RE: Comments on the draft Report by CRA International June 20, 2005 Pertaining to Proposed Vernal Pool Critical Habitat Designation

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1 1 July 20, 2005 TO: FROM: Mr. Wayne White, Field Supervisor Sacramento Fish and Wildlife Service Office U. S. Fish and Wildlife Service 2800 Cottage Way, Room W Sacramento, CA Dr. Barney F. Hope Professor of Economics California State University Chico, CA RE: Comments on the draft Report by CRA International June 20, 2005 Pertaining to Proposed Vernal Pool Critical Habitat Designation A. Please accept my attached comments pertaining to the proposal for critical habitat designation (CHD) for 15 vernal pool species in California and southern Oregon. B. The general problems with the report by CRA International (CRA) can be categorized as follows: 1. The report contains numerous omissions, errors, deceptions, and flaws. 2. The economic concepts and theories used in the report are misapplied, applied incorrectly, or selectively applied. 3. The report includes no cost benefit analysis and virtually no economic analysis of the benefits from environmental protection afforded by CHD for vernal pools. 4. No authors are listed on the report title page. Since the report presents the proposed CHD almost completely from the perspective of real estate development, one can conclude that this report was prepared by real estate developers or those with strong ties to the real estate industry. 5. CRA took months and months to produce this late report and it was submitted to USFWS such that the public does not have a 60 day period to comment. C. My attached comments provide details and specifics to the general problems listed above. D. Because of the poor quality of the CRA report, I urge the USFWS to seek a full refund for monetary compensation paid to the anonymous CRA authors for their report.

2 2 Comments on a Report Prepared for the U. S. Fish and Wildlife Service Economic Impacts of Critical Habitat Designation for Vernal Pool Species Report by CRA International, June 20, ) The CRA Report only tabulates costs. Of the $992 million in costs, $965 million or 97% of the putative costs are projected to be impacts on real estate which the authors of the study label lost development opportunities. 1 A valid study would include benefits. This would allow for a cost-benefit analysis. Therefore this report is only a very narrow and extremely flawed (see below) tabulation of costs: it is not economic analysis. 2) The CRA Report fails to note that the costs of $992 million are expressed in mythical consumer/producer surplus dollars. Furthermore, they are grossly inflated because of incorrectly applying supply and demand curve concepts and inappropriately using an elasticity of demand estimate generated in an economic study 43 years ago. See my comments below. 3) The CRA Report fails to present the $992 million in costs in relative context. For example, what are the $992 million in costs relative to the total economic activity for CHD in the designated areas? What are the costs relative to the total economic activity for CHD in each county? a) The percent of county area proposed for Butte County CHD is 5.5% of the county. So the total real estate development impact will be small relative to the size of Butte County. i) Post CHD adaptive practices, in-fill housing development, densification, and the benefits of environmental protection can mitigate or eliminate the magnitude of CHD impacts. ii) CHD will result in a win win situation for home buyers and builders when environmental and quality-of-life benefits are included in a comprehensive costbenefit study. (1) This is especially true of Butte County as retirees and tourists increasingly come to live and visit Butte County. These benefits are not included in the CRA Report. There is no discussion in the CRA Report of the connections between environmental amenities and population segments: retirees; tourists; families; those engaged in recreation. iii) While the area proposed for Butte County is 5.5%, the map generated for Butte Country in the CRA Report 2 shows an area greater than 5.5%. While this area is label deadweight loss (again expressing mythical consumer/producer surplus dollars ), the public receives the impression that well over 5.5% of Butte County will be impacted. (1) The Butte map constructed by CRA on page 77 expresses deadweight losses based on Census Tract information. But the data for Butte County on page 59 is derived from FIPS sources. In no place in the report do the authors explain the different or the significance of selectively using different sources. 4) The authors only include the aggregate costs in their executive summary and do not include annualized or relative costs in their executive summary. This type of presentation gives a deceptive and extreme overstatement of the costs impacts. While the authors can point to a few numbers referring to annual costs buried in the report, the media has reported only the 1 CRA Report, p. 2 2 Ibid, p. 77

3 larger, non-qualified, number. This communicates a dramatically deceptive tabulation of incorrectly calculated costs to the public and gives the public the impression that there will be draconian economic difficulties with CHD. 5) To illustrate how the CRA report overstates consider the housing impacts in Butte County. The report notes that the change in housing units over a 20 year period because of CHD will be 353 fewer housing units or fewer housing units per year over a 20 year period. 3 Yet the authors fail to compare that figure to the total number of housing units constructed. a) For Butte County, if Federal Information Processing Standards (FIPS) code one of 12 FIPS areas in Butte County is excluded, the total change in housing units is not minus 353, but minus 132. Over a 20 year period, this averages a minus 6.6 housing units per year. The authors report structure again presents data to exaggerate and overstate impacts and costs and the report is seriously deficient in presenting data with relative measures. b) The CRA authors assume that all vernal pool lands are suitable for housing development. But some Butte County land is unsuitable for housing because of soil conditions, agriculture use, infrastructure expenses, or nitrate problems associated with septic systems in rural Butte County. 6) The author s methodology of economic efficiency is deficient in terms of examining producer costs. 4 Since the authors have chosen to examine real estate impacts, then the appropriate methodology would be one that includes balance sheets and income statements as those are the tools used by real estate developers. Real estate developers do not use the neoclassical economist s concept of producer surplus in the course of doing business. Rather they are motivated by profits as manifested on balance sheets and income statements. a) Even if one accepts the use of consumer and producer surplus, the elasticity of demand and supply/demand parts of the report is so flawed that both consumer and producer surplus estimates are incorrect and meaningless. See below. 7) The price elasticities of demand estimates of -1 determined by Reid in 1962 and Rosen in 1979 are not valid for the housing market in the last decade in California, in 2005, or the 20 year time period specified by the USFWS for the study. 5 The price elasticity of demand for housing in the last 5 years especially in Yolo and Butte countries has been extremely inelastic. Demographics, rising per-capita income, and migration to Butte county suggested that the price elasticity of demand will be very inelastic in the next 20 years not the unitary elasticity determined by Reid 43 years ago in a very different housing market and a very different demographic, economic, and land-use planning context. a) The price elasticities numbers and framework used in the CRA Report are only used by economists to examine extremely short term changes of quantity demanded to price. The CRA approach is deficient for the following reasons: i) As noted above, the elasticities numbers used from a 43 year old study are not valid for today s housing market. (1) Even if we accept the authors flawed consumer surplus/producer surplus methodology, note that as the price elasticities of demand becomes more inelastic as they have in over the last decade this will dramatically increase consumer 3 Derived from data on p. 59. Dividing this number by 20 (years) results in a yearly reduction of housing units. The authors present a yearly reduction of 18 units on p The authors assert that Economists generally characterize opportunity costs in terms of changes in producers and consumer surplus in affected markets. [Ibid, p. 8] But there are serious flaws with not including balance sheets and income statements in studies involving business like real estate developers. And as noted in subsequent comments the authors used of consumer and producer surplus in their report is seriously flawed. 5 See footnote #85, p. 52 of the CRA Report. 3

4 surplus in a housing market. Since the authors do not use appropriate number for the price inelasticity of demand, they dramatically understate consumer surplus and dramatically overstate the cost ($965 million) in mythical consumer surplus/ producer surplus dollars. ii) The price elasticity number and framework used by the CRA authors are inappropriate for any 20 year time. Over a 20 year period the demand curve and supply curves will shift. The authors fail to distinguish between a change in quantity demanded (one demand curve for a particular point in time) with a change in demand (demand curve shift over time) in their study. If real estate developers in the last decade used the elasticities numbers used by the CRA authors, they would have missed out on tremendous profits. iii) Given the small increase in relative costs associated with CHD and a very price inelasticity of demand, market conditions will allow CHD costs to be shifted from real estate developers to home buyers with little or no impact on profits. 6 While the CRA authors present flawed producer surplus numbers, the producers will continue to earn profits. iv) Housing studies have shown that home buyers are willing to pay a higher price for environmental amenities. Since the authors only rely on the neoclassical concept of consumer surplus and refused to include any environmental benefits in their report, they fail to see the benefits accruing to home buyers because of environmental protection. Home buyers recognized these benefits and are willing to pay for them. (1) Even if one accepts the authors methodology, note that consumer surplus will increase over time even with higher housing prices. This can be demonstrated with calculating consumer surplus with the demand curve to the left and the demand curve to the right that has shifted out over time and there has been a reduction in the price elasticity of demand as we move from P 1 to P 2. (See diagrams next page) Note that the price of housing, P h, is higher in the right panel but consumer surplus is also higher. This is demonstrated by applying the definition of consumer surplus. The increase in consumer surplus is even more dramatic if the price elasticity of demand in the left panel is the number used in the out-dated and unsuitable Reid and Rose studies (ε = -1) while the elasticity of demand in the right panel at P 2 is less than -1. (2) Now consider what happens if we use the same framework but have the price of land on the vertical axis and the quantity of land on the horizontal axis. If the supply curve (for land) intersects the demand curve at P 2 and the supply curve shifts to the left because of environmental regulation and we remain less than unitary elasticity, producer revenue will increase while costs will stay the same or decrease: profits will increase. (3) When the mistakes are corrected for elasticity and supply/demand frameworks in the CRA Report, it leads to the conclusion that land restrictions imposed by CHD will actually increase consumer surplus and increase producer profits. Therefore, since the CRA authors represent real estate developers, their own framework leads to the conclusion that CHD for vernal pools should be adopted in order to increase consumer surplus and producer profits. 4 6 The CRA Report indicates housing prices in Butte County will increase by 0% to 3.1%. If the FIPS code area is excluded, then the change will be from 0% to 2.2%. [Calculated from data on p. 59] One can see that the estimated increase in housing prices is relatively small.

5 5 P h Ph P 2 P 1 Q h Q h While the slope of the demand curve remains the same, the demand curve shift in the right panel results in a lower elasticity of demand at P 2 compared to P 1. This is consistent with the current housing market in California, especially Butte County. While numbers have not been used in the panels to calculate elasticities, the panel framework is theoretically correct: at P 2 the elasticity of demand is lower that at P 1. 8) The CRA authors note that Executive Order notes that it may not be feasible to monetize, or even quantity, the benefits of environmental regulations. 7 There is no discussion, arguments, or analysis by the CRA authors as to why section of EO applies in the case of CHD for vernal pools. The existence of EO does not mean that it is automatically or uncritically applied. The CRA authors assert Given the limitations associated with estimating the benefits of proposed CHD for the vernal pool species, the Service believes that the benefits of proposed CHD are best expressed in biological terms that can be weighed against the expected cost impacts of the rulemaking. 8 a) There is no discussion as to what are the limitations. b) There is no reference to the environmental literature as to how economists estimate the benefits of environmental protection and how those benefits have been integrated into a cost-benefit analysis. c) The CRA authors assert the Service believes.... Yet there is no reference or footnote as to where the Service believes that Executive Order applies. d) Please note that Executive Order requires a 60 day public comment period. 9 To allow the CRA authors to have months and months to put together a flawed report and then to deny the public a comment period of not less than 60 day is an agency failure. e) The CRA authors assert that the benefits of proposed CHD are best expressed in biological terms that can be weighed against the expected cost impacts of the rulemaking. This discussion will be included in the preamble to the final rulemaking. 10 Since that discussion will be included in the final rulemaking, when will the public have time to comment on this part of the CHD process? The CRA authors delayed the dissemination of a ponderous and flawed report by months and therefore deny the public a 60 day comment period and then notify the public that they will not be able to comment on an important part of the CHD because it will be in a future preamble. 7 Ibid, p Loc cit 9 See EO 12866:... addition, each agency should afford the public a meaningful opportunity to comment on any proposed regulation, which in most cases should include a comment period of not less than 60 days. 10 CRA Report, p. 12.

6 9) The CRA authors presents impacts when the biological and /or non-economic exclusions are included into the propose rule 11 in Section X. This includes a five country model for Butte, Madera, Solano, and Sacramento counties. Section 10 presents a hedonic regression model with no environmental hedonic variables! The model variables include lot size, dwelling unit square footage, bedrooms, baths, stories, and tract, a vector of indicator variables capturing fixed effects for each census tract. 12 While the econometric literature includes hedonic models that include environmental variables, the CRA model excludes environmental variables. Furthermore, the CRA authors tortuously estimate the regional intensive margin value of land, yet the authors note that CHD of vernal pool species has little effect on the regional economy. 13 Their precise estimate is that the reductions equals.0003 of the region s output. 14 No press report included such a tiny and meaningless impact in their articles. a) The CRA authors recognize that in Southern Oregon growth can take place because new migrants are attracted to the quality of life It is well recognized that the quality of life is Southern Oregon is based on environmental protection and amenities. Yet the CRA authors fail to include any benefits quantitatively or qualitatively in their report for CHD for vernal pools. 10) The CRA authors note that CHD has the potential to affect development potential and associated speculative land value at a very early stage in the development process. 16 But the authors fail to indicate whether CHD will be positive or negative in terms of development. Then they use the Alonso-Muth-Mills model to discuss how CHD will negatively impact consumer and producer welfare. 17 This is not surprising since the model does not include any variables for individual or social benefits from environmental protection. The author s conclusion is that there is nothing economically flawed or environmentally unsound by making all land available for development and no land or vernal pools. The logical conclusion from their study is to allow CHD for vernal pools land areas to be reduced to zero and vernal pool species and habitat to become extinct. Their conclusion is that CHD results in higher housing prices and lost rents to developers and landowners, the subtraction of rents earned through the production of scarce housing, and surplus losses to consumers and producers. 18 Even if one accepted those conclusions, then one would also accept the CRA authors claim that the reduction in houses will be 18 a year in Butte County and the price of housing will increase by 0% to 3.1% hardly the frightening conclusion of higher housing prices, lost rents, and lost surplus. But are these price increases in units of mythical consumer/producer surplus? Or are they reflective of real dollars? And if they are real dollars, where is the balance sheet and income statement presentations and economic/environmental analysis that leads to that conclusion? 6 11 See footnote 23, CRA Report, p Ibid, p If the CRA authors really intended the USFWS to understand their model, they would have described the variables included in tract. They do not. They would also provide a more detailed explanation of the result of their model. 13 Ibid, p Loc cit. 15 Ibid, p Ibid, p See p Ibid, p See footnotes #2 & #5 by this commentator.

7 7 The CRA Report is deficient for a dozen reasons: 1. The report attempts to only tabulate costs. 2. The report makes no attempt to include environmental benefits. 3. Executive Order is mentioned in the CRA Report, but there is no discussion of why the incorporation of environmental benefits was not included in the CRA Report. 4. There is no cost-benefit analysis. 5. There is virtually no economic analysis. 6. There is no environmental analysis. 7. There are virtually no relative cost measures. 8. The core methodology is constructed on a flawed and inappropriate economic model with foundations in consumer and producer surplus. If one correct all the mistakes then the logical conclusion of the CRA authors is for USFWS to adopt CHD for vernal pools to increase consumer surplus and producer profits. 9. There is no discussion of economic, financial, or business analysis based on the tools used by businesses: balance sheets and income statements. These tools must be employed if one desires to investigate the impact of land-use policy on business operations. These tools must be supplemented by considering the public interest, economic analysis, and cost benefit analysis including environmental benefits from changing land-use regulations. 10. The elasticity of price demand numbers do not fit today s housing market. Nor do they fit the housing market for 2005 to The hedonic econometric model contains no hedonic environmental variables. 12. While the authors have some data, scant narrative, and consumer/producer surplus measures for Butte County, nothing in their report applies or makes any sense for Butte County. I highly recommend that the USFWS reject the CRA Report and develop an analysis that includes benefits as well as costs and correct the omissions, errors, deceptions, and flaws of the CRA Report before reaching a decision about the CHD for vernal pools. Sincerely, Barney F. Hope Dr. Barney F. Hope, Professor of Economics Department of Economics California State University, Chico Chico, CA The assessments, analysis, and conclusions in this document do not necessarily represent the views of California State University, Chico. The commentator has not been paid by any real estate interests, environmental organizations, the USFWS, or California State University, Chico for producing these comments.