Improve Federal Environmental Cost Accounting

Improve Federal Decisionmaking Through Environmental Cost Accounting

Background

Increased recognition that the long-term health of the economy depends
upon the health of the environment is providing a new direction for
economic and environmental policy. In his 1993 Earth Day address, for
example, President Clinton directed the Department of Commerce to
develop new methods for calculating Gross Domestic Product (GDP)[1].
These new methods would take into account changes in the value of the
natural environment when calculating national income and wealth.  This
new "green GDP" would initially incorporate changes in the value of
marketed natural resources such as oil and timber; eventually these new
methods could help construct broad economic indicators that include the
costs of pollution or the value of a clean environment, including clean
air and water. While the President's directive focuses on the system of
national accounts, it highlights the importance of linking environmental
and economic factors.

The link should also be made by individual entities such as corporations
and government agencies. The daily operating choices made in the private
and public sectors -- which materials to purchase, goods to produce, and
services to provide -- affect the environment. The key to making better
economic and environmental decisions is access to accurate and timely
information on environmental costs and benefits.  With this information
decisionmakers can evaluate alternatives and determine those which are
more environmentally beneficial, as well as more economical.

Currently, however, most federal government decisionmakers do not have
access to environmental cost and benefit information. The two primary
reasons they do not are traditional accounting and financial analysis
practices. These practices may obscure the economic benefits of
pollution prevention investments and other environmentally preferable
management decisions.

Traditional accounting systems often place costs not directly related to
materials or labor in an overhead account, effectively obscuring them
from managers. These costs normally include such things as managerial
salaries, training, janitorial services, printing services, and
environmental costs.

Environmental costs include such expenses as hazardous waste disposal
and treatment, health care, training, and clothing and equipment for
hazardous material handlers. These costs may be placed in overhead
accounts or charged to a group other than the one responsible for
generating the costs. As a result, even managers who would like to use
this type of information find it difficult to know their organization's
environmental costs.

Traditional financial analysis methods often use lowest first cost as
the main criterion to evaluate a project proposal. As a result, time
horizons to evaluate the costs and benefits of specific alternatives are
short, and decisions often do not fully incorporate possible long term
environmental degradation. In addition, the indirect costs often found
in overhead are not included in the analyses. Strategies relying on
control technologies may appear more cost-effective than pollution
prevention alternatives when information about environmental costs is
not included in the financial analysis.


Federal Efforts.

The Environmental Protection Agency's (EPA) Office of Prevention,
Pesticides, and Toxic Substances (OPPTS), as part of its Design for the
Environment Program, is already working with members of industry,
academia, and the financial professions (e.g., accountants, lenders, and
insurers) to encourage the adoption of managerial accounting and capital
budgeting practices that more fully track and integrate environmental
costs into private sector management decisions. These efforts, although
focused on the private sector, could have similar advantages for the
federal government.

Recognizing the importance of incorporating environmental considerations
in the decisionmaking process, President Clinton issued an Executive
Order on pollution prevention.[2] It states that to lead by example and
to be good neighbors in their communities, federal agencies should
develop pollution prevention strategies and goals to cut releases of
toxic chemicals in half by 1999; reduce their acquisition of products
containing hazardous materials; and report use of certain hazardous
substances. It also directs agencies to use, to the maximum extent
practicable, total cost accounting principles in deciding upon projects
needed to meet the requirements of the Executive Order.

A Success Story.

The U.S. Air Force provides an example of how this might be done in the
federal government. The Air Force's Pollution Prevention Program has
made great strides towards incorporating environmental cost accounting.
The program has specific goals to reduce purchases of hazardous
materials, generation of hazardous waste, and the amount of municipal
solid waste sent to landfills. The program has five major focus areas:
**incorporate environmentally preferable materials and processes into
new systems; **incorporate environmentally preferable materials and
processes into existing systems; **evaluate the operations of all
installations, including government- owned plants, and convert them to
environmentally preferable practices; **adopt non-Air Force pollution
prevention technologies and develop new ones where necessary;
**establish an investment strategy to implement the program.[3] Through
the investment strategy, the Air Force created a separate pollution
prevention investment account to fund projects that contribute to
achieving the program's goals and have a good return on investment. In
order to receive a grant from the fund, a manager must propose a project
identifying the environmental costs that will be avoided as a result of
the proposed project. The manager may justify the proposal based on
savings that accrue to all divisions throughout the Air Force, not only
those savings that accrue to his program. This provides an incentive for
managers to seek out as many of the hidden costs related to a project as
they can.

An example of a project that received a grant from the investment
account was the procurement of an aircraft parts cleaning machine.The
new machine uses water and biodegradable detergent to replace a process
that used hazardous solvents. This investment was justified on the basis
of the anticipated reduction of:


** hazardous materials purchases and waste disposal;

** quantities of protective clothing and equipment needed;
  
** health care costs;

** construction and maintenance of waste storage areas;

** training costs for hazardous material and waste handlers;
  
** occurrence of regulatory fines and penalties; and

** any other cost attributable to the need for hazardous solvents

The Air Force has also worked with industry to develop a life cycle cost
model to help make specific decisions on materials and processes for
system development and acquisition projects. The life cycle cost method
requires that all costs associated with an item or process over its
lifetime be included in the cost calculations. Life cycle costs include
acquisition, maintenance, and disposal. The model incorporates many of
the costs mentioned above and strives to assist industry in meeting new
requirements for contract specifications. The new F-22 Advanced Tactical
Fighter is the first major acquisition program to evaluate all hazardous
material and processes and make substitutions based on the life cycle
cost model.

As the F-22 program continues through development and production, it
will serve to establish measurable standards to determine the
comparative benefits of incorporating life cycle costs.

Need for Change

The importance of developing accounting mechanisms that encourage a
prevention-minded approach to procurement and industrial process design
decisions is increasingly being recognized. The federal government's
liabilities for cleanup of nuclear and hazardous wastes is testimony to
this need.

Therefore, accounting concepts similar to the ones that EPA and the Air
Force are developing should be applied more generally across the federal
government. The potential value to the public sector is vast:  new
accounting techniques that encourage prevention could result in
significant short- and long-term savings for the federal government,
substantially reduce the federal government's stress on the environment,
and serve as a model for state and local government and the private
sector.

More comprehensive accounting practices will enable managers to uncover
many of the hidden costs of environmental degradation and regulatory
compliance. Full accounting for these costs would bring them into plain
view and create positive incentives to avoid pollution and reduce costs
of procurement and industrial process design decisions. The result
should be more pollution prevention and significant savings.

Cross References to Other NPR Accompanying Reports

Improving Financial Management, FM01: Accelerate the Issuance of Federal
Accounting Standards.  

Reinventing Federal Procurement, PROC20:  Streamline Buying for the
Environment.

Endnotes

1. President William J. Clinton, "1993 Earth Day Address," April 21,
1993.(Press package.)

2. Executive Order 12856, "Federal Compliance with Right-to-Know Laws
and Pollution Prevention Requirements," August 3, 1993.

3. Telephone interview with Major Tom Morehouse, U.S. Air Force
Pollution Prevention Division, August 13, 1993.