[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]]


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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                        
------------------------------------------------------------------------
                                                                        
-------------------------------------------------------------------------
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.                                                 
------------------------------------------------------------------------

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