[Federal Register Volume 61, Number 197 (Wednesday, October 9, 1996)]
[Notices]
[Pages 53026-53030]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 96-25893]
[[Page 53025]]
_______________________________________________________________________
Part V
Environmental Protection Agency
_______________________________________________________________________
Calculation of the Economic Benefit of Noncompliance in EPA's Civil
Penalty Enforcement Cases; Notice
Federal Register / Vol. 61, No. 197 / Wednesday, October 9, 1996 /
Notices
[[Page 53026]]
ENVIRONMENTAL PROTECTION AGENCY
[FRL-5629-9]
Calculation of the Economic Benefit of Noncompliance in EPA's
Civil Penalty Enforcement Cases
AGENCY: Environmental Protection Agency (EPA).
ACTION: Request for comment.
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SUMMARY: The Environmental Protection Agency (``EPA'') requests comment
on how it calculates the economic benefit obtained by regulated
entities as a result of violating environmental requirements. In
particular, the Agency is seeking comment on three categories of
issues: The most effective mechanism for recapturing economic benefit;
the methodology and assumptions incorporated in the economic benefit
(``BEN'') computer model used by the Agency to calculate that benefit;
and the model's precision and user-friendliness. After the comment
period closes, the Agency plans to review all the comments and revise
its benefit recapture approach as appropriate.
DATES: EPA urges interested parties to comment in writing on the BEN
model and the EPA's benefit recapture approach. Comments must be
received by EPA at the address below by January 1, 1997. Comments may
also be communicated verbally at two public meetings EPA will hold
during the comment period. The first one is scheduled for Washington,
DC in the auditorium at EPA's Education Center at 401 M Street, SW., on
November 6, 1996. The second one is scheduled for San Francisco at the
Holiday Inn Golden Gateway at 1500 Van Ness Ave on November 13. Both
meetings will begin at 9:30 a.m. and end at 4:00 p.m.
ADDRESSES: Written comments should be submitted in triplicate to: U.S.
Environmental Protection Agency, Office of Enforcement and Compliance
Assurance, Economic Benefit Docket Clerk, Mail Code 2248-A, 401 M
Street, SW., Washington, DC 20460, and reference this docket.
EPA will maintain a record of all written comments submitted
pursuant to this notice. Copies of the comments may be reviewed at the
Ariel Rios Federal Building, 1200 Pennsylvania Avenue, Washington, DC
20044. Persons interested in reviewing the comments must make advance
arrangements to do so by calling (202) 564-2235.
FOR FURTHER INFORMATION CONTACT: Copies of the BEN computer model and
the BEN Users Manual may be obtained from the National Technological
Information Service by calling (703) 487-4650. Callers should request
order number PB95-502514INC. Electronic copies of these items are also
downloadable through the Office of Enforcement and Compliance
Assurance's communications network called ``Enviro$en$e.'' Enviro$en$e
is a free public network accessible via the World Wide Web on the
Internet (http://es.inel.gov), and via an electronic Bulletin Board
System ([703] 908-2092). For further information, contact Jonathan
Libber, Office of Regulatory Enforcement, Multimedia Enforcement
Division, at (202) 564-6011.
SUPPLEMENTARY INFORMATION:
I. Introduction
A. Overview
One of the Environmental Protection Agency's most important
responsibilities is ensuring compliance with the federal environmental
laws. These laws, and their implementing regulations, set minimum
standards for protecting human health and welfare and achieving
environmental protection goals, such as clean air and clean water. EPA
upholds these laws through vigorous enforcement actions that correct
the violations and appropriately penalize violators.
A cornerstone of the EPA's civil penalty program is recapture of
the economic benefit that a violator may have gained from illegal
activity, whenever EPA can effectively measure that gain. Recapture
helps level the economic playing field, preventing violators from
obtaining an unfair financial advantage over their competitors who
timely made the necessary investment in environmental compliance.
Generically, penalties serve as incentives to protection of the
environment and public health by encouraging the adoption of pollution
prevention and recycling practices that limit exposure to liability for
pollutant discharges. Finally, appropriate penalties help deter future
violations by the violator and by others similarly situated.
EPA has promulgated a generic civil penalty policy, as well as
specific penalty policies tailored to suit the needs of particular
programs. For example, there is a civil penalty policy specifically
designed to address violations of the Clean Water Act. Civil penalties
imposed by EPA usually have 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 focusses on the violator's economic
gain from noncompliance, which may occur in three basic ways. It can:
(1) Delay necessary pollution control expenditures; (2) avoid necessary
pollution control expenditures; or (3) gain an illegal competitive
advantage during the period of noncompliance. This advantage may occur,
for example, if a company sells banned products, or captures an extra
market share through selling its products at a lower cost than its
complying competitors.
The Agency designed the BEN computer model, for settlement purposes
only, to calculate the economic benefit from these first two types of
economic gain. The Agency does not have a standard methodology for
calculating the benefit gained from an illegal competitive advantage,
which is considered on a case-by-case basis.
B. EPA Policy and Guidance on Recapturing the Economic Benefit of
Noncompliance
Since its development in 1984, the BEN computer model has been
extensively used by EPA staff in generating penalty figures for
settlement purposes that reflect the economic benefit a violator
derived from delaying 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 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 (hereinafter the ``Framework'').
The Agency developed the BEN computer model to assist in fulfilling one
of the main goals of the Policy on Civil Penalties: recovery, at a
minimum, the economic benefit from noncompliance.
The BEN computer model is intended to be used in calculating
economic benefit for purposes of developing a settlement penalty, not
for use at trial or in an administrative hearing. In presenting
economic benefit testimony at trial or in an administrative hearing,
the Agency typically relies on an expert to provide an independent
financial analysis of the economic benefit the violator obtained as a
result of its violations. This independent financial assessment
reflects the expert's analytical approach as applied to the particular
facts of that case. Although such an analysis is usually consistent
[[Page 53027]]
with the principles of the BEN model, it may not be identical to that
set forth in the BEN User's Manual.
2. BEN Calculates the Economic Benefit From Delayed and Avoided
Pollution Control Expenditures
The BEN model is designed to calculate two types of economic
benefits: those gained from delaying and from avoiding required
environmental expenditures. Delayed costs can include capital
investments in pollution control equipment, delayed costs to remediate
environmental damages caused (e.g., remove unpermitted dredged or fill
material and restore wetlands), or one-time expenditures required to
comply with environmental regulations (e.g., the cost of setting up a
reporting system, or land purchases). Avoided costs include operation
and maintenance costs and/or other recurring costs (e.g., off-site
disposal of fluids from injection wells). BEN does not calculate a
third type of benefits: those derived from a competitive advantage
gained by a violator.
3. Current Model Usage and Applicability
The BEN model can be used in all cases where there is a measurable
benefit from delaying or avoiding compliance, except for Clean Air Act
Section 120 enforcement actions. (Section 120 requires the application
of a specific computer model.) BEN was designed to be easy to use for
people with little or no background in economics, financial analysis,
or computers. Because the program contains standard values for many of
the variables needed to calculate the economic benefit, BEN can be run
with only a small number of inputs from the user. The program also
allows the user to replace those standard values with user-specific
information. Table 1 lists the inputs to the BEN model. The optional
inputs listed in Table 1 are those for which the model has standard
values.
The model can estimate economic benefit for many types of
organizations: corporations, partnerships, sole proprietorships, not-
for-profit organizations and municipalities. The BEN model has two sets
of standard values: one applies to for-profit business violators and
the other applies to not-for-profit organizations. The BEN inputs
listed in Table 1 are discussed in detail in Chapter 4 of the BEN Users
Manual for both for-profit and not-for-profit organizations.
Table 1.--Inputs for BEN
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Required Inputs:
(1) Case Name, Profit Status, and Filing Status.
(2) Capital Investment.
(3) One-Time Nondepreciable Expenditure.
(4) Annual Expenses.
(5) Date of Noncompliance.
(6) Date of Compliance.
(7) Date of Penalty Payment.
Optional Inputs (Standard Values that May be Modified):
(8) Useful Life of Pollution Control Equipment.
(9) Marginal Income Tax Rate for 1986 and Before.
(10) Marginal Income Tax Rate for 1987 to 1992.
(11) Marginal Income Tax Rate for 1993 and Beyond.
(12) Inflation Rate.
(13) Discount Rate.
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C. How a Firm Obtains an Economic Benefit From Delaying or Avoiding
Compliance Costs
An organization's decision to comply with environmental regulations
usually implies 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 annual, continuing expenses). These expenditures should
result in better protection of public health or environmental quality;
however, they are unlikely to yield any direct economic benefit (i.e.,
net gain) to the organization. If these financial resources were not
used for compliance, they presumably are invested in projects with an
expected direct economic benefit to the organization. This concept of
alternative investment--that is, the amount the violator would normally
expect to make by not investing in pollution control--is the basis for
calculating the economic benefit of noncompliance.
As part of the Civil Penalty Policy, the Agency uses its penalty
authority to remove or neutralize the economic incentive to violate
environmental regulations. In the absence of enforcement and
appropriate penalties, an organization's best economic interest will
usually be to delay the commitment of funds for compliance with
environmental regulations and to avoid certain other associated costs,
such as operation and maintenance expenses.
1. The Components of Economic Benefit Measured by the BEN Model
A violator may gain economic benefit from either delayed or avoided
compliance costs. By delaying compliance, the violator can earn a
return on the delayed capital or one-time costs of pollution control
equipment. 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 ordinarily
expected to yield a monetary return at the violator's marginal rate of
return on capital. But environmental expenditures typically yield no
direct economic benefit. Thus, by delaying compliance, the violator
benefits by the amount of earnings that could be expected from
alternative investments.
A violator can also gain an economic benefit from avoiding
pollution control expenditures. Avoided expenditures typically include
the annual continuing expenses that a violator would have incurred if
the facility had complied with environmental regulations on time, such
as the costs of labor, raw materials, energy, lease payments and any
other expenditures directly associated with the operation and
maintenance of the pollution control equipment. Unlike capital and one-
time expenditures which are only postponed, annual expenditures are
avoided altogether. The resulting benefits to the violator are the
total avoided annual costs as well as the return that could be expected
on these avoided costs.
[[Page 53028]]
2. Taking Indirect Costs Into Account
EPA's BEN model evaluates economic benefit in terms of the effect
that delayed or avoided pollution control expenditures have on an
entity's cash flows. Cash flow analysis is a standard and accepted
technique for evaluating costs and investments. In essence, the result
of cash flow calculations is to determine the actual dollar costs and
revenue resulting from an expenditure. Thus, noncash expenditures, such
as depreciation, are only considered to the extent that they affect
cash income or expenses. The three factors the model accounts for here
are tax, inflation and discounting.
a. After-Tax Cash Flows
The BEN model computes economic benefit in after-tax terms to take
into account certain financial impacts associated with environmental
expenditures. For example, one important impact of these expenditures
is a reduction in income tax liability. Depreciation and annual
expenditures serve to reduce taxable income, thereby reducing income
taxes. Also, depending upon the tax year, the original purchase of
equipment might have resulted in an investment tax credit. To account
for these tax effects, BEN calculates the economic benefit using after-
tax cash flows.
b. Inflation
Inflation is another indirect factor that the BEN model accounts
for. The BEN model initially converts all costs to dollars of the
noncompliance year before it compares the cost of complying on time
with the cost of complying late. The model uses the inflation rate to
adjust the current or future cost of compliance into dollars from the
year noncompliance began. The BEN Users Manual (see pages 4-27 to 4-29
and Appendix A of the manual) contains a more detailed discussion of
the inflation factor.
c. Discounting
A third impact relates to the timing of the cash flows since cash
flows occurring in different years are not directly comparable. A basic
concept of financial theory is ``present value.'' This concept is based
on the principle that: ``A dollar today is worth more than a dollar a
year from now,'' because today's dollar can be invested immediately to
earn a return over the coming year. Therefore, the earlier a cost (or
benefit) is incurred, the greater its economic impact. BEN accounts for
this ``time value of money'' effect by reducing all estimated future
cash flows to their ``present value'' equivalents. This widely-used
technique is known as ``discounting'' and ``net present value''
analysis. The BEN Users Manual (see pages 4-30 to 4-35 and Appendix A
of the manual) contains a more detailed discussion of discounting and
the concept of present value.
II. Issues
The Agency is seeking 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.
First, we invite comment on some fundamental questions the benefit
recapture approach has raised. Is there a better way to measure benefit
for settlement purposes than using the BEN model? In addition, what is
the best approach to calculate the economic benefit derived from
illegal profits?
Second, we invite comment on the BEN model's calculation
methodology. While the Agency is confident that the BEN model's overall
approach is theoretically sound, it welcomes constructive and
documented comment on alternative approaches. In addition, EPA is aware
of substantial differences of opinion with respect to the basis of some
of the model's assumptions, particularly the discount rate and
inflation rate. EPA requests comment on the BEN model's calculation
methodology, or any other aspect of the model's assumptions or
methodology.
Third, we request comment on the model's user-friendliness. The
Agency has heard comments that the model is too difficult to use,
particularly regarding BEN's ease of operation or how difficult it may
be to obtain the data needed to run BEN. EPA has never been presented
with any concrete evidence in support of these assertions. Thus, the
Agency would like to either substantiate the problems and address them,
or put these issues to rest.
A. Broad Economic Benefit Recapture Issues
1. Alternatives to BEN
EPA requests comment on whether there is a more accurate, simpler
approach to measuring the economic benefit of delayed and avoided
pollution control expenditures than the BEN model. The BEN model was
designed to calculate the economic benefit of noncompliance for the
vast majority of EPA's cases. While BEN has effectively served this
purpose, the Agency recognizes that it should be improved or even
replaced if a better alternative exits or could be easily be developed.
This is particularly relevant as an increasing number of State and
local government enforcement personnel are using 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 should also be
reasonably accurate, simple to use and readily understandable to the
vast majority of the BEN model's users. These Federal, State and local
government enforcement officials usually have limited knowledge of
corporate or municipal finance or accounting.
2. Illegal Competitive Advantage
The Agency would like routinely to evaluate the economic benefit a
violator derives from a competitive advantage gained as a result of the
violation. While the Agency has maintained since 1984 that this was one
aspect of economic benefit we would seek to recapture, EPA is seeking
advice on what should be employed as a standard methodology to measure
what that benefit is. This benefit can accrue to a violator in a number
of different ways:
a. Violator Sells Products at Below Market Price
Depending upon the particular market situation, a violator could
sell its products at a lower price than its complying competitors
because it does not have to pay for environmental compliance costs. It
could then secure a bigger share in that particular market. For
example, instead of controlling 25% of the market for a particular
product, it controls 35% of the market. In theory, the extra 10% of the
market is the economic benefit. Some of the key questions are: how do
we assess and prove what share of the market came from underpricing,
and how do we determine the value of that market share?
b. Violator Sells Products That Were Prohibited by Law
Many of EPA's regulations prohibit the sale of certain products
either permanently or until EPA reviews and approves them. If the
violator produces and sells the prohibited product, the violator will
achieve an economic benefit in two ways. First, it will make money
directly from the sale of the product. Second, it will capture the
market for the product, particularly if it is a new product. Some of
the key questions here are: should the measure of economic benefit be
gross sales, gross sales minus expenses, or some other measure? If it
is the net, what expenses should be considered in determining the
[[Page 53029]]
net (e.g., how should EPA allocate advertising expenses for a violator
producing more than one product)?
c. Violator Initiates Construction or Operation Prior to Government
Approval
Some regulatory requirements prohibit an entity from initiating
construction or operation until it obtains a permit from EPA or another
government agency. When a violator initiates construction or operation
prior to this approval, it can begin operating earlier than it would
have been able to do had it complied with the law. For example, if the
violator's operation begins nine months earlier than it should have,
the violator has an opportunity to generate sales it should not have
made and gain a head start in developing its market. Some of the
motivation to violate could be to take advantage of a business cycle
(e.g., the violator illegally completes construction of a golf course
without the required permits so that it can open at the start of the
golfing season). Another incentive might be to initiate construction as
soon as the financing is available and not wait until approval is
given. (In either of these situations, we assume that the government
will eventually issue the permit, if it does not, then every dollar
produced by the new facility is an illegal economic benefit.)
One of the key issues here is: how should EPA determine the amount
of benefit when a violator initiates construction or operation prior to
government approval? Firms often expect to lose money on a new facility
in the first few years of operation. Similarly, new businesses expect
to lose money in the first few years of operation. For example, if a
firm starts operating one year earlier than it should have, and if EPA
only looks at the gross income minus the expenses, then the violator
may be able to argue that it actually lost money the year it was in
violation. Although that violator will ultimately be able to start
showing a profit one year earlier than it should have, it will show a
loss for that first year.
B. The BEN Model's Calculation Methodology
Over the years, the BEN model has been criticized for alleged flaws
in its calculation methodology. The two issues with the greatest
potential impact involve the model's discount rate and its inflation
rate. The Agency requests substantive and constructive comments on how
the BEN model handles these two issues. In addition, comments are
invited on all aspects of the calculation methodology. Comments that
address issues involving the calculation methodology should clearly
state the rationale for the proposed changes. In addition, the
commenters should address whether the proposed changes would add any
complexity to the computer model. If any of them do add complexity, the
commenter should state why the benefit of the change justifies the
added complexity.
1. Discount Rate Assumptions
The discount rate is an interest rate that reflects the violator's
cost of capital. In essence, this is the cost of financing pollution
control investments. The BEN model bases its discount rate for for-
profit entities on the weighted average cost of capital (WACC) for a
typical firm. This means that the cost of financing a project is based
on a weighted average of a typical firm's cost of debt capital (e.g.,
bonds and bank loans) and equity capital (e.g., stocks). For
municipalities, the discount rate is based on an average municipal bond
yield for the top four grades as reported in Moody's Municipal and
Government Manual.
The discount rate is a key assumption employed in the computer
model. Any changes to the discount rate have a substantial effect on
the BEN results. For a more detailed discussion of the discount rate,
see the BEN Users Manual (at pages 4-30 to 4-35 and Appendix A).
2. Inflation Rate Assumptions
The inflation rate variable is the annual rate at which the costs
of environmental control measures have grown and are expected to grow
over time. These cost increases are the result of various factors
affecting supply and demand for particular products and services, as
well as general inflationary pressures in the economy. BEN applies the
inflation rate to adjust the cost of compliance measures as
appropriate. The standard value of the inflation rate is based on a
ten-year running average of the ``Plant Cost Index'' that appears in
Chemical Engineering. For a more detailed discussion of the inflation
rate, see the BEN Users Manual (pages 4-27 to 4-29).
C. Improving the BEN Model's User Friendliness
EPA understands that some users find the program difficult to use.
While that has not been EPA's experience, the Agency is interested in
learning of any difficulties associated with running the model.
Comments on these issues will be particularly helpful if they suggest
realistic alternatives that would also preserve the model's degree of
precision.
1. Is BEN Too Complex to Operate?
EPA invites comments on whether an aspect of the model's operation
or its user's manual is overly complex. Although designed to be
straight-forward and easy to use, the Agency would welcome any
suggestions to make the model and manual easier to use as long as we
can preserve its degree of precision.
2. Is the Information BEN Needs Difficult or Expensive to Obtain?
One of the main breakthroughs BEN achieved over its predecessor
model was its streamlining of the data needed to operate the model.
While the model requires a minimum of seven and a maximum of only
eighteen pieces of data, some users find that the data is hard to
obtain. This has not been EPA's experience as most, if not all the
required data inputs, are based on facts that are already known to the
litigation team as they are important to other parts of the settlement.
Nevertheless, the Agency would welcome any suggestions as to how to
make this data easier to obtain as long as we can preserve the model's
degree of precision.
III. Public Process
As part of EPA's effort to obtain comments on the BEN model, the
Agency is planning to hold two public comment sessions. At those two
meetings, interested parties may attend and provide verbal comments on
the issues. The first one is scheduled for Washington, D.C. in the
auditorium at EPA's Education Center at 401 M Street, SW, on November
6, 1996. The second one is scheduled for San Francisco at the Holiday
Inn Golden Gateway at 1500 Van Ness Ave on November 13. Both meetings
will begin at 9:30 a.m. and end at 4:00 p.m.
The Agency is especially interested in comments relating to the
issues specified in this Notice. After the comment period closes, the
Agency plans to review all the comments and revise its benefit
recapture approach and the BEN computer model as appropriate. EPA
encourages parties of all interests, including State and local
government, industry, not-for-profit organizations, municipalities,
public interest groups and private citizens to comment so that we can
have as broad a spectrum as possible.
[[Page 53030]]
Dated: September 24, 1996.
Steven A. Herman,
Assistant Administrator, Office of Enforcement and Compliance
Assurance.
[FR Doc. 96-25893 Filed 10-8-96; 8:45 am]
BILLING CODE 6560-50-P