New Circular A-4: A Revolution in Cost-Benefit Analysis

Sometimes called the most important document that most people have never heard of, Circular A-4 encodes the set of technical assumptions and cross-cutting policy approaches that guides U.S. executive agencies’ exercise of their regulatory power. On November 9, the Biden administration’s Office of Management and Budget (OMB) issued a wholesale replacement of the Circular A-4 that had been on the books for 20 years, with profound consequences for the United States’ regulatory landscape, guiding policy at agencies as diverse as the Environmental Protection Agency, the Occupational Safety and Health Administration, the Department of Transportation, and the Department of Health and Human Services, among many others.  

Fundamentally, Circular A-4 is the White House’s guidance on how agencies should analyze their own regulatory proposals, including most notably cost-benefit analysis. Cost-benefit analysis plays a pivotal role in regulatory decision-making. For over 40 years, under presidents of both parties, the White House has required agencies to develop a cost-benefit analysis of their significant proposed regulations. The agencies in turn share that analysis with the White House’s Office of Information and Regulatory Affairs (OIRA), which scrutinizes it, ensuring that the agency has selected the approach that “maximize[s] net benefits.” Cost-benefit analysis thus shapes agencies’ choice among regulatory outcomes and may even cause the agency to reconsider whether to regulate at all. In addition, courts increasingly examine agencies’ cost-benefit analysis to ensure that the final rule is neither arbitrary nor capricious. As a former OIRA administrator has put it, this regulatory review process has gradually transformed the American regulatory state into a “cost-benefit state.”

While presidents of both parties have repeatedly reaffirmed their commitment to cost-benefit analysis, the process is not without its critics, who argue, among other things, that cost-benefit analysis prioritizes efficiency and minimizes other important values, such as distributive justice. Recognizing these ongoing criticisms, on President Joe Biden’s first day in office, he issued a presidential memorandum, “Modernizing Regulatory Review,” that directed OMB to “identify ways to modernize and improve the regulatory review process.” He also directed OMB to “provide concrete suggestions on how the regulatory review process can promote public health and safety, economic growth, social welfare, racial justice, environmental stewardship, human dignity, equity, and the interests of future generations.” 

The result is a dramatically different set of instructions for agencies. The first Circular A-4 was 48 pages. The revised and newly operative Circular is 93 pages and makes numerous significant changes to virtually all aspects of agency cost-benefit analysis. Because cost-benefit analysis shapes regulatory outcomes, even small changes in the technical assumptions underlying the analysis will have a massive effect on regulatory policy, which Circular A-4 promises to have.

While OMB’s finalizing of the new Circular A-4 concludes the debate over the guidance document itself, it also starts a new phase of the debate about regulatory priorities — one in which courts will have a chance to weigh in. Over the next several years, agencies will use the new circular’s guidance as they develop new rules. Those rules — and the understandings and assumptions that underly them — will then be tested in court. It is important to keep in mind that Circular A-4’s directives are merely nonbinding guidance.

By contrast, agencies are legally bound to follow such substantive laws as the Clean Air Act and Occupational Safety and Health Act that grant rulemaking power. Agencies are also legally bound to follow the Administrative Procedure Act (APA) requirement to act reasonably, that is, not to engage in actions that are arbitrary or capricious. Many of Circular A-4’s directives have yet to be tested against either substantive law or the APA. 

Below we highlight three of Circular A-4’s changes that are likely to be highly significant in shaping regulatory policy but that are also largely untested in court.

Discount Rate

• The change to the discount rate is likely the most consequential aspect of the new circular. The 2003 circular set forth two discount rates, a 7% “base rate” reflecting the opportunity cost of capital (i.e., the expected growth of capital investments) and a 3% rate approximating the social rate of time preference (i.e., the rate at which society is willing to trade current consumption for future consumption). Cost-benefit analysis has typically analyzed whether benefits outweigh costs under both rates, with the understanding that the 7% rate is a more accurate measure when the cost or benefit in question affects capital and the 3% rate is a more accurate measure when the cost or benefit in question affects consumption.
• The new circular sets forth a single 2% discount rate reflecting an updated social rate of time preference, and it attempts to factor in the expected growth of capital through the shadow price of capital formula. These many technicalities should not mask the basic point that the discount rate has been reduced dramatically. As a result, regulatory proposals with far-in-the-future, speculative benefits but that impose costs in the here and now are much more likely to be evaluated as cost-justified than they were under the 2003 circular. Moreover, not only will more rules be considered cost-justified, more stringent rules are now more likely to be considered cost-justified. As with all aspects of the regulation, agencies will need to defend the use of the 2% discount rate to the satisfaction of reviewing courts.

Distributional Analysis

• The centerpiece of the revised Circular A-4 are the new directions concerning distributional analysis. While the 2003 circular acknowledged the importance of distributional considerations, it did not make the analysis systematic in any way. It instead called on agencies to “provide a separate description of distributional effects.”
• In addition to emphasizing the importance of describing distributional effects, the new circular suggests (but does not require) a system of distributional weights based on income, on the assumption that the marginal utility of income falls as income rises — that is, that a dollar would create more utility in the hands of a poor person than in the hands of a rich person. Estimates of the rate at which marginal utility decreases vary widely, but OMB took an average of different estimates and came up with 1.4. That would mean that an agency applying distributional weights should weight a benefit accruing to a person in the bottom quintile almost six times as much as a benefit accruing to a person in the median quintile and 40 times as much as a benefit accruing to a person in the top quintile. If the benefits of a rule are concentrated among lower-income Americans (such as a rule that primarily affects pollution localized in low-income neighborhoods), then the distributional weighting under the new circular could justify such a rule, even if it would not have been justified under the prior circular. In many cases, however, distributional weighting could have a deregulatory effect, because many regulations are regressive, imposing compliance costs that are constant across income levels.
• The system of distributional weighting effectively asks agencies to consider the redistributive effects of certain rules as benefits of those rules. But whether an agency can justify a rule based on its redistributive effects depends on whether the underlying statute authorizes the agency to regulate for the sake of redistribution. Outside of certain tax and healthcare statutes, most regulatory statutes do not comprehend redistributive goals.

Global Effects

• The 2003 circular did not discuss effects outside of the domestic United States. By contrast, the new circular instructs agencies not just to consider such effects on U.S. “citizens and residents” who live abroad but to “include effects experienced by noncitizens residing abroad” under certain circumstances. For example, the circular suggests measuring costs and benefits abroad is where “regulating an externality on the basis of its global effects supports a cooperative international approach to the regulation of the externality by potentially inducing other countries to follow suit or maintain existing efforts.” While this change has clear implications for greenhouse-gas regulations, it will likely affect a wide array of regulatory arenas.
• Yet agencies’ ability to regulate for the sake of benefits abroad is, in most cases, dubious at best. Agencies are not permitted to regulate for benefits abroad absent a clearly conferred power to do so. As the Supreme Court said in EEOC v. Aramco (1991), among other places, “Congress legislates against the backdrop of the presumption against extraterritoriality.” Thus, absent the clearly expressed intention of Congress to apply a regulatory statute abroad, the agency may not give it such extraterritorial effect. And vanishingly few regulatory statutes clearly intend to have extraterritorial effect. For example, the Clean Air Act’s codified purpose is “to protect and enhance the quality of the Nation’s air resources so as to promote the public health and welfare and the productive capacity of its population” (emphasis added).

Individuals and businesses that are negatively affected by proposed rules that use these or other novel aspects of the new Circular A-4 should consider challenging those novel aspects as a part of a broader challenges to the rule itself. Such individuals and business also should submit comments that do not take Circular A-4 as a given but that instead preserve issues for litigation. As always, Sidley’s Regulatory Litigation team is well positioned to advise you and your business on the United States’ fast-changing regulatory landscape.