Public finance- cost and benefits i need the spreadsheets with memo

To: Director, Ohio EPA

From: Jill SPEON

Re: Economic Analysis of Vehicle Emissions Testing Programs

Date: Spring 2008

Introduction

Hamilton County Ohio, and the surrounding Air Quality Control Region, do not comply with ambient air quality standards established under the Clean Air Act. The EPA has responded by ordering Hamilton county to establish an annual vehicle emissions inspection and maintenance (I&M) program. This emissions testing program should help bring the county into compliance with applicable federal regulations.

This memo summarizes a cost analysis of three alternative ways of implementing the EPA- mandated emissions inspection program, as well as an assessment of the net-benefits of twice- yearly inspections. The latter option goes beyond the EPA mandate, and would improve ambient air quality in the region above the level required by law.

There are several feasible alternatives for achieving the program objective. First, Hamilton county could require the area’s private service stations to offer the emissions tests as a complement to annual safety inspections. The county would establish the fee level to cover the incremental labor time and equipment costs associated with the emissions inspection. Second, Hamilton county could itself construct, own, and operate five high-volume test facilities exclusively dedicated to emissions testing. A fee would be charged to cover the associated costs. Alternatively, the county could grant a franchise to a private operator who would construct, own, and operate the five centralized facilities, in exchange for a negotiated agreement about the inspections fee. Appendix 1 provides other relevant information and details about the program alternatives.

With these choices as the alternatives, the analysis will show that the private service station option is likely to offer the most-cost effective means of achieving the mandated emissions reductions. This judgement is based on the standard measure of “cost” employed in cost-benefit analysis. By the same measure, the benefits of the optional program expansion do not cover the incremental cost for any program alternative. Hence, the conclusion follows that the county should simply implement the EPA-mandated program, using private service stations as the venue for the emissions testing.

The next section of this memo shows the essential elements of the cost-analysis and explains the logic behind the policy recommendation. Next, we consider whether the program’s distributional impact; fiscal effects, and employment impact affect the basic conclusion. Finally, the memo summarizes the results of the benefit-cost study of the program expansion, and offers a brief conclusion.

Cost Analysis

Tables 1 provide the structure of the comparative cost analysis for one set of assumptions about program cost.1 Notice that the direct costs are lower for the centralized facilities than for the private service station option. The centralization of I&M activities increases the efficiency of labor and capital utilization and reduces administrative overhead. These advantages are large enough to overcome the added costs associated with new facility construction. However, the private service station option reduces inconvenience and direct transit costs associated with emissions inspections (See “Travel and Time Costs” in Table 1). Since more than 2,000 service stations would participate in the program, testing facilities would be proximate to most Hamilton county residents, reducing travel times and costs. Moreover, inspections at private service stations would be piggy-backed on top of annual safety inspections, sparing residents an added trip for the primary emissions inspection. The associated transit and time cost savings are sufficient to overcome the relatively high capital and labor costs, given the assumptions underlying Table 1.

Because the relative merit of the private service option depends on avoiding direct transit and time costs, it is important to assess whether results are robust to other assumptions about these cost components. This assessment is particularly appropriate for inconvenience costs, which do not have a direct market valuation.

Table 2 provides alternative program estimates based on time cost and travel cost valuations spanning a range commonly used and/or derived in similar studies. Case 1 is taken from Table 1: it is based on a relatively high valuation of time and transit costs (respectively, time costs equaling 75% of the average wage rate in the community, and direct transit costs of 25 cents per mile). Although the relative advantage of the service station option declines with lower direct transit costs, it still remains the most-cost effective option if the value of time savings is high (Case 2).When the value of time is relatively low (25% of the wage rate in the community), the private service option is still lowest cost at the higher transit cost (Case 3), but the franchised centralized option becomes the lowest-cost option when both the value of time and the cost of transportation assume the lower bound (Case 4). This analyst believes that the lower bound estimates are unlikely to obtain together and, therefore, that the private service station option can be comfortably recommended if conventionally-measured cost effectiveness is the decision criterion.

This analysis must be qualified on two counts. First, inconvenience costs could systematically vary among options in ways not captured. For example, the state-operated facilities will operate only during regular business hours, in contrast to the contractor-operated facilities and private service stations. Consequently, some or all of the time valuations in Table 2 for the state option could be biased on the low side. However, even with these estimates the state-operated system is not cost-competitive under any scenario. Increasing the value of time costs for this option will thus strengthen the original conclusion.

Conceivably, the program alternatives could differentially alter the flow of traffic; change the pattern of congestion; and/or change the frequency of automobile accidents. All else constant,

1 The methodology assumptions and calculations underling all the Tables in this memo are described in Appendix 2.

the service station option should minimize these collateral effects by avoiding the extra trip for the primary emissions inspection. However, a transportation impact analysis would be needed to enable a conclusive judgement.

Distributional Issues

The aggregate distributional impact of the program on the main participants is illustrated in Table 3, using the valuations from Table 1 to illustrate the essential conclusions. The largest impact is evidently on vehicle owners; they both pay inspection and repair fees and incur the time and inconvenience costs. As noted, however, time and inconvenience costs for vehicle owners are substantially lower for the service station option -- a conclusion that holds under any scenario (See Table 2). The per vehicle owner cost varies from about $20.00 per year for the private service station option to close to $27 per year for the state-operated program.2 Hence, the service station option disadvantages car owners relatively less than the other two options.3 Note, however, that private service operators lose money under the program (See Table 3.1); the aggregate loss in the table implies annual income lose to service owners of $720 per year. This lose could be eliminated by allowing service stations to increase the fee level by $1.8 per emissions inspection. Although such a fee increase would not undermine the relative cost advantage to vehicle owners of the more convenient inspections, it would increase the total burden to consumers of the program (from about $20.00 per vehicle owner per year to about $21.8).

Note that the fiscal impact of the program is most beneficial for the contractor option, since property tax revenue is generated.4 However, the vehicle owners pay the tax indirectly in the form of higher inspection fees, which are 50 cents higher for the contractor option than the state alternative. The state could entirely recoup the costs of its own emissions inspection program simply by raising its own fee by 13 cents (See Appendix 1). This point draws attention to the fact that the fiscal benefit of contractor option is entirely in the form of excess revenue over the direct program costs (the use of labor, capital, etc). There are likely to be more efficient ways to raise this kind of excess revenue than by implementing an emissions inspection program and charging vehicle owners a relatively high price. Given these considerations, the revenue impact of the contractor versus the state option does not seem to be a consequential issue for this analysis.

Possible employment impacts another distributional issue to consider (not presented in Table 3), particularly since the private contractor claims employment creation as a benefit. This claim cannot be conclusively evaluated with available information, but some deductions are possible. First, it is not presumptively obvious that the contractor option would employ more labor than the state-operated alternative or even the private service stations who may hire additional over- time workers to handle the demands of emissions testing. Even if it the contractor does employ more labor, it is not clear that this labor would come from the unemployed pool or simply be

2Derived by dividing the aggregate figures displayed in Table 3 by the number of registered vehicles in the county (800,000).

3This point shows that the fee level is itself not fully relevant for judging the distributional effects of the program. Time and inconvenience costs are a larger fraction of the price consumers pay than the actual fee itself, which ranges between 4.00 and 6.00 per inspection for the different program options .

4This is on the assumption that the buildings constructed by the Contractor represent net additions to the county’s building stock (rather than diverted investment). The overall analysis is premised on this assumption.

diverted from other employment sources. (It is not clear that any option will measurably perturb the aggregate employment baseline.) However, if the contractor does create net employment, the wage bill would overstate labor costs. But notice that entire wage bill for the contractor could be deducted from the cost calculation and contractor option would still be more expensive than the private service station option under the assumptions represented for Cases 1 and Cases 2 (in Table 2). In view of all of the qualifications, it does not seem likely that employment effect of contractor option will affect the relative cost-comparison (in any direction), but a jobs impact assessment would be needed to draw a definitive conclusion.

Benefit-Cost Analysis of Program Expansion

Relative to the one-a-year inspection baseline, semi-annual inspections will reduce ambient ozone concentrations by 10% to .18 mgm3. This air quality improvement will save lives and enhance worker productivity. Table 4 presents estimates of the value of these benefits against the incremental costs of moving from an annual to a semi-annual inspection regime for each of the program options, under a range of cost permutations. It can be seen that benefits of air quality improvements are less than the incremental costs in all cases. Hence, the optional expansion of the emissions inspection program is not justified by benefit/cost analysis.

It should be mentioned that the estimation of air quality benefits and, in particular, the value of human life savings, is a very controversial subject. Hence, results of this part of the analysis should be interpreted with particular caution. As a matter of perspective, the benefit estimates used are at the upper range of those found in the benefits valuation literature. Hence, varying the benefit valuation parameter over the range found in the literature will not vitiate the conclusion that the optional program expansion does not pay off.

Conclusion

Given the available information, the analysis suggest that the service station option is the most cost-effective program alternative for implementing the once-a-year emissions inspections mandate. The conclusion is relatively robust with respect to standard variations in the literature about the value of time and travel costs, and is not altered fundamentally when distributional, fiscal, or employment concerns are introduced. The latter either do not vary systematically across alternatives; vary in ways that are not significant; or vary in ways that reinforce the essential conclusion.

However, the impact of the program of private service station operators is one possible concern of the recommended option. The program administrator should reconsider the charge level to determine if an equity adjustment is warranted.

The benefit-cost analysis does not support a beyond-compliance program expansion. Hence, the recommendation is simply to implement the mandated program using private service stations to administer the emissions tests.

Table 1: Costs of Annual Emission Inspection Programs: High Cost Estimate* (Figures in $; base year = 2005)

________________________________________________________________________

Private Service Contractor State Stations

Direct Costs Buildings 650,000 700,000 0 Equipment 350,000 400,000 2,080,000 Labor 1,500,000 1,800,000 4,160,000 Insurance 300,000 300,000 0 Administrative 100,000 100,000 250,000 Repair 6,240,000 6,240,000 6,240,000 Subtotal 9,140,000 9,540,000 12,730,000

Travel & Time Costs Mileage 3,068,000 3,068,000 336,000 Time 8,840,000 8,840,000 4,620,000 Subtotal 11,908,000 11,908,000 4,956,000

Total 21,048,000 21,448,000 17, 686,000

*Time cost = .75 of wage rate; mileage costs = .25/mile _____________________________________________________________________

Table 2: Sensitivity Analysis of Travel and Time Costs (Figures in $, base year=2005) ____________________________________________________________________________ Subtotal Direct 9,140,000 9,540,000 12,730,000

Case 1 (.75, .25)*

Travel & Time Costs Mileage 3,068,000 3,068,000 336,000 Time 8,840,000 8,840,000 4,620,000 Subtotal 11,908,000 11,908,000 4,956,000

Total 21,048,000 21,448,000 17, 686,000

Case 2 (.75, .15)*

Travel & Time Costs Mileage 1,840,800 1,840,800 201,600 Time 8,840,000 8,840,000 4,620,000 Subtotal 10,680,800 10,680,800 4,821,600

Total 19,820,800 20,220,800 17,551,660

Case 3 (.25,.25)*

Travel & Time Costs Mileage 3,068,000 3,068,000 336,000 Time 2,946,667 2,946,667 1,540,000 Subtotal 6,014,667 6,014,667 1,876,000

Total 15,154,667 15,554,667 14,606,000

Case 4(.25, .15)* Travel & Time Costs Mileage 1,840,800 1,840,800 201,600 Time 2,946,667 2,946,667 1,540,000 Subtotal 4,787,467 4,787,467 1,741,600

Total 13,927,467 14,327,467 14,471,600 ____________________________________________________________________________* *The first figure in the brackets provides an alternative estimate of the unit value of lost time devoted to inspections, ranging from .75 to .25 of the average wage rate in the community (or $7.50 an hour to $2.50 per hour). The second figure in the bracket provides alternative estimates of the direct cost of transportation, ranging from 25 cents per mile to 15 cents per mile.

Table 3: Social Accounting Matrices of Annual Emission Inspection Programs: High Cost Estimate* (Figures in $; base year=2005)

________________________________________________________________________ 5.1 Option 1: Private Service Stations

Service Vehicle County/ Stations Mechanics Owners State Net

Buildings 0 Equipment -2,080,000 -2,080,000 Labor -4,160,000 -4,160,000 Admin. -250,000 -250,000 Repair Costs -6,240,000 -6,240,000 Mileage Costs -336,000 -336,000 Time Costs -4,620,000 -4,620,000 Inspection Fees 4,800,000 -4,800,000 0 Repair Fees 6,240,000 -6,240,000 0

Net -1,440,000 0 -15,996,000 -250,000 -17,686,000

5.2 Option 2: State Operated

Vehicle County/ Mechanics Owners State Net

Buildings -700,000 -700,000 Equipment -400,000 -400,000 Labor -1,800,000 -1,800,000 Insurance -300,000 -300,000 Admin. -100,000 -100,000 Repair Costs -6,240,000 -6,240,000 Mileage Costs -3,068,000 -3,068,000 Time Costs -8,840,000 -8,840,000 Inspection Fees -4,200,000 4,200,000 0 Repair Fees 6,240,000 -6,240,000 0

Net 0 -21,348,000 -100,000 -21,448,000

5.3 Contractor-Operated

Private Vehicle County/ Contractor Mechanics Owners State Net

Buildings -650,000 -650,000 Equipment -350,000 -350,000 Labor -1,500,000 -1,500,000 Insurance -300,000 -300,000 Admin. -100,000 -100,000 Repair Costs -6,240,000 -6,240,000 Mileage Costs -3,068,000 -3,068,000 Time Costs -8,840,000 -8,840,000 Inspection Fees 3,600,000 -3,600,000 0 Repair Fees 6,240,000 -6,240,000 0 Taxes -600,000 600,000 0

Net 200,000 0 -21,748,000 500,000 -21,048,000

Table 4: Benefits and Costs of Beyond-Compliance Program Expansion (Figures $; base year = 2005)

Service Stations

Incremental Cost Benefit Net Benefit

High Case Estimate (.75, .25)

14,532,000 7,320,000 -7,212,000

Medium Estimate 1 (.75, .15)

14,039,200 7,320,000 -6,719,200

Medium Estimate 2 (.25, .25)

10,572,000 7,320,000 -3,252,000

Low Case Cost Estimate (.25, .15)

10,079,200 7,320,000 -2,759,200

State-Provided Inspections

Cost Benefit Net Benefit

High Case Estimate (.75, .25)

14,606,000 7,320,000 -7,286,000

Medium Estimate 1 (.75, .15)

13,567,600 7,320,000 -6,247,600

Medium Estimate 2 (.25, .25)

9,619,333 7,320,000 -2,299,333

Low Case Cost Estimate (.25, .15)

8,580,933 7,320,000 -1,260,933

Contractor-Provided Inspections

Cost Benefit Net Benefit

High Case Estimate (.75, .25)

14,506,000 7,320,000 -7,186,000

Medium Estimate (.75, .15) 13,467,600 7,320,000 -6,147,600 Medium Estimate 2 (.25, .25)

9,519,333 7,320,000 -2,199,333

Low Case Cost Estimate (.25, .15)

8,480,933 7,320,000 -1,160,933

Derived from Page 5, Appendix 5

Appendix 1.

Appendix 1 is not shown since it replicates the information you have in the case description. In real life, the level of detail about the program alternatives in the body of the memo would need to reflect the state-of-knowledge of the reader. Conceivably, the memo reader could be the person who specified the program alternatives. In that case, you wouldn’t need to describe the program too much. On the other hand, a succinct summary of the program in the body of the memo itself would probably be helpful if the decision- maker-reader isn’t familiar with the program. As a general proposition, some description of the alternatives is a good idea since a decision will likely have to be cleared by more than one person, and not all of them will be familiar with the details.

Appendix 2 is attached. It shows all of the calculations. If this was real life, it would also have to more fully describe the assumptions of the analysis. For example, the assumption that contractor option will increase the building stock, thereby enabling property tax revenue to be treated as a pure transfer. Etc.