[Federal Register Volume 59, Number 67 (Thursday, April 7, 1994)]
[Unknown Section]
[Page 0]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 94-6828]


[[Page Unknown]]

[Federal Register: April 7, 1994]


_______________________________________________________________________

Part II





Environmental Protection Agency





_______________________________________________________________________



40 CFR Part 51




Economic Incentive Program Rules; Final Rule
ENVIRONMENTAL PROTECTION AGENCY

40 CFR Part 51

[FRL-4853-8]
RIN 2060-AD58

 
Economic Incentive Program Rules

AGENCY: Environmental Protection Agency (EPA).

ACTION: Final rule and guidance.

-----------------------------------------------------------------------

SUMMARY: This action promulgates rules for economic incentive programs 
(EIP's) which either may or must be adopted by States for certain ozone 
(O3) and carbon monoxide (CO) nonattainment areas upon the failure 
of a State to submit an adequate showing that an applicable reasonable 
further progress (RFP) or a specific emissions reductions milestone has 
been met (in serious, severe, and extreme O3 and serious CO 
nonattainment areas) or upon the failure of a serious CO nonattainment 
area to attain the national ambient air quality standards (NAAQS) for 
CO. Under the Clean Air Act as amended in 1990 (Act), the EPA was 
required to promulgate final EIP rules for stationary, area, and mobile 
sources by November 15, 1992; this action is that rulemaking.
    The provisions of today's rules are also guidance for discretionary 
EIP's that any State may choose to adopt for any criteria pollutant, as 
explicitly allowed for in the Act. The Agency views this action as an 
opportunity to encourage the development and early implementation of 
appropriate EIP's. In so doing, the Agency hopes these rules and 
guidance will stimulate the adoption of incentive-based, innovative 
programs, where appropriate, that will assist States in meeting air 
quality management goals through flexible approaches which benefit both 
the environment and the regulated entities, allow for less costly 
control strategies, and provide stronger incentives for the development 
and implementation of pollution prevention measures and innovative 
emissions reductions technology.
    The EPA intends that the portion of the preamble and rules 
published today that concern discretionary EIP's constitute guidance, 
not final action. Final action with respect to discretionary EIP's will 
occur when the EPA approves or disapproves State implementation plan 
(SIP) revisions containing discretionary EIP's.

EFFECTIVE DATE: The regulations in this rulemaking go into effect on 
April 7, 1994.

ADDRESSES: The public docket for this action, A-91-56, including copies 
of the public comments on the EPA's February 23, 1993 proposed 
rulemaking, is available for public inspection and copying between 8 
a.m. and 4 p.m., Monday through Friday, at the address listed below. A 
reasonable fee for copying may be charged. The address of the EPA Air 
Docket is EPA Central Docket Section, South Conference Center, room 4, 
401 M Street, SW, Washington, DC 20460.

FOR FURTHER INFORMATION CONTACT:
Mr. Willis P. Beal, U.S. EPA, MD-12, Research Triangle Park, North 
Carolina 27711, telephone (919) 541-5667.

SUPPLEMENTARY INFORMATION: The contents of today's preamble are listed 
in the following outline:

I. Background and Purpose
    A. Introduction
    B. Overview
    C. Principles and Regulatory Elements
II. Summary of Rules and Guidance
    A. Applicability
    B. Definitions
    C. State Program Election and Submittal
    D. State Program Requirements
    E. Use of Program Revenues
III. Discussion of Rules and Guidance
    A. Applicability
    B. Definitions
    C. State Program Election and Submittal
    D. State Program Requirements
    E. Use of Program Revenues
IV. Discussion of Comments and Regulatory Changes
    A. Program Goals
    B. Interface With Reasonably Available Control Technology (RACT) 
and Other Statutory Requirements
    C. Program Baseline
    D. Emission Quantification
    E. Monitoring, Recordkeeping, Reporting (MRR)
    F. State Implementation Plan (SIP) Creditability
    G. Audit/Reconciliation Procedures
    H. Penalties for Noncompliance
    I. Interface With Existing Emission Trading Policies
    J. General Issues
V. Administrative Requirements
    A. Executive Order 12866
    B. Paperwork Reduction Act
    C. Regulatory Flexibility Act

I. Background and Purpose

A. Introduction

    The Act, as amended in 1990, broadly encourages the use of 
incentive-based approaches to control air pollution. This encouragement 
is reflected not only in the title IV acid rain program, but also in 
the title I general provisions for State and Federal implementation 
plans for achieving the NAAQS for criteria pollutants, as well as in 
the provisions for certain Federal O3 measures. In title I, 
incentive-based approaches are encouraged, and, in certain cases, 
mandated, through the use of what has been termed an ``economic 
incentive program.'' Today's notice promulgates rules and guidance for 
EIP's adopted by the States pursuant to title I of the Act.
    The Agency views this action as an opportunity to encourage and 
provide guidance on the early implementation of appropriate 
discretionary EIP's, as well as to provide mandated rules for use by 
States after certain specific failures occur. The Agency hopes that 
this guidance will stimulate the early adoption of innovative, 
incentive-based approaches, where appropriate, that will assist the 
States in avoiding such failures, reaching attainment of the NAAQS 
faster than might otherwise occur solely through the use of traditional 
regulatory strategies, and lowering the cost of attaining and 
maintaining the NAAQS. Through this action, the Agency intends to 
encourage the development of EIP's which benefit both the environment 
and the regulated entities by increasing flexibility and stimulating 
the use of less costly strategies, as well as by providing stronger 
incentives for development and implementation of pollution prevention 
measures, innovative emissions reductions technology, and strategies 
beyond those specifically mandated through State and Federal standards 
and regulations. The Agency believes that these goals can be met by 
EIP's that also meet the standards of accountability and enforceability 
currently found in traditional regulatory programs.

B. Overview

    Today's notice promulgates rules for EIP's which may be adopted by 
an authorized governing body, including States, local governments, and 
Indian governing bodies (henceforth State), for certain O3 and CO 
nonattainment areas pursuant to sections 182(g)(3), 182(g)(5), 
187(d)(3), and 187(g) of the Act. These sections mandate for certain 
areas, and identify as one of three options for certain other areas, 
the use of EIP's in certain cases. An EIP is mandated upon the failure 
of a State to submit an adequate demonstration showing that the area 
has met applicable milestones for RFP in extreme O3 nonattainment 
areas (section 182(g)(5)). An EIP is identified as one of three options 
upon such failure in serious and severe O3 nonattainment areas 
(section 182(g)(3)).1 Further, an EIP is also mandated upon the 
failure of a State to submit a milestone demonstration showing 
adequately that the area has met a required specific emissions 
reductions milestone or to attain the CO NAAQS in serious CO 
nonattainment areas (section 187(d)(3), 187(g)).
---------------------------------------------------------------------------

    \1\The other two options are to have the area reclassified to 
the next higher classification and to implement specific additional 
measures adequate to meet the next milestone as provided in the 
applicable contingency plan.
---------------------------------------------------------------------------

    Section 182(g)(4)(A) of the Act requires that EIP's adopted by 
States pursuant to the sections of the Act cited above, characterized 
in today's notice as statutory EIP's, be consistent with the Agency's 
final rules for EIP's. This section also requires that such EIP's be 
nondiscriminatory with regard to applicable laws regarding interstate 
commerce. In addition, section 182(g)(4)(B) imposes constraints on how 
any revenues generated by such programs shall be used. The scope of the 
EIP rules includes programs which may be adopted for ``reducing 
emissions from permitted stationary sources, area sources, and mobile 
sources.''
    Other sections of title I also explicitly allow for EIP's to be 
included as provisions in SIP's in general (section 110(a)(2)(A)), as 
well as specifically in nonattainment area SIP's (section 172(c)(6)). 
Economic incentives are allowable in Federal implementation plans 
(FIP's) by definition (section 302(y)), and in Federal O3 measures 
through the system of regulations for control of emissions from 
consumer or commercial products (section 183(e)(4)). Today's notice 
serves as the Agency's final guidance for EIP's adopted by States 
pursuant to the sections of the Act relating to general SIP provisions, 
characterized in today's notice as discretionary EIP's. Discretionary 
EIP's may be adopted for any criteria pollutant in both nonattainment 
and attainment areas.

C. Principles and Regulatory Elements

    The rules and guidance in today's notice are broadly applicable to 
any type of statutory or discretionary EIP, respectively. This notice 
requires that EIP's submitted for approval to the EPA as part of a SIP 
for a nonattainment area contain design features that will ensure that 
the program will not interfere with other requirements of the Act and 
that emissions reductions credited to the program will be quantifiable; 
consistent with SIP attainment and RFP demonstrations; surplus to 
reductions required by, and credited to, other implementation plan 
provisions to avoid double counting of reductions; enforceable at both 
the State and Federal levels; and permanent over the entire duration of 
the program.2 The Agency does not intend to limit flexibility and 
innovation beyond those constraints that are necessary to meet these 
requirements.
---------------------------------------------------------------------------

    \2\The program need not continue forever to generate permanent 
emissions reductions. Such reductions can be discrete or continuous, 
depending on the nature of the program. Discrete (i.e., temporary) 
reductions can be used to defer but not solely to satisfy continuous 
emission reduction requirements (e.g., RACT).
---------------------------------------------------------------------------

    This notice identifies key program provisions which must generally 
be included to ensure that the above requirements will be met. Adequate 
program designs will generally include the following elements: Clearly 
defined goals and an incentive mechanism that can be rationally related 
to accomplishing the goals; a clearly defined scope, which identifies 
affected sources and assures that the program will not interfere with 
any other applicable Federal regulatory requirements; a program 
baseline from which projected program results (e.g., quantifiable 
emissions reductions) can be determined; credible, workable, replicable 
procedures for quantifying emissions and/or emission-related 
parameters, as appropriate; source requirements, including those for 
MRR, that are consistent with specified quantification procedures and 
allow for compliance certification and enforcement; requirements for 
projecting program results and dealing with uncertainty; and an 
implementation schedule, administrative system, and enforcement 
provisions adequate for ensuring Federal and State enforceability of 
the program. All EIP's for which SIP credit is taken in attainment and 
RFP demonstrations must include additional elements, such as audit 
procedures to evaluate program implementation and track results, and, 
in certain cases, reconciliation procedures to trigger corrective or 
contingency measures to make up any shortfall between projected 
emissions reductions and emissions reductions actually achieved in 
practice.
    The rules are, of necessity, general in nature with regard to 
criteria for designing adequate program elements. This generality 
arises due to the large variety of EIP types and designs which may be 
submitted, and the Agency's goal of encouraging creativity and 
innovation on the part of the States developing such programs. There 
are three broad, interrelated aspects of any program design that 
significantly affect the approvability of an EIP: How the EIP relates 
to other SIP provisions, the level of certainty in quantifying 
emissions and projecting EIP results, and the nature and extent of MRR 
requirements for enabling determinations of compliance. For example, 
today's notice reflects the Agency's view that the scope and nature of 
MRR requirements, including the extent to which an EIP exceeds the 
minimum requirements for such, would be among the factors to be 
considered in assessing the adequacy of any demonstration of projected 
EIP program results. The Agency anticipates preparing additional 
guidance on specific aspects of program design as it gains experience 
with EIP's, partly through participation in feasibility and 
demonstration projects.
    Descriptions of a broad range of general types of incentive 
strategies which exemplify potential EIP's are appended to the final 
rules. These descriptions identify key provisions which distinguish the 
different model program types. These examples are general in nature so 
as to avoid limiting innovation on the part of the States in developing 
programs tailored to individual State needs. The EPA has placed in the 
docket support documents which survey a wide range of EIP's that have 
actually been implemented, as well as programs in the design stage. The 
EPA has also issued information and guidance, as required by section 
108(f)(1)(A) of the Act, regarding the formulation and emissions 
reductions potential of various transportation control measures 
(TCM's).3
---------------------------------------------------------------------------

    \3\Further information on potential TCM's and other mobile 
source measures is also contained in a staff memorandum, 
``Preliminary Mobile Source Economic Incentive Program Strategies,'' 
from P. Okurowski to P. Lorang, March 30, 1992, which is available 
in the docket.
---------------------------------------------------------------------------

    The EPA also published interim guidance on the generation of 
emissions reductions credits (ERC's) from mobile source control 
programs at the same time the EIP rule was proposed.4 The EPA 
intends to respond to comments received on this interim guidance and 
publish final guidance in conjunction with other EIP-related guidance 
on ERC banking currently being developed.
---------------------------------------------------------------------------

    \4\Interim Guidance on the Generation of Mobile Source Emission 
Reduction Credits, 58 FR 11134, February 23, 1993. For information 
and copies of the associated technical addendum entitled Guidance 
for the Implementation of Accelerated Retirement of Vehicles 
Programs, please contact: Mr. Mark Simons, U.S. EPA, 2565 Plymouth 
Road, Ann Arbor, MI 48105, (313) 668-4417. For information and 
copies of the associated technical addenda entitled (1) Guidance for 
Emission Reduction Credit Generation by Clean Fuel Fleets and 
Vehicles or (2) Guidance for Mobile Emission Credit Generation by 
Urban Buses, please contact: Mr. Glenn Passavant, U.S. EPA, 2565 
Plymouth Road, Ann Arbor, MI 48105, (313) 668-4408.
---------------------------------------------------------------------------

    The EPA intends that today's notice be consistent with other 
related rules and policies, either in place or under development, such 
as the title V operating permits rules, the title VII rules for 
enhanced monitoring, general guidance on the implementation of title I, 
and policies on emission trading.

II. Summary of Rules and Guidance

A. Applicability

    The rules promulgated in today's notice apply to any statutory EIP 
submitted to the EPA as a SIP revision to comply with sections 
182(g)(3), 182(g)(5), 187(d)(3), or 187(g) of the Act, which either may 
or must be adopted by States upon the failure of a State either to meet 
or to submit an adequate showing that an applicable RFP or a specific 
emissions reductions milestone has been met (in serious, severe, and 
extreme O3 nonattainment areas, and serious CO nonattainment 
areas), or upon the failure of a serious CO nonattainment area to 
attain the NAAQS for CO. The provisions contained in these rules, 
except as explicitly exempted, also serve as the Agency's policy 
guidance on any discretionary EIP's submitted as SIP revisions.

B. Definitions

    The term ``EIP'' is defined to include State established emission 
fees, marketable permits, State fees on the sale or manufacture of 
products the use of which contributes to O3 formation, TCM's, or 
any combination of such measures.

C. State Program Election and Submittal

    Under today's rules, statutory EIP's submitted as SIP revisions, 
when applicable, must be sufficient, in combination with other elements 
of the plan, to achieve the next applicable milestone (for serious, 
severe, and extreme O3 nonattainment areas), or to reduce the 
total tonnage of emissions of CO in the area by at least 5 percent per 
year until attainment is achieved (for serious CO nonattainment areas). 
Discretionary EIP's must not interfere with any applicable requirement 
concerning attainment and RFP, or any other applicable requirement of 
the Act (section 110(l)).

D. State Program Requirements

    Today's rules and guidance establish as a goal for all EIP's that 
they be designed to benefit both the environment and the regulated 
entities. In addition, EIP's must be State and federally enforceable, 
nondiscriminatory (with respect to interstate commerce), and consistent 
with the timely attainment and maintenance of NAAQS, all applicable RFP 
and visibility requirements, applicable prevention of significant 
deterioration (PSD) increments, and all other applicable requirements 
of the Act. Programs in nonattainment areas for which credit is taken 
in attainment and RFP demonstrations shall be designed to ensure that 
the effects of the program are quantifiable, and that the credit taken 
is limited to that which is surplus to other SIP-credited requirements. 
Statutory EIP's must be designed to result in quantifiable, significant 
reductions in actual emissions.
    A number of program elements are outlined in the rules which must 
be included, as applicable, as part of any EIP design. These elements 
are required to delineate program scope, to specify credible, workable, 
replicable emission quantification procedures and all affected source 
requirements, to project program results, to specify audit and, if 
appropriate, reconciliation procedures (to evaluate program 
implementation, track results, and, as appropriate, trigger corrective 
or contingency measures), and to define an implementation schedule, 
administrative procedures, and effective enforcement mechanisms.

E. Use of Program Revenues

    The rules incorporate statutory restrictions on the use of revenues 
generated by statutory EIP's. Specifically, any such revenues may be 
used by a State for providing incentives for achieving emissions 
reductions, providing assistance (up to 75 percent of the costs) for 
the development of innovative technologies for the control of O3 
air pollution and for the development of lower-polluting solvents and 
surface coatings, and funding (with up to 50 percent of the revenues) 
administrative costs of State programs under this Act. These 
restrictions on the use of revenues do not apply to discretionary 
EIP's.

III. Discussion of Rules and Guidance

    This portion of the notice provides more detail on the provisions 
of the final rules and guidance.

A. Applicability

    The rules published in today's notice apply to any statutory EIP 
submitted to the EPA as a SIP revision to comply with sections 
182(g)(3), 182(g)(5), 187(d)(3), or 187(g) of the Act, which either may 
or must be adopted by States upon the failure of a State either to meet 
or to submit an adequate showing that an applicable RFP or a specific 
emissions reductions milestone has been met (in serious, severe, and 
extreme O3 nonattainment areas, and serious CO nonattainment 
areas), or upon the failure of a serious CO nonattainment area to 
attain the NAAQS for CO. The provisions contained in these rules, 
except as explicitly exempted, also serve as the Agency's policy 
guidance on any discretionary EIP's submitted as SIP revisions. 
Further, the EPA will use the provisions contained in these rules as 
guidance in preparing EIP's, when appropriate, for FIP's necessitated 
by State failures and for other Federal measures.
    The EPA intends to review EIP's submitted as plan revisions based 
on the general SIP review requirements contained in sections 110(k), 
110(l), 182, and 187 of the Act, as applicable, and associated Agency 
policies. For statutory programs, the Agency intends to review the plan 
revision and either approve or disapprove all or part of the revision 
within 9 months after the date of the State's submission of the plan 
revision, consistent with section 182(g)(3) and 182(g)(5) of the Act. 
For discretionary EIP's, Agency action on plan revisions submitted for 
review will be taken according to the same schedule as is applicable to 
any other type of plan revision. An EIP submitted as a plan revision 
will be deemed to be approved only upon an affirmative decision by the 
Agency.

B. Definitions

    The definitions in today's notice include many terms drawn from the 
Act or other regulations or guidance documents, as well as new terms 
relating to EIP's. Key new terms are discussed below.
1. Economic Incentive Program
    Consistent with section 182(g)(4)(A) of the Act, for purposes of 
today's rulemaking, ``EIP'' is defined to mean a program which may 
include ``State established emission fees or a system of marketable 
permits, or a system of State fees on sale or manufacture of products, 
the use of which contributes to O3 formation, or any combination 
of the foregoing or other similar measures.'' In addition, the Act 
expands this definition to include ``incentives and requirements to 
reduce vehicle emissions and vehicle miles traveled in the area, 
including any of the transportation control measures identified in 
section 108(f).''
    For purposes of this rulemaking, this notice classifies EIP's into 
three broad categories: emission limiting, market response, and 
directionally-sound. This categorization is based on whether a 
quantifiable emission-related requirement is directly specified as an 
integral element of the program or whether the program depends upon 
marketplace decisions, in response to a program's incentive, to produce 
the intended emission-related objective of the program. Further, the 
categorization is a function of whether the results of the program are 
quantifiable.
    Emission-limiting strategies directly specify limits on total mass 
emissions, emission-related parameters (e.g., emission rates per unit 
of production, product content limits), or levels of emissions 
reductions relative to a program baseline that are required to be met 
by affected sources, while providing flexibility to sources to reduce 
the cost of meeting such limits. A marketable permits program (i.e., 
emission trading with source-specific mass emissions limitations, or 
caps) is a primary example of such a program. If every affected source 
in such a program complies with its emissions cap (taking into account 
both emissions generated by the source as well as any emissions 
trading), the program will necessarily achieve the specified emissions 
limits.
    A market-response strategy creates one or more incentives for 
affected sources to reduce emissions, without directly mandating 
emission-related requirements for individual sources or even for all 
sources in the aggregate. An emission fee program may be an example of 
a market-response strategy. In such a program, each source might be 
required to pay a fee on each unit of emissions. The response to the 
incentive, in terms of actions which affect emissions levels, will be 
determined by each source according to its abatement opportunities, 
costs, and other factors. Thus, each source has flexibility in 
determining its ultimate level of emissions (within any constraints 
imposed by other regulatory requirements).
    A consequence of programs based on market-response strategies is 
that actual emissions from affected sources may differ from the pre-
implementation projected emissions level even if every affected source 
is in full compliance with the EIP requirements. This added degree of 
uncertainty in program results must be accounted for in designing such 
a strategy (see paragraph III.D.6.).
    Directionally-sound strategies do not yield quantifiable emissions 
reductions creditable towards RFP or attainment demonstrations. Such 
strategies may be included in an area's attainment plan, without 
credit, or in a maintenance plan if the strategy contributes to the 
area coming into or maintaining attainment. Emissions reductions from 
such programs are not creditable towards RFP or attainment 
demonstrations because the program lacks one or more of the basic 
program elements, such as a quantifiable program baseline or adequate 
emissions quantification procedures. However, a State may want to 
pursue such a strategy as a part of their overall program to attain and 
maintain the NAAQS. Directionally-sound strategies must not be used as 
the primary basis for any statutory EIP submitted pursuant to sections 
182(g)(3), 182(g)(5), 187(d)(3), and 187(g) of the Act.
    A number of different types of incentive strategies have been 
identified upon which EIP's could be based. Appendix X contains 
descriptions of different types of strategies, together with a listing 
of the TCM's included in section 108(f) of the Act. There is not, 
however, in all cases a direct correspondence between a type of 
strategy and the regulatory categories described above, since program 
design details can in some cases make a difference in the extent to 
which program results are quantifiable or dependent on market response.
2. Program Baseline
    The determination of a program baseline is the first step in 
projecting program results. Results from EIP's can be projected in 
terms of quantifiable emissions reductions, or, in the case of 
directionally-sound programs, in terms of other emission-related 
parameters. Further, some types of incentive strategies depend upon the 
establishment of a program baseline, in terms of a level of mass 
emissions or emission-related parameter(s), for each affected source or 
aggregated overall affected sources, as a starting point for the 
incentive program mechanism. For example, a marketable emissions permit 
program could be initialized by a program baseline that allocates to 
each source a cap on mass emissions that serves as its starting point 
for any emissions trading transactions or future emissions reductions 
requirements. For other types of programs, this program baseline could 
be defined in terms of emission-related parameters, such as average 
emission rates, solvent content, or vehicle ridership factors.
3. Nondiscriminatory
    Section 182(g)(4) provides that statutory EIP's must be 
``nondiscriminatory'' and must be ``consistent with applicable law 
regarding interstate commerce.'' The EPA interprets these requirements 
to mean that a statutory EIP must not discriminate in favor of 
intrastate commerce and against interstate commerce. In addition, an 
EIP must meet any other applicable limitations under the Commerce 
Clause of the U.S. Constitution. For example, State taxes must meet the 
requirements, to the extent applicable to the tax, set out by the U.S. 
Supreme Court in Complete Auto Transit, Inc. v. Brady, 430 U.S. 274 
(1977). There, the Court stated that a State tax will pass scrutiny 
under the Commerce Clause only if ``the tax is applied to an activity 
with a substantial nexus with the taxing State, is fairly apportioned, 
does not discriminate against interstate commerce, and is fairly 
related to the services provided by the State.'' Id. at 279. Under the 
EPA's interpretation, Congress did not intend, by the provisions 
authorizing EIP's, either statutory or discretionary, to delegate its 
authority under the Commerce Clause to the States, and thereby release 
State EIP's from the limitations that would apply under the Commerce 
Clause had Congress not specifically authorized the EIP; rather, 
Congress intended to maintain those limitations.

C. State Program Election and Submittal

    The mandated schedules for the development, submittal, review/
approval, and implementation of statutory EIP's, submitted pursuant to 
sections 182(g)(3), 182(g)(5), 187(d)(3), and 187(g) of the Act, may 
leave as little as 6 months for the EIP to be operational prior to the 
next milestone requirement. Thus, in these cases, the time available to 
develop, implement, and achieve emissions reductions from an EIP will 
be extremely limited if a State waits until a milestone failure occurs 
to initiate the selection and development of a statutory EIP. As a 
result, the EPA encourages States to initiate development of an EIP as 
soon as they determine that a milestone failure is likely, or even 
sooner, as part of their SIP.
    States are encouraged to consider inclusion of discretionary EIP's, 
where appropriate, in the SIP's (or SIP revisions) due within the first 
4 years after enactment of the amended Act (e.g., sections 182 (b)(1) 
and (c)(2), 187(a)(1)). Submittal at that time would more likely allow 
sufficient time to develop, implement, and evaluate the effectiveness 
of the program. If such an early EIP submittal is made, States must 
account for the effects of the EIP in any subsequent required SIP 
submittals. Nothing in today's notice precludes a State from revisiting 
and amending its original EIP, or any other pre-existing rules, as 
necessary, to ensure consistency with any subsequent required SIP 
submittals.
    The requirements of section 182(g)(3) and 182(g)(5) of the Act 
apply any time that a State fails to submit an adequate milestone 
compliance showing, or when the EPA determines that a milestone has 
been missed by an area covered by these provisions. For example, if 
such a milestone is not met by a serious or severe O3 
nonattainment area, the area may elect among three options, including 
an EIP. The Act does not provide any additional or different 
requirements that would apply when a State that missed one milestone, 
and makes a proper election, misses a subsequent milestone. 
Accordingly, if a subsequent milestone is missed, the same choices are 
available, including the election of an EIP. Thus, the imposed 
requirements or specified options apply not only the first time that a 
milestone is missed, but also if subsequent milestones are missed even 
if an EIP had previously been implemented. Similarly, the EPA 
interprets section 187(g) (requiring serious CO nonattainment areas 
that fail to attain to adopt an EIP) as applying even if the area 
previously missed a milestone and adopted an EIP pursuant to section 
187(d)(3). A second missed-milestone program must provide reductions 
beyond the reductions from a first statutory program. The second EIP 
may either be a new program or a substantive revision of the first 
program.

D. State Program Requirements

    Under today's rules, EIP's must be State and federally enforceable; 
nondiscriminatory (with respect to interstate commerce); and consistent 
with the timely attainment and maintenance of NAAQS, all applicable RFP 
and visibility requirements, applicable PSD increments, and all other 
applicable requirements of the Act. Programs in nonattainment areas for 
which credit is taken in attainment and RFP demonstrations shall be 
designed to ensure that the effects of the program are quantifiable and 
that the credit taken is limited to that which is surplus to other SIP-
credited requirements. Statutory EIP's must be designed to result in 
quantifiable, significant reductions in actual emissions.
    Each of the program elements that must be included, as applicable, 
in an EIP submitted to the EPA as a plan revision are described below. 
For EIP's that allow trading to meet existing source requirements, the 
EPA will consider a two-step process for State submittal and EPA review 
of the program elements outlined below. Under such a step-wise process, 
the initial submittal shall include both a framework for all the 
general elements of program design, as well as all the specific 
regulatory details for a source-specific trade or for an entire source 
category, which trade or source category is representative, with 
respect to all program elements, of the types of trading to be allowed 
under the general framework. For example, for an EIP designed to 
directly implement trading within source categories, the initial 
submittal shall include the full details of all program elements for at 
least one source category. Alternatively, for an EIP designed to 
implement trading on a source-by-source basis, with EPA review of each 
trade, the initial submittal shall include the full details of all 
program elements for at least one source-specific trade. Thus, required 
specific aspects of the emission quantification procedures and MRR 
requirements for additional sources and/or source categories could be 
submitted at a later time to allow the State to phase-in the 
application of the program to other individual sources or source 
categories. Because adequate enforceability elements--including 
emissions quantification procedures, test methods, and MRR 
requirements--are integral to any SIP program, approval by the EPA of a 
framework for trading would constitute approval only of the framework 
elements included as part of the initial submission and of trading for 
those sources or within those source categories submitted with the 
framework and approved for trading by the EPA. Trading involving other 
sources or source categories could not occur until all elements, 
including enforceability elements, were approved by the EPA through a 
subsequent step in the process. The EPA will apply the same criteria in 
reviewing step-wise submittals of emission quantification and MRR 
requirements as in reviewing such requirements submitted together with 
the other program elements. Thus, a subsequent submittal must be fully 
compatible with all the elements in the initial submittal, and, taken 
together, both submittals must meet all the requirements of the EIP 
rules and guidance. The EPA does not intend to consider use of this 
step-wise process for EIP's that mandate new requirements for affected 
sources (e.g., requiring mass emission caps on sources previously 
required to meet emission rate limits).
1. Program Goals and Rationale
    An acceptable EIP must clearly define the goals of the program and 
provide a rationale relating how the program design will accomplish the 
goals. These final rules and guidance establish as a goal for all EIP's 
that they be designed to benefit both the environment and the regulated 
entities. The final rules and guidance require States to design 
programs that will meaningfully meet this goal, while providing 
flexibility to the States to determine how best to accomplish such 
``benefits sharing'' in the context of each specific program.
    The term ``benefits'' is broadly defined to include not only 
economic benefits, such as cost savings and compliance flexibility for 
the regulated sources, but also environmental benefits that will result 
in States reaching attainment of the NAAQS faster than might otherwise 
occur solely through the use of traditional strategies. Environmental 
benefits can be created most directly by EIP's that require increased 
or more rapid emissions reductions beyond those that would be achieved 
through a traditional regulatory program. Specifically, a 10 percent 
increase in emissions reductions would presumptively meet this benefits 
sharing goal. Alternatively, environmental benefits can also be 
achieved by programs that incorporate, for example, improved 
administrative mechanisms (e.g., that achieve emissions reductions from 
sources not readily controllable through traditional regulation), 
reduced administrative burdens on regulatory agencies that result in 
increased environmental benefits through other regulatory programs, 
improved emissions inventories that enhance and lend increased 
certainty to State planning efforts, and the adoption of emission caps 
which over time constrain or reduce growth-related emissions beyond 
traditional regulatory approaches.
    Statutory EIP's will benefit the environment as a result of the 
requirement that they be designed to result in significant reductions 
in actual emissions. For discretionary EIP's, no standard formula for 
benefit sharing is specified, although the EPA encourages States, to 
the extent practicable, to design such programs so as to create most 
directly increased or more rapid emissions reductions (see paragraph 
IV.A.2).
    The EPA notes that any incentive-based program has the potential to 
create incentives for pollution prevention and technological 
innovation. Such an inherent potential benefit can only meaningfully 
meet the goal of providing benefits to the environment if the program 
is specifically designed to allocate some of the effects of such 
innovation to enhancing environmental progress. Likewise, for the other 
ways listed above in which environmental benefits can be accomplished, 
the EPA intends that these approaches be meaningfully implemented so as 
to produce real environmental benefits.
    A well-designed EIP will achieve a number of different kinds of 
environmental benefits. For instance, a marketable emissions permit 
program, with mass emissions caps declining over time, may achieve 
several results. The declining cap aspect of the program can result in 
real emissions reductions creditable towards RFP milestones and 
attainment (to the extent that actual emissions are reduced). The 
marketable aspect of the program allows emission sources facing 
differing costs of further emission control to trade, lowering overall 
control costs. Such programs also encourage sources already able to 
meet their mass emissions caps to find ways of further reducing 
emissions beyond what would otherwise be required by traditional 
regulatory programs (e.g., through pollution prevention, technological 
innovation, or changes in operational procedures).
    Statutory EIP's, submitted because of failures in achieving 
required emissions reductions, must make a significant contribution to 
the required reductions, while not necessarily bearing the full burden 
of achieving all the required reductions or mandating any specific 
percentage reduction. A program producing no additional emissions 
reductions or one based solely on a directionally-sound strategy, 
without quantifiable benefits, would not satisfy these criteria for an 
acceptable statutory EIP. For discretionary EIP's, the final guidance 
relies upon the new State planning, quantitative progress, and 
attainment requirements in the Act to ensure expeditious attainment of 
the NAAQS, regardless of the type of programs that States may choose to 
include in their SIP's.
    Any EIP should include a rationale for how the incentive 
mechanism(s) will achieve the stated goal(s). A State can create a 
better overall program design by carefully examining and explaining the 
linkage between a program's provisions and the desired outcome. The 
provisions of a program must be sufficient to ensure the program goals 
are successfully achieved without creating unintended detrimental side 
effects.
2. Program Scope
    As with any regulatory program, an EIP must identify the affected 
sources covered by the program. The affected sources may be defined on 
the basis of source type (e.g., manufacturing operations), activity 
type (e.g., fuel storage tanks), location, firm size, quantity of 
emissions, or other such characteristics. In addition, a State may 
choose to grant exemptions from program requirements to sources meeting 
specified criteria. For example, States may consider exempting zero-
emitting vehicles from a new parking price program. In establishing the 
affected source criteria, a State must assure that the resultant 
program is nondiscriminatory within the meaning given that term in 
these rules.
    The program must establish procedures for dealing with sources 
entering or exiting affected source categories. In order to promote 
economic growth consistent with achieving environmental goals, a 
regulatory program should not create unwarranted barriers to entry for 
new or expanding business entities.
    In addition, the program must establish criteria and procedures for 
sources voluntarily choosing to opt-in to or to be exempted from the 
program, to the extent that the program design allows for such movement 
into or out of the universe of affected sources. For example, the title 
IV acid rain allowance trading program includes provisions for sources 
not originally in the program to opt-in to the program in order to sell 
sulfur dioxide (SO2) emission allowances to sources already in the 
program. Certain EIP's may also provide criteria for exempting sources 
such that they can leave the program; such criteria must be described 
and the procedures for leaving the program must be included in the EIP. 
Any such procedures must ensure that movement into or out of the 
program will not interfere with other statutory requirements nor result 
in an increase in area-wide emissions that is not reflected in the 
plan's attainment or RFP demonstrations. Finally, the opt-in program 
language must specify that it will not allow sources to opt-in if the 
net result of the opt-in program as a whole is to increase area 
emissions, unless such increase has been accounted for in the 
development of the EIP, and is consistent with attainment and 
maintenance of the NAAQS, RFP, and all other SIP requirements.
    Affected sources in an EIP may also be covered by other Federal 
regulatory requirements. An EIP may not interfere with applicable 
requirements concerning attainment and RFP, or any other applicable 
requirements of the Act. Thus, the program scope must be defined so as 
not to interfere with any other Federal regulatory requirements which 
apply to the affected sources. Such requirements for stationary sources 
may include, but are not limited to, reasonably available control 
technology (RACT), PSD and new source review (NSR) offset requirements, 
lowest achievable emission rate (LAER), best available control 
technology (BACT), new source performance standards (NSPS), national 
emissions standards for hazardous air pollutants (NESHAP's), acid 
deposition program requirements, reasonably available control measures 
(RACM), and best available control measures (BACM). Such requirements 
for mobile sources may include, but are not limited to, programs 
integral to vehicle inspection and maintenance (I/M), clean-fueled 
fleets, reformulated gasoline, oxygenated fuels, employee commute 
options (ECO), TCM's, and Federal motor vehicle controls.
    In general, sources subject to these statutory requirements may 
participate in emissions trades pursuant to an EIP as long as, apart 
from their participation in such trades, they continue to meet the 
statutory requirements. Thus, if these sources reduce their emissions 
below what the applicable statutory requirements call for, the 
reductions beyond the requirements may furnish credits for the 
EIP.5 Following is a more specific discussion of the interplay of 
the EIP rules with several of the statutory provisions listed above.
---------------------------------------------------------------------------

    \5\For example, since VOC reductions that occur as a result of 
controls put in place to meet NESHAP's are creditable to RFP, such 
VOC reductions cannot be considered as surplus to supply VOC credits 
through an EIP. However, if in such a case greater than required 
reductions are made, the incremental VOC reductions could furnish 
credits through an EIP.
---------------------------------------------------------------------------

    RFP Requirements. Credits for emissions reductions from stationary, 
mobile, or area sources may generally be used to meet the ``progress'' 
requirements of the nonattainment provisions of the Act. The SIP's for 
O3 nonattainment areas classified as moderate or higher under 
section 181(a)(1) are required to provide for reductions in volatile 
organic compounds (VOC) of at least 15 percent from baseline emissions 
by 1996, and areas classified as serious or higher are required to 
provide for reductions of at least 3 percent each year (averaged over a 
3-year period) thereafter until the attainment date (section 182(b)(1), 
182(c)(2)(B)). Emissions reductions from all sources may be used to 
meet these progress requirements, except for those reductions 
attributable to Federal motor vehicle programs and RACT and NSR 
corrections (section 182(b)(1) (C)-(D)).
    RACT. An EIP may allow sources subject to the RACT requirement to 
attain RACT-level emissions reductions in the aggregate, and thereby 
trade among themselves. In designing such RACT trading programs (to 
implement new and/or previously existing RACT requirements), as with 
any EIP, States are encouraged, to the extent practicable, to meet the 
benefits sharing goal directly, by requiring increased emissions 
reductions beyond those that would be achieved through a traditional 
RACT program.
    In addition, today's rules and guidance authorize emissions trading 
between the stationary sources subject to the RACT requirement (``RACT 
sources'') and any sources (i.e., stationary, mobile, and area sources) 
not subject to the RACT requirement (``non-RACT sources'') when such 
trading results in an exceptional environmental benefit, e.g., a level 
of reductions that is significantly greater than RACT-level amounts. 
With respect to the level of emissions reductions required from the 
non-RACT sources, the appropriate amount of emissions reductions 
generally should be set at a level that takes into account the severity 
of the nonattainment status in a given area.
    Today's rules establish the statutory offset ratios for 
nonattainment areas as the determinant of the amount of emissions 
reductions that would be required from non-RACT sources generating 
credits for RACT sources. The offset ratios are lower for lower-
classified areas (e.g., compare section 182(a)(4), with a 1.1 to 1 
offset ratio for marginal areas, and section 182(d)(2), with a 1.3 to 1 
offset ratio for severe areas). Looking to offset ratios is instructive 
because offsets are an aspect of emissions trading that is directly 
addressed in the Act. The offset ratios provide a suitable analogy 
because they represent the most substantial benefit to the environment 
for a given area that is required in this statutory context of 
emissions trading.
    However, today's rules authorize emissions trading between RACT and 
non-RACT sources at less than the offset ratios if exceptional 
environmental benefits are otherwise demonstrated, such as, for 
example, an emissions trade that promoted the market penetration of 
emissions reduction measures for non-RACT sources, such that future 
emissions reductions from the universe of non-RACT sources would be 
expected to increase over time. Such measures could include new vehicle 
technologies that utilize alternative fuels, provided that such 
technologies meet all relevant EPA standards and guidelines. Where a 
lower trading ratio is authorized in order to promote the market 
penetration of an environmentally-beneficial, new control measure, a 
lower bound for the trading ratio of 1.1 to 1 will assure that in all 
events some additional benefit will accrue to the environment. In 
setting the appropriate ratio for trades between RACT and non-RACT 
sources, States may also take into account additional State and 
federally-enforceable emissions reductions that are achieved as a 
result of other exceptional environmental features of an EIP (such as a 
separate ``environmental bonus'' provision, as discussed in EPA's 
Interim Guidance on the Generation of Mobile Source Emissions Reduction 
Credits). In no case, however, can a trading ratio be lower than 1 to 
1, and in no case can the effective trading ratio be less than the 
appropriate offset ratio (or such ratio, as low as 1.1 to 1.0, as may 
be authorized to promote the market penetration of environmentally-
beneficial, new control measures).
    Offsets. Credits for emissions reductions generated by stationary, 
mobile, or area sources may be used for purposes of meeting the offset 
requirement for major new and modified sources in nonattainment areas 
so long as they meet the restrictions imposed on offsets by section 173 
of the Act and the EPA's new source review regulations (40 CFR 51.165 
and part 51, appendix S). Under the nonattainment provisions, new or 
modified major stationary sources may not receive permits for 
construction and operation in a nonattainment area unless, among other 
things, their new emissions are offset by reductions from other sources 
in the area (section 172(c)(5), 173(a)(1)(A)). For O3 
nonattainment areas, minimum offset ratios range from 1.1 to 1 for 
marginal areas to 1.5 to 1 for extreme areas (section 182(a)(4), 
182(b)(5), 182(c)(10), 182(d)(2), 182(e)(1)).
    However, the Act does not require that offsets be secured by the 
new source. Rather, any portion of the necessary offsets may be 
generated by the local air quality district or by the State. In other 
words, a jurisdiction may set up an offset ``bank'' to supply new 
sources with sufficient emissions reductions to satisfy their offset 
obligations. To satisfy the requirements set forth in section 173, each 
time a new source commences operations, the jurisdiction must have 
already generated the necessary emissions reductions to offset the new 
emissions. This means that the jurisdiction must be able to demonstrate 
that the program has secured sufficient excess emissions reductions to 
offset all new emissions at the proper ratio. If the source itself is 
only held responsible for securing emissions reductions in an amount 
equal to its new emissions (i.e., a 1 to 1 ratio), the SIP must 
generate sufficient reductions to cover the extra reductions required 
(e.g., 1.2 to 1 in serious O3 nonattainment areas).
    The Act limits offsets to emission reductions not ``otherwise 
required by this Act.'' As part of the ``General Preamble for the 
Implementation of Title I of the Clean Air Act Amendments of 1990,'' 
the EPA described certain circumstances under which reductions would 
not be creditable for offset purposes because those reductions are 
required by other provisions of the Act (57 FR 13498, 13553 (April 16, 
1992)). In addition, the EPA intends to provide additional guidance 
regarding offsets in the near future.
    BACT and LAER. Both the PSD program and the nonattainment NSR 
program contain technology-based emission limitations that are source 
specific. The Act expressly requires that these emissions limitations 
(i.e., BACT in the case of PSD and LAER in the case of NSR) be met by 
the proposed major new source or major modification itself as a 
condition of permit issuance. Consequently, neither of these 
requirements can be met through emissions trading.
    Regarding BACT, section 165(a) of the Act provides that no major 
new source or major modification may be constructed in a PSD area 
unless the requirements in section 165(a)(1)-(8) are met. Section 
165(a)(1) specifies that among these requirements is ``a permit * * * 
setting forth emission limitations for such facility which conform to 
the requirements of this part.'' Section 165(a)(3)(C) further specifies 
that the proposed facility must demonstrate that emissions from the 
facility will not exceed any applicable emission standard under the 
Act.6 The applicable emissions limitations are those provided in 
section 165(a)(4), which provides that the proposed facility must ``be 
subject to the best available control technology for each pollutant 
subject to regulation under this Act emitted from, or which results 
from, such facility.''7
---------------------------------------------------------------------------

    \6\Section 302(k) of the Act defines the terms ``emission 
limitation'' and ``emission standard'' interchangeably.
    \7\Section 169(3) in turn defines BACT as ``an emission 
limitation based on the maximum degree of reduction of each 
pollutant subject to regulation under this Act emitted from or which 
results from any major emitting facility, which the permitting 
authority, on a case-by-case basis, taking into account energy, 
environmental, and economic impacts and other costs, determines is 
achievable for such facility.''
---------------------------------------------------------------------------

    The Act sets forth a similar statutory scheme with respect to LAER. 
Section 173(a) provides that the permit program applicable to major new 
sources or major modifications, which is required to be included in 
part D SIP's under section 172(b)(5),8 shall provide that permits 
to construct and operate may be issued only if the requirements set 
forth in section 173(a)(1)-(5) are met. Among these enumerated 
requirements is section 173(a)(2), which specifies that ``the proposed 
source is required to comply with the lowest achievable emission 
rate.''9
---------------------------------------------------------------------------

    \8\Section 173(a) incorrectly refers to the ``permit program 
required by section 172(b)(6).'' Section 172(b)(6) was renumbered as 
section 172(b)(5) by the 1990 Amendments. Apparently, this change 
was not picked up by the drafters of revised section 173.
    \9\Section 171(3) defines LAER as ``that rate of emissions which 
reflects'' either ``the most stringent emission limitation which is 
contained in (any SIP) for such class or category of source,'' or 
``the most stringent emission limitation which is achieved in 
practice by such class or category of source, whichever is more 
stringent.''
---------------------------------------------------------------------------

    The statutory provisions addressing both BACT and LAER clearly 
require the permitting authority to set, and the source owner to comply 
with, the applicable technology-based emission limitation. There is no 
provision in the statute for lawfully complying with BACT or LAER 
through obtaining emissions reductions at other sources that would 
result in an equivalent reduction of emissions or ambient 
concentrations.
    Inspection and Maintenance Programs. The I/M provisions of the Act 
require a vehicle I/M program that meets specified performance 
standards. The requirements of the I/M provisions cannot be met by 
obtaining ERC's from sources other than vehicles, or from vehicles 
through means other than I/M of the vehicle. An EIP may not substitute 
entirely for an enhanced or basic periodic vehicle I/M program.
    This view is based on the provisions of the Act that set forth 
requirements for a basic I/M program, as well as certain provisions 
relating to enhanced I/M programs. Sections 182(a)(2)(B)(i) (I/M ``fix-
ups'' for O3 nonattainment areas classified marginal and higher), 
182(b)(4) (I/M ``catch-ups'' for O3 nonattainment areas classified 
moderate and higher), and 187(a)(4) (I/M ``fix-up'' requirement for CO 
nonattainment areas classified moderate and higher) each require a SIP 
revision that includes provisions for a ``vehicle inspection and 
maintenance program'' that meets a specified performance standard.
    The provision for an enhanced I/M program for CO nonattainment 
areas classified as moderate and with a design value higher than 12.7 
ppm, or classified as serious, requires the SIP to include provisions 
for ``an enhanced vehicle inspection and maintenance program as 
required in section 182(c)(3) (concerning serious O3 nonattainment 
areas)'' (section 187(a)(6)). This provision confirms that the required 
I/M program is in fact a vehicle I/M program. The primary provision for 
an enhanced I/M program for O3 nonattainment areas classified as 
serious or higher does not include a comparable ``inspection and 
maintenance'' phrase (i.e., requires the SIP ``to provide for an 
enhanced program to reduce hydrocarbon emissions and nitrogen oxides 
(NOX) emissions from in-use motor vehicles''), but it further 
includes specific requirements for various types of testing, 
inspections, etc., that make clear that the program must obtain 
reductions from vehicle I/M (section 182(c)(3)).
    Nevertheless, both the basic I/M program and the enhanced I/M 
program requirements authorize a substantial degree of flexibility in 
program design. The Act directs the EPA to require a specific amount of 
emissions reductions, but also authorizes the State to design the 
program in a manner that meets the EPA established performance standard 
through different means. The EPA's final rule on I/M programs describes 
the EPA's performance standards and the ways that States can meet those 
standards (57 FR 52950-53014). In so doing, the State can take 
advantage of economic efficiencies (e.g., have a better test on more 
older cars to get greater performance, in exchange for some relaxation 
in another element). In addition, States could address mal-maintenance 
in the vehicle fleet in part by including an old car scrappage program 
as an element of the overall package used to meet the performance 
standard. However, the SIP must include a program obtaining the 
required reductions through vehicle inspections.
3. Program Baseline
    An EIP baseline must be fully defined within the EIP, and used as a 
basis for projecting program results and, if applicable, for 
initializing the incentive mechanism. States have flexibility in 
defining the program baseline for EIP's that implement new RACT 
requirements for previously unregulated source categories through 
trading programs, as long as the new RACT requirements reflect, to the 
extent practicable, increased emissions reductions beyond those that 
would be achieved through a traditional RACT program. States may also 
use a flexible baseline for EIP's that allow trading with respect to 
newly imposed RACT requirements on previously unregulated sources in a 
previously regulated source category (e.g., sources newly covered by 
lower applicability cut-offs), as long as the EIP, in the aggregate, 
yields reductions in actual emissions at least equivalent to those 
which would result from source-by-source compliance with the existing 
RACT limit for that source category. This requirement can be satisfied 
by using existing data on actual and allowable emissions from the 
previously regulated sources in the affected source category (see 
paragraph IV.C.).
    A State also has flexibility in defining the program baseline for 
any EIP submitted in conjunction with, or subsequent to, the submission 
of any complete areawide progress plan due at the time of EIP submittal 
(e.g., the 15 percent RFP plan (section 182(b)(1)) and subsequent 3 
percent plans (section 182(c)(2))), and/or an attainment demonstration.
    In all such cases, the flexible program baseline may be based on 
actual, allowable, or some other intermediate10 or lower level of 
emissions, provided the State demonstrates that the program baseline is 
consistent with and reflected in the associated RACT rule, progress 
plans, or attainment demonstration. Further, for EIP's submitted prior 
to the submittal of a required progress or attainment demonstration, 
the State must include with its EIP submittal a commitment that its 
subsequent attainment demonstration and all future progress plans will 
be consistent with the EIP baseline in effect at that time, as well as 
a discussion of how the baseline will be integrated into the State's 
attainment demonstration. Further, in this discussion, the State should 
take into account the potential that emission reduction credits issued 
prior to the attainment demonstration may no longer be surplus relative 
to the attainment demonstration.11
---------------------------------------------------------------------------

    \1\0A typical intermediate baseline may consist of a SIP-
allowable emission rate and an actual level of production.
    \1\1For example, the State could establish an escrow account or 
a formula for pro rata reductions of credits to cover credits that 
subsequently are no longer surplus.
---------------------------------------------------------------------------

    Conversely, for EIP's that do not meet the above conditions 
relating to RACT and progress requirements, the program baseline must 
be set no higher than the lower of actual or allowable emissions. 
Actual emissions are to be taken from the most appropriate inventory, 
such as the 1990 actual emission inventory (which was due for 
submission in November 1992), and allowable emissions are the lower of 
SIP allowable emissions or the level of emissions consistent with 
source compliance with all Federal requirements related to attainment 
and maintenance of the NAAQS.
    In addition, following submission of an EIP that incorporates a 
flexible baseline, if the State fails to submit a complete attainment 
demonstration, or if the EPA disapproves the attainment demonstration 
on the grounds that it does not provide for attainment of the NAAQS, 
the EPA may require the State to incorporate in the EIP a program 
baseline set no higher than the lower of actual or allowable emissions.
    The baseline for an EIP submitted in conjunction with an attainment 
demonstration must be consistent with the assumptions employed in the 
attainment demonstration, including the location of emissions assumed 
in the photochemical grid modelling, if applicable.
    In considering emissions trading, the EPA continues to focus on the 
aspect of trading that involves the relaxation of a control requirement 
on a particular emissions-producing unit (the credit-receiving unit). 
Under trading programs, this relaxation is offset by tightening the 
control requirements on another emissions-producing unit (the credit-
generating unit). Under section 110(l), this relaxation is authorized 
only if it, taken in conjunction with the tighter control requirements, 
does not interfere with the ability of the SIP to meet the various 
requirements of the Act--most importantly, for present purposes, the 
RACT requirement and the requirements for progress (e.g., for RFP in 
O3 nonattainment areas, 15 percent reductions in VOC emissions by 
1996; and 3 percent-per-year over each 3-year period until the 
attainment date), as well as attainment requirements. It is understood 
that when the credit-generating unit's actual emissions are below the 
level mandated by the applicable control requirement, relaxing a 
control requirement on the credit-receiving unit in exchange for 
tightening the requirement on the credit-generating unit may result in 
an increase in aggregate actual emissions. Under these circumstances 
(i.e., trading from an allowables baseline), the relaxation and its 
resulting increase in actual emissions could, in some circumstances, 
jeopardize RFP and attainment.
    As described above, notwithstanding the chance of actual emissions 
increases, EIP's may authorize trading from an allowables baseline when 
the EIP is submitted in conjunction with, or following, the submission 
of the applicable progress plans, and the allowables baseline is 
consistent with those plans. Under these circumstances, trading on the 
basis of allowables would not jeopardize the progress requirements. In 
some cases, the EPA will permit trading to occur on the basis of 
allowables prior to submission of the attainment demonstration SIP. 
However, once the State has submitted any applicable progress plans due 
at the time of EIP submission, the State has made significant progress 
towards attainment. This significant progress, coupled with the 
sanctions provisions that provide strong safeguards that the State will 
develop a SIP requiring any subsequent progress plans and an attainment 
demonstration, provide, in the EPA's judgment, sufficient evidence that 
an EIP authorizing an allowables baseline submitted in conjunction with 
an applicable progress plan will not jeopardize continued progress or 
attainment. In addition, States and sources should be aware that any 
emission limit relaxations approved through an EIP may be subject to 
ongoing scrutiny, and further tightening, if it is unexpectedly 
necessary to do so as part of an attainment demonstration.
    In addition, as described above, the EPA will permit EIP's that 
authorize trading from an allowables baseline in the case of source 
categories, or portions of source categories, that are newly subjected 
to the RACT requirement under the RACT ``catch-up'' provisions of 
section 182(b)(2). Under these circumstances, the imposition of RACT-
level controls meets the RACT requirement, as described above, and is 
expected to result in emissions reductions with respect to the affected 
source categories or sources taken as a whole, even if some of the 
affected sources conduct emissions trades based on allowables. The fact 
that overall emissions from these source categories or sources will be 
reduced indicates that with respect to these source categories, 
progress is being made towards attainment. This progress provides 
adequate assurance that any such trades on an allowables basis will not 
jeopardize progress or attainment requirements.
    If a SIP does not include a required RACT emission limit for a 
source, that source may not participate in an EIP until an appropriate 
RACT limit is determined.
    The provisions described above apply as well in the case of a 
statutory EIP. That is, under the circumstances described above, a 
statutory EIP may incorporate a flexible baseline as long as the EIP as 
a whole provides the required reductions.
    A State may define a program baseline to address a variety of 
equity considerations, such as differing degrees of emission control 
among affected sources prior to the start of the EIP. While emissions 
reductions creditable towards a specific required demonstration will be 
calculated according to the requirements for that demonstration, the 
EIP may use a different baseline. For example, a declining value 
marketable permits program, submitted in conjunction with an areawide 
RFP or attainment plan, could initially allocate mass emissions caps on 
the basis of allowable emissions. However, to the extent that such a 
program baseline exceeds the aggregate actual emissions for the sources 
covered by the program, the EIP baseline allocation would be required 
to decline at a rate consistent with achieving the areawide RFP 
milestone as measured against the RFP baseline.
    The EIP must clearly specify whether the program baseline applies 
to aggregate emissions from all affected sources (similar to the RFP 
baseline) or to individual sources (similar to source-specific LAER 
requirements, for example). If historic emissions are relevant in 
setting the program baseline, the time period must be specified in the 
program. Provisions must be made for determining baselines for sources 
not active during the specified baseline time period. Also, the 
averaging time associated with a program baseline for emissions must be 
specified.
4. Quantification Procedures
    An EIP must describe how emissions and changes in emissions will be 
quantified for SIP credit. If other measurable factors are essential to 
an EIP, the quantification procedures for those must be specified in 
the program. For instance, if emissions reductions are generated by 
reducing total usage of a type of solvent, procedures for measuring 
solvent usage are critical. The program must specify the minimum 
required credible, workable, replicable procedures for quantifying 
emissions, which could include emission factor calculations, direct 
emission monitoring, calculation procedures which are a function of 
process parameters, production practices or volume, or inventory usage, 
or other procedures, as appropriate. Criteria for selecting 
quantification methods and time-averaging considerations are discussed 
below.
    States must carefully consider matching their environmental goals 
with various aspects of the program when determining adequate 
quantification procedures. For example, a procedure wholly adequate for 
determining compliance with long-term mass emissions caps may be 
clearly inadequate for a program aimed at limiting peak daily 
emissions.
    An EIP must establish procedures for quantifying emissions 
reductions arising from sources that shut down or curtail production. A 
State may not take credit for such emissions reductions as part of an 
EIP if the same reductions have already received credit in the SIP's 
attainment or RFP demonstrations. For example, SIP demonstrations may 
include assumptions about equipment turnover rates and normal operating 
levels which may already credit some assumed rate of source shutdowns 
and curtailments. Credit also cannot be taken for shutdowns or 
curtailments that do not result in a decrease in an area's aggregate 
emissions. Changes in emissions at one source may merely increase 
emissions at another. For example, if one retail operation goes out of 
business, the total level of retail business will not necessarily 
change. Instead, customers may shift their business to other merchants 
in the area. The effect on aggregate emissions of such ``demand 
shifting'' will depend upon the nature of the business, and should be 
considered in the design of the EIP.
    An EIP also must establish procedures for quantifying emissions 
from sources with uneven emission patterns due to batch, seasonal or 
cyclical operations. The appropriate procedure for handling these 
expected fluctuations in emissions will depend in part on the emissions 
averaging time upon which the EIP is based.
    The EPA recognizes that the development of quantitative procedures 
for mobile sources can present significant challenges. Such procedures 
must consider, as appropriate, the factors which will affect or 
determine the level of participation in a transportation program, as 
well as how much and where vehicles are driven. Such procedures should 
clearly address how double-counting will be avoided across various 
mobile source programs (e.g., not double-counting I/M program 
reductions in quantifying credits from an accelerated vehicle scrappage 
program). Any assumptions or models which States may use to predict 
behavioral modifications as a result of the implementation of an 
economic incentive strategy must be presented as support information 
with the EIP submittal. The EPA views the development of sound 
incentive-based mobile source programs as an opportunity for the design 
of better, more rigorous tools for accounting for and encouraging 
mobile source emissions reductions beyond those required by traditional 
programs.
    The final rules allow for long-term averaging, while requiring that 
States make statistical showings that any such averaging is consistent 
with applicable RACT, RFP, and short-term NAAQS. Any State that wishes 
to use long-term averaging must include, with the plan revision 
submittal, a statistical showing that the aggregate effect of the 
specified averaging time is consistent with attaining the O3 NAAQS 
and satisfying applicable RFP requirements on the basis of typical 
summer day emissions; and, if applicable, a statistical showing that 
aggregate daily emissions from all affected sources covered by a 
Federal RACT requirement (net of any RACT/non-RACT trades) are no 
greater than the aggregate daily emissions from such sources that would 
result from the implementation of all applicable source-specific RACT 
requirements (see paragraph IV.D.2.).
5. Monitoring, Recordkeeping and Reporting
    Each affected source in an EIP must comply with requirements 
imposed by the program, and must implement the MRR procedures necessary 
to assure compliance with such requirements and to provide State and 
Federal enforceability. Requirements imposed by an EIP could include 
meeting mass emissions limits (either directly or through trading 
marketable permits), paying an emission fee, using specified products 
or procedures, providing product content labeling, or other measures 
specified by the program. Thus, the final rules allow for a wide range 
of alternative MRR procedures that provide sufficiently reliable and 
timely information for determining compliance. Criteria to be 
considered in the development of such procedures include 
representativeness, accuracy, precision, reliability, frequency, and 
timeliness.
    All source-specific program requirements must be structured in such 
a way that both inspectors and facility owners can judge the compliance 
status of a facility at any time, or, in the case of long-term 
emissions limits, at the end of the compliance period. This will 
require an authoritative, reliable repository of all relevant 
information at each facility.
6. SIP Creditability and Audit/Reconciliation Procedures
    A SIP revision that contains an EIP must include projections of the 
emissions reductions the State expects to achieve through the 
implementation of the program. The projections may be based on 
federally-enforceable limits on mass emissions or on other emission-
related parameters, estimates of market response, economic modelling, 
or other relevant information. The State does not have to project 
emission changes for each source, unless that is how the State chooses 
to estimate the emissions reduction from the program. All EIP 
submittals must include documentation which clearly states how sources 
in an EIP are or will be addressed in the emissions inventory, RFP 
plan, and attainment or maintenance plan, as applicable. This 
documentation should include a description of the assumptions used in 
measuring emissions and emissions reductions from affected sources.
    Credit in a nonattainment SIP may be taken for emission limiting 
programs (e.g., emissions trading) and market-response programs (e.g., 
emissions fees). Credit may not be taken for directionally-sound 
programs until experience with such programs makes quantification 
possible, at which time the program could be reclassified into one of 
the other categories for which credit may be taken.
    For determining SIP credit, the projected emissions reductions must 
be adjusted to reflect the uncertainties inherent in EIP's. This 
adjustment is currently done for traditional stationary source control 
measures through the use of a rule effectiveness factor, developed from 
experience with traditional regulatory control programs. For EIP's, the 
State must use two uncertainty adjustment factors, as appropriate, to 
calculate creditable emissions reductions. The sources of uncertainty 
that must be separately addressed are compliance uncertainty (i.e., the 
extent to which sources will actually comply with program requirements) 
and programmatic uncertainties (e.g., the extent to which voluntary 
market responses to incentives actually occur and/or the use of various 
quantification methods with differing confidence levels). These sources 
of uncertainty must be accounted for through the use of a rule 
compliance factor and a program uncertainty factor, respectively.
    The State must specify values for rule compliance and program 
uncertainty factors, based on program elements such as the 
quantification and enforcement procedures, and on the predictive 
quality of the information used by the State to develop the projected 
emissions reductions. Inherent in the way in which these factors are 
defined, the value of either factor must be less than or equal to one. 
The State must include with its EIP submittal a justification for the 
values assigned to these factors. The State must use these factors in 
determining the SIP credit for the program as a whole, or for each 
source-specific trade, if appropriate, to ensure that quantification 
uncertainties not lessen a source's emissions reductions requirements. 
The uncertainty factors should be developed and justified by the State 
by taking into account various aspects of the design of the EIP, 
including but not limited to, the type of incentive mechanism upon 
which the program is based; the variability in emissions from affected 
sources and the nature and extent of uncertainty in the emissions 
quantification procedures required by the program; the frequency and 
type of MRR required by the program; sanctions for noncompliance; the 
frequency, scope and committed responses to program audits; and the 
nature of administrative procedures to be used by the State in 
implementing and enforcing the program (see paragraph IV.F.).
    Unless otherwise provided in program-specific guidance issued by 
the EPA, EIP's for which SIP credit is taken must also contain program 
audit procedures designed to evaluate program implementation and track 
program results in terms of both actual emissions reductions and, to 
the extent practicable, cost savings realized during program 
implementation. The auditing methods and the timing of the audits must 
be specified in the EIP. The maximum time interval for conducting such 
audits is 3 years, although States are encouraged to consider more 
frequent audits. Further, the State must provide timely post-audit 
reports to the EPA. For emission-limiting EIP's, program audit 
provisions must include a State commitment to ensure timely 
implementation of programmatic revisions or other measures which the 
State, in response to the audit, deems necessary for the successful 
operation of the program (see paragraph IV.G.).
    Program audit provisions for market-response EIP's must be 
accompanied by reconciliation procedures, designed to compare credited 
emissions (i.e., adjusted projected emissions) with actual emissions 
achieved through the implementation of the program. The reconciliation 
procedures must specify a range of appropriate actions (e.g., invoke 
part of a general SIP contingency plan or a program-specific 
contingency), revisions to the program requirements (e.g., increase the 
fee, include more sources) that will make up for any shortfall between 
credited and actual emissions revealed by the audit, or reductions in 
the credit taken for the EIP in the SIP (provided that RFP and 
attainment requirements continue to be satisfied area-wide based on 
such reduced EIP credits in combination with the effects of all other 
SIP programs). Such measures must be automatically executing to the 
extent necessary to make up the shortfall, with State action required 
only to identify which of the specified actions are necessary to make 
up the shortfall. Such measures must not require a revision to the 
implementation plan to be effectuated once identified by the State; 
rather, the measures must be built into the original EIP design (or 
incorporated by reference).
    Greater burdens should not necessarily be imposed on EIP's, 
compared to traditional regulatory programs, by virtue of the audit and 
reconciliation requirements. These audit and reconciliation procedures 
are consistent with the general approach to implementing the Act being 
taken by the EPA, as illustrated in the Agency's rules for vehicle I/
M12 and for reformulated gasoline,13 and in the Agency's 
general guidance on the implementation of title I dealing with the rule 
effectiveness of stationary source control measures.14 Further, in 
appropriate cases, routine ongoing air program management procedures 
may be sufficient to fulfill the audit and reconciliation requirements. 
In designing audit procedures, the State should consider the relative 
uncertainty associated with the EIP and specify the scope and extent of 
the audit procedures to be commensurate with that level of uncertainty.
---------------------------------------------------------------------------

    \1\2Inspection/Maintenance Program Requirements, 57 FR 52950, 
November 5, 1992.
    \1\3Regulation of Fuels and Fuel Additives: Standards for 
Reformulated and Conventional Gasoline, 59 FR 7716, February 16, 
1994.
    \1\4Rule Effectiveness Guidance: Integration of Inventory, 
Compliance, and Assessment Applications, EPA-452/4-94-001, January 
1994.
---------------------------------------------------------------------------

7. Implementation Schedule
    An EIP must contain a schedule for implementing the program. The 
schedule must include dates for notifying potentially affected sources, 
as early as possible, about the impending EIP; program initialization 
and start-up procedures; compliance and submittal requirements for 
affected sources; and audit and reconciliation processes, including 
subsequent actions required to make up for any shortfall that occurs.
8. Administrative Procedures
    As part of any EIP design, the State must establish appropriate 
administrative procedures, specific to the type of incentive strategy, 
necessary to implement all of the elements of the EIP. For example, in 
a fee program a State must assure the proper administration of the fee 
collection process, and if rebate provisions are included, the 
administration of the rebate distribution process.
    Administrative procedures specific to marketable emissions permit 
programs which the State must address in a program design are the 
mechanisms required for conducting, approving, verifying, recording, 
and tracking trades. The EIP must clearly describe the administrative 
system, and any State commitments to implement and maintain the system, 
that enables market participants to conduct valid and legally protected 
transactions. The State must design the program to ensure that all 
program requirements are met by sources involved in trades, such that 
the trades result in enforceable changes in allowable emissions levels. 
A well-designed EIP will include the minimum amount of transactional 
oversight, approval, recording, and tracking provisions necessary to 
create a verifiable and enforceable system. Unnecessary or excessive 
administrative requirements in a trading system increase the cost of 
the program and inhibit trading. An active trading market increases the 
opportunities for cost-savings. However, a State must establish 
sufficient administrative procedures to ensure that the environmental 
goals of the EIP are met, and that the program is adequately 
enforceable (see paragraph IV.J.2. and the discussion of emissions 
trading markets in Appendix X).
9. Enforcement Mechanisms
    An EIP must include adequate enforcement consequences for 
noncompliance with any source requirements, including MRR requirements. 
Each program must include provisions ensuring that State/local and 
Federal statutory maximum penalties preserve the deterrent effect of 
traditional regulatory programs. Enforcement provisions should preserve 
the criminal sanctions (for knowing violations) authorized in the Act 
for violations of SIP requirements per se.
    Traditional regulatory programs provide for enforcement against 
noncompliance with emissions limits at both the Federal and State/local 
levels. The statutory maximum Federal penalties under the Act are 
$25,000 per day, per source in violation. To preserve the existing 
level of deterrence under the Act, an EIP that imposes multiday and/or 
multisource emission limits must define violations of those limits in 
such a way that the violations will translate into some combination of 
sufficient numbers of violations, sources in violation, and days of 
violation. One possible approach would be for the EIP to authorize 
predetermined penalties based on the amount of an exceedance of such a 
cap, provided the predetermined amounts are sufficiently large (see 
paragraph IV.H.).
    The EIP's that impose multisource emissions limits must require 
facilities to develop enforceable plans for remedying noncompliance in 
those cases where facilities have exceeded emissions limits for the 
specified averaging period. Such plans must identify appropriate and 
enforceable control measures or other procedures or strategies 
sufficient to achieve and maintain compliance with applicable emissions 
limits. Further, for sources subject to title V requirements, the 
elements of such plans must, at a minimum, be consistent with any 
applicable title V permit requirements concerning compliance plans.
    Compliance with MRR requirements is critical to the integrity and 
success of EIP's. Thus, an EIP must include enforcement provisions that 
establish a regulatory structure which clearly and effectively deters 
inadequate or improper MRR, providing for both State/local and Federal 
penalties. Further, the enforcement provisions must include methods for 
determining required data when MRR violations result in missing, 
inadequate, or erroneous monitoring and recordkeeping data. These 
methods must ensure that sources have a sufficiently strong incentive 
to properly perform monitoring and recordkeeping in the first place.

E. Use of Program Revenues

    Today's rules incorporate statutory restrictions on the use of 
revenues generated by statutory EIP's. These restrictions are mandated 
by section 182(g)(4)(B) of the Act on the use of revenues generated by 
statutory EIP's submitted pursuant to sections 182(g)(3), 182(g)(5), 
187(d)(3), and 187(g) of the Act. Revenues may be generated by an EIP 
from a wide variety of fees or charges, including emission or permit 
fees, fees associated with approving and recording trades, application 
fees associated with labelling or sources opting into an EIP, and fees 
or charges associated with TCM's. Specifically, any such revenues may 
be used by a State for providing incentives for achieving emissions 
reductions, providing assistance (up to 75 percent of costs) for the 
development of innovative technologies for the control of O3 air 
pollution and for the development of lower-polluting solvents and 
surface coatings, and funding (with up to 50 percent of the revenues) 
administrative costs of State programs under the Act. These 
restrictions on the use of revenues do not apply to discretionary 
EIP's.
    Because the use of revenues from discretionary programs is not 
constrained, some or all of the revenues generated by discretionary 
EIP's may be rebated in order to create a revenue-neutral program, or 
one with less revenue retained by the State. Rebate provisions of 
revenue-generating EIP's can be designed to reduce the total cost to 
the affected sources without diminishing the incentive to reduce 
emissions created by the EIP. For example, an emission fee program 
could place a fee on total emissions from affected sources, and rebate 
an amount based on average emissions or percentage emissions reductions 
of the affected sources. In a program with a large number of sources, 
each source would only have a minor influence on the average emissions. 
Thus, the rebate is not dependent on a source's own actions, and would 
not distort the incentive of the fee on every unit of emissions created 
by the source.

IV. Discussion of Comments and Regulatory Changes

    This portion of the preamble is organized according to the 
``Discussion of Issues'' section in the proposal, with additional 
discussion of general issues raised in public comments. The following 
discussion highlights the changes and clarifications made in the final 
rules in response to the public comments on these issues.

A. Program Goals

1. Statutory Programs
    Statutory EIP's are those programs submitted pursuant to sections 
182(g)(3), 182(g)(5), 187(d)(3), and 187(g) of the Act, generally 
because of failures in achieving required emissions reductions. The Act 
does not specify the extent to which the EIP must, in and of itself, 
make up for the specific failure in achieving the emissions reductions 
necessary to meet the next milestone requirement. Rather, the 
provisions specify only that the EIP ``shall be sufficient, in 
combination with other elements'' of the plan, or together with a 
``transportation control plan,'' to achieve the necessary reductions.
    In the proposal, the EPA solicited comments on whether to require 
that some specified minimum percentage of the required reductions be 
met by a statutory EIP. Most commenters, including State and local 
agencies, industry, and an environmental group, felt that EIP's should 
not be required to meet a specified minimum percentage of emission 
reductions. These comments were generally based on the premise that 
opportunities for such reductions will vary because of potential 
differences between nonattainment areas that may implement EIP's. A 
specified minimum percentage would not provide recognition of these 
differences nor the flexibility that needs to be an inherent part of 
EIP's. On the other hand, an environmental group commented that a 
specified minimum percentage of required reductions should be met by a 
statutory EIP, equivalent to the percentage difference between what the 
SIP is achieving and what the next milestone requires.
    The final rules retain the requirement that a statutory EIP make a 
significant contribution to the required emissions reductions, without 
mandating any percentage reduction requirement or that the EIP assume 
the entire burden of making up for the shortfall. This position is most 
consistent with statutory intent that the States have flexibility in 
determining how best to combine an EIP with other emission reduction 
programs to achieve the necessary emissions reductions. Further, this 
position is consistent with meeting the benefits sharing goal 
established for all EIP's.
2. Discretionary Programs
    In explicitly allowing for discretionary (i.e., nonstatutory) EIP's 
to be included as SIP provisions, the Act does not impose any specific 
emissions reductions requirements on such programs (sections 
110(a)(2)(A) and 172(c)(6)). Thus, the proposed rules imposed no 
specific emissions reductions requirements on discretionary EIP's. The 
proposal relied upon the new State planning, quantitative progress, and 
attainment requirements in the Act to ensure expeditious attainment of 
the NAAQS, regardless of the type of emissions reductions programs that 
States may choose to include in their SIP's.
    Comments were received from an environmental group in support of an 
alternative view outlined in the proposal. The alternative view is that 
any savings in compliance costs resulting from discretionary EIP's 
(relative to nonincentive-based programs) should be shared between two 
accounts: the regulated sources should retain only as much savings as 
is sufficient to maintain the incentive to participate in the EIP, with 
the remainder of the savings being used by the State to reach 
attainment more quickly than would be practicable under a nonincentive-
based plan. This alternative view is based on the statutory requirement 
that States should attain the NAAQS as expeditiously as practicable.
    In contrast, other commenters from State and local agencies, 
industry, and a joint environmental/industry work group agreed with the 
proposal that the EPA should not require discretionary EIP's to achieve 
more rapid progress than other regulations. A joint environmental/
industry work group emphasized that EIP's should be designed to 
increase flexibility and cost effectiveness, and should not be held to 
any stricter standard than traditional programs. Several industry 
commenters felt that requiring more rapid progress towards attainment 
in exchange for a more flexible program appears to be a penalty 
provision. These commenters felt that, while EIP's should be structured 
to produce reductions equivalent to traditional SIP rules that the 
EIP's replace, the addition of further reductions as the price for 
entry into an EIP will discourage participation and reduce benefits 
that might otherwise result from broad participation. A State agency 
disagreed with requiring greater emission reductions from discretionary 
EIP's since different types of environmental benefits can be achieved 
by EIP's, such as technological innovation, more available capital for 
other control measures, conservation of natural resources, and 
increased commitment from the regulated sources. Another State agency 
believes that EIP's which replace traditional SIP requirements should 
be equally effective, equitable, and enforceable as the program it 
replaces.
    The final rules take into account the broad array of benefits that 
can result from the use of discretionary EIP's, the statutory 
requirement for expeditious attainment, and the fact that EIP's are 
relatively new and controversial in principle as well as in practice. 
Further, current experience with EIP's makes clear that successful 
adoption and implementation of EIP's requires some degree of consensus 
among the interested groups that both the regulated entities and the 
environment will benefit from such programs. Thus, the final rules and 
guidance establish as a goal for all EIP's that they be designed to 
benefit both the environment and the regulated entities. In so doing, 
the final rules and guidance require States to meet this benefits 
sharing goal, while providing flexibility to the States to determine 
how best to do so. As a result, EIP's will increase flexibility, lower 
the cost of attaining and maintaining the NAAQS, and provide stronger 
incentives for the development and implementation of pollution 
prevention measures and innovative technologies.
    Benefits from discretionary EIP's can be defined in various terms, 
as discussed in paragraph III.D.1. While the EPA encourages that 
discretionary EIP's be designed to produce environmental benefits 
directly, through increased or more rapid emissions reductions, States 
should consider these and other benefits in designing a program to meet 
the goal of sharing benefits between the regulated entities and the 
environment. In many cases, benefits in terms of cost savings will not 
be quantifiable prior to program implementation, due to the complex 
market decisions that sources participating in an EIP will need to make 
and changes in market conditions during the course of the program. 
Thus, the final rules and guidance include analysis of control cost 
savings, to the extent practicable, as a part of the required program 
audit.
    However, the difficulty of quantifying cost savings and the extent 
to which those cost savings constitute an incentive to trade leads the 
EPA to conclude that it is not practicable to require that all EIP's 
discount trades or otherwise require increased or more rapid emissions 
reductions that directly benefit the environment. The authorization for 
discretionary EIP's in sections 110(a)(2)(A) and 172(c)(6) may be 
interpreted to indicate Congress' view that such programs may help 
achieve emissions reductions more effectively or efficiently, but not 
necessarily more expeditiously, than traditional regulatory 
requirements.
    The final rules reflect that it most appropriately falls to the 
States to determine the type and extent of benefits sharing that is 
practicable and appropriate, given the unique circumstances that any 
particular discretionary EIP is designed to address. Therefore, the 
final rules do not require any specific formula for benefit sharing. 
However, the final rules do recognize that the issue of benefits 
sharing will be part of the political consensus building process 
associated with designing a discretionary EIP. In assessing this issue, 
States should not confuse this sharing with accounting for uncertainty 
in an EIP. Since uncertainty is to be accounted for through compliance 
and programmatic uncertainty factors (see paragraph III.F.), 
determining a degree of sharing based on weighing the uncertainty in an 
EIP would in essence be accounting twice for the same uncertainty.
    One commenter also argued that the requirements for attainment as 
expeditiously as practicable [section 181(a)(1)] and for imposition of 
reasonably available control measures [section 172(c)(1)] mandate the 
inclusion of emission fees in EIP's. The EPA encourages States to 
consider emissions fees, but does not believe that, at present, their 
impacts are sufficiently well understood in all cases to conclude that, 
for all EIP's, they are either practicable or reasonably available.

B. Interface With Reasonably Available Control Technology (RACT) and 
Other Statutory Requirements

1. RACT
    The proposal was based on an interpretation of the statutory RACT 
requirements that authorizes sources subject to the statutory RACT 
requirements (RACT sources) to meet their RACT obligations in the 
aggregate (i.e., through trading among themselves), and, when such 
trading results in an exceptional environmental benefit, by acquiring 
emissions reductions from non-RACT sources (as discussed in paragraph 
II.D.2.). Further, the proposal defined exceptional environmental 
benefits in terms of the statutory offset ratios for nonattainment 
areas and other demonstrations of exceptional long-term environmental 
benefits.
    With regard to meeting RACT in the aggregate, all but one commenter 
agreed with the proposed position that trading be allowed among all 
RACT sources. Further, these commenters generally felt that such RACT 
trading should produce emissions reductions that are equivalent to 
those that would be obtained if each source met its source category-
specific RACT limit. On the other hand, one environmental group 
disagreed with the proposed position allowing all sources covered by 
RACT requirements to trade among themselves. This commenter stated that 
nothing in the Act specifically authorizes substituting any trading 
regime for source-specific RACT requirements. However, if the EPA 
allows trading to meet RACT requirements, only trading within a given 
RACT source category should be allowed since section 182(b)(2) 
addresses RACT by source categories. Further, this commenter stated 
that since RACT limits have historically been set based on source-
specific economic and technical constraints, ``tradeable'' RACT limits 
must be based on an analysis of the cost savings achievable by meeting 
RACT through whatever trading approach is permitted in the RACT rule. 
Since trading approaches provide increased compliance flexibility and 
cost savings, the commenter believes that any ``tradeable'' RACT limits 
should be lower than source-specific RACT limits.
    With regard to RACT/non-RACT trading in general, most commenters, 
including industry, State and local agencies, and an environmental 
group, supported such trading. Some stated that any regulation which 
requires certain reductions to be obtained at specified sources, and 
nowhere else, contradicts a ``market-based'' approach. They felt that 
the broadest possible participation in a trading market should be 
encouraged so as to achieve the most benefits from the program. Some 
commenters felt that allowing RACT/non-RACT trading encourages the 
development of new technologies and facilitates obtaining controls on 
previously unregulated sources and source categories. Limiting trades 
to particular source categories was thought by some to substantially 
reduce both the incentives and savings available. Such comments were 
premised on the belief that trading between different source categories 
(involving both RACT and non-RACT categories) can have sufficient 
controls and safeguards built in to ensure compliance.
    On the other hand, other environmental groups opposed RACT/non-RACT 
trading. One such commenter asserted that statutory language regarding 
RACT ``sources'' only refers to stationary sources, such that trading 
between RACT sources and mobile sources would violate the Act. Further, 
this commenter asserted that such trading would make it impossible for 
States to manage mobile source and stationary source budgets properly 
for purposes of demonstrating RFP and attainment. The other 
environmental group commended the EPA's objectives, and approved its 
means in theory, of allowing trades between mobile and stationary 
sources, but concluded that the time for trading between stationary and 
mobile sources has not arrived. This conclusion was premised in part on 
the belief that trading between RACT sources and mobile sources 
violates the Act, because it is impossible to determine whether a given 
mobile source emission reduction is truly surplus. Further, both 
commenters felt that mobile source emissions reductions could not be 
reliably quantified.
    As to the conditions under which RACT/non-RACT trading may occur, 
many commenters from industry expressed the view that such trading 
should be allowed at a 1-to-1 ratio, i.e., that no exceptional 
environmental benefit was required to justify RACT/non-RACT trading. 
These commenters felt that any trading ratio greater than 1 to 1 would 
limit the economic, technological, and environmental benefits that 
could be derived from innovations brought about by RACT/non-RACT 
trading. Other commenters, including State and local agencies and some 
industries and environmental groups, supported the concept of requiring 
RACT/non-RACT trades to achieve an exceptional environmental benefit in 
general, and the use of the proposed statutory offset ratios in 
particular. However, some of these commenters expressed concern that 
the offset ratios may have a chilling effect on such trading, and 
encouraged the EPA to identify justifiable circumstances under which 
trading ratios could be lower than the offset ratios.
    The final rules continue to allow RACT to be met in the aggregate. 
In addition, the final rules continue to allow RACT/non-RACT trading, 
provided that an exceptional environmental benefit is achieved.
    Under the 1977 Act, the requirements specific to nonattainment 
SIP's were found in part D of title I of the Act. Section 172 specified 
the attainment date and the required SIP measures. Subsection (a) of 
section 172 required that nonattainment SIP's provide for attainment by 
specified dates; subsection (b)(2) required that those SIP's ``provide 
for the implementation of all reasonably available control measures 
(RACM) as expeditiously as practicable.'' Subsection (b)(3) required 
that the SIP's provide for RFP, including RACT:

    (Nonattainment SIP's must) require, in the interim (prior to the 
attainment date) reasonable further progress * * * including such 
reduction in emissions from existing sources as may be obtained 
through the adoption, at a minimum, of reasonably available control 
technology.

    The EPA took the position that RACT requirements do not require 
each affected emissions unit to achieve a prescribed amount of 
reductions in emissions from its own processes, but rather require the 
affected sources to achieve in the aggregate the reductions that would 
be achieved if each applied RACT controls to itself. Under the EPA's 
interpretation, the application of the requirement to impose RACT upon 
``existing sources'' meant that RACT applied in the aggregate, as 
opposed to source by source. This interpretation, which is reflected in 
the Emissions Trading Policy Statement (51 FR 43814 (December 4, 1986), 
the ``Bubble Policy''), was upheld in NRDC v. EPA, 33 ERC 1657 (4th 
Cir. 1991), an unpublished decision. There, the Court of Appeals for 
the Fourth Circuit upheld as reasonable EPA's approval of a Maryland 
SIP revision for the American Cyanamid Company relaxing the SIP limit 
on several lines in exchange for tighter limits on other lines. The EPA 
reasoned that the RACT requirement was met by the subject lines in the 
aggregate.
    The Act revamped part D of title I by updating the general 
requirements applicable to all nonattainment SIP's, placing those 
requirements in subpart 1 of part D, and adding subparts 2-5 to cover 
pollutant-specific nonattainment SIP's. Subpart 2 concerns ozone SIP's.
    Under the 1990 Amendments, the 1977 Act's requirements for 
nonattainment SIP's were generally retained in subpart 1, but were 
combined differently--the RACM and attainment date requirements were 
consolidated into one provision and the RACT requirement was shifted to 
the RACM provision. Those provisions (section 172(c)(1)-(2)) now read:

    (1) In General--Such (nonattainment SIP) provisions shall 
provide for the implementation of all reasonably available control 
measures as expeditiously as practicable (including such reductions 
in emissions from existing sources in the area as may be obtained 
through the adoption, at a minimum, of reasonably available control 
technology) and shall provide for attainment of the national primary 
ambient air quality standards.
    (2) RFP--Such plan provisions shall require reasonable further 
progress.

    In addition, subpart 2 contains several RACT provisions. Most 
importantly, section 182(b)(2) sets out the RACT requirement for areas 
classified moderate or higher, as follows:

    The State shall submit a revision to the applicable 
implementation plan to include provisions to require the 
implementation of reasonably available control technology under 
section 172(c)(1) with respect to each of the following:
    (A) Each category of VOC sources in the area covered by a CTG 
document issued by the Administrator between the date of enactment 
of the Clean Air Act Amendments of 1990 and the date of attainment.
    (B) All VOC sources in the area covered by any CTG issued before 
the date of the enactment of the Clean Air Act Amendments of 1990.
    (C) All other major stationary sources of VOC's that are located 
in the area.
    Each revision described in subparagraph (A) shall be submitted 
within the period set forth by the Administrator in issuing the 
relevant CTG document. The revisions with respect to sources 
described in subparagraphs (B) and (C) shall be submitted by 2 years 
after the date of the enactment of the Act, and shall provide for 
the implementation of the required measures as expeditiously as 
practicable but no later than May 31, 1995.

    Under the 1990 Act, the EPA continues to take the position 
established under the 1977 Act that RACT applies in the aggregate 
because the RACT requirement of section 172(c)(1) of the Act is phrased 
identically to the RACT requirement of the 1977 Act (vis., ``existing 
sources''). EPA does not read section 182(b)(2) to indicate to the 
contrary. Rather, the cross-reference to section 172(c)(1) contained in 
section 182(b)(2) indicates that RACT is to be interpreted in the same 
manner under section 182(b)(2) as under section 172(c)(1).
    In addition, the EPA interprets the RACT requirement to authorize 
emissions trading among the stationary sources subject to the RACT 
requirement (``RACT sources'') and those not subject (``non-RACT 
sources'') when emissions reductions result in an amount that provides 
an exceptional environmental benefit, e.g., a level of reductions that 
is significantly greater than RACT-level amounts. This interpretation 
entails viewing the RACT requirement as generally requiring a specified 
level of reduction of emissions from stationary sources subject to 
RACT, but as authorizing those sources to substitute significantly 
greater emissions reductions credits from non-RACT sources in lieu of 
putting controls on themselves.
    The EPA acknowledges that the statute permits different 
interpretations, including the interpretation that the universe of 
sources subject to RACT must themselves implement RACT-level controls, 
and therefore may not trade with non-RACT sources. However, the EPA 
believes that its interpretation allowing such trading is permissible, 
based on the language of section 172(c)(1). The EPA's interpretation 
emphasizes that the RACT requirement is an emissions reduction 
requirement for stationary sources that is designed to yield reductions 
to facilitate the ultimate attainment of the NAAQS and, in the interim, 
RFP towards attainment (sections 172(c)(1)-(2)).
    Section 172(c)(1), as quoted above, requires SIP provisions to 
provide ``such reductions in emissions from existing sources in the 
area as may be obtained through the adoption, at a minimum, of 
reasonably available control technology. This provision requires an 
amount of emissions reductions that equates to the amount that would 
result from the imposition of ``RACT'', but does not require the 
imposition of any particular set of controls or technologies. Further, 
the term ``RACT'' is not defined in the statute. In light of the 
function of this term--to identify the level of required emissions 
reductions--the EPA believes the term may be defined either as a 
specified level of emissions to be reduced from the RACT source itself, 
or as little as a zero level of reductions from the RACT source, 
coupled with the acquisition by the RACT source of emissions reductions 
from sources other than RACT sources in an amount that will yield an 
exceptional environmental benefit.
    With respect to the level of emissions reductions required from the 
RACT source itself, the EPA believes that if the RACT source acquires 
an appropriate amount of emissions reductions ``credits'' from non-RACT 
sources, it is not reasonable to require additional reductions from the 
source itself. Under these circumstances, control technology needed to 
produce such reductions from the source itself is not ``reasonably 
available''.
    With respect to the level of emissions reductions required from the 
non-RACT sources, the final rules retain the proposed approach to 
define such a benefit in terms of the statutory offset ratios in 
general, although flexibility is provided if exceptional environmental 
benefits are otherwise demonstrated, with a lower bound for the trading 
ratio of 1.1 to 1 in such cases. EPA believes that these additional 
amounts of reductions are required because it is ``reasonable''--within 
the meaning of the amount of reductions required through ``RACT''--to 
forego reductions that could be obtained at the RACT source itself only 
when the trading program will result in an exceptionally strong benefit 
to the environment. In addition, requiring substantial additional 
emissions reductions credits from non-RACT sources is consistent with 
the underlying purpose of the RACT requirement--to assure reductions 
that result in an important step towards fulfilling the RFP and 
attainment requirements.
    The EPA incorporated statutory offset ratios because offsets are an 
aspect of emissions trading, and thus provide an indication of 
Congress' view of benefits to the environment to be required in this 
context of emissions trading.
    Section 182(b)(2), quoted above, does not alter EPA's analysis. 
Section 182(b)(2) mandates ``the implementation of reasonably available 
control technology under section 172(c)(1) with respect to (three 
categories of stationary sources).'' The EPA interprets the cross-
reference to section 172(c)(1) to incorporate into section 182(b)(2) 
the definition of the phrase ``reasonably available control 
technology'' and the RACT requirement generally under section 
172(c)(1). In addition, the EPA interprets the phrase ``with respect 
to'' to authorize RACT sources to acquire emissions reductions credits 
in the manner described above, and not to mandate the imposition of 
controls directly on the RACT sources. The EPA believes that this 
provision may be interpreted to identify the source categories 
responsible for securing RACT-level reductions, and to mandate the 
time-frame for them to do so; but does not mandate that those sources 
themselves implement the emissions reductions measures.
    The EPA believes that its interpretation is permissible under 
Chevron U.S.A. Inc. v. Natural Resources Defense Council, 467 U.S. 837 
(1984), because the relevant statutory provisions are not defined in 
the statute in a manner that makes clear whether sources subject to 
RACT may acquire the necessary emissions reductions from other sources 
in lieu of imposing the controls themselves. As a result, the EPA may 
proceed to interpret the provision in a manner that is reasonable and 
consistent with the purpose of the statute. (See generally sections 
110(a)(2)(A) and 172(c)(6) (authorizing SIP measures to include 
``economic incentives such as * * * marketable permits'').)
    As discussed above in paragraph IV.A.2., the final rules and 
guidance require that EIP's be designed to meet the goal of sharing 
benefits between the environment and the regulated entities. For EIP's 
that allow trading or other types of compliance flexibility to meet 
RACT requirements, as with any EIP, the EPA encourages States, to the 
extent practicable, to meet this benefits sharing goal most directly by 
requiring increased emissions reductions beyond those that would be 
achieved through a traditional RACT program. Increased reductions could 
be created in a number of ways, such as by including more sources in 
the program or requiring a greater than 1-to-1 trading ratio. Depending 
on the scope and nature of an EIP, compliance flexibility might include 
not only emissions trading between sources, but also alternative 
compliance methods such as pollution prevention, energy conservation, 
and fuel switching.
    RACT/non-RACT trading programs must, of course, also meet the other 
requirements in the final rules, such as those that relate to credible, 
workable, and replicable quantification methods and to monitoring, 
recordkeeping, and reporting that allow for compliance determinations 
and State and Federal enforceability. The EPA recognizes that several 
commenters raised concerns about the technical workability of emissions 
trades involving mobile sources. Congress arguably contemplated that 
EIP's could incorporate trades involving mobile sources, as indicated 
by the definition of an EIP in section 182(g)(4)(A) to include 
``incentives and requirements to reduce vehicle emissions and vehicle 
miles traveled in the area, including any of the transportation control 
measures identified in section 108(f).'' The EPA will address technical 
concerns raised by commenters when it finalizes guidance on the 
generation of ERC's from mobile source control programs.
    Beyond the requirements in the final rules, the EPA is developing 
more specific guidance on the use of emissions trading to implement new 
NOX RACT requirements. This guidance will address issues such as 
setting tradeable NOX RACT limits and baselines, and is consistent 
with the general RACT trading principles set out in paragraphs III.D.2. 
and III.D.3. The EPA intends to work with States who want to develop 
trading-based RACT programs to incorporate the requirements of the EIP 
rules and related guidance into EIP's that are environmentally sound 
and administratively efficient.
2. Offsets
    The EPA received a number of comments specifically dealing with NSR 
offset issues. These covered a range of issues, but focused primarily 
on offsets banking. Such issues are beyond the scope of this EIP 
rulemaking, but the EPA intends to address them in the near future in 
guidance on ERC banking currently being developed. In the interim, the 
EPA intends to work with States who want to develop offset banking 
programs.
3. ECO Programs
    The EPA received a number of comments dealing with ECO programs 
which are beyond the scope of this EIP rulemaking. The EPA has 
previously issued guidance on ECO programs and anticipates the 
development of additional guidance. Final action with respect to ECO 
programs will occur when the EPA acts on SIP revisions concerning ECO 
programs.

C. Program Baseline

    The proposed rules were based on the premise that a State can only 
take credit in attainment and RFP demonstrations for emissions 
reductions from EIP's that are surplus to what is otherwise required 
and credited to other elements of a federally-approved SIP. This 
restriction is necessary to ensure that a State does not double count 
emissions reductions in SIP demonstrations. The general requirements 
for program baselines are intended to ensure that such double counting 
does not occur, while still providing as much flexibility as possible.
    The proposal solicited comments on the conditions under which 
States should have the flexibility to use an ``allowable'' baseline. In 
particular, comments were solicited on the proposed approach to accept 
an ``allowable'' baseline in an EIP submitted in conjunction with the 
submission of an applicable progress plan (e.g., 15 percent RFP plan 
and/or subsequent 3 percent-per-year plans), prior to the submission of 
an attainment demonstration. Further, comments were solicited on 
approaches for achieving consistency between EIP's with ``allowable'' 
program baselines and statutory RACT, RFP, and attainment requirements.
    There were many comments from industry and State and local agencies 
in support of the proposed flexibility in setting baselines. These 
comments generally supported the concept of considering the use of 
allowable emissions in setting EIP baselines, provided the EIP is 
consistent with RFP and attainment demonstrations. The commenters did 
not, however, address how such consistency could be achieved or 
demonstrated. Some State agencies commented that if allowable emissions 
baselines are used, they should not lead to more actual emissions, in 
the aggregate area-wide, than allowed under a traditional plan. The 
commenters felt that this flexibility would allow States to select 
baselines that were the most practicable and equitable to all sources 
involved.
    An alternative view was expressed by an environmental group which 
advocated that the final rules should require an actual emissions 
baseline for all EIP's until the attainment demonstration is approved. 
This comment was premised on the belief that an allowable emissions 
baseline would violate the requirements for attainment as expeditiously 
as possible and for noninterference with attainment. The commenter 
asserted that relying only on a RFP demonstration and a commitment by 
the State that a future attainment demonstration would be consistent 
with the EIP baseline was a wholly inadequate constraint to ensure 
expeditious as practicable attainment. Further, this commenter 
expressed the view that ``surplus'' reductions should be defined 
relative to those reductions which are necessary to achieve attainment. 
As a result, the commenter concluded that the EPA should not approve 
any EIP's based on emissions trading prior to approval of an attainment 
demonstration.
    The final rules and guidance focus on consistency between progress 
plans and EIP baselines. The rules recognize that RFP requirements are 
defined in terms of actual areawide emissions reductions and annual 
progress. Although such consistency and requirements may be made more 
difficult by the use of an EIP baseline which incorporates allowable 
emissions, the final rules provide States flexibility in designing an 
EIP to achieve these requirements. Further, the final rules encourage 
the development of EIP's as part of an overall attainment strategy that 
lowers the cost of attainment. The final rules recognize that 
attainment strategies that incorporate EIP's can reflect both 
environmentally and economically sound policy choices. Therefore, the 
final rules retain the proposed baseline flexibility and definition of 
surplus, while requiring States to demonstrate in their EIP submittal 
that the EIP baseline is consistent with their progress plans15 
and RACT requirements, when applicable, and to commit that such 
consistency will be reflected in any subsequent progress plans and 
attainment demonstrations. The State should describe how the EIP 
baseline will be integrated into a subsequent attainment demonstration. 
The EPA takes the position that an allowables baseline, when consistent 
with a submitted, complete, and potentially approvable RFP plan 
generally is permissible. It is true, as one commenter emphasized, that 
consistency with RFP does not automatically assure consistency with 
attainment when additional reductions are needed for attainment. 
However, the EPA takes the position that an allowables baseline that is 
consistent with an RFP submittal does not specifically interfere with 
attainment under section 110(l). The State's commitment that the 
attainment demonstration, when submitted, will be consistent with the 
allowables baseline lends additional support to the EPA's position. The 
inducement to States to complete the attainment demonstration that is 
presented by the sanctions/FIP requirement, as well as the fact that 
emissions limits allowed under the EIP may be tightened if they 
unexpectedly develop into impediments to attainment, further support 
the EPA's positions.
---------------------------------------------------------------------------

    \1\5EPA has concluded that it is not necessary in this notice to 
define RFP with any greater specificity than found in the statute; 
that is, it is not necessary to identify the extent, if any, of 
annual emissions reductions needed to comply with the statutory RFP 
requirements.
---------------------------------------------------------------------------

    As stated above in paragraph IV.B.1., the EPA is developing 
guidance that addresses baselines for EIP's implementing new NOX 
RACT requirements. Further, the EPA intends to work with States who 
want to develop trading-based RACT programs to incorporate the 
requirements of the EIP rules and related guidance into EIP's that are 
environmentally sound and administratively efficient.

D. Emission Quantification

1. Criteria for Adequacy of Approach
    The proposed rules and guidance were based on the premise that the 
development and use of credible, workable, and replicable methods to 
quantify emissions are necessary elements of any quantifiable EIP. The 
proposed rules require EIP quantification methods to have a level of 
certainty comparable to that for source-specific standards and 
traditional methods of control strategy development. The proposal 
explicitly allowed States to develop alternative approaches to meet 
these emissions quantification requirements. The proposal solicited 
comments on adequacy criteria for various types of source categories, 
recognizing that no one approach is the most appropriate, or even 
technically feasible, for all source categories.
    Most comments received on this issue were supportive of the general 
requirements in the proposal. Of those supporting the general 
requirements, no commenters offered any specific criteria for levels of 
certainty or accuracy by which quantification approaches should be 
evaluated. On the other hand, an environmental group commented that, 
for trading programs, the EPA should require the use of the most 
accurate available continuous emissions monitors (CEM's) on every 
source in an emissions trading program, and, where such direct 
emissions quantification is not possible, no emissions trading should 
be allowed.
    The final rules reflect the importance of both ensuring 
environmental protection with an adequate degree of accountability and 
fostering the development of innovative and flexible programs. 
Innovation and flexibility would be unduly restricted if the use of the 
most accurate available CEM's were a prerequisite for all sources to be 
included in any emissions trading program. The final rules recognize 
that other approaches may be more appropriate for various source 
categories. The final rules reflect that credible approaches 
necessarily entail levels of accuracy and precision sufficient to 
determine compliance and allow for effective enforcement of all 
emission limits in any EIP. Subject to these enforceability 
considerations, the final rules address uncertainty in emission 
quantification in determining SIP credit through the use of a 
programmatic uncertainty factor.
    A commenter stressed that the need to assure accuracy in trading 
would further burden State agencies, and argued that EPA could not 
approve an EIP absent a demonstration that the State agency has 
adequate resources to handle the additional workload. Many of the 
additional requirements Congress imposed on States through the Clean 
Air Act Amendments of 1990 would place additional burdens on State 
agencies--EPA intends to implement the Act's requirements that States 
have sufficient resources (e.g., section 110(a)(2)(E)) in the context 
of EIP submissions in the same manner as EPA implements these 
requirements in the context of other SIP submissions.
2. Extended Averaging Times
    The proposed rules recognize that long-term averaging by individual 
sources can significantly relax standards that require compliance on a 
short-term basis and jeopardize RFP and attainment demonstrations that 
are based on ``typical summer day'' emissions. The proposal also 
recognized that EIP's which require a number of sources to comply with 
total emissions caps or average emission rate limits could potentially 
mitigate this type of rule relaxation. In such programs, random daily 
positive fluctuations in emissions that are likely to occur from any 
given source (i.e., emission ``spikes'' that could jeopardize 
attainment) may tend to be compensated for by random daily negative 
fluctuations from other sources. Thus, the proposal allowed long-term 
averaging, provided a statistical showing is made that the long-term 
caps or limits are consistent with applicable demonstrations of RFP on 
the basis of typical summer day emissions, demonstrations of attainment 
of short-term NAAQS, and RACT requirements. The proposed approach 
provided increased flexibility to sources and to States in their plan 
development without undermining the EPA's traditional control programs 
or the validity of RFP or attainment demonstrations.
    The proposal recognized the need for additional guidance on such 
statistical ``equivalency'' showings. The proposal also solicited 
comments on specific approaches for RACT equivalency showings, 
including the use of a presumptive norm discount factor of 70 percent 
to be applied to a RACT limit averaged over 30 days, other rule-
specific discount factors determined by States to represent RACT 
equivalency, and the use of short-term caps in conjunction with long-
term caps or limits.
    Many commenters supported the proposed flexibility to allow for 
long-term averaging. One State commenter strongly supported the 
provision to allow States to relate long-term averaging to daily 
emissions by statistical analysis. Another State agreed that the use of 
long-term averaging should not come at the expense of attaining short-
term standards or demonstrations of compliance. Other States noted the 
need for consistency in the EPA's RACT guidance on averaging times. 
Industry commenters endorsed the allowance of long-term averaging, 
although they expressed differing views about the need for statistical 
showings to demonstrate consistency with RACT and short-term standards. 
Some felt that any such showing should not be burdensome, while others 
disagreed that any such showing was necessary. An environmental group 
agreed that increasing averaging periods can significantly relax 
standards and threaten RFP and attainment. This group commented, 
however, that the proposal understated the difficulties which would 
flow from such a relaxation, and felt that discount factors would not 
provide adequate protection against spikes in emissions which could 
prevent attainment of short-term NAAQS.
    With regard to long-term averaging and RACT equivalency, many 
commenters disagreed with the use of a presumptive 30-day RACT 
equivalency factor, such as the 70 percent factor mentioned in the 
proposal. One commenter felt that a RACT equivalency showing should not 
be required if some statistical information was provided showing that 
long-term averaging would not interfere with RFP or the attainment 
demonstration. Many regulatory agency and industry commenters supported 
allowing States flexibility in determining RACT equivalency factors.
    The final rules retain the proposed allowance for long-term 
emissions averaging, as well as requirements that States make 
statistical showings that any such emissions averaging is consistent 
with applicable RACT, RFP, and short-term NAAQS. These statistical 
showings are necessary to show equivalency to, or noninterference with, 
each of these statutory requirements, although as a practical matter 
the same showing may suffice to assure consistency with more than one 
of the requirements. The statistical showings should take into account 
the extent to which emissions variations from an individual source or 
from all sources are random or systematic and, thus, the extent to 
which the variations can be considered to be independent. The showings 
must demonstrate that the pattern of emissions resulting from relaxed 
averaging periods would approximate the pattern of emissions that would 
occur without relaxed averaging periods to an extent sufficient to 
reasonably conclude that the relaxed averaging periods would not 
interfere with the statutory requirements.
    The final rules do not include any presumptive RACT discount 
factor, on the basis that no one factor can adequately account for the 
variations that may occur across different programs. However, the EPA 
remains open-minded to discount factors, especially for specific 
industries, that are substantiated by State analyses. The EPA will work 
with States that want to develop EIP's that incorporate long-term 
averaging requirements to ensure that such a program does not interfere 
with RFP and the attainment of short-term standards. The EPA 
anticipates that more general guidance will be developed in the course 
of working with States on statistical approaches for such equivalency 
demonstrations. In the case of EIP's implementing RACT requirements, 
the guidance referenced above in paragraph IV.B.1. addresses long-term 
averaging for NOX RACT.

E. Monitoring, Recordkeeping, Reporting (MRR)

    The proposed rules were based on the premise that EIP's depend more 
strongly than traditional control programs on MRR to ensure compliance 
and to allow for adequate enforcement because they are inherently more 
flexible and less prescriptive than traditional technology or 
performance standards. The proposal recognized that while a wide range 
of MRR approaches are available that can be used to show compliance for 
different types of sources, no one approach is necessarily the most 
appropriate, or even technically feasible, for all types of sources 
that may be included in an EIP. Thus, the proposal explicitly allowed 
for alternative monitoring methods, while soliciting comments on 
criteria for adequate MRR requirements for EIP's.
    Public comments focused on whether EIP's do depend more strongly on 
MRR and on whether CEM's should be required for any or all sources 
covered by an EIP. Several industry commenters disagreed with the 
premise that EIP's depend more strongly on MRR to ensure compliance, 
and, therefore, felt that no more stringent MRR requirements should be 
required in EIP's than those required in traditional programs. These 
commenters supported the provision allowing a range of MRR requirements 
to be used in EIP's.
    One State commented that EIP's should be limited to source 
categories for which emission quantification and compliance methods are 
available and reasonably accurate. This State felt that the use of 
CEM's was the optimal monitoring method, although it recognized that 
other unit-specific field monitoring methods could be acceptable. An 
environmental group commented that the rules should require use of the 
most accurate available CEM's on every source involved in any emissions 
trading program. Further, this group felt that the maximum amount of 
CEM measurement inaccuracy should be reflected in a program discount 
factor. On the other hand, some industry commenters urged that EIP's 
not require the use of CEM's for any sources.
    The final rules retain the proposed flexibility for alternative 
monitoring approaches that allow for adequate compliance determinations 
and provide for effective State and Federal enforcement. As discussed 
above (see paragraph IV.D.1.), innovation and flexibility would be 
unduly restricted if CEM's were a prerequisite for all sources in any 
emissions trading program. In the development of adequate MRR 
requirements, criteria should be considered to assure that quality-
assured, representative monitoring data will be obtained that can be 
used to determine compliance.
    The EPA recognizes that special consideration should be given to 
developing MRR requirements for small sources to avoid undue burdens, 
consistent with assuring that all EIP sources are required to comply 
with adequate and effective MRR requirements. For mobile source 
programs, the State should refer to program-specific guidance from EPA, 
if applicable.

F. State Implementation Plan (SIP) Creditability

    The proposed rules identify various types of uncertainties 
associated with different categories of EIP's, and required that States 
apply discount factors in calculating SIP credit based on the 
uncertainties inherent in the design of any given EIP. The proposal 
separately addressed compliance-related uncertainty, through a rule 
compliance factor, and programmatic uncertainties associated with 
quantification methods and projected market responses, through a 
program uncertainty factor. The proposal compared the need for a rule 
compliance factor to the historical use of a rule effectiveness factor, 
generally set at 80 percent for traditional stationary source SIP 
programs. The proposal identified an option of setting presumptive 
norms for these factors in lieu of the requirement that the State 
develop and justify program-specific factors. The proposal solicited 
comments on criteria for the development of such factors.
    Many commenters expressed different concerns with the proposed 
approach to dealing with uncertainty. Some commenters interpreted the 
proposal as allowing credit only for emission-limiting programs (e.g., 
emission trading), and argued that credit should be allowed for market-
response programs (e.g., emission fees) and even directionally-sound 
programs (e.g., those that benefit the environment but cannot be 
quantified). One such commenter, an environmental group, urged not only 
that credit be given for emission fee programs, but that they must be 
encouraged since they offer the most attractive opportunity for 
environmental progress. In fact, the proposed and final rules allow 
credit for market-response as well as emission limiting programs, and 
encourage States to consider all such types of programs. The proposed 
and final rules also encourage the use of directionally-sound programs, 
but specify that SIP credit cannot be taken until sufficient experience 
with the program results in the ability to adequately quantify the 
results.
    Some State commenters expressed general concern with the use of any 
up-front discounting of SIP credit, urging instead that alternative 
approaches be allowed to account for uncertainty. In particular, some 
State commenters recommended that the program audit procedures be used 
to provide information on actual emissions reductions resulting from 
program implementation. Such audit results would feed back into updated 
emissions inventories, be compared to initially projected program 
results, and if appropriate, result in additional credit or the need 
for additional reductions if the audited results differ from those 
credited to the EIP in the SIP. One State commenter recommended that 
the State be allowed to adopt various back-up provisions in an EIP 
instead of applying up-front discount factors.
    Some industry commenters disagreed with the use of two discount 
factors, on the basis that such an approach would double count 
uncertainty. These commenters also expressed the view that a 
presumptive norm of 80 percent for a rule compliance factor is too low. 
On the other hand, an environmental group commented that a presumptive 
norm of 80 percent was too high. This commenter also urged that credit 
not be given for prior reductions or for plant shutdowns and slowdowns 
which would have occurred in the absence of a control program.
    The final rules generally retain the proposed approach of requiring 
the State to develop and apply discount factors to account for 
compliance-related and programmatic design uncertainties. In addition, 
however, the final rules also include further guidance and criteria for 
developing and justifying such factors. In particular, various aspects 
of program design should be considered in developing such factors, 
including but not limited to the type of incentive mechanism upon which 
the program is based; the variability in emissions from affected 
sources and the nature and extent of uncertainty in the emissions 
quantification procedures required by the program; the type and 
frequency of MRR required by the program; sanctions for noncompliance; 
the frequency, scope, and committed responses to program audits; and 
the nature of administrative procedures to be used by the State in 
implementing and enforcing the program.

G. Audit/Reconciliation Procedures

    The proposed rules specify that program audits be made at least 
every 3 years, consistent with intervals associated with RFP milestones 
and emission inventory requirements. Alternatively, the State could 
specify a shorter period, so as to allow time to make programmatic 
corrections or adjustments (in either direction) to SIP credited 
emissions reductions, before an RFP milestone is reached. The proposal 
solicited comments on the appropriate audit frequency.
    Several comments were received on the general issue of programs 
audits. Most such comments were generally supportive of a requirement 
for ongoing program tracking and feedback, although the commenters 
differed on the role that the audit should have relative to other EIP 
requirements. Some State commenters felt that ongoing audits should 
serve as an alternative to many of the proposed regulatory requirements 
for up-front technical analyses. Another State supported the use of 
audits to assess EIP adequacy and the need to take corrective actions. 
An environmental group recommended that the EPA require for all EIP's 
contingency measures to compensate for shortfalls revealed through the 
audits. Other State, environmental, and industry commenters felt that 
requiring audits was reasonable, but expressed varying degrees of 
concern that audits not become so burdensome as to serve as a 
disincentive for developing an EIP. On the other hand, one industry 
commenter felt that EIP's ought not be subject to any special audit 
requirements different from those applicable to traditional programs.
    On the issue of audit frequency, most commenters generally agreed 
with the proposed 3-year interval. One State commenter felt that annual 
audits should be conducted to assess progress, with a summary of such 
audits to be incorporated in triennial SIP RFP reports.
    The final rules and guidance retain the proposed requirements for 
program audit and reconciliation procedures, and establish 3 years as 
the maximum time interval for conducting such audits. The final rules 
recognize that the State has flexibility in establishing the frequency 
(within the 3-year constraint) and scope of audit provisions. Further, 
the final rules recognize that there is an interplay between the 
frequency, scope, and other design features of the audit provisions and 
the nature and scope of other program design elements (such as the 
justification for uncertainty factors). In addition, to better define 
the benefits from EIP's, the final rules include analysis of control 
cost savings, to the extent practicable, as a part of the required 
program audit.

H. Penalties for Noncompliance

    The proposed rules recognize that determination of statutory 
maximum penalties for noncompliance is significantly complicated in the 
case of EIP's that incorporate multisource emissions caps and/or long-
term averaging times, since Federal statutory maximum penalty authority 
is specified on a per-day, per-source basis. While establishing the 
principle that such penalty provisions must create a deterrent effect 
comparable to that of traditional programs, the proposal solicited 
comment on criteria for the development of such penalty provisions.
    Commenters generally agreed with the principle of equivalent 
deterrence. Several industry commenters opposed any criteria that would 
suggest that any multisource emissions cap violation should be 
considered to have occurred at each source. Some commenters recommended 
that penalty provisions be based on the amount of the exceedence of a 
cap, and one commenter suggested that the final rules should recommend 
predetermined minimum penalties. Another commenter recommended that 
penalty provisions differentiate between violations that are willful or 
negligent and those that are determined not to be willful or negligent.
    The final rules and guidance continue to allow for a variety of 
approaches to specifying statutory maximum penalties, although 
exceedance-based approaches are encouraged. Thus, for example, where 
emission limits are specified in units of mass emissions, statutory 
maximum penalties can be specified as a function of the degree to which 
the limits are exceeded, as measured in terms of some increment of mass 
emissions. Alternatively, statutory maximum penalties could be 
specified as a function of the cost of credits or allowances in trading 
programs. The final rules and guidance require that EIP's be structured 
in conjunction with applicable enforcement authorities, in such a way 
that violations of multisource and/or multiday emission limits 
translate into sufficient numbers of some combination of violations, 
sources in violation, and days of violation. There are no criteria that 
suggest that this requirement should necessarily be met by considering 
that the violation occurred at each such source. The final rules 
further identify supplemental provisions that may enhance deterrence, 
such as mandatory minimum penalties, or address uncertainties inherent 
in the design of a program, such as penalty triggers linked to measures 
of compliance tracked through the program audit.
    The following criteria have been established for assessing the 
adequacy of the deterrent effect of EIP penalty provisions. The primary 
focus is on an assessment of the adequacy of the statutory maximum 
penalties in the EIP, through an evaluation of deterrence ratios (i.e., 
the ratio of the maximum penalty per violation to the cost of 
compliance). In a program with tradeable emission allowances or ERC's, 
the cost of compliance will be related to the market value of 
allowances or credits. Under a range of foreseeable noncompliance 
circumstances, this deterrence ratio must be high enough to deter 
noncompliance to a degree comparable to traditional programs.
    Other aspects of deterrence should also be considered in evaluating 
the adequacy of penalty provisions. These aspects include the 
likelihood that noncompliance will be detected and the credibility and 
predictability of responses to noncompliance. These aspects should be 
considered in light of administrative procedures and resources 
established within the EIP, as well as other program design elements 
related to emission quantification and monitoring, recordkeeping, and 
reporting.

I. Interface With Existing Emission Trading Policies

    The EIP rules and guidance, being broadly applicable to any kind of 
EIP, generally cover the same type of emission trading programs that 
have historically been addressed by the EPA's previously released 
guidance on emission trading, primarily contained in the Emissions 
Trading Policy Statement (ETPS) and its appendices (51 FR 43831, Dec. 
4, 1986). Although based upon the same general principles, the EIP 
rules and guidance provide both greater flexibility and more 
comprehensive programmatic requirements for such programs. The proposal 
defined the relationship between the EIP rules and the ETPS such that 
the provisions of the ETPS which apply to trading between existing 
sources (i.e., the bubble and generic bubble provisions) would 
represent one particular model for how States could choose to design 
such a program that would be approvable under the EIP rules. The 
proposal, however, in no way constrained EIP's involving emission 
trading to the specific provisions of the ETPS. The proposal solicited 
comments on this proposed relationship.
    Only a few commenters addressed this issue. Two commenters agreed 
with the proposed approach. Another commenter disagreed with retaining 
the elements of the ETPS that are now addressed by the EIP rules, on 
the basis that such ETPS provisions are rendered obsolete by the new 
rules, and the EPA should not encourage the use of less flexible 
policies. Another commenter recommended that the ETPS should be updated 
to include the flexibility contained in the EIP rules and that it 
should then continue to be applied to trading done for the purpose of 
meeting other statutory requirements (e.g., RACT/non-RACT trading).
    The final rules retain the proposed relationship between the ETPS 
and the EIP rules. The final rules do not encourage States to limit 
their design of EIP's to meet the specific provisions in the ETPS. 
However, the final rules recognize that States may want to implement 
emission trading without embarking on the design of new approaches to 
emission trading. Retaining the ETPS provides a known regulatory option 
for those States that want to apply it.

J. General Issues

1. Detailed vs. General Guidance
    Some commenters felt that the EIP proposal was overly specific and 
limited flexibility. These commenters contended that it would be 
difficult for EPA guidance to anticipate and identify all of the 
specific elements of proposed programs that might be approvable until 
actual programs are developed and adopted. They felt that the final EIP 
rules should be limited to a detailed policy statement and discussion 
of principles and criteria to which EIP's must adhere rather than 
specific guidance on how EIP programs should be designed and 
administered.
    Other commenters, including a State and an environmental group, 
felt that the final rules should include more detailed guidance. One 
such commenter felt that without more detailed guidance, technical 
questions such as how to calculate emissions reductions or to establish 
baselines might be so daunting as to discourage attempts to develop 
EIP's. This commenter felt that the need for such guidance is 
particularly great for EIP's relying on area and mobile source 
emissions reductions. Another such commenter felt that without more 
detailed guidance spelling out appropriate design criteria and policy 
and legal limitations, States will succumb to pressures to develop 
EIP's that do not effectively implement the requirements of the Act.
    Some commenters on both sides of this issue recommended that the 
EPA provide examples of successful, appropriate EIP's. Such commenters 
recommended that such information be provided through supplemental 
documentation or through an EPA-established EIP information 
clearinghouse.
    Just as an individual State EIP rule should balance flexibility 
with specificity, the EPA's final EIP rules should do the same. Thus, 
the final rules retain the balance between general statements of 
principles and criteria and specific detailed guidance on technical 
requirements that was reflected in the proposal. The final rules 
provide sufficient detail to allow States to design and implement EIP's 
that will effectively implement the requirements of the Act without 
defeating the purpose of capturing the benefits of market-based 
regulatory approaches.
    Although the final rules do not include specific examples of EIP's 
that have been successfully implemented, the EPA agrees that such 
information is a useful and important aspect of encouraging the 
development of such programs. For the last 3 years, the EPA has funded 
grants to support market-based initiatives by State, regional and local 
agencies.16 All such initiatives have included strong involvement 
from the State, affected local interests, and the relevant EPA Regional 
Office(s). Final reports from these projects are available from the 
States to further the EPA's goal of disseminating information about the 
design and implementation of EIP's.
---------------------------------------------------------------------------

    \1\6The docket contains summaries of such programs and contacts 
for information.
---------------------------------------------------------------------------

    Beyond this grant program, the EPA is committed to working with 
individual States as they develop EIP's. In addition to the program 
survey documents which have been placed in the docket, the EPA is 
developing plans for future outreach activities to make information 
about successful EIP initiatives as broadly available as possible.
2. Administrative Simplicity
    Several commenters agreed that administrative complexity can be one 
of the greatest impediments to a regulation and urged the EPA to 
simplify the terms and processes of these rules. Such commenters felt 
that undue administrative complexity would stifle the development of 
EIP's and provide a significant disincentive for participation in 
trading programs. These commenters generally felt that the EIP rules 
should minimize regulatory barriers because they interfere with the 
functioning of desirable market mechanisms which are necessary for the 
success of the EIP.
    One type of complexity cited by two State commenters related to 
excessive government process, and the associated lack of timeliness, in 
the review of individual emissions trades. These commenters recommended 
that individual emissions trading transactions not be required to be 
submitted to the EPA for review once a State's generic trading rule has 
been approved by the EPA. Further, one such commenter recommended more 
focus on the audit and evaluation of an EIP program, rather than on 
administrative burdens upfront in implementing emissions trades. This 
commenter felt that the EPA should have the authority to conduct 
periodic audits of emissions trading transactions approved by the 
States to assure the integrity of the program.
    In seeking to provide States with the flexibility to implement 
emissions trading programs effectively, the final EIP rules retain the 
proposed requirement for the State to establish appropriate 
administrative procedures for conducting, approving, verifying, 
recording, and tracking trades. As part of an EIP program, these 
procedures would then be reviewed by the EPA in the course of EPA 
review of the SIP revision incorporating the EIP into the SIP. Thus, 
the EIP does not necessarily envision single-source SIP revisions for 
each trade conducted in the context of an EPA-approved generic 
emissions trading program. Of course, EPA approval of such programs is 
predicated on the program containing all the appropriate environmental 
safeguards that are required by the EIP rules. One such safeguard is 
the inclusion of program audits, to be conducted by the State, to 
evaluate program implementation and track program results. The EIP 
rules require that the State provide post-audit reports to the EPA, and 
that the State commits to implement timely programmatic revisions or 
other measures necessary for the successful operation of the program. 
Additionally, the rules require that State and Federal enforceability 
must be preserved, such that when ERC's generated within an emissions 
trading program are used to offset increases in emissions from other 
sources, the EIP must contain a mechanism for ensuring State and 
Federal enforceability of the measures taken to generate the credits.
    The EPA is currently developing additional guidance on such issues 
associated with banking of ERC's. The EPA intends to complete this 
additional guidance as quickly as possible, and, in the interim, to 
work with States developing EIP's involving banking of ERC's.
3. Regional and Interstate Trading
    Neither the proposal nor final rules specifically address the issue 
of regional and interstate emissions trading. Several commenters raised 
this issue, however, particularly in the context of trading of 
emissions offsets. Most such commenters felt that the EPA should 
encourage interstate trading by establishing consistent rules and 
prohibiting States from creating interstate barriers. One State group 
felt that the final rules should provide for the fullest possible 
implementation of trading strategies on a regional basis within the 
Northeast Ozone Transport Region. One environmental group urged that 
the final rules remind States of the statutory geographical constraints 
on trading.
    The EPA has developed some preliminary guidance on this issue as it 
relates to NOx offsets in the Northeast Ozone Transport 
Region.17 Additional guidance on interstate or regional trading 
will be developed in the context of the EPA's working with interested 
States in program development activities.
---------------------------------------------------------------------------

    \1\7This guidance is contained in a March 31, 1993 letter from 
Mr. John Seitz, Director of the EPA's Office of Air Quality Planning 
and Standards, to Mr. Bruce Carhart, Executive Director of the Ozone 
Transport Commission, which includes all or portions of the 
northeastern States from Washington, DC, to the New England States. 
This letter is available in the docket for this rule.
---------------------------------------------------------------------------

V. Administrative Requirements

A. Executive Order 12866

    Under Executive Order 12866, (58 FR 51735 (October 4, 1993)) the 
Agency must determine whether the regulatory action is ``significant'' 
and therefore subject to OMB review and the requirements of the 
Executive Order. The Order defines ``significant regulatory action'' as 
one that is likely to result in a rule that may:
    (1) Have an annual effect on the economy of $100 million or more or 
adversely affect in a material way the economy, a sector of the 
economy, productivity, competition, jobs, the environment, public 
health or safety, or State, local, or tribal governments or 
communities;
    (2) Create a serious inconsistency or otherwise interfere with an 
action taken or planned by another Agency;
    (3) Materially alter the budgetary impact of entitlements, grants, 
user fees, or loan programs or the rights and obligations of recipients 
thereof; or
    (4) Raise novel legal or policy issues arising out of legal 
mandates, the President's priorities, or the principles set forth in 
the Executive Order.''
    It has been determined that these rules are not a ``significant 
regulatory action'' under the terms of Executive Order 12866. This 
action was submitted to OMB for review. Changes made in response to OMB 
suggestions or recommendations will be documented in the public record.

B. Paperwork Reduction Act

    These rules do not contain any information collection requirements 
subject to review by the OMB under the Paperwork Reduction Act of 1980, 
44 U.S.C. 3501, et seq.

C. Regulatory Flexibility Act

    The Regulatory Flexibility Act of 1980 and applicable EPA 
guidelines revised in 1992 require Federal agencies to identify 
potentially adverse impacts of Federal rules upon small entities. Small 
entities include small businesses, organizations, and governmental 
jurisdictions. In instances where significant impacts are possible on a 
substantial number of these entities, agencies are required to perform 
a Regulatory Flexibility Analysis (RFA).
    This rule does not of itself impose any requirements on small 
entities, nor require or exclude small entities from any EIP's which 
may be implemented in the future. As a result, the EPA has determined 
that these rules will not have a significant impact on a substantial 
number of small entities.
    Therefore, as required under section 605 of the RFA, 5 U.S.C. 601 
et seq., I certify that these rules do not have a significant impact on 
a substantial number of small entities.

List of Subjects in 40 CFR Part 51

    Administrative practice and procedure, Air pollution control, 
Carbon monoxide, Intergovernmental relations, Lead, Nitrogen dioxide, 
Ozone, Particulate matter, Reporting and recordkeeping requirements, 
Sulfur oxides, Volatile organic compounds.

    Dated: March 15, 1994.
Carol M. Browner,
Administrator.

    For reasons set out in the preamble, 40 CFR part 51 is amended as 
follows:

PART 51--REQUIREMENTS FOR PREPARATION, ADOPTION, AND SUBMITTAL OF 
IMPLEMENTATION PLANS

    1. The authority citation for part 51 continues to read as follows:

    Authority: 42 U.S.C. 7401-7671q.

    2. Part 51 is amended by adding a new subpart U, consisting of 
Secs. 51.490 through 51.494, to read as follows:

Subpart U--Economic Incentive Programs

Sec.
51.490 Applicability.
51.491 Definitions.
51.492 State program election and submittal.
51.493 State program requirements.
51.494 Use of program revenues.

Subpart U--Economic Incentive Programs


Sec. 51.490  Applicability.

    (a) The rules in this subpart apply to any statutory economic 
incentive program (EIP) submitted to the EPA as an implementation plan 
revision to comply with sections 182(g)(3), 182(g)(5), 187(d)(3), or 
187(g) of the Act. Such programs may be submitted by any authorized 
governmental organization, including States, local governments, and 
Indian governing bodies.
    (b) The provisions contained in these rules, except as explicitly 
exempted, shall also serve as the EPA's policy guidance on 
discretionary EIP's submitted as implementation plan revisions for any 
purpose other than to comply with the statutory requirements specified 
in paragraph (a) of this section.


Sec. 51.491  Definitions.

    Act means the Clean Air Act as amended November 15, 1990.
    Actual emissions means the emissions of a pollutant from an 
affected source determined by taking into account actual emission rates 
associated with normal source operation and actual or representative 
production rates (i.e., capacity utilization and hours of operation).
    Affected source means any stationary, area, or mobile source of a 
criteria pollutant(s) to which an EIP applies. This term applies to 
sources explicitly included at the start of a program, as well as 
sources that voluntarily enter (i.e., opt into) the program.
    Allowable emissions means the emissions of a pollutant from an 
affected source determined by taking into account the most stringent of 
all applicable SIP emissions limits and the level of emissions 
consistent with source compliance with all Federal requirements related 
to attainment and maintenance of the NAAQS and the production rate 
associated with the maximum rated capacity and hours of operation 
(unless the source is subject to federally enforceable limits which 
restrict the operating rate, or hours of operation, or both).
    Area sources means stationary and nonroad sources that are too 
small and/or too numerous to be individually included in a stationary 
source emissions inventory.
    Attainment area means any area of the country designated or 
redesignated by the EPA at 40 CFR part 81 in accordance with section 
107(d) as having attained the relevant NAAQS for a given criteria 
pollutant. An area can be an attainment area for some pollutants and a 
nonattainment area for other pollutants.
    Attainment demonstration means the requirement in section 
182(b)(1)(A) of the Act to demonstrate that the specific annual 
emissions reductions included in a SIP are sufficient to attain the 
primary NAAQS by the date applicable to the area.
    Directionally-sound strategies are strategies for which adequate 
procedures to quantify emissions reductions or specify a program 
baseline are not defined as part of the EIP.
    Discretionary economic incentive program means any EIP submitted to 
the EPA as an implementation plan revision for purposes other than to 
comply with the statutory requirements of sections 182(g)(3), 
182(g)(5), 187(d)(3), or 187(g) of the Act.
    Economic incentive program (EIP) means a program which may include 
State established emission fees or a system of marketable permits, or a 
system of State fees on sale or manufacture of products the use of 
which contributes to O3 formation, or any combination of the 
foregoing or other similar measures, as well as incentives and 
requirements to reduce vehicle emissions and vehicle miles traveled in 
the area, including any of the transportation control measures 
identified in section 108(f). Such programs may be directed toward 
stationary, area, and/or mobile sources, to achieve emissions 
reductions milestones, to attain and maintain ambient air quality 
standards, and/or to provide more flexible, lower-cost approaches to 
meeting environmental goals. Such programs are categorized into the 
following three categories: Emission-limiting, market-response, and 
directionally-sound strategies.
    Emission-limiting strategies are strategies that directly specify 
limits on total mass emissions, emission-related parameters (e.g., 
emission rates per unit of production, product content limits), or 
levels of emissions reductions relative to a program baseline that are 
required to be met by affected sources, while providing flexibility to 
sources to reduce the cost of meeting program requirements.
    Indian governing body means the governing body of any tribe, band, 
or group of Indians subject to the jurisdiction of the U.S. and 
recognized by the U.S. as possessing power of self-government.
    Maintenance plan means an implementation plan for an area for which 
the State is currently seeking designation or has previously sought 
redesignation to attainment, under section 107(d) of the Act, which 
provides for the continued attainment of the NAAQS.
    Market-response strategies are strategies that create one or more 
incentives for affected sources to reduce emissions, without directly 
specifying limits on emissions or emission-related parameters that 
individual sources or even all sources in the aggregate are required to 
meet.
    Milestones means the reductions in emissions required to be 
achieved pursuant to section 182(b)(1) and the corresponding 
requirements in section 182(c)(2) (B) and (C), 182(d), and 182(e) of 
the Act for O3 nonattainment areas, as well as the reduction in 
emissions of CO equivalent to the total of the specified annual 
emissions reductions required by December 31, 1995, pursuant to section 
187(d)(1).
    Mobile sources means on-road (highway) vehicles (e.g., automobiles, 
trucks and motorcycles) and nonroad vehicles (e.g., trains, airplanes, 
agricultural equipment, industrial equipment, construction vehicles, 
off-road motorcycles, and marine vessels).
    National ambient air quality standard (NAAQS) means a standard set 
by the EPA at 40 CFR part 50 under section 109 of the Act.
    Nonattainment area means any area of the country designated by the 
EPA at 40 CFR part 81 in accordance with section 107(d) of the Act as 
nonattainment for one or more criteria pollutants. An area could be a 
nonattainment area for some pollutants and an attainment area for other 
pollutants.
    Nondiscriminatory means that a program in one State does not result 
in discriminatory effects on other States or sources outside the State 
with regard to interstate commerce.
    Program baseline means the level of emissions, or emission-related 
parameter(s), for each affected source or group of affected sources, 
from which program results (e.g., quantifiable emissions reductions) 
shall be determined.
    Program uncertainty factor means a factor applied to discount the 
amount of emissions reductions credited in an implementation plan 
demonstration to account for any strategy-specific uncertainties in an 
EIP.
    Reasonable further progress (RFP) plan means any incremental 
emissions reductions required by the CAA (e.g., section 182(b)) and 
approved by the EPA as meeting these requirements.
    RFP baseline means the total of actual volatile organic compounds 
or nitrogen oxides emissions from all anthropogenic sources in an 
O3 nonattainment area during the calendar year 1990 (net of growth 
and adjusted pursuant to section 182(b)(1)(B) of the Act), expressed as 
typical O3 season, weekday emissions.
    Replicable refers to methods which are sufficiently unambiguous 
such that the same or equivalent results would be obtained by the 
application of the methods by different users.
    Rule compliance factor means a factor applied to discount the 
amount of emissions reductions credited in an implementation plan 
demonstration to account for less-than-complete compliance by the 
affected sources in an EIP.
    Shortfall means the difference between the amount of emissions 
reductions credited in an implementation plan for a particular EIP and 
those that are actually achieved by that EIP, as determined through an 
approved reconciliation process.
    State means State, local government, or Indian-governing body.
    State implementation plan (SIP) means a plan developed by an 
authorized governing body, including States, local governments, and 
Indian-governing bodies, in a nonattainment area, as required under 
titles I & II of the Clean Air Act, and approved by the EPA as meeting 
these same requirements.
    Stationary source means any building, structure, facility or 
installation, other than an area or mobile source, which emits or may 
emit any criteria air pollutant or precursor subject to regulation 
under the Act.
    Statutory economic incentive program means any EIP submitted to the 
EPA as an implementation plan revision to comply with sections 
182(g)(3), 182(g)(5), 187(d)(3), or 187(g) of the Act.
    Surplus means, at a minimum, emissions reductions in excess of an 
established program baseline which are not required by SIP requirements 
or State regulations, relied upon in any applicable attainment plan or 
demonstration, or credited in any RFP or milestone demonstration, so as 
to prevent the double-counting of emissions reductions.
    Transportation control measure (TCM) is any measure of the types 
listed in section 108(F) of the Act, or any measure in an applicable 
implementation plan directed toward reducing emissions of air 
pollutants from transportation sources by a reduction in vehicle use or 
changes in traffic conditions.


Sec. 51.492  State program election and submittal.

    (a) Extreme O3 nonattainment areas. (1) A State or authorized 
governing body for any extreme O3 nonattainment area shall submit 
a plan revision to implement an EIP, in accordance with the 
requirements of this part, pursuant to section 182(g)(5) of the Act, 
if:
    (i) A required milestone compliance demonstration is not submitted 
within the required period.
    (ii) The Administrator determines that the area has not met any 
applicable milestone.
    (2) The plan revision in paragraph (a)(1) of this section shall be 
submitted within 9 months after such failure or determination, and 
shall be sufficient, in combination with other elements of the SIP, to 
achieve the next milestone.
    (b) Serious CO nonattainment areas. (1) A State or authorized 
governing body for any serious CO nonattainment area shall submit a 
plan revision to implement an EIP, in accordance with the requirements 
of this part, if:
    (i) A milestone demonstration is not submitted within the required 
period, pursuant to section 187(d) of the Act.
    (ii) The Administrator notifies the State, pursuant to section 
187(d) of the Act, that a milestone has not been met.
    (iii) The Administrator determines, pursuant to section 186(b)(2) 
of the Act that the NAAQS for CO has not been attained by the 
applicable date for that area. Such revision shall be submitted within 
9 months after such failure or determination.
    (2) Submittals made pursuant to paragraphs (b)(1) (i) and (ii) of 
this section shall be sufficient, together with a transportation 
control program, to achieve the specific annual reductions in CO 
emissions set forth in the implementation plan by the attainment date. 
Submittals made pursuant to paragraph (b)(1)(iii) of this section shall 
be adequate, in combination with other elements of the revised plan, to 
reduce the total tonnage of emissions of CO in the area by at least 5 
percent per year in each year after approval of the plan revision and 
before attainment of the NAAQS for CO.
    (c) Serious and severe O3 nonattainment areas. If a State, for 
any serious or severe O3 nonattainment area, elects to implement 
an EIP in the circumstances set out in section 182(g)(3) of the Act, 
the State shall submit a plan revision to implement the program in 
accordance with the requirements of this part. If the option to 
implement an EIP is elected, a plan revision shall be submitted within 
12 months after the date required for election, and shall be 
sufficient, in combination with other elements of the SIP, to achieve 
the next milestone.
    (d) Any nonattainment or attainment area. Any State may at any time 
submit a plan or plan revision to implement a discretionary EIP, in 
accordance with the requirements of this part, pursuant to sections 
110(a)(2)(A) and 172(c)(6) and other applicable provisions of the Act 
concerning SIP submittals. The plan revision shall not interfere with 
any applicable requirement concerning attainment and RFP, or any other 
applicable requirements of the Act.


Sec. 51.493  State program requirements.

    Economic incentive programs shall be State and federally 
enforceable, nondiscriminatory, and consistent with the timely 
attainment of NAAQS, all applicable RFP and visibility requirements, 
applicable PSD increments, and all other applicable requirements of the 
Act. Programs in nonattainment areas for which credit is taken in 
attainment and RFP demonstrations shall be designed to ensure that the 
effects of the program are quantifiable and permanent over the entire 
duration of the program, and that the credit taken is limited to that 
which is surplus. Statutory programs shall be designed to result in 
quantifiable, significant reductions in actual emissions. The EIP's 
shall include the following elements, as applicable:
    (a) Statement of goals and rationale. This element shall include a 
clear statement as to the environmental problem being addressed, the 
intended environmental and economic goals of the program, and the 
rationale relating the incentive-based strategy to the program goals.
    (1) The statement of goals must include the goal that the program 
will benefit both the environment and the regulated entities. The 
program shall be designed so as to meaningfully meet this goal either 
directly, through increased or more rapid emissions reductions beyond 
those that would be achieved through a traditional regulatory program, 
or, alternatively, through other approaches that will result in real 
environmental benefits. Such alternative approaches include, but are 
not limited to, improved administrative mechanisms, reduced 
administrative burdens on regulatory agencies, improved emissions 
inventories, and the adoption of emission caps which over time 
constrain or reduce growth-related emissions beyond traditional 
regulatory approaches.
    (2) The incentive-based strategy shall be described in terms of one 
of the following three strategies:
    (i) Emission-limiting strategies, which directly specify limits on 
total mass emissions, emission-related parameters (e.g., emission rates 
per unit of production, product content limits), or levels of emissions 
reductions relative to a program baseline that affected sources are 
required to meet, while providing flexibility to sources to reduce the 
cost of meeting program requirements.
    (ii) Market-response strategies, which create one or more 
incentives for affected sources to reduce emissions, without directly 
specifying limits on emissions or emission-related parameters that 
individual sources or even all sources in the aggregate are required to 
meet.
    (iii) Directionally-sound strategies, for which adequate procedures 
to quantify emissions reductions are not defined.
    (b) Program scope. (1) This element shall contain a clear 
definition of the sources affected by the program. This definition 
shall address:
    (i) The extent to which the program is mandatory or voluntary for 
the affected sources.
    (ii) Provisions, if any, by which sources that are not required to 
be in the program may voluntarily enter the program.
    (iii) Provisions, if any, by which sources covered by the program 
may voluntarily leave the program.
    (2) Any opt-in or opt-out provisions in paragraph (b)(1) of this 
section shall be designed to provide mechanisms by which such program 
changes are reflected in an area's attainment and RFP demonstrations, 
thus ensuring that there will not be an increase in the emissions 
inventory for the area caused by voluntary entry or exit from the 
program.
    (3) The program scope shall be defined so as not to interfere with 
any other Federal requirements which apply to the affected sources.
    (c) Program baseline. A program baseline shall be defined as a 
basis for projecting program results and, if applicable, for 
initializing the incentive mechanism (e.g., for marketable permits 
programs). The program baseline shall be consistent with, and 
adequately reflected in, the assumptions and inputs used to develop an 
area's RFP plans and attainment and maintenance demonstrations, as 
applicable. The State shall provide sufficient supporting information 
from the areawide emissions inventory and other sources to justify the 
baseline used in the EIP.
    (1) For EIP's submitted in conjunction with, or subsequent to, the 
submission of any areawide progress plan due at the time of EIP 
submission (e.g., the 15 percent RFP plan and/or subsequent 3 percent 
plans) or an attainment demonstration, a State may exercise flexibility 
in setting a program baseline provided the program baseline is 
consistent with and reflected in all relevant progress plans or 
attainment demonstration. A flexible program baseline may be based on 
the lower of actual, allowable, or some other intermediate or lower 
level of emissions. For any EIP submitted prior to the submittal of an 
attainment demonstration, the State shall include the following with 
its EIP submittal:
    (i) A commitment that its subsequent attainment demonstration and 
all future progress plans, if applicable, will be consistent with the 
EIP baseline.
    (ii) A discussion of how the baseline will be integrated into the 
subsequent attainment demonstration, taking into account the potential 
that credit issued prior to the attainment demonstration may no longer 
be surplus relative to the attainment demonstration.
    (2) Except as provided for in paragraph (c)(4) of this section, for 
EIP's submitted during a time period when any progress plans are 
required but not yet submitted (e.g., the 15 percent RFP plan and/or 
the subsequent 3 percent plans), the program baseline shall be based on 
the lower-of-actual-or-allowable emissions. In such cases, actual 
emissions shall be taken from the most appropriate inventory, such as 
the 1990 actual emission inventory (due for submission in November 
1992), and allowable emissions are the lower of SIP-allowable emissions 
or the level of emissions consistent with source compliance with all 
Federal requirements related to attainment and maintenance of the 
NAAQS.
    (3) For EIP's that are designed to implement new and/or previously 
existing RACT requirements through emissions trading and are submitted 
in conjunction with, or subsequent to, the submission of an associated 
RACT rule, a State may exercise flexibility in setting a program 
baseline provided the program baseline is consistent with and reflected 
in the associated RACT rule, and any applicable progress plans and 
attainment demonstrations.
    (4) For EIP's that are designed to implement new and/or previously 
existing RACT requirements through emissions trading and are submitted 
prior to the submission of a required RFP plan or attainment 
demonstration, States also have flexibility in determining the program 
baseline, provided the following conditions are met.
    (i) For EIP's that implement new RACT requirements for previously 
unregulated source categories through emissions trading, the new RACT 
requirements must reflect, to the extent practicable, increased 
emissions reductions beyond those that would be achieved through a 
traditional RACT program.
    (ii) For EIP's that impose new RACT requirements on previously 
unregulated sources in a previously regulated source category (e.g., 
RACT ``catch-up'' programs), the new incentive-based RACT rule shall, 
in the aggregate, yield reductions in actual emissions at least 
equivalent to that which would result from source-by-source compliance 
with the existing RACT limit for that source category.
    (5) A program baseline for individual sources shall, as 
appropriate, be contained or incorporated by reference in federally-
enforceable operating permits or a federally-enforceable SIP.
    (6) An initial baseline for TCM's shall be calculated by 
establishing the preexisting conditions in the areas of interest. This 
may include establishing to what extent TCM's have already been 
implemented, what average vehicle occupancy (AVO) levels have been 
achieved during peak and off-peak periods, what types of trips occur in 
the region, and what mode choices have been made in making these trips. 
In addition, the extent to which travel options are currently available 
within the region of interest shall be determined. These travel options 
may include, but are not limited to, the degree of dispersion of 
transit services, the current ridership rates, and the availability and 
usage of parking facilities.
    (7) Information used in setting a program baseline shall be of 
sufficient quality to provide for at least as high a degree of 
accountability as currently exists for traditional control requirements 
for the categories of sources affected by the program.
    (d) Replicable emission quantification methods. This program 
element, for programs other than those which are categorized as 
directionally-sound, shall include credible, workable, and replicable 
methods for projecting program results from affected sources and, where 
necessary, for quantifying emissions from individual sources subject to 
the EIP. Such methods, if used to determine credit taken in attainment, 
RFP, and maintenance demonstrations, as applicable, shall yield results 
which can be shown to have a level of certainty comparable to that for 
source-specific standards and traditional methods of control strategy 
development. Such methods include, as applicable, the following 
elements:
    (1) Specification of quantification methods. This element shall 
specify the approach or the combination or range of approaches that are 
acceptable for each source category affected by the program. Acceptable 
approaches may include, but are not limited to:
    (i) Test methods for the direct measurement of emissions, either 
continuously or periodically.
    (ii) Calculation equations which are a function of process or 
control system parameters, ambient conditions, activity levels, and/or 
throughput or production rates.
    (iii) Mass balance calculations which are a function of inventory, 
usage, and/or disposal records.
    (iv) EPA-approved emission factors, where appropriate and adequate.
    (v) Any combination of these approaches.
    (2) Specification of averaging times.
    (i) The averaging time for any specified mass emissions caps or 
emission rate limits shall be consistent with: attaining and 
maintaining all applicable NAAQS, meeting RFP requirements, and 
ensuring equivalency with all applicable RACT requirements.
    (ii) If the averaging time for any specified VOC or NOX mass 
emissions caps or emission rate limits for stationary sources (and for 
other sources, as appropriate) is longer than 24 hours, the State shall 
provide, in support of the SIP submittal, a statistical showing that 
the specified averaging time is consistent with attaining the O3 
NAAQS and satisfying RFP requirements, as applicable, on the basis of 
typical summer day emissions; and, if applicable, a statistical showing 
that the longer averaging time will produce emissions reductions that 
are equivalent on a daily basis to source-specific RACT requirements.
    (3) Accounting for shutdowns and production curtailments. This 
accounting shall include provisions which ensure that:
    (i) Emissions reductions associated with shutdowns and production 
curtailments are not double-counted in attainment or RFP 
demonstrations.
    (ii) Any resultant ``shifting demand'' which increases emissions 
from other sources is accounted for in such demonstrations.
    (4) Accounting for batch, seasonal, and cyclical operations. This 
accounting shall include provisions which ensure that the approaches 
used to account for such variable operations are consistent with 
attainment and RFP plans.
    (5) Accounting for travel mode choice options, as appropriate, for 
TCM's. This accounting shall consider the factors or attributes of the 
different forms of travel modes (e.g., bus, ridesharing) which 
determine which type of travel an individual will choose. Such factors 
include, but are not limited to, time, cost, reliability, and 
convenience of the mode.
    (e) Source requirements. This program element shall include all 
source-specific requirements that constitute compliance with the 
program. Such requirements shall be appropriate, readily ascertainable, 
and State and federally enforceable, including, as applicable:
    (1) Emission limits.
    (i) For programs that impose limits on total mass emissions, 
emission rates, or other emission-related parameter(s), there must be 
an appropriate tracking system so that a facility's limits are readily 
ascertainable at all times.
    (ii) For emission-limiting EIP's that authorize RACT sources to 
meet their RACT requirements through RACT/non-RACT trading, such 
trading shall result in an exceptional environmental benefit. 
Demonstration of an exceptional environmental benefit shall require 
either the use of the statutory offset ratios for nonattainment areas 
as the determinant of the amount of emissions reductions that would be 
required from non-RACT sources generating credits for RACT sources or, 
alternatively, a trading ratio of 1.1 to 1, at a minimum, may be 
authorized, provided exceptional environmental benefits are otherwise 
demonstrated.
    (2) Monitoring, recordkeeping, and reporting requirements.
    (i) An EIP (or the SIP as a whole) must contain test methods and, 
where necessary, emission quantification methodologies, appropriate to 
the emission limits established in the SIP. EIP sources must be subject 
to clearly specified MRR requirements appropriate to the test methods 
and any applicable quantification methodologies, and consistent with 
the EPA's title V rules, where applicable. Such MRR requirements shall 
provide sufficiently reliable and timely information to determine 
compliance with emission limits and other applicable strategy-specific 
requirements, and to provide for State and Federal enforceability of 
such limits and requirements. Methods for MRR may include, but are not 
limited to:
    (A) The continuous monitoring of mass emissions, emission rates, or 
process or control parameters.
    (B) In situ or portable measurement devices to verify control 
system operating conditions.
    (C) Periodic measurement of mass emissions or emission rates using 
reference test methods.
    (D) Operation and maintenance procedures and/or other work 
practices designed to prevent, identify, or remedy noncomplying 
conditions.
    (E) Manual or automated recordkeeping of material usage, 
inventories, throughput, production, or levels of required activities.
    (F) Any combination of these methods. EIP's shall require that 
responsible parties at each facility in the EIP program certify 
reported information.
    (ii) Procedures for determining required data, including the 
emissions contribution from affected sources, for periods for which 
required data monitoring is not performed, data are otherwise missing, 
or data have been demonstrated to have been inaccurately determined.
    (3) Any other applicable strategy-specific requirements.
    (f) Projected results and audit/reconciliation procedures. (1) The 
SIP submittal shall include projections of the emissions reductions 
associated with the implementation of the program. These projected 
results shall be related to and consistent with the assumptions used to 
develop the area's attainment demonstration and maintenance plan, as 
applicable. For programs designed to produce emissions reductions 
creditable towards RFP milestones, projected emissions reductions shall 
be related to the RFP baseline and consistent with the area's RFP 
compliance demonstration. The State shall provide sufficient supporting 
information that shows how affected sources are or will be addressed in 
the emissions inventory, RFP plan, and attainment demonstration or 
maintenance plan, as applicable.
    (i) For emission-limiting programs, the projected results shall be 
consistent with the reductions in mass emissions or emissions-related 
parameters specified in the program design.
    (ii) For market-response programs, the projected results shall be 
based on market analyses relating levels of targeted emissions and/or 
emission-related activities to program design parameters.
    (iii) For directionally-sound programs, the projected results may 
be descriptive and shall be consistent with the area's attainment 
demonstration or maintenance plan.
    (2) Quantitative projected results shall be adjusted through the 
use of two uncertainty factors, as appropriate, to reflect 
uncertainties inherent in both the extent to which sources will comply 
with program requirements and the overall program design.
    (i) Uncertainty resulting from incomplete compliance shall be 
addressed through the use of a rule compliance factor.
    (ii) Programmatic uncertainty shall be addressed through the use of 
a program uncertainty factor. Any presumptive norms set by the EPA 
shall be used unless an adequate justification for an alternative 
factor is included in supporting information to be supplied with the 
SIP submittal. In the absence of any EPA-specified presumptive norms, 
the State shall provide an adequate justification for the selected 
factors as part of the supporting information to be supplied with the 
SIP submittal.
    (3) Unless otherwise provided in program-specific guidance issued 
by the EPA, EIP's for which SIP credit is taken shall include audit 
procedures to evaluate program implementation and track program results 
in terms of both actual emissions reductions, and, to the extent 
practicable, cost savings relative to traditional regulatory program 
requirements realized during program implementation. Such audits shall 
be conducted at specified time intervals, not to exceed three years. 
The State shall provide timely post-audit reports to the EPA.
    (i) For emission-limiting EIP's, the State shall commit to ensure 
the timely implementation of programmatic revisions or other measures 
which the State, in response to the audit, deems necessary for the 
successful operation of the program in the context of overall RFP and 
attainment requirements.
    (ii) For market-response EIP's, reconciliation procedures that 
identify a range of appropriate actions or revisions to program 
requirements that will make up for any shortfall between credited 
results (i.e., projected results, as adjusted by the two uncertainty 
factors described above) and actual results obtained during program 
implementation shall be submitted together with the program audit 
provisions. Such measures must be federally enforceable, as 
appropriate, and automatically executing to the extent necessary to 
make up the shortfall within a specified period of time, consistent 
with relevant RFP and attainment requirements.
    (g) Implementation schedule. The program shall contain a schedule 
for the adoption and implementation of all State commitments and source 
requirements included in the program design.
    (h) Administrative procedures. The program shall contain a 
description of State commitments which are integral to the 
implementation of the program, and the administrative system to be used 
to implement the program, addressing the adequacy of the personnel, 
funding, and legislative authority.
    (1) States shall furnish adequate documentation of existing legal 
authority and demonstrated administrative capacity to implement and 
enforce the provisions of the EIP.
    (2) For programs which require private and/or public entities to 
establish emission-related economic incentives (e.g., programs 
requiring employers to exempt carpoolers/multiple occupancy vehicles 
from paying for parking), States shall furnish adequate documentation 
of State authority and administrative capacity to implement and enforce 
the underlying program.
    (i) Enforcement mechanisms. The program shall contain a compliance 
instrument(s) for all program requirements, which is legally binding 
and State and federally enforceable. This program element shall also 
include a State enforcement program which defines violations, and 
specifies auditing and inspections plans and provisions for enforcement 
actions. The program shall contain effective penalties for 
noncompliance which preserve the level of deterrence in traditional 
programs. For all such programs, the manner of collection of penalties 
must be specified.
    (1) Emission limit violations. (i) Programs imposing limits on mass 
emissions or emission rates that provide for extended averaging times 
and/or compliance on a multisource basis shall include procedures for 
determining the number of violations, the number of days of violation, 
and sources in violation, for statutory maximum penalty purposes, when 
the limits are exceeded. The State shall demonstrate that such 
procedures shall not lessen the incentive for source compliance as 
compared to a program applied on a source-by-source, daily basis.
    (ii) Programs shall require plans for remedying noncompliance at 
any facility that exceeds a multisource emissions limit for a given 
averaging period. These plans shall be enforceable both federally and 
by the State.
    (2) Violations of MRR requirements. The MRR requirements shall 
apply on a daily basis, as appropriate, and violations thereof shall be 
subject to State enforcement sanctions and to the Federal penalty of up 
to $25,000 for each day a violation occurs or continues. In addition, 
where the requisite scienter conditions are met, violations of such 
requirements shall be subject to the Act's criminal penalty sanctions 
of section 113(c)(2), which provides for fines and imprisonment of up 
to 2 years.


Sec. 51.494  Use of program revenues.

    Any revenues generated from statutory EIP's shall be used by the 
State for any of the following:
    (a) Providing incentives for achieving emissions reductions.
    (b) Providing assistance for the development of innovative 
technologies for the control of O3 air pollution and for the 
development of lower-polluting solvents and surface coatings. Such 
assistance shall not provide for the payment of more than 75 percent of 
either the costs of any project to develop such a technology or the 
costs of development of a lower-polluting solvent or surface coating.
    (c) Funding the administrative costs of State programs under this 
Act. Not more than 50 percent of such revenues may be used for this 
purpose. The use of any revenues generated from discretionary EIP's 
shall not be constrained by the provisions of this part.
    3. Part 51 is amended by adding a new appendix X to read as 
follows:

Appendix X to Part 51--Examples of Economic Incentive Programs

I. Introduction and Purpose

    This appendix contains examples of EIP's which are covered by 
the EIP rules. Program descriptions identify key provisions which 
distinguish the different model program types. The examples provide 
additional information and guidance on various types of regulatory 
programs collectively referred to as EIP's. The examples include 
programs involving stationary, area, and mobile sources. The 
definition section at 40 CFR 51.491 defines an EIP as a program 
which may include State established emission fees or a system of 
marketable permits, or a system of State fees on sale or manufacture 
of products the use of which contributes to O3 formation, or 
any combination of the foregoing or other similar measures, as well 
as incentives and requirements to reduce vehicle emissions and 
vehicle miles traveled in the area, including any of the 
transportation control measures identified in section 108(f). Such 
programs span a wide spectrum of program designs.
    The EIP's are comprised of several elements that, in combination 
with each other, must insure that the fundamental principles of any 
regulatory program (including accountability, enforceability and 
noninterference with other requirements of the Act) are met. There 
are many possible combinations of program elements that would be 
acceptable. Also, it is important to emphasize that the 
effectiveness of an EIP is dependent upon the particular area in 
which it is implemented. No two areas face the same air quality 
circumstances and, therefore, effective strategies and programs will 
differ among areas.
    Because of these considerations, the EPA is not specifying one 
particular design or type of strategy as acceptable for any given 
EIP. Such specific guidance would potentially discourage States (or 
other entities with delegated authority to administer parts of an 
implementation plan) from utilizing other equally viable program 
designs that may be more appropriate for their situation. Thus, the 
examples given in this Appendix are general in nature so as to avoid 
limiting innovation on the part of the States in developing programs 
tailored to individual State needs.
    Another important consideration in designing effective EIP's is 
the extent to which different strategies, or programs targeted at 
different types of sources, can complement one another when 
implemented together as an EIP ``package.'' The EPA encourages 
States to consider packaging different measures together when such a 
strategy is likely to increase the overall benefits from the program 
as a whole. Furthermore, some activities, such as information 
distribution or public awareness programs, while not EIP's in and of 
themselves, are often critical to the success of other measures and, 
therefore, would be appropriate complementary components of a 
program package. All SIP emissions reductions credits should reflect 
a consideration of the effectiveness of the entire package.

II. Examples of Stationary and Mobile Source Economic Incentive 
Strategies

    There is a wide variety of programs that fall under the general 
heading of EIP's. Further, within each general type of program are 
several different basic program designs. This section describes 
common types of EIP's that have been implemented, designed, or 
discussed in the literature for stationary and mobile sources. The 
program types discussed below do not include all of the possible 
types of EIP's. Innovative approaches incorporating new ideas in 
existing programs, different combinations of existing program 
elements, or wholly new incentive systems provide additional 
opportunities for States to find ways to meet environmental goals at 
lower total cost.

A. Emissions Trading Markets

    One prominent class of EIP's is based upon the creation of a 
market in which trading of source-specific emissions requirements 
may occur. Such programs may include traditional rate-based 
emissions limits (generally referred to as emissions averaging) or 
overall limits on a source's total mass emissions per unit of time 
(generally referred to as an emissions cap). The emissions limits, 
which may be placed on individual emitting units or on facilities as 
a whole, may decline over time. The common feature of such programs 
is that sources have an ongoing incentive to reduce pollution and 
increased flexibility in meeting their regulatory requirements. A 
source may meet its own requirements either by directly preventing 
or controlling emissions or by trading or averaging with another 
source. Trading or averaging may occur within the same facility, 
within the same firm, or between different firms. Sources with lower 
cost abatement alternatives may provide the necessary emissions 
reductions to sources facing more expensive alternatives. These 
programs can lower the overall cost of meeting a given total level 
of abatement. All sources eligible to trade in an emissions market 
are faced with continuing incentives to find better ways of reducing 
emissions at the lowest possible cost, even if they are already 
meeting their own emissions requirements.
    Stationary, area, and mobile sources could be allowed to 
participate in a common emissions trading market. Programs involving 
emissions trading markets are particularly effective at reducing 
overall costs when individual affected sources face significantly 
different emissions control costs. A wider range in control costs 
among affected sources creates greater opportunities for cost-
reducing trades. Thus, for example, areas which face relatively high 
stationary source control costs relative to mobile source control 
costs benefit most by including both stationary and mobile sources 
in a single emissions trading market.
    Programs involving emissions trading markets have generally been 
designated as either emission allowance or emission reduction credit 
(ERC) trading programs. The Federal Acid Rain Program is an example 
of an emission allowance trading program, while ``bubbles'' and 
``generic bubbles'' created under the EPA's 1986 Emission Trading 
Policy Statement are examples of ERC trading. Allowance trading 
programs can establish emission allocations to be effective at the 
start of a program, at some specific time in the future, or at 
varying levels over time. An ERC trading program requires ERC's to 
be measured against a pre-established emission baseline. Allowance 
allocations or emission baselines can be established either directly 
by the EIP rules or by reference to traditional regulations (e.g., 
RACT requirements). In either type of program, sources can either 
meet their EIP requirements by maintaining their own emissions 
within the limits established by the program, or by buying surplus 
allowances or ERC's from other sources. In any case, the State will 
need to establish adequate enforceable procedures for certifying and 
tracking trades, and for monitoring and enforcing compliance with 
the EIP.
    The definition of the commodity to be traded and the design of 
the administrative procedures the buyer and seller must follow to 
complete a trade are obvious elements that must be carefully 
selected to help ensure a successful trading market that achieves 
the desired environmental goal at the lowest cost. An emissions 
market is defined as efficient if it achieves the environmental goal 
at the lowest possible total cost. Any feature of a program that 
unnecessarily increases the total cost without helping achieve the 
environmental goals causes market inefficiency. Thus, the design of 
an emission trading program should be evaluated not only in terms of 
the likelihood that the program design will ensure that the 
environmental goals of the program will be met, but also in terms of 
the costs that the design imposes upon market transactions and the 
impact of those costs on market efficiency.
    Transaction costs are the investment in time and resources to 
acquire information about the price and availability of allowances 
or ERC's, to negotiate a trade, and to assure the trade is properly 
recorded and legally enforceable. All trading markets impose some 
level of transaction costs. The level of transaction costs in an 
emissions trading market are affected by various aspects of the 
design of the market, such as the nature of the procedures for 
reviewing, approving, and recording trades, the timing of such 
procedures (i.e., before or after the trade is made), uncertainties 
in the value of the allowance or credit being traded, the legitimacy 
of the allowance or credit being offered for sale, and the long-term 
integrity of the market itself. Emissions trading programs in which 
every transaction is different, such as programs requiring 
significant consideration of the differences in the chemical 
properties or geographic location of the emissions, can result in 
higher transaction costs than programs with a standardized trading 
commodity and well-defined rules for acceptable trades. Transaction 
costs are also affected by the relative ease with which information 
can be obtained about the availability and price of allowances or 
credits.
    While the market considerations discussed above are clearly 
important in designing an efficient market to minimize the 
transaction costs of such a program, other considerations, such as 
regulatory certainty, enforcement issues, and public acceptance, 
also clearly need to be factored into the design of any emissions 
trading program.

B. Fee Programs

    A fee on each unit of emissions is a strategy that can provide a 
direct incentive for sources to reduce emissions. Ideally, fees 
should be set so as to result in emissions being reduced to the 
socially optimal level considering the costs of control and the 
benefits of the emissions reductions. In order to motivate a change 
in emissions, the fees must be high enough that sources will 
actively seek to reduce emissions. It is important to note that not 
all emission fee programs are designed to motivate sources to lower 
emissions. Fee programs using small fees are designed primarily to 
generate revenue, often to cover some of the administrative costs of 
a regulatory program.
    There can be significant variations in emission fee programs. 
For example, potential emissions could be targeted by placing a fee 
on an input (e.g., a fee on the quantity and BTU content of fuel 
used in an industrial boiler) rather than on actual emissions. 
Sources paying a fee on potential emissions could be eligible for a 
fee waiver or rebate by demonstrating that potential emissions are 
not actually emitted, such as through a carbon absorber system on a 
coating operation.
    Some fee program variations are designed to mitigate the 
potentially large amount of revenue that a fee program could 
generate. Although more complex than a simple fee program, programs 
that reduce or eliminate the total revenues may be more readily 
adopted in a SIP than a simple emission fee. Some programs lower the 
amount of total revenues generated by waiving the fee on some 
emissions. These programs reduce the total amount of revenue 
generated, while providing an incentive to decrease emissions. 
Alternatively, a program may impose higher per-unit fees on a 
portion of the emissions stream, providing a more powerful but 
targeted incentive at the same revenue levels. For example, fees 
could be collected on all emissions in excess of some fixed level. 
The level could be set as a percentage of a baseline (e.g., fees on 
emissions above some percentage of historical emissions), or as the 
lowest emissions possible (e.g., fees on emissions in excess of the 
lowest demonstrated emissions from the source category).
    Other fee programs are ``revenue neutral,'' meaning that the 
pollution control agency does not receive any net revenues. One way 
to design a revenue-neutral program is to have both a fee provision 
and a rebate provision. Rebates must be carefully designed to avoid 
lessening the incentive provided by the emission fee. For example, a 
rebate based on comparing a source's actual emissions and the 
average emissions for the source category can be designed to be 
revenue neutral and not diminish the incentive.
    Other types of fee programs collect a fee in relation to 
particular activities or types of products to encourage the use of 
alternatives. While these fees are not necessarily directly linked 
to the total amount of emissions from the activity or product, the 
relative simplicity of a usage fee may make such programs an 
effective way to lower emissions. An area source example is a 
construction permit fee for wood stoves. Such a permit fee is 
directly related to the potential to emit inherent in a wood stove, 
and not to the actual emissions from each wood stove in use. Fees on 
raw materials to a manufacturing process can encourage product 
reformulation (e.g., fees on solvent sold to makers of architectural 
coatings) or changes in work practices (e.g., fees on specialty 
solvents and degreasing compounds used in manufacturing).
    Road pricing mechanisms are fee programs that are available to 
curtail low occupancy vehicle use, fund transportation system 
improvements and control measures, spatially and temporally shift 
driving patterns, and attempt to effect land usage changes. Primary 
examples include increased peak period roadway, bridge, or tunnel 
tolls (this could also be accomplished with automated vehicle 
identification systems as well), and toll discounts for pooling 
arrangements and zero-emitting/low-emitting vehicles.

C. Tax Code and Zoning Provisions

    Modifications to existing State or local tax codes, zoning 
provisions, and land use planning can provide effective economic 
incentives. Possible modifications to encourage emissions reductions 
cover a broad span of programs, such as accelerated depreciation of 
capital equipment used for emissions reductions, corporate income 
tax deductions or credits for emission abatement costs, property tax 
waivers based on decreasing emissions, exempting low-emitting 
products from sales tax, and limitations on parking spaces for 
office facilities. Mobile source strategies include waiving or 
lowering any of the following for zero- or low-emitting vehicles: 
vehicle registration fees, vehicle property tax, sales tax, taxicab 
license fees, and parking taxes.

D. Subsidies

    A State may create incentives for reducing emissions by offering 
direct subsidies, grants or low-interest loans to encourage the 
purchase of lower-emitting capital equipment, or a switch to less 
polluting operating practices. Examples of such programs include 
clean vehicle conversions, starting shuttle bus or van pool 
programs, and mass transit fare subsidies. Subsidy programs often 
suffer from a variety of ``free rider'' problems. For instance, 
subsidies for people or firms who were going to switch to the 
cleaner alternative anyway lower the effectiveness of the subsidy 
program, or drive up the cost of achieving a targeted level of 
emissions reductions.

E. Transportation Control Measures

    The following measures are the TCM's listed in section 108(f):
    (i) Programs for improved public transit;
    (ii) Restriction of certain roads or lanes to, or construction 
of such roads or lanes for use by, passenger buses or high occupancy 
vehicles;
    (iii) Employer-based transportation management plans, including 
incentives;
    (iv) Trip-reduction ordinances;
    (v) Traffic flow improvement programs that achieve emission 
reductions;
    (vi) Fringe and transportation corridor parking facilities 
serving multiple-occupancy vehicle programs or transit service;
    (vii) Programs to limit or restrict vehicle use in downtown 
areas or other areas of emission concentration particularly during 
periods of peak use;
    (viii) Programs for the provision of all forms of high-
occupancy, shared-ride services;
    (ix) Programs to limit portions of road surfaces or certain 
sections of the metropolitan area to the use of non-motorized 
vehicles or pedestrian use, both as to time and place;
    (x) Programs for secure bicycle storage facilities and other 
facilities, including bicycle lanes, for the convenience and 
protection of bicyclists, in both public and private areas;
    (xi) Programs to control extended idling of vehicles;
    (xii) Programs to reduce motor vehicle emissions, consistent 
with title II, which are caused by extreme cold start conditions;
    (xiii) Employer-sponsored programs to permit flexible work 
schedules;
    (xiv) Programs and ordinances to facilitate non-automobile 
travel, provision and utilization of mass transit, and to generally 
reduce the need for single-occupant vehicle travel, as part of 
transportation planning and development efforts of a locality, 
including programs and ordinances applicable to new shopping 
centers, special events, and other centers of vehicle activity;
    (xv) Programs for new construction and major reconstruction of 
paths, tracks or areas solely for the use by pedestrian or other 
non-motorized means of transportation when economically feasible and 
in the public interest. For purposes of this clause, the 
Administrator shall also consult with the Secretary of the Interior; 
and
    (xvi) Programs to encourage the voluntary removal from use and 
the marketplace of pre-1980 model year light-duty vehicles and pre-
1980 model light-duty trucks.

[FR Doc. 94-6828 Filed 4-6-94; 8:45 am]
BILLING CODE 6560-50-P