Regulatory Reform Contracts and Regulatory Reform

William F. Pedersen

William F. Pedersen is an individual practitioner in the District of Columbia. He serves as Senior Fellow in the Program on Consensus, Democracy, and Governance at Vermont Law School. Mr. Pedersen can be reached at bill.pedersen@billpedersen.com.

This Dialogue is based on a considerably longer version of the same argument (including footnotes) that appeared at 53 ADMIN. L. REV. 1067 (2001), a publication of the American Bar Association Section of Administrative Law and Regulatory Practice and Washington College of Law, American University.

[32 ELR 10589]

Introduction

By almost universal consensus, our existing federal systems of environmental and public health regulation are inefficient, incoherent, and slow to adapt to changing times. Our regulatory statutes do not achieve their ends at the lowest economic cost. Indeed, their very structure often prohibits low-cost approaches. They often prescribe in great and binding detail the way an agency must approach a problem, whether or not that approach is the most effective. Such statutes tend to function as piles of unrelated commands, not tied together by any operationally effective common goal. Although we live in an era of rapid change, such statutes will be particularly unable to react to new knowledge and priorities, since that requires substituting new tools for old approaches that have not worked or that have not solved their problems.

This Dialogue argues that a new statute authorizing "regulatory reform contracts" could help cure these problems. That statute would authorize agencies to accept a limited number of offers from the regulated each year to comply with a set of regulatory obligations different from the existing legal requirements, as long as "equal social benefits" would result. The statute would specify the range of obligations that could be traded, e.g., "all pollution control requirements under statutes administered by the U.S. Environmental Protection Agency (EPA)," and, perhaps, set other conditions as well, e.g., forbidding trades that caused violations of air or water quality standards. Since most EPA statutes impose comprehensive planning burdens on states, states would qualify as regulated entities entitled to make contract offers. The statute would also subject all such contracts to public comment and limited judicial review. Any contract that met those conditions would be valid.

This Dialogue is organized as follows. First, it discusses the causes of the statutory defects just outlined, and why current reform suggestions cannot adequately address them. It then argues that "regulatory reform contracts" could address these causes and that the potential objections to their use are largely insubstantial. It concludes by outlining the reformed regulatory system that widespread reliance on reform contracts might produce.

The Causes of Our Regulatory Defects

Writers on regulation and "regulatory reform" have often identified cumbersome rulemaking procedures, agency passivity and reluctance to take political risks, and agency failure to enlist the cooperation of the regulated as causes of regulatory dysfunction. This Dialogue suggests an additional more important cause—namely, the failure of our regulatory statutes to distinguish between the ends a regulatory program seeks to achieve, and the means used to achieve it.

Cumbersome Procedures

To update existing programs, an agency must generally amend the governing regulations, even if no statutory amendment is required. To do that, the agency must issue a notice of proposed rulemaking, invite public comment on it, respond to those comments when it issues the final rule, and survive any resulting court challenge.

This process, originally conceived as a streamlined alternative to the use of trial-type hearings to make policy, has become more complex and resource-intensive in recent years, as new analytical requirements have been imposed to assure that major regulations are well planned and socially beneficial, and as requirements for public participation have increased.

Many believe that the rulemaking process has also become less certain, since judicial review that takes a severe "hard look" can unpredictably invalidate a rule after all the work of promulgating it has been done. This is especially true for long and detailed rules—which are also, of course, the most important.

These factors make rules difficult to set in the first place, and difficult to amend once established. Since amending an existing rule will generally be less politically and program-matically rewarding to the agency than issuing a new rule, cumbersome procedures disproportionately discourage such amendments.

Passive Agencies

Although regulatory agencies were originally conceived as disinterested and expert resolvers of social problems, today they are often viewed as simple brokers among the conflicting views of their various constituencies, not as advocates [32 ELR 10590] for a program of their own. Some analysts view this as the proper function of an agency; others simply observe—and there is much supporting evidence—that agencies are often far too weak politically to do anything more.

Such a passive agency will be uniquely unable to reform its existing programs. New programs come from new statutes, which by definition resolve political conflicts into a mandate that can give even a passive agency the power to act. But by the same definition, no similar resolution will exist for disputed issues arising under established statutes. Moreover, legislative change, which is always difficult, becomes even harder after a complex statute has been in operation for years and interests have crystallized around its details.

Lack of Cooperation From the Regulated

Competitive markets operate through the continuing reciprocal actions of sellers and buyers. They motivate sellers to produce a given good more cheaply and to discover different ways to meet the same underlying need. Contact lenses replace glasses and are challenged, in turn, by laser vision correction. Producers who offer dramatic price reductions or quality improvements can expect to displace their rivals in the existing market and to profit from an overall market expansion, as purchasers shift their outlays from other goods and services toward the new or cheaper product.

In a similar fashion, regulation depends for its beneficial results on the reciprocal actions of the regulators, who issue commands designed to achieve some social good, and the regulated, who must act to make those commands reality. However, because regulatory commands are so hard to change, regulatory agencies—the "purchasers" of the services they command to be produced—are far less able to adjust their conduct to the innovative actions of the regulated than most purchasers in private markets. Often they cannot abandon old approaches to a problem even if a new and better one is offered. Indeed, the response to a new suggestion may be to tighten regulatory requirements to reflect that new knowledge, thus validating the old saying: "No good deed goes unpunished." Such unresponsiveness in turn discourages the regulated from offering new ways to achieve social benefits.

Statutes Without Clear Goals

If we designed our regulatory statutes rationally, they would distinguish with precision between the ultimate ends that society had chosen to achieve, which could not be varied without generating a new social consensus, and the means to that end, which would be selected for their efficiency in achieving those ends, and readily changed for more effective means as knowledge advanced.

Our actual statutes are very different. Because it is so hard to vary the particular commands they authorize, they can hardly be said to possess goals at all, in the sense of guides to action and decision. In the absence of ends-means distinctions, every effort that the statute commands tends to become an end in itself. This allows any change in regulatory instruments to be depicted as a change in ends that cannot be legitimately made without generating a new social consensus.

And since different statutes emerge from different political constellations, the chances that some common ends will guide the means employed by two different statutes are even smaller than the chances of such guidance within a single statute.

In the absence of clearly defined ends, and rankings between ends, it also becomes very difficult to trade a slight reduction in realizing one end for a dramatic improvement in realizing another, since there is no established foundation for comparing the two ends.

Such goal-free statutes make all the problems described so far worse. The U.S. Congress is unlikely to hit upon the most efficient means of achieving an end when it enacts a statute. Moreover, the means that are selected will get less efficient and less serviceable over time, as knowledge advances and priorities change. Yet the absence of goals will make it hard even to evaluate improvements—since there will be no yardstick for measuring their worth—and even harder to adopt them.

Goal-free statutes make the regulatory system more cumbersome, since every decision they require tends to be governed ad hoc by statutory complexities. They make agencies more passive, since a statute without goals gives its implementing agency no principled way to resist political pressure. Finally, such statutes diminish any incentive that the regulated might have to suggest changes in the regulatory approach, since they make regulatory change so difficult.

Why Current Reform Suggestions Will Not Fix These Problems

Most current reform suggestions hardly address our lack of statutory clarity about ends and means, or the ways that lack of clarity intensifies the regulatory system's inefficiency, hostility to change, cumbersome procedures, passivity, and failure to enlist the cooperation of the regulated.

Economic Analysis

Every president since 1974 has required economic analysis and centralized review of all new major rules. President George W. Bush has revitalized the implementing of that requirement, and similar suggestions are regularly put forward in draft "regulatory reform" legislation.

Yet at any given time, and particularly in these anti-regulatory times, existing regulations will vastly outnumber new regulations being developed. To correct our regulatory system's defects those existing regulations must be amended.

Analysis and review of proposed new rules will, if anything, discourage revision of existing rules, both by making that revision more expensive for the agency, and by the incentives it creates for the regulated. Cost-benefit analysis of a new regulation will inevitably focus on whether that regulation itself would be socially desirable. That in turn tends to limit the participation of the regulated to questioning (or, rarely, supporting) the merits of that new rule viewed in isolation. But the social desirability of that regulation might depend on the ability to combine its issuance with the repeal or modification of older requirements that had become less necessary because the new regulation would achieve their ends more effectively. For example, a new regional program of "acid rain" control might well reduce or eliminate the need for case-by-case regulation of individual emitting sources. Allowing such "trading off" between old and new obligations would encourage the participation of the regulated [32 ELR 10591] in the process of regulatory reform, and would clarify ends and means by encouraging focused debate on particular trade offs. Yet new and old rules are almost never "packaged" in this manner at present.

Seeking Consensus

Reformers also recommend greater reliance on "consensus-based" approaches to developing rules. Such approaches, too, will be largely restricted to new regulations. Experience with "regulatory negotiations" shows that consensus will be far easier to achieve when addressing a new regulation where the requirements are as yet undefined than for an existing regulation with specific terms.

Market-Based Regulation

Finally, reformers recommend greater reliance on "market-based" approaches to controlling social cost under which activities that cause such costs would be assessed a fee, or would be required to obtain an "allowance," for each unit of social cost they caused.

However, market-based approaches are only suited to certain regulatory problems. Calls for their wider use beg the question of how society should determine which problems are suited to such approaches and which are not. Moreover, even where market-based approaches do fit a problem, they differ dramatically from our current statutes in requiring a clear separation between the statutory ends—namely, the conduct that is limited—and the market-based means that are used to limit it. Proponents of market-based approaches rarely explain how to move from our current approach, in which ends and means are blurred together, to new approaches that distinguish precisely between them.

How Regulatory Reform Contracts Would Help to Correct These Problems

A "regulatory reform contract" approach would adapt for regulatory use the mechanism of reciprocal adjustment that makes competitive markets such a dynamic form of social organization. Their use would enlist the cooperation of the regulated in designing improved regulations, make agency decisionmaking less cumbersome, make agencies less passive, and eventually make regulations more efficient and clarify the distinction between statutory ends and statutory means.

Regulatory Reform Contracts and the Cooperation of the Regulated

A "regulatory reform contract" approach would convert one of the main sources of resistance to change—namely, the regulated states, local governments, or private entities themselves—into advocates for reform. By offering such case-by-case relief, the contract program would "select out" as offerors the members of the regulated community with the most to gain from such disclosure, and would give them an incentive to "break ranks" by disclosing new and more effective ways to achieve social cost reductions, just as low prices are encouraged by competitive bidding for contracts. In addition, the mechanism of offer and approval would enlist the expertise of the regulated themselves, not the resources of overtaxed agencies, to develop the proposal details. Any dangers stemming from that approach could be mitigated by a rule—borrowed from standard contract law—that in cases of contract ambiguity, the ambiguity would be resolved against the interest of the regulated offeror.

In this manner, the reform contract approach would turn the very incoherence and inefficiency of the regulatory system into a force for change, by granting relief from it to those who make the best suggestions for new approaches.

Reducing Procedural Delay

In negotiating offers for regulatory reform into contracts, the offeror would be unable to use the existing system's legal and political mechanisms for resisting change. Regulation, by contrast, all too often gives the advantage to the most recalcitrant.

Making Passive Agencies Active

Each regulatory reform contract would allow a specific agency judgment to override more generic regulatory and even statutory requirements. Public acceptance of such decisions would require agencies with the ability and political mandate to judge the worth of offers for redefined ends and new means, to negotiate full contracts arising out of those offers, and to defend the wisdom of their choices in the public arena.

The regulatory reform contract approach would therefore force agencies to articulate more directly than at present the ends they believed they should pursue and the most desirable means of pursuing them. Otherwise, the agency would have no basis for approving one experiment rather than another, or for justifying its choice. Moreover, the contract approach would allow the agency to build this capacity gradually, by starting with easy cases and moving on to more difficult issues.

A successful series of reform contract negotiations could therefore help to create "activist" agencies conforming to a new model of activism. These agencies would not be "New Deal" organizations that themselves decided on the generic "public interest" and pursued it, but organizations that were better judges of the acceptability of different experiments in changing social ends and means, and better advocates in the larger political system for reforms based on those experiments, than the agencies we now possess. Such organizations would not function in isolation from the political system, which may have been the "New Deal" philosophy, but rather as its integral parts.

Regulatory Reform Contracts and the Clarification of Statutory Ends and Means

Every offer for a regulatory reform contract would suggest greater performance in some regulatory direction in return for lesser performance in another. A contract offer that simply suggests more efficient means to achieve a given end will be easier to accept than an offer that suggests a change in ends. Accordingly, agencies faced with contract offers will need to decide whether a given statutory obligation—for example, the requirement for industrial dischargers into water to drastically reduce their pollution levels—is [32 ELR 10592] an end in itself, or simply a means to the end of clean water. If it is simply a means to an end, then an offer to reduce control levels for industrial dischargers in return for greater reductions from other dischargers (such as farms) will be far easier to accept than if control of industrial pollution is an end in itself.

If some change in ends is required to accept a regulatory reform contract offer, then evaluating the offer will require the agency to decide whether the ends involved are comparable, and, if so, whether the trade off is worth it. In some cases, trading among ends may be unacceptable. Few would argue that a company should be allowed to make drug A less safe if in return it made drug B a lot safer. But in other cases, it may be possible to compare different ends in terms of some larger, reconciling set of values, and therefore to evaluate and accept "regulatory reform contract" offers to trade among them. For example, a proposal to reduce pollution control levels along a river in return for greatly increased wetland protection might be unacceptable if pollution control were viewed as a freestanding end in itself, but acceptable if it were viewed as one approach to protecting the ecological health of the river.

Every offer for a regulatory reform contract will therefore present an invitation to rethink the relationship between regulatory ends and means in our current statutes, and to state those ends more broadly. Indeed, since those who make offers for regulatory reform contracts will want to see those offers accepted, they will have a natural motive to select out those cases where our current systems confusion causes the greatest inefficiency, and make offers that are attractive because they show how much more effective that system would be if the confusion were removed. As the ends of our environmental protection effort are described more broadly, it will become progressively easier to vary the means of attaining them in a manner that reflects new knowledge and promotes economic efficiency.

Safeguards Against Abuse of the Contract Approach

The regulatory reform contract approach would give the regulated a special right to make offers for changing the regulatory system, and give the government a special right to accept those offers. Wouldn't such an approach give too much power to the regulated, and result in "sweetheart" contracts that damaged the public interest?

There are five reasons why it would not.

First, the existing regulatory system would serve as the "baseline," in that only trades that were found to increase its social benefits could be approved. As noted earlier, that system is confused and incoherent, and offers wide scope for improvement. The specific purpose of a contract approach would be to select out those cases where the potential improvements would be most dramatic. Given this background, there seems no reason to assume that offerors will suggest, still less that regulators after public comment will approve, more trades that decrease environmental benefits than trades that increase them. Such a position rests on the unlikely assumption that the decision rules of a reform contract program, and the procedures that enforce them, would be so grossly less effective than the procedures that generated our current system that the potential for improving that system would not just go unrealized, but would actually be reversed.

Second, all contracts would take place within a statutorily defined "trading range" that specified which obligations could be traded. That would prevent the trading of obligations that the legislature found incommensurable—for example, the trade between the safety of different drugs described earlier.

Third, regulatory reform contracts would be experiments. In an experimental context the chances of success will disproportionately outweigh the risks of failure, since successes can be applied more broadly while failures can be abandoned (and may be instructive in themselves).

Fourth, all regulatory reform contracts would require public notice and comment before approval. That would provide the public with exactly the same degree of procedural protection it enjoys for most regulatory decisions—including many decisions like drug approvals, pesticide registrations, or the grant of individual permits that resemble regulatory reform contracts in imposing individual, ad hoc controls (which are often negotiated) on a single regulated party.

Finally, establishing elaborate substantive and procedural conditions on regulatory reform contracts to reduce their alleged dangers would directly and predictably reduce their benefits. It would discourage contract offers by increasing the costs and uncertainties of negotiating final contracts. Moreover, by reducing agency freedom of action, it would reduce the ability of a reform contract approach to generate less passive agencies, or to support the freedom of choice and public debate that might clarify the distinction between regulatory ends and regulatory means.

The New Type of Regulatory System That Regulatory Reform Contracts Might Generate

Successful regulatory reform contracts could be expected to reveal many new technical and management approaches to solving regulatory problems. Once these approaches had succeeded as experiments, they could be incorporated into the permanent regulatory program.

In addition, three more fundamental reforms would be promoted by the clearer definition of ends, and the clearer distinction between ends and means, to which regulatory reform contracts would contribute. These are (1) increased use of "market-based" approaches to pollution control, (2) increased "devolution" of the responsibility for programs to states and private groups, and (3) increased use of contracts as a "base load" regulatory mechanism, not just as a vehicle for experiments.

Increased Use of Market-Based Approaches

As noted earlier, effective market-based approaches require a rigorous distinction between their ends, which is a reduction in the activity that is limited (for example, sulfur dioxide (SO₂) emissions) and the means used to achieve it (for example, a requirement for every SO₂ emission to be covered by an allowance).

Often, this distinction between ends and means will not be clear from the physical facts, but will incorporate elements of social judgment. The "acid rain" control program under Title IV of the Clean Air Act in effect assumes that every reduction of one ton of SO₂ anywhere in the continental United States is as good as one ton anywhere else, even [32 ELR 10593] though this is clearly not completely true, since the effects of emissions will vary locally. Instead, this assumption is a social judgment—a trade off—that was necessary to achieve the benefits of a broad-based, simple, trading system.

The blurring of ends and means in our current system may make it hard to even see the possibility of trading based on a rigorous separation between them. Once the possibilities are recognized, the need for social judgment to define ends and means may make that definition controversial.

Many reform contract proposals would suggest new trading approaches, which means they would suggest new distinctions between regulatory ends and regulatory means. Where the distinction involved an element of social judgment, the implementing of such contracts would allow society to determine—by experiment—whether that distinction had benefits or detriments that could not have been determined in advance, and, in general, whether it was acceptable to the public. In these ways, regulatory reform contracts could pave the way for broader adoption of market-based approaches.

Devolution to States and Private Persons

The essence of the contract approach is to allow variation in the means of achieving ends as long as the ends themselves are achieved. That separation between ends and means will require new efforts to determine whether the ends have actually been attained, since ability to attain the ends now becomes the only proper way to determine the effectiveness of means. Accordingly, regulatory reform contracts would encourage improved performance monitoring. That increased ability to monitor performance could allow devolution of the performance obligation to states or private entities, since their success or failure could now be measured accurately. A "devolved" regulatory system could be far less intrusively detailed, and depend far less on central government processing of information, than our present system, while being no less effective in achieving its goals, and no less "transparent" to the public.

The regulatory reform contract approach would also encourage less detailed federal prescriptions by diminishing the sense of agency "ownership" of the details of the regulatory system that our current system naturally encourages, and thus further increase agency willingness to allow others to use alternative means as long as they could perform at least equally well in achieving the prescribed end.

Use of Contracts as a Permanent Regulatory Tool

Experience with contracts in the regulatory reform setting could lead naturally to their use in the permanent regulatory system as alternative methods of giving effect to regulatory commands. No new legal issues would be raised by such a step, since any concerns about "undue delegation" of power to the contracting agency could be resolved as they are where regulations are concerned, by setting legislative boundaries to agency freedom of action. The more immediate issues of how to measure and enforce performance by the private contractor are ideally suited to resolution by a reform contract approach.

Conclusion

With remarkable unanimity, regulatory reform advocates call for less reliance on detailed, formalistic agency commands issued to the regulated, and more reliance on market-based approaches. Yet, an almost equally uniform failure to suggest procedural mechanisms that might actually accomplish such reform has accompanied this unanimity on substance. It seems clear that to achieve a less formalistic and agency-centered regulatory system, the procedures for moving toward it must also be less formalistic and agency-centered—in short, procedures such as "regulatory reform contracts." Indeed, such contracts reflect in procedure precisely the decentralized and flexible approaches that are so often endorsed by academic and think-tank commenters where regulatory substance is concerned.