Appendix 4-1Overview of Cost-Benefit Analysis

I. What is a Cost-Benefit Analysis?A cost-benefit analysis is an analytical tool that provides a formal and systematic way of evaluating the likely impact of proposed policy changes. It is an approach that compares the cost of particular action against its benefits over time. It also presents the distributional effects of the action; it describes who bears the costs and who receives the benefits.

II. DefinitionsBaseline: The way the world would look absent of the proposed program, often the status quo or the expected status quo. For example, the baseline for 2020 is not the status quo of 2016 but the expected status quo in 2020.

Opportunity Cost: The value of the best forgone alternative as a result of taking a certain action. For example, when an individual decides to attend college full-time, his/her opportunity cost could be the forgone income he/she could have made if he/she was not in school. Similarly, when a worker takes on new tasks, the opportunity cost is the value placed on the tasks she no longer has time to do. Note, the value placed on state employees’ time is their total compensation: salary plus benefits, including paid leave.1

Net Present Value (NPV) and Discounting: In some projects, benefits and costs may accrue over time. In order to aggregate all these costs and benefits, they need to be discounted into present value to represent all future costs and benefits in terms of what they are worth today. You cannot simply add all the benefits and costs. The main reasons for discounting are:

Resources invested in the present will typically earn a return, so current spending is more expensive than future spending.

Research has found that people typically prefer to spend and consume in the present rather than defer consumption to the future.

III. Components of the Cost-Benefit Analysis1. General Information (from corresponding Worksheet II)

a. Title of the requestb. Description of the requestc. Problem/Issue being addressedd. Anticipated impact after implementation of changes

2. Discussion of baseline and alternatives3. Identified costs and benefits with data sources and assumptions4. Monetized costs and benefits by year5. Calculation of net present value

IV. InstructionsPart 1, General Information, of the Cost-Benefit Analysis should be entered in the appropriate fields on Worksheet II. Parts 2 and 3 (discussion of baseline and alternatives and identification of impacts) should

1 OSHR Total Compensation Calculator: http://oshr.nc.gov/state-employee-resources/classification-compensation/total-compensation-calculator

be entered in the Documentation tab of the Cost-Benefit Analysis workbook (Attachment 4-3), while parts 4 and 5 should be entered in the Analysis tab of the workbook.

Please refer to the example provided in the workbook (see Example Documentation, Example Analysis, and Worksheet II Example tabs). The example is a modified analysis of recent changes to a DHHS program.

Part 1: General Information: Define the problem being addressed by the request and estimate the impact of the proposed change.In Worksheet II, provide a description of the request, identify the problem being addressed by the request, and the expected outcomes. The general information should clearly demonstrate the existence of the problem in North Carolina that the request would address, and if possible, define the size or scope of the problem. When describing the anticipated outcome of the request, be sure to explain how the proposed intervention would address the problem.

Part 2: Discussion of baseline and alternatives.The baseline is an assessment of how the world would look absent the proposed action. Often, the baseline is the status quo. In the Documentation tab of the workbook, include information on how the proposed change would differ from the baseline, or status quo. Describe how the proposed action would generate costs and benefits. For example, agency practices, actions, or tasks may change as a result of the proposed action, and it may cause members of the public and other entities affected by the proposal to change their behavior.

For developing alternatives, many or only a few dimensions/variables of the specific project may be altered. For example, if the project was to build a new highway, different variables you could alter could be the road surface material, the route itself, or the size of the highway.

The analysis should describe which alternatives you considered and the reasons for why one alternative was chosen over another.

Part 3: Identify all costs and benefits to affected parties. Document data sources and assumptions for each cost/benefit. The anticipated impact of the proposed policy/program should be based on rigorous research and data. Why do you think the proposed action will solve the problem you identified? What evidence can you provide? In the Documentation tab, list the sources that informed the impact estimate (e.g., peer-reviewed studies, analysis of internal Agency data, information gathered from other states, etc.).

In Part 3, analysts should also list out the impacts from the proposed change, categorize them as costs or benefits, estimate the timing of the impacts, and identify the affected party (e.g., state government, local governments, state residents, etc.). Impacts include both inputs (required resources) as well as outputs and outcomes. In order to treat something as an impact, there has to be a cause-and-effect relationship. Some of these are easier to identify than others.

Using the highway example, some impacts the analysis could contain include the following: The financial costs of building and maintaining the new highway. The opportunity costs of existing State staff for time spent planning and overseeing the

construction of the highway. The number of trips on the new highway.

Then number of trips on the old roads. The number of accidents (or accidents avoided). Time saved. Lives saved.

For cost estimates, the analysis should include all direct costs, including opportunity costs. How is the proposal expected to change the current state of the world? What costs, including financial and opportunity costs, are associated with these changes, and when will affected parties incur these costs? For benefit estimates, the analysis should explain how the proposal is linked to the expected benefits.

The analysis should also include all data sources and assumptions used for each cost and benefit. A good analysis will clearly set up out the basic assumptions and methods employed, as well as cite the scientific, technical, economic, and other data and information used in the analysis. This enables readers to understand how the authors of the analysis reached their conclusions. Predicting impacts can often be challenging. It is especially difficult when projects are unique and when they have long time horizons. In such cases, make use of the best available evidence to make supportable assumptions about what impacts are likely to occur, and be sure to document those assumptions.

If a cost or benefit cannot be monetized, list it and include any available data to demonstrate the magnitude of the cost or benefit in the appropriate fields on the Documentation tab.

Part 4: Quantify and monetize the impacts. Document data sources and assumptions.In Part 4, the analysis should quantify and monetize all the impacts for seven fiscal years. If impacts will continue beyond FY 2023-24, include the annual value of those costs or benefits in the column marked “Recurring Indefinitely.”

To monetize some of the impacts in the highway example, the analyst would have to determine the value of the opportunity costs of existing staff time (typically the number of staff hours spent on a task multiplied by staff compensation rate), the value an hour saved by each traveler, the statistical value of a life,2 and the value of benefits associated with an avoided accident.

While studies have been conducted to help analysts value certain impacts, sometimes certain impacts are difficult to value in monetary terms. When you are unable to quantify the impacts, please identify them in your analysis and discuss them qualitatively instead. If the impact cannot be quantified due to lack of data, indicate the data that is needed. If a cost/benefit cannot be quantified, please list it and separately attach any available data to demonstrated magnitude of the cost/benefit.

Be careful to document “transfers.” For example, revenue collected from a fee or tax would be considered a benefit from the government perspective; however, from those paying the taxes, it would be considered a cost. In the societal perspective, this would be considered a transfer, as the benefit and cost would come to a net zero.

2 Economists generally agree that the value of a statistical life is $9.1 million in 2012 dollar and that it grows at 1.07 percent per year prior to discounting. So, the value of a statistical life in 2016 is $9.5 million. https://www.transportation.gov/sites/dot.dev/files/docs/VSL%20Guidance%202013.pdf

Part 5: Calculate the net present value (NPV) To aggregate costs and benefits that occur in different years, the analyst must discount future costs and benefits to obtain the present value of the flow of costs and benefits. Present value (PV) is the current worth of a future sum of money. It is the amount of money you would need to invest today to receive a given sum in the future at a specific rate of return. The net present value (NPV) is the difference between the present value of the costs (C) and benefits (B).

NPV=PV (B )−PV (C)

The NPV will be calculated for you automatically in the analysis tab at rates of return (discount rates) of 3% and 7%.

When the NPV is positive, the estimated quantified benefits of a proposed policy action exceed the estimated quantified costs. If all of the assumptions in the analysis hold true, adopting a policy action with a positive NPV will make North Carolina residents better-off compared to the baseline.

Additional Information and Guidance

OSBM Budget Manual (Chapter 7): https://ncosbm.s3.amazonaws.com/s3fs-public/documents/files/BudgetManual_2015November.pdf. Chapter 7 covers OSBM’s guidance to regulatory analysis. It provides a formal and systematic way of organizing evidence on the impacts of rules on affected parties.

Circular A-4: https://www.whitehouse.gov/omb/circulars_a004_a-4. This Circular covers the Office of Management and Budget’s (OMB’s) guidance for regulatory analysis.

OSHR Total Compensation Calculator: http://oshr.nc.gov/state-employee-resources/classification-compensation/total-compensation-calculator. Note, the value placed on state employee time is their total compensation: salary plus benefits, including paid leave.