This is a preliminary document prepared by a subgroup of members of the National and Regional Strategies Work Group as part of the Federal Advisory Committee Act (FACA) Subcommittee process. It is not an EPA document. Interested people should forward their comments to a member of either the National and Regional Strategies Work Group or the Economics Advisory Group.

Using Economic Incentives to Achieve Air Quality Objectives

Date:	December 3, 1997

Contact:	Joe Belanger, Connecticut Department of Environmental Protection, (860) 424-3027, fax (860) 424-4063, and Mark Brownstein, Public Service Electric and Gas Company, (201) 430-7196, fax (201) 565-0525

Status:	Draft #2. The Subcommittee has not discussed the section on early reductions, nor has it discussed this draft of the issue paper.

Contents

1	INTRODUCTION AND RECOMMENDATIONS	1

2	BACKGROUND	2

2.1	General	2

2.1.1	Reducing Emission Abatement Costs Further with "Ambient-Based" Programs	4

2.1.2	Examples of Economic Incentive Programs	4

2.1.3	Relationship to Other Papers	4

2.1.4	Economic Incentive Design Principles	5

2.1.5	Early Reductions	5

2.2	Background on Area and Mobile Sources	5

2.2.1	Existing Incentive-Based Programs for Area and Mobile Sources	6

2.2.2	Relationship to Other Issue Papers and National Activities	7

3	FRAMEWORK FOR ANALYSIS	7

3.1	The Basic Questions	7

3.2	Area and Mobile Sources of Emissions	8

3.3	Opportunities for Realizing Emission Reductions from Area and Mobile Source Categories	10

3.4	Incentive Mechanisms: Available Tools for Realizing Emission Reduction Opportunities	10

3.5	Considerations When Choosing a Tool to Match an Opportunity	11

3.6	Examples Used to Illustrate Application of the Framework	12

3.6.1	Woodstoves	13

3.6.1.1 Background	13

3.6.1.2 Opportunities	14

3.6.1.3 Tools	14

3.6.2	Off-Road Gasoline Engines	16

3.6.2.1 Background	16

3.6.2.2 Opportunities	18

3.6.2.3 Tools	19

3.6.3	Highway Heavy-Duty Diesel Engines	21

3.6.3.1 Background	21

3.6.3.2 Opportunities	23

3.6.3.3 Tools	25

3.6.4	Large Stationary Sources	26

3.7	Attributes That Make Incentive-Based Programs Work	31

3.7.1	Attributes That Make Emission Budget Progams Work	31

3.7.2	Attributes That Make Non-Budget Emission Trading Progams Work	32

3.7.3	Attributes That Make Emission Fees Work	32

3.7.4	Attributes That Make Consumer Information Mechanisms Work	33

4	EARLY REDUCTIONS	33

4.1	Problem Statement	33

4.2	General Issues	34

4.2.1	Establishing the Overall Baseline	34

4.2.2	Equitable Future Treatment	34

4.3	Programs	34

4.3.1	Safe Harbors	34

4.3.2	Trading	35

4.3.2.1 Adjusting the Target	35

4.3.2.2 Tightening the Target	36

5	CLEAN AIR INVESTMENT FUND	36

5.1	Goals and Strategies	36

5.2	Benefits	37

5.3	Design Principles	38

5.4	Geographic Scope	39

5.5	Price	40

5.6	Payors and Funding Sources	40

5.7	Use of the Fund - Pollutants	41

5.8	Use of Fund - Investment Projects	41

5.9	Use of the Fund - State/Local versus Federal Investment	41

5.10	Use of the Fund – Predictability of Funding	42

5.11	Relationship to SIP Review	42

5.12	Verifying Emissions Reduction Benefits	43

5.13	Verifying User Emissions	43

5.14	Reporting Fund Performance	43

5.15	Temporal Issues	43

5.16	Other Issues	44

Appendix 1.	Examples of Economic Incentive Programs	45

Appendix 2.	Economic Incentive Design Principles	54

Appendix 3.	Connecticut Department of Environmental Protection's Survey on Attitudes Toward Early Reduction Programs: Questionnaire Cover Letter and Results	55

1	INTRODUCTION AND RECOMMENDATIONS

This paper presents a framework for analyzing the various incentive-based tools available to implement an emission control strategy which affects large stationary sources, area sources, mobile sources, or crosscutting groups of these sources. By way of example, the framework is applied to four source categories. Specifically, the framework is applied to woodstoves, off-road gasoline engines, highway heavy-duty diesel engines, and large stationary sources other than electricity generating stations. The paper also presents a framework for Clean Air Investment Funds, lists the attributes that make four types of incentive-based programs work (budget-based emission trading programs, emission fees, consumer information mechanisms, and non-budget emission trading programs), and discusses incentives for early emission reductions. Appendixes provide numerous examples of actual economic incentive programs in use across the country, economic incentive design principles, and results from the Connecticut Department of Environmental Protection's survey of attitudes toward early reduction programs.

In the world of air quality policy, there is a tendency to treat economic incentive mechanisms as an after-thought, i.e., a last resort when traditional regulatory approaches are infeasible or fail. It is our hope that the framework and examples presented here will encourage a shift in thinking. Incentives should be the tools of first resort. Prescriptive "command and control" regulations make sense only when these tools are infeasible or fail.

The Economics Advisory Group makes the following five recommendations.

•	Economic incentive approaches to achieving air quality goals should receive the same planning emphasis as other strategies, and should be considered among the initial approaches when developing a regulatory program.

•	Economic incentive programs should assure equivalent environmental results but should not bear a greater burden of pre-implementation assurances than those required of traditional command-and-control programs.

•	The Clean Air Act Advisory Committee, through its other standing subcommittees, should ensure the further development of the work in this paper including, but not limited to, the Clean Air Investment Fund, ambient-based programs, incentives for early reductions, and expansion of the area and mobile sources framework to small and large stationary sources.

•	The Clean Air Act Advisory Committee should encourage the U.S. Environmental Protection Agency to develop appropriate guidance on policy, including revising present policies such as the Economic Incentive Program Rules, so that local, State, and regional authorities can easily and efficiently develop and implement economic incentive programs. Such policies should include clear planning, implementation, and enforcement guidelines to avoid the ambiguity and confusion that exists today for State regulatory agencies.

•	The use of demonstration or pilot projects should be encouraged to provide information for the development of innovative, untested emission control programs, and the U.S. Environmental Protection Agency should provide any necessary changes in policy, including SIP approvability criteria, on an expedited basis to allow such programs to be implemented.

2	BACKGROUND

2.1	General

Economic incentives include emission trading programs, emission fees and other financial mechanisms, time-savers such as special access to high-occupancy vehicle lane for car pools, and consumer information mechanisms. In addition, the Clean Air Act Amendments of 1990 identify 16 specific transportation control measures as economic incentives.

Compared to direct regulation, incentive-based regulation may hold promise for achieving necessary pollutant reductions with economy, certainty and timeliness, and equity. For example, the reasons for emissions trading include: saving States' resources, less conflict with sources, letting sources determine the best/most effective control technology, focusing on emissions loading, increasing cost-effectiveness and promoting control technology innovation and diffusion.

To be effective and cost-minimizing, economic incentives for air quality management must be tailored to the conditions that are specific to the pollutant which is being addressed, and must be designed with specific goals in mind. Because of the complexity of any particular area's air pollution problem, this issue paper does not attempt to present more than a general discussion of the salient issues involved in developing incentive-based regulations for controlling ozone, particulate matter, and regional haze.

The most fundamental determinant of the desired program is the goal or set of goals that provides the purpose of the program. The basic characteristics of the program will reflect choices pertaining to: whether the program caps aggregate emissions or an emissions rate, or instead is primarily intended to just increase sources' efforts to reduce emissions; whether the program is intended to fully implement a pollutant control strategy or function as an adjunct to a strategy that isn't essentially dependent on economic incentives; whether the program is an area's approach to reducing background concentrations throughout an area of influence (AOI) or a local program that primarily reduces pollutant concentrations in a small area. In addition, for emission trading programs, the importance of adjusting the "currency" for source location and of imposing geographical restrictions on trading depend on the extent to which the location of a source, relative to a particular receptor, is one of the determinants of effect. Therefore, basic features of incentive-based regulations reflect the desired scope of the program and the technical characteristics of the pollutant of concern.

Consideration of the following will enhance the match between incentive-based regulations and the pollution problem and related equity concerns:

•	program scope,

•	regional/local nature of the pollution problem,

•	type, size, and location of sources that contribute to the problem,

•	meteorological characteristics of the problem,

•	location of the area with the pollution problem,

•	needs of small entities, and

•	environmental justice.

An incentive-based regulation may be an area's attainment strategy, but it is also true that some emission trading programs, for example, classic emission averaging and the classic "open-market" trading programs, are useful only when combined with other components of an attainment strategy.

In addition to limiting emissions or providing flexibility to sources, an area may also wish to use incentive-based regulation to achieve one or more of these goals:

•	encourage early emission reductions,

•	increase rule-effectiveness by allowing sources to purchase credits in lieu of delays, variances, and alternative emission limitations (AELs),

•	increase sources' options for complying with reasonably available control technology (RACT) and other technology-based performance standards,

•	increase options for areas that are required to satisfy vehicle inspection and maintenance requirements and reformulated gasoline requirements,

•	encourage emissions reductions from sources not usually subject to control requirements,

•	promote control technology innovation and diffusion, and

•	address residual nonattainment (unexpected failure to meet reasonable further progress (RFP), attain one or more national ambient air quality standards (NAAQS), or make desired progress in ameliorating regional haze).

2.1.1	Reducing Emission Abatement Costs Further with "Ambient-Based" Programs

Ozone, particulate matter, and regional haze are examples of air pollution problems in which the location of a source relative to a particular receptor is one of the determinants of effect. Costs may be reduced by using a more "refined" emission trading program than one in which tons are traded for tons without regard to the location of the sources. The basic emission trading program, such as the SO2 acid rain program, minimizes costs for an air pollution problem in which only the quantity of emissions matters. Different approaches may be more efficient for an air pollution problem in which both the quantity of emissions and the location of sources matter. Many approaches--including adjusting the "currency" in emission trading programs--may be used to explicitly incorporate source location into program design. While those approaches are potentially valuable, the incentive-based regulations that are most likely to be implemented in the near-term most probably will not adjust the "currency" or fee rate for the differential effects of emissions in an area of influence on areas of violation.

2.1.2	Examples of Economic Incentive Programs

States and air quality management districts are using, or have proposed to use, economic incentives to reduce emissions of NOX (southern California, OTC, and OTAG), SOX and SO2 (southern California and Grand Canyon Visibility Transport Commission), and VOCs (IL). Minnesota has considered using fees to reduce emissions of toxic air pollutants. Appendix 1 contains additional information on these programs and several EPA programs.

2.1.3	Relationship to Other Papers

Other papers prepared by FACA work groups and subgroups address specialized applications of economic incentives or special issues that should be resolved. The Ad Hoc Group on Monitoring Incentives recommended several incentives for accelerated or more extensive air quality monitoring.

Incentive-based regulatory programs, like all regulatory programs, exist in an organizational matrix which provides planning and implementation functions. The National and Regional Strategies Work Group has discussed institutional mechanisms that will be primarily responsible for identifying areas of influence and developing regionally integrated plans. The issue paper "Institutional Mechanism for Development and Implementation of Regional Strategies" makes a recommendation for the structure and function of the new institutions. As used in this document, the neutral term "planning authority" indicates the organization which develops the regulatory programs under discussion.

2.1.4	Economic Incentive Design Principles

The National and Regional Strategies Work Group developed a set of principles that it is proposing as the basis for the design and implementation of any economic incentive contained in a regional plan. Appendix 2 presents these principles.

2.1.5	Early Reductions

To inform EAG's discussion of the benefits and concerns pertaining to programs to encourage early emission reductions, the Connecticut Department of Environmental Protection conducted a survey of the members of the National and Regional Strategies Work Group. Appendix 3 presents the results of the survey.

2.2	Background on Area and Mobile Sources

Throughout the nation, emissions from mobile and area sources are a substantial part of the emissions inventory. These sources contribute to nonattainment with the NAAQS for ozone and particulate matter, and they emit all precursors of concern, VOCs, NOX, and primary PM. Fine particulate matter (PM2.5) comprises sulfate, nitrate, soil, organics, elemental carbon, and other substances.

Area and mobile sources are diverse, and the States use different definitions of these source categories. Nevertheless, they do have features in common. Nearly everyone in the nation owns and operates area and mobile sources. Almost all products in these categories are distributed nationally. With the largest exception being vehicles used in commercial transportation, area and mobile sources are primarily used or consumed locally. The sources are innumerable, and the quantity of emissions from any one source is extremely small compared to aggregate emissions from its source category.

Emissions from area and mobile sources are regulated under multiple Federal, State, and local programs. Vehicle and engine emission standards, in-use emission detection programs, and fuel requirements control emission rates but not aggregate emissions of nonmethane hydrocarbons (NMHC), NOX, particulate matter, and carbon monoxide (CO) from light- and heavy-duty vehicles, nonroad engines, recreational marine engines, and lawn and garden equipment. The issue paper "General Mobile Sources Measures Paper" provides some details on these regulations and describes planned Federal regulations.

In some places, notably southern California, regulatory agencies already require most of the known measures for reducing emissions from area sources, but other places have been reluctant. Several obstacles are perceived: emissions are difficult to estimate, progress in reducing emissions is difficult to measure, controls are intrusive, and the sources are diffuse and hence costly to regulate. The impact of area and mobile source regulations tend to fall on small business and average citizens, raising difficult political issues.

Particular resistance to the use of economic incentives or other incentive-based programs to reduce emissions from area and mobile sources can also be observed. Fee-based programs such as fees on emissions from passenger cars are perceived to be inequitable because of the financial burden borne by low-income owners. Emission trading programs in which stationary sources may purchase emission reduction credits from either mobile sources or distant sources are perceived to be unjust because the local population's exposure is reduced less than if the purchasing source had increased on-site emissions abatement. More generally, incentive-based programs are perceived to be uncertain with respect to effectiveness, and, regarding sources that burn gasoline, to provide less overall control of toxic pollutants.

Nonetheless, as described more fully below, multiple communities are using incentive-based programs because of their tendency to motivate innovations in technology for emissions abatement. Some of the concerns with equity and environmental justice may be alleviated by designing programs that take full advantage of the flexibility associated with incentive mechanisms.

2.2.1	Existing Incentive-Based Programs for Area and Mobile Sources

There are scattered examples where incentive programs are used to control emissions from area and mobile sources. Pilot projects and programs vary greatly across the United States to reflect the scope of the pollution problem, the particular sources of pollution involved, and the specific needs of the area that is implementing the control strategies. Economic incentives are used in local programs to control emissions from area sources, for example, PM emissions from wood-burning stoves and agricultural burning. Appendix 1 summarizes a number of economic incentive programs which EPA and regional, State, and local agencies are implementing to reduce emissions from area and mobile sources.

2.2.2	Relationship to Other Issue Papers and National Activities

The Base Programs Analyses and Policies Work Group's issue paper "General Mobile Source Measures Paper" describes the Federal programs, implemented under the Clean Air Act as amended, that set national vehicle emission standards and standards for gasoline and diesel fuels, and that set requirements for in-use emission detection programs. The paper identifies the important issues to address if revisions are made to the Federal programs for in-use emission detection and gasoline standards.

Other FACA Subcommittees are also planning to discuss mobile source incentive programs. In particular, the Mobile Source Technical Review Subcommittee is forming a work group to examine vehicle-specific issues as they relate to incentive programs. The Linking Transportation, Energy, and Air Quality Concerns Subcommittee is discussing innovative transportation programs, potentially including incentive programs.

3	FRAMEWORK FOR ANALYSIS

The framework is a general guide for State air quality regulators who are considering use of an economic incentive to achieve an emission control objective. The framework will help regulators to identify many of the significant technical and political issues that arise when determining whether to use an incentive-based mechanism: emission trading, a financial mechanism, or a consumer information mechanism. Although the framework applies equally well to any type of source, the exposition and all of the examples give prominence to area and mobile sources. This emphasis attempts to anticipate a growing interest in including more types of sources other than large stationary sources in incentive-based regulatory programs. The framework also includes lists of the attributes which make different types of incentives work well.

3.1	The Basic Questions

The framework molds the task of evaluating incentives around four basic questions.

1.	What are the sources of emissions of concern?

2.	What opportunities exist for controlling emissions from the sources of concern?

3.	What economic incentive mechanisms are available?

4.	What considerations must one take into account as one engages the process of matching the mechanisms with the source categories, and the opportunities for emission control within those categories?

The first two questions are questions that anyone would ask when trying to develop a control strategy. The second two questions raise issues specific to the design and implementation of an economic incentive program. These four questions need to be asked and answered as a package.

Too often, the first two questions are asked without reference to the second two questions. Decisions are made about source categories and control strategies, without reference to the economic incentive tools available or the considerations that influence the feasibility of their use. Treating economic incentive tools as an afterthought limits their value; they become an appendage for achieving compliance flexibility rather than an engine for accomplishing the primary objective of the strategy, which is cleaner air.

Asking all four questions together integrates thinking about the problem to be solved and the tools to solve it. This ensures that the end result is optimized to make the best use of the economic incentive tools at hand. The following discussion explores each of the four questions in greater detail as they relate to area and mobile sources.

3.2	Area and Mobile Sources of Emissions

It seems like there is no end to the number of source categories to be found within the general classification of area and mobile sources. The Work Group's experience is that every jurisdiction involved in air quality planning, whether EPA, States, Tribes, municipalities, or some other political subdivision, has its own unique way of classifying area and mobile sources. What some call an area source, others call a mobile source. Some jurisdictions have a single source category for a particular source, while other jurisdictions will subdivide the source into three source categories based upon size or some other defining feature.

Ultimately, there is no right or wrong way to categorize area and mobile sources. For the purpose of this paper it is irrelevant. The following list represents the basic sources of area and mobile emissions.

Basic Typology of Area

and Mobile Sources Aircraft Agriculture Architectural Coatings Consumer Products Fuels Heavy-Duty Vehicles Light-Duty Vehicles Locomotives Marine Engines Motorcycles Off-Road Engines Paved & Unpaved Roads Silviculture Woodstoves

In keeping with the philosophy of integrated thinking, the decision to design an economic incentive program for any of the sources listed here should be directly related to an identified need to control emissions from one or more of these sources. The fact that a particular source category is "easy" to control or "easily lends" itself to a particular type of economic incentive instrument is of no consequence if the source category's emissions do not contribute to the air quality problem that needs to be solved. The determination as to whether a particular source category requires control can only be done on a case-by-case basis during the normal course of air quality planning. There are no cookie-cutter answers to this question.

3.3	Opportunities for Realizing Emission Reductions from Area and Mobile Source Categories

The opportunities for realizing an emission reduction from any particular area or mobile source are basically the same as the opportunities that exist for reducing emissions from stationary sources. The following six opportunities make up the basic list.

New Equipment	Improve the performance of new equipment as it comes in to the market. Stimulate innovation.

Turnover of Equipment	Accelerate the retirement and replacement of existing equipment.

Existing Equipment	Encourage the retrofit or repair of existing equipment.

Activity	Reduce activity, limit activity, or modify the time, place, or conduct of activity.

Consumable Goods	Encourage the reformulation or re-engineering of products. Change the distribution of products. Encourage product substitution.

Behavioral Change	Modify or change patterns and practices.

Identification of emission control opportunities is critical to identifying the strategy for achieving emission control objectives. At bottom, an emission control strategy is nothing more than one or more control opportunities strung together to achieve a specific result. The opportunities available are linked to the source categories under consideration for control.

3.4	Incentive Mechanisms: Available Tools for Realizing Emission Reduction Opportunities

There are three basic mechanisms for realizing emission reduction opportunities through economic incentives. The list is as follows:

Emission Trading	Includes budget programs, open market trading programs, and emissions averaging programs.

Financial Mechanisms	Includes fees, subsidies, taxes, and time-savers. An example of a time-saver incentive mechanism is special access to a high occupancy vehicle lane for car pools.

Consumer Information	Includes product certification, content disclosure, and public

Mechanisms	education.

As an initial matter, it may appear that certain economic incentive tools naturally match certain reduction opportunities. For example, it might be natural to assume that public education is the most appropriate tool to stimulate behavior change. However, it is far from clear that certain opportunities are unobtainable by certain tools. For example, is it impossible that a trading program might be used to create behavior change?

3.5	Considerations When Choosing a Tool to Match an Opportunity

This final section of the framework is the most challenging. The challenge in choosing a specific mechanism to match a specific opportunity is in choosing the one that achieves the maximum benefit for the minimum cost. The following points attempt to capture the various considerations that apply when choosing a tool to meet the identified opportunity.

Intent Behind Strategy

•Creditable State implementation plan measure

•Directionally correct measure, but no intention of claiming credit in SIP

•Reduction of ambient concentrations of a pollutant

•Reduction in peak concentration of a pollutant

Scope of Strategy

•Primary impacts, i.e., the magnitude of the change being sought

•Ancillary impacts

•Other affected pollutants (if any)

•Other affected individuals and/or sources

Geography

•Geographic spread of individual/sources within source category

•Ambient or episodic air quality problem

•Multiple jurisdictions or single jurisdiction

Quantification

•Quantification of the magnitude of the primary impact

•Quantification of the magnitude of the ancillary impacts

•Quantification of the individuals' or sources' emission impact

Information

•Current reporting requirements for the targeted individuals or sources

•Publicly available information on the targeted individuals or sources

Enforceability

•Credible mechanisms for accounting/enforcement between government and individual/source

•Credible mechanisms for accounting/enforcement between federal government and local government

•Jurisdictional issues

Equity Concerns

•Assignment of emission responsibility

•Number of individual/sources affected

•Regulatory sophistication of individuals affected

•Source of best information concerning polluting activity or source

•Locus of greatest control over polluting activity or source

•Prior action or investment to reduce emissions

•Whether some individuals/sources have higher emissions than other similarly situated individuals/sources

•Disposition of revenues or credits generated by an incentive program

•Neutral

•Redistribute

•Environmental justice concerns

•Hot spots

•Income effects

•Mobility

Resources

•Resource costs for both government and program participants

•Transaction costs

•Private expenditures

•Administration and infrastructure to collect, receive, and/or process information

•Extent of infrastructure necessary

•Existence of some or all of infrastructure

•Personnel

•Financial commitment to administer or participate in program

Resource and transaction costs are particularly important when the focus of the strategy is on small businesses or consumers.

3.6	Examples Used to Illustrate Application of the Framework

The Economics Advisory Group did not fully discuss the examples. The group does not intend the examples to be read as recommendations.

3.6.1	Woodstoves

3.6.1.1 Background

Woodstoves offer an excellent example of an area source problem that responds well to economic incentives. Woodstoves emit primary PM-fine particles (1 micron and smaller), as well as hazardous air pollutants (HAPs). Woodstoves are a factor in two types of communities and their emission inventories. In small rural communities, with winter inversions, woodstoves can be one of the top two sources of fine particulates (for example, Kalamath Falls, Oregon; Libby, Montana; Prescott, Arizona). In larger metropolitan areas, woodstoves can still rank in the top five sources of PM-fine, especially in areas that have historically used electricity for residential heating (for example, Denver, Seattle, Albuquerque, Fresno).

All households with woodstoves fall into at least two broad economic categories. The first type is middle-income households who use woodstoves to supplement another, more expensive form of heating. The other type tends toward lower incomes, and uses wood heat almost exclusively. These groups respond vary differently to economic signals.

The bulk of woodstoves in use today was built prior to the middle 1980s and contain no emission control technology. The peak years for modern woodstove sales were 1978–81, with estimates of as high as 1 to 1.5 million units annually. In 1988, following a regulatory negotiation, EPA issued a New Source Performance Standard (NSPS) for woodheaters with two phases of reductions. The second phase was effective on units manufactured after July 1, 1990. Subsequent to that negotiation, woodstove companies also began to produce pellet stoves, which burn a specially prepared fuel. These appliances are largely outside the NSPS, but have demonstrated even lower emissions. In-situ monitoring has indicated reductions of from 70 to 95% between uncertified stoves and EPA-certified stoves or pellet stoves. Unfortunately, the current turnover of old stoves is quite low. From 1991 to 1996, fewer than 150,000 new EPA-certified and pellet stoves were built each year. The fraction of these units that have replaced the old stoves varies between one-half in the West and one-third in the East. At the current rate of replacement it will take over 10 years to replace all the units put into service in just one of the peak years.

For consumer products, woodstoves tend to have a very long life span. The vast majority of woodstoves built in the late 1970s are still in use and some are expected to last for 40 or more years. Prohibiting the use of an already installed device has not proved to be politically feasible, although that strategy was included in some PM10 SIPS as a contingency measure. Mandatory "no-burn" nights, which are episodic and called during a winter inversion, have thus far been the only useful command-and-control strategy that is effective for this source. No-burn controls are very resource intensive and must be constantly enforced to avoid reduced compliance. Episodic controls have enabled many areas to attain the PM10 standard, but may be insufficiently effective in the face of an annual PM 2.5 standard since this control strategy leaves in place the old technology. Consequently, these old appliances will be part of the emission inventories for many years to come.

3.6.1.2 Opportunities

As air agencies seek to permanently reduce the level of PM fine in their areas, as well as the neighborhood scale HAPs, they must inevitably address this source. In many respects, the opportunities in this source parallel those in other sources, i.e., they fall into two broad

categories, "fleet turnover" and fuels.

Turnover. This strategy can create a substantial emission benefit by accelerating the retirement of uncertified stoves. It is important that these stoves be destroyed so they do not end up contributing to another area's nonattainment status.

Existing Equipment Modification. This strategy can potentially offer very low cost emission reductions, however, consistently reliable retrofit technology has not yet been developed.

Activity Controls. This is the principle command-and-control option for these appliances and are already in place in many areas. Controls that exempt clean burning appliances have proved to be a useful incentive to consumers for voluntary turnover.

New Standard: Revise and/or Reconfigure. This option could be important in the future if the NSPS were extended to fireplaces. Averaging, banking, and trading were not available to these manufacturers in the initial standard, but could be included in a revision.

Behavior. This area includes better understanding of how to burn wood in an old stove with lower emissions, and the importance of dry fuel.

Fuel Substitution. This strategy has two aspects: fuel substitution for existing appliances and fuel substitution that requires turnover. Pressed logs have demonstrated lower emissions in woodstoves, just as manufactured firelogs have demonstrated lower emissions in open fireplaces. Pellet stoves represent the second type of substitution, as the different fuel can

only be burned in a specially-designed appliance.

3.6.1.3 Tools

Trading Mechanisms

Budgets

A community could fix the number of woodstove permits in their AOV and establish a market for household level trades. This type of program creates a market driver, but has high transaction and administrative costs as well as very negative public relation costs to the

regulatory agency. In addition, if few new woodburning households are being added to the community, there is little actual reduction. If the community is not experiencing substantial growth then this type of program becomes a disincentive to turnover.

Non-Budget Trading

Credits for harvesting of old pre-NSPS stoves could be funded by residential development approval, or by an NSR program. This could be used to fully subsidize woodstove turnover in low income households. Middle income households will respond to a partial subsidy, which allows for significant leveraging. Average remaining life and actual usage of each appliance complicate the quantification of actual credits. This type of program would need a facilitating organization to accumulate the appliances and the credits.

Financial Mechanisms

Fees

Fees can be levied on wood cut in Federal forests and on wood purchased. This strategy would tend to encourage more efficient use, but would be difficult to enforce uniformly.

Fees on new appliances have been used in Washington State, although the revenue finances their public information campaign and not appliance turnover. Since the ratio of new stoves purchased to existing inventory is so small, the size of any fee would have to be significant to generate meaningful revenue. This would add a powerful economic disincentive to all purchases of low emitting devices.

Subsidies

Subsidies have been used in highly impacted areas and are very effective in addressing low income and/or senior citizen populations. Subsidies are unnecessary for middle income households and too expensive for many situations.

Taxes

Taxes are similar to fees. Taxes will inhibit adoption of new technology if applied to appliances. Taxes could be applied to households on real estate transfer but would entail challenging enforcement requirements. Sales tax and/or property tax rebates can be used as an incentive and are relatively easy to administer.

Consumer Information Mechanisms

Certification and labeling programs are already in place for this category but a disclosure program tied to real estate sales would be a useful mechanism for consumer awareness.

3.6.2	Off-Road Gasoline Engines

3.6.2.1 Background

This example briefly analyzes incentive-based tools available for implementing emission control strategies affecting small off-road gasoline engine sources (under 25 horsepower). Information included in this analysis includes a description of this source category, background information relating to local, State, and national efforts to implement off-road emission reduction programs, and the identification of opportunities for emission reductions in the small gasoline engine off-road sector. In addition, economic incentives and considerations that need to be addressed when matching market-based emission reduction mechanisms with the source category are discussed.

Small gasoline engines, or spark ignition engines, can be divided into two classifications. Nonhandheld engines are produced by engine manufacturers and sold to equipment manufacturers that produce, for example, lawnmowers, tillers, garden tractors, farm and construction equipment and small generators. Handheld engines are generally produced by companies that make lawn and garden equipment, including chainsaws, string trimmers, hedge trimmers, and leaf blowers. Nonhandheld equipment is usually powered with a four stroke engine, whereas almost all handheld equipment utilized two stroke engine technology. The popularity of two stroke engines for handheld equipment applications is explained by the fact the these engine are smaller, lighter, and can operate multipositionally, compared to their four stroke engine counterparts. From an emissions standpoint, utilization of four stroke engines is preferred, since two stroke engines burn a combination of oil and gasoline, resulting in high hydrocarbon emissions.

This section summarizes local (South Coast Air Quality Management District), State (California Air Resources Board), and Federal (U.S. EPA) efforts to require and motivate emission reductions efforts in the small gasoline off-road equipment sector. In addition, incentive programs from other jurisdictions are noted and briefly discussed.

The South Coast Air Quality Management District (SCAQMD) has promoted market based measures for several years in an effort to reduce the emissions impact of off-road mobile sources. These include a control measure (CM# 94MOF-03) in the 1994 Air Quality Management Plan (AQMP) that allows SCAQMD to issue emission reduction credits for the replacement of leaf blowers with non-polluting alternatives. The 1994 AQMP also included a control measure (CM# 94MOF-04) that allowed SCAQMD to issue emission reduction credits for the accelerated retirement and replacement of old off-road equipment with zero- or low-emitting units. These two control measures paved the way for the May 1996 adoption of Rule 1623 - Credits for Clean Lawn and Garden Equipment. This rule provides emission reduction credits for the accelerated retirement of old lawn and garden equipment and replacement with new equipment, or the direct sale of lawn and garden equipment that meets emission standards more stringent than mandatory standards.

On a State level, the California Air Resources Board (CARB) adopted regulations requiring emission reductions from small, off-road, spark ignition mobile sources. It periodically issues reports which examine the status and technological feasibility of low-emission off-road engine technologies. It also issued guidelines for the development of credit rules by local air pollution districts. In December 1990, CARB adopted emission standards for 1994 and subsequent model year utility and lawn and garden equipment engines. This regulation provided two tiers of emission standards. Tier I applies to 1994 and subsequent model year engines, and results in about a 30 percent emission reduction (HC + NOX) from uncontrolled levels). Tier II applies to 1999 and subsequent model year engines, and results in about a 70 percent emission reduction compared to Tier I levels. This rulemaking included a Technical Support Document, which provided equipment population and emission inventory information in support of the emission standards. Besides exhaust emissions, the Technical Support Document included fuel spillage emissions for various types of gasoline powered utility equipment: 2.1 lb/yr for walk-behind mowers and 2-cycle leaf blowers and 3.4 lb/yr for chain saws.

Subsequent to this rulemaking, CARB issued the reports Utility and Lawn and Garden Engine Status Review (April 1996) and Small Off-Road Engine Regulatory Review (May 1997). Both reports propose alternatives to the Tier II emission standards to provide engine manufacturers more compliance flexibility as well as a slight relaxation of the Tier II standards, in an effort to attain most of the emission reductions that would have been captured from the current standard.

With regard to national efforts to reduce small off-road gasoline engine emissions, the U.S. EPA in July 1995 promulgated national regulations for small spark ignition engines primarily used in lawn and garden applications. The Phase I emission standards included in this regulation will be implemented in the 1997 model year, and will result in about a 30 percent emission reduction in HC + NOX emissions compared to uncontrolled levels. Subsequent to this rulemaking, a Statement of Principles was agreed upon between U.S. EPA and small hand-held spark ignition engine manufacturers, in May 1996, for a framework specifying Phase II emission standards. This framework proposed a 30 percent HC + NOX emission reduction compared to Phase I standards. Similarly, a Statement of Principles for small non-hand-held spark ignition engines was agreed upon in December 1996, targeting a Phase II emission standards equivalent to a 40 percent HC + NOX emission reduction for these engines. In March 1997, U.S. EPA issued an Advanced Notice of Proposed Rulemaking, which notified the public about the availability of the two Statements of Principles, and the forthcoming Phase II small onroad engine Notice of Proposed Rulemaking. U.S. EPA anticipates that the final rule promulgating the Phase II standards will occur by the fall of 1998.

Besides efforts from SCAQMD, CARB, and U.S. EPA to reduce emissions from small off-road gasoline equipment sources, The Center for Clean Air Policy (a national organization that develops and promotes innovative policy approaches to State, Federal and international environment and energy problems) published the report entitled Wisconsin Strategy. This report includes guidance for developing emission reduction credit programs including some targeting small gasoline engines. Finally, the Sacramento Metropolitan Air Quality Management District, in April 1997, implemented an incentive-based program to promote the scrapping of gas-powered lawnmowers and replacement with rechargeable electric lawnmowers. Between 800 and 1,000 gas-powered lawnmowers were scrapped, with no emission credits generated.

3.6.2.2 Opportunities

This section summarizes various strategies that could be implemented for additional emission reductions beyond current mandatory requirements as described in the previous section. These strategies included the following:

Low-Emission Engines. CARB and U.S. EPA have adopted regulations requiring more stringent emission standards for new lawn and garden equipment (planned for expansion to other gasoline off-road sources). With additional incentives, engine manufacturers may be able to design engines with even lower emission rates.

Utilization of Reformulated Fuel. The 1990 Clean Air Act Amendments required U.S. EPA to issue regulations that require gasoline to be reformulated to reduce on-road vehicle emissions. These regulations have been adopted, resulting in a gasoline recipe that includes a significant concentration of oxygenates (up to 10 percent ethanol or 15 percent methyl tertiary butyl ether). Oxygenates have the effect of enleaning the air/fuel mixture on engines. This effect has the potential of slightly lowering hydrocarbon emissions in two-cycle gasoline engines, which tend to run "rich" and would most likely benefit by the extra oxygen entering the engine via the fuel.

Emissions from Gasoline Spills, Refueling, and Storage. Emissions from gasoline storage and spillage during the refueling of small off-road gasoline powered equipment are recognized as a significant air pollution problem and contributor to the emissions inventory. This strategy would promote public education with regard to proper storage and refueling procedures and the commercialization of standardized equipment/components to minimize fuel spillage during refueling.

Activity Changes. This strategy reduces use of gasoline powered equipment. An example of a lawn and garden application would be the use of low-maintenance turf grasses that grow slowly and require less mowing.

Turnover. CARB and U.S. EPA have adopted regulations requiring more stringent emission standards for new lawn and garden equipment (planned for expansion to other gasoline off-road sources). Therefore, an emission benefit would be created by accelerating the retirement of uncontrolled lawn and garden equipment (i.e., the scrapping of equipment that has some useful remaining life), and replacing it with new equipment that is subject to emission standards.

Behavior. This strategy relates to the use of manual tools for small lawn and garden jobs. These can be hand tools that will meet a variety of lawn and garden needs, which generate no emissions.

3.6.2.3 Tools

This section discusses the various market based "tools" that could be used to generate emission reductions for the small gasoline off road sector. These tools are primarily classified into two groups: trading mechanisms and financial mechanisms. Arguments for and against each specific trading and financial mechanism are included.

Trading Mechanisms

Credits for scrapping old higher polluting engines

Pro: Consumer acceptability high since use of existing equipment not subject to penalty; accelerates fleet turnover to newer, lower-polluting equipment

Con: Cost effectiveness of program may be unattractive, especially for equipment used in residential applications; verification of operability and remaining life of existing equipment difficult and administrative costs to implement program are high; difficulty of quantifying emission reductions

Credits for purchase of low-emission engines

Pro: Promotes advanced engine technologies

Con: Availability of low-emission engines uncertain; difficulty of quantifying emission reductions

Credits for reducing emissions from fuel spillage during equipment refueling

Pro: Large potential for emission reduction credit generation

Con: This opportunity may disappear in California, depending on a potential revision to CARB's utility and lawn and garden regulation; difficulty of quantifying emission reductions

Credits for Green Labeling

Pro: Low cost method of assisting those interested in purchasing lowest polluting equipment

Con: Double-counting emission reductions if used in conjunction with an ABT program for equipment manufacturers; difficulty of quantifying emission reductions

Credits for Voluntary or Episodic Controls

Voluntary or episodic controls could also be thought of as consumer information mechanisms.

Pro: Could be zero or low cost (to equipment operators) methods to reduce emissions

Con: Difficulty of tracking activity levels and quantifying emission reductions; cost of verification of control effectiveness. However, statistical analyses of pilot programs could provide quantifiability.

Financial Mechanisms

Fees

Impose fees on the operation of equipment that is uncontrolled

Pro: would promote the accelerated retirement of older equipment

Con: would have to identify owners of older equipment (enforceability), and negative public reaction due to increased costs of lawn and garden care; difficulty of quantifying emission reductions

Subsidies

Fund rebate program for the purchase of low- or zero-emission equipment

Pro: Consumer acceptability high since use of existing equipment not subject to penalty; accelerates fleet turnover to newer, lower-polluting equipment

Con: Cost effectiveness of program may be unattractive, especially for equipment used in residential applications; verification of operability and remaining life of existing equipment difficult and administrative costs to implement program are high; difficulty of quantifying emission reductions

Taxes

Taxes could be levied on the sale of new equipment to provide funds to subsidize sale of electric or other low-polluting technologies, or fund the scrapping of older equipment

Pro: Source of revenue for funding rebates, subsidies, and scrapping programs.

Con: Additional tax on the sale of new equipment may slow overall fleet turnover to the new equipment; difficulty of quantifying emission reductions

Consumer Information Mechanisms: Product Labeling

Equipment that emits at levels lower than mandatory requirements would be identified by an equipment label.

Pro: Low cost, would allow consumers to make an educated purchase decisions among otherwise equivalent equipment

Con: Difficulty of quantifying emission reductions

Other Mechanisms: Relief from Engine Testing Burden

Under certain circumstances, engine manufacturers might not have to perform certification emission testing on engines if the design of the engine is primarily based on an existing commercially available engine.

Pro: Certification cost would be lowered, possibly resulting in lower equipment cost to the consumer.

Con: Emission benefits might be sacrificed if a defective engine design is marketed, due to the lack of certification emission testing.

3.6.3	Highway Heavy-Duty Diesel Engines

3.6.3.1 Background

Emission Standards for New HDDEs. Emissions from on-highway HDDEs have been regulated for over 20 years. Initial control efforts were focused on HC and NOX emissions; HDDEs are an inherently low CO emission source. More recent efforts have focused on PM emissions with significant PM reductions occurring in both 1991 and 1994. Additionally, significant NOX reductions will occur in both 1998 and 2004 (with secondary PM benefits). If EPA's existing regulatory programs are fully implemented, on-highway HDDEs will meet standards for NOX and PM emissions approximately 90% below the uncontrolled levels of HDDEs manufactured in the early 1980s. In addition, urban bus engines are required to meet a PM standard 50% more stringent than the standard applicable to other categories of on-highway HDDEs. Even given the significant progress that has been made in reducing NOX and PM emissions from HDDEs, additional reductions are possible if the proper incentives are created.

Under the Clean Air Act, HDDEs are preempted from State control by any State other than California. However, other States can opt into the California standards by adopting any standards which have been adopted by California. No State may adopt HDDE emission standards which are different than EPA's or California's.

Other Emission Reduction Initiatives. EPA's HDDE regulations also include an averaging, banking, and trading (ABT) program designed to provide incentives for manufacturers to introduce new technology early and/or to introduce lower emitting technologies.

In June 1993, California included in its regulatory program for urban buses provisions under which bus engine manufacturers could certify to NOX standards below the mandatory standards and thereby generate marketable emission credits which they could sell or give to the ultimate purchaser. The program was primarily designed to provide additional incentives for fleet operators to purchase alternative-fueled buses.

In April 1993, EPA adopted a mandatory retrofit/engine upgrade program for 1993 and earlier model year urban bus engines rebuilt after January 1, 1995 for use in larger urban areas. Under the program, bus fleet operators are required to retrofit or upgrade bus engines if a certified retrofit or engine upgrade kit is available for a particular engine. Operators may also meet a fleet average emission reduction target by combining retrofits/upgrades with early retirement of bus engines and the purchase of buses with lower emissions. Under the program, retrofit or upgrade kits which can provide either a 25% PM reduction or which will permit a rebuilt bus engine to meet a 0.1 g/bhp-hr (the standard for new buses in 1993) may be certified. A number of retrofit/engine upgrade kits have been certified. Based on the success of the urban bus program, EPA recently endorsed the concept of developing a voluntary retrofit/engine upgrade program for other categories of HDDEs.

Operating Characteristics and Emission Control Considerations Affecting Implementation of Incentive-Based Programs. HDDEs are used commercially to generate income for business users. Therefore, there are significant existing marketplace incentives for manufacturers to build reliable, durable, and well-performing products and for users to properly maintain and use their HDDEs as a capital investment. For example, a truck owner has an existing commercial incentive to deliver goods in the most efficient manner possible, with the fewest miles traveled.

HDDEs are designed to be rebuilt. As such, they have relatively long lives. Since HDDE emission performance is a function of basic engine design and does not deteriorate over time, long life does not impact emissions as a result of deterioration provided the engine is properly maintained. EPA recently concluded in a study of HDDE rebuild practices that there are existing incentives that work to assure that HDDEs are rebuilt to an emissions configuration the same or better than the original engine.

As a consequence of the incentives to build reliable and durable engines, it is not uncommon for diesel engines to have a life of 1,000,000 miles in heavy-duty trucks or to power city buses up to 15-20 years. The long life of HDDEs can delay the introduction of newer, cleaner technologies. One opportunity for HDDE marketplace incentives, therefore, is to encourage fleet turnover. Similarly, the opportunity for upgrades or retrofits that go beyond current rebuild practices is also available.

In addition to fleet turnover and upgrade/retrofit programs, there are other opportunities for implementing incentive programs to reduce emissions from HDDE. For example, there are potential opportunities to change the fuels used by HDDEs, i.e., to reformulated diesel or to use alternative fuels. Likewise, there may be opportunities to change customer behavior. A few of the key opportunities and incentive tools are discussed below.

In examining emission reduction opportunities for HDDEs, it is critical to recognize the well-established engineering emission tradeoff between the control of NOX and PM emissions that can occur. With some in-cylinder control strategies, as one of these emissions goes down, the other goes up and vice-versa. With other control strategies, there may not necessarily be an increase in other pollutants. Indeed, control strategies which combine PM and NOX reductions are available. Nevertheless, the potential for a NOX/PM tradeoff needs to be considered in developing marketplace incentive programs.

3.6.3.2 Opportunities

Fleet Turnover. Financial incentives may be used to encourage faster turnover of the existing fleet. This may be done through various methods, including tax benefits or subsidies for the purchase of new, lower emitting technologies. Financial incentives must be substantial enough to compensate for the residual value of the older engines which are being scrapped and/or to overcome any costs associated with owning and operating new technologies.

Potential incentives for engine manufacturers include cash; exemptions from certification fees, exemption from selective enforcement audit testing, and/or exemption from in-use liability; and tax breaks for developing and certifying new low emission engines. Potential incentives for operators could include cash; fuel tax reductions; registration fee waivers; tax incentives to purchase low emission engines; and exemption from I/M requirements and transportation control measures such as operating restrictions in certain areas and/or at certain times.

Low Emitting, New HDDEs. Another strategy is to promote the manufacture, sale, and use of new highway HDDEs which are certified to meet emissions levels below the mandatory standards. These engines can be either diesel-powered with advanced emission controls or alternative-fueled engines(see discussion below).

As with the concept of fleet turnover, incentives to purchasers of low emitting engines could include cash; fuel tax reductions; registration fee waivers; tax incentives to purchase low emission engines; and exemption from I/M requirements. Potential incentives for engine manufacturers could include cash; exemptions from certification fees, exemption from selective enforcement audit testing, and/or exemption from in-use liability; and tax breaks for developing and certifying new low emission engines.

The concept of emission credits, which is discussed below, also could be used as an incentive for both engine manufacturers and the ultimate purchasers.

Retrofit/Engine Upgrade Programs. These programs are designed to improve emissions from the existing fleet by upgrading emissions performance by retrofitting emission control technology, upgrading engine parts or a combination of both. Retrofitting control technology on diesel-powered vehicles is not new; both highway and nonroad HDDEs have been retrofitted with exhaust controls. The EPA urban bus engine retrofit program focuses only on PM reductions. However, development work on retrofit/engine upgrade technologies to achieve NOX reductions and simultaneous NOX/PM is being developed and demonstrated as well.

A number of issues need to be addressed with retrofit/engine upgrade initiatives, including the cost, impact on the NOX/PM trade-off, durability and reliability of a given technology, as well as its potential impact on engine performance and durability. Also, a mechanism for certifying or at least verifying the emission reduction performance of retrofit/upgrade kits needs to be in place.

The types of incentives identified for promoting vehicle operators to retire older vehicles and to purchase low emitting new vehicles could be used to promote retrofit/upgrades.

Fuel Improvements. Another potential means of reducing emissions from HDDEs is development of fuel improvements designed to reduce emissions from all HDDEs (e.g., ultra-low sulfur, lower aromatics, higher cetane number). Improvements in fuel quality would not only have a direct impact on engine out emissions but in some cases (e.g., low sulfur fuel) would facilitate the optimization and utilization of technology that could provide significant additional emission reductions. For example, the availability of ultra-low sulfur fuel in urban areas would permit the introduction of a retrofit technology that reduces PM emissions by over 90%.

The widespread benefits from using improved fuels would have to be balanced against the costs of such fuels. Improved fuels would likely be most cost effective if it is introduced on a nationwide basis. However, in some localities, depending on crude stock quality and refining capability, it may be possible to create cost effective spot markets for high quality diesel fuel to be used, for example, by centrally-fueled fleet operators in urban areas. Localized use of improved fuels, however, would not be as effective in addressing emission transport as would be the case with a nationwide improvement in diesel fuel. Finally, engine performance and durability impacts of modified fuels must be studied before such fuels are introduced.

Incentives to promote the production and sale of high quality diesel fuel can include preferential tax treatment, averaging, trading and banking between refiners, and the generation of emission credits for the production of high quality diesel fuel.

Alternative Fuels. Alternative fuels may also be used to reduce NOX and PM emissions, both through fuel conversion of existing vehicles or manufacture of new engines designed to operate on alternative fuels. New alternative fuel engines for certain applications are available, but they typically cost more than the comparable diesel engines and they can only be used where there is a refueling infrastructure to support their operation. Similarly, fuel conversion kits are available for existing diesel engines, but the same cost and fueling issues must be considered. Applicability of alternative fuels is probably most cost effective for new engines used in vehicles that are centrally fueled.

Inspection/Maintenance Programs. There is a high likelihood of success for inspection/maintenance programs designed to reduce emission from poorly maintained or illegally tampered engines if existing procedures (SAE J 1667) are used and if agreement can be reached on uniform pass-fail levels. Currently, 13 States have some form of I/M test program for highway HDDEs and the trend in programs is towards implementing the SAE J 1667 test procedure.

The benefits of an HDDE I/M program may be difficult to quantify. In addition, EPA guidance is needed for implementation of these programs because HDDEs are used in interstate commerce and travel from State to State. Uniformity among all programs of this nature (whether State or local) is therefore essential.

3.6.3.3 Tools

Emission Credits. A potential marketplace incentive which can be used in combination with a number of the incentive opportunities reviewed above is an emission credits program. Existing clean fuel fleet regulations already provide some credit opportunities for HDDEs and a similar program could be developed for diesel engines certified below the mandatory standards. Indeed, EPA recently revised the on-highway HDDE engine ABT program to permit the generation of emission credits which can be sold by the engine manufacturer or given to the purchaser of the engine to use in other programs. A key to the expansion of the credits program will be whether third parties are willing to pay for the credits that can be generated and whether the available credits are big enough.

Education and Behavioral Changes. Incentives and customer education may provide benefits through improved in-use performance and maintenance by encouraging the purchase of cleaner engines or the retrofit/upgrade of existing engines. In addition, there may be some opportunities to educate customers on the benefits of behavioral changes (e.g., less idling time, most direct delivery routes, etc.).

3.6.4	Large Stationary Sources

The Economics Advisory Group's discussion of large stationary sources preceded development of the analytical framework and application of the framework to area and mobile sources. Time did not permit the group to resume discussion of application of economic incentives to these sources. Consequently, the organization of the example departs from the framework, and reflects the group's earlier, more general discussion of developing an incentive-based program to reduce emissions from large stationary sources.

Which sources should be included in the program? In general the more sources included in a program the more robust the market and the more economically efficient the air quality improvement program. However source categories and sizes that have not been included in innovative programs before often do not have accurate and reliable emission measurement techniques. Depending on the measurement techniques which are available, different programs work better in different degrees, and some programs will require development of better techniques. While economic incentive programs also have the flexibility to address the special needs of small entities and to bring environmental justice concerns to bear on the choice of sources, they can also result in negative impacts on some areas of concern unless these areas are given explicit attention during program design.

Depending on the specific pollutant which is being addressed by the program as well as where the program is to be implemented, the importance of additional emissions reductions from large stationary sources versus reductions from area and mobile sources may vary. This consideration is implicitly included in the following discussion of options.

Option 1: Cover only traditional, well measured sources (e.g., power plants)

Pros: Minimizes resources spent to develop emission measurement protocols

Cons: For many pollutants, misses a large and fast growing portion of the current anthropogenic emissions.

Option 2: Cover all large sources

Pros: Compared to option 1, target emission level achieved at lower cost

Cons: Additional resources needed to develop emission measurement protocols; need to define "large" sources

Option 3: Cover all sources to the extent possible, including area and mobile sources

Pros: Target emission level achieved at least emission abatement cost

Cons: Small entity concerns; greater increase in resources needed for emission measurement

Option 4: Cover large sources and allow smaller sources to opt in

Pros: Increases profits of sources that opt in and reduces social costs

Cons: Smaller sources may not have accurate and reliable data on emissions; opt-ins don't contribute to net emission reductions, only reduction in social costs

What is the correct geographic size for a market-based emission reduction program? The issue involves both the aggregate cost of achieving a program's environmental goal and the geographical integration of control strategies. Other things being equal, in general a larger geographic domain means more sources, a more robust market and a more economically efficient solution. However, with a large geographic area the emission reductions may not occur where they need to occur for local problems. Solutions include using the market based program to reduce background emissions and imposing additional controls in small localized areas. Alternatively, the target emission level for a regional program could be set lower to ensure localized problems are addressed. Finally, the geographical nesting of programs--several local programs set in a regional program--may be appropriate. Where nonattainment problems in an area are isolated, being unrelated by long range transport, separate local programs may be sufficient to bring the area into attainment.

If a program includes multiple jurisdictions, the planning authority needs to take action to ensure consistency. Ensuring consistency is likely to be less difficult if an institution that spans the area of influence (AOI) designs the program.

Option 1: Use a market-based program to reduce background emissions throughout the AOI, and impose additional controls in small, localized areas

Pros: May be less expensive than option 3b

Cons: Sources subject to additional controls may question equity of program

Option 2: Reduce the target emission level for a regional program (RAMP-wide)

Pros: Administratively simple

Cons: Possibly more expensive in aggregate than a program that takes source location into account; regional program does not provide price signals to influence new sources to locate in areas where their emissions would have less effect on the AOVs

Option 3: To determine the cost-effective geographic size, expand the set of covered sources until the expected abatement and transaction costs for the last included source just equal the expected cost-savings to the already-included sources

Pros: Minimizes the aggregate cost of achieving the objective of the program

Cons: May provide an incentive for sources to move just outside the boundary of a local program (sprawling emissions problem)

How should the design of an emission trading program incorporate the timing of emissions? Ambient concentrations of criteria pollutants have episodic fluctuations. The effect of precursor emissions on the criteria pollutant may vary by hour and by day (and of course it varies by season). An exchange of allowances may not be neutral with respect to air pollutant concentrations if allowance generation and use occur at different times. Sources prefer flexibility in planning their production schedules, and profits may be decreased by either a) restrictions on the use of allowances if the restrictions alter production schedules or b) trading ratios which account for differential effects of emissions timing.

Option 1: Allow one ton of precursor emissions to be covered by one ton of allowances.

Pros: Reduces costs to sources; simplicity

Cons: Does not ensure environmental neutrality of trades

Option 2: Require each ton of precursor emissions during episodes and critical periods to be covered by more than one ton of allowances.

Pros: Provides a greater incentive for emission reductions during episodes and critical periods

Cons: Increases expenditures on emission abatement; because of uncertainty in predicting pollutant concentrations, may be difficult to provide advance notice to sources in time for them to respond appropriately

Should emission budget programs allow interpollutant trading? Should interpollutant trading of precursor emissions for one criteria pollutant be handled differently than interpollutant trading between criteria pollutants? How should interpollutant trading be managed? Changes in levels of one NAAQS precursor pollutant affect other NAAQS pollutants. For example, changing NOX emissions will impact ozone, PM-fine, and regional haze. When one action reduces emissions of several precursors and the reductions improve environmental quality, it is relatively easy to integrate the programs. However there are situations when either an action decreases one precursor but increases others or a decrease in a precursor has the side effect of increasing the ambient concentration of another pollutant.

Current emission control programs have almost always prohibited trading between classes of pollutants. When several classes of precursors affect ambient concentrations, is it advantageous to allow the market to decide which precursors will be reduced? Current scientific tools may not support determinations of the correct ratio for interpollutant trades.

Even when not formally established, interpollutant trading can occur when two separate emission trading programs covering the same sources operate simultaneously. Assuming for simplicity that the trading program uses pollutant allowances, optimizing sources will participate in both allowance markets. Presumably, some sources will minimize emission abatement costs by purchasing one type of allowance and selling the other. Thus interpollutant trading occurs even though it is not organized by the planning authority.

The question arises as to whether formal and informal interpollutant trading achieve the same air quality, aggregate costs, and distribution of costs among the covered sources. It appears that whether the approaches are functionally equivalent depends on, among other things, any differential effects of precursor emissions on air pollutant concentrations, the significance of transaction costs in allowance markets, and the allocation of allowances. Equivalence is unlikely, but additional analysis is needed to determine how much similarity in the outcomes of formal and informal interpollutant trading can be achieved.

Option 1: Formally establish interpollutant trading

Pros: If trading ratio is correct, minimizes aggregate cost of achieving environmental goal

Cons: Increases complexity of program design and implementation

Option 2: Determine the pollutant which requires the greatest reduction in precursor emissions, and set the emission budget for the "limiting" precursor at that level; emissions of other precursors are also capped

Pros: Administratively simple

Cons: Assumption of a limiting precursor has not been validated

Option 3: Allow only single-pollutant trades

Pros: More certainty in environmental neutrality of trades

Cons: Greater aggregate cost of achieving environmental goal

In a program with an emission budget, how can the planning authority allocate initial allowances and allowances in future years? One of the major obstacles to emission budgets is allocating the budget. In theory the original allocation shouldn't matter if there is a robust market. In practical terms, sources would rather have their allocations to begin with than have to go to the market and buy them. An annual auction of all available allowances is one solution. An area that chooses to allocate shares of the budget has several issues to address including how to adjust allocations for economic cycles, the impacts of other air quality programs (both reductions and increases in emissions), and sources that reduced emissions early.

Option 1: Auction off all allowances

Pros: Treats existing and new sources uniformly

Cons: Sources incur out-of-pocket expenses to purchase allowances; requires some form of recycling of auction proceeds if costs to controlled sources are not to be increased

Option 2: Allocate some and auction off others

Pros: Planning authority can still set aside allowances for special uses, for example, exclusive purchase by new sources

Cons: Planning authority needs to find an equitable way of making allocations

Option 3: Allocate all allowances

Pros: Gives planning authority maximum flexibility to determine the equitable allocation

Cons: Sources may question equity of allocations; may discriminate against some sources

What are the differences/similarities of emission trading programs and emission fee programs? The first step in implementing either program is to determine how much of a particular pollutant may be emitted. When this total allowed emission loading is determined under an emissions budget program an area must split these "budgeted" emissions among the covered sources. Under an emission fee program the planning authority must determine the emission fee that would result in only the budgeted amount of emissions being emitted. In the case of regional haze where progress rather than attainment is the objective, less precision would be required. The emission fee is determined by using marginal cost information from the regulated sources. The planning authority also decides how to use the fee revenue.

Emission trading programs include but are not limited to budget (or "cap") programs. The distinguishing characteristic of an emission budget program that allows trading is that the program sets a definite upper limit on the aggregate quantity of allowances that the planning authority grants (or sells) to the covered sources. Without banking, an emission budget program limits aggregate emissions from the covered sources. Alternatively, emission trading programs may limit an average emission rate for all covered sources. Proposals developed by the Ozone Transport Assessment Group (OTAG) would not only limit the average rate but would set the rate to limit aggregate emissions from the covered sources. Another type of emission trading program is exemplified by the Open Market Trading Guidance programs, which allow sources to generate and trade "discrete emission reductions" (DERs) but limits neither aggregate emissions nor average emission rates for entire categories of sources; environmental benefits are obtained by mandatory retirement of 10% of DERs at the time of use.

Option 1: Emission fees (with or without redistribution of fee revenue)

Pros: Raise or lower fees as more data are received

Cons: Planning authorities may not customarily obtain the economic information necessary to justify the starting fee rate. Unless fees are rebated, in general, sources or source categories incur greater out-of-pocket costs than comparable cap-and-trade program (assuming allowances are given away to existing sources).

Option 2: Emission budgets (cap and trade)

Pros: Emissions are directly limited

Cons: Historically, the allocation process has led to inflated emission budgets and market distortions

Option 3: Rate-based emission reduction credit program

Pros: Planning authority does not need to determine how to allocate emission allowances to every covered source

Cons: Does not limit aggregate emissions from covered sources unless rate is automatically adjusted to reflect change in activity

Option 4: Discrete emission reduction trading (no cap)

Pros: Planning authority does not need to determine how to allocate emission allowances to every covered source, nor does the planning authority need to determine the target, aggregate, average emission rate

Cons: Does not limit aggregate emissions from covered sources; DER retirement provision (10% deduction) is equivalent to a tax or tighter control limit for traders

3.7	Attributes That Make Incentive-Based Programs Work

The attributes which appear in the four following lists are not requirements but ideals. Further, taken as a whole, the lists are best used to compare one type of incentive-based program to other incentive-based programs. Thus a regulator, having decided to use an economic incentive to achieve an air quality objective, can inform his or her choice of a specific incentive by determining which attributes are most likely to be fulfilled by his or her regulatory development process.

3	3.7.1	Attributes That Make Emission Budget Progams Work

•	A well-defined set of included sources

•	Included sources are a major portion of the air quality problem, although the sources do not necessarily need to be the largest sources

•	Emission quantification methods which are generally accepted as precise, unbiased, and trustworthy, and the measurement error is quantified and accepted

•	Emission sources could feasibly collect the data used to calculate emissions

•	Small potential for emissions to shift from included sources to excluded sources

•	Given the purpose of the emission trading program, the justification for the total emission budget is acceptable

•	Methods for allocating budget shares do not depend on unavailable data

•	Probable emission spikes (short-lived peaks) or localized increases in emissions would not lead to unacceptable degradation in air quality

•	Adequate penalty provisions

3	3.7.2	Attributes That Make Non-Budget Emission Trading Progams Work

•	Comparing potential trading partners, emission control cost differentials exceed transaction costs

•	A cap on the total emissions from participating sources is not crucial for achieving air quality objectives

•	Well-defined emission baseline (from which surplus emission reductions are calculated)

•	Emission quantification methods which are generally accepted as precise, unbiased, and trustworthy, and the measurement error is quantified and accepted

•	Emission sources either already collect much of the data used to calculate emissions or could feasibly do so

•	Probable emission spikes (short-lived peaks) or localized increases in emissions do not lead to unacceptable degradation in air quality

•	Adequate penalty provisions

•	Regulatory agency has sufficient resources to administer and enforce a program

3	3.7.3	Attributes That Make Emission Fees Work*

•	Relevant governmental body possesses legal authority to levy emission fees

•	Fees levied on emissions or on an activity or commodity that bears a reasonable relationship to actual emissions or potential emissions

•	Reasonable fees to motivate significant emission reductions

•	Methods for measuring the basis of the fees which are generally accepted as precise, unbiased, and trustworthy, and the measurement error is quantified and accepted

•	Possibly substantial divergence between expected emission reductions and results from fees is acceptable

•	Increase in emissions over time from included sources is acceptable

•	Regulatory agency increases fees within a reasonable period of time if fees are initially set too low

•	Relevant governmental body authorizes regulatory agency's use of fee revenue

•	Planned use of fee revenue is generally accepted

•	Rebate mechanism (if any) does not dilute the incentive

•	Adequate penalty provisions

*Similar attributes apply to subsidies for emission reductions.

3	3.7.4	Attributes That Make Consumer Information Mechanisms Work

•	Consumers have ability to reduce emissions

•	Consumers understand intent of providing information

•	Information specifically identifies desired behavior

•	Information motivates behavioral change

•	Information is provided early enough for consumers to have the time necessary to change their behavior

•	Information is provided frequently enough, through enough media, and in sufficient variety to blanket target audiences and continually get their attention

•	Where target populations are culturally diverse, information is tailored to each cultural group

•	Regulatory agency collects data (before, during, and after implementation) that allow comparison of emissions with and without program

4	EARLY REDUCTIONS

4.1	Problem Statement

Except for rate of progress requirements, States do not need to plan for emissions reductions to reach attainment of the NAAQS before the required date of attainment. Especially given the long lead times for SIP submissions and attaining the ozone and PM2.5 standards recently issued by EPA, society would benefit from reductions in emissions that occur ahead of this schedule. In addition, the cost of implementing reduction programs "all at once" is extremely high. Shortages of materials and engineering talent, suboptimal technology choices, higher cost, and delayed implementation have been the result of this approach in the past. Creating incentives for early reductions create benefits that include increased experimentation with alternative technologies, incremental improvements of existing technologies, fine-tuning of operational techniques, and incentives for developing and implementing the most cost-effective technologies first.

Therefore, there is a desire to create incentives, targeted at States and emission sources, for early reductions, meaning actual pollution reductions which occur ahead of any regulatory or legislatively mandated schedule. In general, early reductions are measured from prior, actual emission levels rather than prior allowable levels; the concept of early reductions does not apply when prior, actual emission levels exceed prior allowable levels. At the same time, there is concern that programs to foster such early reductions, such as a trading program with banking, may ultimately lead to increases in emissions beyond the attainment date and therefore delay attainment. Regulatory innovations should expedite, not delay attainment. The challenge of this section is to suggest two incentive structures that provide for real emissions reductions and achieve air quality progress at a more rapid rate while still delivering lower costs.

4.2	General Issues

4.2.1	Establishing the Overall Baseline

Early reductions are measured against a baseline showing mandated reductions. The baseline would represent expected levels of reductions at any point in time as established by the combination of requirements for programs during SIP development, reasonable further progress and attainment scheduled to be in effect at each point in time. The rules for establishing the baseline are obviously important and would need to be provided by EPA as guidance to ensure uniformity of treatment of early reductions across States. This would be particularly important for States participating in the same emissions trading program or in other regional-based pollution reduction programs.

4.2.2	Equitable Future Treatment

To avoid negative incentives, early reductions programs should provide assurances that those sources who voluntarily reduce emissions ahead of schedule will be treated equitably when mandatory reductions for a source category are required. This can be accomplished by incorporating program features that assure a source will not prejudice itself relative to other sources. For example, covered sources would be subject to across-the-board percentage reductions of their starting point, not their reduced actual level of emissions.

4.3	Programs

4.3.1	Safe Harbors

Sources will not engage in early reductions, that is, in taking some costly action before they are required to do so, unless they see a return greater than this cost. One way that such a return can be obtained is through the establishment of a "safe harbor." If a source reduces emissions early, the source will be provided a grace period during which the regulatory agency will not seek additional reductions. The longer the grace period, the greater the incentive for early reductions. Conversely, a program could be established that provided options for longer periods of safe harbor in return for greater levels of early reductions. In addition, the greater the likelihood that the source will be required to do more, the higher the value of the safe harbor. Also, the more rapidly the source thinks that its compliance costs will rise over time, the greater the incentive for early reductions. To the extent that the safe harbor period extends beyond the attainment date or allows emissions at higher levels than the baseline, this effect needs to be explicitly compensated for in the design of the SIP.

4.3.2	Trading

A stronger incentive for early reductions can be provided by a trading system with banking. This system provides opportunities for early reductions to all market participants who for whatever reason see advantages from such actions.

Unfortunately, banking can create SIP planning concerns and might also result in future air quality problems if many banked emissions are used during the same episode (causing pollution spikes) or allow emissions for some interim period to be above the baseline for RFP (perhaps causing attainment delays or backsliding). Such scenarios may be judged unlikely, and could easily be addressed by, for example, emission rate limitations applicable during a potential episode of unusually bad air pollution. Indeed, this greater environmental certainty can be provided by any quantity or rate constrained program that explicitly links profits from early reductions to progress towards attainment.

4.3.2.1 Adjusting the Target

State and Federal air quality officials operate with substantial uncertainty concerning meteorology, inventories, and secondary formation of pollutants such as PM2.5 or ozone. Achieving certainty about the exact level of emissions that are allowable to achieve attainment in any particular location is unrealistic. A more common sense approach is to establish targets that are modified based on additional real data as reductions are achieved. This idea is most simply explained with the example of a cap and trade program with banking.

A cap and trade program can be established with the express provision that the cap may be altered depending on the state's assessment of its air quality achievements in relation to the NAAQS at specified intervals in the implementation period. If the State finds that it is doing too little, the cap may be tightened; if the State is ahead of its goals, the cap may be loosened. If the cap is tightened, any banked emissions will go up in value. Thus, if trading participants put a high probability on the cap being tightened it pays them to obtain early reductions because they believe that the value of their resulting banked emissions will appreciate.

The most direct problem with this idea is that making the cap subject to change clearly adds uncertainty to the decision to participate in the emission allowance market. Uncertainties generally reduce participation, and the smaller the participation the smaller the efficiency gains from trade. However, the market provides a substantial benefit to the regulatory process because without the ability to bank emission reductions, the sources would face the same regulatory uncertainty with only incremental technological controls as the compliance option.

A partial way through this is to make the cap adjustment mechanism sufficiently automated or subject to clear, explicit, up-front rules. Since the environmental uncertainty can not be eliminated, participants in the market system should be assured that they will not be discriminated against compared to other sources of the environmental problem. Most importantly, sources require the assurance that although the emissions target level may change, they will retain the ability to use their early reductions toward compliance. If the regulatory agency wishes to maximize sources' certainty and participation in the market, it should make clear that it won't devalue banked allowances.

4.3.2.2 Tightening the Target

In situations where a target cannot be expressed in a tonnage cap (mobile sources for example), there may be additional uncertainty concerning the ultimate emission level that will exist. In that circumstance, the regulatory agency can estimate the rate of participation and the timing of the use of banked reductions and impose a correspondingly rigorous level of control (timing and/or allowable emissions) in the design of the program to assure that the SIP levels of emissions are reached.

5	CLEAN AIR INVESTMENT FUND

5.1	Goals and Strategies

The clean air investment fund serves the fundamental goal of improving the economic efficiency of attainment plans. This goal is achieved through one or both of two basic strategies. The first is to stimulate the development of clean air technologies. Deficiencies in current capital markets result in underinvestment in some desired technologies. The fund can correct some of these deficiencies, or market failures, by providing capital not otherwise available for investing in certain technologies, due to the scale of the required investment, the delay in a return, or the degree of risk, among other factors. It can also give local governments flexibility to seek out targets of cost-effective emissions reductions that, for one reason or another, lie outside of or are constrained by the regulatory system.

The second strategy is to provide a compliance option for sources when control costs reach or exceed a designated cost threshold. It should also be noted that there is a technological innovation incentive associated with the cost threshold, as well, but one that works directly through the regulated firms rather than through fund managers.

Relative emphasis on one or the other of these two strategies reflects two models of clean air investment funds. Under the first, a State, region, Tribe or other entity, can seek a high degree of participation in the fund and thus significant fund raising, by setting the fee level relatively low. This approach views the funding of new technologies and, potentially, the associated enhancement of private or public emission reduction credit markets, as an integral part of an area's nonattainment plan, fully complementing the plan's control measures. Under the second, the fund is used more as a relief valve when regulated sources face high control costs. Under this latter approach, fund investments are viewed as a last resort, allowing the area to obtain some emission reductions when more direct control options have proven too costly. Of course, areas can structure programs with elements of both approaches.

5.2	Benefits

The benefits of a clean air investment fund are many. The proportion of the various types of benefits realized will depend on whether the fund is designed to encourage use or whether it is viewed merely as a cost-relief mechanism. Potentially the fund offers several benefits, including the following:

•	Provide incentives for innovation and emission reductions: the fund provides an incentive for regulated sources to find innovative and cost-effective ways to reduce emissions in order to avoid having to pay into the fund.

•	Aggregator role: the fund can aggregate dollars for large-scale strategic investments that are unlikely to occur in private emission reduction credit markets.

•	Diversified investments: the fund also offers the advantage of diversified investments, potentially allowing a State or other entity who controls the fund to experiment with different emission reduction strategies, including both low-risk, lower-return investments (e.g., vehicle scrappage and repair) and higher-risk but potentially higher-return investments (e.g., new products, fuels or technologies);

•	Targeted investments: the fund can target specific emission reduction opportunities that regulations cannot address;

•	Bridge to private emission reduction credit markets: by providing funds for pilot projects and experimentation, the fund can serve as a valuable "jump start" for private emission reduction credit markets, by providing real-world opportunities to (1) develop quantification protocols that can later be used by private parties to fund emission reductions in private credit markets and (2) understand (and remove) barriers to and identify conditions conducive to technology advancement.

•	Compliance option: the fund can provide a one-stop compliance alternative for sources facing higher-than-anticipated compliance costs. Note, with the exception of private emission reduction credit markets, which are not uniformly available, there is no compliance option (e.g., variance) available for most SIP control requirements.

•	Regulatory certainty: the fund can provide regulatory certainty that costs per ton will be capped at a certain level.

•	Cost-effectiveness: the fund can help States and local governments find the most cost-effective paths to clean air.

•	Barometer of the accuracy of SIP control measure cost projections: the fund will indicate whether an area's control measure cost projections were accurate.

5.3	Design Principles

EPA guidance for the clean air investment fund program and the design of funds by States and other entities should keep the following principles in mind:

•	to maximize the autonomy of States, Tribes and local governments in crafting their attainment strategies;

•	to ensure that what a SIP requires for attainment is the fundamental guide for fund design;

•	to ensure that States, Tribes and local governments have adequate authority to operate such funds and that those entities provide adequate authority to their funds to make appropriate investments;

•	to enable States, Tribes and local governments to craft nonattainment plans that take into account local economic and political considerations;

•	to place special emphasis on developing incentives for technological innovation and advancement, and on technology transfer;

•	to ensure that the cost of attaining clean air standards is reduced and kept within a socially acceptable level; and

•	to increase State, Tribal, and local government tools to achieve environmental benefits; to invest in necessary infrastructure, and to develop appropriate accounting methods.

5.4	Geographic Scope

Presumably, the clean air investment funds will be established by States, Tribes, and/or local governments based on their own unique needs for technology advancement and compliance flexibility. When appropriate, States and local governments may consider entering into voluntary regional agreements to expand the operation of such funds to meet regional needs. In such cases, participating jurisdictions should address both special opportunities for investments in specific locations (i.e., to achieve the greatest possible regional benefit) and special impacts (e.g., shifting benefits within the region).

Additional issues accompany considerations of scope in the design of a fund. First, States or localities may decide to limit the geographic scope of a fund to increase the likelihood that the benefits of fund investments remain localized. This will decrease the chance that regulators will be forced to impose additional, potentially costly controls on sources that have already made contributions to the fund.

Second, public officials and advocacy groups may regard state-wide and regional funds in particular as plentiful sources of financial support for a wide range of worthy public purposes. Whatever the purpose, however, fund investments should be commensurate with the air quality benefits obtained. Investments that will yield very little measurable improvements in air quality should be subjected to especially close scrutiny.

Finally, large-scale R&D activities are best addressed at the national level. National authorities therefore may need to find appropriate mechanisms to access State or regional funds for such investments. One approach would bring national authorities into negotiations with individual State or regional funds to obtain a share of fund resources for national R&D investments. Another approach would require all clean air investment funds to set aside a fixed portion of their assets that would remain accessible to national authorities to finance R&D activities.

5.5	Price

An area should set the fund price based on its objectives for the fund (see item one). The fund price can be set by one or more of the following factors:

•	slightly above the price prevailing in private emission reduction credit markets (if any);

•	at or below applicable cost-effectiveness benchmarks (e.g., cost per ton) or caps; and/or

•	set as a result of bidding among emission reduction credit suppliers.

States would retain the flexibility, as a planning function, of differentiating among reductions (e.g., in setting different prices) if the State determines that certain reductions are likely to be more beneficial than others.

5.6	Payors and Funding Sources

States, Tribes, and local governments will need to decide who should have the option of paying into the fund. Potential payors could include the following:

•	any regulated entity or

•	only regulated entities in certain sectors (e.g., stationary, mobile, area source, consumer product).

States, Tribes, and local governments should have the flexibility to design a fund to meet their own unique objectives, and thus to set differing conditions for paying into the fund. Nevertheless, the President's Directive suggests that there should be some point at which every regulated entity should have the option to pay into the fund (e.g., at the very least when the cost of regulation reaches $10,000 per ton). It is important to keep in mind, however, that $10,000 per ton is meant to be illustrative of the kind of cost control obtainable through the use of clean air investment funds intended as relief valves when sources face high control costs. The circumstances that some areas face may require that the threshold for payment into a fund be set higher than $10,000 per ton.

Other funding sources could include voluntary contributions and funds collected from motor vehicle emission fees, among others.

5.7	Use of the Fund - Pollutants

States, Tribes, and local governments will need to determine how payments into the fund are best used. Among other questions, this judgment includes consideration of whether the fund should invest in NOX, VOC, or PM reductions and in what proportion. To a great extent these decisions need to be made on a case-by-case basis, according to each area's special circumstances. See also discussion of equivalency below.

5.8	Use of Fund - Investment Projects

Another important question regarding the use of the fund is what should be its investment projects. As suggested above, investment decisions should largely be determined by the State, Tribe, or local government that establishes or administers the program, based on the needs of its nonattainment program. Investments can include:

•	short-term, low-cost, surplus emission reductions (e.g., programs to accelerate the turnover of certain engines) and/or

•	longer-term investments in technology advancement, including investments in research and development, infrastructure, and the provision of subsidies for product purchases.

5.9	Use of the Fund - State/Local versus Federal Investment

Another important issue is what should be EPA's role in supporting such investment decisions. For example, should EPA set preferred priorities for funds or leave such decisions entirely to the States, Tribes, and local governments? If EPA identifies particular technologies that promise large-scale national or regional benefits, would it assist those technologies (and indirectly the States, Tribes, and local governments) to have EPA identify such national priority technologies and provide technical assistance (such as protocol development) for related investments?

Uses of the fund can have both local and national aspects. For example, some State, local and tribal investments might best operate as a laboratory for smaller scale experimentation, targeting unregulated sources or encouraging promising local emission reduction efforts. Other investments can be designed to operate on a larger scale, targeting development of nationally beneficial technologies.

One important issue is how best to achieve national-scale investments when funds are collected at the State, local, or Tribal level. EPA could significantly encourage States to harmonize their investments if it were to clear the way for certain targeted technologies (e.g., by defining in advance the benefits associated with the fund's investment in given technologies). Further discussion is needed regarding the best ways to achieve such large-scale investment.

As a caveat to this section, it is not intended that EPA, or any other governmental entity, would attempt to "pick winners" among competing technologies. Therefore, to the extent that national technology investments are made, one will need to consider appropriate mechanisms to ensure that private financial markets continue to determine outcomes and performance whenever possible.

5.10	Use of the Fund – Predictability of Funding

Sources paying into the fund on an annual basis may, at some later time, elect to withdraw from the fund and meet emission reduction responsibilities in other ways. This means that fund managers will need to take into account this uncertainty in cash flow when they make commitments to long-term projects.

5.11	Relationship to SIP Review

Determining the appropriate relationship between the clean air investment fund and an area's SIP will depend on the approach selected by each area.

If an area uses the fund as a compliance option for sources whose control costs reach or exceed the maximum level anticipated (as of some point in time) to be necessary for attainment or RFP, then arguably the area will not need to make any particular demonstration (e.g., that it can or has achieved equivalent emission reductions). By paying into the fund at such a price, a source is demonstrating that it cannot achieve reductions at the lower cost assumed when a control measure was adopted. These are the very sources that, in the absence of such a fund, would likely receive a variance or other regulatory relief. Whether and how an area should demonstrate equivalency if it chooses to set the participation price at a level lower than the anticipated cost of attainment or RFP probably also will depend on each area's need for technology advancement. One approach in such circumstances can be to allow an area to forego any specific equivalency demonstration provided that (1) the total percentage of the inventory paying into the fund as a compliance option is relatively small (e.g., less than 5%) and (2) the area can demonstrate that its investments are related to long-term attainment needs.

In either of the above contexts, areas using the fund should be able to avoid the need for difficult, short-term equivalency demonstrations, that can prevent them from making the very types of long-term, strategic investments for which the fund is designed. Instead, areas can provide EPA with a periodic (i.e., every three to five years) review of fund performance.

5.12	Verifying Emissions Reduction Benefits

As with any market program, EPA, the States, Tribes, or local governments will need to define responsibilities for quantifying and verifying emission reductions achieved by fund investments. The options for assigning responsibility are no different from those identified during discussions of other market programs (e.g., the State, Tribal, or local agency; EPA, private parties, a specially sanctioned entity (e.g., Underwriters' Laboratory); or some combination thereof). However, one advantage of the fund relative to other market programs is that it provides an opportunity for an agency (or other entity) to develop quantification protocols contemporaneous with actual pilot investments.

5.13	Verifying User Emissions

Also, as with any market program, sources using the fund as a compliance option will need to verify the extent of emissions reductions shortfall for which they are using the fund. The fund does not seem to raise any special issues here.

5.14	Reporting Fund Performance

As suggested above, fund performance should be publicly reported on a periodic basis (e.g., every 5 years).

5.15	Temporal Issues

There are at least two sets of timing issues associated with the fund:

•	Timing of Emission Reductions. Can the fund invest in future reductions to offset current reduction commitments (particularly if the cost of current reductions exceeds the anticipated cost level, i.e., cost-effectiveness cap)? See item 9 for a discussion of whether an area would need to make an equivalency demonstration at all.

•	Timing of Participation. Presumably, a regulated source would pay into the fund at or near the time for which an emissions reduction shortfall occurs (e.g., on an annual basis). If advance participation is required, how much advance notice? If after-the-fact participation is allowed, must the participant pay a higher price (e.g., a penalty for not predicting the shortfall)?

5.16	Other Issues

There are a variety of other issues that implementing jurisdictions may wish to consider, including the following:

•	Non-Cash Contributions. May a participant contribute other assets, such as equipment, services?

•	Fund Management. Should the fund be managed on a public or private basis?

•	State Authority. Must States create statutory authority for clean air funds? Can localities create funds on their own?

•	New Source Review. Should States be allowed to use the fund to enable new or modified sources to meet NSR offset or LAER requirements (e.g., by making up shortfalls in either requirement)?

•	Periodic Adjustments. States should periodically review fund performance and make appropriate adjustments in price and structure to improve performance and assure accountability.

•	Indirect Fee-Setting. While the fund can be integrated with fee and/or budget allocation programs, States should not use the fund as an indirect means of imposing fees on sources (i.e., by imposing technology control measures that they know to cost more than the fund price) simply to raise revenues. Periodic fund reviews should disclose whether all, or almost all, of the sources subject to particular control measures have paid into the fund in lieu of installing controls contemplated by a control measure. Such a finding should provide a basis for reviewing, and potentially revising, the measure to correct cost-effectiveness assumptions or other observed inequities.

Appendix 1. Examples of Economic Incentive Programs

RECLAIM

RECLAIM stands for the Regional Clean Air Incentives Market program. It is one of a series of reforms initiated by the South Coast Air Quality Management District (SCAQMD) in 1991. The program applies to NOX and SOX emitted by sources that produce more than four tons per day of either pollutant. RECLAIM Trading Credits (RTCs) have been allocated to sources based on adjusted peak annual emissions between 1989 and 1991. RTCs depreciate as a mechanism designed to achieve target emission levels by 2003. A limited number of significant trades have occurred, for example one valued at $1.27 million accounted for 1,700 tons of NOX up through the year 2011. Cost savings were forecasted to average $57.9 million per year from 1994 through 1999, or about 40% less cost for equivalent emission reductions.

Northeast States' Rules to Implement OTC NOX MOU

Several Northeast States (OTC members) have drafted rules to comply with the Ozone Transport Commission's September 27, 1994 Memorandum of Understanding creating a regional (OTR) NOX cap-and-trade program. This emission trading program operates only during the ozone season. During Phase II of the OTR's NOX Budget Program, which begins May 1, 1999, "budget" sources begin the ozone season subject to an individual emission cap and with an allocation of allowances in their "compliance account;" budget sources are defined as fossil fuel-fired boilers or indirect heat exchangers with a maximum rated heat input of 250 MMBtu or more, fossil fuel-fired electric generating facilities with a rated output of 15 MW or more, and opt-in sources. At the end of each year, every budget source must have a number of allowances in its compliance account that equals or exceeds the tons of NOX it emitted during the past ozone season. In all States, budget sources may bank allowances for an indefinite period, and withdrawals of banked allowances are subject to flow control. Opt-ins are allowed.

The bases for allocation proposed by the States range widely from historic emissions to target emission rates. States are also proposing to provide for new sources through a variety of mechanisms such as reserve accounts. These differences in allocation method have been of some concern to the members of the regulated community operating in more than one state.

Connecticut's Market-Based Program for NOX Reduction

Prior to the implementation of the OTC based rule, Connecticut's Market-Based Program for NOX Reduction allows sources to use emission reduction credits and averaging ("bubbling") to comply with NOX RACT and the new source review offset requirement. Shutdown or curtailment of production may not be used to create emission reduction credits (ERCs) to be used for NOX RACT compliance. Only ERCs created during the ozone season may be used during the ozone season. In order to create an ERC, a source must have taken an action after 1992 to produce a reduction in emissions. ERCs must be approved by the Department before use. From June to December 1995 (the first six months of implementation), twenty seven sources reported using 609.3 tons of NOX ERCs. One-third of the major regulated NOX sources in Connecticut chose a market-based approach to compliance. The State approved use of 11,336 NOX ERCs from two sources in Connecticut and New Jersey.

Illinois Emissions Reduction Market System

The State of Illinois is completing rulemaking for the cap-and-trade Emissions Reduction Market System that is designed to implement innovative and cost-effective strategies to attain the ozone NAAQS in the Chicago ozone nonattainment area primarily by reducing emissions of volatile organic material (VOM) from stationary sources. In general, the sources that will be required to participate in the program have VOM emissions of 10-tons or more during the ozone season. Each season, existing sources will receive Allotment Trading Units (ATUs) from the State; a source's seasonal emission allotments are based on its pre-program VOM emissions. Participating sources may buy ATUs from the State's Alternative Compliance Market Account, which is a reserve created by mandatory deposits of 1% of sources' allotments. A process is provided to issue ATUs for emission reductions from mobile and area sources.

Area Sources: Woodstoves (Colorado) and Grass Seed Field Burning (Washington)

Economic incentives are used in local programs to control emissions from area sources. The town of Telluride in Colorado, which in past winters has had a PM problem, has implemented a marketable permit program to place a cap on the number of wood-burning stoves. Another example is the marketable-permits program being developed by Washington State to facilitate implementation, by easing the financial burden on farmers, of the new statewide curb on burning grass seed fields.

Area and Mobile Sources: Ozone Transport Assessment Group (OTAG)

The Area/Mobile Sources Task Group of OTAG examined approaches to including area and mobile sources in a trading program. The key issue was how responsibility for emissions is to be assigned. By law, motor vehicle and engine manufacturers are assigned the responsibility for designing products to meet emissions standards, which set allowable emissions rates. The manufacturers do not have control over how their products will be used or maintained. In contrast, the owners and operators of area and mobile sources, and/or government, have control over the levels of activity that determine total emissions.

The OTAG Task Group considered inclusion of mobile sources in voluntary "opt-in" programs for the generation of emission credits, using credit generation protocols developed by the various States and/or EPA. If the responsibility for limiting the activity level rests with the party with influence over activity—the government or the vehicle owner—a system of credits could be established. For example, once the planning authority has set the target emission rate—X grams per vehicle mile traveled—emission credits would be generated by vehicles emitting less than X grams per mile, and vehicles could emit above that rate if adequate credits were purchased.

The Task Group also considered how area and mobile sources might become part of a cap-and-trade emission trading program. It developed a three-part conceptual model for implementation which covers 1) establishing the emission target for a source category, 2) allocating the emission responsibility to all covered sources, and 3) demonstrating compliance with the allocation (the last step applies to individual sources).

The Task Group developed two examples to illustrate the use of credits or allocations to supplement a State inspection and maintenance program, and also to apply trading mechanisms to a heavy-duty engine standard. The examples illustrate how the credits are calculated, and how the emission reduction responsibility is allocated.

EPA Programs

The emission trading programs developed by EPA, or with its guidance, have progressively expanded the scope of trading, increasing in turn the allowed flexibility sources possess to meet their emission reduction responsibilities, and the breadth of the emission reduction goal. EPA's programs and rules encompass netting (introduced in 1974), offsets (1977), bubbles (1979), the lead trading program (1982), the emissions trading policy statement (1986), the SO2 allowance trading program (1990), Economic Incentive Programs (EIP) rules (1994), and the Open Market Trading Rule (proposal 1995).

Phase I of the SO2 emissions trading program took effect in 1995. It requires the "dirtiest" 110 electric utility coal fired power plants to reduce emissions. Phase II takes effect in 2000. It will affect all utility sources greater than 25 MW that burn fossil fuels. Phase I will lower the average SO2 emissions to about 2.5 lb/MM Btu, or about 6.9 million tons reduced annually. Phase II will lower the average emissions to below 1.2 lb/MM Btu, or about 8.95 million tons allowed annually. By early 1995, 27 major trades had exchanged 2.3 million allowances, and the price was about $170 per ton. A separate auction totaled 326,210 tons traded. In 1994, the GAO estimated almost 40% lower costs for limited allowance transfers, relative to a command and control baseline. For 2001, the projected costs for the command and control baseline were $4.3 billion, for constrained trading were $2.5 billion, and for a flexible implementation scenario were $1.4 billion.

In 1995, EPA proposed a model rule for an open market trading program. The responses to the proposal will result in a guidance document for States to use in creating a market for "discrete emission reductions" (DERs). Sources may generate and use DERs for compliance with VOC and NOX requirements in the Clean Air Act. At the time of use, DER users permanently retire ten percent of all DERs dedicated to that particular use. The open market trading guidance (OMTG) does not place restrictions on who can own or hold DERs, nor does it require government notification or tracking of DER ownership transactions.

National EPA Programs for Area and Mobile Sources

Programs have been national, regional, State, or local in scope. Nationally, the EPA has incorporated incentives measures into many of its programs to reduce emissions from mobile sources.

The lead phase down program incorporated trading and banking from 1983 to 1987, to help implement the schedule of lead reduction from 1.1 grams per gallon of gasoline sold in 1982 to 0.1 grams in 1986. From 1983 to 1985, this program allowed for the trading in lead credits among refiners and importers. All credits generated in a quarter had to be used within that quarter. Beginning in 1985, the agency allowed refiners to bank lead credits until the end of 1987. The number of participants in the program reached 537 in the third quarter of 1985. A total of 10 billion grams of credits were banked, with a projected cost savings of 2.5 cents per gram banked.

The EPA is also incorporating averaging, banking and trading (ABT) components into many of its rules on engine standards. These programs allow manufacturers to meet an engine emission rate standard on average. The manufacturers may average the standard across their own engine families, may trade credits with other manufacturers, and bank credits for meeting standards before the requirements go into effect. The heavy-duty on-highway engine program has incorporated this component since 1989. Other proposed and final rules (heavy-duty on-highway engines, heavy-duty nonroad engines, marine engines, small nonroad engines, and locomotives) incorporate averaging, banking, and trading.

Regional, State and Local Programs for Area and Mobile Sources

Many areas around the country have implemented a wide range of incentive types of programs. These programs can essentially be grouped into three categories: trading or credit generation strategies, fee programs, and subsidy and buy back programs.

Trading/ Credit Generation Strategies

Trading involving the mobile source sector has largely consisted of strategies to generate credits that can be used for compliance flexibility by stationary sources. Many of the proposed and implemented trading programs allow for generation of credits from a number of sources.

In California, a number of specific rules have been adopted allowing for the generation of credits by mobile sources. The South Coast Air Quality Management District has five rules which allow for the generation of mobile source emission reduction credits (MSERCs). MSERCS can be used by or traded to stationary sources for alternative compliance with certain SCAQMD regulations. These rules include 1) voluntary repair of high-emitting motor vehicles, 2) old vehicle scrapping programs, 3) voluntary operation of low- or zero emission off-road equipment, 4) voluntary operation of low- or zero emission on-road vehicles, and 5) voluntary scrapping and replacing of existing lawn and garden equipment with new equipment which meets lower emission standards or voluntarily purchasing of new low- or zero emission lawn and garden equipment.

In addition, the San Diego Air Pollution Control District allows for the generation of mobile source emission reduction credits through five programs: 1) accelerated vehicle retirement, 2) purchasing and operating new low emission buses, 3) purchasing zero-emission vehicles, 4) retrofitting passenger cars, light duty trucks, and medium-duty vehicles, and 5) retrofitting on-road heavy-duty vehicles and engines to low-emission configurations.

Fee Programs

Many areas have begun to explore the possibility of fee programs to reduce traffic congestion and emissions. The Department of Transportation is currently sponsoring a ten-city pilot project/study to examine the feasibility and potential effectiveness of congestion pricing. While the primary goal of the programs being looked at is to reduce traffic congestion during peak travel times, the study recognizes the potential benefits to air quality as well.

Several pilot projects have begun. In Orange County California, the first congestion priced toll road in the United States opened in December, 1995. The fee for the entire ten mile stretch of road varies from $0.25 to $2.50 in peak hours. Vehicles with three or more occupants are exempt from the tolls. The air quality benefit is uncertain, however, as road capacity has increased, while traffic flow has improved.

The San Diego Association of Governments (SANDAG) is also implementing a congestion pricing project on two HOV express lanes on I-15. Like SR 91, the other lanes will remain free of charge. The project is being implemented in two stages. Initially, vehicles can buy month-long passes to use the express lanes. In June, 1997 electronic toll technology will be implemented allowing for variable tolling depending on the time of day.

In Los Angeles, the REACH (Reduce Emission and Congestion on Highways) task force was formed in 1995 with the charge to study the potential for implementing a regional system of transportation user fees (both emissions and congestion based). The task force included representatives from business and industry, environmental and policy groups, local, regional and State government officials, and concerned citizens. In January of 1997 the group approved a report recommending several transportation pricing implementation steps and requirements for project monitoring and evaluation. As a first step, the group recommended the implementation of high-occupancy toll lane projects by 1999. All of these projects must consider the use of both congestion and emissions fees.

The pricing of parking also is used to reduce the demand for single occupancy vehicle travel, thereby potentially reducing emissions. For example the city of Santa Monica, CA enforces the California Assembly Bill (AB) 2109), parking cash-out. Employers of 50 or more who meet specific criteria are required to offer eligible employees the option, in lieu of subsidized parking, of a cash allowance equivalent to the parking subsidy. Employees have the choice of forgoing the cash offer and continuing to receive subsidized parking, or accepting the offer and paying for parking or finding an alternative way to work. A total of 23 employers are operating a parking cash-out program.

In Glendale (California) the Nestle Company and Common Wealth Land Company discontinued subsidized parking for solo driver employees while offering incentives to commute using an alternative mode of transportation.

Subsidy and Buy Back Programs

Several areas and private companies have implemented vehicle scrappage programs. In addition, several areas have recently implemented or studied the possibility of buy back programs for non-road engines and equipment.

Lawn mower buy-back programs have been implemented in Maryland, Portland (Oregon), and Maricopa County (Arizona). In the Maricopa County program, on three consecutive Saturdays in August, 1996, Salt River Project (SRP) (an electric utility company) offered customers and employees a $100-$140 rebate for the on site purchase of electric lawn mower in exchange for bringing in a gas-powered mower for scrappage. $20 rebates were offered for leaf blowers, trimmers, and edgers. 1,967 lawn mowers and over 100 pieces of other lawn care equipment were turned in.

The Wisconsin Department of Natural Resources sponsored a survey of boat owners in the summer of 1995 to determine if an outboard engine buy back program would provide cost-effective emission reductions. The cost per ton of VOCs removed was estimated to range from $4,000 for 100 horsepower engines to $10,000 for 10 horsepower engines. This was determined to not be cost-effective, and the implementation of the buy back program is currently on hold.

Other Subsidies

Many programs are in place throughout the country that provide financial incentives to commuters to reduce single occupancy vehicle travel. One example is the Washington State Commuter Trip Reduction Law, under which many employers offer subsidies for mass transit, and localities offer mass transit discounts or subsidized van pool formation costs. Another example is the Milwaukee Commuter Check.

In Chicago, San Francisco and Los Angeles, the Natural Resources Defense Council, the Center for Neighborhood Technology and the Surface Transportation Policy Project are sponsoring the "Location Efficient Mortgage (LEM) Partnership." This program considers the transportation cost savings related to the location of a property. Consideration of location efficient factors may increase the pool of qualified applicants for mortgages and qualify applicants for bigger mortgages. LEMs are hoped to be an inducement to reside in densely populated neighborhoods near public transportation, thereby helping to reduce congestion and improve air quality. It is hoped that location efficient mortgages will be issued starting in the spring of 1997.

In Los Angeles, the South Coast Air Quality Management District and the Mobile Source Air Pollution Reduction Review Committee (MSRC) are sponsoring the Quick Charge Program, which provides a $5,000 vehicle subsidy to manufacturers that is applied directly to the sticker price of approved zero emission vehicles (ZEVs). Funding has come entirely from vehicle registration fees. A similar program for alternatively fueled ultra-low emissions vehicles (ULEVs) is under consideration.

Additional Programs in California for Area and Mobile Sources

Air District Corridor Working Group

The purpose of this working group is to coordinate efforts to implement heavy-duty vehicle emission reduction programs as well as share technical information among various air pollution agencies in California. Members include the California Air Resources Board (CARB), San Joaquin Valley Air Pollution Control District, and the South Coast and Sacramento Metropolitan Air Quality Management Districts. Programs being evaluated for funding target on-road vehicles weighing more than 21,000 pounds using low-emission technologies implemented through repower (engine replacement), retrofit, or new-vehicle purchase. Funding will be used to offset the differential cost between low-emission technologies and diesel engines meeting mandatory emission requirements. Projects will be selected based on emission level and cost-effectiveness criteria.

California Ad Hoc Working Group on Heavy-Duty Vehicles

This is a working group of California-based interests affected by the truck-emission provisions of the California State Implementation Plan (SIP). Members include the South Coast and Sacramento Air Quality Management Districts, Coalition for Clean Air, Natural Resources Defense Council, Sierra Club, Cleaner Air Partnership, Environmental Council of Sacramento, and California Trucking Association. This group was originally formed to provide a response to EPA's truck related provisions of the Federal Implementation Plan. The group's current focus is the promotion of State legislation that would fund or otherwise advance the implementation of truck related SIP control measures including: 1) Control Measure M4 - Early Introduction of 2.0 g/bhp-hr NOX Engines in Heavy-Duty Diesel Vehicle Fleets through Incentives, 2) Control Measure M5 - Additional Reductions Equivalent to a California only 2.0 g/bhp-hr NOX Standard for Heavy-Duty Diesel Vehicles, and 3) Control Measure M7 - Accelerated Retirement of Heavy-Duty Vehicles. A bill is currently before the State legislature calling for a 30 cents per barrel surcharge on crude oil. If passed this bill will provide up to $125 million dollars per year for incentive programs to reduce heavy-duty diesel-related emissions.

California Low-Emission Vehicle Program

In 1990, CARB adopted the Low-Emission Vehicle (LEV) Program, applicable to new light-and medium-duty vehicle sales with implementation beginning in the 1994 model year. The LEV program contains four categories of increasingly cleaner emission standards requirements: transitional low-emission vehicles, low-emission vehicles, ultra-low emission vehicles, and zero-emission vehicles. The LEV program provides a market-based approach which allows vehicle manufacturers considerable compliance flexibility. For light-duty vehicles, manufacturers are not required to phase-in specific percentages of vehicles certified to each low-emission vehicle category. Instead, a fleet average requirement allows manufacturers to certify any combination of low-emission vehicle categories provided that an overall fleet average is met. Additional flexibility is provided through the use of a marketable credit trading system. Manufacturers that produce more low-emission vehicles than needed to meet the fleet average requirement will generate credits which can be banked, traded or sold to other manufacturers. For medium-duty vehicles, a similar market-based approach is utilized. Manufacturers must meet specific percentage phase in requirements for each low-emission vehicle category; exceeding these requirements will generate marketable emission credits, which allows these manufacturers significant compliance flexibility.

Accelerated Retirement of Light-Duty Vehicles

In the South Coast Air Basin in 2010, light-duty vehicles eight years and older account for about 60 percent of all light-duty ROG emissions. This occurs because the newer model vehicles must meet significantly more stringent emission standards compared to the remaining older vehicles. Control Measure MI of the AQMD's Air Quality Management Plan involves the annual retirement (scrap or removal) of up to 75,000 older, high-emitting vehicles in the South Coast Air Basin, beginning in 1999. A smaller number of vehicles will be retired in 1997 to 1998 in order to gain experience with the program, and to gain insight into the effects on the used car market. CARB is currently developing statewide requirements which specify vehicle eligibility requirements and emission reductions generated when a vehicle retirement program is implemented. Adoption of these requirements is expected in June 1997, along with the initial implementation of the small scale vehicle retirement program.

Alternative Control Plan Regulation

The Alternative Control Plan (ACP) supplements existing State regulations for VOC emissions from the use of consumer products by allowing emissions averaging/bubbling. Limits can be placed on aggregate emissions from a group of products rather than on emission from individual products. Manufacturers (or other "responsible ACP parties") can sell products that exceed VOC standards in the existing regulations provided that the emissions from these high-VOC products will be offset by the emissions from other products reformulated to "over-comply" with the standards. Participation in the ACP is voluntary (although the existing VOC regulations are mandatory). For the benefit of businesses without sufficient resources or product diversity to significantly average emissions under an ACP bubble, the ACP allows limited trading of "surplus reduction credits." Only small businesses and businesses that market only one product or product line subject to the existing VOC regulations can purchase surplus reduction credits. An exception is made under certain conditions when a business needs credits to reconcile an exceedance of the ACP bubble limit. Businesses of any size can sell surplus reduction credits.

Appendix 2. Economic Incentive Design Principles

Regional marketable permit programs or other incentive-based regulations should be structured on the following principles:

a) prevent the possibility of area-wide backsliding,

b) include the broadest possible spectrum of sources contributing to the problem, including especially mobile and area sources,

c) account for the differing temporal and geographic impact of reducing the pollutants of concern,

d) provide for evaluation and verification of environmental performance,

e) provide a consistent program across emission source types in order to ensure a common or convertible "currency" for emission trading purposes,

f) provide for transition from other emissions trading programs adopted by OTAG, OTC, and States, as necessary or appropriate,

g) provide for seamless trading across governmental jurisdictions,

h) avoid the creation of bias or market distortions,

i) reward or protect sources that accomplish innovative, early, or voluntary reductions including those later required by law (early reduction credit, baseline protection, etc.),

j) avoid delays in meeting or dilution of reduction responsibility (e.g., no delayed compliance schedules or alternative emission limitations),

k) use economic incentives or market-based mechanisms rather than command-and-control strategies (e.g., LAER) to assure that appropriate levels of emissions are achieved by new or modified major sources, and

l) provide equivalent environmental benefit as compared to command-and-control approaches. (When used as an alternative to a technology requirement, some sharing of the benefit of lower costs should be reflected in a net environmental benefit.)

Appendix 3. Connecticut Department of Environmental

Protection's Survey on Attitudes Toward Early Reduction Programs:

Questionnaire Cover Letter and Results

September 15, 1997

To: National/Regional Strategies Work Group Members

From: Joe Belanger

I am distributing the following survey to assist me in the efforts regarding the Early Reduction Issue being considered by the Economics Advisory Group. It is being sent to all members of the National Regional Strategies Work Group.

Name _____________________________________ (Name is optional, but I would prefer to have your name so I can contact you if I need to ask about your responses.)

Sector: (check one)

( ) Industry or small business

( ) U.S. Environmental Protection Agency

( ) Other Federal agency

( ) State or local agency

( ) Environmental or public health interest group

( ) Academia

Introduction. On August 20th, I suggested a survey of the Work Group members' attitudes toward incentives for early reductions. Because of restrictions on the use of federal resources for such activities, I am circulating and compiling this on my own.

An early reduction is a creditable, "surplus" emission reduction that occurs either before implementation of a new regulatory program or before a deadline imposed by an existing regulatory program. Societal benefits from early reductions could include faster improvement in air quality. Another potential benefit is collection and dissemination of information on currently unproven strategies that are supported by such programs as a Clean Air Investment Fund. The benefits to sources could include early testing of innovative technologies, good public relations, production cost savings, and extension of compliance dates. Another way to ensure that a source realizes an adequate return on its investment in early emission abatement would be to allow early reductions to be sold or used as an alternative compliance option according to a SIP-approved emission trading program. Depending on the specific emission trading program, trading may result in early reductions being exchanged for later emission increases or a delay in emission decreases. The net environmental benefit of early reductions may vary from case to case and conceivably could be zero or negative.

Instructions. After providing your name and organizational affiliation, you will find two sections representing alternative perspectives. Please complete either or both sections as you feel appropriate. Fax the completed survey to me at (860) 424-4063 by the close of business on September 16, 1997.

Thank you!

Section 1 (from industry and small business perspectives)

7 Respondents

1 Has your company (or companies you are familiar with) participated in the following programs?

a) 33/50 Program

b) WasteWi$e

c) Climate-Wise

d) WAVE (Water Alliance for Voluntary Efficiency)

e) Energy Star Buildings

f) Green Lights

g) Design for the Environment

h) HAP Early Reductions Program

i) Project XL

j) Climate Challenge (DOE program)

k) Emission banking under the Title IV SO2 allowance trading program

Additional: Natural Gas Star Program (methane)

Yes (4)

Yes (1)

Yes (0)

Yes (0)

Yes (2)

Yes (7)

Yes (1)

Yes (0)

Yes (2)

Yes (3)

Yes (3)

No

No

No

No

No

No

No

No

No

No

No 2 If your company (or companies you are familiar with) participated in one or more of the programs listed in question 1, please indicate whether the following incentives provided a significant motivation for participation.

a) Savings from reduced production costs

b) Publicity

c) Extension of deadline for compliance with regulations

d) Revenue from sale of emission reductions

e) Other (please specify):

"In anticipation of potential future regulations."

Provide compliance alternatives and safety nets.

* "Depending on length of extension."

Sig. (5)

Sig. (7)

Sig. (4)

Sig. (3)

Not Sig. (1)

Not Sig. (0)

Not Sig. (3)*

Not Sig. (3) 3 Thinking about the pollutants which are responsible for ozone or PM-fine, would your company (or companies you are familiar with or companies whom you represent) generate early reductions if the only incentive were:

a) Savings from reduced production costs?

b) Publicity?*

c) Extension of deadline for compliance with regulations?*

d) An opportunity to explore unproven but promising emission reduction strategies?*

e) Revenue from sale of emission reductions in a trading program?

f) Other (please specify): None

*Please specify the minimum incentive you would require:

Compliance extensions equivalent to emissions reduced over time. Few restrictions on banking of emission reductions.

Assurances against enforcement actions.

Avoidance of excessive monitoring requirements.

Cost of early reductions must be significantly less than the cost of meeting compliance deadline over the length of the extension period.

Yes (7)

Yes (1)

Yes (4)

Yes (4)

Yes (5)

No

No

No

No

No 4 For the pollutants which are responsible for ozone or PM-fine, an incentive for early reductions that is under consideration is protecting companies' baselines if further controls are necessary to achieve one or both NAAQS. What protection do you think is necessary?

a) Baseline protection: specifically, if a future emission reduction requirement is set as a reduction (in tons or percent) from a baseline level, a source would be able to use its pre-early reduction emission level as its baseline.

b) Safe harbor: specifically, if a source produces a specific amount of early reductions, then it is protected from further emission reduction obligations for a specified period of time.

Give us your thoughts on the relationship between the amount reduction and the length of time the safe harbor applies to a source? How much reduction would should be required for a source to receive a safe harbor? For how long should the safe harbor apply? For example, the toxics early reduction program requires 90% Hap reduction and 95% PM HAP reduction control for a six year safe harbor.

90-95% HAP reduction too high for a six-year safe harbor.

75% reduction from 1990 tonnage baseline should yield a safe harbor until 2010.

Safe harbor should last until other sources achieve a similar level of control.

Safe harbor should protect against further reductions that would go beyond those to meet NAAQS. Additional reductions should be exacted from other source categories.

c) Both baseline protection and a safe harbor

Yes (5)

Yes (6)

Yes (3)

No

No

No 5 What are the requirements for flexibility in the timing of when emission reductions can be used?

i) The reductions must be contemporaneous, as in most classic trading programs. In other words, the reductions must be used in the same compliance period.

ii) The reductions could be used to provide alternative compliance options for future emissions reduction responsibilities (possibly delaying planned emission reductions), as with banked ERCs or in the Open Market trading program. In other words, the reductions could be used in future compliance periods.

Accept-able (3)

Accept-able (7)

Not Acceptable (4)

Not Acceptable (0) 6 How should considerations of environmental justice influence incentives for early reductions? Please enter your answer in the space provided below.

Environmental justice should not be a consideration because environmental justice is too ill-defined a concept.

Environmental justice is not a consideration in ozone and PM2.5 precursor pollutants because of their "distant and widespread" effects.

The entire early reduction program should be reviewed with regard to environmental justice, not individual uses, understanding that emission standards are health-based. Use of credits and trading should be allowed at facilities with emissions below health-based standards.

Sources that cause or contribute to local health problems (by violating emission standards) should not be able to trade. However, trading may be an incentive to induce early reductions to improve local air quality.

End of Section 1

Section 2 (from other than industry and small business perspectives)

5 Respondents

7 Thinking about ozone and PM precursor emissions, which benefits should be provided to encourage early reduction?

a) Company savings from reduced production costs

b) Publicity*

c) Extension of deadline for compliance with regulations*

d) An opportunity to explore unproven but promising emission reduction strategies*

e) Revenue from sale of emission reductions in a trading program?

f) Other (please specify): None

*Please specify the maximum incentive you would provide:

Maximum incentives, provided an environmentally superior result is ensured.

Yes (5)

Yes (4)

Yes (2)

Yes (3)

Yes (3)

No

No

No

No

No

8 For the pollutants which are responsible for ozone or PM-fine, an incentive for early reductions that is under consideration is protecting companies' baselines if further controls are necessary to achieve one or both NAAQS. What protection would you endorse?

a) Baseline protection: specifically, if a future emission reduction requirement is set as a reduction (in tons or percent) from a baseline level, a source would be able to use its pre-early reduction emission level as its baseline.

b) Safe harbor: specifically, if a source produces a specific amount of early reductions, then it is protected from further emission reduction obligations for a specified period of time.

i) How much reduction should be required for a source to receive a safe harbor?

Unsure, but there should be a minimum, and the reduction must be made much earlier than command-and-control compliance date.

ii) For how long should the safe harbor apply?

Unsure.

iii) Do you have any thoughts on the relationship between the amount reduced and the length of time the safe harbor applies to a source?

There must be some link.

c) Both baseline protection and a safe harbor

Yes (4)

Yes (2)

Yes (0)

No

No

No 9 What is acceptable to you regarding flexibility in the timing of when emission reductions can be used?

i) The reductions must be contemporaneous, as in most classic trading programs. In other words, the reductions must be used in the same compliance period.

ii) The reductions could be used to provide alternative compliance options for future emissions reduction responsibilities (possibly delaying planned emission reductions), as with banked ERCs or in the Open Market trading program. In other words, the reductions could be used in future compliance periods.

Req. (2)

Accept-able (2)

Not Req (2)

Not Accept-able (3) 10 How should considerations of environmental justice influence incentives for early reductions? Please enter your answer in the space provided below.

Environmental justice considerations do not enter discussion of the use of early reductions to cure broad, regional problems. Environmental justice considerations are valid in discussions of using early reductions to cure direct, harmful exposures caused local sources, where early reductions are a valuable tool.

Environmental justice considerations should be a factor in trading programs to prevent undue disparities in health risks.

Environmental justice considerations should be addressed during the design of the early reduction program.

Environmental justice considerations could be considered a partial settlement of enforcement cases.

End of Section 2