State and Federal Standards for Mobile-Source Emissions (2006)

The current system for setting mobile-source emissions standards permits California to set more stringent standards than the federal U.S. Environmental Protection Agency (EPA) and allows other states to choose between the two. This system is an attempt to create a compromise between two legitimate, yet competing interests—that of state governments attempting to tailor regulations to meet air quality objectives and that of manufacturers attempting to keep costs of equipment and distribution down.

In this chapter, the committee elaborates on the rationales for uniform versus two standards to clarify the key factors favoring one or the other. The committee also discusses the harmonization and possible impacts of different approaches in setting emissions standards. The chapter concludes by outlining a framework for assessing the costs and benefits to provide a basis for comparing the methods used by EPA, California Air Resources Board (CARB), and other states that choose to adopt California’s emissions standards.

The current system for establishing mobile-source emissions standards in the United States is a compromise between two conflicting interests. From the perspective of a mobile-source manufacturer, the advantages of uniform national emissions standards are clear and compel-

ling. Dual standards complicate equipment design, magnify certification costs and risks, erode economies of scale, and complicate supply-chain logistics. Uniform national standards provide substantial economies in production throughout the supply chain. By helping to keep costs down, uniform standards benefit consumers. Dual standards will mean higher prices for mobile sources in some or all regions, depending on how higher costs are passed on to consumers.

From the perspective of a state government given the responsibility of protecting the public’s health by meeting the National Ambient Air Quality Standards (NAAQS), the need to have commensurate authority to regulate emissions by all possible means is equally clear and compelling. If one option for reducing emissions from a major contributor such as a mobile source is preempted, the task of meeting air quality requirements might be more difficult. Both perspectives are valid, and the current system under which California may set its own standards and other states may adopt those standards reflects a particular compromise between the two competing interests. In this section, the arguments for having uniform mobile-source emissions standards and for having dual standards are examined.

From the earliest days of regulation of pollution sources, some argued that pollution standards for new mobile sources should be set at a uniform level in all parts of the country. In fact, as this report describes in Chapter 3, the federal government preempted the ability of individual states to set separate mobile-source emissions standards and allowed only California to obtain a waiver from the preemption.

The early legislative debate brought out a number of justifications for setting uniform standards. On the basis of arguments presented by vehicle manufacturers and others, Congress found that allowing states to set different standards might cause economic disruption in vehicle markets and increased cost to consumers. Because of the substantial time frame needed to modify and manufacture vehicles to different emissions specifications, a particular concern was having consistent and fixed standards for manufacturers to take advantage of economies in productions. An additional argument in favor of uniform standards was that mobile emissions sources often cross state lines; therefore, the impacts of different state standards on air quality and human health may be diluted and

difficult to discern. For example, many heavy-duty diesel trucks routinely cross state lines.

In general, a uniform standard is thought to lower overall costs of bringing mobile-source products to market. These arguments are drawn from early congressional debates, vehicle manufacturers, and economic principles. A uniform standard would accomplish the following:

• Lower costs as a result of economies of scale in production. Large-scale production also allows fixed costs of meeting new emissions standards to be spread across more vehicles.

• Keep the costs of distributing vehicles low. Different standards require mobile- source products to be matched to particular states.

• Avoid duplicating inventory, certification, and testing costs that might result when there is more than one standard.

• Avoid boundary and enforcement problems. Mobile sources cross state lines and enforcing different state standards would add to costs.

Economies of scale in the production of mobile sources occurs when the cost per unit declines with the number of units produced. Large-scale production to meet a single standard could affect costs in several ways. First, fixed costs imposed by a new standard include research and development (R&D) expenditures, redesign and retooling of plants, and certification of the vehicles or other mobile-source products. Those costs would be reduced on a per unit basis with a larger volume of production. For more than one standard, those fixed costs would be higher but spread over approximately the same number of vehicles, raising the cost per vehicle.

Pure economies of scale in production often occurs up to a certain output level. Due to specialization and production efficiencies, costs per unit fall as production volume increases along an assembly line or across an entire production facility. It has long been argued that scale economies continue for very large volumes of vehicle production (Maxcy and Silberston 1959). However, automakers argue that it is increasingly difficult today to take advantage of scale economies in production because of the rapid pace of technical change, which causes models to be outdated more quickly than in the past. Different regulatory requirements may also contribute to this trend. Although lower costs through larger produc-

tion on a given assembly line still occur, manufacturers often cannot take full advantage of scale economics (J. German, Honda, personal commun., May 18, 2005; R. Babik, General Motors, personal commun., June 21, 2005).

There is evidence, however, that manufacturers are attempting to find and exploit economies of scale in production whenever possible. Truett and Truett (2003) find evidence of economies of scale for Fiat in the Italian auto industry. The authors argue that for Fiat to be competitive with other manufacturers in Europe, they will need to increase volume to lower costs. Also, Chrysler is moving toward a world engine for all its vehicles, which would allow Chrysler to achieve further scale economies and reduce engine prices (Fletcher 2004). General Motors has moved to purchase other companies, including Saab, in part to increase the potential for lower costs. It is integrating production facilities to achieve savings through scale economies and through common administrative offices in finance, information systems, and fleet management. In a similar approach, Ford and PSA Peugeot Citroën are integrating design and production of diesel engines to achieve scale economies for lower-cost engines that will be used in each companies’ different product lines. The consolidation of vehicle manufacturers also points to the increased globalization that is occurring among manufacturers of mobile sources.

Scale economies can reduce the cost of meeting any standard. However, the extent of these economies can vary a great deal for different engine types, vehicle types, and design changes. Compared with light-duty-vehicle volumes, heavy-duty engine and vehicle sales volumes are lower overall, so increasing sales volume with a uniform standard might be particularly important for manufacturers of heavy-duty engines and vehicles to take advantage of scale economies (French 2004).

In general, the committee could not obtain data from individual manufacturers on the effects of specific emissions standards on fixed costs or production costs. Manufacturers were reluctant to disclose such proprietary information. Therefore, it is difficult to say that the extent to which scale economies would be affected by a different standard in one or more regions as compared with a uniform standard.

Uniform standards are most likely to keep inventory costs at the lowest possible level for holding stocks of vehicles. Production levels are always subject to uncertainty about demand conditions. To the extent

that production does not exactly match demand, inventories will rise or fall. The larger the number of types of products that must be delivered to market, the greater the inventory holdings must be to meet fluctuations and uncertainties in demand. Gruenspecht (2002) explained this issue for the fuels industry in meeting multiple fuel standards and provided some evidence about how large the effect could be. The increase in costs from the need to hold larger inventories depends on the extent of the tailoring of standards and the size of the different markets.

Automobile manufacturers have argued that higher inventory costs of meeting two standards will result in higher vehicle prices and, therefore, fewer sales (R. Babik, General Motors, personal commun., June 21, 2005). Manufacturers have to produce more vehicles to meet uncertain demand for several types of vehicles. Dealers may end up holding more inventory or having to sell at a discount to prevent inventory buildup. However, the committee could not obtain data from manufacturers to evaluate the effects of two emissions standards on inventory costs.

Mobile-source distribution costs are most likely to increase if there is more than one standard. There are logistical costs of getting different types of vehicles or other products to different locations. In a presentation to the committee, Babik (2005) stated that General Motors has full-time staff ensuring that fleet-average emissions within an individual state meet the fleet-average emissions requirements specified for the California low-emission vehicle (LEV) II program. Honda has argued that distribution costs are one of the most serious problems it faces when there is more than one standard. There is a great deal of uncertainty about whether the right vehicles will get to the right markets—dealers can swap over state lines, and the logistical difficulties in allocating vehicles are substantial. To avoid dealing with these distributional issues, Honda tries to certify at least some vehicles to meet a California and a federal standard (J. German, Honda, personal commun., May 18, 2005). Manufacturers of handheld lawn and garden equipment argued that distribution costs would be higher with two standards even if they produced the exact same product because they would have to use different stock-keeping-unit (SKU) identifiers on the same product. Different SKUs would have to be scanned as a way to ensure that products sold in a state are complying with certification required by the state. Chapter 7 discusses some distribution complications associated with small-engine equipment.

Economies of scale can also occur in distribution. For example, if a vehicle is sold in a small state, it might be sold in all surrounding states to take advantage of the scale economies in distribution. There is evidence of that occurring in the LEV II program in northeastern states. For example, Maine did not adopt the zero-emission-vehicle (ZEV) component of the California LEV II program, but the surrounding states did by 2004. There is evidence that advanced-technology partial zero-emission vehicles (AT-PZEVs), which are required under the ZEV mandate, have been sold in Maine, even though Maine is not required to sell them.

Because mobile-source emissions sources are numerous and can cross state lines, separate standards in different jurisdictions must be enforced. In California, new vehicles cannot be sold or imported into the state unless they show proof of California certification. There is a civil penalty of $5,000 per vehicle for vehicles offered for sale or brought into the state that do not meet the standards. California has had a fair amount of success in enforcing their light-duty vehicle standards, mostly through required registration, and through the inspection and maintenance (I/M) program. In the last few years, California and EPA have worked together to produce a uniform standard for heavy-duty trucks, many of which are frequently driven across state lines. Even without separate standards, California has found that trucks need to be inspected to ensure they have in operation vehicle emissions-control components required based on their model-year standards. In general, if vehicle I/M and centralized registration programs are already in place and enforced, the costs of enforcing a separate standard will be reduced. In contrast, nonroad sources do not have registration or inspection procedures in place and enforcement must be done at the point of sale. The CARB annual reports of enforcement activities (for example, CARB 2004a) detail the process used to enforce mobile-source emissions standards in the state.

Enforcement costs are likely to vary a great deal with the type of product and the technology for enforcement (Harrington et al. 1996). In some industries, the production of the engine is separate from assembly of the product. Heavy-duty diesel and small-engine manufacturers operate under that type of nonintegrated manufacturing system, unlike automobile manufacturing, which has fully integrated production of the vehicle. Manufacturers using the nonintegrated system face a variety of issues to comply with emissions standards, as discussed for small engines

in Chapter 7. It is much harder for engine manufacturers to achieve compliance with different standards if the engines cannot be tracked easily through assembly and distribution.

A key rationale for allowing one state to set the most stringent technology-forcing emissions standards is that it could limit the risks of failure. The principle that air quality standards are to be established at levels that protect the public’s health implies that emissions standards might be too stringent for the capabilities of existing technologies. Such technology-forcing standards inevitably entail the risk that it might not be possible to develop technologies that can achieve the standard at acceptable costs. The risks of setting technology-forcing standards are of three types: (1) expenditures on research and development (R&D) do not result in an acceptable technological solution, and the emission standard is subsequently relaxed; (2) if the standard is implemented and technologies are implemented that are later found to be ineffective, capital invested in production facilities and labor expended in production are also wasted; and (3) if the modification of vehicles or equipment to meet the emission standard results in unacceptable deterioration of the quality of the product or other serious malfunctions, additional damages or recall and retrofit costs might occur. Allowing more states to adopt the alternative standard can increase these risks. Allowing one state to function as a laboratory is unlikely to lower R&D costs substantially. However, the potential costs of derivative damages and remedies for technologies that prove to be ineffectual or defective should be reduced because fewer vehicles or pieces of equipment will have been produced.

If the “laboratory” state’s technology-forcing emissions standards result in cost-effective technological breakthroughs, the rest of the country can take advantage of the new technologies by adopting equally stringent standards without risk, although with some delay. By reducing the risks of technology-forcing standards, the laboratory state model allows the rest of the nation to enjoy cleaner air sooner than would be achievable otherwise. As discussed in previous chapters, much of the progress made in reducing emissions from mobile sources has come via regulations that set emissions standards beyond levels that could be

achieved with commercially available control techniques. Such technology-forcing standards have often produced impressive advances in emissions control that have enormous air quality and public health benefits. Giving the responsibility for setting alternative emissions standards to the state with the most difficult air quality problems has ensured that the alternative standards would challenge the limits of available technology. It is also not surprising that the most interest in having a second tighter standard has historically been in California and the Northeast, which have been struggling with reaching ozone attainment for the longest periods.

As the experience of having California and federal mobile-source emissions standards has increased, other advantages have appeared. The CARB regulatory process allows California standards to be amended more rapidly without the federal regulatory review in the face of changing market and technological conditions. This process aids in the implementation of technology-forcing regulations. Having a second authority establish emissions standards occasionally allows a division of labor in research and analysis. For example, EPA specializes in developing standards for heavy-duty vehicles, and CARB specializes in developing standards for light-duty vehicles. Their coordination allows the leading agency to do most of the work in the area in which it specializes and allows the other agency to avoid duplicating the effort.

A second rationale for having different emissions standards is the potential efficiency gained by states when they have a greater ability to match control strategies to the local conditions that determine air quality. The severity and nature of air quality problems vary substantially across geographic regions, as shown in detail in Chapter 2. The factors that determine air quality vary from place to place and time to time. The quantities of air pollutants vary with such factors as the regional population, intensity of vehicle traffic, number and types of industries, types of fuels used to generate electricity, and the rate of biogenic emissions in the region. In addition, the factors that turn pollution into violations of NAAQS depend on atmospheric chemistry, wind and air circulation patterns, and many other climatic and topographical characteristics, all of which vary substantially across the United States.

Regional differences in the factors that determine the quantities of pollutant emissions and the processes that transform pollutants into air quality problems and consequently into public health and environmental

damage imply that uniform national emissions standards could be economically inefficient in low-pollution areas and potentially ineffective for meeting NAAQS in regions with the most extreme air quality problems.

To illustrate this economic efficiency argument, assume there are two hypothetical regions attempting to reduce ozone pollution, one that has greater sensitivity to nitrogen oxide (NO_x) emission reductions and the other that has greater sensitivity to hydrocarbon (HC) emission reductions. Figure 5-1a shows the marginal costs and the marginal benefits of reducing NO_x emissions in both regions. Assume in this example that NO_x reductions are most important for reducing ozone in Region 2. Therefore, the damage prevented by greater NO_x reduction in Region 2 (the marginal benefit of compliance, labeled, MB_Region2) is above that prevented by greater NO_x reduction in Region 1 (MB_Region1). Assume further that the additional costs of achieving successively greater NO_x reduction (the marginal cost of compliance, labeled MC_NOx) are identical in both Regions 1 and 2. If the emission standard for both regions is set at Q1—the efficient standard for Region 1 where marginal costs of control equals marginal benefits—Region 2 will incur excessive damage in that its marginal benefit from reducing NO_x will be greater than its marginal costs. Region 2 would be willing to incur additional costs up to C2 to reduce NO_x emissions up to Q2. The single uniform standard represented by Q1 is economically inefficient because it does not allow Region 2 to equate marginal control costs to marginal benefits.

Similarly, in Figure 5-1b, the marginal costs and benefits of HC emission reductions are illustrated for the two regions. Assume that Region 1 has ozone levels that respond more to HC emission changes and that Region 2 has ozone levels that respond more to NO_x changes and less to HC emission changes. Once again, the standard has been set at the efficient standard for Region 1, namely q1. However, this level of control is excessive for Region 2, which would prefer control level q2 at the lower cost of c2. In this example, Region 2 has too little NO_x control, as shown in Figure 5-1a, and too much HC control. Not only is Region 2 incurring excessive damage in that its marginal benefit from reducing NO_x is greater than its marginal costs, it is also wasting money on unnecessary HC controls. In this example, allowing each region to tailor their emission reductions to their needs (Q1 in Region 1 and Q2 in Region 2

FIGURE 5-1 Costs and benefits of (a) NO_x reduction and (b) HC reduction in Regions 1 and 2. The lines represent marginal costs (MC) and marginal benefits (MB) for NO_x and HC controls in each region. Vertical axes represent the costs and benefits for NO_x (C) and HC (c) controls. Horizontal axes represent NO_x (Q) and HC (q) emissions reductions.

for NO_x and q1 in Region 1 and q2 in Region 2 for HC) allows them to meet air quality goals in the most economically efficient manner.

Emissions and their air quality effects are more complex than shown in this simple figure. NO_x is a precursor to particulate matter (PM) as well as ozone, so the effect of NO_x standards in PM markets should also be considered. HC controls also have an effect on the reduction of hazardous air pollutants. Another complication is that a single region is not necessarily homogenous. For example, NARSTO (2000) concluded that local HC emission reductions may be effective in reducing ozone in urban centers, while NO_x emissions reductions are more effective at distances removed from urban centers.

Other qualifications to the simple model are also important. The argument as illustrated in Figure 5-1 is based on the assumption that states can be expected to make the correct choice between two available options, one focused on HC control and one focused on NO_x control. Policy choices are not always so clear, however. The model also does not ad-

dress the possibility that a state might choose a set of standards that adversely affects air quality in a downwind state.

For many reasons, the single emission-standard system is economically inefficient and often ineffective in achieving air quality goals. However, setting mobile-source standards for each region is not a feasible option and not necessarily optimal for many of the reasons argued above. Having two standards to select from, the California standard or the federal standard, offers regions at least a choice and may provide states with opportunities to develop more efficient levels of control.

Harmonization refers to the practice of aligning regulatory standards and procedures of different jurisdictions to relieve regulatory burdens on industry and consumers by allowing for greater scale economies in production and distribution. Most nations have adopted one of three types of emissions standards for mobile sources: (1) the United States federal emissions standards, (2) the European Union (EU) standards, or (3) the Japanese emissions standards (Jorgensen 2005; Walsh 2005). Most countries outside North America are adopting EU emissions standards rather than developing their own. For example, China and India have adopted the EU standards for both light- and heavy-duty vehicles, whereas Korea and Brazil have adopted EU standards for heavy-duty vehicles and U.S. or CARB standards for gasoline-powered light-duty vehicles (Walsh 2005). Regulators from the three authorities also meet frequently to find ways to make their emissions requirements and certification procedures similar.

Their efforts have had some success but have not achieved complete unification of standards and procedures. Different driving characteristics and atmospheric conditions make the nature of emissions and the severity of pollution problems vary across the globe. For example, differing driving conditions in Japan and the United States contribute to differences in standard driving cycles for certifying vehicles. As within the United States, there are economic interests that seek harmonization, and there are air quality needs and other characteristics that are better served by differences in standards and certification tests. Harmonization need not imply that standards are to be the same. Many countries are adopting older EU or U.S. standards first and then progressively tighten them in

the same manner that has historically occurred in the EU and the United States, although often at an accelerated pace.

The increasing globalization of manufacturing of mobile-source equipment is having an impact on improving harmonization on an international basis. Increased globalization means that foreign manufacturers are producing and selling their products within the United States, and domestic manufacturers are producing and selling globally. As discussed above under Economies of Scale, major automobile manufactures now have alliances with foreign competitors. In addition, many of the major automobile manufactures, both U.S. and foreign, have manufacturing subsidiaries around the world. Globalization also has an impact on the small-engine manufacturing sector. Importing and exporting in the small-engine industry has increased steadily since 1990. Since 1995, imports have been rising and rose to $359 million in 2000, according to the U.S. International Trade Commission. Exports of lawn and garden equipment have also increased steadily to a level of $867 million. Canada and France have continued to be the largest market for U.S. manufactured outdoor equipment. Both countries accounted for over $300 million in exports for U.S. companies in 2000.

Harmonization involves the levels of pollutant emissions and the test procedures used to measure emissions. Harmonization of certification procedures can be as important as harmonization of emissions levels because driving cycles and operating conditions (such as cold versus hot start and ambient temperatures) can have a strong impact on emissions levels. Different certification regimes may not only require repeat testing of the same vehicle and separate testing facilities but may also impose different technology and design requirements. Driving behavior, traffic conditions, and the ambient environment can vary substantially from one region to another. As a result, full harmonization is not always the most desirable situation. It may be preferable and more cost-effective to allow both standards and procedures to differ in accordance with local needs and conditions. Nonetheless, even where different standards are appro-

priate, there may be opportunities to harmonize technical aspects of requirements and procedures with meaningful benefits.

In the United States, California and the EPA have jointly sought opportunities to harmonize mobile-source emissions standards. A single nationwide standard can have strong advantages, such as successful harmonization of heavy-duty diesel engine (HDDE) standards and test procedures. The following excerpt is from the California Air Resources Board digest (CARB 2005d):

Recognizing the needs of some states to adopt more stringent mobile-source emissions standards to help meet air quality goals, a desirable objective is harmonization of CARB’s and EPA’s certification procedures. Although meaningful differences in standards can be important in achieving clean air, superficial differences, in areas such as certification procedures, can be wasteful. As technological advances create the ability to manufacture extremely low-emissions vehicles at a reasonable cost, regulators should make a determined effort to harmonize not only the levels of emissions required but also the procedures for testing and certification to the maximum extent possible without sacrificing the primary goal of achieving clean air.

The pricing, employment, and production effects of standards are complex and will depend on consumer preferences, overall vehicle and machine characteristics, and the ability of firms to innovate in the face of

FIGURE 5-2 Impacts of safety and emissions equipment and other quality improvements on average vehicle price from 1967 to 2001. Source: Sperling et al. 2004b. Reprinted with permission; copyright 2004, University of California, Davis.

regulation. In general, emissions-control regulations can be assumed to result in higher prices paid by consumers, other things being the same.¹ There is evidence from the literature that vehicle prices have been higher through time than they would have been without environmental regulation (White 1982; Crandall et al. 1986). For example, Figure 5-2, uses information provided in Ward’s Automotive Yearbook to estimate that one-third of the price increase on new cars between 1967 and 2001 could be attributed to safety and emissions regulations. However, prices charged in markets do not always reflect the full cost of producing the product; pricing decisions also depend on other considerations, such as profits and sales. The assumption here is that manufacturers will try to pass on the higher costs of emissions controls in the form of higher prices. Under such conditions, higher prices will reduce unit sales and, depending on the price elasticity of demand, may increase or decrease

manufacturers’ revenues, which will affect profits. Employment is likely to fall in some parts of the vehicle and engine manufacturing industries as a result of fewer products being produced. Employment is likely to rise in other industries, such as manufacturers of emissions-control equipment as more or different pollution-control components are needed. Despite requests, the committee has been unable to obtain detailed quantitative information on how vehicles and other mobile sources are priced and what the production and employment effects of different standards have been in the past.

In general, if emissions standards are necessary to protect public health as defined by the Clean Air Act, then the possibilities of reductions in profits and employment are trade-offs that society has implicitly accepted. There are still, however, the distributional effects when one region sets or adopts stricter standards. If all the negative impacts occur within the state, it can be assumed that the state will take account of them, but there can be both costs and benefits that fall outside the adopting state. When making the decision to adopt, California and other states usually do not consider impacts outside their own borders.

An argument has also been made that the imposition of emissions standards will cause domestic manufacturers of small engines to move production from the United States to a lower-cost location. If a firm is competitive in the U.S. today and does not have sufficient incentive to move offshore, this argument asserts that the additional cost of the emissions-control equipment tips the scales in favor of relocation. The cost of capital, such as that for major pollution control requirements, could trigger a relocation decision. For example, it might be less expensive for a company to retool and relocate to a new lower-cost facility in another country than to retool and re-outfit an existing manufacturing plant in the United States. The elasticity of demand for products affects the ability to pass costs on and therefore to recover the investment of capital. A decision to relocate could possibly be the only option to remain competitive.

The relocation decision can also be affected by the product and market diversity of a company. A company that is solely in the small-engine or small-equipment industry would not have the same capability to absorb capital costs and fixed and variable overhead that a company that has small nonroad engines and equipment plus motorcycles, automobiles, marine, agricultural or industrial products. Because the small nonroad engine and equipment industry is diverse, having large diversified companies, large undiversified companies and many small companies, located in the United States and overseas, the impacts of state stan-

dards may vary widely. Some may choose to move production to a lower-cost location to remain competitive whereas others may choose to not offer a product in a particular market. Some might have the flexibility to absorb the cost of regulations, and some might have to take drastic measures to maintain their competitive position in the market. In other cases, firms might already have an economic incentive to move production offshore and may do so even if the emissions regulation is not enacted.

One important issue is when and whether the emissions regulations would trigger or accelerate a move out of the country. The committee lacks sufficient information to evaluate substantively such issues with respect to domestic small-engine manufacturers. However, the question raises a number of important policy issues. Given the wide range of factors that determine whether domestic manufacturers are at a competitive disadvantage compared to foreign manufacturers, these issues are often resolved in the political arena.

The committee summarizes the general benefits and costs of allowing an additional state standard compared with a uniform standard. Table 5-1 surveys the benefits and costs with some indication of the distribution of the effects in different regions. This table does not identify all effects of the alternative regulatory policies. It summarizes benefits by describing only the direction of the effect on benefits from improved air quality resulting from probable changes in emissions. The real benefits come from health and welfare improvements resulting from changes in air quality and emissions. More issues in estimating benefits and costs are discussed in greater detail in the following section.

The second column of Table 5-1 compares the cases of having a separate standard in California and having a national uniform standard. Under the current waiver process, California may set a separate and more stringent standard than the rest of the country. The emissions reductions, air quality benefits, and health improvements of a stricter standard will occur in California, and the state is likely to weigh those benefits in assessing the need for the stricter standard. In addition, other jurisdictions

might be affected by the stricter standards, depending on the mobile source and the pollutant. For example, air quality benefits might spill over into adjacent states, depending on wind patterns, such as ozone-reduction policies that can affect air quality in parts of Arizona and Nevada and relocation of cleaner California units to neighboring states. Current California law requires that the standard-setting process in the state not consider effects elsewhere in the country. This law is unlikely to cause any objections if there are only spillover benefits. However, costs that affect other regions do raise objections, as discussed below.

The costs of a separate standard in California are the resource costs of developing and producing a different product for the California market. These costs include the higher costs to the manufacturers in fixed costs (R&D, retooling, and certification costs) and production costs. Inventory costs are also likely to be higher if inventory holdings have to be higher with two markets. The costs of distributing a different vehicle to California might be somewhat higher as well. Higher costs to the manufacturers are likely to be passed on at least partially to buyers in California, but higher prices also mean fewer products sold. It is difficult to determine who pays for these higher costs, because pricing strategies by mobile-source producers often depend not only on the cost of the vehicle but also on other marketing and profit strategies. As Sperling et al. (2004b) point out, “the relationship between pricing and costs is quite complex.” Finally, to maintain compliance with the separate standard, California probably has some administrative and enforcement costs.

Some of the costs of California’s separate standards probably fall on jurisdictions other than California. As discussed in Chapter 3, these costs are not typically considered in the formal standard-setting process in California. Production and employment effects could be either positive or negative in other parts of the country as a result of the separate standard. Production sites might need to be different for a product with a new standard, or a new standard may mean retooling or relocation of existing

plants, as discussed earlier in this chapter. For example, Hanz and Hotz (2005) argued that a more stringent standard in California for Briggs and Stratton Corporation might require sufficient retooling to cause it to relocate plants outside the United States. The committee did not obtain any information to determine whether relocation was a plausible result of the imposition of a second emissions standard on any industry. The case study is discussed more in Chapter 7.

There are also changes in employment and sales for the emissions-control industries when there are additional stricter standards. Because new technology must be developed and sold, new products will be developed, and the product mix of emissions-control parts will be changed. Emissions-control industries will expand, although sales of some equipment may not be as robust in the absence of a national market that is available under a uniform standard.

CARB (2001a) discussed how the board found that the costs of one emission standard was passed on to consumers. CARB concluded that (1) manufacturers might not pass on all the costs associated with the zero-emission vehicle (ZEV) mandate and might absorb them internally; (2) automakers do not mark up cars sold in California to reflect the increased cost of emissions controls there; and (3) costs associated with the ZEV program and other California vehicle emissions-control initiatives might be spread across all car purchases in the United States, not just in California. Vehicle manufacturers also claim that they usually cannot pass emissions-control costs to consumers through higher prices if vehicles are similar in other respects, although views differ on whether the increased costs are only to California consumers or are spread across the country (J. German, Honda, personal commun., May 18, 2005; R. Babik, General Motors, personal commun., June 21, 2005).

A final point about allowing California to set more stringent standards than the rest of the country is that this policy has sometimes led to more stringent standards nationwide. One of the major rationales described above for allowing California to explore when and how to set a more stringent standard is that it will serve as a laboratory for emissions control in the rest of the nation. When California acts as a laboratory, additional federal standards might have higher benefits and lower costs than would otherwise occur. California standards as they evolve over

time might help to identify ways to more cost-effectively reduce emissions. The federal government might then adopt stricter standards already proved to be effective in California. In that case, inventory and distribution costs will depend on whether the new standard is harmonized with California’s standard or whether it is different. In some cases, the federal government has adopted a stricter standard at least in part because of California’s more stringent standard. For example, the federal Tier II program for light-duty vehicles is stricter than earlier standards but is different from California’s LEV II program. In other cases, such as HDDE standards after 2007, the standards are identical.

Some have argued that when CARB sets a stricter standard that is adopted by EPA, California in effect sets standards for the entire nation. Since CARB bases its standards on the needs of the Los Angeles area, the most polluted regions of the country are likely to benefit the most, but these standards are unlikely to be efficient for all regions.

The third column of Table 5-1 compares (1) the benefits and costs of allowing states to adopt (also called opt-in) the California standards with (2) the benefits and costs of not allowing states to adopt the California standards. There are effectively two standards—one in California and opt-in states and one in the rest of the country.

When states are allowed to adopt the California standard, as some do now under the section 177 provisions of the Clean Air Act, there are a range of benefits and costs. The opt-in states will identify improvements in health and welfare within the state. Emissions reductions from stricter standards may also spill over into other states that do not adopt, allowing for air quality and health benefits in other jurisdictions. These spillover benefits probably will not be considered during the state decision process, because few decision-making bodies have any regional jurisdiction over environmental issues. In the case of the northeastern states, the Northeast States for Coordinated Air Use Management (NESCAUM) provides a regional perspective on mobile-source emissions standards policy.

The costs of the stricter standards for the opt-in states are difficult to determine. The full costs of additional emissions controls will not be reflected in the prices of individual vehicles. As mentioned above, vehicle pricing by manufacturers is complex and reflects many factors, in-

cluding marketing strategies for different vehicles. Vehicle manufacturers argue that they usually cannot pass emissions-control costs to consumers through higher prices if vehicles are similar in other respects. If emissions-control costs are not included in vehicle prices in opt-in states, the costs will probably be spread across the vehicle fleet and perhaps the nation. In that case, the opt-in region might benefit, but the costs are spread nationwide. If prices of vehicles in the opt-in states reflect cost differences, consumers might try to cross states lines to buy vehicles, and regions would have to make greater enforcement efforts.

Overall, there will be benefits and higher costs in the opt-in states. The higher costs might not reflect the full costs of the standards, but the committee did not have the data needed to evaluate that issue. Some spillover effects from opt-in states can occur from changes in emissions and air quality, sale of products in regional markets, and employment effects in states that do not opt-in.

There is some evidence that allowing a separate standard in California and all states to opt-in might induce manufacturers to produce uniform products for the nation at the more stringent standard. For example, automobile manufacturers have stated their intention to certify all their vehicles according to the stricter California evaporative emissions standards rather than produce some vehicles certified according to federal standards and some certified according to California standards. The increased costs of having a uniform standard, even a stricter standard, may be lower than the costs of complying with two separate standards. Various manufacturers have expressed a willingness to comply with some stricter standards as long as they are uniform (Hanz and Hotz 2005; Jorgensen 2005; J. German, Honda, personal commun., May 18, 2005). Manufacturers’ preference for one standard suggests that the scale economies and inventory and distribution costs of different standards are high enough to offset any additional costs of meeting a stricter uniform standard.

The next two chapters review mobile-source emissions standards for a number of specific cases. Before the committee examines those cases in detail, we review here some of the important overall issues related to costs and benefits of standards in the analyses of these regulatory

activities. OMB (2003) and EPA (2000b) provide specific guidance on the preparation of economic analysis for EPA rule-makings.

The effects of a regulatory policy on human health and welfare are the key elements that define the benefits of any mobile-source regulation. Further, in a full benefit-cost analysis of a regulation, both benefits and costs are estimated in dollars. Dollar values are particularly difficult to estimate on the benefit side because emissions changes must be tracked through their effects on air quality to their health consequences and finally to the value of various health outcomes. Attempts at such estimates are increasingly frequent, however, in regulatory assessments. The last link to dollar benefits is important because of the range of different pollutants affected by a mobile-source regulation and the variation in the severity of health outcomes that occur under those regulations. Aggregating emissions changes, as is done in cost-effectiveness analysis (see below), usually does not account for the different effects of pollutants on human health and welfare. A thorough analysis of estimating the benefits of air pollution regulations can be found in NRC (2002b).

The data are often not available for a full analysis of the benefits, and the data needed for such an analysis are often expensive to collect, particularly for multiple small regions. Nevertheless, the link of the regulatory change to air quality and to health is important and often gets lost in the regulatory analyses. One can argue that the goal of the emissions reductions targeted in a state implementation plan (SIP) is to provide an indirect link to air quality and health benefits. Thus, regions often evaluate policies in terms of the emissions reductions since the NAAQS are designed to protect public health.

Cost-effectiveness analysis can be a useful way to compare regulatory policies when only the emission changes resulting from the policy and the costs are known. A cost-effectiveness measure is calculated as the full cost of the policy in relation to the resulting emissions reductions. The costs and emissions-reductions outcomes over time must be measured relative to a baseline set of outcomes. For example, one cost-

effectiveness comparison of the on-road diesel standards would be the costs and emissions resulting from those standards compared with the emissions allowed under the previous standards. With SIP emissions goals in place, this comparison of standards is the most frequent policy tool used by state and local governments to consider policy alternatives.

Several issues arise in the implementation of cost-effectiveness analysis. Looking only at the average costs and emissions reductions from a specific regulatory policy does not reveal whether that policy should be adopted. One aspect of adoption is environmental equity: costs may be borne by a segment of the population that gets little of the benefit or vice versa. The policy must be compared with alternative policies that attain similar emissions reductions at lower costs or with policies that attain greater reductions at the same cost. When it is possible, incremental analysis of policy components may be more appropriate than analysis of the average cost-effectiveness of an entire package of policies or standards. Parts of the policy may be cost-effective but other parts costly relative to alternatives.

Finally, policies to reduce mobile-source emissions often result in the reduction of multiple pollutants because a single pollutant, such as NO_x, might contribute to increased concentrations of multiple other pollutants, such as ozone and PM. If the denominator of the cost-effectiveness calculation is in tons, then the effects of different pollutants on air quality and human health will not be distinguished. For example, if the effect of NO_x reductions on ozone and therefore on health differ between Massachusetts and Texas (for example, because of interactions among pollutants), those different effects will not show up in cost-effectiveness analysis unless the tons of reductions from the different pollutants are somehow weighted by their relative impacts on air quality and health.

Estimating costs is more complex than simply assessing the costs of the emissions-control technologies. Costs should include the full opportunity costs, including not only private costs but also public costs. As described above, the costs of many mobile-source standards involve not only additional equipment costs but also fixed costs, such as R&D, distribution, and certification costs, associated with a new standard. The public costs of enforcing a stricter standard include testing and monitor-

ing products in the region where they are being sold. Cost savings from the regulation, if any, should also be included, and direct and indirect costs should be considered.

There are also complex incentives for the various groups that produce cost estimates to inflate or understate costs, making independent analysis difficult. A frequent argument is that a regulated industry has an incentive to overstate the costs of complying with regulations, in part to convince regulatory authorities to make regulations less stringent. The regulatory agencies might have the opposite incentive, to understate costs, if their goal is to enforce regulations that will have the greatest effect on emissions and air quality. For example, Anderson and Sherwood (2002) found that EPA cost estimates for regulations on highway vehicles and their fuels were generally significantly lower than estimates from other stakeholders. Thus, ex ante estimates of the costs of regulation are not only predictions based on best estimates of future technology, design, and behavior, they may also be subject to bias based on the perspective of the estimator. Goodstein and Hodges (1997) and OTA (1995) found that ex ante costs tend to be overestimated, compared with ex post costs, because new technologies not anticipated in the ex ante analyses are often discovered in response to the regulation. Squitieri (1998) and Harrington et al. (2000) find the issue of assessment of costs to be more complex than these early studies suggest. First, it matters who is doing both the ex ante and ex post studies, since the biases discussed above can be inherent in both. Second, it is important to assess costs in combination with emissions reductions. For example, if total costs are accurately estimated but the emissions are only half of those originally predicted, then the costs of achieving the emissions goal are actually higher than estimated. When these issues are taken in account, the accuracy of ex ante cost estimates are somewhat more mixed than the early studies suggested (Harrington et al. 2000).

Indirect effects should be examined, and any that are significant should be included in any regulatory analysis. For example, one presentation to the committee (Austin 2005) included an analysis of the effect of the cost of stricter new light-duty-vehicle standards and the effects of the higher price of new vehicles on fleet turnover. Higher new vehicle prices may slow new vehicles purchases. Austin argued that the emissions reductions of stricter standards are not as high as the direct esti-

mates show because the slowing of fleet turnover tends to increase fleet emissions. Another example is that if stricter standards are adopted in one state, residents there might cross-over to adjacent states to buy vehicles. The magnitude of this behavioral change can be estimated to determine how much benefits would be reduced. Recent rules that treat fuels and engines as a system, such as the federal Tier 2/low sulfur standards discussed in the following chapter, add to the complexity of estimating impacts since such standards produce non-emissions benefits such as improved engine life, longer spark plug life, greater oil change intervals, and reduced maintenance. Other indirect impacts include impacts on safety, which are discussed in more detail in Chapter 7.

The tendency for manufacturing costs to decrease as experience is gained through cumulative production increases the difficulty of estimating the costs of future emissions controls. For most manufacturing processes, including vehicle production, the unit costs of production have been shown to fall over time as producers gain experience in producing the product. A number of studies of vehicular and other products show that there is a distribution of this type of learning effect on costs. The amount of learning will depend on the technology and production process involved. However, the most common value for this “progress ratio” found in the empirical literature is about 0.8, meaning that as production increases by 100%, costs fall to 80% of their previous value (Argote and Epple 1990; Manson et al. 2002). Rubin (2005) found evidence that costs for installed vehicle control devices have fallen at slower rate, closer to 93% as production volumes double. Although the committee is not in the position to judge the evidence for the presence of such a progress ratio for reducing costs, it does note that such learning curves have been used by EPA to estimate the long-term cost of regulations (more than 5 years after implementation) for the Tier II tailpipe standards (EPA 1999a), for the heavy-duty diesel rule (EPA 2000c), and for the Phase II final rule on handheld spark-ignition engines (EPA 2000d).

Cost-benefit estimates will also vary depending on the assumptions made about conditions in the absence of new emissions standards. It is

important that costs and benefits of emissions reductions be compared in a consistent way with an assumed or forecast state of the world in the absence of the proposed standards. The baseline can include changes in external factors or other policies that might occur over time if the policy under consideration is not adopted. The baseline will have a time profile to which the costs and emissions reductions of the proposed standards can be compared as they vary over time.

An evaluation of the costs and benefits of adopting a new standard should include a comparison of the costs and benefits of feasible alternative policies. Alternative design or implementation of a standard should consider whether the same air quality goals could be met by a new standard or by a more flexible set of standards. It could also consider whether the costs and benefits of a specific set of standards can compare to alternative ways to reduce emissions from the same sources or from different sources.

Estimating the future emissions reductions (or when possible, the benefits) and costs of a stricter standard are going to be highly uncertain. Point estimates of emissions reductions and costs often convey precision in the estimates that is not warranted. Some knowledge of the extent of uncertainty is necessary to decide whether a new policy would be cost-effective.

There are various ways to reflect the extent of uncertainty. The most accurate way is to use statistical techniques that show the underlying probability distributions of different outcomes. Probabilistic analyses of health outcomes are being done for federal standard setting. The most recent example is the Regulatory Impact Analysis done by EPA (2004e) for the federal rules for nonroad heavy-duty engines.

For mobile-source standard setting, particularly at the state level, there are not enough data on either costs or benefits to do this type of statistical analysis. Some sensitivity analysis on costs and benefits would be useful but is rarely done. The emissions reductions are often estimated using the MOBILE or EMFAC models, which have assumptions incor-

porated about future changes. Uncertainty must be included by identifying the assumptions that have the greatest uncertainty and by varying those assumptions in plausible and transparent ways. For example, if there is uncertainty about the effectiveness of a particular technology, that can be reflected by showing a range of results. Similarly for costs, areas of uncertainty can be identified and plausible alternative assumptions can be used to generate a range of cost estimates.

It is important to identify the groups who are likely to be affected by emissions reductions from a proposed standard and who are likely to bear those costs. The benefits and costs may differ across geographic areas within the region considering the standard or they may be distributed in other regions or throughout the country. As discussed above, in many cases, vehicle pricing policies result in the same price for the same model vehicle regardless of whether the standards are stricter, indicating that the costs of adopting stricter standards in one region are paid throughout the country.

The current system of regulating mobile-source emissions that allows a second set of emissions standards is a compromise between the interests of manufacturers, who prefer a single set of emissions standards to reduce compliance costs, and state air quality managers, who prefer standards tailored to air quality objectives. The desire to harmonize emissions standards and certification testing procedures stems from the need to improve regulatory efficiency. Several conclusions come from this chapter.

• Emissions-control regulations can be assumed to result in higher prices paid by consumers, other things being the same. Impacts from a second set of standards include changes to equipment and certification costs as well as costs related to distribution and enforcement. Quantifying the impacts of a second set of standards, however, is difficult. Costs are difficult to assess. Pricing, employment, and production effects are complex and depend on consumer preferences, overall vehicle

or machine characteristics, and the ability of firms to innovate in the face of regulation. The committee has been unable to obtain detailed quantitative information on the pricing of vehicles and other mobile sources, and the production and employment effects of different standards in the past.

• Recognizing the needs of some states to adopt more stringent mobile-source emissions standards to help improve air quality, a desirable objective is to harmonize CARB’s and EPA’s certification procedures. Although meaningful differences in standards can be important in achieving clean air, superficial differences, in such areas as certification procedures, can be wasteful. Harmonization of standards and testing procedures also has the global context of foreign manufacturers producing and selling their products within the United States and domestic manufacturers producing and selling their products globally.