Basic Cost Benefit Analysis for Assessing Local Public Projects, Second Edition

Barry P. Keating, Maryann O. Keating

• Publisher: Business Expert Press
• Year: 2017
• ISBN:
  9781631578823
• Topic: Economics
• Subtopic: Public Finance
• Index: Economics

The cost benefit technique is so often referenced in government policy that a correct understanding is necessary for officials entrusted with public decisions. This book presents essential elements for understanding, interpreting, and conducting cost benefit analysis (CBA) in the context of local government. If you're charged with preparing numerical analyses to assess the worthiness of a specific policy proposal, you'll need this book to understand how costs and benefits are identified and analyzed in terms of economic efficiency and resource allocation. CBA is rooted in and has little or no value apart from the economic concepts of cost and resource efficiency. This book is designed to teach the correct use and interpretation of cost benefit analysis, while advising you of CBA's limitations and pitfalls. Case studies, presented in the final chapters of this book, represent typical proposals confronted by local officials. The book also includes instructions for using computer spreadsheets to build basic cost benefit models and an appendix on the step-by-step process of discounting future costs and benefits.

CHAPTER 1

An Introduction to Cost-Benefit Analysis

The very need to weigh benefits against costs-the essence of economics-is evaded by the irresponsible exercise of arrogance.

—Thomas Sowell

Chapter 1 Preview

When you have completed reading this chapter you will:

• see this book as a practical guide for decision-makers charged either with performing or interpreting basic cost-benefit analysis (CBA);

• be aware of project proposals for which CBA is and is not an appropriate decision tool;

• know why government project assessment requires different tools than private project assessment;

• realize that objective decision making is based on considering foregone options, minimizing costs, and using scarce resources to produce what residents need and desire;

• be able to explain why CBA is a useful tool for determining net benefits based on the difference between discounted benefits and discounted costs;

• refer to available statistics for your particular local government unit;

• know how to discount future costs and benefits using a spreadsheet;

• realize that collective decision-making, with respect to a specific government proposal, ultimately depends on the choice of the voting public.

Introduction

It is a truth universally acknowledged that any project proposed to local government is in want of a good justification. In too many instances, only well-meaning intentions suffice. It is odd that public projects, in contrast to private corporate investments, are often devoid of simple decision-making rules. There is a way, however, for local officials and residents to rank and evaluate modest public proposals without commissioning costly feasibility studies. In modified form, CBA methodology has a role in ruling out egregious, unrealistic proposals.

Suppose that you were one of nine Common Council Members of a mid-sized town. The main business at the next Council meeting is to read for the second time a Bill forwarded to the Council for consideration and approval by the mayor and the Community and Economic Development Committee. The Bill represents a plan to be implemented by the city, the nonprofit Northside Neighborhood Association, and a private for-profit corporation working together to develop the housing stock in a strategic area of the city. The goal is to improve the quality of present owner-occupied properties, to renovate viable homes for resale and as rentals, and to demolish vacant and abandoned structures.

The proposal requests that $9 million be allocated to the program in equal installments over the next 5 years. The source of funds would be city tax revenue, the state foreclosure prevention program, and federal government’s block grants for community development and neighborhood stabilization. A total of 100 properties would be affected by the program. The city would retain ownership of 50 vacant and abandoned properties until sold on behalf of the city prior to the program completion in 10 years. Another 50 dwellings would be rehabilitated. Increased property values are expected to generate additional property taxes to finance infrastructure and policing throughout the city.

As a hypothetical council member you are undecided on voting to approve the mayor and development committee’s proposed bill. Distressed by the number of decaying properties in town, you, nevertheless, act in trust for a district outside the targeted area. A quick calculation ($9 million divided by 100 properties) suggests that per property cost of $90,000 exceeds the average price of homes throughout the city. You are not an expert in law, finance, or construction, and there are so many variables to consider. What technique would allow you to get a handle on voting rationally in the present and long-term best interests of the city? CBA is an option, worthy of serious consideration.

CBA is an exercise leading decision-makers to list and quantify in monetary terms all costs and benefits associated with a proposal. Assessing costs and benefits is resisted, understandably. It is emotionally difficult to accept that certain benefits, particularly the value of human life, be evaluated and quantified. In addition, we are legitimately cautious about any analysis that can be easily skewed in favor of personal interests. Yet, accountability requires public officials, as well as agency administrators, to deal with the question, “What value do residents receive in return for projects subsidized with taxpayer funds?”

Corporations, in maximizing profits, rely on benefits per dollar to differentiate between projects. Unfortunately, such tools do not translate well into the government sector. In the case of public goods and services, those who benefit do not necessarily purchase them, and those who finance them do not necessarily consume them. Also, in both the nonprofit and government sectors, users generally do not pay fees covering the full cost of providing the goods and services offered.

CBA is an appropriate tool for estimating a project’s net direct and indirect benefits received regardless of who pays the bill or who receives the benefits. In assessing public project proposals, CBA attempts explicitly to account for external (public) effects in addition to personal (private) costs and benefits. External effects refer to those costs and benefits affecting all members, not just those who are the primary providers or recipients. For example, students and their parents, the primary beneficiaries of publicly funded K-12 education, are charged nominal fees with the remaining amount financed by community funded endowments plus federal, state, and local tax revenues.

In this book, we reserve the term CBA to government-financed projects, but elsewhere this method is referred to as “social cost benefit analysis.” We prefer the simple term “cost benefit analysis (CBA)” and use it both in reference to infrastructure-type projects such as highways as well as those dealing with social concerns such as housing, education, and health.

Federal agencies struggle with mandates requiring them to provide cost-benefit analysis for all proposals above a certain cost. If large federal bureaucracies struggle with it, how can we argue here for CBA’s applicability in assessing modest local government projects? If CBA is such an appropriate tool, why is it so seldom applied? The answer to both questions is that CBA is based on economic theory that is sometimes difficult to understand and even more difficult to operationalize; undoubtedly it is easier to make decisions based on emotions and political expediency. In essence, we repeat, CBA is simply a standardized method to fully account for all costs associated with a new proposal along with a detailed calculation of specific private and public benefits. Properly employed, CBA determines whether or not a proposal should be considered and attempts to calculate net benefits relative to an alternative project or the default option of doing nothing.

Government guidelines are essential for CBA but, at this point, are still in the developmental stage. However, CBA templates may be found in governmental handbooks and in reports that have been contracted out to corporate consultants. At present, these handbooks and reports (listed in the “Suggestions for Further Reading” section in this book) are good reference sources, but...

Table of contents

• Cover
• Half-title Page
• Title Page
• Copyright
• Abstract
• Keywords
• Contents
• Chapter 1 An Introduction to Cost-Benefit Analysis
• Chapter 2 Cost-Benefit Analysis and Individual Preferences
• Chapter 3 Time Preference and the Discount Rate
• Chapter 4 Measuring Costs and Benefits
• Chapter 5 Shadow Pricing
• Chapter 6 Potential Pitfalls in Cost Benefit Analysis
• Chapter 7 Introducing Cost Benefit Analysis to the Nonspecialist
• Chapter 8 Cost Benefit Analysis of Proposed New Regulations
• Chapter 9 Case Study: Contracting Versus a Municipal Animal Control Shelter
• Chapter 10 Case Study: Cost Benefit Analysis for a Forty Acre Industrial Park Intended to Spawn Economic Development and Jobs
• Chapter 11 Case Study: Establishing a Recreational Program for the Disabled
• Appendix: Some Numerical Background
• Notes
• Bibliography
• Index
• Other Titles from the Economics Collection
• Backcover