“Cost-benefit analysis” is a phrase that is used in a lot of different contexts with a variety of meanings. Some people trace cost-benefit analysis in the United States as far back as Benjamin Franklin, who is said to have generated pro-con lists over a number of days to evaluate decision-making.
Cost-benefit analysis is a formalized process in the economic world. Since the New Deal era of large-scale public works, the Army Corps of Engineers has been conducting formal cost-benefit analysis to inform project selection. All major federal regulations have been subject to cost-benefit analysis for nearly half a century. How cost-benefit analysis is conducted at the federal level is the subject of Supreme Court cases. The federal government issues guidance to agencies on how to conduct cost-benefit analysis and the international Society for Benefit-Cost Analysis hosts conferences and workshops and publishes a journal on cost-benefit analysis.
To support this work, Scioto Analysis publishes the State Handbook of Cost-Benefit Analysis, a free resource for state analysts and policymakers interested in interpreting and conducting cost-benefit analysis at the state level.
But what are the steps of formal cost-benefit analysis? While different agencies have different standards for cost-benefit analysis and different contexts call for different specific approaches, the following steps separate a formal cost-benefit analysis from an informal one.
Establishing a baseline for your cost-benefit analysis
At its heart, cost-benefit analysis is a specific form of policy analysis. Policymakers have to make decisions about which policies to adopt and how to implement them. Cost-benefit analysis allows policymakers to understand how a policy works, who is impacted by the policy, and the relative share of costs and benefits of the policy borne by different members of society when it is implemented.
Because of this, having a baseline assessment of conditions is crucial for a cost-benefit analysis. In December, Scioto Analysis released a cost-benefit analysis we conducted on cigarette taxation in Ohio. Because the research we were doing relied on estimates of how much people will reduce their cigarette consumption as prices increased, the baseline number of cigarette sales was a crucial input to our model. Because cigarette consumption is on the decline in Ohio as it is throughout the country, this meant the impacts of the policy would have been smaller than if cigarette consumption was otherwise steady or on the rise.
Determining policy options for cost-benefit analysis
Next, a policy analyst needs to decide which policy options to analyze. If you are working for a policymaker, they will often tell you which options to analyze. But going deeper can be an important undertaking for a policy analyst. In a cost analysis we conducted a few years ago on climate policy in Ohio, we analyzed cap-and-trade, carbon tax, and renewable portfolio standard options for abating climate change in Ohio. In this analysis, we used cap-and-trade policies espoused in other states, renewable portfolio standards adopted by comparable states, and carbon tax levels introduced in Congress as potential policy options for Ohio.
Deciding whose costs and benefits to count
When conducting a cost-benefit analysis, an analyst needs to determine standing early, or whose costs and benefits to count. Should we count people all across the world or just in the jurisdiction the policy applies to? What about residents who are not citizens? What about people who commute into the area? These are all questions that need to be answered by a policy analyst as they conduct a cost-benefit analysis because they can have significant impacts on the outcome of the policy.
Identifying impacts in a cost-benefit analysis
Next, an analyst needs to determine which impacts to analyze in the cost-benefit analysis. This usually involves consuming literature, understanding what economists and researchers have established about what policies like this have done in this and comparable jurisdictions. This is usually a step in the process where analysts can get creative and expand their scope, seeing how many potential impacts there are of a policy as well as the research behind them. In a recent cost-benefit analysis we conducted on wildlife crossings, we analyzed impacts ranging from loss of life from wildlife collisions to the benefits of connecting ecosystems to the cost of pouring concrete.
Quantification and Monetization in cost-benefit analysis
This is what many would consider the “heart” of cost-benefit analysis: the process of taking impacts and putting numbers on them, then converting them into dollar amounts. The goal here is to use the best available evidence to quantify the impacts of policies on key social outcomes of interest. The analyst will then use this to put dollar figure amounts on each impact based on the social costs and benefits levied by those impacts.
Discounting costs and benefits
Discounting is a key element of cost-benefit analysis. Dollars spent on programs today cannot be spent tomorrow, so there is a future social cost to investing dollars today that must be reconciled with benefits accrued later. This also can work the other way: benefits gained now can lead to costs down the road. This is what we found in our cost-benefit analysis of school closings for COVID-19.
The specific rate that benefits and costs should be discounted at is a subject of debate among scholars of cost-benefit analysis. Analysts usually consult sources of guidance such as the federal government’s Circular A-4 or the textbook by Anthony Boardman et al for answers.
Sensitivity analysis of your results
All analysis includes assumptions. Good analysis tests those assumptions and sees what the results are. Using techniques like partial sensitivity analysis, best-case/worst-case analysis, break-even analysis, and Monte Carlo simulation helps analysts understand how much their results rely on assumptions and which assumptions will impact results most if they are wrong. It can also be a good tool for understanding how likely results are to be directionally correct, like how the Washington State Institute for Public Policy presents their benefit-cost results.
Telling your story
Last, the analyst has to share her results! This could be in a report, a press release, a presentation, or anything else you could think of. But good communication is key in cost-benefit analysis. Even preliminary results or presentation of a list of impacts can be valuable to a policymaker trying to craft better policy. After all, often the process of cost-benefit analysis is more important than the results.