Ozone is a great thing: it keeps us from being fried alive by the more damaging forms of UV radiation. But to fulfil its worthy task it must float in the stratosphere, some 15 to 50 km above our heads. When it hovers at ground level, even at very low concentrations it is highly damaging for people and plants.

Mounting awareness regarding our respiratory bill of rights was accompanied by an increasingly loud outcry against the villainous ground-hugging ozone. Governments finally felt compelled to do something about it.

First, they had to identify the main sources for it. That was easy. Nitrogen oxides, better known as NO_x, are belched by many industries and by fossil-fuelled vehicles, react with volatile organic compounds in the presence of sunlight and presto: ozone. Curtailing NO_x emissions would seem then to be the right way to reduce ground-level ozone, with some beneficial side effects as well: NO_x is also responsible for acid rain, plant-choking of aquatic ecosystems through the addition of excess nitrogen, and the creation of unhealthy microscopic particles. How to curb these emissions, however, has not proved easy. Shutting down industries en masse is out of the question, as is the idea that people would relinquish their SUVs in favour of bicycles.

A better approach was to tax the output of the NO_x-belching plants and have motorists install catalytic converters in their cars. The problem was that the resulting tax revenue was not exactly used to curb emissions or to explore technologies to eliminate or reduce them. Everyone paid their taxes and merrily continued belching along.

What to do? Well, market approaches, with their uncannily effective invisible hand, seem somehow to work on a number of fronts by providing businesses with incentives to reduce emissions in order to save money. Why not try it here as well? And so was the cap-and-trade mechanism born. It consists of setting a cap on the total emissions allowed by a collection of large emitters, and then allowing the belchers to trade their rights to emit in an open market. This has proved to be a relatively inexpensive way to reduce total emissions.

But nothing is perfect. Careful examination of the application of cap-and-trade and its consequences by the late David Bradford and his colleagues Denise L. Mauzerall —an atmospheric chemist and environmental policy analyst—, Babar Sultan and Namsoug Kim, all of Princeton University, revealed a number of flaws. Their findings are contained in a scientifically rigorous and economically sound CESifo Working Paper.

The cap-and-trade NO_x regulation presumes that shifts of emissions over time and space, holding the total fixed over the course of the summer —the surface ozone season— would have minimal effect on the environmental outcome. But the authors show that a shift of a unit of NO_x emissions from one place or time to another could bring about large changes in resulting health effects: population density at that location, weather patterns over the period in question, and local hydrocarbon emissions all play a role.

Using a proven regional atmospheric model for the eastern United States to examine the variation in the amount of ozone produced, the authors found that for the same NO_x emission level, the ozone produced can vary by more than a factor of five, depending on things such as temperature and local biogenic hydrocarbon emissions.

Furthermore, the variation in health damages caused by the resulting ozone depends strongly on the size of the exposed population. The compound effect of variation in ozone production and downwind population can translate into a five-fold difference in resulting mortalities for an identical change in the quantity of NO_x emitted.

Thus, while the cap-and-trade mechanism has been highly successful at reducing total NO_x emissions from large point sources, it has been less successful at minimising the damages that result from the emissions permitted under the cap.

To correct this, the authors propose coupling a regional atmospheric chemistry model that calculates ozone concentrations derived from NO_x emitted from individual point sources with estimates of resulting health damages and their economic cost.

This would enable regulators to set emission fees commensurate with the damage produced, and not merely with the amount of NO_x emitted. Such a system would create an incentive to reduce total damages in an economically efficient manner rather than simply requiring a reduction in total emissions or the attainment of a particular uniform air quality goal regardless of location or resulting damage.

The details of the fee-setting system merit closer examination, though. Considering that such fees would depend on weather and other conditions, would they be set after the fact or in advance, based on expected damages? In either case, a refined chemical weather forecasting model would improve the estimation of appropriate corrective fees to be set, and emitters would have an effective tool to tailor their NO_x output to prevailing conditions.

This approach can be further extended to account for the other deleterious health effects of NO_x emissions, such as those caused by NO_x-derived microscopic particulates, which are formed not only in summer but also in winter. Thus, emitters could be charged for the total damage their emissions cause, prompting them in turn to seek ways to cut back on emissions.

This way, ozone would return to being where it is most beneficial: up in the stratosphere, letting us enjoy air that is not only free of the more damaging UV bands but pure to breathe as well.

• Other CESifo Working Papers dealing with pollution
• Other CESifo Working Papers by David Bradford
• CESifo Working Papers published in the past three months

Note: This text is the responsibility of the writer and does not necessarily reflect the opinion of either the CESifo Working Paper author(s) cited or the CESifo Group Munich.