Abstract

This essay briefly introduces FEMA’s hazard mitigation assistance programs, cost-effectiveness, benefit-cost analysis, and discount rates. The essay discusses consequences of the unjustifiably high 7% discount rate that FEMA applies in its evaluation of the cost-effectiveness of proposed hazard mitigation projects, raising particular concern about the misleading inconsistency with which FEMA reports the benefits of hazard mitigation, calculated using a 2.2% discount rate, compared to the high 7% discount rate that FEMA applies in its standard benefit-cost analysis for proposed mitigation projects. The high discount rate undermines FEMA’s efforts to promote resilience to natural hazards, particularly in light of the increasing frequency and intensity of natural hazards brought about by climate change. The essay further challenges FEMA’s assertion that its approach to establishing cost-effectiveness for proposed mitigation projects cannot be modified due to inflexible instructions included in the Office of Management and Budget Circular A-94. It concludes with recommendations to improve FEMA’s approach to demonstrating cost-effectiveness and to lower the discount rate included in its analyses.

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Suggested Citation

Luke Dodds. “Mitigation Saves? High Discount Rates Undermine FEMA’s Efforts to Promote National Resilience” Homeland Security Affairs 18, Article 2 (May 2022) www.hsaj.org/articles19529

Introduction

Discount rates– critical parameters of benefit-cost analysis (BCA) that translate future costs and benefits into present value– exercise undue influence over BCA results and have the potential to undermine the effectiveness and purpose of Federal appropriations for public investments. Discount rates are not neutral or objective parameters, but rather are subjective policy decisions that reflect competing social, economic, and political priorities.[1] Given their highly technical nature and potential for extraordinary influence over public investment decisions, establishment of discount rates should: 1) be subject to public involvement; 2) include a wide variety of expert input; and 3) offer clear and transparent reasoning that explains priorities and responds to competing viewpoints.

As a condition of consideration for mitigation grants, FEMA requires demonstration of positive net benefits through conducting BCA on proposed projects using its rigid “BCA toolkit.” This essay is primarily concerned with the high 7% discount rate applied in the BCA toolkit, which: 1) undermines the ability of wise mitigation investments to receive consideration for grant funding, including mitigation investments that support building climate resilience; 2) departs significantly from industry best practice; 3) is based on flawed and highly selective reasoning; 4) lacks an analytical or empirical basis; and 5) lacks a written record of decision-making.

This essay begins with brief introductions to: 1) FEMA’s hazard mitigation assistance programs, 2) cost-effectiveness and benefit-cost analysis, and 3) discount rates. It then discusses the consequences of and observations about the high 7% discount rate listed above. The essay concludes with general recommendations regarding BCA and specific recommendations related to discount rates. Beyond a primary concern with the undue influence of discount rates, a few additional key ideas are relevant throughout this discussion:

  1. Cost-effectiveness and benefit-cost analysis are distinct concepts;
  2. Despite a technocratic veneer, benefit-cost analysis is a highly customizable and subjective approach to informing decision-making;
  3. The origins and legal foundations of FEMA’s current interpretation and application of Office of Management and Budget Circular (OMB) A-94 warrant clarification; and
  4. Application of a high 7% discount rate in the benefit-cost analysis that FEMA requires as a condition to receive consideration for hazard mitigation grant funding is antithetical to FEMA Administrator Deanne Criswell’s and the Biden-Harris Administration’s policy position to promote climate resilience. The 7% discount rate also works against the Administration’s goals to advance support for underserved communities.

Hazard Mitigation Assistance

Since the 1979 creation of the Federal Emergency Management Agency (FEMA) through President Jimmy Carter’s Executive Order 12127, FEMA’s areas of responsibility across the emergency management timeline have expanded from supporting immediate disaster response to include supporting longer term community recovery, emergency preparedness, and hazard mitigation. Hazard mitigation involves taking measures to reduce the damage of future disasters, such as elevating structures to prevent flood damage; installing emergency generators at critical facilities like police stations and hospitals to prevent loss of service in the event of power outage; installing impact resistant windows to withstand hurricane force winds; and reinforcing structures to withstand earthquakes. Whether before or after a disaster, hazard mitigation measures are a good investment. But the period immediately following a disaster during which many structures may need to be repaired and rebuilt, presents a unique opportunity to build back stronger through incorporating hazard mitigation measures into repairs and reconstruction and reducing the chances of experiencing similar damage when the next disaster strikes.

As the costs of Federal disaster relief ballooned over the decades from the 1950s into the 1980s, Congress became increasingly interested in methods to reduce Federal expenditures in federally supported disaster response and recovery operations, and so moved to formalize and encourage increased Federal support for hazard mitigation.[2] The Disaster Relief and Emergency Assistance Amendments Act of 1988 (Public Law 100-707 – better known as the Stafford Act) established FEMA’s post-disaster Hazard Mitigation Grant Program (HMGP) under section 404.

Since the creation of the post-disaster hazard mitigation grant program, FEMA’s hazard mitigation authorities and programs have significantly expanded to now include mitigation grants focused on floods, wildfires, and “pre-disaster mitigation,” which awards mitigation grants to states through an annual nationwide competitive grant program. Following passage of the Disaster Recovery Reform Act of 2018, FEMA’s pre-disaster mitigation grant program was expanded, and renamed the Building Resilient Infrastructure and Communities (BRIC) program.

Over the last forty years, despite steadily increasing Federal support for hazard mitigation, average annual Federal disaster relief expenditures continue to climb. This is driven in part by human development in disaster prone areas, such as along hurricane-vulnerable coasts or in wildfire prone mountains; in part by poor mitigation planning in urban areas, through for example, increasing impermeable pavement without sufficient consideration of stormwater management; and in part through an increasingly unstable global climate, leading to more intense rain, floods, drought, wildfires, hurricanes, and other dangerous weather phenomena.

Cost Effectiveness

The first sentence of section 404 of the Stafford Act (42 USC 5170c), as amended, states:

[t]he President may contribute up to 75 percent of the cost of hazard mitigation measures which the President has determined are cost effective and which substantially reduce the risk of, or increase resilience to, future damage, hardship, loss, or suffering in any area affected by a major disaster…

Two points warrant highlighting. First, mitigation measures that FEMA funds through these grants are required to substantially reduce the risk of, or increase resilience to, damage and suffering caused by future disasters. There’s good evidence that they do, as explored in detail in the National Institute of Building Sciences Mitigation Saves studies,[3] among many other academic studies. The second point is more significant for this essay: these mitigation measures must also be “cost-effective.” Congress was concerned with increasing Federal disaster relief expenditures, and so the Stafford Act mandated that federally funded mitigation measures must be cost-effective, implying a requirement to demonstrate that the projects are worth what the government and taxpayers pay for them.

“Cost-effective” is a poorly defined legal term, the precise meaning of which varies across contexts. Plain language dictionary definitions include entries like “providing good value for the amount paid” and “returning benefits that justify the initial investment.” Without further criteria for evaluation, the phrase is inevitably subjective, hinging on judgments of what constitutes good value. The term “cost-effective” appears some 650 times in the United States Code, [4] almost all instances of which appear without further elaboration or definition, suggesting a general meaning along the lines of “not wasteful” or “choosing the lowest cost approach to achieve the objectives.”

The most straightforward statutory definition of “cost-effective” occurs at 50 USC 50501(4):

The term ‘cost effective’ means costing no more than the available alternatives, determined by a comparison of all related direct and indirect costs including, in the case of Government costs, applicable Government labor and overhead costs as well as contractor charges, and taking into account the ability of each alternative to accommodate mission requirements as well as the related factors of risk, reliability, schedule, and technical performance.

Another statutory definition at 16 USC 839a(4)(A) includes similar discussion of availability, reliability, and costing no more than similar alternatives. Definitions for “cost-effective lighting technology” and “cost-effective technologies and practices” appear at 42 USC 17061(5) and (6).

One statutory example does not define the term, but offers some basis for evaluation: 23 USC 119(d) explains that funds may be apportioned to a state for the purpose of improving a highway that is not in the National Highway System if, compared to improving a nearby highway that is in the National Highway System, the improvements will increase regional traffic flow and “the construction or improvements are more cost-effective, as determined by benefit-cost analysis, than an improvement to the [nearby National Highway System highway]” (emphasis added). Note, the explicit added instruction to determine cost-effectiveness through performing benefit-cost analysis—in this case the purpose of which is to evaluate lifecycle costs of the two competing approaches and choose the approach with the lowest cost for the amount of benefit provided.

In the medical field, cost-effectiveness is often applied to the costs of medical interventions expressed in the unit dollars per “Quality-Adjusted Life Year” ($/QALY). For each additional QALY a medical intervention is likely to provide, it may be considered high value if it costs under $50,000; intermediate value if it costs between $50,000 and $150,000; and low value if it costs more than $150,000.[5]

The Office of Management Budget (OMB), a White House-level office that exercises broad administrative functions over the Executive Branch of the U.S. Federal Government, publishes cost-effectiveness and benefit-cost analysis guidance for executive agencies. In 1992, OMB issued a revised Circular A-94 which offers a default definition of cost-effectiveness similar to the statutory examples above: “A program is cost-effective if, on the basis of life cycle cost analysis of competing alternatives, it is determined to have the lowest costs expressed in present value terms for a given amount of benefits.”[6] It is noteworthy that these examples of statutory and executive-level guidance define cost-effective as a comparison among possible alternatives, and not simply as an accounting of all costs and benefits, the sum of which must meet some minimum threshold.

As for determining the cost-effectiveness of FEMA’s hazard mitigation grants, Circular A-94 has taken on critical significance, though not for its discussion of cost-effectiveness. Confusingly, in establishing the cost-effectiveness of its mitigation grants, FEMA strictly follows Circular A-94’s “benefit-cost analysis” guidance, while overlooking its “cost-effectiveness analysis” guidance. This is significant in that while cost-effectiveness analysis involves a comparison of costs and outcomes among alternative approaches, as in the highway and $/QALY examples above, benefit-cost analysis need not include any comparison. FEMA’s approach to establishing cost-effectiveness includes no comparison of alternatives, but rather applies benefit-cost analysis as an accounting method to establish whether the sum of a project’s estimated costs and benefits are greater than zero, according to parameters set within its rigid benefit-cost analysis model.

A-94 establishes a default discount rate of 7% for benefit-cost analysis, but it also provides annually updated discount rates for cost-effectiveness analysis that are based on the “real Treasury borrowing rate on marketable securities of comparable maturity to the period of analysis.”[7] For calendar year 2021, the annually published real discount rates for cost-effectiveness are all negative, ranging from -1.8% for 3-year projects to -0.3%. for projects with a useful life of 30 years or greater.[8] At a -0.3% discount rate, the same fixed 30-year stream of benefits is more than two and a half times (253%) as valuable as it is if calculated with a 7% discount rate. In other words, a hazard mitigation project purported to provide $1 million in benefits over thirty years at a 7% discount rate, would provide $2.53 million in benefits at a -0.3% discount rate. The equations below demonstrate how this is calculated.

Benefit-Cost Analysis 

Benefit-cost analysis (BCA) (also known as cost-benefit analysis) and cost-effectiveness analysis are different but conceptually related methods of economic analysis that were gradually integrated into Federal Government decision-making beginning in the 1930s.[9] The methods initially supported government decisions related to investments in managing water resources but have since been widely adopted across the Federal Government. Regarding BCA, Circular A-94 describes a highly customizable approach to translating both monetary and non-monetary estimated project costs and benefits into dollar values, in order to incorporate disparate considerations into a unified accounting scheme. There is no strict formula or method for BCA, beyond incorporating costs and benefits into the analysis through “monetization,” i.e., translation into dollar values, so that they may be added up over the lifetime of the project and compared as “net present value.” Rather than providing a thorough and objective accounting capable of representing the value of an investment across all contexts, BCA results depend fundamentally on discretionary factors embedded in the model itself. Such factors include:

  • How and if non-monetary costs and benefits like environmental quality, health, injuries, lives, community, and quality of life are monetized and incorporated into the analysis;[10]
  • The scope of costs and benefits included in the analysis—an analysis might only consider immediate costs and benefits based on current conditions, or it could include estimated economic growth that may not occur without investing in the project;
  • Predictions of future conditions and project performance;
  • Estimated probabilities of future occurrences (such as disasters); and
  • How costs and benefits that accrue in the future are incorporated into the analysis; i.e., translated into present value through a discount rate.

Some discretionary factors, such as estimates of future conditions and performance, may be well-informed by expert technical evaluations; but other factors, such as how to value quality of life and community and how to treat benefits accruing over time, are inevitably subjective.

For a very simple example: consider a community that faces a 1% annual risk of flooding that would result in an estimated $100 million dollars in damages. A mitigation project might involve building stormwater retention ponds and drainage canals that eliminate the risk of flooding. Using benefit-cost analysis, such a project would be considered to provide $1 million dollars in annual benefits ($100 million x 0.01). Further assume this project costs $15 million to build, involves zero maintenance costs, and is expected to provide the same benefit for 50 years.[11] Without discounting (equivalent to a 0% discount rate), this simple project would provide $50 million dollars in benefits ($1 million/year x 50 years). With a 7% discount rate, the project is calculated to provide $13.8 million in benefits. The $13.8 million in benefits is less than the $15 million in estimated costs, so this project would be considered not cost-effective, and would not be considered for funding. At a 3% discount rate this project is calculated to provide $25.7 million in benefits, well over the $15 million in costs, and therefore, cost-effective. By doing nothing more than adjusting this critical parameter in the BCA model, a project can be judged as providing less value than it costs to build, or much greater value than it costs, and therefore a wise investment. This illustrates the fundamental problem with discount rates, and to a lesser degree with benefit-cost analysis. See Figure 1 for a graphical representation of the dramatic influence of discount rates.

BCA is not an exact science. It’s a decision-making support technique that derives rough estimates based on methods, policy decisions (e.g., the discount rate), incomplete information, and lots of assumptions. Even excellent benefit-cost analysis is heavily influenced by priorities embedded in the methodology, and therefore cannot be considered highly precise or yielding results of high accuracy, validity, or reliability. Furthermore, you can’t have benefit-cost analysis without a model, but the model itself is not benefit-cost analysis. The model can be as broad or as narrowly focused as the modeler wants it to be, and any results can be dialed up or down by adjusting critical parameters like the discount rate. This excellent passage captures these concerns:

As a result of these uncertainties, cost-benefit analysis can really only identify a few highly promising projects or rule out extremely poor projects. Most decisions fall into a grey area in which the cost-benefit analysis turns on discretionary technical choices. Hence, cost-benefit analysis can often serve most effectively as a method of triage. Thus, we reject the view that cost-benefit analysis provides the solution to the problems of weighing various policy options and their ramifications. On the other hand, environmental regulation does involve difficult tradeoffs, and economic analysis, including cost-benefit analysis, can help clarify those trade-offs… Cost-benefit analysis thus incorporates useful factors, but sometimes makes the mistake of seeking to turn guidelines and insights into definitive answers.[12]

FEMA is a clear case in point of this mistaken application of BCA. FEMA uses a rigid BCA model and an inappropriately high discount rate to find definitive answers about what is and is not worth investing in. Although an inflexible approach to establishing cost-effectiveness that relies on a package of prebuilt models may generate some efficiency in terms of standardizing application and review processes, it results in several negative consequences:

  • It discourages innovation. To the extent that a model is built around already monetized costs and benefits, it strongly favors projects that result in benefits for which a model already exists (such as for tornado safe rooms) or for which benefits are easy to monetize (e.g., reduction in property damage caused by flooding) over projects that result in more abstract benefits such as warning systems, risk reduction education and outreach, and other indirect or complex social, environmental, and economic benefits.
  • A policy position that rejects consideration of novel approaches a priori undermines development of new approaches to establishing cost-effectiveness. A less rigid approach may result in development and refinement of new models and tools that support analysis of an ever-growing range of mitigation projects.
  • An unwillingness to recognize benefit-cost analyses conducted by other Federal agencies or published in well-respected peer-reviewed academic journals, results in wasted effort and resources evaluating projects that could be immediately determined to be cost-effective based on existing reputable sources.

Discount Rates

Discount rates are key parameters in economic models that involve costs and benefits that accrue in the future. Future costs and future benefits are translated to present value using a discount rate that adjusts (almost always reduces) the real value of future costs and benefits, usually at a constant annual rate, to account for the observations that:

  1. People tend to place greater value on events that occur closer in time to now than on events that occur farther away in the future, and
  2. Investing in anything involves an opportunity cost, which means if we use money to invest in project A, then we can’t use that same money to invest in project B.

The discount rate determines the relative weight of current vis-à-vis future benefits and costs. Unfortunately for policymakers, however, academic experts disagree on the appropriate discount rate for evaluating whether a public investment is good for the nation. The debate has economic, political, and ethical components.[13]

To help visualize the discount rate’s effect, imagine a medieval city surrounded by a stone wall. The only way into the city is through a large set of double doors operated by a crank wheel inside the wall’s gatehouse. Turn the crank wheel to the left and the opening between the doors widens; turn it to the right and the opening narrows and ultimately closes. By varying the width of the opening between the double doors, the gatekeeper can control the size of the carts that are able to pass through the gate. The discount rate exercises a similar control over the budget, complexity, and useful life of projects that the government considers for funding. Increase the discount rate, and consideration narrows to smaller, simpler projects, with shorter useful lives or immediate one-time effects; lower the discount rate, and consideration widens to include larger, more complex projects with longer useful lives and that require more time to recoup the initial investment.

In the case of FEMA’s hazard mitigation grants, because a hazard’s probability of occurrence in any given year is an essential component of the benefit-cost analysis, a high discount rate also creates a major obstacle to investing in projects that address relatively infrequent disasters with potentially devastating impacts, like major earthquakes. This is because multiplying a very small probability of occurrence against the total estimated damages of a major earthquake has the effect of slicing catastrophic loss into much smaller “estimated annual losses” which are made even smaller with discounting. By deeply discounting the future and converting catastrophic loss into a manageable and rapidly declining estimated annual loss, high discount rates are fundamentally antithetical to a policy of proactively preparing for unlikely but catastrophic disasters and gradually unfolding disasters such as climate change.

In general, high discount rates prioritize low-cost straightforward projects that are relatively short-lived (~10 years) or that result in immediate benefits, such as emergency generators and relocation of flood prone structures, over high-cost more complex projects that have long useful lives and that provide incremental benefits over a long time horizon (~20 or more years), such as stormwater management systems and sea walls. High discount rates prioritize rapid return on investment over long-term and large-scale planning because the reduction in value of future benefits is cumulative year after year. The annual benefits provided by projects with large upfront costs, which must be recouped over a long useful life, diminish more rapidly under higher discount rates. The lower the discount rate, the greater the perceived value of the future benefits provided by the project; the higher the discount rate the greater the imperative to rapidly recoup any upfront costs. Higher discount rates have the effect of driving down maximum allowable project budgets and narrowing areas of investment to only those that provide quick returns that exceed the value of the initial investment as rapidly as possible, generally within about a decade.

Figure 1 shows the dramatic spread of the notional present value of a $1 million stream of benefits provided by a hypothetical 50-year project, depending on the discount rate. The graphic includes a few examples of discount rates between -0.3% and 10%, though discount rates can be set at any value, below, above, or in between.

Figure 1: $1 million dollar stream of benefits for 50 years. Net present value by discount rate.

Figure 2 shows how the discount rate changes the perceived present value of $1 million dollars accrued in future years. Observe that with a 0% discount rate, the present value does not change at all, and the value drops much more rapidly for a 7% rate than for a 3% rate.

Figure 2: $1 million stream of benefits for 50 years. Year (x) value by discount rate.

An indirect consequence of high discount rates is to prioritize projects that result in benefits that are easy to monetize, such as reducing property damage from flooding, over projects that result in more abstract benefits, such as warning systems, risk reduction education and outreach, and community resilience. The Principles and Requirements for Federal Investments in Water Resources provides a good description of this phenomenon:

…economic performance assessments… largely focus on maximizing net economic development gains and typically involve an unduly narrow benefit-cost comparison of the monetized effects. Non-monetized and unquantified effects are often included in the overall analysis process, but are not necessarily weighted as heavily or considered key drivers in the final decision making process. As a result, decision making processes are, at this point in time, unnecessarily biased towards those economic effects that are generally more easily quantified and monetized. A narrow focus on monetized or monetizable effects is no longer reflective of our national needs… [A] more integrated approach will allow decision makers to view a full range of effects of alternative actions and lead to more socially beneficial investments.[14]

Other indirect consequences of a high discount rate relate to how FEMA treats BCA as a minimum threshold analysis (i.e., counted benefits must be equal to or greater than estimated costs) rather than as a decision support process or as an accounting exercise to compare alternatives. FEMA expresses BCA results as a “benefit-cost ratio” or BCR, in which a project’s total net present value of benefits is divided by its total net present value of costs. A BCR of 1 or greater indicates that a project’s benefits are equal to or greater than its costs, and therefore cost-effective. Because discount rates diminish the value of a project’s future benefits, the higher the discount rate, the more difficult it is for a BCA to result in a BCR of 1 or greater. So higher discount rates make “passing” BCA (i.e., showing a BCR of 1 or greater) more difficult, forcing applicants to devote more resources to conducting BCA and raising the administrative costs of preparing mitigation grant applications. Conducting BCA is technically demanding, and most applicants hire private contractors to do it. The higher the discount rate, the more effort and expense necessary to demonstrate cost-effectiveness and the more unlikely it is for projects to pass.[15] In this way, a high discount rate indirectly discourages rural and lower-income communities from applying for FEMA’s mitigation grants.

With a lower discount rate, the value of all future benefits increases, making it easier to pass BCA and widening the range of projects for which FEMA could consider awarding grants, including larger, longer-lived, and more capital-intensive projects. A lower discount rate would also promote the applicant’s priorities about which hazard mitigation projects to invest in, lower the barrier to entry for consideration, and increase the opportunity for rural and lower-income communities to demonstrate cost-effectiveness for proposed projects.

State and local partners are the best judges of the most significant hazards they face, but FEMA’s high discount rate and its rigid BCA model force them to focus narrowly on smaller scale projects that are most likely to pass the BCA. Lowering the discount rate would likely have cascading effects that support a more appropriate realignment of local, state, and Federal roles in supporting building a more resilient nation. Lowering the discount rate would reduce the administrative burden of BCA, promote innovation, and widen the range of alternatives that state and local applicants could consider. This may also allow state and local partners to independently invest more in smaller scale mitigation projects, and work with FEMA on more ambitious, more innovative, and larger scale projects. Lowering the discount rate supports all three of FEMA’s strategic goals: promoting a culture of preparedness, readying the nation for catastrophic disasters, and reducing the complexity of FEMA’s programs.[16]

Table 1: Summary of consequences of applying lower and higher discount rates in benefit-cost analysis.

 Lower Discount RateHigher Discount Rate
Time HorizonShifts priority toward longer time horizon; perceives greater value in reducing risk further in the future; supports efforts to promote resilience to natural hazards and climate changePrioritizes now and the nearer term; perceives less value in reducing risk across long time horizon; undermines efforts to promote resilience to natural hazards and climate change
Hazard
Frequency
Offers greater flexibility in choosing whether to mitigate risk of frequently occurring disasters, or lower frequency but potentially higher impact disastersShifts investment toward mitigating risk of most frequently occurring disasters, while reducing mitigation investment in lower frequency but potentially higher impact disasters and disasters projected to occur more frequently
Scope /
Innovation
Offers greater flexibility for innovation in project scope and design, which could lead to discovery of new approaches to mitigationStringent acceptance criteria discourage innovation and promote “cookie cutter” (or “tried and true”) project design
Innovation RiskIncreases opportunities to fund unconventional projects that may turn out to be bad ideas, but may also turn out to be positive innovations for mitigationReduces risk of funding unconventional projects that may perform poorly, but also excludes possibility of funding positive innovations for mitigation
Project scale /
Comprehen-siveness
Allows applicants greater freedom to formulate more comprehensive mitigation investment strategies and invest in larger projects that reduce risk across longer time horizonsPromotes “checkerboarding” of projects: Using grants to pay for many small projects, where the priority is meeting stringent acceptance criteria, rather than formulating comprehensive mitigation investment strategies
Burden for
Applicants
Reduces administrative burden for applicants, as value of future avoided damages increases, and it is therefore easier to demonstrate positive net benefitsIncreases administrative burden for applicants, as value of future avoided damages is reduced, and it is therefore more difficult to demonstrate positive net benefits
Burden of
Reviewing
Applications
Widens pool of acceptable applications, possibly increasing administrative burden of reviewing applicationsWinnows pool of acceptable applications, possibly reducing administrative burden of reviewing applications

Mitigation Saves?

On June 29, 2021 FEMA Administrator Deanne Criswell testified before Congress:

We must face the challenges that climate change poses to [FEMA’s] mission head-on and make generational-level investments to reduce the impacts. Developing resilient communities ahead of an incident reduces both the loss of life and economic disruption: Every dollar invested in mitigation saves the American taxpayer six dollars in future spending.[17]

Also, in testimony before Congress, Former FEMA Administrators Bob Fenton, Pete Gaynor, Brock Long, and Craig Fugate have all made nearly identical claims that $1 dollar invested in mitigation will save $6 in future spending.[18] Not only do FEMA Administrators recognize the value of hazard mitigation, but Congress has also made similar statements in laws that it has passed. The “Findings” section of the Hazard Mitigation Act of 2010, reports that:

(1) The predisaster hazard mitigation program has been successful and cost-effective. Funding from the predisaster hazard mitigation program has successfully reduced loss of life, personal injuries, damage to and destruction of property, and disruption of communities from disasters.

(2) The predisaster hazard mitigation program has saved Federal taxpayers from spending significant sums on disaster recovery and relief that would have been otherwise incurred had communities not successfully applied mitigation techniques.

(3) A 2007 Congressional Budget Office report found that the predisaster hazard mitigation program reduced losses by roughly $3 (measured in 2007 dollars) for each dollar invested in mitigation efforts funded under the predisaster hazard mitigation program. Moreover, the Congressional Budget Office found that projects funded under the predisaster hazard mitigation program could lower the need for post-disaster assistance from the Federal Government so that the predisaster hazard mitigation investment by the Federal Government would actually save taxpayer funds.

(4) A 2005 report by the Multihazard Mitigation Council showed substantial benefits and cost savings from the hazard mitigation programs of the Federal Emergency Management Agency generally. Looking at a range of hazard mitigation programs of the Federal Emergency Management Agency, the study found that, on average, $1 invested by the Federal Emergency Management Agency in hazard mitigation provided the Nation with roughly $4 in benefits. Moreover, the report projected that the mitigation grants awarded between 1993 and 2003 would save more than 220 lives and prevent nearly 4,700 injuries over approximately 50 years.

(5) Given the substantial savings generated from the predisaster hazard mitigation program in the years following the provision of assistance under the program, increasing funds appropriated for the program would be a wise investment (emphasis added).[19]

It is encouraging that the Congress and FEMA’s administrators, past and present, recognize the value and wisdom of investing in hazard mitigation. It is confusing, and somewhat misleading, that all these acknowledgments are based on studies that apply much lower discount rates. The Hazard Mitigation Act of 2010 refers to the widely quoted 2005 Mitigation Saves study published by the National Institute of Building Sciences. That study found that on average every $1 invested in mitigation measures results in $4 dollars in cost savings due to reducing damages caused by future disasters. And it used a 2% discount rate.[20] The 2007 Congressional Budget Office report, also referenced in the statute, uses a 2.5% discount rate.[21] The most recent five FEMA administrators all quote a 2019 update to the 2005 Mitigation Saves report, which uses a 2.2% discount rate, “consistent with principles of engineering economics.”[22]

Had the 2019 Mitigation Saves report applied a 7% discount rate, the claim of $6 of benefit for every $1 dollar invested would fall to $3.70—over a third lower.[23] It is critically important not to confuse or gloss over the significance of this observation. The specific dollar value of the average benefit is far less significant than acknowledging that these routinely quoted ratios are fundamentally arbitrary, and that dialing up or down this obscure parameter—the discount rate—has enormous influence on the bottom line of any benefit-cost analysis. When defending the wisdom of investing in hazard mitigation, proponents refer to analyses that incorporate discount rates more in line with “principles of engineering economics” and with standard practice for considering long-term investments. But when evaluating the benefits of any specific project, FEMA applies a much higher discount rate which undermines taking a long-term perspective and undermines appropriately accounting for low probability, high consequence incidents.

Does Circular A-94 Prescribe a 7% Discount Rate?

In 2019 FEMA’s National Advisory Council (a body of non-Federal emergency management experts authorized by the Post-Katrina Emergency Management Reform Act of 2006 to advise the FEMA administrator on all aspects of emergency management) recommended that FEMA apply a lower discount rate in its approach to BCA and specifically suggested use of the annually updated rates published in OMB Circular A-94 Appendix C.[24]

FEMA Administrator Pete Gaynor responded to this recommendation as follows:

FEMA does not have the authority to implement this recommendation. The annually updated discount rates do not apply to regulatory analysis or benefit-cost analysis of public investment (see https://www.whitehouse.gov/wp-content/uploads/2019/12/M-20-07.pdf). As noted in the cover letter to Appendix C and OMB Circular A-94, they apply only to lease-purchase and cost-effectiveness analysis and do not apply to regulatory analysis or benefit-cost analysis of public investment.[25]

This response reflects a widely believed narrative that has emerged over the last decade or so within FEMA and the national hazard mitigation community. To offer a rebuttal to this response, it is worth referring to benefit-cost analysis training slides that FEMA offers on its website.

Figure 3: FEMA training slides from: “Benefit-Cost Analysis Training Materials – Basic Concepts in Benefit-Cost Analysis (BCA) Unit 2 – Visual.” Slides for E/L 0276: Introduction to Benefit-Cost Analysis, Federal Emergency Management Agency, Department of Homeland Security, Washington, DC, 2019. https://www.fema.gov/grants/guidance-tools/benefit-cost-analysis/training.

Responding to slide 5: The Stafford Act tells us that hazard mitigation measures must be cost-effective, but it does not mention benefit-cost analysis. Unlike the statutory text at 23 USC 119(d) quoted above, it does not define how to determine cost-effectiveness. FEMA’s regulations also do not refer to benefit-cost analysis. The regulations neither prescribe a specific approach to determining cost-effectiveness nor do they prescribe a discount rate. Slide 7 quotes statutory language that mandates FEMA hazard mitigation projects be cost-effective. The law says nothing about benefit cost-analysis.

OMB Circular A-94 addresses both benefit-cost analysis and cost-effectiveness analysis and provides different instructions and discount rates for each. A plain language read of A-94 could suggest that cost-effectiveness analysis is more applicable to FEMA’s hazard mitigation grants.[26] A-94 explains, “cost effectiveness analysis is a less comprehensive technique, but it can be appropriate when the benefits from competing alternatives are the same or where a policy decision has been made that the benefits must be provided,” and “analysis of alternative defense systems often falls in this category.”[27] So the language of FEMA’s statutory authorities for mitigation assistance and the language of OMB Circular A-94 indicate that cost-effectiveness analysis and associated discount rates are more appropriate for evaluation of hazard mitigation projects. Confusingly, and without any explanation, FEMA applies the 7% discount rate that Circular A-94 prescribes for benefit-cost analysis, even though the same circular offers annually updated discount rates for cost-effectiveness analysis which would require no additional legal parsing or interpretation to find applicable to FEMA’s hazard mitigation programs.

To summarize the above two paragraphs:

  • Circular A-94 provides guidance and discount rates for BOTH cost-effectiveness analysis AND benefit-cost analysis.
  • The statutes and regulations governing FEMA’s hazard mitigation programs mandate that mitigation actions must be cost-effective, but do not mention benefit-cost analysis.
  • Hazard mitigation projects align more closely with Circular A-94 conditions associated with cost-effectiveness analysis—NOT benefit-cost analysis.
  • FEMA insists on using the 7% discount rate for evaluating hazard mitigation projects, which Circular A-94 states is appropriate for benefit-cost analysis—NOT cost-effectiveness analysis.
Figure 4: FEMA training slides from: “Benefit-Cost Analysis Training Materials – Basic Concepts in Benefit-Cost Analysis (BCA) Unit 2 – Visual.” https://www.fema.gov/grants/guidance-tools/benefit-cost-analysis/training.

Slides 9 and 10 provide regulatory text for two of FEMA’s hazard mitigation assistance programs: Flood Mitigation Assistance (FMA), which specifically targets flood-prone structures covered by the National Flood Insurance Program, and the Hazard Mitigation Grant Program (HMGP), which provides post-disaster hazard mitigation assistance. These two regulatory clauses are the most authoritative prescription for an approach to establish the cost-effectiveness of hazard mitigation grant projects. They require comparison of costs and benefits, and in the case of flood mitigation assistance, computation on a net present value basis (the slide for 44 CFR Part 206, Subpart N erroneously includes “Both costs and benefits will be computed on a net present value basis”). Neither passage prescribes a discount rate, and neither passage is incompatible with OMB Circular A-94 guidance for cost-effectiveness analysis. It is also noteworthy that FEMA’s pre-disaster mitigation grant program, the Building Resilient Infrastructure and Communities program, has no such regulations.

Figure 5: FEMA training slides from: “Benefit-Cost Analysis Training Materials – Basic Concepts in Benefit-Cost Analysis (BCA) Unit 2 – Visual.” https://www.fema.gov/grants/guidance-tools/benefit-cost-analysis/training.

Slide 14, on the left, quotes the 2019 Multi-Hazard Mitigation Council Mitigation Saves report, which, as discussed earlier, applies a 2.2% discount rate—notable that even FEMA’s training materials that mandate a BCA process with an unjustifiably high discount rate quote the results of an analysis that applies a much lower and more appropriate discount rate.

Slide 11, on the right, introduces OMB Circular A-94, the linchpin of the claim that FEMA has no authority to implement a lower discount rate. An earlier slide in unit 1 of the training claims: “Federally-funded mitigation projects must use a discount rate of 7%, which is set by the U.S. Office of Management and Budget.”[28] Remarkably, these slides contain no reference to the fact that Circular A-94 also includes guidance on cost-effectiveness analysis and annually updated discount rates that a plain language read could easily find more applicable to evaluation of hazard mitigation assistance grants.

Circular A-94 also includes several other specific instructions related to benefit-cost analysis that FEMA does not include in its approach to evaluating the cost-effectiveness of hazard mitigation projects. A few examples include:

  • Providing a comprehensive enumeration of different types of benefits and costs, monetized or not, to support identifying the full range of program effects;
  • Discussion of a policy rationale for examination of the Government program that is under analysis, which could include program justification on efficiency grounds where the program addresses a market failure, or where the program provides cost-savings to the Government;
  • Analysis of alternatives in achieving a program’s objectives, including analysis of doing nothing; and
  • Identification of both intangible and tangible benefits. Circular A-94 explains, “costs should reflect the opportunity cost of any resources used, measured by the return to those resources in their most productive application elsewhere.”[29]

Within the text of A-94 there are many noteworthy passages that raise additional questions and offer support for using cost-effectiveness analysis or applying lower discount rates, though a comprehensive analysis of Circular A-94 is beyond the scope of this essay. One passage, however, warrants particular consideration:

In general, public investments and regulations displace both private investment and consumption. To account for this displacement and to promote efficient investment and regulatory policies, the following guidance should be observed.

  • Base-Case Analysis. Constant-dollar benefit-cost analyses of proposed investments and regulations should report net present value and other outcomes determined using a real discount rate of 7 percent. This rate approximates the marginal pretax rate of return on an average investment in the private sector in recent years.[30]

Within Circular A-94, a 7% discount rate is asserted on grounds that it promotes efficient investment and helps account for displacement of private investment and consumption. Because the alternative to publicly funded mitigation is usually to do nothing, rather than displace private investment and consumption, hazard mitigation projects promote more private investment and consumption. More resilient communities that are at lower risk of being destroyed by natural hazards are safer places to build, invest, and consume. Furthermore, most of the public money spent on mitigation projects directly supports private industry and small businesses which contribute to the planning, construction, and contracting involved with implementing mitigation projects. Mitigation grants provide a public good by addressing a market failure to provide resilient communities and are justified on efficiency grounds. Because mitigation grants do not displace private investment and consumption, according to OMB guidance, the 7% discount rate does not apply to the market environment within which hazard mitigation assistance occurs.

In 2003, OMB published Circular A-4, which, despite a primary focus on regulatory analysis, directly refers to A-94 and includes additional guidance and discussion relevant to benefit-cost analysis, cost-effectiveness analysis, and discount rates. A-4 refers to two separate discount rates that should be applied in benefit-cost analysis: 7% and 3%. The following passages explain the rationale for each.

Rationale for 7% discount rate:

As a default position, OMB Circular A-94 states that a real discount rate of 7 percent should be used as a base-case for regulatory analysis. The 7 percent rate is an estimate of the average before-tax rate of return to private capital in the U.S. economy. It is a broad measure that reflects the returns to real estate and small business capital as well as corporate capital. It approximates the opportunity cost of capital, and it is the appropriate discount rate whenever the main effect of a regulation is to displace or alter the use of capital in the private sector.[31]

Rationale for 3% discount rate:

The effects of regulation do not always fall exclusively or primarily on the allocation of capital. When regulation primarily and directly affects private consumption (e.g., through higher consumer prices for goods and services), a lower discount rate is appropriate. The alternative most often used is sometimes called the “social rate of time preference.” This simply means the rate at which “society” discounts future consumption flows to their present value. If we take the rate that the average saver uses to discount future consumption as our measure of the social rate of time preference, then the real rate of return on long-term government debt may provide a fair approximation. Over the last thirty years, this rate has averaged around 3 percent in real terms on a pre-tax basis. [32]

When FEMA uses a 7% discount rate in its BCA, the implication is that it is ensuring that the investment in the project will generate at least as much return on investment as allowing the money to stay in the private sector where it would earn a 7% return on investment on average. To say nothing on the validity of that claim, not only do mitigation projects not displace private sector activity, lowering the discount rate would have little influence on the amount of money the government spends on mitigation, rendering moot any concern that the funds would somehow generate a higher return if left in the private sector. Hazard mitigation project funding is made available regardless of the discount rate used in the BCA. The budgets for FEMA’s largest mitigation grant programs are determined as a fraction of total Federal disaster expenditures, or specifically appropriated by Congress. So applying a 7% discount rate does not mean the government spends less money on mitigation than it would if the discount rate were 3%. The primary consequence of using a high discount rate is that it reduces consideration of larger scale projects with long-term benefits and shifts funding toward smaller projects with more immediate benefits. And it bears repeating that Federal statutes and the last several FEMA Administrators continually endorse the position that rather than result in net costs to taxpayers and displacing private investment, mitigation projects save money for the taxpayer by reducing Federal expenditure on disaster assistance.[33]

Beyond vague references to OMB Circular A-94, there is no publicly available authoritative explanation for why FEMA adopted and has become so committed to its rigid approach to BCA and the 7% discount rate. Without an OMB memo or a FEMA policy document that specifically addresses the discrepancies between FEMA’s statutory and regulatory requirements, on the one hand, and OMB Circulars A-94 and A-4, on the other, it is remarkable that FEMA remains committed to the 7% discount rate despite growing frustration among the national hazard mitigation community. Application of such a high discount rate is at odds with FEMA’s strategic plan to promote a culture of preparedness, ready the nation for catastrophic disasters, and reduce the complexity of FEMA’s programs.[34] It is also at odds with FEMA Administrator Deanne Criswell and President Biden’s stated priorities to meet the challenge of climate change through building more resilient communities. Shortly after her confirmation, Administrator Criswell announced to the FEMA workforce: “The impact of climate change is one that cannot continue to be overlooked when it comes to emergency management. It is incumbent upon all of us to drive the kind of system-based mitigation this nation needs to make our communities more resilient.”[35] A rigid approach to BCA and a high 7% discount rate are fundamentally incompatible with driving system-based mitigation that will make our communities more resilient to climate change.

A few observations and questions regarding FEMA’s current rigid approach to BCA and its commitment to the high 7% discount rate that is supposedly prescribed in OMB Circular A-94:

  • At what point does a proclamation from the Office of Management and Budget become subject to concern that it undermines the intent of statutory authorities? This is especially relevant when there is no written record of a particular OMB mandate, and the only source of justification for a supposed OMB requirement is ambiguous and confusing.
  • Like any legal requirement, A-94 is subject to interpretation. At some point in the past decade or so, FEMA adopted a very specific and narrow interpretation of how it observes A-94—through implementation of a standardized approach to benefit-cost analysis. If, after adopting a particular interpretation, FEMA decides there are good reasons for adopting a different interpretation and modifying its approach, does it need permission to do that? Is OMB approval required? On how short of a leash is FEMA attached to OMB? This question is of critical significance because many in FEMA seem convinced that even modifying the approach to establishing cost-effectiveness in such a way that doesn’t violate the language of A-94 constitutes violation of A-94 simply because FEMA previously adopted a very specific and very narrow interpretation of A-94.
  • A-94 is an awkward stretch to fit onto FEMA’s mitigation grants. A plain language read of A-94 could easily find not applicable much of the language that FEMA treats as applicable to its mitigation programs. There is an apparent unwillingness to go back to the language to reevaluate whether it makes sense to apply it that way. Not only does A-94 explicitly state that the Circular “does not apply to… non-Federal recipients of loans, contracts or grants,”[36] it reads as if it is most concerned with Federal investments and activities that impose costs on the public and negatively distort private investment markets, such as public and occupational health and safety requirements and regulation of pollution (smokestack exhaust scrubbers, food additive limits, or child car seats, for example). Circular A-94 offers approaches to evaluate measures pursued by regulatory agencies such as the Environmental Protection Agency to protect public health and safety, which in many cases do impose specific identifiable costs on private industry and the public. Mitigation investments paid for with funds that are already earmarked for that purpose generally don’t have that sort of effect.

Resolving these questions and inconsistencies becomes increasingly urgent, as the Federal Government assumes greater leadership in addressing climate change and promoting national resilience, and as the budget for FEMA’s mitigation grant programs continues to grow. This essay hopefully provides a foundation from which to begin addressing these questions, some of which have been waiting for over a decade for resolution.

Not The First to Raise Concerns

In a 1999 report to Congressional Committees, the Government Accountability Office (GAO) (then known as the General Accounting Office) observed the following:

[FEMA] also commented that our report is focused on the use of benefit-cost analysis in determining the cost-effectiveness of hazard mitigation projects, although cost-effectiveness determinations do not always equate to the use of benefit-cost analysis. [FEMA] noted that the decisions it makes in approving a project cannot always be reduced to a single economic analysis, because determining a project’s eligibility also involves considering issues such as its environmental and social benefits and the uncertainty associated with the analytical methods used. While our report acknowledges that the Stafford Act does not define how to determine cost-effectiveness, it mentions that OMB’s guidelines, as well as the agency’s regulations and guidance, suggest that benefit-cost analysis is the primary approach for ensuring that mitigation projects are cost-effective. We agree that there are difficulties inherent in using benefit-cost analysis to determine the cost-effectiveness of some hazard mitigation projects—such as the inability to estimate the value of the benefits of some projects or the difficulties in considering public policy issues—and that alternative approaches for determining the cost-effectiveness of these projects can be used. However, as discussed in our recommendations, we believe that to ensure the cost-effectiveness of hazard mitigation projects, either a sound analytical basis must be established for the alternative approaches before they are used, or the cost-effectiveness of the approaches must be validated through periodic reviews of projects after they are implemented”(emphasis added).[37]

While this report indicates that “benefit-cost analysis is the primary approach for ensuring that mitigation projects are cost-effective,” six critical points stand out:

  • The report acknowledges that cost-effectiveness determinations do not always equate to the use of benefit-cost analysis;
  • The report acknowledges that the Stafford Act does not define how to determine cost-effectiveness (and neither do FEMA’s regulations);
  • The report explicitly states, “We agree that… alternative approaches for determining cost effectiveness can be used;”
  • The report states that ensuring cost-effectiveness of mitigation projects requires that either “a sound analytical basis must be established” OR
  • Cost-effectiveness of mitigation projects must be “validated through periodic reviews of projects after they are implemented;” and
  • Discount rates are not mentioned in the document.

A “sound analytical basis” for determining the cost-effectiveness of public investments is a laudable concern. Somehow after the publication of this report, a “sound analytical basis,” became a rigid BCA model that includes decidedly unsound parameters such as the high 7% discount rate. Furthermore, rather than singular reliance on a rigid BCA model, FEMA apparently abandoned the alternative (note the “or” that appears in the last sentence of the above quoted paragraph) of validating mitigation project cost-effectiveness through periodic project reviews after they are implemented. Nonetheless, in addition to mitigation “loss avoidance studies” that FEMA posts on its public facing website,[38] the routinely quoted Mitigation Saves reports clearly validate the cost-effectiveness of mitigation projects through post-implementation evaluation. While GAO acknowledges that multiple approaches may be used to validate cost-effectiveness, and FEMA makes use of multiple pre- and post-implementation approaches, it insists on the most inflexible and inappropriately restrictive approach as a condition of consideration for funding.

A 2009 Congressional Research Service report on FEMA’s Hazard Mitigation Grant Program observed:

“Policy analysts generally distinguish between cost-effectiveness and BCA. FEMA appears to use these concepts interchangeably since they have interpreted statutory cost-effectiveness requirements to mean that a BCA should be conducted.”[39]

This brief paragraph raises three key points about FEMA’s approach to establishing cost-effectiveness:

  • FEMA has interpreted its statutory mandates;
  • FEMA has adopted an unusual interpretation of cost-effectiveness, conflating it with benefit-cost analysis; and
  • This implies that FEMA has latitude in its interpretation.

In 2008, the Association of State Floodplain Managers (ASFPM), a non-profit that engages with FEMA on flooding and floodplain management, published a position paper that opens with the following:

When it comes to stemming the tide of ever-mounting losses from natural disasters in the United States, there is no more valuable option than mitigation. However, since all FEMA-funded mitigation projects are required to meet certain cost-effectiveness guidelines, there is a chance that the true economic benefit of mitigation is being misrepresented to Congress if economic assumptions used in the economic models are questionable. At the top of the list of questionable economic assumptions used in mitigation project applications is the discount rate. This is an important issue because if the discount rate is too high, there is the danger that some good mitigation projects are failing to make the cut for approval… Since the primary method for determining the cost-effectiveness of FEMA’s mitigation programs is the BCA required for each project, the statistics calculated using FEMA’s Benefit-Cost Analysis Module are what is reported to Congress. This means that if a lower discount rate is more reasonable, the economic benefit of hazard mitigation being reported to Congress could be substantially understated. This paper promotes the idea that the 7% discount rate mandated by [OMB Circular A-94] is questionable and that it should be reviewed by OMB or a panel of economic experts (emphasis added).[40]

Although ASFPM’s position paper correctly recognized the problem with the high 7% discount rate, it could not have predicted that somehow the benefits of mitigation would come to be reported to Congress using a 2.2% discount rate, while FEMA’s BCA requirement continues to use the 7% discount rate. In some ways this problem is more pernicious because none of these proclamations on the benefits of mitigation include any discussion of the discount rate or the highly subjective nature of benefit-cost analysis, and so there’s no reason to suspect that there is a discrepancy to the point of misrepresentation between how the benefits are reported to Congress and the public and how FEMA evaluates potential projects for funding.

On November 20, 2019 ASFPM Executive Director Chad Berginnis testified before the House of Representatives Select Committee on the Climate Crisis. Florida Representative Kathy Castor asked him the following question: “How can federal programs that use a Benefit-Cost Analysis better measure and integrate resilience into those analyses, and prioritize mitigation investments toward more resilient outcomes?” His response:

A couple of thoughts. First, is that the discount rate, at least for FEMA’s benefit-cost analysis needs to be lowered. The effect of the artificially high discount rate in the FEMA BCA methodology limits FEMA’s ability to approve mitigation projects that are, in fact cost effective. This is a recommendation recently made in the November 2019 FEMA National Advisory Council report which recommended the discount rate be lowered from 7% to 2-3%. Second, is that most benefit-cost analysis modules do not account for social impacts.[41]

FEMA officials themselves are aware of and acknowledge the problem with the high 7% discount rate, and they claim to routinely engage with OMB on this issue.[42] But there is hardly any written evidence of recent efforts to change the approach or explain adoption of the current approach beyond “because A-94 says so.” Given the ambiguity of statutory, regulatory, and OMB language, given how the narrative surrounding the cost-effectiveness of FEMA’s mitigation grants has evolved over the past two decades, and given the enormous influence that BCA exercises over the annual expenditure of hundreds of millions of dollars of public funds, at a minimum, transparency and accountability require a clear written administrative record with transparent reasoning that explains priorities and responds to competing viewpoints.

Recommendations and Conclusion     

Future research on this topic could address the questions posed above regarding the applicability of OMB Circular A-94 to FEMA’s mitigation programs. A comprehensive history of FEMA’s approaches to establishing the cost-effectiveness of hazard mitigation proposals would be valuable for understanding how FEMA arrived at its current approach and support better understanding of the evolution of cost-effectiveness and BCA, as practiced in the Federal government. Future research could also highlight specific examples of valuable or innovative hazard mitigation projects that have not or would not be able to pass FEMA’s rigid BCA model—this would offer the most persuasive evidence of the problem with FEMA’s current approach.

The longer FEMA delays in lowering the discount rate and relaxing its rigid approach to evaluating mitigation proposals, the more opportunities are missed to build resilience through more comprehensive and more innovative hazard mitigation projects. FEMA and the Federal Government could take several measures to address the discount rate problem.

The easiest and most straightforward improvement would be for FEMA to simply acknowledge that the 7% discount rate is inappropriate for evaluation of the cost-effectiveness of hazard mitigation projects and adopt a lower discount rate according to some other defensible and analytically sound approach. FEMA would not need to look far, as OMB provides an alternative approach within A-94; and contrary to the FEMA Administrator’s response to the National Advisory Council’s recommendation to adopt this approach (discussed above in the A-94 section), there is no clear statutory, regulatory, or OMB proscription against FEMA taking this measure. In fact, in January 2017 the President’s Council of Economic Advisers published an issue brief explaining that recent empirical evidence supports lowering standard government discount rates.[43] There are also other approaches to discounting applied in different parts of the Federal Government. A comprehensive discussion of these approaches is beyond the scope of this paper, but they are currently all lower than 3%. The U.S. Department of Agriculture Natural Resources Conservation Service provides a great starting point to research other discount rates applicable to this discussion.[44]

For a more comprehensive approach, FEMA or the Federal Government could convene an expert advisory committee under the Federal Advisory Committee Act, to support development of more rigorous and analytically sound approaches to establishing cost-effectiveness and discount rates.[45] Acknowledging the subjective and highly technical nature of these evaluations, a Federal Advisory Committee approach would promote transparency and participation of experts and the interested public.

Another long-term approach offered by researchers in the public health sector, recognizing that “Congress does not have formal criteria to judge cost-effectiveness, and thereby consider the efficiency of proposed programs,” suggests establishment of a “Congressional committee on cost-effectiveness, whose objectives are to transparently rank risks by both their magnitude and likelihood, identify misallocations of resources on the basis of cost-effectiveness analyses, and initiate legislative corrections.”[46]

Benefit-cost analysis and cost-effectiveness analysis are methods intended to promote good stewardship of Federal resources. Developing more rigorous, more transparent, and more analytically sound techniques for economic analysis will not only benefit FEMA’s mission to support hazard mitigation, but it will also benefit the wider homeland security enterprise, and the entire Federal Government. For example, the Department of Homeland Security has faced criticism for spending too much on counterterrorism measures, often with little concrete evidence justifying the expenditures.[47] Better methods will help prioritize expenditures across myriad competing threats and provide justification and accountability to taxpayers.

To fulfill the spirit and intent of statutory authorities to provide mitigation assistance to FEMA’s state, local, tribal, and territorial partners, FEMA should support them in determining which investments represent the best value in achieving their own mitigation priorities—not force them to thread the needle of an overly prescriptive BCA methodology with an arbitrarily high discount rate that is not applicable to the purpose of mitigation grants. The current approach to establishing cost-effectiveness is overly prescriptive, imposes unjustifiable burdens on applicants, and due to the high discount rate, undermines support for larger scale projects that will reduce risk across long time horizons. Given the increasing scale, frequency, and cost of devastating natural disasters, the people of the United States need a method for prioritizing mitigation investments that is thoughtful, flexible, responsive to changing conditions, open to the input of academic and government experts, accountable to the people, and transparent about priorities. The current approach falls far short, and further delay in improvements continues to force mitigation investments into a narrow range of projects of limited scope, at the cost of more comprehensive, more effective, and more resilient mitigation projects.

About the Author

Luke Dodds is a master’s student at the Naval Postgraduate School Center for Homeland Defense and Security. Since April 2015 he has worked at FEMA headquarters in various positions pertaining to flood risk reduction, environmental policy, hazard mitigation policy, continuous improvement, and data management. Prior to joining FEMA Luke traveled widely, studying international relations, foreign language, Chinese history, and climate and energy policy. He is an accomplished writer, editor, linguist, and political historian, having studied and worked for five years in mainland China and Taiwan. Luke is particularly passionate about natural resource and energy economics, hazard mitigation, climate and environmental policy, and governance of risk. He has a bachelor’s degree in International Studies from American University and a master’s degree in Energy and Resources from the University of California at Berkeley. Luke grew up in rural Galena, Illinois, and currently lives in Washington DC.


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U.S. Congress. Senate. Nomination of Hon. Peter T. Gaynor to be Administrator, Federal Emergency Management Agency, U.S. Department of Homeland Security: Hearing before the Committee on Homeland Security and Governmental Affairs. 116th Congress., 1st sess., November 14, 2019.


Notes

[1] There is a huge amount of academic literature discussing how to choose an appropriate discount rate. There isn’t a consensus. A few accessible explainers include: Brian Pest, Discounting 101, (Washington, DC: Resources for the Future, 2020), https://media.rff.org/documents/Discounting_Explainer_-_Final.pdf; Environmental Protection Agency, “Chapter 6: Discounting Future Benefits and Costs,” in Guidelines for Preparing Economic Analyses (Washington, DC: EPA, 2010), https://www.epa.gov/environmental-economics/guidelines-preparing-economic-analyses; David Roberts, “Discount Rates: A Boring Thing You Should Know About (with Otters!)” Grist, September 24, 2012, https://grist.org/article/discount-rates-a-boring-thing-you-should-know-about-with-otters/.

[2] Keith Bea, “The Formative Years: 1950-1978,” in Emergency Management: The American Experience, 3rd Edition, ed. Claire B. Rubin (New York: Routledge, 2020), 81-112.

[3] Multi-Hazard Mitigation Council, Natural Hazard Mitigation Saves: 2019 Report, (Washington, DC: National Institute of Building Sciences, 2019), https://www.nibs.org/projects/natural-hazard-mitigation-saves-2019-report.

[4] https://uscode.house.gov. Search: “cost-effective.”

[5] Peter J. Neumann, Sc.D., Joshua T. Cohen, Ph.D., and Milton C. Weinstein, Ph.D., “Updating Cost-Effectiveness – The Curious Resilience of the $50,000-per-QALY Threshold,” New England Journal of Medicine 371, 9 (August 2014): 796-797, https://doi.org/10.1056/NEJMp1405158; Robert W Dubois, “Cost-Effectiveness Thresholds in the USA: Are They Coming? Are They Already Here?” Future Medicine 5, 1 (December 2015), https://doi.org/10.2217/cer.15.50.

[6] Office of Management and Budget, Circular A-94: Guidelines and Discount Rates for Benefit-Cost Analysis of Federal Programs, (Washington, DC: The White House, 1992), 5, https://obamawhitehouse.archives.gov/sites/default/files/omb/assets/a94/a094.pdf.

[7] Office of Management and Budget. Circular A-94: Guidelines and Discount Rates for Benefit-Cost Analysis of Federal Programs, 9.

[8] Office of Management and Budget, OMB Circular A-94 Appendix C: Discount Rates for Cost-Effectiveness, Lease Purchase, and Related Analysis, (Washington, DC: The White House, 2020), https://www.whitehouse.gov/wp-content/uploads/2020/12/2020_Appendix-C.pdf.

[9] D. W. Pierce, Cost-Benefit Analysis, 2nd ed. (New York: St. Martin’s Press, 1983), 14-15.

[10] How much is a life worth? How much is the stability or resilience of a community worth? How much is ecological diversity worth? How much is a stable climate worth?

[11] In reality, such a project would likely involve annual maintenance costs, and the flood protection it provides would fluctuate over time based on changing precipitation patterns or rising sea levels, and based on the changing stock of buildings and structures that it protects.

[12] Daniel A. Farber and Paul A. Hemmersbaugh, “The Shadow of the Future: Discount Rates, Later Generations, and the Environment,” Vanderbilt Law Review 46, no. 2 (March 1993): 301-302, https://scholarship.law.vanderbilt.edu/vlr/vol46/iss2/1/.

[13] Kyna Powers, Benefit-Cost Analysis and the Discount Rate for the Corps of Engineers’ Water Resource Projects: Theory and Practice, CRS Report No. RL31976 (Washington, DC: Congressional Research Service, 2003), 12, https://www.everycrsreport.com/files/20030623_RL31976_45cd4e99630664d295f13c5fd63f4e2da220ab0b.pdf.

[14] Council on Environmental Quality, Principles and Requirements for Federal Investments in Water Resources, (Washington, DC: The White House, 2013), 7, https://obamawhitehouse.archives.gov/sites/default/files/final_principles_and_requirements_march_2013.pdf.

[15] Gavin Smith and Olivia Vila, “A National Evaluation of State and Territory Roles in Hazard Mitigation: Building Local Capacity to Implement FEMA Hazard Mitigation Assistance Grants,” Sustainability 12, no. 23 (November 2020): 12. https://doi.org/10.3390/su122310013.

[16] Federal Emergency Management Agency, 2018-2022 Strategic Plan, (Washington, DC: FEMA, 2018), https://www.fema.gov/sites/default/files/2020-03/fema-strategic-plan_2018-2022.pdf.

[17] Examining FEMA’s Readiness to Meet its Mission: Hearing before the Committee on Homeland Security, House, 117th Cong., 1st sess., June 29, 2021.

[18] Impacts of the 2017 Wildfires in the United States: Hearing before the Subcommittee on Economic Development, Public Buildings, and Emergency Management Committee on Transportation and Infrastructure, House, 115th Cong., 2nd sess., March 20, 2018.
Nomination of Hon. Peter T. Gaynor to be Administrator, Federal Emergency Management Agency, U.S. Department of Homeland Security: Hearing before the Committee on Homeland Security and Governmental Affairs, Senate, 116th Congress., 1st sess., November 14, 2019
The Federal Emergency Management Agency’s Budget Submission for Fiscal Year 2019: Hearing before the Subcommittee on Homeland Security Committee on Appropriations, House, 115th Cong., 2nd sess., April 13, 2018.
Creating a Climate Resilient American: Reducing Risks and Costs: Hearing before the Select Committee on the Climate Crisis, House, 116th Cong., 1st Sess., November 20, 2019.

[19] Disaster Mitigation Act of 2000, Public Law 106-390, U.S. Statutes at Large 114 (2000): 1552-1576. https://www.congress.gov/106/plaws/publ390/PLAW-106publ390.pdf.

[20] Multi-Hazard Mitigation Council, Natural Hazard Mitigation Saves: An Independent Study to Assess the Future Savings from Mitigation Activities, Volume 2 – Study Documentation (Washington, DC: National Institute of Building Sciences, 2005), 8, https://www.nibs.org/reports/natural-hazard-mitigation-saves-independent-study-assess-future-savings-mitigation.

[21] Congressional Budget Office, Potential Cost Savings from the Pre-Disaster Mitigation Program, Pub. No. 2926 (Washington, DC: Congressional Budget Office, 2007), 6, https://www.cbo.gov/publication/19166.

[22] Multi-Hazard Mitigation Council, Natural Hazard Mitigation Saves: 2019 Report, 4 & 546.

[23] Multi-Hazard Mitigation Council, Natural Hazard Mitigation Saves: 2019 Report, 126. Note: $3.70 is calculated by dividing $101.9 billion by $27.4 billion.

[24] National Advisory Council, Report to the FEMA Administrator: November 2019, (Washington, DC: FEMA, 2019), 45-46, https://www.fema.gov/sites/default/files/2020-08/fema_nac-report_11-2019.pdf.

[25] Pete Gaynor, “Response to November 2019 National Advisory Council Recommendations” (official memorandum, Washington, DC: FEMA, 2020), https://www.fema.gov/sites/default/files/2020-08/fema_agency-response-nac-11-2019-report_06-2020.pdf.

[26] Though beyond the scope of this paper, language within A-94 suggests that the Circular should not apply to hazard mitigation grants. Item c in the Scope section states: “This Circular applies to all agencies of the Executive Branch of the Federal Government. It does not apply to the Government of the District of Columbia or to non-Federal recipients of loans, contracts or grants. Recipients are encouraged, however, to follow the guidelines provided here when preparing analyses in support of Federal activities” (emphasis added).

[27] Office of Management and Budget. Circular A-94: Guidelines and Discount Rates for Benefit-Cost Analysis of Federal Programs, 4, 5.

[28] “Benefit-Cost Analysis Training Materials – Basic Concepts in Benefit-Cost Analysis (BCA) Unit 1 – Visual,” (slides for E/L 0276: Introduction to Benefit-Cost Analysis, Federal Emergency Management Agency, Department of Homeland Security, Washington, DC, 2019), 14, https://www.fema.gov/grants/guidance-tools/benefit-cost-analysis/training.

[29] Office of Management and Budget. Circular A-94: Guidelines and Discount Rates for Benefit-Cost Analysis of Federal Programs, 4-6.

[30] Ibid., 9.

[31] Office of Management and Budget, Circular A-4: Regulatory Analysis, (Washington, DC: The White House, 2003), 33, https://www.whitehouse.gov/sites/whitehouse.gov/files/omb/circulars/A4/a-4.pdf.

[32] Office of Management and Budget, Circular A-4: Regulatory Analysis, 33.

[33] See “Mitigation Saves?” section above.

[34] Federal Emergency Management Agency, 2018-2022 Strategic Plan.

[35] For a similar speech see, “FEMA Administrator Deanne Criswell Delivers Speech at National Hurricane Conference,” Federal Emergency Management Agency, June 16, 2021, https://www.fema.gov/fr/node/620976.

[36] Office of Management and Budget. Circular A-94: Guidelines and Discount Rates for Benefit-Cost Analysis of Federal Programs, 4.

[37] Disaster Assistance: Opportunities to Improve Cost-Effectiveness Determinations for Mitigation Grants, GAO/RCED-99-236 (Washington, DC: General Accounting Office, 1999), 17-18, https://www.gao.gov/products/rced-99-236.

[38] “Hazard Mitigation Assistance Loss Avoidance Study Summaries,” Federal Emergency Management Agency, November 30, 2020, https://www.fema.gov/grants/mitigation/loss-avoidance-studies.

[39] Congressional Research Service, “FEMA’s Hazard Mitigation Grant Program: Overview and Issues,” CRS Report No. R40471 (Washington, DC: Congressional Research Service, 2009), 7, https://crsreports.congress.gov/product/pdf/R/R40471/5.

[40] Discount Rate, (Madison, WI: Association of State Floodplain Managers, 2008), 1, https://asfpm-library.s3-us-west-2.amazonaws.com/ASFPM_Pubs/ASFPM_Discount_+Rate_Whitepaper_2008.pdf.

[41] Creating a Climate Resilient America: Reducing Risks and Costs: Hearing before the Select Committee on the Climate Crisis, House, 116th Cong., 1st Sess., November 20, 2019, https://www.congress.gov/event/116th-congress/house-event/LC64872/text?s=1&r=1.

[42] During the whole year of 2019 I worked closely with relevant FEMA officials and regularly discussed this topic. I maintain contact with and continue discuss it with several of them.

[43] Council of Economic Advisers, Discounting for Public Policy: Theory and Recent Evidence on the Merits of Updating the Discount Rate, Issue Brief (Washington, DC: Council of Economic Advisers, 2017), https://obamawhitehouse.archives.gov/sites/default/files/page/files/201701_cea_discounting_issue_brief.pdf.

[44] See: Natural Resources Conservation Service Economics,“Rate for Federal Water Projects| NRCS Economics,” Natural Resources Conservation Service, United States Department of Agriculture, accessed July 16, 2021, https://www.nrcs.usda.gov/wps/portal/nrcs/detail/national/technical/econ/prices/?cid=nrcs143_009685.

[45] See: “Federal Advisory Committee Act (FACA) Management Overview,” General Services Administration, last modified January 28, 2018, https://www.gsa.gov/policy-regulations/policy/federal-advisory-committee-act-faca-management-overview.

[46] Meagan C. Fitzpatrick, Ph.D., Burton H. Singer, Ph.D., Peter J. Hotez, M.D., Ph.D., and Alison P. Galvani, Ph.D., “Saving Lives Efficiently Across Sectors: The Need for a Congressional Cost-Effectiveness Committee.” Lancet 390, No. 10110 (November 25, 2017): 1, 4, https://doi.org/10.1016/S0140-6736(17)31440-X.

[47] See for example: John Mueller and Mark G. Stewart, Terror, Security, and Money: Balancing the Risks, Benefits, and Costs of Homeland Security (New York: Oxford University Press, 2011). 



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