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OAQPS Economic Analysis Resource Document

8.1 Specifying the Time Period of Analysis

    By their nature, most regulations impose costs and confer benefits for many years.  In fact, the intent of a regulatory action is usually to correct a current problem indefinitely.  As a result, EAs of regulatory actions must be designed to facilitate the comparison of regulatory benefits and costs over time.  However, because analytical resources are not unlimited and because the accuracy of cost and benefit estimates decreases for values far in the future, it is often necessary and appropriate to limit that time period to a finite time period.  There is frequently no clear basis for determining the appropriate time period for analysis.  The time period must allow the analyst to capture any specific identified changes expected to occur over time, and it must be applied consistently to the calculation of both benefits and costs.
    It is common practice to calculate the costs of a regulatory option over the period of time corresponding to the expected useful lifetime of capital equipment purchased to comply with the rule.  For example, if the capital equipment purchased as a result of the rule has an expected useful life of 15 years, an analyst might calculate the expected costs of the rule over a 15-year period.  For consistency, benefits should be calculated over the same 15-year period.

8 Methodological

 8.0 Intro

 8.1 Specifying the Time
   Period of Analysis

 8.2 Specifying a Baseline
   for Analysis

 8.3 Discounting Benefits
   and Costs

 8.4 Addressing Uncertainty
    It is often not necessary to extend the time period of analysis beyond the length of a single capital life cycle.  In most cases the estimated benefits and costs of distant years will not differ substantially from those of the years immediately following the effective date of the regulation.  Also, it is often difficult to predict factors, such as the development of new technologies, changes in demand, or changes in behavior patterns, that could cause substantial changes in costs or benefits over time.  Therefore, the benefits and costs estimated for the first several years will typically represent all that can be said in the analysis regarding the impacts of the rule for the indefinite future.
    Some of the benefits resulting from actions taken during the capital life cycle, however, may not be realized during the time period of analysis.  For example, if the cost analysis calculates costs over a 15-year period, the benefits analysis should include any benefits realized during Years 1 through 15 as well as any benefits realized after Year 15 attributable to actions taken to comply with the regulation during Years 1 through 15.  Benefits realized in Year 20 should be counted if they are related to compliance actions taken in Year 15 or earlier; they should not be counted if they are related to actions taken in Year 16 or later.  In general, benefits realized in the future should be counted in the analysis if they can be directly related to actions taken during the period of analysis used for estimating costs.
    For some regulations, using the equipment cycle criterion to select the analysis time period may be difficult to apply either practically or conceptually.  From the practical standpoint, a regulation might require the regulated entity to purchase multiple capital equipment items, each having different service lives.  In these cases, determination of the appropriate capital cycle is a judgment call.  In other cases, the capital cycle may be of limited conceptual relevance.  For instance, the required capital expenditure might simply involve a one-time expenditure to change a production process, or it may involve the acceleration of purchases that would be made as normal business practice (e.g., accelerated replacement of equipment).  Because both of these situations involve an initial expenditure of funds to generate service flows over time, they are appropriately viewed as capital expenditures.  However, in contrast to the purchase of a specific piece of equipment, the “useful life” of the one-time expenditure or accelerated expenditures is not as well defined.  
    An example of an OAQPS regulation in which useful life conceptual issues arise is the architectural coatings rule ( EPA, 1998b).  That rule required some producers of architectural coatings to reduce the content of volatile organic compounds (VOCs) by reformulating their products.  Reformulation—for the purposes of compliance—would presumably occur only once. In that regard, the useful life of this initial action is not necessarily confined to a finite period, as would be the case for equipment that physically depreciates and must be replaced at some point in the future.  An alternative view is that reformulation is a normal business practice and that the rule requires some producers to simply expedite that process.  The EIA prepared for the architectural coatings presents a variety of different service life interpretations for the reformulation requirement and evaluates their cost implications.
    One way to minimize the confusion surrounding the capital cycle issue is to convert all costs and benefits to their annualized equivalents.  This does not entirely circumvent the service life issue.  The analyst must still select a service life over which to annualize any capital requirements.  However, it ensures that costs and benefits will be compared on a consistent time frame basis and does not require the arbitrary selection of a multiyear time period for analysis. Moreover, issues of economic significance addressed in various statutes and EOs (e.g., UMRA and EO 12866) often use annual impact as a criterion.     
    Discounting may also provide some perspective on the appropriate time period of analysis.  In particular, once discounted future benefits or costs become negligible, little is gained by extending the analysis further into the future.  It is important to note, however, that this method of determining the time period of analysis is highly sensitive to the discount rate used. Discounting methods and rates are discussed in more detail later in this section.

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