Improving Enviromental Management

ENV01: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.

Actions

1. Develop pilot projects to demonstrate the use of environmental cost accounting by the federal government. (1)

An interagency working group should be convened by EPA and the Department of Defense Office of the Deputy Under Secretary of Defense for Environmental Security, in consultation with the Office of Management and Budget, to:

**develop demonstration projects to test the applicability and effectiveness of environmental cost accounting in the federal government; and

**formulate accounting guidelines for the demonstration projects. The demonstration projects will be developed by September 1994 and completed by July 1995.

2. Report on the demonstration projects and make recommendations on the use of environmental cost accounting in the federal government. (1)

By October 1995, the interagency working group should report to the Director of the White House Office on Environmental Policy on the results of the demonstration projects and make recommendations on the extent to which environmental cost accounting could be implemented throughout the federal government. By March 1996, the group should develop environmental cost accounting guidelines for broader application throughout the federal government.

3. Issue a directive to implement environmental cost accounting in the federal government. (2)

Based on the recommended guidelines from the interagency working group, the President should issue a directive in April 1996 directing agencies to incorporate environmental cost accounting into the appropriate decisionmaking processes.

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.