 19%, and were lower than costs in 25%.
The scope of the cost-benefit analysis only includes deaths from skin cancer in the United States. The scope does not include benefits to other countries, and it also doesn’t include non-health benefits or benefits from avoidance of non-fatal skin cancers and cataracts. This suggests that the Council’s estimates, while high, are likely to be an underestimate of the full benefits from reducing chlorofluorocarbons.
As a result of the cost-benefit analysis, the Council of Economic Advisers changed their initial stance of skepticism to support a strong international protocol to reduce chlorofluorocarbons. Some members of the Reagan administration continued to emphasize their opposition to the regulation, but President Reagan ultimately accepted the freeze and 20% reduction in chlorofluorocarbons, alongside the additional 30% reduction. It would be imprecise to say that the cost-benefit analysis conducted by the Council of Economic Advisers was the single determinant of President Reagan’s decision, but it likely helped tip the scales.
The implications of the Montreal Protocol CBA
An important part of cost-benefit analysis is making well-founded assumptions and using high-quality data. In 1987, economists and researchers from the Council of Economic Advisers and the Environmental Protection Agency were working with limited models and data. In the decades since, scientists have gathered far more evidence, and the models used to estimate the effects of ultraviolet radiation have improved. Revisiting the Montreal Protocol with updated estimates shows how our understanding of a policy’s impacts can change over time.
In 2020, the Environmental Protection Agency estimated that the efforts taken to restore the ozone layer will reduce United States cases of skin cancer by 443 million, save an estimated 2.3 million American lives, and prevent more than 63 million cataract cases for Americans born between 1890 and 2100. These estimates are not directly comparable to the 1987 analysis, however, as they reflect the Montreal Protocol in its final state, which went beyond the scope of the original freeze and 50% reduction.
Additionally, the National Oceanic and Atmospheric Administration found that the Montreal Protocol eliminated a significant contributor to climate change, which will avoid a potential global temperature increase of 0.5 to 1 degree Fahrenheit by the year 2100. This is a benefit the 1987 analyses did not consider at all.
The Montreal Protocol cost-benefit analysis is a useful case study for anyone who works in this field. A one-page memo from the Council of Economic Advisers helped persuade skeptical officials in an administration generally wary of regulation. At Scioto Analysis, we see cost-benefit analysis as a tool to inform decisions. The Montreal Protocol is a reminder that a clear, well-communicated analysis can shape policy even when the politics are difficult, and that looking back at how a policy actually turned out is one of the best ways to improve the analyses we do going forward.
