Market-based incentives to reduce air pollution have gained considerable interest and support over the past ten years. The concept encompasses the ideology of using the behaviors inherent to the free market as a tool to promote pollution abatement and control. This system implies a type of entrepreneurial flexibility to achieve desired results. For example, a company required to reduce emissions can choose a number of ways to achieve the limitation, including operational changes, installing pollution control equipment, utilizing efficient technologies and buying and trading pollution credits. The theory behind market-based incentives is supported by the concept that industrial source managers are more knowledgeable of their operations and are, therefore, the best entity to make cost-effective decisions. Ideally, the result should be increased regulatory flexibility and accelerated progress toward environmental goals.

Acid Rain Program

According to the EPA, this approach has been successful for the Acid Rain program, resulting in significant reductions in sulfur dioxide (SO2) emissions. In 1995, the first year of compliance under the program, SO2 emissions dropped by 3-million tons. Since then, emissions have dropped a total of 6-million tons below 1980 (baseline year) levels. The results include SO2 emissions currently running more than 30% below allowable emission levels. Even more intriguing, the costs to achieve these reductions were 75% below initial industry estimates.

Critics argue for greater SO2 reductions, as some studies indicate, that acid rain levels are not decreasing proportionately. Furthermore, there is concern regarding environmental justice and the impact to poorer neighborhoods as an issue of environmental equity. Most importantly, the critics should be viewing this program as a successful first step in creating a process to achieve emission reductions through increased regulatory flexibility.

Federal NOx Emission Trading Program

The success of the Acid Rain Program ignited similar interest for nitrous oxide (NOx) pollution management. On December 17, 1999, the EPA finalized the Findings of Significant Contribution and Rulemaking on Section 126 (Clean Air Act) Petitions for purposes of reducing regional transport of ozone. The final action requires 392 facilities in 13 States and regions to reduce annual NOx emissions by a total of nearly 510,000 tons. The affected facilities will participate in a federal NOx emissions cap-and-trade program aimed at reducing interstate ozone transport. (NOx reacts with volatile organic compounds in the presence of sunlight to form ground-level ozone). The cap-and-trade program effectively reduces air pollution by setting a permanent cap on emissions, then allowing trading within that cap.

The NOx Trading Program sets emissions limits for the affected sources in the form of NOx "allowances." One allowance authorizes the emission of one ton of NOx. To facilitate increased activity and accessibility to emission trading, the EPA recently released an Online Allowance Transfer System (OATS) to manage the current hold allowances estimated at over $20 billion. This online system will enable participants in the SO2 and NOx markets to record trades directly on the Internet instead of submitting paper forms to the EPA for processing. Furthermore, it creates greater opportunity for private parties to purchase allowances. Anyone anywhere in the world can participate in the market, and hundreds of companies, brokers and individuals are already engaged in trading.

Currently, only certain large polluters (>25 tons NOx emitted per year) are required to partake in the cap-and-trade program, while others are permitted to opt in voluntarily. As a prerequisite to the program, however, the EPA requires rigorous monitoring and reporting standards and mandates that companies pay automatic fees to the government for any emissions above the legal limit. Rigorous monitoring is essential to ensuring certainty and consistency in the program, making sure that each allowance traded represents one ton of emissions, regardless of where it is generated. The EPA believes that certainty and consistency enables the creation of a robust market for allowances, free from the need for government review and transaction approval.

Overall, the program is an improvement over the regulatory and legally cumbersome command and control approach. It does have shortcomings, such as the EPA acting as the equivalent to the Securities and Exchange Commission and the susceptibility for traditional forms of market failure to occur in the form of monopolies and other negative externalities. The EPA already has stated that the program will be expanded to include more areas by 2004. Prudent strategic planning should involve at least a cursory knowledge and basic impact analysis of these programs as they evolve. Additional information can be obtained at www.epa.gov/airmarkets.