Calculation of the Economic Benefit of Noncompliance in EPA's Civil Penalty Enforcement Cases, 50326-50345 [05-17033]

Agencies

• ENVIRONMENTAL PROTECTION AGENCY

[Federal Register Volume 70, Number 165 (Friday, August 26, 2005)]
[Notices]
[Pages 50326-50345]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 05-17033]


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ENVIRONMENTAL PROTECTION AGENCY

[FRL-7960-3]


Calculation of the Economic Benefit of Noncompliance in EPA's 
Civil Penalty Enforcement Cases

AGENCY: Environmental Protection Agency (EPA).

ACTION: Notice of final action and response to comment.

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SUMMARY: In a Federal Register notice issued on October 9, 1996, the 
Environmental Protection Agency (``EPA'') requested comment on how it 
calculates the economic benefit that regulated entities obtain as a 
result of violating environmental requirements. EPA makes this 
calculation as a part of establishing an appropriate penalty for 
settlement purposes. The Agency's policy is that any civil penalty 
should at least recapture the economic benefit the violator has 
obtained through its unlawful actions. Because enforcement staff 
typically use the BEN (short for benefit) computer model to perform the 
economic benefit calculations, the Agency requested comments on the BEN 
model as well as the larger benefit recapture issues. In a subsequent 
Federal Register notice issued on June 18, 1999, EPA responded to the 
comments on the October 1996 Federal Register notice; provided advance 
notice of the changes EPA proposed to make to its benefit recapture 
approach and the BEN computer model; and requested a second round of 
comment of those proposed changes. This notice responds to the comments 
on the June 1999 notice and contains the changes EPA will implement in 
its benefit recapture program.

ADDRESSES: The Agency has dedicated a page of its website to the 
computers models the enforcement program uses to addresses benefit 
recapture as well as ability to pay claims and the evaluation of the 
costs of supplemental environmental projects (SEP's). The web address 
for those models is: www.epa.gov/compliance/civil/econmodels/ index. 
html.

FOR FURTHER INFORMATION CONTACT: For further information, contact 
Jonathan Libber, Office of Civil Enforcement, Special Litigation and 
Projects Division, at (202) 564-6102, or through electronic

[[Page 50327]]

mail at libber.jonathan@epa.gov. Government users (Federal, State, or 
local) can also obtain assistance with the model through the Agency's 
toll-free enforcement economics helpline at (888) ECONSPT or through 
electronic mail at benabel@indecon.com.

SUPPLEMENTARY INFORMATION: In EPA's October 1996 Federal Register 
notice, the Agency was considering changes in three areas: (1) Broad 
economic benefit recapture issues; (2) the BEN computer model's 
calculation methodology; and (3) improving the BEN model's user-
friendliness. In regard to the broad economic benefit recapture issues, 
the Agency sought out any legitimate alternatives to BEN, but found 
none. In addition, EPA solicited comments on the best way to determine 
the economic benefit from the violator's illegal competitive advantage. 
The comments confirmed our initial thoughts that a model to handle such 
calculations was infeasible. The Agency has instead developed a draft 
conceptual framework document for such cases, and has initiated a peer 
review process by its Science Advisory Board to examine this type of 
benefit.
    With regard to the BEN model's calculation methodology, the Agency 
is making eight sets of changes that should improve the model's 
precision and function. Although the combined effect of these changes 
will affect individual cases differently, the overall impact across all 
EPA's enforcement cases should be insignificant. The two most 
significant changes involve tailoring the discount/compound rate to the 
case and using a more precise inflation adjustment. The new BEN model 
tailors the discount rate to the period of violation through the 
present, which the prior version of the model was incapable of doing. 
The new BEN model also adjusts for inflation based on actual historical 
month-by-month inflation data, whereas the prior version simply applied 
one single average rate for both past inflation and projected 
inflation. All of these changes reflect the Agency's consideration of 
both rounds of public comments, as well as an academic peer review that 
the Agency completed in January of 2004. These reviews should be 
available by within the next few months on the Agency's computer models 
web page (see ADDRESSES section above). Electronic copies of the BEN 
computer model (which includes a comprehensive help system) can be 
downloaded from that same site.
    The major change in improving the BEN model's user-friendliness is 
that EPA has moved the model from the old DOS operating system to the 
Windows environment. This should address those concerns that the model 
was cumbersome. We have also established a helpline to assist 
enforcement personnel from Federal, State and local governments in 
their use of the model.
    This notice is organized as follows:

I. Background
    A. Overview
    B. EPA Policy and Guidance on Recapturing the Economic Benefit 
of Noncompliance
    1. Policy Background
    2. BEN Calculates the Economic Benefit From Delayed and Avoided 
Pollution Control Expenditures
    3. Current Model Usage and Applicability
    C. How a Firm Obtains an Economic Benefit From Delaying and/or 
Avoiding Compliance Costs
    1. The Economic Benefit Components that the BEN Model Measures
    2. BEN and Cash Flow Analysis
II.Final Changes
    A. Broad Economic Benefit Recapture Issues
    1. Alternatives to BEN
    2. Illegal Competitive Advantage
    B. The BEN Model's Calculation Methodology
    1. Depreciation Method
    2. Tax Rates
    3. Differences in On-Time and Delay Scenarios
    4. Capital Equipment Replacement
    5. Inflation Treatment
    6. Discount/Compound Rate
    7. Discounting/Compounding Methodology
    8. Investment Tax Credit and Low-Interest Financing
    C. Improving the BEN Model's User-friendliness
    1. Is BEN Too Complex to Operate?
    2. Is the Information BEN Needs Difficult or Expensive to 
Obtain?
    D. Procedural Issues Regarding the Public Comment Process
III. Response to Comments
    A. Broad Economic Benefit Recapture Issues
    1. Alternatives to BEN
    2. Illegal Competitive Advantage
    3. Other Broad Economic Benefit Recapture Issues
    B. The BEN Model's Calculation Methodology
    1. Discounting/Compounding
    2. Inflation Adjustments
    3. Other Technical Aspects
    C. Improving the BEN Model's User-Friendliness
    1. Is BEN Too Complex to Operate?
    2. Is the Information BEN Needs Difficult or Expensive to 
Obtain?
    3. Other Issues Affecting Use of BEN
    D. Procedural Issues Regarding the Public Comment Process

I. Background

A. Overview

    One of EPA's most important responsibilities is to ensure that 
regulated entities comply with Federal environmental laws. These laws--
and their implementing regulations--set minimum standards for 
protecting human health and achieving environmental protection and for 
achieving environmental protection goals, such as clean air and clean 
water. EPA upholds these laws through vigorous enforcement actions that 
seek to correct the violations and appropriately penalize violators.
    A cornerstone of the EPA's civil penalty program is at least 
recapturing the economic benefit that a violator may have gained from 
illegal activity. Economic benefit recapture helps level the economic 
playing field by preventing violators from obtaining an unfair 
financial advantage over their competitors who make the necessary 
expenditures for environmental compliance. Penalties also serve as 
incentives to protect the environment and public health by encouraging 
prompt compliance with environmental requirements and the adoption of 
pollution prevention and recycling practices. Finally, appropriate 
penalties help deter future violations by both the penalized entity and 
by similarly situated regulatees.
    EPA has promulgated a generic civil penalty policy, as well as 
specific penalty policies tailored to suit the needs of particular 
regulatory programs. For example, one civil penalty policy specifically 
addresses violations of the Clean Water Act. The civil penalties that 
EPA seeks usually embody two components: gravity and economic benefit. 
The gravity component reflects the seriousness of the violation and is 
generally determined through the application of the appropriate EPA 
civil penalty policy.
    The economic benefit component, on the other hand, focuses on the 
violator's economic gain from noncompliance, i.e., the extent to which 
the violator is financially better off because of its noncompliance. 
This economic benefit can accrue to the violator in three basic ways: 
(1) Delaying necessary pollution control expenditures; (2) avoiding 
necessary pollution control expenditures; and/or (3) obtaining an 
illegal competitive advantage. The term ``illegal competitive 
advantage'' is a broad catch-all category for economic benefit that 
goes beyond that derived from the mere delay and/or avoidance of 
pollution control expenditures. For example, the violator might have 
sold a product that is entirely illegal (and could not have been 
produced legally by incurring any pollution control expenditures).
    The Agency designed the BEN computer model in 1984 to calculate the 
economic benefit from these first two

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types of economic gain for settlement purposes. BEN may not be 
appropriate for all cases, and EPA's regional offices may use 
alternative approaches that produce reasonably accurate benefit 
calculations. For example, the pattern of necessary pollution control 
expenditures might be so complicated that a customized spreadsheet 
computation would be more appropriate than BEN. Alternatively, the 
pattern of expenditures might be so simple that a mere table in a word 
processing document would suffice. Nevertheless, the Agency believes 
that in the vast majority of cases BEN is by far the best approach 
available for calculating economic benefit derived from delayed and/or 
avoided costs.
    The Agency does not have a computer model for calculating the 
benefit gained from an illegal competitive advantage. EPA considers 
such gains on a case-by-case basis.

B. EPA Policy and Guidance on Recapturing the Economic Benefit of 
Noncompliance

    Since the BEN computer model's development in 1984, EPA staff have 
used BEN extensively in generating penalty figures for settlement 
purposes. These figures reflect the economic benefit a violator derived 
from delaying and/or avoiding compliance with environmental statutes.
1. Policy Background
    Calculating a violator's economic benefit using the BEN computer 
model is usually the first step in developing a civil settlement 
penalty figure under the Agency's Policy on Civil Penalties (PT.1-1) 
February 16, 1984, and A Framework for Statute-Specific Approaches to 
Penalty Assessments (PT.1-2) February 16, 1984. The Agency developed 
the BEN computer model to assist in fulfilling one of the main goals of 
the Policy on Civil Penalties: to recover, at a minimum, the economic 
benefit derived from noncompliance.
    The BEN computer model is a tool that is primarily intended to be 
used in calculating economic benefit for purposes of developing a 
settlement penalty. In presenting economic benefit testimony at a 
judicial trial or in an administrative hearing, the Agency relies on an 
expert in financial economics to provide an independent analysis of the 
economic benefit the violator obtained from its violations, reflecting 
the expert's own analytical approach as applied to the particular facts 
of that case. Use of an expert in a trial or hearing allows the parties 
the opportunity to examine more closely the analysis applied to the 
facts at issue, since a computer model itself cannot be deposed or 
cross-examined.\1\
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    \1\ EPA designed the BEN model as a flexible tool primarily for 
use in settlement negotiations; it is not used, nor was it ever 
intended to function, as a rule. An expert witness testifying for 
the government may use the new Windows version of BEN as 
appropriate, but the responsibility to determine the economic 
benefit--as well as explain and defend the results--still resides 
with the expert. That expert may choose to use whatever analytical 
tool (e.g., customized computer spreadsheets, the BEN model, or even 
a calculator) deemed appropriate for the particular calculations 
necessary in the case.
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2. BEN Calculates the Economic Benefit From Delayed and Avoided 
Pollution Control Expenditures
    The BEN model calculates the economic benefit from delaying and/or 
avoiding required environmental expenditures. Delayed costs can include 
capital investments in pollution control equipment, remediation of 
environmental damages (e.g., removing unpermitted fill material and 
restoring wetlands), or one-time expenditures required to comply with 
environmental regulations (e.g., establishing a reporting system, or 
purchasing land on which to site a wastewater treatment facility). 
Avoided costs typically include operation and maintenance costs and/or 
other annually recurring costs (e.g., off-site disposal of fluids from 
injection wells), but can occasionally include capital investments or 
one-time expenditures. BEN does not calculate the economic benefit that 
takes the form of illegal competitive advantage. For example, the BEN 
model is not the appropriate method for calculating the economic 
benefit derived from selling DDT on the black market to U.S. pesticide 
applicators.
3. Current Model Usage and Applicability
    The BEN model can be used in all cases that have delayed and/or 
avoided compliance costs. (The only exception is Clean Air Act Section 
120 enforcement actions, which require the application of a specific 
computer model.) EPA designed BEN to be easy to use for people with 
little or no background in economics, financial analysis, or computers, 
although it is also useful for those with such backgrounds. Because the 
program contains standard default values for many of the variables 
needed to calculate the economic benefit, BEN can be run with only a 
small number of required inputs from the user. The program also allows 
the user to replace those standard values with case-specific 
information. The table below lists the inputs to the BEN model, both 
the required inputs and also those inputs with standard default values 
that may be modified.
    The BEN model can calculate economic benefit for many types of 
organizations: corporations, partnerships, sole proprietorships, not-
for-profit organizations, federal facilities, and municipalities. BEN 
customizes its standard values to the entity type, as well as other 
aspects of the case. The BEN inputs listed in the table are discussed 
in detail in the model's help system.
Inputs for BEN
    Required Inputs:

--Descriptive Information (case name, office/agency, analyst name)
--Entity Type and State
--Competitive Advantage Questionnaire
--Penalty Payment Date
--Capital Investment (cost estimate and estimate date)
--One-Time Nondepreciable Expenditure (cost estimate and estimate date)
--Annually Recurring Costs (cost estimate and estimate date)
--Date of Initial Noncompliance
--Date of Compliance

    Inputs with Standard Default Values that May be Modified:

--Year-Specific Marginal Income Tax Rates
--Discount/Compound Rate
--Cost Index for Inflation (specified separately by compliance cost 
component)
--Consideration of Future Capital Replacement
--Useful Life of Capital Equipment
--Delayed v. Avoided (specified separately for capital and one-time 
nondepreciable)
--Tax Deductibility (of one-time nondepreciable expenditure)
--Specific Cost Estimates (for on-time and delay scenarios)

C. How a Firm Obtains an Economic Benefit From Delaying and/or Avoiding 
Compliance Costs

    An organization's compliance with environmental regulations usually 
entails a commitment of financial resources, both initially (in the 
form of a capital investment or one-time expenditure) and over time (in 
the form of continuing, annually recurring costs). These expenditures 
should result in better protection of public health or environmental 
quality, but they are unlikely to yield any direct economic benefit 
(i.e., net gain) to the organization. (Otherwise, and with the 
assumption of some measure of foresight, the organization should have 
already committed the financial

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resources, even in the absence of such environmental regulations.) If 
these financial resources are not used for compliance, then they 
presumably are invested in projects with an expected financial return 
to the organization. This concept of alternative investment--that is, 
the amount the violator would normally expect to make by investing in 
something other than pollution control--is the basis for calculating 
the economic benefit of noncompliance.
    In implementing EPA's penalty policies, the Agency invokes its 
authority to assess penalties to remove or neutralize the economic 
incentive to violate environmental regulations. In the absence of 
enforcement and appropriate penalties, an organization's narrowly 
construed economic interest would usually dictate delaying the 
commitment of funds for compliance with environmental regulations and 
avoiding certain associated costs, such as operation and maintenance 
expenses.
1. The Economic Benefit Components That the BEN Model Measures
    A violator may gain an economic benefit from either delaying and/or 
avoiding compliance costs. By delaying compliance, the violator can 
earn a return on the funds that should have been committed to the 
capital investment or one-time expenditure required for pollution 
control compliance. In other words, violators have the opportunity to 
invest their funds in projects other than those required to comply with 
environmental regulations. These other investments are expected to 
generate a financial return, as opposed to the required pollution 
control investments that typically generate no direct financial return 
for a company. Thus, by delaying compliance, the violator's economic 
benefit is the difference between investing in pollution control and 
investing in other projects.
    A violator can also gain an economic benefit from avoiding 
pollution control costs. Avoided costs typically include the 
continuing, annually recurring costs that a violator would have 
incurred had it complied with environmental regulations on time (e.g., 
the costs of labor, raw materials, energy, lease payments and any other 
expenditures directly associated with the operation and maintenance of 
pollution control equipment). Annual costs are thereby avoided 
entirely, as opposed to capital investments and one-time expenditures 
that are usually only delayed.\2\ Thus, the violator's economic benefit 
from avoided costs is the sum of the total avoided annual costs plus 
the return that could be expected on the funds that were used for 
projects other than pollution control.
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    \2\ Even capital investments and one-time expenditures may be 
avoided on occasion. The typical situation where this happens is 
when a violator shuts down a particular operation rather than 
install required pollution control equipment.
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2. BEN and Cash Flow Analysis
    The BEN model calculates economic benefit by focusing on the effect 
that delayed and/or avoided pollution control costs have on an entity's 
cash flows. Cash flow analysis is a standard and widely accepted 
technique for evaluating costs and investments. In essence, cash flow 
calculations focus on the real, ``out-of-pocket'' cash effects 
resulting from an expenditure.\3\ Three important factors that enter 
into BEN's cash flow analysis are inflation, taxation, and the time 
value of money.
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    \3\ Thus, noncash ``paper'' expenses, such as depreciation, are 
considered only to the extent that they affect cash flow.
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a. Inflation
    BEN first requires users to enter a single cost estimate for the 
capital investment and another single cost estimate for the one-time 
nondepreciable expenditure. Then, to adjust for inflation, BEN 
extrapolates from this single cost estimate to create separate 
estimates for the hypothetical cost of complying on-time and the actual 
cost of complying in a delayed fashion. Similarly, BEN extrapolates 
from the user's annually recurring cost estimate to a complete set of 
cost estimates for every year during the noncompliance period. (The BEN 
model's help system provides a more detailed discussion of these 
inflation adjustments.) These adjusted cost estimates form the basis 
for the on-time and delay scenarios: The actions and associated costs 
that would have been necessary for hypothetical on-time compliance, and 
the actions and associated costs that were necessary for the actual 
delayed compliance.
b. Taxation
    The BEN model computes economic benefit on an after-tax basis, 
since environmental expenditures can reduce income tax liability.\4\ 
Depreciation (from capital investments), one-time expenditures, and 
annual costs all effectively reduce taxable income and thereby reduce 
income tax payments. To account for these tax effects, BEN calculates 
the economic benefit using after-tax cash flows for the on-time 
compliance and delayed compliance scenarios.
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    \4\ The term environmental expenditures refers to firms' 
compliance costs and does not include the payment of civil 
penalties. Civil penalties are in almost all cases not deductible.
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c. Time Value of Money
    A third factor relates to the timing of the cash flows, because 
cash flows occurring in different years are not directly comparable. 
The fundamental financial concept of the time value of money is based 
on the principle that a dollar today is worth more than a dollar a year 
from now, since today's dollar can be invested immediately to earn a 
return over the coming year. (Alternatively, a dollar last year is 
worth more than a dollar today because investment opportunities existed 
for last year's dollar.) Therefore, the earlier a cost (or benefit) is 
incurred, the greater its economic impact.
    BEN accounts for the time value of money by adjusting all estimated 
cash flows to their present value equivalents. BEN first discounts back 
to the initial noncompliance date all cash flows from the on-time and 
delay scenarios. The initial economic benefit as of this date is simply 
the difference in the present values of these two scenarios. Finally, 
BEN compounds the initial economic benefit forward from the 
noncompliance date to the penalty payment date.
    To adjust the cash flows for both discounting and compounding, BEN 
uses a discount or compound rate (depending on the direction of the 
adjustment) that reflects the time value of money. The selection of the 
appropriate rate, and the structure of the discounting and compounding 
methodology, is a significant issue in the BEN model and will be 
addressed later in this notice. (The model's help system provides a 
more detailed discussion of the discounting and compounding that BEN 
performs for its present value adjustments.)

II. Final Changes

    In its October 9, 1996, Federal Register notice, the Agency sought 
comment on three categories of issues: (1) Broad economic benefit 
recapture questions, (2) the BEN model's calculation methodology and 
assumptions, and (3) the model's user-friendliness. The June 18, 1999, 
notice provided responses to these comments, as well as advance notice 
of EPA's proposed changes to the BEN model. The June 1999 notice also 
invited a second round of public comments, especially on EPA's proposed 
changes. EPA also conducted a peer review by academic experts in 
financial economics during the spring of 2003 on the draft proposed 
changes to the model. This peer review of the model changes was

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specifically requested by the United States Senate.\5\
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    \5\ Senate Report No. 106-410 (2000) at page 81.
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    The first area in which we invited comment covered some fundamental 
questions that the benefit recapture approach has raised. Is there an 
alternative to the BEN model that would be both easier to use and at 
least as accurate in calculating the economic benefit of delayed and/or 
avoided pollution control expenditures? How should EPA evaluate the 
economic benefit that companies receive as a result of any illegal 
competitive advantage stemming from noncompliance?
    Second, we invited comment on the BEN model's calculation 
methodology. While the Agency is confident that the BEN model's overall 
approach is theoretically sound, we welcomed constructive and 
documented comment on alternative methodologies. In particular, EPA has 
been aware of substantial differences of opinion with respect to 
inflation adjustments and discounting/compounding. EPA requested 
comment on the BEN model's calculation methodology, or any other aspect 
of the model's assumptions or methodology.
    Third, we requested comment on the model's user-friendliness. The 
Agency had heard concerns that the model is too difficult to use, 
particularly regarding the necessary data acquisition. Because EPA had 
never been presented with any concrete evidence in support of these 
assertions, the Agency wanted either to substantiate the problems and 
address them or to put these issues to rest.
    In the following sections, we address the final changes that EPA is 
making in each of the areas on which we requested comment. Note that 
final changes incorporate EPA's consideration not only of the public 
comments but also of the previously mentioned academic peer review that 
EPA completed in January of 2004.

A. Broad Economic Benefit Recapture Issues

1. Alternatives to BEN
a. Background
    EPA requested comment on whether anyone had an approach that would 
be simpler and at least as accurate as BEN in calculating the economic 
benefit from delayed and/or avoided pollution control expenditures. EPA 
designed the BEN model to calculate the economic benefit of 
noncompliance in settlement of the vast majority of its civil penalty 
enforcement cases. Although BEN has served this purpose effectively, 
the Agency recognizes that it should be improved or even replaced if a 
better alternative exists or could be developed easily. This concern is 
particularly relevant because an increasing number of State and local 
government enforcement personnel use the BEN model regularly. Any 
alternative approach must meet EPA's policy objective of ensuring that 
violators are put on an even financial footing with those regulated 
entities that comply on time. Alternatives must also be reasonably 
accurate, simple to use, and readily understandable to the vast 
majority of the BEN model's users--Federal, State and local government 
enforcement officials who usually have limited knowledge of financial 
economics.
b. Final Changes
    Many commenters expressed various criticisms on different aspects 
of the BEN model. But these criticisms focused on suggestions for 
improving BEN. No commenter proposed an alternative approach to a 
stand-alone computer model that performs net present value 
calculations. Therefore, the Agency will continue its use of BEN, 
although it will also implement significant revisions (see following 
sections).
    On a related topic, two commenters questioned the entire benefit 
recapture framework. Although one comment along these lines was 
somewhat unclear, the other comment presented a comprehensive approach 
for basing penalties on the lesser of economic benefit or social cost 
(i.e., environmental damages). Under this proposal, if a violator 
gained a significant economic benefit from its violations but caused 
only trivial environmental damage (as monetized through some 
unspecified economic methodology), then the penalty would be 
commensurately trivial. The Agency finds this approach entirely 
unacceptable in the context of enforcing regulatory requirements for 
individual violators. The appropriate context for considering social 
costs is in the process of formulating proposed regulations. Penalties 
based on social costs (when less than economic benefit) would provide 
an implicit yet clear incentive to violate the law if a company 
anticipated that its economic benefit would exceed the consequent 
measurable environmental damage. Further, such an approach would be 
fundamentally unfair to those firms that resisted the temptation to 
violate the law. In addition, quantifying environmental damages in a 
monetary measure is an exceedingly difficult analytical problem. Even 
if this fundamentally different approach was theoretically sound, it 
would be infeasible for the vast majority of enforcement cases.
2. Illegal Competitive Advantage
a. Background
    Since the issuance of EPA's Policy on Civil Penalties in 1984, the 
Agency has maintained that any given penalty should be structured to 
recover--at a minimum--the economic benefit a violator has enjoyed as a 
result of its noncompliance. That 1984 policy recognized that the 
benefit would be based on delayed costs, avoided costs and illegal 
competitive advantage. In addition to this economic benefit component, 
EPA assesses a gravity component that reflects the seriousness of the 
violation. This gravity component is designed to ensure that the 
penalty puts the violator in a worse position than those in the 
regulated community who complied with the law. The economic benefit 
component of EPA's civil penalty policy focuses specifically on 
identifying and recovering the gain to a violator in order to remove 
any economic incentive to violate environmental regulations.
    The BEN model calculates the economic benefit from delaying and/or 
avoiding required environmental expenditures. The economic benefit that 
arises from situations other than the delay and/or avoidance of 
pollution control expenditures is broadly termed ``illegal competitive 
advantage,'' which BEN is incapable of measuring. The essential 
distinction between these two types of economic benefit is that in the 
illegal competitive advantage situation, the violator's noncompliant 
actions have allowed (or will allow) it to attain a level of revenues 
that would have been unattainable had it always been in compliance. In 
delayed and avoided costs situations, the implicit assumption is that 
the revenues from a noncompliant and compliant state are identical. 
Consequently, BEN focuses exclusively on a violator's pollution control 
costs and does not require any data on the violator's revenues.
    In either type of situation (BEN-type economic benefit or illegal 
competitive advantage), the fundamental definition of economic benefit 
is still the same: The economic benefit is the difference in the net 
present values of the compliant/on-time and noncompliant/delay 
scenarios (i.e., the actions and cash flows--both historical and 
possibly also future--associated with the hypothetical compliance, and 
the actual noncompliance). But in the cases

[[Page 50331]]

amenable to BEN, the violator's revenues from the compliant and 
noncompliant states simply cancel each other out, allowing BEN to 
measure economic benefit through a calculation involving only the costs 
that would have differed had the violator been in compliance. Illegal 
competitive advantage encompasses all situations in which the revenues 
do not cancel out each other. Since the revenues were higher in the 
noncompliant state than they would have been in a compliant state, more 
detailed research and analysis is necessary, going beyond the scope of 
the BEN model.
    The BEN model's widespread application is made possible by its 
simplifying assumption regarding revenues, obviating the need for a 
detailed examination of a violator's business records or competitive 
market situation. But in some cases, this assumption is not valid.\6\ 
In such cases, the violator would not have been able to generate a 
given level of revenues were it not for its noncompliance. In those 
cases, EPA's policy is to seek to recapture the economic benefit based 
on the violator's illegal competitive advantage.
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    \6\ The Agency suspects that this relationship may be reversed 
for cases involving wetlands. Although the evidence is largely 
anecdotal, most wetlands cases encompass violations that allowed a 
violator to engage in operations that would not have been feasible 
but for the violation. Therefore, in evaluating wetlands cases, the 
Agency will be particularly sensitive to the possible presence of 
illegal competitive advantage.
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b. Final Changes
    The Agency received many comments on illegal competitive advantage. 
The first round of comments focused mainly on the feasibility of 
developing a stand-alone computer model analogous to BEN (or an add-on 
module to BEN) that could easily and reliably determine the economic 
benefit from the widely varying examples of illegal competitive 
advantage. The broad consensus was that no such model was feasible, and 
the Agency agrees. Without BEN's simplifying assumption that the 
violator's revenues from the on-time and delay scenarios cancel out 
each other, no ``one-size-fits-all'' computer model can analyze the 
range of likely situations.
    The second round of comments the Agency received on illegal 
competitive advantage mainly focused on the June 1999 notice's proposed 
questions for BEN's module and the illegal competitive advantage 
examples. But since the ICA concept is currently under review by EPA's 
Science Advisory Board (SAB), OECA will not put any ICA questions in 
the revised BEN model.
    After careful review of the comments, and in light of the fact that 
the SAB is currently reviewing the ICA issues, EPA has decided against 
publishing at this time any formal guidance delineating detailed 
analytical steps. While EPA remains committed to recapturing economic 
benefit based on illegal competitive advantage, if appropriate, 
quantifying illegal competitive advantage requires a careful 
examination of the facts of the particular case, and EPA believes it is 
premature to try to establish formal guidance in light of these case-
specific issues. Similarly, the Agency does not envision providing a 
specific formula for calculating a benefit component in such cases.
    In summary, EPA will continue to seek the recovery of illegal 
competitive advantage in cases where the BEN model is incapable of 
fully assessing the extent to which a violator is financially better 
off as a result of its noncompliance. The proper evaluation of illegal 
competitive advantage will involve verifying that the use of the BEN 
model alone is inappropriate to the case-specific facts, and then 
formulating an analytical approach that captures the extent of the 
violator's gain.

B. The BEN Model's Calculation Methodology

    Over the years, BEN has received occasional criticism for alleged 
flaws in its calculation methodology, particularly regarding the 
model's inflation adjustments and discounting/compounding. The Agency 
requested substantive comments on how the BEN model handles these two 
issues. In addition, EPA invited comment on all aspects of BEN's 
calculation methodology. The Agency also asked commenters to address 
whether their proposed changes would add any complexity to the computer 
model and, if so, why the benefit of the change justified the added 
complexity.
1. Depreciation Method
a. Background
    The BEN model calculates depreciation for capital investments, 
since the tax deduction for accounting depreciation charges provides a 
real after-tax positive cash flow to businesses.\7\ BEN used to 
calculate depreciation using a five-year straight-line methodology for 
capital investments made before January 1, 1987, and a seven-year 
Modified Accelerated Cost Recovery System for capital investments made 
after January 1, 1987. These assumptions represent the most rapid 
depreciation periods available for typical pollution control 
investments, thereby producing the positive depreciation cash flow 
effects as early as possible. These particular depreciation methods 
generally result in a conservative economic benefit calculation (i.e., 
lower than would otherwise be calculated) because they minimize out-of-
pocket costs to the violator. Therefore, BEN is often producing 
economic benefit figures that are very conservative.\8\
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    \7\ The IRS does not allow companies to write off completely a 
capital investment in the year of purchase. Companies must spread 
the expense of the investment over several years using the 
appropriate depreciation schedule.
    \8\ The IRS requires that many types of pollution control 
equipment be depreciated over a longer period than assumed in the 
BEN model. Were EPA to tailor the depreciation to account for that 
longer period, the result would be a higher economic benefit 
calculation.
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    For capital equipment that has a very short useful life, the 
selection of alternative depreciation schedules might be available and 
also more beneficial to a business. In unusual cases where the violator 
can demonstrate that an alternative depreciation schedule would be both 
available and beneficial, more detailed calculations by a financial 
analyst in lieu of the BEN model may be necessary.
b. Final Changes
    EPA received no comments on its proposal in the June 1999 notice 
that although a revised BEN model could conceivably allow alternative 
depreciation schedules, the drawbacks of the added complexity and 
potential user confusion might outweigh the gains from addressing a 
rare circumstance. Nevertheless, EPA has devised a relatively simple 
means for BEN to apply shorter depreciation schedules when the user 
enters a capital equipment useful life less than 10 years (as opposed 
to the default 15 years).
    The specification of shorter depreciation schedules will ensure 
that BEN does not overestimate economic benefit in the relatively rare 
cases that involve such short-lived capital equipment. Once the shorter 
useful life has been specified, the alternative depreciation schedule 
will not require any additional input from the user. BEN will also 
include a provision to account for legislation that allows for 
depreciation bonuses over certain periods. This provision will key off 
the previously required noncompliance and compliance dates, and it 
therefore will

[[Page 50332]]

not require any additional input from the user.
2. Tax Rates
a. Background
    The DOS versions of BEN that were issued after 1993 used to apply 
three marginal tax rates: a rate for 1986 and before, one for 1987 
through 1992, and one for 1993 and beyond. Users could accept the 
standard values--which incorporate national averages of State tax 
rates--or modify the inputs to reflect specific State values.\9\
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    \9\ Tax rate modification can also reflect a business whose low 
net income entails a tax bracket other than the assumed highest 
bracket. Note that BEN's assumption of the highest marginal tax rate 
produces a lower economic benefit calculation than assuming a lower 
tax rate because a higher tax rate decreases the compliance costs' 
after-tax value. Since the model employs an after-tax cost in its 
analysis, the lower the tax, the higher the BEN result.
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b. Final Changes
    EPA did not receive any objections to the June 1999 notice's 
proposal that the revised BEN model will require the user to enter the 
violator's State of operation, then automatically reference an internal 
database of State tax rates and perform the necessary calculations for 
the violator's combined Federal and State tax rate.\10\ BEN will 
calculate the tax rate for each separate year of noncompliance, to 
allow for annual changes in the relevant State tax rate (even when the 
Federal rate remains constant). Users will have the additional option 
of entering year-by-year combined Federal and State rates in a 
spreadsheet-like format.\11\
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    \10\ The model will also offer the option of the national 
average of all the State tax rates for cases where the State in 
which the violator pays taxes is unclear.
    \11\ This option would allow users to account for, among other 
situations, a company whose profitability (and hence tax bracket) 
was highly variable over different years. (As noted before, BEN's 
assumption of the highest marginal tax rate throughout the 
noncompliance period results in a lower economic benefit estimate 
than would be produced by a more precise calculation of the 
violator-specific marginal tax rate.)
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    Although these options may sound complex, the only data required of 
the user will be the violator's State. The other screens for additional 
data entry and modification will appear only to those users who 
selected such advanced options.
3. Differences in On-Time and Delay Scenarios
a. Background
    The BEN model's baseline assumption is that the violator would have 
used the same technology and approach in the hypothetical on-time 
compliance as it did in the actual delayed compliance scenario. The 
only allowed differences are in the two scenarios' exact costs of 
compliance, which BEN adjusts for automatically in its inflation 
treatment. But technological, legal, or other relevant changes between 
the on-time and delay scenarios can conceivably alter the components of 
the compliance scenarios, increasing or decreasing the compliance costs 
by a rate other than general price inflation. Where the delay case 
costs are substantially less than the on-time case costs (e.g., a 
technological breakthrough in control equipment), BEN will understate 
the benefit. Where the delay costs are substantially higher (e.g., 
regulations become more stringent, but with ``grandfather'' clauses for 
already-compliant firms) BEN will overstate the benefit.
    Where, in the unusual case, the on-time and delay compliance 
scenarios are significantly different, BEN's baseline assumption of two 
identical scenarios is inappropriate.\12\ More sophisticated 
calculations are necessary.\13\
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    \12\ The inexperienced user will become aware that a more 
sophisticated analysis is needed because there are two sets of cost 
figures, but only one place to put them. The more experienced user 
will just go directly to the ``Specific Cost Estimates'' option 
during data entry.
    \13\ A similar problem arises when no technologically feasible 
method of compliance is available. If the only possible compliance 
method that the Agency would have allowed is to cease all 
production, then this falls under the category of illegal 
competitive advantage, which by definition is beyond the scope of 
the BEN model.
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b. Final Changes
    EPA received only one minor objection to the June 1999 notice's 
proposal that the revised BEN model allow users to enter separate on-
time and delayed compliance costs. Although the standard operation of 
the revised model will still entail only a single compliance scenario, 
the new screens for additional data entry/modification of separate on-
time vs. delay scenarios will be available to those users who select 
such advanced options. The availability of more advanced options will 
also enhance the model's ability to account for atypical situations 
such as valid pre-compliance expenditures and credits for salvaged 
capital equipment, thus decreasing the need for off-line calculations.
4. Capital Equipment Replacement
a. Background
    One of the three components of compliance costs BEN analyzes is the 
capital investment, which represents depreciable pollution control 
equipment. As the name implies, depreciable equipment wears out with 
usage and the passage of time. BEN used to ask the user if the violator 
will need to replace the equipment at some point in the future. If the 
user specified that the investment in capital equipment is recurring, 
then the user could accept the standard value of 15 years for the 
useful life of the capital equipment, or enter another value.
    If the capital equipment does need to be replaced in the future, 
then the violator is financially better off from its delayed compliance 
in two distinct yet related ways: the violator has received a benefit 
in the past from delaying the initial purchase of the capital 
equipment, and will receive a benefit in the future from delaying the 
replacement of the capital equipment when that initial purchase wears 
out. For example, if a steel mill delays installation of a $1,000,000 
baghouse for 5 years, it first obtains a benefit from delaying the 
purchase of that baghouse for 5 years. But when that baghouse needs to 
be replaced 15 years later, the violator's second baghouse is purchased 
5 years later than it should have because the initial purchase lasted 
five years later than if it had complied on time.
b. Final Changes
    Some commenters characterized any consideration of future 
replacement cycles as ``speculative,'' as these cycles have yet to 
occur in the typical case (because the noncompliance period is almost 
always shorter than the capital equipment's useful life). EPA agrees 
only to the extent that BEN does make an assumption about the future, 
but this assumption is essentially a baseline one: BEN assumes that 
future pollution control requirements will be neither more stringent 
nor more lax than current requirements, and that the cost of the 
replacement equipment will increase by no more and no less than the 
projected rate of inflation. Therefore, the Agency will retain the BEN 
model's default consideration of capital equipment replacement.
    Some commenters argued that BEN should not offer infinitely 
recurring replacement cycles. The Agency notes that although modeling 
infinite cycles might at first seem excessive, all future costs are 
``discounted'' back to their present values (see following sections for 
an explanation of discounting). Thus, the first replacement cycle 
typically has a relatively small impact on the benefit calculation.\14\ 
The impact

[[Page 50333]]

of later replacement cycles is almost negligible.
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    \14\ If the initial capital investment is $1 million and the 
equipment lasts for 15 years, then the first replacement cycle is 
still $1 million (assuming, for now, the lack of any intervening 
inflation). But since it is purchased 15 years later, the $1 million 
is discounted to a present value at, for example, 10 percent, over 
15 years. The first replacement cycle would only increase the 
benefit component by about 30%. The second replacement cycle is 
purchased 30 years later. Thus, the $1 million piece of equipment is 
discounted at the same 10 percent over 30 years. The economic 
benefit from the delay of that second replacement cycle would only 
increase the benefit component by about 7%.
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    Some commenters, as well as academic peer reviewers, favored the 
approach of a finite number of replacement cycles (which the Agency 
initially proposed to adopt). But one peer reviewer pointed out that 
this approach runs into problems when the noncompliance period is very 
long, especially when it approximates the useful life of the capital 
equipment. For example, assume a 10-year compliance delay, coupled with 
a 10-year useful life. If BEN were to use one replacement cycle, the 
on-time scenario would include two capital equipment installations, 
covering the years 1 through 20. The delay scenario would also include 
two capital equipment installations, but run from years 11 through 30. 
BEN would implicitly be stating that the violator would need to have 
functional equipment in place for years 21 through 30 (i.e., the delay 
scenario's replacement cycle), but that a company complying on-time 
need not do so (i.e., since the cash flow analysis for the on-time 
scenario runs out only to the year 20).
    Therefore, the revised BEN model will adopt this peer reviewer's 
solution by implementing the concept of economic depreciation, which 
essentially calculates the lease value of pollution control equipment. 
In other words, instead of modeling the on-time replacement capital 
investment and the subsequent depreciation tax shields, and comparing 
that to delayed replacement, the calculation models leasing the 
equipment over the period when the on-time equipment would have 
required replacement yet the delay equipment is still functional. The 
avoided lease cost, therefore, serves as a reasonable approximation of 
the economic benefit from the delayed replacement equipment 
installation, and also allows the two scenarios to the modeled out to 
the same end point. Furthermore, projections far into the future are no 
longer necessary, as the imputed lease cost is calculated only for the 
interim period when the on-time equipment would have required 
replacement yet the delay equipment is still functional.
    This approach will add a few new cells on one of the pages in the 
BEN detailed printouts, yet allow the elimination of another entire 
page of calculations. It will also simplify the previous 0-5 
replacement cycles optional input to a simple ``yes/no'' choice for the 
consideration of future capital replacement (with the default set to 
``yes''). The previously included optional input for the future 
inflation rate (which applied only to replacement cycles in addition to 
the first one) will be eliminated.
5. Inflation Treatment
a. Background
    The first step in the economic benefit calculation is to determine 
the compliance costs--for both the on-time and delay scenarios--as of 
the year in which they were actually incurred (or should have been 
incurred). Therefore, BEN adjusts the compliance costs from the date 
they were estimated to the date the costs will be incurred to account 
for the effects of inflation.
    To adjust for inflation, BEN previously used a standard-value rate 
calculated from the prior ten years of inflation data from the Plant 
Cost Index (PCI) in the magazine Chemical Engineering. (The PCI is 
generally the cost index most relevant to the types of costs typically 
associated with pollution control technology.) This simple inflation 
rate adjusted the initial compliance cost estimates. BEN applied this 
simple inflation rate to the compliance cost figures in order to 
determine what compliance would have cost at the noncompliance date. 
Then BEN applied the same simple inflation rate to determine what the 
costs actually were (or will be) at the compliance date. Finally, the 
model used the same rate to go well into the future to determine what 
those costs will be for the capital equipment replacement cycles.
b. Final Changes
    Despite the Agency's specific request for comment on BEN's 
inflation adjustment, we received almost none. The issues that the few 
commenters did raise were:
    (1) The use of a single inflation rate for both actual and 
projected inflation,
    (2) The basis for the actual inflation rate, and
    (3) The basis for the projected inflation rate.
    For actual historical inflation, the revised BEN model will adjust 
each cash flow automatically from the date of the cost estimate to the 
date on which it is incurred by referencing a look-up table of cost 
index values.\15\ The default cost index will be the PCI. This 
particular index may not be perfectly appropriate for every single 
case, but we have yet to encounter any other cost index that would form 
a better basis for a standard value, nor did any commenters submit any 
specific nominations for a more suitable index.
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    \15\ The model will not apply an explicit inflation rate, 
although an annualized rate could be imputed from the model's data. 
For example, suppose a $200 cost estimate from 1991 must be adjusted 
for inflation to the same day in 1992. The 1991 cost index value is 
100, whereas the 1992 index value is 103. The calculation the model 
performs is $200 x 103 / 100 = $206 (i.e., multiplying the original 
cost estimate by the ratio of the cost index values from the date on 
which the cost is actually incurred, and the date on which the 
estimate is made). The index change from 1991 to 1992 does represent 
an annual inflation rate of three percent (i.e., 103 / 100 = 1.03 - 
1 = 0.03), although the model would not directly apply this rate. 
The calculation that uses the ratio of the index values is both more 
precise and more simple than calculating multiple annual inflation 
rates over different periods for historical costs.
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    The revised BEN model will also allow the user to override the PCI 
and instead specify different cost indices for different compliance 
components. The table below describes the alternative cost indices.

------------------------------------------------------------------------
                                                            Typical
   Abbr          Full name           Description         applications
------------------------------------------------------------------------
2.5%......     2.5-percent constant inflation rate    Sensitivity tests;
                                                       model testing.
CCI.......  Construction Cost    Constructions        General
             Index.               costs; based on      construction
                                  1.128 tons           costs, especially
                                  Portland cement,     where labor costs
                                  1,088 bd. ft. 2x4    are a high
                                  lumber, 200 hrs.     proportion of
                                  common labor.        total costs;
                                                       often used for
                                                       municipal
                                                       wastewater
                                                       projects.
ECI.......  Employment Cost      Employment costs...  One-time
             Index.                                    nondepreciable
                                                       expenditures or
                                                       annual costs that
                                                       are mainly labor
GDP.......  Gross Domestic       Economy-wide         A very broad,
             Product price        measure of price     economy-wide
             deflator.            changes.             measure of
                                                       inflation is
                                                       desired.
PCI.......  Plant Cost Index...  Plant equipment and  Standard value.
                                  labor costs.

[[Page 50334]]

 
PPI.......  Producer Price       Representative       General costs for
             Index.               producer costs.      producers, not
                                                       tied to
                                                       industrial
                                                       process
                                                       equipment.
------------------------------------------------------------------------

    The user may also override BEN's inflation adjustments for the 
capital investment and one-time nondepreciable expenditure, and instead 
enter separate estimates for these compliance costs as of the 
noncompliance date and compliance date. This customized data entry 
could represent another alternative cost index, case-specific inflation 
assumptions, or entirely different actions for on-time and delayed 
compliance (as discussed in a previous section). For projected future 
inflation, the model will project all the cost indices forward in time 
at publically available, consensus-oriented forecasted rates.
    The standard operation of the model will still entail absolutely no 
input whatsoever from the user who is satisfied with BEN's default 
values. The other screens for additional data entry and modification 
will appear only to those users who selected more advanced options.
6. Discount/Compound Rate
a. Background
    Once the compliance cost estimates are adjusted for inflation and 
then for taxation, the BEN model must adjust these after-tax cash flows 
to a common present value as of the date of noncompliance. The 
difference between the two present values (of the on-time and delay 
scenarios) is the initial economic benefit as of the noncompliance 
date. BEN then compounds this initial economic benefit forward from the 
noncompliance date to the penalty payment date to determine the final 
economic benefit. A single rate adjusts all present values both 
backward and forward in time.\16\ This section addresses only the 
calculation of BEN's standard value for this single discount rate, 
which was previously based upon a ten-year after-tax weighted average 
cost of capital (WACC), with the inputs representing averages across 
all industries.\17\
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    \16\ The Agency received many comments on the use of a single 
rate as opposed to two different rates. The notice addresses this 
issue in section II. B. 8, Discounting/Compounding Methodology.
    \17\ The discount rate standard value for not-for-profits is 
based upon municipal bond yields, averaged across the four 
investment-quality ratings of Aaa, Aa, A, and Baa. The only comment 
EPA received on the not-for-profit discount rate was a suggestion 
that municipal economic benefit be calculated using a discount rate 
for private entities that perform similar functions (e.g., on a 
municipal Clean Water Act case, the discount rate would be the 
average WACC for privately owned wastewater treatment plants). 
However, because the Agency is trying to calculate the economic 
benefit that the municipality and its residents or rate payers have 
actually gained, the Agency prefers to use an estimation of the 
municipal government's opportunity cost of financing projects, which 
is equal to the interest rate on the municipality's bonds. This debt 
rate--which forms the basis for the BEN model's not-for-profit 
standard value discount rate--will almost always be substantially 
lower than the private-sector-equivalent cost of capital. The 
discount rate for Federal facilities is based upon the yields from 
five-year U.S. Treasury notes.
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    The WACC is the average of the cost of debt and the cost of equity, 
weighted by the portions of debt and equity out of total financing. The 
WACC is first calculated for each year, and then the prior version of 
BEN averaged these annual values over the most recent ten-year period. 
The (after-tax) cost of debt is the average return on corporate bonds 
averaged across all industries, and then multiplied by one minus the 
highest marginal corporate tax rate (Federal combined with an average 
of all States). The cost of equity is based upon the widely used 
Capital Asset Pricing Model (CAPM), and is equal to a risk-free rate 
component plus the expected equity risk premium (i.e., the average 
since 1926 of each year's excess stock market return over the risk-free 
rate).
b. Final Changes
    Based on the June 1999 notice's proposal and the lack of any 
objections, the revised BEN model will tailor the standard value 
discount rate to the period from the noncompliance date to the penalty 
payment date.\18\ The standard value will reference a look-up table, 
averaging the annual values over the relevant years. Each individual 
annual calculation will be similar to the standard value's previous 
methodology.\19\
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    \18\ Although the following discussion focuses on the for-profit 
discount rate, the tailoring of the discount rate to the relevant 
time period would also apply to not-for-profit entities.
    \19\ The revised BEN model will implement two relatively minor 
changes to the previous model's annual WACC calculation. First, the 
previous practice of applying the most recent figure for the 
expected equity risk premium to all prior years' calculations will 
be replaced with the figure that was actually available at the time 
for that specific year's calculation.
    The second change is altering the horizon for the equity risk 
premium. The standard value previously combined the long-term 
Treasury security rate with the long-horizon equity risk premium, 
the latter being equal to the average of each year's stock market 
return minus the corresponding-maturity risk-free rate. Because the 
WACC calculation combines the equity risk premium with the risk-free 
rate of the same maturity that is used initially to calculate the 
premium, the issue of which horizon premium to use is largely moot. 
(The expected deviations of the resulting WACC will thereby be both 
small and nonsystematic.) The new calculation will switch to the 
intermediate-horizon risk premium (and the corresponding risk-free 
rate) as a simple compromise between the long-horizon and short-
horizon.
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    The model will also perform additional customizing in a similar 
automated fashion. Since BEN will have an input for the violator's 
State--thereby customizing the tax rate for compliance costs--that same 
customized tax rate will determine the after-tax debt cost component of 
the WACC. The model will even select the individual tax rate if the 
company is not organized as a C-corporation (as profits and losses from 
S-corporations, partnerships, and sole proprietorships flow through to 
the owners' individual tax returns).
    The standard operation of the model will still entail absolutely no 
input whatsoever from the user who is satisfied with BEN's derived WACC 
for the discount/compound rate. Another screen to override BEN's 
derived rate will appear only to those users who selected such advanced 
options.
7. Discounting/Compounding Methodology
a. Background
    As stated in the previous section, once the compliance cost 
estimates are adjusted for inflation, and then for taxation, the BEN 
model must adjust these after-tax cash flows to a common present value 
as of the noncompliance date. The difference between the two present 
values (of the on-time and delay scenarios) is the initial economic 
benefit as of the noncompliance date. BEN then compounds this initial 
economic benefit forward from the noncompliance date to the penalty 
payment date in order to determine the final economic benefit. BEN uses 
a single rate to adjust all present values both backward and forward in 
time. Because BEN uses the same rate for going both backward and 
forward, this calculation is computationally equivalent to bringing all 
cash flows--both past and future--directly to the penalty payment date 
at the WACC rate.